DEFM14A 1 csi210807_defm14a.htm DEFINITIVE PROXY STATEMENT
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

     

 

SCHEDULE 14A

 

Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934
(Amendment No.    )

     

 

Filed by the Registrant   x   Filed by a Party other than the Registrant   o  

 

Check the appropriate box:

 

o

Preliminary Proxy Statement

   

o

Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))

   

x

Definitive Proxy Statement

   

o

Definitive Additional Materials

   

o

Soliciting Material Pursuant to §240.14a-12

 

Communications Systems, Inc.

(Name of Registrant as Specified In Its Charter)

 

N/A

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

 

Payment of Filing Fee (Check the appropriate box):

 

o

No fee required.

   

o

Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

   

 

(1)

Title of each class of securities to which transaction applies: Not applicable.

 

 

 

 

(2)

Aggregate number of securities to which transaction applies: Not applicable.

 

 

 

 

(3)

Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined): In accordance with Exchange Act Rule 0-11, the filing fee was determined by taking one-fiftieth of one percent of $32,027,566, the maximum aggregate cash that may be received by the registrant in the transaction.

 

 

 

 

(4)

Proposed maximum aggregate value of transaction: $32,027,566

 

 

 

 

(5)

Total fee paid: $6,405.51

 

 

 

x

Fee paid previously with preliminary materials.

   

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Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing.

   

 

(1)

Amount Previously Paid:

 

(2)

Form, Schedule or Registration Statement No.:

 

(3)

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(4)

Date Filed:

 

 

 

 

 

 

COMMUNICATIONS SYSTEMS, INC.
10900 Red Circle Drive
Minnetonka, MN 55343

 


Dear Fellow Shareholder:

 

You are invited to attend a special meeting of shareholders of Communications Systems, Inc. (“CSI,” “Communications Systems,” “we” or “us”), which will be held on Wednesday, July 28, 2021 at 10:00 a.m. CDT. Please see page 9 of the enclosed proxy statement for information on attending the special meeting virtually.

 

We announced the proposed merger involving Communications Systems and Pineapple Energy LLC on March 2, 2021. Consistent with that announcement, we have been devoting our efforts to monetizing CSI’s assets for the benefit of our shareholders by actively pursuing the divestiture of substantially all our current operating and non-operating assets. As a result of these efforts, we announced on April 29, 2021 that Communications Systems entered into a securities purchase agreement with Lantronix, Inc. pursuant to which we have agreed to sell all of the issued and outstanding stock of our wholly owned subsidiary, Transition Networks, Inc., and the entire issued share capital of our wholly owned subsidiary, Transition Networks Europe Limited. These two subsidiaries operate the Transition Networks and Net2Edge Limited businesses that constitute our Electronics & Software ("E&S") Segment, and we refer to the proposed sale of these subsidiaries as the "E&S Sale Transaction."

 

Currently, we expect to distribute to our shareholders a cash dividend of $3.50 per share or approximately $35.0 million from the net proceeds from the E&S Sale Transaction and other available cash resources. We have not determined the exact timing of the cash dividend or set a record date for CSI shareholders entitled to the dividend. Any net proceeds we receive from Lantronix from the earnout in connection with the E&S Sale Transaction will be delivered to CSI shareholders through the contingent value rights (CVRs) to be issued in connection with the Pineapple merger. The E&S Sale Transaction will not alter the rights, privileges or nature of the issued and outstanding shares of our common stock. A shareholder who owns shares of our common stock immediately prior to the closing of the E&S Sale Transaction will continue to hold the same number of shares immediately following the closing. Also, the E&S Sale Transaction will not change the number of CVRs a shareholder of CSI as of immediately prior to the closing of the merger with Pineapple would receive under the agreement governing the CVRs.

 

At the special meeting of shareholders, you will be asked to approve the E&S Sale Transaction. CSI’s board of directors has unanimously approved the E&S Sale Transaction and unanimously recommends that shareholders vote in favor of the proposal to approve the E&S Sale Transaction. The proposal to approve the E&S Sale Transaction requires the approval of the holders of at least two-thirds of our common stock outstanding and entitled to vote.

 

At the special meeting of shareholders, you also will be asked to approve on an advisory, non-binding basis, certain compensation that has, will or may be paid or become payable to our named executive officers in connection with the E&S Sale Transaction. Additionally, if there are insufficient votes in favor of the proposal to approve the E&S Sale Transaction, you will be asked to vote to adjourn or postpone the special meeting of shareholders to solicit additional proxies.

 

The accompanying proxy statement contains important information concerning the E&S Sale Transaction, specific information about the special meeting and how to cast your vote on the proposals. We encourage you to read the accompanying proxy statement in its entirety.

 

Your vote is very important. Whether or not you plan to attend the special meeting of shareholders, please vote by proxy over the internet, by telephone or by mailing the enclosed proxy card or by following the instructions for voting that accompanied your proxy materials.

 

We cannot complete the E&S Sale Transaction without the approval of the holders of two-thirds of the shares that were outstanding on the record date. Accordingly, it is extremely important that you vote your shares. Please vote promptly so that your shares will be represented, to avoid delays in completing the E&S Sale Transaction and to save the company the cost of additional solicitation.

 

 

 

 

 

We look forward to your support at the special meeting.

 

Sincerely,

 

Roger H. D. Lacey
Executive Chairman
Communications Systems, Inc.

 

Neither the Securities and Exchange Commission nor any state securities regulatory agency has approved or disapproved the E&S Sale Transaction, passed upon the merits or fairness of the E&S Sale Transaction or passed upon the adequacy or accuracy of the disclosure in the accompanying proxy statement. Any representation to the contrary is a criminal offense.

 

This proxy statement is dated June 14, 2021 and is first being mailed to shareholders on or about June 15, 2021.

 

 

 

 

 

COMMUNICATIONS SYSTEMS, INC.
10900 Red Circle Drive
Minnetonka, Minnesota 55343

 

NOTICE OF SPECIAL MEETING OF SHAREHOLDERS

 

To be held on Wednesday, July 28, 2021

 

To Shareholders of Communications Systems, Inc.:

 

A special meeting of shareholders of Communications Systems, Inc., a Minnesota corporation, will be held on Wednesday, July 28, 2021 at 10:00 a.m. CDT for the following purposes:

 

1.To approve the sale by Communications Systems, Inc. of all of the issued and outstanding stock of its wholly owned subsidiary, Transition Networks, Inc., and the entire issued share capital of its wholly owned subsidiary, Transition Networks Europe Limited, to Lantronix, Inc. pursuant to the securities purchase agreement dated April 28, 2021. We refer to this transaction as the “E&S Sale Transaction” and this proposal as the “E&S Sale Proposal.”

 

2.To approve, on an advisory, non-binding basis, certain compensation that has, will or may be paid or become payable to the Communications Systems, Inc. named executive officers in connection with the E&S Sale Transaction. We refer to this proposal as the “Advisory Compensation Proposal.”

 

3.To approve the adjournment or postponement of the special meeting to solicit additional proxies if there are insufficient votes at the time of the special meeting to approve the E&S Sale Proposal. We refer to this proposal as the “Adjournment Proposal.”

 

The special meeting will be a virtual meeting of shareholders.

 

You may attend the online meeting and vote your shares electronically during the special meeting via the internet by visiting: www.virtualshareholdermeeting.com/JCS2021SM1. You will need the 16-digit control number that is printed in the box marked by the arrow on your proxy card or on the voting instructions that accompanied your proxy materials. We recommend that you log in at least fifteen minutes before the start of the special meeting to ensure that you are logged in when the special meeting starts.

 

Please note that if you hold shares in the CSI Employee Stock Purchase Plan (ESOP), your voting instructions for these shares must be received by 11:59 p.m. Eastern Daylight Time on July 25, 2021. You may not vote the ESOP shares allocated to you electronically during the special meeting.

 

The CSI board of directors has fixed June 11, 2021, as the record date for the determination of shareholders entitled to notice of, and to vote at, the special meeting and any adjournment or postponement thereof. Only holders of record of shares of our common stock at the close of business on the record date are entitled to notice of, and to vote at, the special meeting. At the close of business on the record date, we had 9,470,425 shares of common stock outstanding and entitled to vote.

 

The CSI board of directors has unanimously approved the E&S Sale Transaction. The CSI board of directors unanimously recommends that you vote “FOR” the E&S Sale Proposal, “FOR” the Advisory Compensation Proposal, and “FOR” the Adjournment Proposal.

 

Your vote is very important. Please vote your shares by proxy as promptly as possible whether or not you plan to attend the special meeting.

 

By Order of the Board of Directors,

 

Roger H. D. Lacey
Executive Chairman
Communications Systems, Inc.
Minnetonka, Minnesota

 

June 14, 2021

 

 

 

 

Table of Contents

 

SUMMARY TERM SHEET 1
Information About the Parties 1
Communications Systems, Inc. 1
Lantronix, Inc. 2
Securities Purchase Agreement 2
Purchase Price 2
Financing 2
Use of Proceeds 2
Reasons for the E&S Sale Transaction 3
Recommendation of Our Board of Directors 3
Opinion of CSI’s Financial Advisor 3
Special Meeting 4
Interests of Certain Persons in the E&S Sale Transaction 5
Conditions to Closing 5
Solicitation of Transactions 6
Change of CSI Board Recommendation 6
Termination 6
When the E&S Sale Transaction is Expected to be Completed 7
Effects on Our Company if the E&S Sale Transaction is Completed 7
Effects on Our Company if the E&S Sale Transaction is Not Completed 7
No Appraisal or Dissenters’ Rights 8
Anticipated Accounting Treatment 8
Material U.S. Federal Income Tax Consequences of the E&S Sale Transaction 8
Risk Factors 8
QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING AND THE E&S SALE TRANSACTION 9
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS 14
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 15
PROPOSAL #1 E&S SALE PROPOSAL 17
Parties to the Securities Purchase Agreement 17
Communications Systems, Inc. 17
Lantronix, Inc. 17
Background of the E&S Sale Transaction 17
Past Contacts, Transactions or Negotiations 24
Reasons for the E&S Sale Transaction and Recommendation of the CSI Board of Directors 24
Opinion of CSI’s Financial Advisor 29
Financial Analyses 32
Miscellaneous 35
Projected Financial Results 36
Financing 38
When the E&S Sale Transaction is Expected to be Completed 38
Effects on Our Company if the E&S Sale Transaction is Completed and the Nature of Our Business Following the Transaction 38
Effects on Our Company if the E&S Sale Transaction is Not Completed 39
No Appraisal or Dissenters’ Rights 39
Interests of Our Directors and Executive Officers in the E&S Sale Transaction 39
Anticipated Accounting Treatment 43
Use of Proceeds 43
Material U.S. Federal Income Tax Consequences of the E&S Sale Transaction 44
Vote Required 44

 

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SECURITIES PURCHASE AGREEMENT 45
General 45
Purchase and Sale of the Securities of the E&S Companies 45
Base Purchase Price and Earnout 46
Financing 46
Conditions to Closing 47
Representations and Warranties 48
Covenants 50
Conduct of the E&S Companies 50
Access to Business 50
Solicitation of Transactions 50
Preparation of the Proxy Statement; Shareholder Meeting 53
Notice of Breaches 54
Efforts to Consummate 54
Financing Cooperation 54
Non-Competition and Non-Solicitation 54
Employee Matters 54
Tax Matters 55
Transaction Litigation 55
Confidentiality 56
Release 56
CSI Stock Awards 56
UK Lease 56
Termination 56
Termination Fee 57
Indemnification 57
Transition Services Agreement 58
PROPOSAL #2 ADVISORY COMPENSATION PROPOSAL 59
PROPOSAL #3 ADJOURNMENT PROPOSAL 60
RISK FACTORS 61
HOUSEHOLDING OF MATERIALS 64
SHAREHOLDER PROPOSALS 64
WHERE YOU CAN FIND MORE INFORMATION 64
FINANCIAL STATEMENTS 65

 

APPENDIX A: Securities Purchase Agreement dated April 28, 2021 by and between Lantronix, Inc., as Purchaser and Communications Systems, Inc., as Seller
APPENDIX B: Opinion of Northland Securities, Inc. dated April 27, 2021
APPENDIX C: Communications Systems, Inc. Unaudited Pro Forma Condensed Consolidated Financial Statements
APPENDIX D: Communications Systems, Inc. Unaudited Condensed Combined Financial Statements for the Electronics & Software Segment
   

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SUMMARY TERM SHEET

 

This summary term sheet, together with the question and answer section that follows, highlights selected information from this proxy statement about the E&S Sale Transaction. This summary term sheet and the question and answer section may not contain all of the information that is important to you. For a more complete description of the E&S Sale Transaction, you should carefully read this proxy statement and its appendices, in their entirety. Each item in this summary includes a page reference directing you to a more complete description of that topic. Also see “WHERE YOU CAN FIND MORE INFORMATION” on page 64.

 

All references in this proxy statement to:

 

“CSI,” “Communications Systems,” the “Company,” “we,” “us,” or “our” refer to Communications Systems, Inc.,

 

“Lantronix” refers to Lantronix, Inc. in its capacity as Purchaser under the securities purchase agreement,

 

the “securities purchase agreement” refers to the Securities Purchase Agreement dated April 28, 2021 by and between Lantronix, Inc., as Purchaser and Communications Systems, Inc., as Seller, a copy of which is attached as Appendix A, and

 

the “E&S Sale Transaction” refers to the sale by Communications Systems to Lantronix of all of the issued and outstanding stock of CSI’s wholly owned subsidiary, Transition Networks, Inc., and the entire issued share capital of CSI’s wholly owned subsidiary, Transition Networks Europe Limited.

 

Information About the Parties (page 17)

 

Communications Systems, Inc.

 

Communications Systems, Inc. is a Minnesota corporation that was organized in 1969. CSI classifies its businesses into the following two segments:

 

Electronics & Software (E&S): designs, develops and sells Intelligent Edge solutions that provide connectivity and power through Power over Ethernet (“PoE”) products and actionable intelligence to end devices in an Internet of Things (“IoT”) ecosystem through embedded and cloud-based management software. In addition, this segment 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; and

 

Services & Support (S&S): provides SD-WAN and other technology solutions that address prevalent IT challenges, including network resiliency, security products and services, network virtualization, and cloud migrations, IT managed services, wired and wireless network design and implementation, and converged infrastructure configuration, deployment and management.

 

On March 2, 2021, CSI announced that it had entered into a definitive merger agreement with privately held Pineapple Energy LLC (“Pineapple”), a growing U.S. operator and consolidator of residential solar, battery storage, and grid services solutions. A meeting of the Company's shareholders to approve the merger agreement with Pineapple is expected to be held later in 2021. If the merger is approved by our shareholders, upon closing, CSI will commence doing business as Pineapple Energy, with a business model focused on the rapidly growing home solar industry.

 

At the time the merger with Pineapple was announced, CSI stated its intention to divest substantially all its current operating and non-operating assets, including its E&S Segment business, its S&S Segment business, real estate holdings, and cash, cash equivalents, and investments. The E&S Sale Transaction is part of CSI’s planned strategy to monetize its assets for the benefit of the pre-merger CSI shareholders as contemplated by the Pineapple merger transaction.

 

Our mailing address is 10900 Red Circle Drive, Minnetonka, MN 55343, and the telephone number at that location is (952) 996-1674. Our principal website is www.commsystems.com.

 

 

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Lantronix, Inc.

 

Lantronix, Inc. (Nasdaq: LTRX) is a global provider of software as a service (“SaaS”), engineering services, and hardware for Edge Computing, the Internet of Things (“IoT”), and Remote Environment Management (“REM”). Lantronix enables its customers to provide reliable and secure solutions while accelerating their time to market. Lantronix’s products and services dramatically simplify operations through the creation, development, deployment, and management of customer projects at scale while providing quality, reliability and security.

 

The mailing address for Lantronix is 7535 Irvine Center Drive, Suite 100, Irvine, California 92618 and the telephone number at that location is (949) 453-3990. The principal website for Lantronix is www.lantronix.com.

 

Securities Purchase Agreement (page 45 and Appendix A)

 

On April 28, 2021, we entered into a securities purchase agreement with Lantronix, pursuant to which we have agreed, subject to specified terms and conditions, including approval of the E&S Sale Transaction by our shareholders at the special meeting, to sell to Lantronix all of the issued and outstanding stock of our wholly owned subsidiary, Transition Networks, Inc., and the entire issued share capital of our wholly owned subsidiary, Transition Networks Europe Limited.

 

In this proxy statement, we sometimes refer to Transition Networks, Inc. as “TNI,” to Transition Networks Europe Limited as “TN Europe” and to both of the companies collectively as the “E&S Companies.”

 

The TNI stock and the TN Europe ordinary shares we have agreed to sell to Lantronix are sometimes referred to as the “purchased securities.”

 

The E&S Segment is comprised of the Transition Networks and Net2Edge businesses conducted by TNI and TN Europe. For the purposes of this proxy statement, we refer to these businesses as the “E&S Segment business.”

 

A copy of the securities purchase agreement is attached as Appendix A to this proxy statement. We encourage you to read the securities purchase agreement in its entirety.

 

Purchase Price (page 46)

 

The base purchase price for the purchased securities will be approximately $25.0 million. At the closing of the E&S Sale Transaction, Lantronix will pay us the base purchase price in cash.

 

Following the closing date, the base purchase price will be recalculated based upon final determinations of net working capital as compared to target working capital, with any positive or negative difference paid by Lantronix to us or us to Lantronix, as the case may be, in cash.

 

In addition to the base purchase price, Lantronix will pay us, if earned, earnout payments of up to $7.0 million, payable following two successive 180-day intervals after the closing of the E&S Sale Transaction based on revenue targets for the business of the E&S Companies as specified in the securities purchase agreement, subject to certain adjustments and allocations as further described in the securities purchase agreement.

 

Financing (page 46)

 

Lantronix estimates that approximately $26.0 million will be required to complete the E&S Sale Transaction. It is anticipated that Lantronix will fund these amounts with bank financing in accordance with the commitment letters dated April 28, 2021 issued to Lantronix from Silicon Valley Bank and from SVB Innovation Credit Fund VIII, L.P., and cash on hand of Lantronix. The securities purchase agreement provides that in no event will the receipt by, or the availability of any funds or financing to, Lantronix or any other financing be a condition to the obligation of Lantronix to consummate the E&S Sale Transaction.

 

Use of Proceeds (page 44)

 

Our company, and not our shareholders, will receive the proceeds from the E&S Sale Transaction.

 

 

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As we have previously communicated in connection with the proposed Pineapple merger, CSI expects the net sale proceeds from any pre-merger divestitures, such as the E&S Sale Transaction, to be distributed in the form of a cash dividend to existing CSI shareholders prior to the effective date of the proposed merger with Pineapple. Currently, we expect to distribute to our shareholders a cash dividend of $3.50 per share or approximately $35.0 million from the net proceeds from the E&S Sale Transaction and other available cash resources. We have not determined the exact timing of the cash dividend or set a record date for CSI shareholders entitled to the dividend.

 

Any net proceeds we receive from Lantronix from the earnout in connection with the E&S Sale Transaction will be delivered to CSI shareholders through the contingent value rights (CVRs) to be issued in connection with the Pineapple merger. The record date for CSI shareholders entitled to the CVRs will be set as of immediately prior to the closing of the merger with Pineapple under the agreement governing the CVRs. We expect the closing of the proposed merger with Pineapple will occur following receipt of CSI shareholder approval of the merger at a shareholder meeting to be held later in 2021.

 

Reasons for the E&S Sale Transaction (page 24)

 

After taking into account all of the material factors relating to the securities purchase agreement and the E&S Sale Transaction, the CSI board of directors concluded that the benefits of the securities purchase agreement and the E&S Sale Transaction outweigh the risks, and that the securities purchase agreement and the E&S Sale Transaction are advisable and in the best interests of our company and our shareholders. The CSI board of directors did not assign relative weights to the material factors it considered. In addition, the CSI board of directors did not reach any specific conclusion on each of the material factors considered, but conducted an overall analysis of all of the material factors. Individual members of the CSI board of directors may have given different weights to different factors.

 

Recommendation of the CSI Board of Directors (page 24)

 

After careful consideration, the CSI board of directors unanimously recommends that you vote:

 

“FOR” the E&S Sale Proposal;

 

“FOR” the Advisory Compensation Proposal; and

 

“FOR” the Adjournment Proposal.

 

Opinion of CSI’s Financial Advisor (page 29 and Appendix B)

 

CSI has engaged Northland Securities, Inc., referred to as “Northland,” as financial advisor to CSI in connection with the proposed E&S Sale Transaction. In connection with this engagement, Northland delivered a written opinion, dated April 27, 2021, to the CSI board of directors as to the fairness, from a financial point of view and as of the date of the opinion, to CSI of the aggregate purchase price of $32,027,566, such amount referred to as the “Aggregate Purchase Price,” to be paid to CSI for the E&S Segment business pursuant to the securities purchase agreement. The full text of Northland’s written opinion, dated April 27, 2021, which describes the assumptions made, procedures followed, matters considered, limitations on the review undertaken and qualifications, is attached as Appendix B to this proxy statement and is incorporated herein by reference. The description of Northland’s opinion set forth herein is qualified in its entirety by reference to the full text of Northland’s opinion. Northland’s opinion was directed to the CSI board of directors (in its capacity as such) in connection with its evaluation of the Aggregate Purchase Price from a financial point of view to CSI and did not address any other terms, aspects or implications of the E&S Sale Transaction. Northland was not requested to opine as to, and its opinion did not address, the basic business decision of CSI to proceed with or effect the E&S Sale Transaction. Northland expressed no opinion or view as to the relative merits of the E&S Sale Transaction as compared to any alternative business strategies or transactions that might exist for the E&S Segment business or CSI or the effect of any other transaction in which CSI or TNI and TN Europe might engage. Northland’s opinion is not intended to be and does not constitute a recommendation to the CSI board of directors or to any shareholder as to how to act or vote with respect to the E&S Sale Transaction or any other matter.

 

 

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Special Meeting (page 9)

 

Date, Time and Place. The special meeting will be held on Wednesday, July 28, 2021 at 10:00 a.m. Central Daylight Time (CDT). The special meeting will be a virtual meeting of shareholders.

 

You may attend the online meeting and vote your shares electronically during the special meeting via the internet by visiting: www.virtualshareholdermeeting.com/JCS2021SM1. You will need the 16-digit control number that is printed in the box marked by the arrow on your proxy card or on the voting instructions that accompanied your proxy materials. We recommend that you log in at least fifteen minutes before the start of the special meeting to ensure that you are logged in when the special meeting starts.

 

Record Date and Voting Power. You are entitled to vote at the special meeting if you owned shares of our common stock at the close of business on June 11, 2021, the record date for the special meeting. You will have one vote at the special meeting for each share of our common stock you held at the close of business on the record date. There are 9,470,425 shares of our common stock entitled to be voted at the special meeting.

 

Required Vote. You may vote “FOR,” “AGAINST” or “ABSTAIN” on each of the E&S Sale Proposal, the Advisory Compensation Proposal and the Adjournment Proposal.

 

The approval of the E&S Sale Proposal requires the affirmative vote of holders of at least two-thirds of the issued and outstanding shares of CSI common stock that are entitled to vote on this proposal. If you vote ABSTAIN on the E&S Sale Proposal, it will have the same effect as a vote against the E&S Sale Proposal. Except with respect to shares allocated to you as a participant in the CSI Employee Stock Ownership Plan and Trust (ESOP), if you fail to vote, it will have the same effect as a vote against the E&S Sale Proposal.

 

The approval, on an advisory, non-binding basis, of the Advisory Compensation Proposal requires the affirmative vote of holders of at least a majority of the shares of CSI common stock present at the special meeting and entitled to vote on this proposal. If you vote ABSTAIN on the Advisory Compensation Proposal, it will have the same effect as a vote against the Advisory Compensation Proposal. Except with respect to shares allocated to you as a participant in the CSI ESOP, if you fail to vote, it will have no effect on the outcome of the Advisory Compensation Proposal.

 

If a quorum is present at the special meeting, the Adjournment Proposal will be approved by the affirmative vote of holders of at least a majority of the shares of CSI common stock present at the special meeting and entitled to vote on this proposal. If a quorum is not present at the special meeting, the Adjournment Proposal will be approved by the affirmative vote of the holders of a majority of the voting power of our common stock present at the special meeting and no other business will be transacted thereat. Except with respect to shares allocated to you as a participant in the CSI ESOP, if you fail to vote, it will have no effect on the outcome of the vote on the Adjournment Proposal. If you vote ABSTAIN, it will have no effect on the outcome of the vote on the Adjournment Proposal if it is submitted for shareholder approval when a quorum is present at the meeting. If you vote ABSTAIN, it would have the same effect as a vote against the Adjournment Proposal if it is submitted for approval when a quorum is not present at the special meeting.

 

If you are a participant in the CSI ESOP and do not vote the CSI shares allocated to you in the CSI ESOP, your shares will be voted at the special meeting according to the provisions of the CSI ESOP, which provide that the trustees will vote these shares on each proposal in the same proportion as all shares of CSI common stock allocated to ESOP participants for which voting instructions were received were voted on that proposal.

 

Voting. Prior to the start of the special meeting, you may vote your shares of CSI common stock by internet, telephone or signing and returning the enclosed proxy or other voting instruction form. During the special meeting, you may vote by internet if you are logged into www.virtualshareholdermeeting.com/JCS2021SM1 with the 16-digit control number that is printed in the box marked by the arrow on your proxy card or on the voting instructions that accompanied your proxy materials.

 

Please note that if you hold shares in the CSI Employee Stock Purchase Plan (ESOP), your voting instructions for these shares must be received by 11:59 p.m. Eastern Daylight Time on July 25, 2021. You may not vote the ESOP shares allocated to you electronically during the special meeting.

 

Whether you are a record holder or street name holder, if you vote your shares, your shares will be voted as you have directed. If you just execute and submit your proxy or voting instruction form without providing voting instructions, your shares will be voted FOR each of the E&S Sale Proposal, the Advisory Compensation Proposal or the Adjournment Proposal.

 

 

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If you are a participant in the CSI ESOP, the CSI common stock allocated to you on the record date, plus all shares of common stock held by you as a record holder, will appear together on a single proxy voting form. If you do not return an executed proxy or vote online at the special meeting on any proposals, the CSI common stock allocated to you in the CSI ESOP on the record date will be voted according to the provisions of the CSI ESOP, which provide that the trustees will vote these shares on each proposal in the same proportion as all shares of CSI common stock allocated to ESOP participants for which voting instructions were received were voted on such proposal. If you do not return an executed proxy or vote online at the special meeting, the CSI common stock you otherwise hold of record will not be voted at the special meeting.

 

Quorum. The presence at the special meeting of at least a majority of the issued and outstanding shares of CSI’s common stock entitled to vote at the special meeting is necessary to constitute a quorum for transacting business at the special meeting. A shareholder is counted as present at the special meeting if the shareholder attends the online special meeting or the shareholder has properly submitted a proxy by internet, telephone or signing and returning the enclosed proxy or other voting instruction form.

 

Proxy Solicitation. We have engaged The Proxy Advisory Group, LLC (“PAG”) to assist in the solicitation of proxies and provide related advice and information support, for a services fee and the reimbursement of customary disbursements, which are not expected to exceed $40,000 in total. CSI will be solely responsible for the costs of the solicitation. Additionally, certain of CSI’s directors, officers and regular employees may, without additional compensation, solicit proxies personally or by telephone, letter, facsimile or email. These directors, officers and employees will not be paid additional remuneration for their efforts but may be reimbursed for out-of-pocket expenses incurred in connection therewith. We will request brokers, custodians, nominees and other record holders to forward copies of the proxy statement and related soliciting materials to persons for whom they hold shares of our common stock and to request authority for the exercise of proxies. In such cases, upon the request of the record holders, we will reimburse such holders for their reasonable out-of-pocket expenses.

 

Interests of Certain Persons in the E&S Sale Transaction (page 39)

 

In considering the recommendation of the CSI board of directors that you vote for the E&S Sale Proposal, you should be aware that certain of our directors and executive officers may have interests in the E&S Sale Proposal that are different from, or in addition to, your interests as a shareholder.

 

Members of the CSI board of directors were aware of and considered these interests, among other matters, in evaluating and negotiating the E&S Sale Transaction, and in recommending to our shareholders that the E&S Sale Proposal be approved. For more information, see the sections entitled “Proposal #1: E&S Sale Proposal—Background of the E&S Sale Transaction” and “Proposal #1: E&S Sale Proposal —Reasons for the E&S Sale Transaction and Recommendation of the CSI Board of Directors.”

 

Conditions to Closing (page 47)

 

The obligation of Lantronix to complete the E&S Sale Transaction is subject to the satisfaction or, to the extent permissible under applicable law or pursuant to the securities purchase agreement, waiver of certain conditions on or prior to the closing. Such conditions include, among others and in addition to customary closing conditions:

 

approval by CSI’s shareholders of the E&S Sale Proposal;

 

delivery of evidence transferring all of the outstanding ownership interests in the acquired subsidiaries to Lantronix;

 

the specified third party consents and approvals will have been obtained; and

 

execution and delivery of the transition services agreement between Lantronix and us.

 

 

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The obligation of CSI to complete the E&S Sale Transaction is subject to the satisfaction or, to the extent permissible under applicable law or pursuant to the securities purchase agreement, waiver of certain conditions on or prior to the closing. Such conditions include, among others and in addition to customary closing conditions:

 

approval by CSI’s shareholders of the E&S Sale Proposal; and

 

Lantronix will have executed and delivered the transition services agreement.

 

Solicitation of Transactions (page 50)

 

The securities purchase agreement prohibits us from soliciting, encouraging or facilitating any offers or proposals for the acquisition of the E&S Segment business and certain other acquisition proposals by a buyer other than Lantronix. However, the securities purchase agreement does not prohibit us from considering and pursuing certain unsolicited acquisition proposals from a buyer other than Lantronix that the CSI board of directors determines in good faith constitutes a superior proposal, subject to certain requirements and conditions.

 

Change of CSI Board Recommendation (page 50)

 

The CSI board of directors unanimously recommends that you vote for the E&S Sale Proposal.

 

The CSI board of directors may withdraw or change its recommendation for approval of the E&S Sale Proposal at any time prior to obtaining the required shareholder vote, if the CSI board of directors or any committee of the CSI board determines in good faith, after consultation with outside counsel, that the failure to do so would be inconsistent with its fiduciary duties under applicable law, which would include, without limitation, the pursuit of an unsolicited acquisition proposal that constitutes a superior proposal. Our board will not be entitled to exercise its right to make a change in its recommendation unless we and our representatives have complied with the non-solicitation, notice and information, negotiation and other provisions of the securities purchase agreement.

 

Lantronix (at any time prior to CSI obtaining the required shareholder vote) may terminate the securities purchase agreement if the CSI board of directors approves, endorses or recommends any superior proposal. We may also terminate the securities purchase agreement, at any time prior to obtaining the required shareholder vote, in order to enter into a definitive agreement to effect a transaction contemplated by a superior proposal, subject to certain conditions.

 

Termination (page 56)

 

Subject to certain exceptions, the securities purchase agreement may be terminated prior to the closing in certain circumstances, including:

 

by Lantronix or by CSI if the closing does not occur on or before August 31, 2021;

 

by Lantronix or by CSI if there has been a court or other governmental action permanently restraining, enjoining or otherwise prohibiting the E&S Sale Transaction;

 

by Lantronix or by CSI if a meeting of our shareholders to approve the E&S Sale Transaction has been held and the requisite vote of the CSI shareholders in favor of the E&S Sale Proposal was not obtained;

 

by Lantronix, at any time prior to the receipt of shareholder approval of the E&S Sale Transaction, if a seller board recommendation change has occurred or we breached the no-solicitation provisions of the securities purchase agreement in any material respect, in which case, we must pay Lantronix the $875,000 termination fee;

 

by either Lantronix or CSI, if there has been an uncured material breach of or material failure to perform any representation, warranty, covenant or agreement set forth in the securities purchase agreement on the part of the other party, which breach would cause the corresponding closing conditions not to be satisfied;

 

 

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by CSI if, at any time prior to the receipt of the shareholder approval of the E&S Sale Proposal, each of the following occur: (a) we receive a superior proposal and we did not breach the no-solicitation provisions, including with respect to making a seller board recommendation change with respect to such superior proposal; (b) the CSI board of directors approves, and we concurrently with the termination of the securities purchase agreement enter into, a definitive agreement with respect to such superior proposal; and (c) we pay Lantronix the $875,000 termination fee.

 

The termination of the securities purchase agreement generally relieves the parties from their obligations, except that certain obligations will survive any termination including, among others, obligations relating to confidentiality and termination fees.

 

When the E&S Sale Transaction is Expected to be Completed (page 38)

 

We expect to complete the E&S Sale Transaction promptly after satisfaction or waiver of all of the closing conditions in the securities purchase agreement, including approval of the E&S Sale Proposal by our shareholders. Subject to the satisfaction or waiver of these conditions, we expect the E&S Sale Transaction to close by August 31, 2021. However, there can be no assurance that the E&S Sale Transaction will be completed at all or, if completed, when it will be completed.

 

Effects on Our Company if the E&S Sale Transaction is Completed (page 38)

 

If the E&S Sale Transaction is completed, we will no longer conduct the E&S Segment business. Prior to and after the closing of the E&S Sale Transaction, we expect to continue our efforts to divest substantially all our current operating and non-operating assets as part of our planned strategy to monetize our assets for the benefit of the CSI shareholders existing prior to the effective date of the proposed merger with Pineapple. Prior to and after the closing of the E&S Sale Transaction, we also plan on continuing to pursue the proposed merger with Pineapple. There can be no assurance that the proposed merger with Pineapple will be completed or completed within any specific timeframe. The E&S Sale Transaction is not conditioned upon the Pineapple merger in any way.

 

The E&S Sale Transaction will not alter the rights, privileges or nature of the issued and outstanding shares of our common stock. A shareholder who owns shares of our common stock immediately prior to the closing of the E&S Sale Transaction will continue to hold the same number of shares immediately following the closing.

 

A meeting of the Company's shareholders to approve the merger agreement with Pineapple is expected to be held later in 2021. If the merger is approved by our shareholders, shareholders of CSI as of immediately prior to the closing of the merger with Pineapple will receive one non-transferable contingent value right (CVR) for each outstanding share of common stock of CSI held as of the close of business on the day immediately before the effective time (as defined in the agreement governing the CVRs). The E&S Sale Transaction will not change the number of CVRs a shareholder of CSI as of immediately prior to the closing of the merger with Pineapple would receive under the agreement governing the CVRs.

 

Our SEC reporting obligations as a public company will not be affected as a result of completing the E&S Sale Transaction. We believe that immediately after the E&S Sale Transaction we will continue to qualify for listing on the Nasdaq Global Market.

 

Effects on Our Company if the E&S Sale Transaction is Not Completed (page 39)

 

If the E&S Sale Transaction is not completed, we will continue our efforts to divest substantially all our current operating and non-operating assets, and we may consider and evaluate other strategic opportunities for the E&S Segment business. In such a circumstance, there can be no assurances that our continued operation of the E&S Segment business or any alternative strategic opportunities will result in the same or greater value to our shareholders as the proposed E&S Sale Transaction.

 

The securities purchase agreement may be terminated under certain circumstances as set forth in the securities purchase agreement and summarized in this proxy statement. We have agreed to pay Lantronix a termination fee of $875,000 if the securities purchase agreement is terminated under certain circumstances.

 

 

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No Appraisal or Dissenters’ Rights (page 39)

 

No appraisal or dissenters’ rights are available to our shareholders under Minnesota law or our articles of incorporation or bylaws in connection with the E&S Sale Proposal or the Adjournment Proposal.

 

Anticipated Accounting Treatment (page 43)

 

Under generally accepted accounting principles in the United States of America, commencing with the quarter during which our shareholders approve the E&S Sale Proposal, we expect to reflect the results of operations of the E&S Segment business as discontinued operations.  The related anticipated gain on the sale, net of any applicable taxes, will also be reported within discontinued operations upon completion of the E&S Sale Transaction. For further information, see “UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS” attached to this proxy statement as Appendix C.

 

Material U.S. Federal Income Tax Consequences of the E&S Sale Transaction (page 44)

 

The E&S Sale Transaction will not be a taxable event for U.S. federal income tax purposes to our shareholders.

 

The E&S Sale Transaction will be treated for U.S. federal income tax purposes as a taxable transaction for which Communications Systems will recognize gain or loss. The amount of gain or loss we recognize with respect to the sale of the stock of TNI and the sale of the ordinary shares of TN Europe will be measured by the difference between the amount realized by us on the sale of that particular equity interest and our tax basis in that equity interest. The determination of whether we recognize gain or loss will be made separately with respect to our equity interests in each of TNI and TN Europe. To the extent the E&S Sale Transaction results in us recognizing a net gain for U.S. federal income tax purposes, we expect that our available net operating loss carryforwards will offset all or a substantial part of such gain.

 

Risk Factors (page 61)

 

In evaluating the E&S Sale Proposal, in addition to the other information contained in this proxy statement, you should carefully consider the special risks relating to the E&S Sale Transaction under “RISK FACTORS” beginning on page 61.

 

 

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QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING AND THE E&S SALE TRANSACTION

 

Q: Why am I receiving this proxy statement?

 

A: The CSI board of directors is furnishing this proxy statement in connection with the solicitation of proxies to be voted at the special meeting of shareholders, or at any adjournments or postponements of the special meeting.

 

Q: When and where will the special meeting be held?

 

A: The special meeting will be held on Wednesday, July 28, 2021, at 10:00 a.m. Central Daylight Time (CDT). The special meeting will be a virtual meeting of shareholders. You may attend the online meeting and vote your shares electronically during the special meeting via the internet by visiting: www.virtualshareholdermeeting.com/JCS2021SM1.

 

Q: How can I attend and vote my shares at the virtual special meeting?

 

A: The special meeting will be online and a completely virtual meeting of shareholders due to the ongoing public health impact of the coronavirus (COVID-19) pandemic. This decision was made in light of the protocols that federal, state, and local governments have imposed or may impose in the near future and taking into account the health and safety of our shareholders, directors and members of management, as well as our desire to allow shareholders to participate in the special meeting wherever they may be located.

 

All shareholders are cordially invited to attend the special meeting. Whether or not you plan to attend the special meeting, please vote your shares by internet, telephone or signing and returning the enclosed proxy or other voting instruction form.

 

Please note that if you hold shares in the CSI Employee Stock Purchase Plan (ESOP), your voting instructions for these shares must be received by 11:59 p.m. Eastern Daylight Time on July 25, 2021. You may not vote the ESOP shares allocated to you electronically during the special meeting.

To participate in the special meeting, you will need the 16-digit control number included on your proxy card or on the voting instructions that accompanied your proxy materials. Please have your 16-digit control number readily available and log on to the special meeting by visiting www.virtualshareholdermeeting.com/JCS2021SM1 and entering your 16-digit control number. You may begin to log into the meeting platform beginning at 9:30 a.m. CDT on July 28, 2021. The special meeting will begin promptly at 10:00 a.m. CDT on July 28, 2021.

 

The internet address to attend and vote at the special meeting is
www.virtualshareholdermeeting.com/JCS2021SM1. 

 

The virtual meeting platform is fully supported across browsers (Internet Explorer, Firefox, Chrome, and Safari) and devices (desktops, laptops, tablets, and cell phones) running the most updated version of applicable software and plugins. Participants should ensure that they have a strong internet connection wherever they intend to participate in the special meeting. Participants should also give themselves plenty of time to log in and ensure that they can hear streaming audio prior to the start of the special meeting. We recommend that you log in at least fifteen minutes before the special meeting.

 

Q: What matters will the shareholders vote on at the special meeting?

 

A: The shareholders will vote on the following three proposals:

 

To approve the E&S Sale Proposal;

 

To approve, on an advisory, non-binding basis, the Advisory Compensation Proposal; and

 

To approve the Adjournment Proposal.

 

Q: What is the E&S Sale Proposal?

 

A: The E&S Sale Proposal is a proposal to approve the sale by CSI to Lantronix, Inc. of all of the issued and outstanding shares of stock of its wholly owned subsidiary, Transition Networks, Inc., and the entire issued share capital of its wholly owned subsidiary, Transition Networks Europe Limited, pursuant to a securities purchase agreement dated as of April 28, 2021 between Lantronix, Inc. as Purchaser and Communications Systems, Inc. as Seller.

 

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CSI’s ownership interest of these two subsidiaries, sometimes referred to as the “purchased securities,” constitutes substantially all of the assets of CSI under the Minnesota Business Corporation Act.

 

Q: What will happen if the E&S Sale Proposal is approved by our shareholders?

 

A: Under the terms of the securities purchase agreement, if the E&S Sale Proposal is approved by our shareholders and the other closing conditions under the securities purchase agreement have been satisfied or waived, we will sell the purchased securities to Lantronix and we will discontinue operation of the E&S Segment business.

 

Q: What is the Advisory Compensation Proposal?

 

A: The Advisory Compensation Proposal is a proposal to approve, on an advisory, non-binding basis, certain compensation that has, will or may be paid or become payable to our named executive officers in connection with the E&S Sale Transaction.

 

Q: What will happen if the Advisory Compensation Proposal is approved by our shareholders?

 

A: The Advisory Compensation Proposal is advisory in nature and the outcome of the vote on the Advisory Compensation Proposal is not binding on CSI. Further, because we are contractually obligated to make the potential payments detailed in “Proposal #1: E&S Sale Proposal – Interests of Our Directors and Executive Officers in the E&S Sale Transaction – Golden Parachute Compensation,” such compensation may be paid, subject only to the conditions applicable thereto, regardless of the outcome of the vote on the Advisory Compensation Proposal.

 

Q: What is the Adjournment Proposal?

 

A: The Adjournment Proposal is a proposal to permit us to adjourn or postpone the special meeting for the purpose of soliciting additional proxies in the event that, at the special meeting, the affirmative votes in favor of the E&S Sale Proposal are less than required to approve the E&S Sale Proposal.

 

Q: What will happen if the Adjournment Proposal is approved by our shareholders?

 

A: If there are insufficient votes at the time of the special meeting to approve the E&S Sale Proposal, and the Adjournment Proposal is approved at the special meeting, we will be able to adjourn or postpone the special meeting for purposes of soliciting additional proxies to approve the E&S Sale Proposal. If you have previously submitted a proxy on the proposals discussed in this proxy statement and wish to revoke it upon adjournment or postponement of the special meeting, you may do so.

 

Q: Am I entitled to appraisal or dissenters’ rights in connection with the E&S Sale Proposal, the Advisory Compensation Proposal or the Adjournment Proposal?

 

A: Shareholders are not entitled to appraisal or dissenters’ rights under Minnesota law or under our articles of incorporation or bylaws in connection with the E&S Sale Proposal, the Advisory Compensation Proposal or the Adjournment Proposal.

 

Q: Who is entitled to vote at the special meeting?

 

A: Holders of our common stock at the close of business on June 11, 2021, the record date for the special meeting established by the CSI board of directors, are entitled to receive notice of, and to vote their shares at, the special meeting and any related adjournments or postponements. As of the close of business on the record date, there were 9,470,425 shares of our common stock outstanding and entitled to vote. Holders of our common stock are entitled to one vote per share.

 

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Q: What are the quorum requirements for the special meeting?

 

A: The presence at the special meeting of at least a majority of the issued and outstanding shares of CSI’s common stock entitled to vote at the special meeting is necessary to constitute a quorum for transacting business at the special meeting. A shareholder is counted as present at the special meeting if the shareholder attends the online special meeting or the shareholder has properly submitted a proxy by internet, telephone or signing and returning the enclosed proxy or other voting instruction form as described below under “Q: How do I vote?” A validly submitted proxy will result in your shares counting towards a quorum even if no voting instructions are provided.

 

Q: What vote is required to approve each of the proposals?

 

A: You may vote “FOR,” “AGAINST” or “ABSTAIN” on the E&S Sale Proposal, the Advisory Compensation Proposal and the Adjournment Proposal.

 

The approval of the E&S Sale Proposal requires the affirmative vote of holders of at least two-thirds of the issued and outstanding shares of CSI common stock that are entitled to vote on this proposal. If you vote ABSTAIN on the E&S Sale Proposal, it will have the same effect as a vote against the E&S Sale Proposal. Except with respect to shares allocated to you as a participant in the CSI ESOP, if you fail to vote, it will have the same effect as a vote against the E&S Sale Proposal.

 

The approval, on an advisory, non-binding basis, of the Advisory Compensation Proposal requires the affirmative vote of holders of at least a majority of the shares of CSI common stock present at the special meeting and entitled to vote on this proposal. If you vote ABSTAIN on the Advisory Compensation Proposal, it will have the same effect as a vote against the Advisory Compensation Proposal. Except with respect to shares allocated to you as a participant in the CSI ESOP, if you fail to vote, it will have no effect on the outcome of the Advisory Compensation Proposal.

 

If a quorum is present at the special meeting, the Adjournment Proposal will be approved if the number of shares voted in favor of that proposal is greater than the number of shares voted against that proposal. If a quorum is not present at the special meeting, the Adjournment Proposal will be approved by the affirmative vote of the holders of a majority of the voting power of our common stock present at the special meeting and no other business will be transacted thereat. Failure to attend the special meeting and a vote of ABSTAIN will have no effect on the outcome of the vote on the Adjournment Proposal if it is submitted for shareholder approval when a quorum is present at the meeting. If a quorum is not present at the special meeting, the Adjournment Proposal will be approved by the affirmative vote of the holders of a majority of the voting power of our common stock present at the special meeting. Abstentions would have the same effect as a vote AGAINST this proposal if it is submitted for approval when no quorum is present at the special meeting.

 

If you are a participant in the CSI ESOP and do not vote the CSI shares allocated to you in the CSI ESOP, your shares will be voted at the special meeting according to the provisions of the CSI ESOP, which provide that the trustees will vote these shares on each proposal in the same proportion as all shares of CSI common stock allocated to ESOP participants for which voting instructions were received were voted on that proposal.

 

Q: How do I vote?

 

A: Whether or not you plan to attend the special meeting, you may vote your shares in advance of the special meeting by internet, telephone or signing and returning the enclosed proxy or other voting instruction form. If you hold your shares in street name, then you received this proxy statement from your broker, bank or nominee, along with a voting instruction card from your broker, bank or nominee. You will need to instruct your broker, bank or other nominee on how to vote your shares of common stock using the voting instructions provided.

 

Please note that if you hold shares in the CSI Employee Stock Purchase Plan (ESOP), your voting instructions for these shares must be received by 11:59 p.m. Eastern Daylight Time on July 25, 2021. You may not vote the ESOP shares allocated to you electronically during the special meeting. 

If you are able to vote at the special meeting, you will need the 16-digit control number included on your proxy card or on the voting instructions that accompanied your proxy materials. Please have your 16-digit control number readily available and log on to the special meeting by visiting www.virtualshareholdermeeting.com/JCS2021SM1 and entering your 16-digit control number. You may begin to log into the meeting platform beginning at 9:30 a.m. CDT on July 28, 2021. The special meeting will begin promptly at 10:00 a.m. CDT on July 28, 2021.

 

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Even if you plan to attend the special meeting, we strongly encourage you to submit a proxy for your shares in advance as described above, so your vote will be counted if you are not able to attend.

 

All shares represented by properly executed proxies received in time for the special meeting will be voted in the manner specified by the shareholders giving those proxies.

 

Q: What happens if I do not vote the CSI shares allocated to me in the CSI ESOP?

 

A: If you are a participant in the CSI ESOP and do not vote the CSI shares allocated to you in the CSI ESOP on any proposal, your shares will be voted at the special meeting according to the provisions of the CSI ESOP, which provide that the trustees will vote these shares on each proposal in the same proportion as all shares of CSI common stock allocated to ESOP participants for which voting instructions were received were voted on such proposal.

 

Q: What happens if I do not vote the CSI shares I own of record (other than ESOP shares)?

 

A: Other than with respect to any shares allocated to you as a participant in the CSI ESOP, if you are a record holder and do not vote, your shares will not be voted at the special meeting and this failure to vote will have the same effect as a vote against the E&S Sale Proposal, but will not have an effect on the outcome of the Advisory Compensation Proposal or the Adjournment Proposal.

 

Q: If I hold my shares in street name through my broker, will my broker vote these shares for me?

 

A: If you hold your shares in street name, you must provide your broker, bank or other nominee with instructions in order to vote those shares. To do so, you should follow the voting instructions provided to you by your bank, broker or other nominee. If your bank, broker or nominee holds your shares in its name and you do not instruct it how to vote, it will not have discretion to vote on any of the proposals at the special meeting and none of your street name shares will be voted at the special meeting. If you provide voting instructions to your broker, bank or other nominee, that entity will vote your shares as you instruct.

 

Q: Can I change my vote?

 

A: Yes. If you are a shareholder of record, you may change your vote or revoke your proxy at any time before the vote at the special meeting by:

 

delivering to us a written notice, bearing a date later than your proxy, stating that you revoke the proxy;

 

submitting a properly signed proxy card or other voting instruction form with a later date;

 

if you voted by telephone or through the internet, by voting again for those same shares by telephone or through the internet prior to the close of the voting facility; or

 

for shares other than those allocated to CSI ESOP participants, attending the special meeting and voting at the online special meeting (although attendance at the special meeting will not, by itself, revoke a proxy).

 

If your shares are held in street name, you must contact your broker, bank or nominee to revoke your proxy.

 

Q: What if I do not specify a voting choice for a proposal when returning a proxy?

 

A: Proxies or other voting instruction forms that are signed and returned without voting instructions will be voted in accordance with the recommendations of the CSI board of directors. The CSI board of directors unanimously recommends that shareholders vote FOR the E&S Sale Proposal, FOR the Advisory Compensation Proposal and FOR the Adjournment Proposal the special meeting.

 

Q: What is the difference between a shareholder of record and a shareholder who holds stock in street name?

 

A: If your shares are registered in your name, that is, you have a Communications Systems stock certificate or hold your shares in an account with our transfer agent, Equiniti Trust Company, you are a shareholder of record. If your shares are held in an account with a broker, bank or another holder of record, these shares are considered to be held in street name.

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Q: What does it mean if I get more than one proxy card?

 

A: If your shares are registered differently and are in more than one account, you may receive more than one proxy card. Please complete, sign, date, and return all of the proxy cards you receive regarding the special meeting to ensure that all of your shares are voted.

 

Q: How are proxies solicited and what is the cost?

 

A: We will bear all expenses incurred in connection with the solicitation of proxies and printing, filing and mailing this proxy statement. We have engaged The Proxy Advisory Group, LLC (“PAG”) to assist in the solicitation of proxies and provide related advice and information support, for a services fee and the reimbursement of customary disbursements, which are not expected to exceed $40,000 in total. CSI will be solely responsible for the costs of the solicitation.

 

Additionally, certain of CSI’s directors, officers and regular employees may, without additional compensation, solicit proxies personally or by telephone, letter, facsimile or email. These directors, officers and employees will not be paid additional remuneration for their efforts but may be reimbursed for out-of-pocket expenses incurred in connection therewith. We will request brokers, custodians, nominees and other record holders to forward copies of the proxy statement and related soliciting materials to persons for whom they hold shares of our common stock and to request authority for the exercise of proxies. In such cases, upon the request of the record holders, we will reimburse such holders for their reasonable out-of-pocket expenses.

 

Q: What should I do if I have questions regarding the special meeting?

 

A: If you have any questions about how to cast your vote for the special meeting or would like copies of any of the documents referred to or incorporated by reference in this proxy statement, you should call our Secretary at (952) 996-1674 or our proxy solicitor, The Proxy Advisory Group, LLC, 18 East 41st Street, Suite 2000, New York, New York 10017, by calling the following phone number: (212) 616-2181.

 

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CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

 

This proxy statement contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management’s current expectations and assumptions about future events, which are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. The use of words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans” and “believes,” among others, generally identifies forward-looking statements.

 

Actual results could differ materially from those contained in the forward-looking statements. Factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include those set forth under “RISK FACTORS” beginning on page 61, as well as the risk factors about our company included as part of our Annual Report on Form 10-K for the year ended December 31, 2020. See “WHERE YOU CAN FIND ADDITIONAL INFORMATION” on page 64.

 

Other unknown or unpredictable factors may arise from time to time that could also adversely affect the E&S Sale Transaction or our other ongoing efforts to divest substantially all our current operating and non-operating assets, our business, financial condition and results of operations, and our proposed merger with Pineapple. In light of these risks and uncertainties, the forward-looking statements discussed in this proxy statement may not prove to be accurate. Accordingly, you should not place undue reliance on these forward-looking statements, which only reflect the views of CSI management as of the date of this proxy statement. Except as required by applicable law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results or expectations.

 

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OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

The following table sets forth, as of June 11, 2021, certain information with respect to the beneficial ownership of CSI’s common stock by (i) each shareholder known by us to be the beneficial owner of more than 5% of CSI’s common stock, (ii) each director of CSI, (iii) each of the named executive officers of CSI (which are our executive officers identified as named executive officers in the amendment to our Annual Report on Form 10-K for the year ended December 31, 2020 filed with the SEC on April 30, 2021), and (iv) all directors and executive officers of CSI as a group. Percentage ownership is based on 9,470,425 shares of CSI common stock outstanding. Unless otherwise stated, the address of each person is 10900 Red Circle Drive, Minnetonka, MN 55343.

 

Name and Address of Beneficial Owner Number of Shares
Beneficially Owned (1)
Percent of Outstanding
     
GAMCO Investors, Inc. (2)
One Corporate Center
Rye, NY 10580-1435
1,451,524 15.3%
     
Renaissance Technologies LLC (3)
800 Third Avenue
New York, NY 10022
630,018 6.7%
     
Punch & Associates Investment Management, Inc. (4)
7701 France Ave. S., Suite 300
Edina, MN 55435
490,491 5.2%
     
Communications Systems, Inc. Employee Stock Ownership Plan and Trust (5) 638,544 6.7%
     
Roger H.D. Lacey (6)(7) 418,323 4.3%
     
Mark Fandrich (7) 110,615 1.2%
     
Scott Fluegge (7) 113,493 1.2%
     
Anita Kumar (6)(7) 23,597 *
     
Richard A. Primuth (6) 132,344 1.4%
     
Randall D. Sampson (6)(8) 1,371,142 14.3%
     
Steven C. Webster (6) 50,000 *
     
Michael R. Zapata (6) 10,000 *
     
All current executive officers and directors
as a group (10 persons)
2,292,257 22.3%

 

*Less than one percent

 

(1)Includes the following number of shares that could be acquired within 60 days of June 11, 2021 upon the exercise of stock options: Mr. Lacey, 307,947 shares; Mr. Fandrich, 72,805 shares; Mr. Fluegge, 75,489 shares; Ms. Kumar, 8,873 shares; Mr. Primuth, 106,215 shares; Mr. Sampson, 150,298 shares, which including the right to exercise 77,923 stock options originally issued to Curtis A. Sampson; Mr. Webster 45,000 shares; Mr. Zapata, 10,000 shares; and all current directors and executive officers as a group, 810,564 shares.

 

Also includes the following number of shares allocated to the accounts of the following participants in the CSI Employee Stock Ownership Plan and Trust (ESOP) as of June 11, 2021: Mr. Lacey, 9,630 shares; Mr. Fandrich, 8,141 shares; Mr. Fluegge, 11,110 shares; Ms. Kumar, 7,331 shares; and all current directors and executive officers as a group, 45,629 shares.

 

(2)Based on an Amendment No. 19 to Schedule 13D filed on March 5, 2021 in which the reporting persons disclose the following beneficial ownership as of March 4, 2021: Gabelli Funds, LLC, 321,500 shares sole voting and dispositive power; GAMCO Asset Management Inc., 762,524 shares sole voting power and 822,524 shares sole dispositive power; Teton Advisors, Inc., 343,500 shares sole voting power and sole dispositive power; MJG Associates, Inc., 9,000 shares sole voting power and sole dispositive power; and Gabelli Foundation, Inc., 15,000 shares sole voting power and sole dispositive power.

 

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(3)Based on an Amendment No. 2 to Schedule 13G filed by Renaissance Technologies LLC on February 11, 2021 reporting sole voting power over 630,018 shares and sole dispositive power over 682,714 shares as of December 31, 2020.

 

(4)Based on a Schedule 13G filed by Punch & Associates Investment Management, Inc. on February 17, 2021 reporting sole voting and sole dispositive power over 490,491 shares as of December 31, 2020.

 

(5)Based on an Amendment No. 7 to Schedule 13G filed by the CSI ESOP on February 12, 2021 reporting ownership as of December 31, 2020, as well as CSI records. Messrs. Roger H.D. Lacey, Randall D. Sampson and Mark Fandrich serve as Trustees of the CSI ESOP, and disclaim beneficial ownership of the shares held by the CSI ESOP, except for shares allocated to their respective accounts.

 

(6)Currently serves as a director of Communications Systems.

 

(7)Named executive officer of Communications Systems.

 

(8)Based on a Schedule 13G filed on April 15, 2021 by Mr. Sampson reporting his beneficial ownership as of March 15, 2021, as well as CSI records. As of June 11, 2021, Mr. Sampson has or shares voting and dispositive power over: (i) 34,550 shares of common stock owned by Mr. Sampson individually; (ii) 25,349 shares of common stock owned jointly by Mr. Sampson and his spouse; (iii) 380,370 shares of common stock held by the Marian Arlis Sampson Revocable Trust, of which Mr. Sampson is the sole trustee; (iv) 37,722 shares of common stock held by the Marian Sampson IRA, of which Mr. Sampson is an attorney-in-fact authorized to act alone and Ms. Sampson retains authority to act on behalf of the Marian Sampson IRA; (v) 681,334 shares of common stock held by Sampson Family Real Estate Holdings, LLC, of which Mr. Sampson is the sole manager; and (vi) 61,519 shares of common stock held by the Sampson Family Foundation, a charitable foundation of which Mr. Sampson is one of five directors. The two officers of the Sampson Family Foundation have the authority to vote and dispose of the shares of common stock held by the Sampson Family Foundation. Mr. Sampson is not an officer of the Sampson Family Foundation. Mr. Sampson disclaims beneficial ownership of all of the shares of CSI common stock except those shares he holds individually or jointly with his spouse. Mr. Sampson is not a participant in the CSI ESOP.

 

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PROPOSAL #1
E&S SALE PROPOSAL

 

Parties to the Securities Purchase Agreement

 

Communications Systems, Inc.

 

Communications Systems, Inc. is a Minnesota corporation that was organized in 1969. CSI classifies its businesses into the following two segments:

 

Electronics & Software (E&S): designs, develops and sells Intelligent Edge solutions that provide connectivity and power through Power over Ethernet (“PoE”) products and actionable intelligence to end devices in an Internet of Things (“IoT”) ecosystem through embedded and cloud-based management software. In addition, this segment 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; and

 

Services & Support (S&S): provides SD-WAN and other technology solutions that address prevalent IT challenges, including network resiliency, security products and services, network virtualization, and cloud migrations, IT managed services, wired and wireless network design and implementation, and converged infrastructure configuration, deployment and management.

 

Communications Systems’ headquarters and mailing address is 10900 Red Circle Drive, Minnetonka, MN 55343, and the telephone number at that location is (952) 996-1674. Our principal website is www.commsystems.com.

 

On March 2, 2021, CSI announced that it had entered into a definitive merger agreement with privately held Pineapple Energy LLC (“Pineapple”), a growing U.S. operator and consolidator of residential solar, battery storage, and grid services solutions. A meeting of the Company’s shareholders to approve the merger agreement with Pineapple is expected to be held later in 2021. If the merger is approved by our shareholders, upon closing, CSI will commence doing business as Pineapple Energy, with a business model focused on the rapidly growing home solar industry.

 

At the time the merger with Pineapple was announced, CSI stated its intention to divest substantially all its current operating and non-operating assets, including its E&S business, its S&S business, real estate holdings, and cash, cash equivalents, and investments. The E&S Sale Transaction is part of CSI’s planned strategy to monetize its assets for the benefit of the pre-merger CSI shareholders as contemplated by the Pineapple merger transaction.

 

Lantronix, Inc.

 

Lantronix, Inc. (Nasdaq: LTRX) is a global provider of software as a service (“SaaS”), engineering services, and hardware for Edge Computing, the Internet of Things (“IoT”), and Remote Environment Management (“REM”). Lantronix enables its customers to provide reliable and secure solutions while accelerating their time to market. Lantronix’s products and services dramatically simplify operations through the creation, development, deployment, and management of customer projects at scale while providing quality, reliability and security.

 

The mailing address for Lantronix is 7535 Irvine Center Drive, Suite 100, Irvine, California 92618 and the telephone number at that location is (949) 453-3990. The principal website for Lantronix is www.lantronix.com.

 

Background of the E&S Sale Transaction

 

Our board of directors, together with our management, regularly reviews and assesses CSI’s performance, future growth prospects, business plans, competitive position, and overall strategic direction. As part of that review process, from time to time, we have considered a number of strategic alternatives, including potential strategic transactions with third parties, in each case with the goal of maximizing shareholder value.

 

As part of this process, on May 23, 2018, the CSI board of directors announced the formation of a CSI special committee consisting of independent directors Richard Primuth, Randall D. Sampson and Steven Webster to explore strategic alternatives for CSI. We also announced that the CSI special committee expected to retain an investment banking firm to advise it in this process. CSI director Michael Zapata joined the special committee

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shortly following his election to the CSI board of directors in June 2020. In fulfilling its responsibilities to explore strategic alternatives, the CSI special committee, as well as the CSI board of directors, were advised by the law firm of Ballard Spahr LLP. In addition, CSI subsequently engaged Northland Securities, Inc., referred to as “Northland,” as CSI’s financial advisor.

 

The CSI special committee, working with members of management, studied a number of strategic initiatives and strategic alternatives for CSI, and, in the period following May 23, 2018, the Company took the following actions that were approved by the CSI special committee and the CSI board of directors:

 

On April 5, 2019, CSI’s wholly owned subsidiary Suttle, Inc. (“Suttle”) sold its FutureLink Fiber business line for $5.0 million in cash;

 

On March 11, 2020, CSI sold the remainder of its Suttle business and related assets for $8.0 million in cash;

 

On May 14, 2020, CSI acquired Ecessa Corporation in a reverse triangular merger for $4.6 million in cash; and

 

On November 3, 2020, CSI acquired the operating assets of privately held IVDesk Minnesota, Inc. from a third-party receiver appointed by a Hennepin County, Minnesota State District Court Judge for aggregate consideration of $1.4 million, including a $550,000 earnout payment made in March 2021.

 

Beginning in December 2020, the special committee and management began considering a proposal to merge with Pineapple Energy LLC (“Pineapple”) and, following due diligence and negotiations, the CSI special committee and the CSI board of directors approved a definitive merger agreement with Pineapple that was announced on March 2, 2021. Throughout the negotiations with Pineapple leading to the approval of the Pineapple merger agreement, the CSI special committee and the CSI board of directors agreed with Pineapple that as part of the proposed merger, CSI would divest substantially all of its existing operating and non-operating assets. Accordingly, concurrent with the ongoing discussions and negotiations with Pineapple between December 2020 and March 2, 2021, the CSI special committee also considered strategic alternatives for the divestiture of the operating and non-operating assets of CSI that would maximize the value of these assets for its current shareholders. In this regard, it identified Lantronix as a possible acquiror of CSI’s E&S business segment, which consisted of two business units: Transition Networks Inc. (“TNI”) based in the U.S. and Net2Edge (“N2E”), a business based in the U.K. that was owned by TNI through its subsidiary, Transition Networks Europe Limited (“TN Europe”).

 

From time to time beginning in 2018, CSI and Lantronix had engaged in discussions regarding a possible strategic transaction. These discussions included a dinner at Mobile World Congress in Los Angeles in October 2019. Given Lantronix’s previously expressed interest in a possible transaction with CSI and in particular, its expressed interest in the TNI portion of the E&S Segment business, on December 15, 2020, after CSI had received and considered the initial inquiry from Pineapple, the CSI special committee instructed Northland to contact Lantronix to determine its interest in acquiring the E&S Segment business if CSI proceeded with the Pineapple merger. At this time, the special committee also directed Northland to contact other qualified buyers, which resulted in several additional parties entering into non-disclosure agreements with CSI, and receiving information regarding the E&S Segment business.

 

On December 17, 2020, in accordance with the CSI special committee’s directives, representatives of Northland contacted Lantronix’s Chief Financial Officer, Jeremy Whitaker, to gauge Lantronix’s interest in CSI’s E&S Segment business. The Lantronix management team confirmed Lantronix’s interest in acquiring some or all of the E&S Segment business assets.

 

Later on December 17, 2020, CSI provided Lantronix with preliminary 2020 and 2021 revenue estimates for the E&S Segment. On December 22, 2020, CSI shared with Lantronix historical revenue relating to the E&S Segment that included revenues for both TNI and N2E as one consolidated operating segment.

 

On December 29, 2020, Lantronix submitted a preliminary non-binding letter of intent to acquire the assets of TNI for a total purchase price of $24.75 million, stating that it also would consider including the assets of the N2E business of TN Europe as part of the transaction.

 

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On January 6, 2021, in accordance with the CSI special committee’s directives, Northland representatives had a telephone discussion with Mr. Whitaker regarding including the assets of N2E as part of the proposed transaction and changing the structure of the transaction from an asset sale to the sale of CSI’s stock in TNI and TN Europe, indicating that if N2E were included in the transaction, the purchase price would need to be increased from the proposed $24.75 million purchase price reflected in Lantronix’s December 29, 2020 letter of intent.

 

Later on January 6, 2021, CSI’s Executive Chairman, Roger H.D. Lacey, and CSI’s Chief Financial Officer, Mark Fandrich, attorneys from Ballard Spahr, and Northland representatives discussed Lantronix’s December 29, 2020 letter of intent and potential revisions to reflect the inclusion of the N2E business, an increase in the proposed purchase price and the change in structure from an asset sale to the sale of CSI’s stock in TNI and TN Europe. The Company believed that the E&S Segment was worth more than Lantronix’s proposed purchase price and that the N2E business was worth more if sold as part of the E&S Segment than on a stand-alone basis.

 

Also on January 6, 2021, CSI sent Lantronix a five-year financial forecast for the E&S Segment for fiscal years 2021 through 2025. This five-year financial forecast had been approved by the CSI board on December 8, 2020 as part of its regular planning cycle.

 

On January 7, 2021, the CSI board of directors held a special meeting attended by Mr. Fandrich and representatives of Ballard Spahr and Northland. CSI management and Northland reviewed and discussed with the CSI board of directors the December 29, 2020 letter of intent from Lantronix. At that meeting, the CSI board of directors also reviewed in detail a non-binding letter of intent with respect to the Pineapple transaction and the CSI board of directors authorized CSI management to enter into the non-binding letter of intent for the Pineapple transaction. The CSI board of directors determined that if negotiations with Pineapple led to a definitive merger agreement, then CSI should pursue a sale of the E&S Segment as an appropriate next step in the overall strategy to maximize shareholder value and provide liquidity to CSI shareholders.

 

The CSI board of directors then discussed the process for the possible disposition of the E&S Segment, including the proposed purchase price and the need to include the N2E business, and the strategies to support the CSI board of directors’ exercise of its fiduciary duties. In particular, the CSI board of directors discussed CSI’s ability to explore or respond to other superior proposals for the E&S Segment at various times, including before the execution of any letter of intent, from the period of the signing of the letter of intent until the execution of a definitive agreement, and between signing of a definitive agreement and closing. The directors also requested that management prepare an analysis of how the potential merger with Pineapple and the potential sale of the E&S Segment would affect outstanding equity awards under the CSI 2011 Executive Incentive Compensation Plan (the “2011 Plan”) and other compensation agreements so that the CSI board of directors would understand CSI’s obligations and could take appropriate actions consistent with the 2011 Plan and the outstanding awards and other agreements.

 

The CSI board of directors then authorized CSI management to continue to negotiate with Lantronix if Lantronix agreed to include N2E in the transaction, agreed to increase the proposed purchase price and agreed to structure the transaction as a sale of the stock of the E&S Companies rather than as an asset sale. The CSI board of directors also authorized management to undertake to document these terms in a letter of intent and, consistent with direction from the CSI special committee and CSI board of directors when a letter of intent was agreed upon, to proceed with negotiating a definitive transaction agreement relating to the transaction with Lantronix, with the final transaction agreement subject to subsequent approval by the CSI special committee and the CSI board of directors. Although the CSI board of directors gave management discretion to proceed, as discussed below, CSI and Lantronix did not agree on a letter of intent until after the February 2, 2021 meeting of the CSI board of directors. The CSI board of directors also instructed Northland to continue to explore, and respond to other inquiries from, other interested parties on behalf of CSI until there was an exclusivity obligation with Lantronix or another party.

 

On January 8, 2021, a meeting was held among CSI management consisting of Messrs. Lacey and Fandrich and CSI’s Chief Executive Officer, Anita Kumar, Ballard Spahr attorneys, and Northland representatives to discuss the draft December 29, 2020 Lantronix letter of intent, the CSI board of directors’ authorization, and strategies for negotiations with Lantronix. Later on January 8, 2021, CSI delivered a revised letter of intent to Lantronix proposing a stock sale of the E&S Companies for a cash purchase price to be further discussed between the parties. In response to the CSI board of directors’ discussion at the January 7, 2021 meeting, the revised letter of intent contained a one-year standstill provision and clarification that the purchase agreement would include a customary fiduciary-out provision. Also on January 8, 2021, CSI management met with CSI’s tax advisory firm to review tax aspects of the E&S Segment transaction.

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On January 11, 2021, Lantronix delivered to CSI a revised draft letter of intent that proposed a cash purchase price equal to 75% of the revenue generated by the E&S Segment business for the 12-month period ended December 31, 2020, or approximately $25.9 million, and indicated that Lantronix would consider acquiring the stock of TN Europe with an appropriate adjustment of the purchase price if included.

 

On January 14, 2021, CSI delivered to Lantronix a revised letter of intent with an increased purchase price of $38 million. This revised letter of intent was accompanied by a cover email outlining to Lantronix the rationale for CSI’s counterproposal and proposed purchase price based on publicly available market data for comparable entities.

 

On January 15, 2021, Lantronix delivered to CSI a revised letter of intent with a proposed purchase price of $24 million for both the Transition Networks and Net2Edge entities.

 

Also on January 15, 2021, at the request of Mr. Fandrich, as part of the ongoing effort to continue to assess market interest in the E&S Segment, Northland provided CSI with a list of potential purchasers of the E&S Segment businesses and updated CSI on the status of discussions with potentially interested parties. CSI management and Northland discussed alternatives for a potential approach to these other potential purchasers if CSI did not receive a revised proposal from Lantronix. CSI management directed Northland to inform Lantronix that, to remain competitive in the process, Lantronix would need to increase its $24.0 million proposed purchase price given that Lantronix was offering to acquire the N2E business in its proposal. CSI management believed the E&S Segment was worth more than the amount proposed by Lantronix, which was based solely on 2020 revenue that had been negatively affected by COVID-19. CSI management also directed Northland to emphasize that CSI had significant cash reserves and was not in a distressed situation.

 

On January 20, 2021, Rob Adams, Lantronix’s Head of Corporate Development and Investor Relations, contacted a representative of Northland to continue discussions regarding the E&S Segment. In accordance with CSI’s directives, the Northland representative relayed CSI’s position regarding changes to Lantronix’s proposal that would be required in order to be acceptable to CSI.

 

On January 22, 2021, Mr. Whitaker called a Northland representative, indicating that Lantronix was open to increasing its proposed purchase price to $25.0 million in cash at closing, with an additional $5.0 million earnout based on existing revenue forecasts for a total purchase price of up to $30 million.

 

On January 26, 2021, CSI management and Northland representatives held a call to discuss Lantronix’s revised purchase price.

 

On January 28, 2021, CSI instructed Northland to relay a counterproposal to Lantronix with a purchase price of $32.0 million, including a $7.0 million earnout contingent upon the E&S Segment achieving designated operating milestones.

 

On January 29, 2021, Messrs. Lacey and Fandrich and Ms. Kumar, together with Northland representatives, held a virtual meeting with the chief executive officer and other management members of Company A regarding Company A’s potential acquisition of the E&S Segment.

 

On February 1, 2021, in accordance with CSI’s instructions, Northland representatives discussed the $32.0 million purchase price, including the $7.0 earnout amount, with Mr. Adams, who verbally agreed in principle with an earnout of $7.0 million, but indicated that Lantronix would make a counterproposal for the revenue parameters of the earnout.

 

On February 2, 2021, the CSI board of directors held a special meeting attended by Mr. Fandrich and CSI Corporate Controller Kristin Hlavka, and representatives of Ballard Spahr and Northland. The CSI board of directors discussed the status of the potential sale of the E&S Segment and authorized management to continue to negotiate toward execution of a letter of intent reflecting a $25.0 million base cash purchase price and a $7.0 million earnout payable to CSI shareholders within the parameters contemplated by the Pineapple merger agreement. CSI management also shared with the CSI board of directors information regarding the effect on shareholders of the acceleration of outstanding stock options and restricted stock units if a change of control occurred.

 

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Later on February 2, 2021, CSI delivered to Lantronix a revised letter of intent reflecting a proposed base purchase price of $25.0 million and a $7.0 million earnout assuming $39.5 million in revenue during the first full 12 months immediately after the closing, subject to a capped earnout of $2 million for revenues above $39.5 million (based on $0.50 in earnout for each $1.00 in additional revenue). As was the case with the letter of intent exchanged between the parties after January 8, 2021, CSI’s revised letter of intent included a one-year standstill provision and indicated that the purchase agreement would include a customary fiduciary-out provision.

 

On February 5, 2021, Lantronix delivered to CSI a revised letter of intent altering the earnout consideration language by removing the $0.50 in earnout consideration for each $1.00 in additional revenue concept and replacing this concept with a series of revenue targets with corresponding payments. The new earnout concept maintained the total potential earnout consideration of $7.0 million, with increased back-end weighting over the first 360 days post-closing.

 

On February 8, 2021, CSI delivered to Lantronix a revised letter of intent altering the earnout consideration language, maintaining total potential earnout consideration of $7.0 million, while establishing a straight line measurement formula with lower hurdles for the initial targets and payments over the 360 days after closing and extending the exclusivity date from January 31, 2021 to February 28, 2021. During the previous several weeks, in accordance with the instructions of the CSI board of directors, Northland had continued to solicit indications of interest regarding a transaction involving the E&S Segment, and CSI entered into confidentiality agreements with certain potential buyers of the E&S Segment, shared certain financial and other business information with such parties, and discussed potential alternative proposals regarding the E&S Segment business. While those discussions were active and ongoing, none of the potential proposals discussed with other parties matched the value to shareholders and certainty of closing contemplated by Lantronix’s February 5, 2021 letter of intent.

 

On February 9, 2021, CSI and Lantronix executed the non-binding letter of intent reflecting a purchase price of up to $32.0 million with $25.0 million payable at closing and an additional $7.0 million earnout contingent upon meeting revenue targets in two 180-day periods following closing, a one-year standstill provision and exclusivity until March 5, 2021. After execution of the letter of intent, on February 9, 2021, Lantronix was provided with access to CSI’s virtual data room.

 

On February 10, 2021, Mr. Fandrich from CSI and Mr. Whitaker from Lantronix discussed planned overview meetings with TNI and Lantronix management regarding certain functional areas of the E&S Segment business.

 

On February 12, 2021, representatives of Ballard Spahr and legal counsel for Lantronix and Mr. Whitaker, discussed drafting responsibilities for the securities purchase agreement, transaction structure (stock sale or asset sale), due diligence to be conducted by Lantronix, and the fact that CSI shareholder approval was required to consummate the transaction.

 

On February 16, 2021, the CSI compensation committee and CSI board of directors held regularly scheduled meetings attended by Mr. Fandrich and Ms. Hlavka and representatives of Ballard Spahr. Representatives of Northland also attended the portion of the CSI board meeting relating to the E&S Segment transaction. At this board meeting, the CSI board of directors reviewed the status of the potential transaction with Lantronix, including the February 9, 2021 letter of intent, and were briefed on a discussion among the CSI and Lantronix attorneys on February 12, 2021. The CSI board of directors discussed upcoming due diligence and meetings, and potential timing for the proposed transactions with Pineapple and Lantronix.

 

At the February 16, 2021 meeting of the CSI board of directors, the CSI compensation committee recommended in connection with a change in control under the proposed Pineapple transaction, with respect to outstanding equity awards under 2011 Plan and the CSI Employee Stock Purchase Plan (“ESPP”), that the CSI board of directors take the following actions pursuant to its obligations and authority under the 2011 Plan and the ESPP:

 

Approve that on a date no earlier than 20 days before a change in control (the “Action Effective Date”) resulting from the proposed Pineapple merger transaction, all outstanding, in-the-money stock options would be settled by exchanging the options for a “net” number of shares (“Net Shares”) that took into account that option holders would not pay the exercise price to exercise their options, as calculated under the formula for determining the number of Net Shares provided in the 2011 Plan and that these Net Shares would be contingently issued as of the Action Effective Date.

 

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Approve that the Action Effective Date would be set to ensure that the holders of RSUs and in-the-money stock options would receive any dividends paid to the other CSI shareholders prior to the effective time of the merger;

 

Approve that, as provided in the 2011 Plan, with respect to options for which the per share exercise price was equal to or greater than the market price for the shares on the Action Effective Date, such options automatically would be cancelled without payment of any consideration therefor; and

 

Approve that, with respect to the ESPP, after the current quarterly phase of the ESPP ending on March 31, 2021, unless approved by Pineapple, no new phase of the ESPP would commence prior to the effective time of the merger or until the merger agreement is terminated.

 

The full CSI board of directors discussed this recommendation and subsequently adopted these resolutions with respect to the Pineapple transaction at a meeting on March 1, 2021. In addition, given the possibility that approval and consummation of the proposed transaction under discussion with Lantronix could occur prior to the Pineapple merger, and that the proposed transaction with Lantronix also would represent a change in control under the 2011 Plan, on April 27, 2021 the CSI board of directors adopted similar resolutions with respect to the proposed Lantronix transaction as summarized under “Treatment of Outstanding Equity Awards.”

 

During the period from February 16, 2021 through February 22, 2021, Lantronix participated in CSI management presentations and due diligence conference calls.

 

During the period from February 25, 2021 through March 1, 2021, the CSI board of directors held several special meetings focused primarily on the Pineapple transaction. On March 1, 2021, the CSI board of directors approved the CSI-Pineapple merger agreement and CSI and Pineapple entered into that agreement. On March 2, 2021, CSI issued a press release announcing the proposed Pineapple merger transaction. In that press release, CSI announced that in conjunction with the merger, CSI intended to divest substantially all its current operating and non-operating assets, including its E&S Segment, its S&S Segment, real estate holdings, and cash and cash equivalents.

 

Beginning February 12, 2021, counsel for CSI and Lantronix exchanged and negotiated the securities purchase agreement consistent with the February 9, 2021 letter of intent.

 

On March 2 and March 3, 2021, Lantronix and CSI held in-person due diligence meetings at CSI’s offices in Minnetonka, Minnesota.

 

On March 5, 2021, the exclusivity period under the February 9, 2021 letter of intent expired. Prior to the expiration date, Lantronix had proposed extending the date, but CSI responded that the parties should focus on negotiating and signing a definitive securities purchase agreement.

 

Despite the expiration of exclusivity, CSI and Lantronix then continued to pursue negotiating the E&S Segment transaction in a manner consistent with the letter of intent. In accordance with the instructions of the CSI board of directors, Northland continued to discuss a possible transaction with other potential buyers of the E&S Segment and CSI’s availability to discuss alternative proposals for the E&S Segment. No clear alternative emerged, however, that CSI believed offered more value and certainty of closing than contemplated by the ongoing discussions with Lantronix.

 

On March 12, 2021, Lantronix and Northland held a call in which Lantronix relayed a new proposal to pay a portion of the purchase price payable at closing of the transaction by Lantronix’s delivery of a promissory note to CSI (“seller note”).

 

On March 14, 2021, CSI and Northland held a call to discuss Lantronix’s proposal to pay part of its purchase price with a seller note. CSI expressed its desire to limit the amount of any seller note to less than $10 million and requested confirmation from Lantronix that Lantronix would consider pursuing equity financing to repay the seller note within a reasonable timeframe after closing of the purchase of the E&S Segment by Lantronix.

 

On March 16, 2021, Lantronix and CSI held an international sales due diligence call.

 

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Also on March 16, 2021, Lantronix and Northland held a call in which Lantronix proposed payment terms for the transaction, including the seller note in an amount of $9.5 million, upfront cash of $16.0 million, and a $7.0 million earnout.

 

On March 17, 2021, CSI and Lantronix discussed certain details of the transaction, including UK employees, a former sales representative issue, employment arrangements, and IT services to be provided under the transition services agreement.

 

Also on March 17, 2021, the CSI special committee met. Messrs. Lacey and Fandrich and representatives of Ballard Spahr and Northland, attended the meeting. CSI management discussed certain items that were covered in more detail at the subsequent March 19, 2021 meeting.

 

On March 19, 2021, the CSI board of directors held a special meeting attended by Mr. Fandrich and Ms. Hlavka, and representatives of Ballard Spahr and Northland. During the meeting, the CSI board of directors reviewed and discussed with Ballard Spahr and CSI management drafts of the securities purchase agreement, transition services agreement and related schedules that had been circulated prior to the meeting. Northland then provided an overview of certain terms of the draft securities purchase agreement, summarized the transaction timeline and process, and discussed certain market and other financial information relating to the E&S Segment and the proposed transaction. Representatives of Ballard Spahr reviewed the fiduciary duties of the CSI board of directors.

 

The CSI board of directors discussed at length the factors supporting the proposed sale of the E&S Segment business and the potential risks and challenges relating to the proposed sale of the E&S Segment business. The CSI board of directors directed CSI management, Ballard Spahr and Northland to continue to negotiate and resolve open points in the definitive agreements for the sale of the E&S Segment.

 

On March 25, 2021, the CSI board of directors met to discuss the E&S Segment transaction and the status of the legal documentation for such transaction. The CSI board of directors was advised that representatives of CSI and Lantronix continued to negotiate the terms of the securities purchase agreement and the transition services agreement without reaching agreement.

 

On April 8, 2021, CSI and Northland had an introductory call with the chief executive officer of Company B, a private company that CSI viewed as a competitor of the E&S Segment business. At this time, CSI was not under exclusivity with Lantronix given the expiration of the exclusivity period included in the February 9, 2021 letter of intent. In accordance with the instructions of the CSI board of directors, Northland also continued to seek out other alternative purchasers that might be interested in the E&S Segment.

 

On April 9, 2021, the CSI board of directors held a special meeting attended by Mr. Fandrich and Ms. Hlavka and representatives of Ballard Spahr and Northland. The CSI board of directors discussed the status of the transaction, potential liability issues under the transition services agreement, financial terms of the transaction, and the seller note. The CSI board of directors also considered Lantronix’s request for a 14-day extension of the exclusivity period included in the February 9, 2021 letter of intent. At this meeting, the CSI board of directors directed CSI management to inform Lantronix that as conditions to the requested extension of the exclusivity period, the CSI board of directors would require that Lantronix remove its request to finance a portion of its purchase price with a seller note, provide reasonable assurance that Lantronix would have sufficient financing to pay the full cash purchase price at closing, and agree to CSI’s proposed terms for the transition services agreement.

 

On April 15, 2021, CSI management, in consultation with representatives of Ballard Spahr, determined that Lantronix had met CSI’s stated conditions for extending exclusivity. Accordingly, CSI and Lantronix amended the exclusivity period of the February 9, 2021 letter of intent from April 15, 2021 to April 29, 2021. Also on April 15, 2021, CSI cancelled a planned follow-up call with Company B.

 

Between April 15, 2021 and April 27, 2021, representatives of Ballard Spahr and representatives of Lantronix and Lantronix’s legal counsel, O’Melveny & Myers LLP, negotiated and exchanged drafts of the securities purchase agreement, transition services agreement and related schedules and ancillary documents.

 

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On April 27, 2021, representatives of Ballard Spahr, on the one hand, and representatives of Lantronix and O’Melveny & Myers LLP, on the other hand, finalized the form of the securities purchase agreement and transition services agreement.

 

Later on April 27, 2021, the CSI board of directors held a special meeting. Also present were Mr. Fandrich and Ms. Hlavka of CSI management and representatives of Ballard Spahr and Northland. At this meeting the CSI board of directors reviewed the history of discussions with Lantronix and prospective acquirors other than Lantronix, including Company A, Company B and other potential purchasers contacted to gauge potential interest in the E&S Segment business, noting that none of these discussions resulted in receiving an indication of interest or offer to purchase the E&S Segment on terms that it considered to be competitive with Lantronix’s offer. Northland reviewed with the CSI board of directors its financial analysis of the aggregate purchase price of $32,027,566 (referred to as the “Aggregate Purchase Price”) provided for in the transaction, and rendered an oral opinion, confirmed by delivery of a written opinion dated April 27, 2021, to the CSI board of directors to the effect that, as of such date and based on and subject to various assumptions made, procedures followed, matters considered, limitations on the review undertaken and qualifications, the Aggregate Purchase Price to be paid to CSI for the E&S Segment business pursuant to the securities purchase agreement was fair, from a financial point of view, to CSI. Representatives of Northland were then excused from the meeting. Representatives of Ballard Spahr then reviewed with the CSI board of directors its fiduciary duties with respect to the E&S Sale Transaction, and the material terms of the draft securities purchase agreement.

 

At the April 27, 2021 meeting, after discussion among the special committee and the CSI board of directors, the CSI board of directors unanimously took the following actions: (i) determined that the securities purchase agreement and the transactions contemplated thereby were fair to and in the best interests of CSI and its shareholders, (ii) approved, adopted and declared advisable the securities purchase agreement and the transactions contemplated thereby, (iii) directed that the approval of transactions contemplated by the securities purchase agreement be submitted to a vote at a meeting of CSI’s shareholders and (iv) recommended the adoption of the securities purchase agreement and the approval of the transactions contemplated by CSI’s shareholders at the special meeting, and instructed CSI management to sign and deliver the securities purchase agreement on behalf of CSI. The CSI board of directors, upon recommendation from the CSI compensation committee, also adopted resolutions to the effect that, upon the closing of the E&S Sale Transaction, all outstanding equity awards under the 2011 Plan would accelerate, the outstanding in-the-money stock options would be settled by exchanging the options for a “net” number of shares pursuant to the 2011 Plan, and that these net shares would be issued effective as of the date of closing, and the out-of-the-money stock options would be cancelled.

 

After conclusion of the April 27, 2021 meeting, CSI and Lantronix exchanged signature pages, which were held in escrow until the evening of April 28, 2021, when Lantronix confirmed to CSI that Lantronix had secured two commitment letters for the financing needed to complete the E&S Sale Transaction. On April 28, 2021, each of CSI and Lantronix and CSI released their signature pages to form a fully executed securities purchase agreement.

 

On April 29, 2021, prior to the opening of the stock markets, both CSI and Lantronix issued press releases announcing the securities purchase agreement and the E&S Sale Transaction.

 

Past Contacts, Transactions or Negotiations

 

Other than as described under “Background of the E&S Sale Transaction” above, we and Lantronix have not had any negotiations, transactions or material contacts during the past two years, and, other than as described therein and in the securities purchase agreement, there are no present or proposed material agreements, arrangements, understandings or relationships between our executive officers or directors and Lantronix, or its executive officers or directors.

 

Reasons for the E&S Sale Transaction and Recommendation of the CSI Board of Directors

 

In evaluating the E&S Sale Transaction, the CSI board of directors consulted with CSI’s management, legal counsel and financial advisor. In reaching its decision to approve the E&S Sale Transaction, and to recommend that our shareholders vote to approve the E&S Sale Transaction, the CSI board of directors considered certain factors as described below.

 

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The CSI board of directors discussed the fact that, prior to and throughout the course of its meetings and discussions leading up to the publicly announced merger with Pineapple, the CSI board of directors specifically contemplated dispositions of CSI’s current operations, and the CSI board of directors considered a number of factors regarding whether the proposed E&S Sale Transaction for the business of the E&S Segment (which comprises substantially all of the assets of CSI), was in the best interests of CSI’s current shareholders, including, but not limited to, the following factors:

 

the consideration we receive in the E&S Sale Transaction will enable CSI to deliver an attractive return on the CSI common stock, particularly considering:

 

othe historically low trading volume and resulting lack of liquidity in the CSI common stock, as well as the lack of dividends since June 2020 as we have reserved cash for operating and potential strategic growth activities;

 

othat because the E&S Sale Transaction will not alter the rights, privileges or nature of the issued and outstanding shares of our common stock, the E&S Sale Transaction will allow CSI shareholders the opportunity to receive an additional return from their continuing ownership of CSI common stock through CSI’s monetization of its other assets, such as the S&S Segment business and real estate holdings, and through the proposed CSI-Pineapple merger;

 

othe provisions of the merger agreement with Pineapple, which provides a framework that enables CSI to sell the business of the E&S Segment to Lantronix and distribute the net proceeds to the CSI shareholders prior to the proposed Pineapple merger;

 

the consideration we receive in the E&S Sale Transaction will provide us with substantial cash at closing, which we intend to combine with our other available cash resources to distribute to our shareholders a cash dividend of $3.50 per share or approximately $35.0 million, consistent with the strategy to monetize our assets for the benefit of the CSI shareholders existing prior to the effective date of the proposed merger with Pineapple;

 

the absence of any other, bona fide expression of interest in acquiring CSI as a whole, either prior to or after the announcement of the E&S Sale Transaction, that would allow us to deliver a comparably attractive return to the CSI shareholders as the E&S Sale Transaction giving consideration to the opportunities for future attractive returns to CSI shareholders from the net proceeds of CSI’s other businesses and property;

 

the timing of the signing of the securities purchase agreement for the E&S Sale Transaction in relation to the effective time of the proposed merger with Pineapple and, in particular, the fact that CSI shareholders will receive 100% of the net proceeds from the E&S Sale Transaction given the fact the securities purchase agreement was signed prior to the effective time of the Pineapple merger rather than 90% of the net proceeds from the E&S Sale Transaction if the securities purchase agreement were signed after the effective time of the Pineapple merger under the provisions of the merger agreement with Pineapple and the agreement governing the CVRs;

 

the CSI board of directors believed that the E&S Sale Transaction consideration, consisting of approximately $25.0 million base purchase price plus up to $7.0 million that may become payable to CSI upon achievement of the earnout, was the best price reasonably attainable for CSI shareholders after considering:

 

othe absence of any other, bona fide expression of interest in acquiring the E&S Segment on terms competitive with the proposal made by Lantronix, despite CSI publicly announcing its strategy to dispose of substantially all CSI’s operating and non-operating assets in connection with the announcement of the proposed merger with Pineapple on March 2, 2021;

 

othe improvement in the E&S Sale Transaction consideration proposed by Lantronix from $24.75 million in its revised preliminary non-binding letter of intent dated December 29, 2020 to approximately $25.0 plus the potential $7.0 million earnout, as well as the fact that CSI negotiated for improved payment terms by eliminating Lantronix’s proposed seller note in favor of an all-cash transaction;

 

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othe CSI board of directors’ belief, based on the nature of the negotiations, that the E&S Sale Transaction consideration is the highest amount that Lantronix was willing to pay and that the terms and conditions of the securities purchase agreement were, in the CSI board of directors’ view, the most favorable to us and our shareholders to which Lantronix was willing to agree;

 

othe E&S Sale Transaction consideration is payable in cash and the closing of the E&S Sale Transaction is not subject to any financing contingency, which provides greater certainty of value and liquidity to our shareholders;

 

othe relative uncertainty of the value that we may receive from the continued operation of the E&S Segment business as part of CSI in light of the meaningful risks involved in that alternative as compared to the certainty of the consideration CSI will receive in the E&S Sale Transaction;

 

the CSI board of directors believed that the potential $7.0 million that may become payable to CSI upon achievement of the earnout was the best alternative reasonably attainable for our shareholders to derive additional value from the E&S Segment for our shareholders after considering:

 

othe two successive 180-day periods for determining the earnout are relatively short, the periods fall within 2021 and 2022 of the five-year strategic plan for the E&S Segment, and the revenue targets for the business of the E&S Companies are consistent with the projected financial results reflected in the five-year strategic plan, which the CSI board of directors believed reduced the risk that the earnout would not be achieved as compared to a longer multi-year earnout period or periods at the end of the five-year projection period;

 

oa meaningful portion of the expected revenue in the earnout period relates to customer opportunities developed and cultivated by the CSI team and already included in the E&S Segment business pipeline;

 

othe revenue targets for the business of the E&S Companies are consistent with the projected financial results reflected for 2021 and 2022 in the five-year strategic plan, which the CSI board of directors believed was a reasonable allocation of risk relating to future revenue achievement as between CSI and Lantronix;

 

othe structure of the earnout with two performance periods and the sliding scale method of calculating the earnout further reduced the risk that CSI would not receive any additional purchase price in respect of the earnout;

 

after a review of the current and historical financial condition of the E&S Segment, its results of operations, prospects, business strategy, management team, competitive position, and the E&S Segment industry and the industries in which the E&S Segment customers operate, the CSI board of directors believed that the E&S Sale Transaction would enable the CSI board of directors to deliver a more favorable and attractive return to the CSI shareholders with the net proceeds at closing of the E&S Sale Transaction (including the opportunity for additional future returns to CSI’s shareholders through the earnout) than the potential value that might have resulted from possible alternatives to the E&S Sale Transaction, including continued operation of the E&S Segment business;

 

the CSI board of directors’ assessment over the last several years of the challenges and risks that we have faced, and would likely continue to face, if we continued a strategy of operating the E&S Segment business, including the challenges and risks that the CSI board of directors’ identified in its review of the five-year strategic plan for the E&S Segment approved on December 8, 2020, including:

 

odespite significant effort and investment, CSI and the E&S Segment have not achieved many of their business and financial objectives during the past several years;

 

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othe fact that many of the E&S Segment’s existing products are legacy products that are not expected to produce significant future revenue growth and may contribute a declining amount of revenues in future years;

 

othe fact that the financial results of the E&S Segment and CSI as a whole could be adversely affected if one or more of the E&S Segment’s larger customers substantially reduces its orders;

 

othe size of the E&S Segment business and its position in its primary markets, the stiff competition with respect to price and other factors faced by the E&S Segment business, including competition from larger, better-capitalized competitors that could engage in discounting to retain market share;

 

othe fact that substantial costs of remaining a public company, the level of corporate overhead expense and risk as a public company given CSI’s relatively small revenues and profits, combined with our investors’ expectations, which materially constrain our ability to invest significant additional amounts to accelerate new product development or to acquire new products for the E&S Segment without adversely affecting our profitability;

 

othe expense and risk associated with any acquisition strategy CSI has pursued and may pursue to achieve sustainable growth and profitability for the E&S Segment and to spread public company costs over substantially greater revenues, including lack of attractive acquisition candidates, substantial expense, risk that transactions will not be completed with corresponding expense incurred, risk that the acquisitions will not successfully deliver the growth and profitability we expect, integration risk and other risks;

 

oCSI’s ability to compete and increase revenues for the E&S Segment requires continual focus on delivering high-quality, innovative and competitively priced products and services and the regular introduction of new products and services that meet evolving customer requirements, but given the challenges and risks associated with our product development efforts, we cannot guarantee our ability to commercialize new E&S Segment products in a timely manner and generate substantial revenues from these products;

 

othe view of the CSI board of directors starting in December 2020 that continued independent operation of the E&S Segment likely would require the development and execution of a transformative plan in order to offset the limited prospects for significant growth in the E&S Segment (and, therefore, CSI as a whole) and to address the challenges we historically have experienced, the fact that any transformative plan would require significant changes in business strategy and significant additional investment in the E&S Segment, lead to operating losses for one or more years, reduce our cash reserves, and the other risks, challenges and uncertainties that would be associated with a transformative plan, including the risk that it would not overcome our current and future challenges;

 

the business of the E&S Segment would be better served and provided more substantial long-term growth opportunities in Lantronix, which can leverage synergies, expand into adjacent markets, add scale, and broaden its existing product lines, which may benefit CSI in the short-term through the potential to achieve the earnout;

 

the structure of the E&S Sale Transaction is expected, subject to final analysis, to allow us to use the net operating loss carryforwards for U.S. federal income tax purposes to offset a substantial part of the gain recognized in the E&S Sale Transaction;

 

the securities purchase agreement permits, subject to certain limitations, CSI to be contacted regarding, and potentially consider, other proposals to purchase the business of the E&S Segment that may represent a “superior proposal” to the terms offered by Lantronix pursuant to the securities purchase agreement; and

 

the opinion of Northland, dated April 27, 2021, to the CSI board of directors as to the fairness, from a financial point of view and as of the date of the opinion, to CSI of the Aggregate Purchase Price to be paid to CSI for the E&S Segment business pursuant to the securities purchase agreement, which opinion was based on and subject to various assumptions made, procedures followed, matters considered, limitations on the review undertaken and qualifications as more fully described below in the section entitled “Opinion of CSI’s Financial Advisor.”

 

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The CSI board also considered potential drawbacks and risks relating to the E&S Sale Transaction, including, but not limited to:

 

up to $7.0 million of the purchase price is structured in the form of an earnout based on revenues generated by Lantronix in the 360 days following closing, and there is no guaranty that sufficient revenues will be generated for the earnout to become payable to us;

 

the restrictions placed on our ability to actively solicit competing bids, and the insistence by Lantronix as a condition to its offer that CSI would be obligated to pay a termination fee of $875,000 under certain circumstances, and that the potential payment of this fee might deter other potential acquirors of the E&S Segment;

 

that the transaction may not close in the expected time period or any event, change or other circumstance that could give rise to the termination of the securities purchase agreement and termination of the E&S Sale Transaction;

 

that we cannot guarantee that the net proceeds from the E&S Sale Transaction or the net proceeds from the planned divestiture of any of our remaining assets (such as our S&S Segment and headquarters) will result in any specific dividend amount to CSI shareholders;

 

our ability to obtain shareholder approval for the E&S Sale Transaction, which requires approval by the holders of at least two-thirds of our common stock outstanding and entitled to vote on the E&S Sale Proposal;

 

conditions to the closing of the E&S Sale Transaction may not be satisfied or the sale may involve unexpected costs, liabilities or delays;

 

conditions to the closing of the previously announced CSI-Pineapple merger may not be satisfied or the merger may involve unexpected costs, liabilities or delays;

 

risks that the E&S Sale Transaction will disrupt current CSI plans and operations or that the business or stock price of CSI may suffer as a result of uncertainty surrounding the E&S Sale Transaction;

 

the outcome of any legal proceedings related to the E&S Sale Transaction or the CSI-Pineapple merger; and

 

the fact that CSI cannot yet determine the exact amount and timing of any pre-CSI-Pineapple merger cash dividends or the value of the CVRs that CSI intends to distribute to its shareholders immediately prior to the effective date of the CSI-Pineapple merger.

 

After taking into account the material factors relating to the securities purchase agreement and the E&S Sale Transaction, including those factors set forth above, the CSI board of directors unanimously concluded that the benefits of the securities purchase agreement and the E&S Sale Transaction outweigh the risks and that the securities purchase agreement and the E&S Sale Transaction are advisable and in the best interests of CSI and our shareholders. The CSI board of directors did not assign relative weights to the material factors it considered. In addition, the CSI board of directors did not reach any specific conclusion on each of the material factors considered, but conducted an overall analysis of all of the material factors. Individual members of the CSI board of directors may have given different weights to different factors.

 

For the reasons set forth above, the CSI board of directors has unanimously determined that the securities purchase agreement and the E&S Sale Transaction are advisable and in the best interests of our company and our shareholders, and unanimously recommends that shareholders vote “FOR” the E&S Sale Proposal.

 

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Opinion of CSI’s Financial Advisor

 

CSI has engaged Northland as financial advisor to CSI in connection with the proposed E&S Sale Transaction. In connection with Northland’s engagement, the CSI board of directors requested that Northland evaluate the fairness, from a financial point of view, to CSI of the Aggregate Purchase Price to be paid to CSI for the E&S Segment business pursuant to the securities purchase agreement. At a meeting of the CSI board of directors held on April 27, 2021 to evaluate the proposed E&S Sale Transaction, Northland rendered an oral opinion, confirmed by delivery of a written opinion dated April 27, 2021, to the CSI board of directors to the effect that, as of that date and based on and subject to various assumptions made, procedures followed, matters considered, limitations on the review undertaken and qualifications, the Aggregate Purchase Price to be paid to CSI for the E&S Segment business pursuant to the securities purchase agreement was fair, from a financial point of view, to CSI.

 

The full text of Northland’s written opinion, dated April 27, 2021, which describes the assumptions made, procedures followed, matters considered, limitations on the review undertaken and qualifications, is attached as Appendix B to this proxy statement and is incorporated herein by reference. The description of Northland’s opinion set forth below is qualified in its entirety by reference to the full text of Northland’s opinion. Northland’s opinion was directed to the CSI board of directors (in its capacity as such) in connection with its evaluation of the Aggregate Purchase Price from a financial point of view to CSI and did not address any other terms, aspects or implications of the E&S Sale Transaction. Northland was not requested to opine as to, and its opinion did not address, the basic business decision of CSI to proceed with or effect the E&S Sale Transaction. Northland expressed no opinion or view as to the relative merits of the E&S Sale Transaction as compared to any alternative business strategies or transactions that might exist for the E&S Segment business or CSI or the effect of any other transaction in which CSI or TNI and TN Europe might engage. Northland’s opinion is not intended to be and does not constitute a recommendation to the CSI board of directors or to any shareholder as to how to act or vote with respect to the E&S Sale Transaction or any other matter.

 

In arriving at its opinion, Northland:

 

reviewed the financial terms of the execution version, provided to Northland on April 27, 2021, of the securities purchase agreement;

 

reviewed certain business, financial and other information and data relating to the E&S Segment business publicly available or made available to Northland from internal records of CSI;

 

reviewed certain internal financial projections and estimates relating to the E&S Segment business furnished to Northland by the management of CSI;

 

conducted discussions with members of the senior management of CSI with respect to the E&S Segment business and its prospects;

 

compared the financial performance of the E&S Segment business with that of certain publicly traded companies Northland deemed relevant in evaluating the E&S Segment business;

 

reviewed the financial terms, to the extent publicly available, of certain acquisition transactions Northland deemed relevant in evaluating the E&S Sale Transaction; and

 

conducted a discounted cash flow analysis of the E&S Segment business based on the financial projections and estimates referred to above provided by the management of CSI.

 

In addition, Northland conducted such other analyses, examinations and inquiries and considered such other financial, economic and market criteria as it deemed necessary and appropriate in arriving at its opinion.

 

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In conducting its review and in rendering its opinion, Northland relied upon and assumed, without independent verification, the accuracy and completeness of all financial, accounting and other information furnished or otherwise made available to Northland, discussed with or reviewed by Northland, or publicly available, and did not assume any responsibility with respect to any such information. Northland also relied upon the assurances of the management of CSI that such management was not aware of any information or facts that would make the information provided to Northland incomplete or misleading. In addition, the management of CSI advised Northland, and Northland assumed, that the financial projections and estimates reviewed by Northland were reasonably prepared in good faith on bases reflecting the best currently available estimates and judgments of such management as to, and were an appropriate basis upon which to evaluate, the future financial results and condition of the E&S Segment business and the other matters covered thereby. Northland also assumed that there was no change in the assets, liabilities, financial condition, results of operations, cash flows or prospects of the E&S Segment business since the dates of the most recent financial statements and other information, financial or otherwise, provided to Northland that would be meaningful in any respect to its analyses or opinion. For purposes of Northland’s analyses and opinion, Northland further assumed, at the direction of CSI and consistent with the financial projections and estimates provided by the management of CSI, that the full Earnout Amount will be received. Northland expressed no opinion or view with respect to any projections, estimates or other financial information provided to or reviewed by Northland or the assumptions on which they were based.

 

Northland relied upon the assessments of the management of CSI as to, among other things, (i) the potential impact on the E&S Segment business of macroeconomic, geopolitical, market, competitive and other conditions, trends and developments in and prospects for, and governmental, regulatory and legislative matters relating to or otherwise affecting, the electronics and software industry and the internet connectivity products sector thereof, (ii) implications for the E&S Segment business of the global COVID-19 pandemic, and (iii) the existing and future agreements and other arrangements involving, and ability to attract, retain and/or replace, key employees, customers, manufacturers, suppliers distributors, resellers, integrators, and other commercial relationships of the E&S Segment business. Northland assumed that there would be no developments with respect to any such matters, or any adjustments to or allocations of the Aggregate Purchase Price, that would be meaningful in any respect to its analyses or opinion.

 

Northland assumed that the executed securities purchase agreement would be substantially similar to the execution version reviewed by Northland, without modification of material terms or conditions. Northland also assumed that the representations and warranties contained in the securities purchase agreement were true and correct and that each party will perform all of the covenants and agreements required to be performed by it under the securities purchase agreement. Northland further assumed that the E&S Sale Transaction will be consummated in accordance with its terms and in compliance with all applicable laws, documents and other requirements, without waiver, modification or amendment of any material term, condition or agreement, and that, in the course of obtaining the necessary governmental, regulatory or third party approvals, consents, releases, waivers and agreements for the E&S Sale Transaction or otherwise, no delay, limitation, restriction, condition or other action, including any divestiture or other requirements, amendments or modifications, will be imposed or occur that would be meaningful in any respect to Northland’s analyses or opinion.

 

Northland did not perform any appraisals or evaluations of any specific assets or liabilities (fixed, contingent, accrued, derivative, off-balance sheet or otherwise) of the E&S Segment business, CSI or its affiliates or any other business or entity and Northland was not furnished with any such appraisals or evaluations, and Northland made no physical inspection of the property or assets of the E&S Segment business, CSI or its affiliates or any other business or entity. Northland did not evaluate the solvency, or liquidation or fair value, of the E&S Segment business, CSI or its affiliates or any other business or entity under any state, federal or other applicable laws relating to bankruptcy, insolvency or similar matters. Northland also did not undertake any independent analysis of any pending or threatened litigation, governmental proceedings or investigations, possible unasserted claims or other contingent liabilities involving the E&S Segment business, CSI or its affiliates or any other business or entity or to which they may be subject and Northland made no assumption concerning, and its opinion did not consider, the potential impact of any claims, outcomes, damages, costs, recoveries or other aspects relating to any such matters.

 

Northland’s opinion was necessarily based upon the financial, market, economic and other conditions that existed on, and the information made available to Northland as of, the date of such opinion. Subsequent developments may affect Northland’s opinion and Northland disclaimed and disclaims any undertaking or obligation to advise any person of any change in any fact or matter affecting its opinion which may come or be brought to its attention after the date of its opinion. Northland did not undertake to reaffirm or revise its opinion or otherwise comment upon any events occurring after the date of its opinion and does not have any obligation to update, revise or reaffirm its opinion. As the CSI board of directors was aware, the credit, financial and stock markets have from time to time experienced unusual volatility and Northland expressed no opinion or view as to any potential effects of such volatility on the E&S Segment business, CSI or its affiliates, Lantronix or the E&S Sale Transaction and its opinion did not purport to address potential developments in any such markets.

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Northland’s opinion addressed only the fairness, from a financial point of view and as of the date of such opinion, to CSI of the Aggregate Purchase Price (to the extent expressly set forth therein) and did not address any other terms, aspects or implications of the E&S Sale Transaction, including, without limitation, the form or structure of the Aggregate Purchase Price or the E&S Sale Transaction, any adjustments to or allocations of the Aggregate Purchase Price, or any terms, aspects or implications of any transition services agreement, indemnification arrangements or any other agreement, arrangement or understanding to be entered into in connection with or contemplated by the E&S Sale Transaction or otherwise. Northland was not asked to, and its opinion did not, address the fairness, financial or otherwise, of any consideration to the holders of any class of securities, creditors or other constituencies of CSI or any other party. Northland expressed no opinion or view as to the amount, nature or fairness of the consideration or compensation to be received in or as a result of the E&S Sale Transaction by officers, directors or employees of CSI, or any class of such persons, relative to or in comparison with the Aggregate Purchase Price or otherwise. Northland also expressed no opinion or view as to the prices at which CSI common stock may trade, or the prices at which the Purchased Securities may be transferable, at any time.

 

Northland was not requested to opine as to, and its opinion did not address, the basic business decision of CSI to proceed with or effect the E&S Sale Transaction. Northland expressed no opinion or view as to the relative merits of the E&S Sale Transaction as compared to any alternative business strategies or transactions that might exist for the E&S Segment business or CSI or the effect of any other transaction in which CSI or TNI or TN Europe might engage. Northland did not render any financial, legal, accounting or other advice and Northland relied on the assumptions of the management of CSI as to all accounting, tax, regulatory, legal and similar matters with respect to the E&S Segment business and the securities purchase agreement, including, without limitation, as to tax or other consequences of the E&S Sale Transaction or otherwise or changes in, or the impact of, accounting standards or tax and other laws, regulations and governmental and legislative policies affecting the E&S Segment business, CSI or its affiliates or the E&S Sale Transaction and Northland assumed that CSI obtained advice as to such matters from appropriate professionals. The issuance of Northland’s opinion was approved by the Northland Fairness Opinion Committee.

 

In accordance with customary investment banking practice, Northland employed generally accepted financial analyses in reaching its opinion. The preparation of analyses and an opinion is a complex analytic process involving various determinations as to the most appropriate and relevant methods of financial analysis and the application of those methods to the particular circumstances and is not necessarily susceptible to partial analysis or summary description. The summary set forth below does not contain a complete description of the analyses performed by Northland, but does summarize the material analyses performed by Northland in rendering its opinion. Northland believes that its analyses and the summary set forth below must be considered as a whole and in context and that selecting portions of its analyses or of the summary, without considering the analyses as a whole or all of the factors included in its analyses, would create an incomplete view of the processes underlying Northland’s financial analyses and opinion. In arriving at its opinion, Northland considered the results of all of its analyses and did not attribute any particular weight to any factor or analysis. Instead, Northland made its determination as to fairness on the basis of its experience and financial judgment after considering the results of all of its analyses. The fact that any specific analysis has been referred to in the summary below is not meant to indicate that this analysis was given greater weight than any other analysis. In addition, the reference ranges resulting from any particular analysis described below should not be taken to be Northland’s view of the actual value of the E&S Segment business.

 

No company, business or transaction used in the analyses described below is identical or directly comparable to the E&S Segment business or the E&S Sale Transaction. Accordingly, an evaluation of these analyses or methodologies is not mathematical; rather, it involves complex considerations and judgments concerning financial and operating characteristics and other factors that could affect the acquisition, public trading or other values of the companies, businesses or transactions reviewed or the results from any particular analysis or methodology.

 

Northland performed its analyses solely for purposes of providing its opinion to the CSI board of directors. In performing its analyses, Northland made numerous assumptions with respect to industry performance, general business and economic conditions and other matters. Certain of the analyses performed by Northland are based upon forecasts of future results furnished to Northland, which are not necessarily indicative of actual future results and may be significantly more or less favorable than actual future results. These forecasts are inherently subject to uncertainty because, among other things, they are based upon numerous factors or events beyond the control of the parties to the E&S Sale Transaction or their respective advisors. Northland does not assume responsibility if future results are materially different from forecasted results.

 

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The Aggregate Purchase Price was determined through arm’s-length negotiations between CSI and Lantronix and was approved by the CSI board of directors. Northland did not recommend any specific consideration to CSI or the CSI board of directors or suggest that any specific consideration constituted the only appropriate consideration for the E&S Sale Transaction, including but not limited to, the Aggregate Purchase Price. In addition, Northland’s opinion and financial analyses were one of many factors taken into consideration by the CSI board of directors in deciding to approve the E&S Sale Transaction.

 

Financial Analyses

 

The summary of the financial analyses described below under this heading “—Financial Analyses” is a summary of the material financial analyses reviewed with the CSI board of directors and performed by Northland in connection with its opinion, dated April 27, 2021. The summary set forth below does not purport to be a complete description of the financial analyses performed by, and underlying the opinion of, Northland, nor does the order of the financial analyses described represent the relative importance or weight given to those financial analyses by Northland. Certain financial analyses summarized below include information presented in tabular format. In order to fully understand the financial analyses, the tables must be read together with the text of each summary as the tables alone do not constitute a complete description of the financial analyses. Considering the data in the tables below without considering the full narrative description of the financial analyses, including the methodologies and assumptions underlying the financial analyses, could create a misleading or incomplete view of such financial analyses. Future results may be different from those described and such differences may be material.

 

Selected Public Companies Analysis. Northland performed a selected public companies analysis of the E&S Segment business in which Northland reviewed certain financial information relating to the E&S Segment business and certain financial and stock market information for the following 12 selected publicly traded technology hardware or communications equipment companies with market capitalizations of up to $300 million that Northland considered generally relevant for purposes of analysis, consisting of seven such companies for which forward-looking estimates from Wall Street research analysts were available, collectively referred to in this subsection as the “selected companies with forward-looking estimates,” and five such companies for which forward-looking estimates from Wall Street research analysts were unavailable, collectively referred to in this subsection as the “selected companies without forward-looking estimates” and, together with the selected companies with forward-looking estimates, the “selected companies:”

 

Selected Companies with Forward-Looking Estimates Selected Companies without Forward-Looking Estimates
●     Applied Optoelectronics, Inc. ●     BK Technologies Corporation
●     Daktronics, Inc. ●     Richardson Electronics, Ltd.
●     KVH Industries, Inc. ●     The LGL Group, Inc.
●     PCTEL, Inc. ●     UTStarcom Holdings Corp.
●     RADCOM Ltd. ●     Wayside Technology Group, Inc.
●     RF Industries, Ltd.  
●     TESSCO Technologies Incorporated  

 

Northland reviewed, among other information and to the extent publicly available and meaningful, enterprise values of the selected companies, calculated as implied equity values based on closing stock prices on April 26, 2021 plus total debt, preferred equity and non-controlling interests (as applicable) and less cash and cash equivalents, as multiples of such companies’ (i) most recent publicly reported last 12 months, referred to in this subsection as “LTM,” revenue and calendar years 2021 and 2022 estimated revenue, and (ii) LTM earnings before interest, taxes, depreciation and amortization, referred to as “EBITDA,” adjusted for stock-based compensation expense and one-time non-recurring items, referred to as “adjusted EBITDA,” and calendar years 2021 and 2022 estimated EBITDA. Financial data of the selected companies were based on publicly available Wall Street research analysts’ estimates, public filings and other publicly available information. Financial data for the E&S Segment business was based on financial projections and estimates of CSI’s management and public filings.

 

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The overall low to high, and first and third quartile, LTM revenue and calendar years 2021 and 2022 estimated revenue multiples and LTM adjusted EBITDA and calendar years 2021 and 2022 estimated EBITDA multiples observed for the selected companies with forward-looking estimates were as follows:

 

Revenue multiples:

 

oLTM revenue multiples: low to high of 0.2x to 1.7x, first and third quartiles of 0.8x and 1.5x, respectively (with a mean of 1.1x and a median of 1.3x)

 

oCalendar year 2021 estimated revenue multiples: low to high of 0.3x to 1.6x, first and third quartiles of 0.7x and 1.4x, respectively (with a mean of 1.0x and a median of 1.1x)

 

oCalendar year 2022 estimated revenue multiples: low to high of 0.2x to 1.5x, first and third quartiles of 0.5x and 1.2x, respectively (with a mean of 0.9x and a median of 1.1x)

 

EBITDA multiples:

 

oLTM adjusted EBITDA multiples: low to high of 6.7x to 10.2x, first and third quartiles of 7.6x and 9.3x, respectively (with a mean and median of 8.4x)

 

oCalendar year 2021 estimated EBITDA multiples: low to high of 6.7x to 26.7x, first and third quartiles of 10.5x and 17.4x, respectively (with a mean of 14.9x and a median of 13.0x)

 

oCalendar year 2022 estimated EBITDA multiples: low to high of 6.1x to 18.8x, first and third quartiles of 7.8x and 13.1x, respectively (with a mean of 11.1x and a median of 9.8x)

 

The overall low to high, and first and third quartile, LTM revenue multiples and LTM adjusted EBITDA multiples observed for the selected companies without forward-looking estimates were as follows:

 

LTM revenue multiples: low to high of 0.3x to 1.5x, first and third quartiles of 0.4x and 1.4x, respectively (with a mean of 0.9x and a median of 1.2x)

 

LTM adjusted EBITDA multiples: low to high of 11.6x to 22.6x, first and third quartiles of 12.8x and 17.5x, respectively (with a mean of 15.8x and a median of 14.5x)

 

Northland then applied the first and third quartiles of the revenue, adjusted EBITDA and EBITDA multiples described above derived from the selected companies with forward-looking estimates and derived from the selected companies without forward-looking estimates, as applicable, to the LTM revenue and adjusted EBITDA, and calendar year 2021 and calendar year 2022 estimated revenue and adjusted EBITDA, as the case may be, of the E&S Segment business. This analysis indicated the following approximate implied aggregate enterprise value reference ranges for the E&S Segment business, as compared to the Aggregate Purchase Price:

 

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Selected Companies with Forward-Looking Estimates   Aggregate Purchase Price

 

Implied Aggregate Enterprise Value Reference Ranges Based on:

 

 

$32,027,566

LTM Revenue
 
CY2021E Revenue
 
CY2022E Revenue
 
$28.1 million – $50.6 million   $27.2 million – $54.4 million   $23.2 million – $54.0 million  

LTM Adjusted EBITDA
 
CY2021E Adjusted EBITDA
 
CY2022E Adjusted EBITDA
 
$6.3 million – $7.8 million   $29.1 million – $48.4 million   $32.8 million – $55.3 million  

 

Selected Companies without Forward-Looking Estimates 

 

 

Implied Aggregate Enterprise Value Reference Ranges Based on:

 

 

LTM Revenue
 
LTM Adjusted EBITDA
 
$14.4 million – $47.1 million   $10.7 million – $14.6 million  
                 

Selected Precedent Transactions Analysis. Using publicly available information, Northland reviewed financial data relating to the following 20 selected transactions that Northland considered generally relevant for purposes of analysis as transactions that closed during the three-year period prior to April 26, 2021 involving target companies with operations in the technology hardware or communications equipment industry and enterprise values of $20 million to $125 million, collectively referred to in this subsection as the “selected precedent transactions:”

 

Closed Acquiror Target
●     December 2020 ●     Securitas AB ●     FE Moran Security Solutions
●     July 2020 ●     Standex International Corporation ●     Renco Electronics, Inc.
●     June 2020 ●     Motorola Solutions, Inc. ●     IndigoVision Group plc
●     January 2020 ●     Lantronix, Inc. ●     Intrinsyc Technologies Corporation
●     December 2019 ●     QinetiQ Group plc ●     Manufacturing Techniques, Inc.
●     July 2019 ●     Services Volex plc ●     Servatron, Inc.
●     July 2019 ●     Astronics Corporation ●     Freedom Communication Technologies, Inc.
●     July 2019 ●     Casa Systems, Inc. ●     NetComm Wireless Limited
●     May 2019 ●     MSA Safety Incorporated ●     Sierra Monitor Corporation
●     January 2019 ●     AGC Networks Pte. Limited ●     Black Box Corporation
●     December 2018 ●     Reliance Industries Limited ●     Radisys Corporation
●     November 2018 ●     The Vitec Group plc ●     AMIMON, Inc.
●     November 2018 ●     SMTC Corporation ●     MC Test Service, Inc.
●     October 2018 ●     Standex International Corporation ●     Agile Magnetics, Inc.
●     September 2018 ●     Adesto Technologies Corporation ●     Echelon Corporation
●     September 2018 ●     Sangoma Technologies US Inc. ●     Digium, Inc.
●     September 2018 ●     II-VI Incorporated ●     CoAdna Holdings, Inc.
●     August 2018 ●     Ribbon Communications Inc. ●     Edgewater Networks Inc.
●     June 2018 ●     SMART Global Holdings, Inc. ●     Penguin Computing, Inc.
●     April 2018 ●     TT Electronics plc ●     Stadium Group plc

 

Northland reviewed transaction values in the selected precedent transactions, based on the consideration paid in such transactions, as multiples of the target company’s (i) LTM revenue and next 12 months, referred to as “NTM,” estimated revenue available as of the closing date of the relevant transaction, and (ii) LTM adjusted EBITDA and NTM estimated EBITDA available as of the closing date of the relevant transaction. Financial data of the selected precedent transactions were based on publicly available Wall Street research analysts’ estimates and public filings. Financial data of the E&S Segment business was based on financial projections and estimates of CSI’s management and public filings.

 

The overall low to high, and first and third quartile, LTM revenue and NTM estimated revenue multiples and LTM adjusted EBITDA and NTM estimated EBITDA multiples observed for the selected precedent transactions were as follows:

 

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Revenue multiples:

 

oLTM revenue multiples: low to high of 0.1x to 3.0x, first and third quartiles of 0.7x and 1.6x, respectively (with a mean of 1.2x and a median of 0.9x)

 

oNTM estimated revenue multiples: low to high of 0.7x to 1.0x, first and third quartiles of 0.8x and 1.0x, respectively (with a mean of 0.9x and a median of 1.0x)

 

EBITDA multiples:

 

oLTM adjusted EBITDA multiples: low to high of 4.3x to 58.6x, first and third quartiles of 10.6x and 26.2x, respectively (with a mean of 21.6x and a median of 11.8x)

 

oNTM estimated EBITDA multiples: low to high of 9.3x to 13.9x, first and third quartiles of 9.5x and 11.1x, respectively (with a mean of 10.7x and a median of 9.8x)

 

Northland then applied the first and third quartiles of the LTM revenue and NTM estimated revenue multiples described above derived from the selected precedent transactions to the calendar year 2020 (LTM) revenue and the calendar year 2021 (NTM) estimated revenue of the E&S Segment business, respectively, and applied the first and third quartiles of the LTM adjusted EBITDA and NTM estimated EBITDA multiples described above derived from the selected precedent transactions to the calendar year 2020 (LTM) adjusted EBITDA and calendar year 2021 (NTM) estimated adjusted EBITDA of the E&S Segment business, respectively. This analysis indicated the following approximate implied aggregate enterprise value reference ranges for the E&S Segment business, as compared to the Aggregate Purchase Price:

 

Implied Aggregate Enterprise Value Reference Ranges Based on:   Aggregate Purchase Price

LTM Revenue
 
NTM Estimated Revenue
   
$25.7 million – $54.6 million   $30.0 million – $39.4 million    
    $32,027,566
LTM Adjusted EBITDA   NTM Estimated Adjusted EBITDA    
$8.8 million – $21.9 million   $26.4 million – $30.8 million    

 

Discounted Cash Flow Analysis. Northland performed a discounted cash flow analysis of the E&S Segment business by calculating the estimated present value (as of April 26, 2021) of the stand-alone unlevered, after-tax free cash flows that the E&S Segment business was forecasted to generate during the calendar years ending December 31, 2021 through December 31, 2025 based on financial projections and estimates of CSI’s management. For purposes of this analysis, net operating loss carryforwards expected by CSI’s management to be utilized were taken into account. Northland calculated implied terminal values for the E&S Segment business by applying to the calendar year 2025 estimated unlevered, after-tax free cash flow of the E&S Segment business a selected range of perpetuity growth rates of 0.0% to 4.0%. The present values (as of April 26, 2021) of the cash flows and terminal values were then calculated using a selected range of discount rates of 14.7% to 17.7%. This analysis indicated the following first quartile to third quartile approximate implied aggregate enterprise value reference range for the E&S Segment business, as compared to the Aggregate Purchase Price:

 

Implied Aggregate Enterprise Value Reference Range   Aggregate Purchase Price
$29.3 million – $36.2 million   $32,027,566

 

Miscellaneous

 

CSI has agreed to pay Northland for its services in connection with the E&S Sale Transaction an aggregate fee currently estimated to be approximately $901,000, of which $200,000 was payable upon delivery of Northland’s opinion, approximately $526,000 is payable contingent upon consummation of the E&S Sale Transaction and up to $175,000 is payable contingent on CSI’s receipt of the earnout portion of the purchase price. In addition, CSI agreed to reimburse Northland for expenses, including fees and expenses of counsel, and to indemnify Northland against certain liabilities, including liabilities under federal securities laws, arising from Northland’s engagement.

 

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In the ordinary course of business, Northland and its affiliates may actively trade securities of CSI, Lantronix or their respective affiliates for their own account or the account of their customers and, accordingly, may at any time hold a long or short position in such securities. Northland in the past provided financial advisory services to CSI and/or certain of its affiliates and may continue to do so, and received, and may receive, fees for the rendering of such services, including, during the approximately two-year period prior to the date of its opinion, having acted or acting as financial advisor to CSI and certain of its affiliates in connection with certain minority investments and acquisition and sale transactions, for which services Northland and its affiliates received or expect to receive fees of approximately $4.2 million. Although Northland did not in the two-year period prior to the date of its opinion provide financial advisory or financing services to Lantronix, Northland may provide such services to Lantronix and its affiliates in the future and may receive fees for the rendering of such services.

 

Consistent with applicable legal and regulatory requirements, Northland has adopted policies and procedures to establish and maintain the independence of Northland’s research department and personnel. As a result, Northland’s research analysts may hold opinions, make statements or recommendations, and/or publish research reports with respect to CSI and the E&S Sale Transaction and other participants in the E&S Sale Transaction that differ from the views of Northland’s investment banking personnel.

 

Northland is a nationally recognized investment banking firm and, as a customary part of its investment banking business, is continually engaged in performing financial analyses with respect to businesses and their securities in connection with mergers and acquisitions, negotiated underwritings, competitive biddings, secondary distributions of listed and unlisted securities, private placements and other transactions as well as for estate, corporate and other purposes. CSI selected Northland as its financial advisor on the basis of Northland’s familiarity with CSI and Northland’s experience and reputation in connection with mergers, acquisitions and other similar transactions.

 

Projected Financial Results

 

Each year our management provides the CSI board of directors certain estimates of projected financial results as part of our budget and planning processes. Our management also provided certain projected financial results to parties that participated in the competitive sale process relating to the E&S Segment business, including Lantronix and its financial advisor. The projected results set forth below are included in this proxy statement only because this information was presented to and discussed with the CSI board of directors as part of its consideration of the E&S Sale Transaction. The projected financial results were provided to Northland, the CSI board’s financial advisor, for its use and reliance in connection with Northland’s financial analyses and opinion as described in the section entitled “Opinion of CSI’s Financial Advisor.”

 

The projected results described below were prepared by management of CSI and were not prepared with a view towards public disclosure. These projections do not purport to present the results of operations in accordance with generally accepted accounting principles. Our independent auditors have not examined or compiled the projections and accordingly, assume no responsibility for them. CSI’s internal financial projections are, in general, prepared solely for internal use and budgeting and other management decisions and are subjective in many respects and thus susceptible to interpretations and periodic revision based on actual experience and business developments. The projections also reflect numerous assumptions made by our management with respect to the financial performance of the E&S Segment business as part of Communications Systems, Inc., the allocation of costs for shared services, the continuing effects of competition, industry performance, general business, economic, market and financial conditions, and other matters, all of which are difficult to predict and many of which are beyond CSI’s control. Accordingly, there can be no assurance that the projected financial results would be necessarily realized, including if CSI retained the E&S Segment business.

 

Set forth below are projected financial results of certain income statement measures for the E&S Segment business for the fiscal years ending December 31, 2021 through December 31, 2025 (may reflect rounding). Selling, general and administrative expense (SG&A) below includes an allocation to the E&S Segment business of corporate shared services costs for finance, human resources, information technology, and facility.

 

The projected financial results below include adjusted EBITDA, a financial measure that is not prepared in accordance with generally accepted accounting principles in the United States (non-GAAP), which excludes interest, taxes, depreciation and amortization from net income, as well as stock-based compensation expense. For the purposes of the projected financial results, CSI calculated adjusted EBITDA below by starting with operating income for the E&S Segment, which does not include the impact of interest or taxes, and adding back depreciation, amortization and stock-based compensation expense.

 

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We have reconciled the non-GAAP financial measure used in each of projected financial results with the most directly comparable GAAP financial measure below. CSI management believes that the non-GAAP financial measure not only provides CSI management with comparable financial data for internal financial analysis but also allows investors to better understand the performance of CSI’s E&S Segment business on a period-over-period basis from the same perspective as management. However, other companies may calculate these non-GAAP financial measures differently than CSI does. Investors should not consider the non-GAAP financial measures in isolation or as a substitute for analysis of CSI’s results or projections as reported under GAAP. CSI’s presentation of non-GAAP financial measures should not be construed to imply that CSI’s future results will be unaffected by the adjustments made to calculate adjusted EBITDA, such as interest, taxes, depreciation, amortization, and stock-based compensation expense.

 

    2021E   2022E   2023E   2024E   2025E
Revenue   $39,435,000    $43,200,867    $47,352,471    $52,452,332    $57,697,565 
Product Profit   $22,593,000    $25,013,302    $28,032,663    $31,995,923    $35,830,188 
Product Margin   57.3%   57.9%   59.2%   61.0%   62.1%

 

 

    2021E 

% of Sales

    2022E 

% of Sales

    2023E 

% of Sales 

    2024E 

% of Sales

    2025E 

% of Sales

 
Revenue  $39,435,000       $43,201,000       $47,352,000       $52,452,000       $57,698,000     
Product Margin   22,593,000   57%   25,013,000   58%   28,033,000   59%   31,996,000   61%   35,830,000   62%
Other Cost of Goods Sold   4,450,000   11%   4,568,000   11%   4,854,000   10%   5,084,000   10%   5,440,000   9%
Gross Margin   18,143,000   46%   20,446,000   47%   23,179,000   49%   26,911,000   51%   30,390,000   53%
SG&A   15,655,000   40%   16,516,000   38%   17,578,000   37%   18,736,000   36%   20,297,000   35%
Operating Income  $2,488,000   6%  $3,930,000   9%  $5,601,000   12%  $8,176,000   16%  $10,093,000   17%
                                              
Reconciliation of Operating Income to Adjusted EBITDA:                                             
Depreciation and Amortization  $200,000       $200,000       $200,000       $200,000       $200,000     
Stock-Based Compensation  $100,000       $100,000       $100,000       $100,000       $100,000     
Adjusted EBITDA  $2,788,000       $4,230,000       $5,901,000       $8,476,000       $10,393,000     

 

 

The projected results described above were not prepared with a view to public disclosure or compliance with published guidelines of the Securities and Exchange Commission or the guidelines established by the American Institute of Certified Public Accountants regarding forecasts or projections. These projections are forward-looking statements and are based on expectations and assumptions at the time they were prepared by management. The projections above involve risks and uncertainties that could cause actual outcomes and results to differ materially from such expectations, including risks and uncertainties described under “CAUTION CONCERNING FORWARD-LOOKING STATEMENTS” and “RISK FACTORS.” There can be no assurance that the assumptions and adjustments made in preparing the projected financials results above will prove appropriate, or that the projected financial results necessarily will be realized. There will be differences between actual and projected results, and actual results may be materially greater or less than those contained in the projected results above. The inclusion of these projections should not be regarded as an indication that CSI or its affiliates or representatives, considered or consider the projections to be an actual prediction of future events, and the projections should not be relied upon as such. Neither CSI nor its affiliates or representatives has made or makes any representations to any person regarding the ultimate performance of CSI or the E&S Segment business compared to the information contained in the projected financial results, and none of them intends to provide any update or revision thereof.

 

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Financing

 

Lantronix estimates that approximately $26.0 million will be required to complete the E&S Sale Transaction. Lantronix anticipates that these amounts will be funded with bank financing in accordance with the commitment letter from Silicon Valley Bank and the commitment letter from SVB Innovation Credit Fund VIII, L.P., each dated April 28, 2021 and issued to Lantronix (together, the “commitment letters”), and cash on hand of Lantronix. The securities purchase agreement provides that in no event will the receipt by, or the availability of any funds or financing to, Lantronix or any other financing be a condition to the obligation of Lantronix to consummate the E&S Sale Transaction. Pursuant to the securities purchase agreement, Lantronix has delivered to us copies of the commitment letters and the corresponding fee letters.

 

Pursuant to the commitment letters, Lantronix intends to (a) refinance all existing indebtedness of Lantronix and Lantronix Holding Company, a Delaware corporation, owing to Silicon Valley Bank, and (b) finance the E&S Sale Transaction, costs and expenses related to the E&S Sale Transaction and the ongoing working capital and other general corporate purposes of Lantronix, the E&S Companies and their subsidiaries after consummation of the E&S Sale Transaction, from, among others, the following sources: (i) up to $20,000,000 in senior secured credit facilities comprised of (A) a term loan facility in an aggregate principal amount equal to $17,500,000 and (B) a revolving credit facility of up to $2,500,000, and (ii) a $12,000,000 junior secured credit facility provided by SVB Innovation Credit Fund VIII, L.P. The commitments contained in the commitment letters expire on August 31, 2021.

 

Under the commitment letters, (a) Silicon Valley Bank will have a first priority perfected security interest in substantially all assets of Lantronix and its affiliates (including the E&S Companies after the closing of the E&S Sale Transaction), including intellectual property, and (b) SVB Innovation Credit Fund VIII, L.P. will have a perfected security interest in substantially all assets of Lantronix and its affiliates (including the E&S Companies after the closing of the E&S Sale Transaction), including intellectual property. Such collateral will also include a stock pledge equal to 65% of the shares of material foreign subsidiaries that are not borrowers or guarantors.

 

The commitment letters are subject to standard closing conditions, including (a) the negotiation, execution and delivery of final loan documentation, (b) evidence of certain filings, recordings and endorsements, (c) delivery of satisfactory opinions of counsel and evidence of lien and security interests, (d) delivery of certain pro forma consolidated financial statements as to the borrower and its subsidiaries, (e) delivery of a quality of earnings report from the E&S Companies and borrower and its subsidiaries, (f) final terms and conditions of the E&S Sale Transaction documents, (g) payment of all fees and expenses of Silicon Valley Bank and SVB Innovation Credit Fund VIII, L.P., (h) a bring-down in the accuracy of all representations and warranties in the loan documentation as of the funding date and (i) that no event of default or material adverse change has occurred.

 

When the E&S Sale Transaction is Expected to be Completed

 

We expect to complete the E&S Sale Transaction promptly after all of the closing conditions in the securities purchase agreement, including approval of the E&S Sale Proposal by our shareholders. Subject to the uncertainty concerning the satisfaction or waiver of these conditions, we expect the E&S Sale Transaction to close by August 31, 2021. However, there can be no assurance that the E&S Sale Transaction will be completed at all or, if completed, when it will be completed.

 

Effects on Our Company if the E&S Sale Transaction is Completed and the Nature of Our Business Following the Transaction

 

If the E&S Sale Transaction is completed, we will no longer conduct the E&S Segment business, and will be prevented by the securities purchase agreement from competing with the E&S Segment business for a period of five years.

 

Prior to and after the closing of the E&S Sale Transaction, we expect to continue our efforts to divest substantially all our current operating and non-operating assets as part of our planned strategy to monetize our assets for the benefit of the CSI shareholders existing prior to the effective date of the proposed merger with Pineapple. Prior to and after the closing of the E&S Sale Transaction, we also plan on continuing to pursue the proposed merger with Pineapple. A meeting of the Company’s shareholders to approve the merger agreement with Pineapple is expected to be held later in 2021. There can be no assurance that the proposed merger with Pineapple will be completed or completed within any specific timeframe. The E&S Sale Transaction is not conditioned upon the Pineapple merger in any way.

 

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The E&S Sale Transaction will not alter the rights, privileges or nature of the issued and outstanding shares of our common stock. A shareholder who owns shares of our common stock immediately prior to the closing of the E&S Sale Transaction will continue to hold the same number of shares immediately following the closing. A meeting of the Company's shareholders to approve the merger agreement with Pineapple is expected to be held later in 2021. If the merger is approved by our shareholders, upon shareholders of CSI as of immediately prior to the closing of the merger with Pineapple will receive one non-transferable contingent value right (CVR) for each outstanding share of common stock of CSI held as of the close of business on the day immediately before the effective time (as defined in the agreement governing the CVRs). The E&S Sale Transaction will not change the number of CVRs a shareholder of CSI as of immediately prior to the closing of the merger with Pineapple would receive under the agreement governing the CVRs.

 

Our SEC reporting obligations as a public company will not be affected as a result of completing the E&S Sale Transaction. We believe that immediately after the E&S Sale Transaction we will continue to qualify for listing on the Nasdaq Global Market.

 

Effects on Our Company if the E&S Sale Transaction is Not Completed

 

If the E&S Sale Transaction is not completed, we will continue our efforts to divest substantially all our current operating and non-operating assets as part of our planned strategy to monetize our assets for the benefit of the CSI shareholders existing prior to the effective date of the proposed merger with Pineapple, and we may consider and evaluate other strategic opportunities for the E&S Segment. In such a circumstance, there can be no assurances that our continued operation of the E&S Segment business or any alternative strategic opportunities will result in the same or greater value to our shareholders as the E&S Sale Transaction.

 

The securities purchase agreement may be terminated under certain circumstances as set forth in the securities purchase agreement and summarized in this proxy statement. We have agreed to pay Lantronix a termination fee of $875,000 if the securities purchase agreement is terminated under certain circumstances. See “SECURITIES PURCHASE AGREEMENT—Remedies; Termination Fees” below.

 

No Appraisal or Dissenters’ Rights

 

No appraisal or dissenters’ rights are available to our shareholders under Minnesota law or our articles of incorporation or bylaws in connection with the E&S Sale Proposal.

 

Interests of Our Directors and Executive Officers in the E&S Sale Transaction

 

In considering the recommendation of our board to vote “FOR” the E&S Sale Proposal, you should be aware that, aside from their interests as Company shareholders, our directors and executive officers have interests in the E&S Sale Transaction that are different from, or in addition to, the interests of our shareholders generally.

 

Members of our board were aware of and considered these interests, among other matters, in evaluating and negotiating the E&S Sale Transaction, and in recommending to our shareholders that the E&S Sale Proposal be approved. For more information see the sections entitled “Proposal #1: E&S Sale Proposal—Background of the E&S Sale Transaction” and “Proposal #1: E&S Sale Proposal—Reasons for the E&S Sale Transaction and Recommendation of the CSI Board of Directors” above. These interests are described in more detail below, and certain of them are quantified in the narrative below.

 

Additional information concerning these potential payments and the vesting of outstanding equity awards held by our directors and executive officers is provided in the discussion and table below.

 

Treatment of Outstanding Equity Awards. All of our outstanding equity incentive awards, consisting of stock options and restricted stock units (RSUs), have been granted under our 2011 Executive Incentive Compensation Plan (the “2011 Plan”), which is administered by the CSI compensation committee. As of June 14, 2021, there were outstanding under the 2011 Plan stock options to purchase 1,113,825 shares of CSI common stock and RSUs for 98,705 shares of CSI common stock.

 

The 2011 Plan provides that upon a change of control any outstanding incentive award that is not assumed or substituted will immediately vest and be exercisable and any restrictions on the incentive award will lapse. The 2011 Plan provides that the compensation committee may take any or all actions in respect of these accelerated incentive awards. The E&S Sale Transaction will constitute a change of control under the 2011 Plan.

 

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In view of its authority under the 2011 Plan, the terms of the E&S Sale Transaction, and after considering our proposed merger transaction with Pineapple, our compensation committee has determined that if the E&S Sale Transaction occurs before the effective time of the proposed merger with Pineapple, then the outstanding incentive awards of the 2011 Plan will be affected as follows, all as of the closing date of the E&S Sale Transaction:

 

All outstanding incentive awards will immediately vest and be exercisable and any restrictions on the incentive award will lapse.

 

All then outstanding restricted stock units (RSUs) would be settled by exchanging them for the equivalent number of shares specified in the respective RSU agreements, reduced by that number of whole shares (rounded up to the nearest whole share) having a Fair Market Value (as defined in the 2011 Plan) equal to the amount of any tax withholding required. The shares of CSI common stock issued on settlement of the RSUs will be issued and outstanding as of the closing date of the E&S Sale Transaction.

 

All stock options on the closing date having an exercise price less than the fair market value of CSI’s common stock (i.e. in-the-money stock options) would be settled by exchanging the options for a “net” number of shares of CSI common stock as if exercised on a net or cashless basis as provided in the 2011 Plan. The shares of CSI common stock issued on settlement of in-the-money stock options will be further reduced by that number of whole shares (rounded up to the nearest whole share) having a Fair Market Value equal to the amount of any tax withholding required. The shares of CSI common stock issued on settlement of the in-the-money stock options will be issued and outstanding as of the closing date of the E&S Sale Transaction.

 

Following the settlement of outstanding RSUs and in-the-money stock options as provided above, these awards will terminate and be cancelled.

 

All stock options on the closing date having an exercise price equal to or greater than the fair market value of CSI’s common stock (i.e. out-of-the-money stock options) will terminate and be cancelled without any payment therefor.

 

The intention of our compensation committee is that the closing date of the E&S Sale Transaction would be set to ensure that the holders of RSUs and in-the-money stock options would receive any dividends paid to CSI shareholders generally prior to the effective time of the merger with Pineapple.

 

If the outstanding stock options and RSUs granted under the 2011 Plan are treated as described above, we would issue 252,564 shares of CSI common stock in respect of stock options and 98,705 shares of CSI common stock in respect of RSUs, assuming all stock options have not previously been exercised and all restricted stock unit awards have not previously been settled. These amounts assume (a) a price per share of CSI common stock of $6.62 (which is the average of the closing prices for a share of the Company’s common stock for the first five trading days following the public announcement of the E&S Sale Transaction) and (b) the E&S Sale Transaction was consummated on June 14, 2021, which is the last practicable date prior to the filing of this proxy statement.

 

Our non-employee directors are: Randall D. Sampson, Richard A. Primuth, Steven C. Webster and Michael R. Zapata. The estimated value to CSI’s non-employee directors as a group for the unvested stock options that would accelerate in connection with the closing of the E&S Sale Transaction is $67,200, which assumes the E&S Sale Transaction was consummated on June 14, 2021, which is the last practicable date prior to the filing of this proxy statement. None of the non-employee directors hold any outstanding RSU awards. The value of the unvested stock option awards that would accelerate in connection with the closing of the E&S Sale Transaction is calculated as follows: the product of (a) the excess, if any, of $6.62 (the assumed value of a share of the CSI’s common stock) over the exercise price per share of such stock option, multiplied by (b) the number of shares of common stock subject to the unvested portion of such stock option

 

The number of shares issuable in respect of outstanding stock options or RSUs may be more or less based on the incentive awards outstanding on, and fair market value of CSI’s common stock on, the closing date of the E&S Sale Transaction. For an estimate of the amounts that would be payable to each of the Company’s executive officers in connection with the Company equity incentive awards, see the “Golden Parachute Compensation” table below.

 

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Employment and Change of Control Agreements. CSI entered into an employment agreement with Anita Kumar on December 1, 2020 in connection with CSI’s hiring of Ms. Kumar as its Chief Executive Officer. If CSI terminates the employment agreement with Ms. Kumar without Cause (as defined in the employment agreement) prior to December 31, 2021, Ms. Kumar will receive a guaranteed separation payment equivalent to 6 months base salary, subject to Ms. Kumar’s continued compliance with certain covenants and delivery of a general release.

 

We have entered into change of control agreements (“CIC Agreements”) with each named executive officer. The CIC Agreements provide for payment of severance compensation if there is a change in control of CSI and within 24 months following this change of control, there is either an involuntary termination of employment other than for cause, death, disability or retirement or a voluntary termination of employment for good reason (each a “Triggering Event”). The closing of the E&S Sale Transaction will constitute a change of control under the CIC Agreements.

 

Under the securities purchase agreement, we are obligated to terminate the employment of certain E&S Companies personnel who accept Lantronix’s offer of employment and we will be responsible for any severance obligations to these E&S Companies transferred personnel in connection with that termination of employment. Lantronix has indicated its intention to make an offer of employment to Ms. Kumar. Additionally, we intend to terminate employees of the E&S Companies not hired by Lantronix around the time of the completion of the E&S Sale Transaction. However, we do not expect to terminate Roger H.D. Lacey, Executive Chairman of CSI, and Mark Fandrich, CSI’s Chief Financial Officer, following the completion of the E&S Sale Transaction as they are expected to remain in these same roles following the closing of the CSI-Pineapple merger as stated in our March 2, 2021 announcement of the proposed Pineapple merger. Additionally, we also do not expect to terminate Scott Fluegge, CSI’s Vice President of Information Technology and Digital Transformation, following the completion of the E&S Sale Transaction as he is expected to continue employment following the closing of the CSI-Pineapple merger.

 

The severance benefit is a specified multiple of the executive’s annual compensation at the date of the change of control, payable in a lump sum within 75 days following the date of the Triggering Event. The multiple of the executive’s annual compensation for our named executive officers is as follows: Mr. Lacey, 1.0 times; Ms. Kumar, 1.5 times; Mr. Fandrich, 1.5 times; and Mr. Fluegge, 1.0 times. Additionally, each executive will be entitled to receive medical and dental insurance and life insurance substantially in the form and expense to the executive as received by the executive on the date of the Triggering Event.

 

The CIC Agreements provide that the payments made to the executive will be one dollar less than the amount which would cause all payments to the executive (including payments to the executive which are not included in the CIC Agreement) to be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code. Executive officers are not entitled to any gross-up payment under CIC Agreements for such excise taxes.

 

The CIC Agreements include provisions requiring each executive to maintain confidentiality of information acquired during the period of employment, to refrain for a period of one year from competing with CSI or soliciting other CSI employees to leave their employment with us and to provide a release of all claims against CSI in exchange for the benefit paid pursuant to the CIC agreement.

 

LTI Plan Awards. Over the last several years, we have granted our named executive officers and senior executives awards under our Long-Term Incentive Plan (“LTI Plan”), which is a subplan of the 2011 Plan. The LTI Plan awards provide the opportunity to earn a payout in CSI equity awards or cash awards after the end of three-year performance periods. There are two performance periods currently outstanding under the LTI Plan, the three-year performance period of 2019 to 2021 and the three year performance period of 2020 to 2022. All CSI equity awards for all prior performance periods have been granted under the LTI Plan and are included in the awards outstanding under the 2011 Plan, which will be settled as described above under “Treatment of Outstanding Equity Awards.” As of June 14, 2021, participants had opportunities for cash awards under the LTI Plan of $127,737 for 2019 to 2021 and $188,760 for 2020 to 2022.

 

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The closing of the E&S Sale Transaction will constitute a change in control under the LTI Plan. A participant will be entitled to a payment from the LTI Plan upon a change in control. The amount of the payment to each participant must be equitably prorated based on the period between the beginning of the three-year performance period and the change in control. However, the compensation committee has the discretion to extend this period to be a longer period not to exceed the conclusion of the year in which the change in control occurred. The compensation committee intends to determine the amount of the cash payments to LTI Plan participants prior to the closing of the E&S Sale Transaction. For an estimate of the amounts that would be payable to each of the Company’s executive officers in connection with the LTI Plan cash awards, see the “Golden Parachute Compensation” table below.

 

Golden Parachute Compensation. The table below sets forth the information required by Item 402(t) of Regulation S-K regarding certain compensation that has, will or may be paid or become payable to our named executive officers in connection with the E&S Sale Transaction, based on a number of assumptions. The table below assumes that:

 

the E&S Sale Transaction was consummated on June 14, 2021, which is the last practicable date prior to the filing of this proxy statement, and that the E&S Sale Transaction is consummated prior to the effective time of our proposed merger with Pineapple;

 

the employment of each of our named executive officers is terminated by CSI immediately following the closing of the E&S Sale Transaction if it were consummated on June 14, 2021, which is the last practicable date prior to the filing of this proxy statement, constituting a Triggering Event under the CIC Agreements (but see “Employment and Change of Control Agreements” above for a description of our current intentions relating to the termination of the named executive officers);

 

the price per share of the Company’s common stock is $6.62 (which, in accordance with the SEC rules, is the average of the closing prices for a share of the Company’s common stock for the first five trading days following the public announcement of the E&S Sale Transaction); and

 

the compensation levels and outstanding and unvested equity awards for the named executive officers at the relevant time are the levels in effect and the equity awards outstanding and unvested.

 

Golden Parachute Compensation (1)

Name

  Cash ($)(2)  Equity ($)(3)  Perquisites / Benefits ($)(4)  Total
Roger H. D. Lacey  $410,301  $229,201  $782  $640,284
Anita Kumar  $487,540  $128,031  $3,487  $619,058
Mark Fandrich  $646,820  $172,091  $15,790  $834,701
Scott Fluegge  $299,266  $119,300  $26,302  $444,868

 

(1) There are no tax reimbursement, pension benefits or other payments to the named executive officers that are required to be disclosed in this table pursuant to Item 402(t) of Regulation S-K.

 

(2) The amounts reported in this column represent (a) the cash severance payment that each named executive officer would be entitled to receive under his or her CIC Agreement, which is a “double trigger” arrangement requiring both a change of control and a qualifying termination of employment within 24 months following the change of control, and for Ms. Kumar includes the cash severance to which she is entitled under her employment agreement upon a termination of employment without Cause and (b) the amount of cash payable to each named executive officer in respect of the LTI cash awards, which is a “single trigger” arrangement, assuming the compensation committee exercised its discretion to extend the period for equitable proration to the end of 2021. See the section entitled “Employment and Change of Control Agreements” and “LTI Plan Awards” above for additional details. The following table presents the allocation of the value as between cash severance payment and LTI Plan cash awards for each named executive officer:

 

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Name

 

Value of Cash Severance Payment

 

Value of LTI Plan
Cash Awards

Roger H. D. Lacey  $350,301  $60,000
Anita Kumar  $469,769  $17,771
Mark Fandrich  $593,015  $53,805
Scott Fluegge  $262,362  $36,904

 

(3) The amounts reported in this column represent the value of acceleration in connection with the closing of the E&S Sale Transaction of stock options and restricted stock units (RSUs) outstanding to our named executive officers under the 2011 Plan after giving effect to the determinations of our compensation committee as described above in the section entitled “Treatment of Outstanding Equity Awards.” The value of the unvested equity awards that would accelerate in connection with the closing of the E&S Sale Transaction is calculated as follows: (a) in the case of a CSI stock option, the product of (i) the excess, if any, of $6.62 (the assumed value of a share of the CSI’s common stock) over the exercise price per share of such stock option, multiplied by (ii) the number of shares of common stock subject to the unvested portion of such stock option; and (b) in the case of CSI RSU awards, the assumed value of a share of the Company’s common stock ($6.62) multiplied by the number of shares of common stock subject to the RSU award. The following table presents the allocation of the value as between the accelerated stock options and the accelerated RSUs for each named executive officer:

 

Name  Aggregate Value of Accelerated Stock Options  Aggregate Value of Accelerated Restricted Stock Unit Awards
Roger H. D. Lacey  $93,862  $135,339
Anita Kumar  $50,345  $77,686
Mark Fandrich  $64,516  $107,575
Scott Fluegge  $45,672  $73,628

 

(4) The amounts reported in this column represent the estimated cost of the employer portion of medical and dental insurance and life insurance premiums payable by CSI under the CIC Agreements assuming a qualifying termination of the named executive officer’s employment within 24 months following the change of control as described in note 2 above.

 

Anticipated Accounting Treatment

 

Under generally accepted accounting principles in the United States of America, commencing with the quarter during which our shareholders approve the E&S Sale Proposal, we expect to reflect the results of operations of the E&S Segment business as discontinued operations.  The related anticipated gain on the sale, net of any applicable taxes, will also be reported within discontinued operations upon completion of the E&S Sale Transaction. For further information, see “UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS” attached to this proxy statement as Appendix C.

 

Use of Proceeds

 

Communications Systems, and not our shareholders, will receive the proceeds from the E&S Sale Transaction.

 

As we have previously communicated in connection with the proposed Pineapple merger, CSI expects the net sale proceeds from any pre-merger divestitures, such as the E&S Sale Transaction, to be distributed in the form of a cash dividend to existing CSI shareholders prior to the effective date of the proposed merger with Pineapple.

 

Currently, we expect to distribute to our shareholders a cash dividend of $3.50 per share or approximately $35.0 million from the net proceeds from the E&S Sale Transaction and other available cash resources. We have not determined the exact timing of the cash dividend or set a record date for CSI shareholders entitled to the dividend.

 

We also intend to make additional cash dividends from cash, cash equivalents, and investments, net proceeds from the sale of legacy CSI assets and businesses sold after the merger, and any net proceeds we receive from Lantronix from the earnout in connection with the E&S Sale Transaction, through the contingent value rights (CVRs). The record date for CSI shareholders entitled to the CVRs will be set as of immediately prior to the closing of the merger with Pineapple under the agreement governing the CVRs. We expect the closing of the proposed merger with Pineapple will occur following receipt of CSI shareholder approval of the merger at a shareholder meeting to be held later in 2021.

 

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Material U.S. Federal Income Tax Consequences of the E&S Sale Transaction

 

The following is a general discussion of the anticipated material U.S. federal income tax consequences of the E&S Sale Transaction. The discussion addresses only the specific U.S. federal income tax consequences set forth below and does not address any other U.S. federal, state, local or foreign income, estate, gift, transfer, sales, use or other tax consequences that may result from the E&S Sale Transaction or any other transaction.

 

The following discussion is based on the Internal Revenue Code of 1986, as amended, or the Code, its legislative history, currently applicable and proposed Treasury regulations and published rulings and decisions, all as currently in effect as of the date of this proxy statement, an all of which are subject to change, possibly with retroactive effect. Tax considerations under state and local laws, federal laws other than those pertaining to income tax, or non-U.S. tax laws are not addressed in this proxy statement. The following discussion has no binding effect on the Internal Revenue Service or the courts. No ruling has been requested from the IRS with respect to the anticipated tax treatment of E&S Sale Transaction, and we will not seek an opinion of counsel with respect to the anticipated tax treatment summarized herein. There can be no assurance that the IRS will not take a different position concerning the tax consequences of the E&S Sale Transaction or that any such position would not be sustained.

 

The E&S Sale Transaction is entirely a corporate level action. Accordingly, the E&S Sale Transaction will not be a taxable event for U.S. federal income tax purposes to our shareholders.

 

The E&S Sale Transaction will be treated for U.S. federal income tax purposes as a taxable transaction for which Communications Systems will recognize gain or loss. The amount of gain or loss we recognize with respect to the sale of the stock of TNI and the sale of the ordinary shares of TN Europe will be measured by the difference between the amount realized by us on the sale of that particular equity interest and our tax basis in that equity interest. The determination of whether we recognize gain or loss will be made separately with respect to our equity interests in each of TNI and TN Europe.

 

Management of CSI anticipates that the E&S Sale Transaction will likely result in some taxable gain to the CSI for U.S. federal income tax purposes. To the extent the E&S Sale Transaction results in us recognizing a net gain for U.S. federal income tax purposes, we expect that our available net operating loss carryforwards will offset all or a substantial part of such gain.

 

Each shareholder is encouraged to consult his, her, or its own tax advisor as to the U.S. federal income tax consequences of the E&S Sale Transaction, and as to any state, local, foreign or other tax consequences based on his or her particular facts and circumstances.

 

Vote Required

 

The approval of the E&S Sale Proposal requires the affirmative vote of holders of at least two-thirds of the issued and outstanding shares of CSI common stock that are entitled to vote at the special meeting. A vote of ABSTAIN on the E&S Sale Proposal will have the same effect as a vote AGAINST the approval of the E&S Sale Proposal.

 

Other than with respect to any shares allocated to you as a participant in the CSI ESOP, if you are a record holder and do not vote, your shares will not be voted at the special meeting and this failure to vote will have the same effect as a vote against the E&S Sale Proposal. If you are a participant in the CSI ESOP and do not vote the CSI shares allocated to you in the CSI ESOP on any proposal, your shares will be voted at the special meeting on the E&S Sale Proposal according to the provisions of the CSI ESOP, which provide that the trustees will vote these shares on the E&S Sale Proposal in the same proportion as all shares of CSI common stock allocated to ESOP participants for which voting instructions were received were voted on the E&S Sale Proposal.

 

OUR BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT OUR SHAREHOLDERS VOTE “FOR” PROPOSAL #1, THE E&S SALE PROPOSAL.

 

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SECURITIES PURCHASE AGREEMENT

 

This section describes the material terms of the securities purchase agreement. Please note that the summary below and elsewhere in this proxy statement regarding the securities purchase agreement may not contain all of the information that is important to you. The summary below and elsewhere in this proxy statement of the securities purchase agreement does not purport to be complete and is subject to, and qualified in its entirety by, reference to the full text of the securities purchase agreement, a copy of which is attached to this proxy statement as Appendix A. We encourage you to read the securities purchase agreement carefully in its entirety for a more complete understanding of the E&S Sale Transaction, the terms of the securities purchase agreement, and other information that may be important to you.

 

The securities purchase agreement has been included to provide shareholders with information regarding its terms. The securities purchase agreement also references certain of the other transaction documents, including the transition services agreement. Certain of the other transaction documents are summarized below, but are not binding upon any party until executed and delivered. This proxy statement is not soliciting shareholder approval for any transaction or agreement other than the E&S Sale Transaction as described in the E&S Sale Proposal.

 

General

 

On April 28, 2021, we entered into a securities purchase agreement with Lantronix pursuant to which we have agreed, subject to specified terms and conditions, including approval of the E&S Sale Proposal by our shareholders at the special meeting, to sell to Lantronix all of the issued and outstanding shares of stock of our wholly owned subsidiary, Transition Networks, Inc., and the entire issued share capital of our wholly owned subsidiary, Transition Networks Europe Limited. In this proxy statement, we sometimes refer to Transition Networks, Inc. as “TNI,” to Transition Networks Europe Limited as “TN Europe” and to both of the companies collectively with their respective subsidiaries, if any, as the “E&S Companies.”

 

CSI classifies its businesses into the following two segments:

 

Electronics & Software (E&S): designs, develops and sells Intelligent Edge solutions that provide connectivity and power through Power over Ethernet (“PoE”) products and actionable intelligence to end devices in an Internet of Things (“IoT”) ecosystem through embedded and cloud-based management software. In addition, this segment 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; and

 

Services & Support (S&S): provides SD-WAN and other technology solutions that address prevalent IT challenges, including network resiliency, security products and services, network virtualization, and cloud migrations, IT managed services, wired and wireless network design and implementation, and converged infrastructure configuration, deployment and management.

 

The E&S Segment is comprised of the Transition Networks and Net2Edge businesses conducted by TNI and TN Europe. For the purposes of this proxy statement, we refer to these businesses as the “E&S Segment business.”

 

We are not selling to Lantronix any of the assets relating to our S&S Segment business.

 

Purchase and Sale of the Securities of the E&S Companies

 

Subject to certain exceptions described below, we agreed to sell to Lantronix:

 

all of the issued and outstanding stock of our wholly owned subsidiary, Transition Networks, Inc., a Minnesota corporation; and

 

the entire issued share capital of our wholly owned subsidiary, Transition Networks Europe Limited, a private limited company incorporated in England and Wales.

 

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The TNI stock and the TN Europe ordinary shares we have agreed to sell to Lantronix are sometimes referred to as the “purchased securities.”

 

Base Purchase Price and Earnout

 

The base purchase price for the purchased securities will be approximately $25,027,566. At the closing of the E&S Sale Transaction, Lantronix will pay us the base purchase price in cash.

 

Following the closing date, the base purchase price will be recalculated based upon final determinations of net working capital. The base purchase price then will be adjusted upward or downward for the amount by which the base purchase price recalculated using these final amounts is more than or less than the base purchase price paid at closing. If the recalculated base purchase price is more than base purchase price paid at closing, Lantronix will pay to CSI such amount within five business days. If the recalculated base purchase price is less than base purchase price paid at closing, we will pay to Lantronix such amount within five business days.

 

In addition to the base purchase price, Lantronix will pay us, if earned, earnout payments of up to $7.0 million, payable following two successive 180-day intervals after the closing of the E&S Sale Transaction based on revenue targets for the business of the E&S Companies as specified in the securities purchase agreement, subject to certain adjustments and allocations as further described in the securities purchase agreement. The earnout amount, if any, would be payable as follows:

 

On a sliding scale from $1.0 million up to $3.0 million based on revenue generated by the business of the E&S Companies in the first 180 days after the closing of the E&S Sale Transaction meeting or exceeding $18 million; and

 

On a sliding scale from $1.0 million up to $4.0 million based on revenue generated by the business of the E&S Companies in the subsequent 180 days after the closing of the E&S Sale Transaction meeting or exceeding $19 million.

 

For purposes of calculating the earnout amount, “revenue” includes all revenue recognized by Lantronix from the current business of the E&S Companies, and also includes revenue from all products that are either in development by the E&S Companies as of the closing or subsequently developed by the E&S Companies after the closing, but that were on the roadmap of the business and under development, and all products substantially similar to or readily derivative of a current product or development product on the roadmap, but excluding any revenue recognized from products, software or services of Lantronix that are currently sold or offered for sale by Lantronix or are being developed by Lantronix as of the date of the securities purchase agreement.

 

Financing

 

Lantronix estimates that approximately $26.0 million will be required to complete the E&S Sale Transaction. Lantronix anticipates that these amounts will be funded with bank financing in accordance with the commitment letter from Silicon Valley Bank and the commitment letter from SVB Innovation Credit Fund VIII, L.P., each dated April 28, 2021 and issued to Lantronix (together, the “commitment letters”), and cash on hand of Lantronix. The securities purchase agreement provides that in no event will the receipt by, or the availability of any funds or financing to, Lantronix or any other financing be a condition to the obligation of Lantronix to consummate the E&S Sale Transaction. Pursuant to the securities purchase agreement, Lantronix has delivered to us copies of the commitment letters and the corresponding fee letters.

 

Pursuant to the commitment letters, Lantronix intends to (a) refinance all existing indebtedness of Lantronix and Lantronix Holding Company, a Delaware corporation, owing to Silicon Valley Bank, and (b) finance the E&S Sale Transaction, costs and expenses related to the E&S Sale Transaction and the ongoing working capital and other general corporate purposes of Lantronix, the E&S Companies and their subsidiaries after consummation of the E&S Sale Transaction, from, among others, the following sources: (i) up to $20,000,000 in senior secured credit facilities comprised of (A) a term loan facility in an aggregate principal amount equal to $17,500,000 and (B) a revolving credit facility of up to $2,500,000, and (ii) a $12,000,000 junior secured credit facility provided by SVB Innovation Credit Fund VIII, L.P. The commitments contained in the commitment letters expire on August 31, 2021.

 

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Under the commitment letters, (a) Silicon Valley Bank will have a first priority perfected security interest in substantially all assets of Lantronix and its affiliates (including the E&S Companies after the closing of the E&S Sale Transaction), including intellectual property, and (b) SVB Innovation Credit Fund VIII, L.P. will have a perfected security interest in substantially all assets of Lantronix and its affiliates (including the E&S Companies after the closing of the E&S Sale Transaction), including intellectual property. Such collateral will also include a stock pledge equal to 65% of the shares of material foreign subsidiaries that are not borrowers or guarantors.

 

The commitment letters are subject to standard closing conditions, including (a) the negotiation, execution and delivery of final loan documentation, (b) evidence of certain filings, recordings and endorsements, (c) delivery of satisfactory opinions of counsel and evidence of lien and security interests, (d) delivery of certain pro forma consolidated financial statements as to the borrower and its subsidiaries, (e) delivery of a quality of earnings report from the E&S Companies and borrower and its subsidiaries, (f) final terms and conditions of the E&S Sale Transaction documents, (g) payment of all fees and expenses of Silicon Valley Bank and SVB Innovation Credit Fund VIII, L.P., (h) a bring-down in the accuracy of all representations and warranties in the loan documentation as of the funding date and (i) that no event of default or material adverse change has occurred.

 

Conditions to Closing

 

The obligation of CSI and Lantronix to complete the E&S Sale Transaction is subject to the satisfaction (or waiver by the party entitled to the benefit thereof) of the following conditions:

 

The securities purchase agreement and the E&S Sale Transaction must have been duly approved and adopted by the requisite shareholders of CSI at the special meeting in accordance with the Minnesota Business Corporation Act and CSI’s organizational documents; and

 

No government entity has enacted, issued, promulgated, enforced, or entered any law or order, decree, ruling or other action that makes illegal, enjoins or otherwise prohibits consummation of the E&S Sale Transaction.

 

The obligation of Lantronix to complete the E&S Sale Transaction is subject to the satisfaction (or waiver by Lantronix) of the following conditions:

 

CSI’s representations and warranties identified as fundamental must be true and correct in all respects on the date of the securities purchase agreement and the closing date, or in the case of representations and warranties made as of a specified date earlier than the closing date, as of such earlier date;

 

CSI’s representations and warranties (other than its representations and warranties identified as fundamental) must be true and correct in all material respects on the date of the securities purchase agreement and the closing date, or in the case of representations and warranties made as of a specified date earlier than the closing date, as of such earlier date;

 

CSI must have performed and complied with, in all material respects, all obligations, agreements and covenants as specified in the securities purchase agreement;

 

CSI must have delivered to Lantronix a certificate, executed by a duly authorized officer, that the preceding three conditions are satisfied; and

 

CSI must have delivered to Lantronix all of the required closing deliveries contemplated by the securities purchase agreement (including a certificate of good standing of TNI; appropriate assignment of the purchased securities; resolutions of the directors of each of TN Europe and each subsidiary thereof to approve various closing matters; a certificate of the secretary of CSI certifying to the resolutions duly adopted by CSI’s board of directors authorizing and approving the securities purchase agreement and the E&S Sale Transaction; the executed transition services agreement; resignations of certain directors and officers of the E&S Companies; evidence of certain required consents, waivers or approvals; register of members of each of TN Europe and its subsidiaries together with all of the other statutory registers and statutory books of each of TN Europe and its subsidiaries; the share certificates for all issued shares in TN Europe and each subsidiary thereof (or, if such share certificates are lost, indemnities for lost share certificate); a power of attorney duly executed by CSI appointing Lantronix as CSI’s duly authorized attorney to exercise all voting and other rights attaching to the TN Europe share pending stamping of the transfer of the TN Europe share and the registration of Lantronix of the holder of the TN Europe share; a letter from CSI confirming that at closing it will cease to be a relevant registrable entity in relation to TN Europe; release and termination of all liens with respect to the E&S Companies and the purchased securities; and a Deed of Waiver to cause a waiver of the debt of £2,334,258 owed by TN Europe to CSI).

 

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The obligation of CSI to complete the E&S Sale Transaction is subject to the satisfaction (or waiver by CSI) of the following conditions:

 

Lantronix’s representations and warranties identified as fundamental must be true and correct in all respects on the date of the securities purchase agreement and the closing date, or in the case of representations and warranties made as of a specified date earlier than the closing date, as of such earlier date;

 

Lantronix’s representations and warranties (other than its representations and warranties identified as fundamental) must be true and correct in all material respects on the date of the securities purchase agreement and the closing date, or in the case of representations and warranties made as of a specified date earlier than the closing date, as of such earlier date;

 

Lantronix must have performed and complied with, in all material respects, all obligations, agreements and covenants as specified in the securities purchase agreement;

 

Lantronix must have delivered to CSI a certificate, executed by a duly authorized officer, that the preceding three conditions are satisfied; and

 

Lantronix must have delivered to CSI all of the required closing deliveries contemplated by the securities purchase agreement (including a certificate of good standing of Lantronix; a certificate of the secretary of Lantronix certifying to the resolutions duly adopted by Lantronix’s board of directors authorizing and approving the securities purchase agreement and the E&S Sale Transaction; the executed transition services agreement; evidence that the landlord under the UK lease has released CSI from all obligations as guarantor under such lease as of the closing (subject to certain additional terms set forth in the securities purchase agreement); and evidence of certain required consents, waivers or approvals).

 

Representations and Warranties

 

In the securities purchase agreement and subject to the exceptions, qualifications and schedules to the securities purchase agreement, as applicable, CSI makes representations and warranties to Lantronix relating to, among other things:

 

the organization, power and authority of CSI and the E&S Companies to enter into and perform their respective obligations under the securities purchase agreement and the other documents contemplated thereby, together with other corporate matters with respect to CSI and the E&S Companies;

 

the binding effect of the securities purchase agreement and the other documents contemplated thereby;

 

the absence of conflicts with, or defaults under, CSI’s or the E&S Companies’ organizational documents, certain material contracts and the absence of violations of applicable laws;

 

required consents and approvals of third parties or government entities;

 

broker, finder, investment banker or other intermediary fees;

 

ownership of the purchased securities;

 

CSI’s filings with the SEC;

 

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the capitalization of the E&S Companies and their respective subsidiaries;

 

the financial statements of the E&S Companies;

 

undisclosed liabilities and indebtedness of the E&S Companies;

 

conduct of the E&S Companies since December 31, 2020, including the absence of any event or occurrence which has had a material adverse effect and the absence, subject to certain threshold limitations, of certain changes;

 

title to, condition of and sufficiency of personal property;

 

compliance with laws;

 

certain tax matters;

 

certain environmental matters;

 

intellectual property owned, licensed or used by the E&S Companies;

 

matters relating to the real property leased by the E&S Companies;

 

litigation and other proceedings;

 

employee benefit plans;

 

insurance policies, bonds or other insurance maintained by the E&S Companies;

 

material contracts of the E&S Companies and certain information relating thereto;

 

labor and employment matters;

 

certain affiliate transactions;

 

inventory of the E&S Companies;

 

accounts receivable of the E&S Companies;

 

permits and licenses of the E&S Companies;

 

compliance with certain anti-corruption laws;

 

books and records of the E&S Companies; and

 

a disclaimer of other representations and warranties regarding CSI or the E&S Companies.

 

Pursuant to the securities purchase agreement and subject to the exceptions, qualifications and schedules to the securities purchase agreement, as applicable, Lantronix makes representations and warranties to CSI relating to, among other things:

 

the organization, power and authority of Lantronix to enter into and perform its obligations under the securities purchase agreement and the other documents contemplated thereby, together with other corporate matters with respect to Lantronix;

 

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the binding effect of the securities purchase agreement and the other documents contemplated thereby;

 

the absence of conflicts with, or defaults under, Lantronix’s organizational documents and the absence of violations of applicable laws;

 

required consents and approvals of third parties or government entities;

 

broker, finder, investment banker or other intermediary fees;

 

litigation and other proceedings;

 

investment intent and “accredited investor” status;

 

type, terms, validity and sufficiency of the bank financing obtained by Lantronix in accordance with the commitment letters delivered to us;

 

no beneficial ownership of CSI’s voting stock in the prior four years; and

 

the independent investigation conducted by Lantronix and its representatives relating to the E&S Sale Transaction and no reliance on any extra-contractual statements.

 

Covenants

 

Conduct of the E&S Companies

 

From and after the date of the securities purchase agreement and until the effective time of the E&S Sale Transaction or until the earlier termination of the securities purchase agreement, we have agreed to (a) conduct the E&S Segment business in the ordinary course of business; (b) use commercially reasonable efforts to preserve intact the E&S Segment business and to keep available the services of the employees of TN Europe or any subsidiary thereof and the TNI personnel; (c) use commercially reasonable efforts to preserve the goodwill of, and maintain satisfactory relationships with, all material customers, suppliers, distributors, lessors, tenants, creditors, debtors, employees, consultants and agents of the E&S Segment business; and (d) not take or omit to take certain specified other actions. Our obligations relating to the conduct of the E&S Segment business prior to the closing date are subject to exceptions for actions that are specified by the parties and those otherwise contemplated by the securities purchase agreement, required by applicable legal requirements, or as Lantronix may consent to in writing (which may not be unreasonably withheld, conditioned or delayed).

 

Access to Business

 

We are required to give Lantronix, upon reasonable notice to us, reasonable access to any employee of the E&S Companies for in-person, phone or video meetings during normal business hours. We are also required to provide Lantronix with reasonable access at reasonable times and upon reasonable advance notice to the offices, properties, personnel, books and records of the E&S Companies; provided, that such access does not unreasonably interfere with the normal operations of the E&S Companies.

 

Solicitation of Transactions

 

Subject to certain exceptions in the securities purchase agreement, following the date of the securities purchase agreement and until the effective time of the E&S Sale Transaction, CSI and its subsidiaries (including the E&S Companies) will not, and will cause its representatives not to, directly or indirectly:

 

solicit, seek or initiate or knowingly take any action to facilitate or encourage any offers, inquiries or the making of any proposal or offer that constitutes, or could reasonably be expected to lead to, any “acquisition proposal,” or engage, participate in, or knowingly facilitate, any discussions or negotiations regarding, or furnish any nonpublic information to any person in connection with any inquiries, proposals or offers that constitute or could reasonably be expected to lead to, an acquisition proposal;

 

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enter into, continue or otherwise participate or engage in any discussions or negotiations regarding any acquisition proposal, or furnish to any person any non-public information or afford any person other than Lantronix access to such party’s property, books or records (except pursuant to a request by a government entity) in connection with any offers, inquiries or the making of any proposal or offer that constitutes, or could reasonably be expected to lead to, any acquisition proposal; or

 

take any action to make the provisions of any takeover statute inapplicable to any transactions contemplated by an acquisition proposal.

 

Notwithstanding the foregoing, prior to receipt of the required vote of our shareholders of the E&S Sale Transaction, we may furnish non-public information with respect to the E&S Companies to any “qualified person,” or engage in discussions or negotiations (including solicitation of revised acquisition proposals) with any qualified person regarding any such acquisition proposal. However, before taking these actions, we must have received a bona fide written unsolicited acquisition proposal from a qualified person, we must have received an executed confidentiality agreement from such qualified person, and the CSI board of directors must have determined, after consultation with outside legal counsel, that the failure to take such actions would reasonably be expected to be inconsistent with the its fiduciary duties under applicable law. Any information made available or provided to a qualified person by or on behalf of CSI will, substantively concurrently therewith, be made available or provided to Lantronix.

 

Following the date of the securities purchase agreement and until the effective time of the E&S Sale Transaction, the CSI board of directors may not, except as set forth in the securities purchase agreement:

 

(a) withhold, withdraw or modify, or publicly propose to withhold, withdraw or modify, in a manner adverse to Lantronix, the approval or recommendation by the CSI board of directors with respect to the E&S Sale Transaction, (b) fail to include the CSI board of directors’ recommendation that you vote for the E&S Sale Proposal in this proxy statement or (c) if any person (other than Lantronix) has publicly announced an acquisition proposal (or publicly announced any material modification thereto), fail to publicly reaffirm the CSI board of directors’ recommendation that you vote for the E&S Sale Proposal within 10 business days (with certain exceptions) of being requested to do so by Lantronix (any of clauses (a), (b) or (c), a “seller board recommendation change”);

 

enter into any letter of intent, memorandum of understanding, agreement in principle, acquisition agreement, merger agreement, purchase agreement, exchange agreement or similar agreement contemplating any acquisition proposal (other than a confidentiality agreement); and

 

adopt, approve or recommend, or publicly propose to adopt, approve or recommend, any acquisition proposal.

 

The CSI board of directors unanimously recommends that you vote for the E&S Sale Proposal.

 

Prior to receipt of the required vote of our shareholders of the E&S Sale Transaction, the CSI board of directors may effect a seller board recommendation change or terminate the securities purchase agreement in order to enter into an alternative acquisition agreement, with respect to an unsolicited bona fide acquisition proposal that did not result from a breach of the securities purchase agreement if:

 

the CSI board of directors has determined after consultation with outside legal counsel and financial advisors, that such acquisition proposal constitutes a “superior proposal” and, after consultation with outside legal counsel, that the failure to make such seller board recommendation change would reasonably be expected to be inconsistent with the CSI board of directors’ fiduciary obligations under applicable law;

 

we have provided at least four business days prior written notice to Lantronix that we intend to effect a seller board recommendation change;

 

during such four business day period, we negotiate with Lantronix in good faith to make adjustments in the terms and conditions of the securities purchase agreement so that the acquisition proposal ceases to constitute a superior proposal, if Lantronix, in its discretion, proposes to make adjustments; and

 

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if Lantronix has delivered to us a written offer to alter the terms or conditions of the securities purchase agreement during such four business day period, the CSI board of directors has determined in good faith, after considering the terms of such offer by Lantronix, that a seller board recommendation change would still be required for the CSI board of directors to be consistent with its fiduciary obligations under applicable law.

 

We must notify Lantronix of our receipt of any acquisition proposal and provide Lantronix a copy of such acquisition proposal (if written), or a summary of the material terms and conditions of such acquisition proposal (if oral). We further agreed to cease immediately all discussions and negotiations that commenced prior to the date of the securities purchase agreement regarding any proposal or offer that constitutes, or could reasonably be expected to lead to, an acquisition proposal.

 

As used in the securities purchase agreement, “acquisition proposal” means any inquiry, proposal or offer from any person, other than Lantronix or its subsidiaries, relating to any:

 

merger, consolidation, sale of assets, dissolution, liquidation, joint venture, recapitalization, reorganization, share exchange, tender offer, exchange offer, or other business combination transaction or series of related transactions involving any E&S Company, CSI or any other subsidiary of CSI, under which (a) such person would, directly or indirectly, acquire assets equal to 20% or more of the consolidated assets of CSI or any E&S Company, or to which 20% or more of the revenues CSI or of the E&S Companies on a consolidated basis are attributable for the most recent fiscal year in which audited financial statements are then available, or (b) the equity holders of such person immediately after giving effect to such transaction(s) would beneficially own 20% or more of any class of equity or voting securities of CSI or any E&S Company or the surviving or resulting entity in such transaction(s);

 

issuance by CSI or any E&S Company of 20% or more of its equity or voting securities; or

 

acquisition in any manner, directly or indirectly, of 20% or more of the equity securities or consolidated total assets of CSI or any E&S Company, in each case other than the transactions contemplated by the securities purchase agreement.

 

For clarity, CSI and Lantronix have agreed that the transactions contemplated by our proposed merger agreement with Pineapple are expressly excluded from the definition of “acquisition proposal” in the securities purchase agreement.

 

As used in the securities purchase agreement, “superior proposal” means a bona fide, unsolicited written acquisition proposal that was first received after the date of the securities purchase agreement that is:

 

on terms which the CSI board of directors determines in its good faith judgment to be more favorable to the holders of our capital stock from a financial point of view than the transactions contemplated by the securities purchase agreement, taking into account all the terms and conditions of such proposal and this Agreement that the CSI board of directors determines to be relevant;

 

is not subject to any financing condition (and if financing is required, such financing is then fully committed to the third party);

 

is reasonably capable of being completed on the terms proposed without unreasonable delay; and

 

includes termination rights no less favorable than the terms set forth in the securities purchase agreement, and in all respects from a third party capable of performing such terms.

 

If an “intervening event” occurs after the date of the securities purchase agreement but prior to the receipt of the required vote of our shareholders of the E&S Sale Transaction, the CSI board of directors may effect a seller board recommendation change if:

 

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the CSI board of directors has determined (after consultation with outside legal counsel) that the failure to make such seller board recommendation change would reasonably be expected to be inconsistent with its fiduciary obligations under applicable law,

 

prior to effecting the seller board recommendation change, we notify Lantronix, in writing, at least five business days before taking such action of the CSI board of directors’ intent to consider such action;

 

during such period we negotiate with Lantronix in good faith to make such adjustments in the terms and conditions of the securities purchase agreement so that the underlying facts giving rise to, and the reasons for taking such action, cease to constitute an intervening event, if Lantronix, in its reasonable discretion, proposes to make such adjustments; and

 

the CSI board of directors still determines in good faith, after consulting with outside legal counsel, that the failure to effect such seller board recommendation change, after taking into account any adjustments made by Lantronix, would reasonably be expected to be inconsistent with its fiduciary duties under applicable law.

 

As used in the securities purchase agreement, “intervening event” means with respect to CSI any material event, circumstance, change, effect, development, or condition occurring or arising after the date of the securities purchase agreement that (a) affects the business, assets or operations of the E&S Companies; (b) was not known to, nor reasonably foreseeable by, or if known, the effect of which was not reasonably foreseeable by, any member of the CSI board of directors as of or prior to the date of the securities purchase agreement; (c) becomes known to the CSI board of directors prior to the receipt of the required vote of our shareholders of the E&S Sale Transaction; and (d) did not result from or arise out of the announcement or pendency of, or any actions required to be taken by either Lantronix or CSI (or to be refrained from being taken by Lantronix or CSI) pursuant to, the securities purchase agreement. However, neither an acquisition proposal nor a change in the market price or trading volume of our securities constitutes an intervening event.

 

Preparation of the Proxy Statement; Shareholder Meeting

 

The securities purchase agreement requires that we prepare and file a proxy statement to be delivered to our shareholders in connection with a meeting of our shareholders to approve the E&S Sale Transaction as promptly as practicable following the date of the securities purchase agreement (and in any event within 45 days after the date of the securities purchase agreement). In connection with the preparation of this proxy statement, Lantronix and its advisors were required to and have provided certain information for inclusion in this proxy statement. Prior to any filing or mailing of the proxy statement (or any amendment or supplement thereto) or responding to any comments of the SEC with respect thereto, we have and will provide Lantronix a reasonable opportunity to review and comment on such document or response and have and will consider in good faith any such comments proposed by Lantronix. As soon as reasonably practicable following the establishment of the record date for a meeting of our shareholders to approve the E&S Sale Transaction and clearance of the proxy statement by the SEC, we will cause the proxy statement to be mailed to each of our shareholders entitled to vote at such meeting. We may adjourn or postpone such meeting (a) to the extent necessary to ensure that any required supplement or amendment to the proxy statement is provided to our shareholders within a reasonable amount of time in advance of such meeting, (b) as otherwise required by applicable law or (c) if as of the time for which such meeting is scheduled as set forth in the proxy statement, there are insufficient shares of our capital stock represented to constitute a quorum necessary to conduct the business of such meeting. We and Lantronix must each promptly make all necessary filings with respect to the transactions contemplated by the securities purchase agreement under the Securities Exchange Act of 1934, as amended, applicable state blue sky laws and the rules and regulations thereunder, and each party will furnish to the other party all information concerning the other party as may be reasonably requested in connection with any such actions.

 

Subject to the terms of the securities purchase agreement, the CSI board of directors must recommend that our shareholders vote in favor of the E&S Sale Transaction, and we are required to use our reasonable best efforts to obtain approval and adoption of the securities purchase agreement and the transactions contemplated thereby by our requisite shareholders at a meeting of our shareholders in accordance with the Minnesota Business Corporation Act and our organizational documents.

 

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Notice of Breaches

 

During the period between the date of the securities purchase agreement and the closing of the E&S Sale Transaction, each party will give prompt written notice to the other if such notifying party becomes aware of any breach of, or inaccuracy in, or of any facts or circumstances constituting or resulting in the breach of, or inaccuracy in, any representation, warranty, covenant or agreement of such notifying party or of such other party that would cause a failure of the conditions to closing set forth in the securities purchase agreement with respect to such party.

 

Efforts to Consummate

 

Subject to the terms and conditions of the securities purchase agreement, each party will use its commercially reasonable efforts to take, or cause to be taken, and to assist and cooperate with the other party in taking or causing to be taken, all actions and to use its commercially reasonable efforts to do, or cause to be done, all things necessary, proper or advisable under the securities purchase agreement and applicable law to cause the conditions set forth in the securities purchase agreement to be satisfied and to consummate and make effective the transactions contemplated thereby.

 

Financing Cooperation

 

Prior to the closing of the E&S Sale Transaction, we will cooperate with Lantronix in connection with obtaining its bank financing. Lantronix will keep us informed on a reasonable basis and in reasonable details regarding the status of the bank financing and will reimburse and indemnify us for our cooperation with its bank financing.

 

Non-Competition and Non-Solicitation

 

For five years after the closing of the E&S Sale Transaction, neither CSI nor its affiliates or designees will:

 

design, develop, license, manufacture, distribute, sell or support (or knowingly assist any third party, directly or indirectly, in designing, developing, licensing, manufacturing, distributing, selling or supporting) any existing product of the E&S Segment business or on any related roadmap or any other similar product anywhere in the world (subject to certain customary exceptions and specifically excluding the S&S Segment and strategic investments in Quortus Limited, Spyrus Solutions, Inc. and Kogniz, Inc.);

 

directly or indirectly (a) solicit for employment or any similar arrangement any employee of the E&S Companies or their subsidiaries or (b) hire or knowingly assist any other person in hiring any employee of the E&S Companies or their subsidiaries (subject to certain customary exceptions); or

 

directly or indirectly cause, solicit, induce or encourage any client, customer, supplier or licensor of the E&S Segment business or the E&S Companies prior to the closing to terminate or modify such relationship.

 

Employee Matters

 

Lantronix will offer employment to all TNI personnel listed on Schedule 7.2(a) attached to the securities purchase agreement; provided, however, that Lantronix may amend such schedule and the TNI personnel listed thereon for up to 30 days following the date of the securities purchase agreement. Effective prior to 11:59:59 p.m. on the day prior to the closing of the E&S Sale Transaction, we will terminate the employment of the TNI personnel, and we will be solely responsible for any severance obligations arising out of such termination. The employment of the employees of TN Europe or any subsidiary thereof will not be terminated by the closing of the E&S Sale Transaction.

 

Lantronix will, for one year following the closing of the E&S Sale Transaction, provide each “transferred employee” with employee benefits that are substantially comparable to the employee benefits offered to similarly-situated employees of Lantronix, and, for six months following the closing of the E&S Sale Transaction, each transferred employee who continues to be employed by Lantronix or its affiliates will continue to be provided with a salary that is substantially comparable in the aggregate to the salary in effect with respect to such transferred employee immediately prior to the closing. For clarity, nothing in the securities purchase agreement limits Lantronix’s right to terminate the employment of any of the transferred employees after the closing.

 

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With respect to any employees of TN Europe or any subsidiary thereof terminated by Lantronix during the 60 day period after the closing of the E&S Sale Transaction, Lantronix may, within such 60 day period, submit to us an invoice detailing any statutory redundancy and minimum notice period costs incurred by Lantronix with respect to any such terminations and we will promptly pay such invoice. However, Lantronix is required to use commercially reasonable efforts to minimize such statutory redundancy and minimum notice period costs incurred by Lantronix and in no event will CSI be responsible for more than $400,000 in costs, fees or expenses arising out of the termination of these employees following the closing.

 

With respect to each employee benefit plan and arrangement of Lantronix providing medical, dental, pharmaceutical and vision benefits in which any transferred employee becomes eligible to participate after the closing of the E&S Sale Transaction, Lantronix will waive or use commercially reasonable efforts to cause the applicable provider to waive, all pre-existing condition limitations, exclusions and waiting periods with respect to participation and coverage requirements applicable to the transferred employees and their eligible dependents, other than any such limitations, exclusions and waiting periods that are in effect with respect to such individuals and have not been satisfied under the analogous welfare benefit plan sponsored or participated in by CSI or its subsidiary, as applicable, immediately prior to the closing.

 

Tax Matters

 

We will prepare and timely file all tax returns with respect to the E&S Companies for all tax periods ending on or prior to the closing of the E&S Sale Transaction. Lantronix will prepare and timely file all other tax returns required to be filed in respect to the E&S Companies for all tax periods ending after the closing date of the E&S Sale Transaction. In the case of any tax return of any E&S Company for a pre-closing tax period, such tax return will be prepared in a manner that is consistent with practices, procedures, and accounting methods of such E&S Company in existence on the date of the securities purchase agreement. At least 30 days prior to the due date of any tax return relating to the pre-closing tax period other than a “straddle period,” the party responsible for preparing such tax return will deliver such tax return to the other party for the reviewing party’s review and comment.

 

Lantronix is prohibited from taking certain actions following the closing pertaining to the pre-closing tax period, and Lantronix will indemnify CSI for any liability for taxes resulting from any such prohibited actions taken by it without the prior written consent of CSI, save where such consent has been unreasonably withheld or delayed.

 

All refunds of taxes of the E&S Companies for any pre-closing tax period will be the property of CSI to the extent not included in the computation of final net working capital and only to the extent that such refunds are not the result of a voluntary act, transaction or omission of Lantronix after the closing or the utilization of a “buyer’s relief” (defined as any loss, relief, allowance, exemption, set-off or deduction for any tax purpose that is (a) a relief of the relevant E&S Company which arises in any period other than a pre-closing tax period; or (b) a relief of Lantronix which arises at any time).

 

Lantronix will pay to CSI all amounts received by Net2Edge Limited, a private limited company incorporated in England and Wales, that constitute relief in the form of a tax credit claimed pursuant to Section 1054 of the UK Corporation Tax Act 2009 arising as a result of any expenditure incurred (or otherwise accrued) by Net2Edge during the last accounting period ending on or before the closing of the E&S Sale Transaction.

 

CSI and Lantronix will equally share the payment of any stamp, transfer, recordation, documentary, sales and use, value added, registration and other similar taxes and fees (including any penalties and interest) incurred in connection with, or as a consequence of, the securities purchase agreement or any other transaction contemplated thereby; provided, however, that Lantronix will be solely responsible for all costs incurred in connection with the stamp duty tax submission in the United Kingdom for the one ordinary share of TN Europe.

 

Transaction Litigation

 

We will control the defense of any litigation brought by our shareholders against us and/or our directors or officers relating to the transactions contemplated by the securities purchase agreement, and we will promptly provide Lantronix with copies of all proceedings and correspondence relating to such litigation (to the extent permitted by applicable law). Prior to the earlier of the closing and the termination of the securities purchase agreement, we will not settle any litigation against us or any of our directors or officers by any shareholder relating to the securities purchase agreement or the transactions contemplated thereby that would materially and adversely affect Lantronix or the E&S Companies, in each case, without the prior written consent of Lantronix, which may not be unreasonably withheld, conditioned or delayed.

 

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Confidentiality

 

The parties have agreed that an existing confidentiality agreement between us and Lantronix protecting our confidential information will continue in full force and effect in accordance with its terms, except as expressly modified by the securities purchase agreement. Following closing, we have agreed to maintain in confidence confidential and non-public information regarding the E&S Companies subject to certain customary exceptions.

 

Release

 

Effective as of the closing, CSI and its affiliates will provide a customary release of claims against Lantronix, the E&S Companies and certain persons and parties relating thereto.

 

CSI Stock Awards

 

Lantronix will not assume, substitute or have any responsibility or liability with respect to any of the equity or equity-based awards under our 2011 Executive Incentive Compensation Plan or any other equity incentive plan of CSI that has any equity award outstanding.

 

UK Lease

 

CSI and Lantronix will use commercially reasonable efforts to have the landlord under the Lease dated July 20, 2016 in respect of the premises at Kulite House, Stroudley Road, Basingstoke RU24 8UG, UK, release us from all obligations as guarantor effective as of the closing. If such release is not received prior to or as of the closing of the E&S Sale Transaction, (a) CSI and Lantronix will continue to use commercially reasonable efforts to have the landlord release us therefrom, and (b) CSI and Lantronix will enter into a mutually acceptable indemnity agreement pursuant to which Lantronix will indemnify us for all losses suffered or incurred by us arising out of or relating to our continuing status as the guarantor under such lease.

 

Termination

 

The securities purchase agreement may be terminated prior to the closing of the E&S Sale Transaction in certain circumstances summarized as follows:

 

by mutual written consent of the parties;

 

by us or Lantronix if the closing does not occur on or before August 31, 2021, however if the SEC has cleared or approved the proxy statement but our special meeting has not yet been held and completed, either party is permitted to extend the date for termination of the securities purchase agreement for an additional 30 days;

 

by Lantronix or by us if a court of competent jurisdiction or other government entity has issued a final and nonappealable order, or has taken any other nonappealable final action, in each case having the effect of permanently restraining, enjoining or otherwise prohibiting the E&S Sale Transaction;

 

by Lantronix or by us if a meeting of our shareholders to approve the securities purchase agreement has been held (including any adjournment or postponement) and the requisite vote of our shareholders in favor of such approval was not obtained;

 

by Lantronix, at any time prior to the receipt of approval by our shareholders of the securities purchase agreement, if either a seller board recommendation change has occurred or we breached the no-solicitation provisions of the securities purchase agreement in any material respect;

 

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by us, if there has been a material breach of or material failure to perform any representation, warranty, covenant or agreement set forth in the securities purchase agreement on the part of Lantronix, which breach would cause the corresponding closing conditions not to be satisfied, subject to a 10-day cure period;

 

by Lantronix, if there has been a material breach of or material failure to perform any representation, warranty, covenant or agreement set forth in the securities purchase agreement on the part of us, which breach would cause the corresponding closing conditions not to be satisfied, subject to a 10-day cure period; and

 

by us if, at any time prior to the receipt of the approval by our shareholders of the securities purchase agreement, each of the following occur: (a) we receive a superior proposal and we did not breach the no-solicitation provisions of the securities purchase agreement, including with respect to making a seller board recommendation change with respect to such superior proposal; (b) the CSI board of directors approves, and we concurrently with the termination of the securities purchase agreement enter into, a definitive agreement with respect to such superior proposal and (c) we pay Lantronix the termination fee described below.

 

The termination of the securities purchase agreement generally relieves the parties from their obligations, except that certain obligations will survive any termination including obligations relating to confidentiality, remedies, termination fees and indemnification, and such termination will not relieve any party from any liability for fraud or intentional misconduct.

 

Termination Fee

 

We have agreed to pay Lantronix a termination fee of $875,000 if:

 

the securities purchase agreement is terminated by Lantronix if a seller board recommendation change occurs or we breached or must be deemed to have breached the no-solicitation provisions of the securities purchase agreement;

 

the securities purchase agreement is terminated by us and if, at any time prior to the receipt of the approval by our shareholders of the securities purchase agreement, each of the following occur: (a) we receive a superior proposal and we did not breach the no-solicitation provisions of the securities purchase agreement, including with respect to making a seller board recommendation change with respect to such superior proposal; (b) the CSI board of directors approves, and we concurrently with the termination of the securities purchase agreement enter into, a definitive agreement with respect to such superior proposal and (c) we pay Lantronix the termination fee; or

 

(a) after the date of the securities purchase agreement, an acquisition proposal is made, proposed or communicated to the CSI board of directors or becomes publicly known; (b) thereafter the securities purchase agreement is terminated by either us or Lantronix pursuant to certain specified sections in the securities purchase agreement and (c) within 12 months after such termination (i) any transaction included within the definition of an acquisition proposal is consummated or (ii) we enter into a definitive agreement providing for the consummation of any transaction within the definition of acquisition proposal; provided that, in connection therewith, the term “acquisition proposal” has the meaning ascribed thereto in the securities purchase agreement, except that all references to 20% must be changed to 50%.

 

Indemnification

 

All of the representations and warranties contained in the securities purchase agreement will survive the closing of the E&S Sale Transaction and continue in full force and effect for a period of 12 months thereafter, except that the representations and warranties identified as fundamental and the tax matters representations and warranties will survive until the expiration of the applicable statute of limitations.

 

Subject to the limitations described below, we will indemnify Lantronix and its other indemnified persons from and against any loss that Lantronix or such other indemnified persons incur or suffer arising out of or relating to the breach of our representations, warranties, covenants or agreements, certain taxes for pre-closing tax periods, certain “indemnified liabilities” (including indebtedness, transaction expenses, intercompany payables, pension liabilities and liabilities arising out of the securities purchase agreement solely to the extent brought by or on behalf of holders of our equity securities) and any actual fraud of CSI or any of the E&S Companies prior to or as of the closing.

 

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Subject to the limitations described below, Lantronix will indemnify us and our other indemnified persons from and against any loss that we or such other indemnified person incur or suffer arising out of or relating to the breach of Lantronix’s representations, warranties, covenants or agreements, certain taxes for post-closing tax periods, and any actual fraud of Lantronix prior to or as of the closing.

 

The applicable indemnified party will not be entitled to indemnification with respect to breaches of representations and warranties unless and until all losses in connection therewith exceeds a deductible amount of $200,000, and then only for the amount of losses in excess of such deductible. This deductible amount does not apply to the representations and warranties identified as fundamental representations.

 

Each party’s maximum aggregate obligation to indemnify the other party and their respective other indemnified persons with respect to breaches of representations and warranties will not exceed a cap amount equal to the sum of (a) $2.5 million plus (b) 10% of the earnout payments actually earned pursuant to the securities purchase agreement. This cap amount does not apply to the representations and warranties identified as fundamental representations. Further, a party’s liability for any losses claimed by the other party and their respective other indemnified persons under the securities purchase agreement may not exceed the purchase price.

 

Except in the event of our actual fraud, with respect to any indemnification payment for losses to which Lantronix is entitled under the securities purchase agreement, Lantronix will (a) first seek to recover such losses pursuant to an offset by Lantronix against any earnout payment otherwise due and payable to us or that is reasonably likely to become owing in the subsequent 90 days and (b) second, to the extent that the offset contemplated by clause (a) is not sufficient or not available to satisfy in full the amount of losses to which Lantronix is entitled, then Lantronix may recover the remainder of such losses directly from us.

 

CSI and Lantronix will equally share all losses incurred by either party arising out of or relating to the Brazilian litigation (as defined in the disclosure schedule to the securities purchase agreement) from and after the closing. We will have the exclusive right to conduct and control the defense, compromise and settlement of the Brazilian litigation (provided, we will not compromise or settle the Brazilian litigation without the consent of Lantronix, which consent may not be unreasonably withheld, conditioned or delayed). Lantronix will reimburse us for 50% of all costs, fees and expenses (including court costs, arbitration costs and reasonable attorneys’ fees and expenses) incurred by us or our affiliates arising out of or relating to conducting, controlling and/or settling or otherwise resolving the Brazilian litigation from and after the closing of the E&S Sale Transaction.

 

Transition Services Agreement

 

At the closing, we and Lantronix will enter into a transition services agreement pursuant to which we will provide services to Lantronix to enable it to operate the E&S Segment business immediately following the closing date. Under the transition services agreement, we will provide Lantronix with licensed space in our current headquarters and transition services in areas such as accounting, information technology, and IFS ERP application software. Lantronix will pay us the monthly cost for each service specified in the transition services agreement. Each service will continue for the duration specified for such service in the transition services agreement, subject to earlier termination in accordance with the terms set forth therein. The transition services agreement contains limitation of liability provisions limiting the parties’ respective liability arising out of the transition services agreement; provided, that certain breaches relating to access to the licensed space and the IFS application software are excluded therefrom and instead governed by separate liability limitations and remedies. The transition services agreement also contains confidentiality provisions that prohibit each party from using or disclosing the confidential information of the other party received pursuant to or in connection with the transition services agreement.

 

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PROPOSAL #2
ADVISORY COMPENSATION PROPOSAL

 

In accordance with Section 14A of the Exchange Act, we are providing our shareholders with the opportunity to cast a non-binding, advisory vote on the compensation that has, will or may be paid or become payable to our named executive officers in connection with the E&S Sale Transaction, the value of which is set forth in the table entitled “Golden Parachute Compensation” on page 42.

 

As required by Section 14A of the Exchange Act, we are asking our shareholders to vote on the adoption of the following resolution:

 

“RESOLVED, that the compensation that has, will or may be paid or become payable to the Company’s named executive officers in connection with the E&S Sale Transaction, as disclosed pursuant to Item 402(t) of Regulation S-K in the proxy statement for this meeting under “Proposal #1: E&S Sale Proposal – Interests of Our Directors and Executive Officers in the E&S Sale Transaction – Golden Parachute Compensation,” including the table, associated footnotes and narrative discussion, is hereby APPROVED.”

 

Shareholders should note that this proposal is advisory in nature and will not be binding on CSI or the CSI board of directors. The vote to approve the named executive officers’ compensation in this Proposal #2 is separate and apart from the vote to approve the E&S Sale Transaction in Proposal #1, the E&S Sale Proposal. Accordingly, you may vote to approve the E&S Sale Proposal and vote not to approve this Advisory Compensation Proposal and vice versa. Further, because we are contractually obligated to make the potential payments detailed in the sections described above, such compensation may be paid, subject only to the conditions applicable thereto, regardless of the outcome of the vote on this Advisory Compensation Proposal.

 

Vote Required

 

The approval of the Advisory Compensation Proposal requires the affirmative vote of the holders of at least a majority of the outstanding shares of CSI common stock present at the special meeting and entitled to vote on this proposal.

 

If you vote ABSTAIN on the Advisory Compensation Proposal, it will have the same effect as a vote against the Advisory Compensation Proposal. Except with respect to shares allocated to you as a participant in the CSI ESOP, if you fail to vote, it will have no effect on the outcome of the Advisory Compensation Proposal. If you are a participant in the CSI ESOP and do not vote the CSI shares allocated to you in the CSI ESOP on any proposal, your shares will be voted at the special meeting on the Advisory Compensation Proposal according to the provisions of the CSI ESOP, which provide that the trustees will vote these shares on the Advisory Compensation Proposal in the same proportion as all shares of CSI common stock allocated to ESOP participants for which voting instructions were received were voted on the Advisory Compensation Proposal.

 

OUR BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT OUR SHAREHOLDERS VOTE “FOR” PROPOSAL #2, THE ADVISORY COMPENSATION PROPOSAL.

 

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PROPOSAL #3
ADJOURNMENT PROPOSAL

 

At the special meeting, we are also submitting for shareholder consideration Proposal #3, which is a proposal to permit us to adjourn or postpone the special meeting for the purpose of soliciting additional proxies in the event that, at the special meeting, there are insufficient votes to approve the E&S Sale Proposal. This Proposal #3 is referred to in this proxy statement as the Adjournment Proposal.

 

In this Adjournment Proposal, we are asking you to authorize the holder of any proxy solicited by the CSI board of directors to vote in favor of adjourning the special meeting, and any later adjournments, to another time and place. If our shareholders approve the Adjournment Proposal, we could adjourn the special meeting, and any adjourned session of the special meeting, to a later date and use the additional time to solicit additional proxies in favor of the E&S Sale Proposal, including the solicitation of proxies from holders of our common stock that have previously voted against the E&S Sale Proposal. If the Adjournment Proposal is approved, we could adjourn the special meeting without a vote on the E&S Sale Proposal even if we had received proxies representing two-thirds of the votes against the E&S Sale Proposal and seek to convince the holders of those shares to change their votes to votes in favor of the E&S Sale Proposal. If you have previously submitted a proxy on either the E&S Sale Proposal or the Adjournment Proposal and wish to revoke it upon adjournment or postponement of the special meeting, you may do so.

 

The length of time the special meeting is adjourned or postponed will depend on the circumstances and will be determined by CSI. If the special meeting is adjourned for more than 120 days after the date fixed for the original meeting date, we will be required to provide our shareholders with formal notice of the adjourned meeting.

 

The CSI board of directors believes that if the number of shares of our common stock present or represented at the special meeting is insufficient to approve the E&S Sale Proposal, it is in the best interests of our shareholders to enable us, for a limited period of time, to continue to seek to obtain a sufficient number of additional votes to approve the E&S Sale Proposal.

 

Vote Required

 

If a quorum is present at the special meeting, the Adjournment Proposal will be approved by the affirmative vote of holders of at least a majority of the shares of CSI common stock present at the special meeting and entitled to vote on this proposal. If a quorum is not present at the special meeting, the Adjournment Proposal will be approved by the affirmative vote of the holders of a majority of the voting power of our common stock present at the special meeting and no other business will be transacted thereat. Except with respect to shares allocated to you as a participant in the CSI ESOP, if you fail to vote, it will have no effect on the outcome of the vote on the Adjournment Proposal. If you vote ABSTAIN, it will have no effect on the outcome of the vote on the Adjournment Proposal if it is submitted for shareholder approval when a quorum is present at the meeting. If you vote ABSTAIN, it would have the same effect as a vote against the Adjournment Proposal if it is submitted for approval when a quorum is not present at the special meeting.

 

If you are a participant in the CSI ESOP and do not vote the CSI shares allocated to you in the CSI ESOP, your shares will be voted at the special meeting on the Adjournment Proposal according to the provisions of the CSI ESOP, which provide that the trustees will vote these shares on the Adjournment Proposal the same proportion as all shares of CSI common stock allocated to ESOP participants were voted on the Adjournment Proposal.

 

OUR BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT OUR SHAREHOLDERS VOTE “FOR” PROPOSAL #3, THE ADJOURNMENT PROPOSAL.

 

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RISK FACTORS

 

You should carefully consider the special risks described below relating to the E&S Sale Transaction and those risk factors generally associated with our business contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 and our subsequent SEC filings, along with other information provided to you in this proxy statement, in deciding how to vote on the E&S Sale Proposal. See “WHERE YOU CAN FIND ADDITIONAL INFORMATION” on page 64. The special risks described below are not the only ones facing us. Additional risks not presently known to us or that we currently believe are immaterial may also impair our business operations. If any of the following special risks actually occurs, our business, financial condition or results of operations could be materially adversely affected, the market price of our common stock may decline, and you may lose all or part of your investment.

 

The E&S Sale Transaction may not be completed even if the shareholders approve the E&S Sale Proposal.

 

Lantronix’s obligation to close the E&S Sale Transaction is subject to a number of conditions, including approval by our shareholders, as well as other closing conditions set forth in the securities purchase agreement. We cannot control some of these conditions and we cannot ensure that they will be satisfied or that Lantronix will waive any that are not satisfied.

 

There can be no certainty, nor can we provide any assurance to shareholders, that, even if the shareholders approve the E&S Sale Proposal, these conditions will be satisfied or, if satisfied, when they will be satisfied. If the E&S Sale Transaction is not completed by August 31, 2021, either we or Lantronix may terminate the securities purchase agreement.

 

There is no assurance that the Pineapple merger will be completed and the E&S Sale Transaction is not conditioned upon the Pineapple merger.

 

The closing of the proposed merger of Communications Systems with Pineapple Energy LLC that was announced on March 2, 2021 is subject to a number of conditions and these conditions to the closing of the merger may not be satisfied in the timeframe the parties expect or at all. While the E&S Sale Transaction is part of CSI’s planned strategy to monetize its assets for the benefit of the pre-merger CSI shareholders as contemplated by the Pineapple merger transaction, there can be no assurance that the Pineapple merger transaction will be consummated. The E&S Sale Transaction is not conditioned upon the Pineapple merger. Accordingly, it is possible that the E&S Sale Transaction is consummated but that the Pineapple merger is not consummated.

 

Additionally, the proposed merger of CSI with Pineapple is expected to close after the date of this special meeting and after the date of the closing of the E&S Sale Transaction, if the E&S Sale Proposal is approved by our shareholders and the other closing conditions to the E&S Sale Transaction are met. Risks associated with the Pineapple merger, such as the risk that the merger will not be consummated within the expected time period or any event, change or other circumstances that could give rise to the termination of the merger agreement between CSI and Pineapple, may become known to us and our shareholders after the date of this special meeting or after the date of the closing of the E&S Sale Transaction.

 

If our shareholders approve the E&S Sale Proposal and we complete the E&S Sale Transaction, but the CSI-Pineapple merger is terminated for any reason, it is expected that the CSI board of directors will consider the full range of strategic alternatives regarding the use of the net proceeds from the consummation of E&S Sale Transaction and the future of CSI, with a view to maximizing value for our shareholders under the circumstances. These strategic alternatives may include pursuing an alternative transaction to the CSI-Pineapple merger, retaining some or all of the net proceeds from the E&S Sale Transaction, the acquisition of a new business or an investment in our S&S Segment business, adoption of a plan of liquidation, or a combination of these.

 

The failure to complete the E&S Sale Transaction may result in a decrease in the market value of our common stock and delay our strategy to divest substantially all our current operating and non-operating assets or result in a reduced price for the E&S Segment business.

 

If the E&S Sale Transaction is not completed, we may be subject to a number of risks, including the following:

 

61

 

 

there may not be another party interested in and able to purchase the E&S Segment business;

 

if an alternate purchaser and transaction is identified, such alternate transaction may not result in an equivalent price to what is proposed in the E&S Sale Transaction;

 

the trading price of our common stock may decline to the extent that the current market price reflects a market assumption that the E&S Sale Transaction will be completed;

 

our financial position will be negatively impacted by the expenses we have incurred with respect to the E&S Sale Transaction;

 

our efforts to divest substantially all of our current operating and non-operating assets may suffer because of the diversion of management attention to continuing the E&S Segment business and delay in the E&S Segment divestiture;

 

our relationships with our E&S Segment customers, suppliers and employees may be damaged and our E&S Segment business may be harmed, making it even more challenging to later divest the E&S Segment business in an alternative transaction with an equivalent price to what is proposed in the E&S Sale Transaction; and

 

we may be required to pay the $875,000 termination fee if the securities purchase agreement is terminated under certain circumstances.

 

The occurrence of any of these events individually or in combination could have a material adverse effect on our business, financial condition and results of operations and the market value of our common stock may decline.

 

While the E&S Sale Transaction is pending, it creates uncertainty about our future, which could have a material adverse effect on our business, financial condition and results of operations.

 

While the E&S Sale Transaction is pending, it creates uncertainty about our future. As a result of this uncertainty, our current or potential customers of either the E&S Segment or the S&S Segment may decide to delay, defer or cancel orders with us pending completion or termination of the E&S Sale Transaction. In addition, while the E&S Sale Transaction is pending, we are subject to a number of risks, including:

 

the diversion of management and employee attention from our proposed merger transaction with Pineapple and our efforts to divest our other current operating and non-operating assets;

 

the potential disruption to business partners and other service providers of either the E&S Segment or the S&S Segment; and

 

the loss of employees who may depart due to concerns regarding uncertainty relating to their jobs following the closing of the E&S Sale Transaction.

 

The occurrence of any of these events individually or in combination could have a material adverse effect on our business, financial condition and results of operations. Additionally, we have incurred substantial transaction costs and diversion of management resources in connection with the E&S Sale Transaction, and we will continue to do so until the closing.

 

We expect to incur substantial employee separation and similar expenses related to the E&S Sale Transaction.

 

We expect to incur approximately $1.26 million in expenses for employee separations, including severance costs, relating to the E&S Sale Transaction. Under the securities purchase agreement, we are obligated to terminate the employment of certain E&S Companies personnel who accept Lantronix’s offer of employment and we will be responsible for any severance obligations to these transferred personnel in connection with their termination of employment. Additionally, we intend to terminate employees of the E&S Companies not hired by Lantronix at some time following the completion of the E&S Sale Transaction and we will be responsible for any severance obligations to these terminated personnel.

 

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We also expect to incur approximately $424,000 in non-cash expense relating to the acceleration and settlement of outstanding equity awards under the 2011 Plan as provided in the section entitled “Interests of Our Directors and Executive Officers in the E&S Sale Transaction – Treatment of Outstanding Equity Awards.”

 

There are many factors beyond our control that could affect the total amount or the timing of employee separation and similar expenses relating to the E&S Sale Transaction. Moreover, many of the expenses that will be incurred are, by their nature, difficult to estimate accurately. Our future operating results and financial condition may be materially adversely affected by these expenses.

 

We expect to incur substantial expenses related to the E&S Sale Transaction.

 

We expect to incur approximately $1.5 million in transaction expenses relating to the E&S Sale Transaction. These expenses include, but are not limited to, legal, accounting and financial advisory fees and expenses, filing fees, printing expenses, and other related fees and expenses. There are many factors beyond our control that could affect the total amount or the timing of E&S Sale Transaction and divestiture expenses. Moreover, many of the expenses that will be incurred are, by their nature, difficult to estimate accurately. Our future operating results and financial condition may be materially adversely affected by transaction and divestiture expenses. Additionally, many of these expenses will be payable by us regardless of whether the E&S Sale Transaction is completed.

 

Following the E&S Sale Transaction, the continuing costs and burdens associated with being a public company will constitute a much larger percentage of our annual revenue.

 

If the E&S Sale Transaction is completed, we will remain a public company and will continue to be subject to Nasdaq Stock Market listing standards and SEC rules and regulations, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Sarbanes-Oxley Act of 2002. While all public companies face the costs and burdens associated with being public companies, the costs and burden of being a public company will be a significant portion of our annual revenues, which will be significantly reduced if the E&S Segment business is sold in the E&S Sale Transaction.

 

Our future results following the E&S Sale Transaction may differ materially from the unaudited pro forma financial statements attached as Appendix C to this proxy statement.

 

The unaudited pro forma condensed consolidated financial statements attached to this proxy statement as Appendix C presents our historical consolidated financial statements as adjusted to give effect to the contemplated E&S Sale Transaction. The unaudited pro forma condensed consolidated financial statements reflect the sale of the E&S Segment business, as well as the allocation of certain expenses to the E&S Segment business. The unaudited pro forma condensed consolidated financial statements are not necessarily indicative of the financial condition or results of operations of the S&S Segment business, which will be our remaining business, following the E&S Sale Transaction. In addition, the assumptions used in preparing the pro forma financial information may not prove to be accurate, and other factors may affect our financial condition and results of operations following the E&S Sale Transaction. Any change in our financial condition or results of operations may cause significant variations in the price of our common stock. See “UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS” at Appendix C for more information.

 

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HOUSEHOLDING OF MATERIALS

 

Some banks, brokers and other nominee record holders may be participating in the practice of “householding.” This means that only one copy of this proxy statement may have been sent to multiple shareholders in a household. We will promptly deliver, upon oral or written request, a separate copy of the proxy statement to any shareholder residing at an address to which only one copy was mailed. Requests for additional copies should be directed in writing to a shareholder’s broker, bank or other nominee holding shares of our common stock for such shareholder or to us at Communications Systems, Inc., 10900 Red Circle Drive, Minnetonka, MN 55343, Attention: Secretary, or call our Secretary at (952) 996-1674. Shareholders wishing to receive separate copies of our proxy statements in the future, and shareholders sharing an address that wish to receive a single copy of our proxy statements if they are receiving multiple copies of our proxy statements, should contact their bank, broker or other nominee record holder, or may contact the Secretary at the above address.

 

SHAREHOLDER PROPOSALS

 

Pursuant to our bylaws, the business transacted at all special meetings must be confined to the purposes stated in the notice and accordingly, shareholder proposals cannot be submitted for the special meeting.

 

Whether or not the E&S Sale Transaction is consummated, our SEC reporting obligations as a public company will not be affected. We have not yet held a 2021 annual meeting of shareholders. As a result, under Rule 14a-8 promulgated under the Exchange Act (“Rule 14a-8”), a stockholder may submit proposals before our 2021 annual meeting of shareholders if all applicable requirements of Rule 14a-8 are satisfied and such proposals are received by our Secretary within a reasonable time before we print and mail materials for our 2021 annual meeting of shareholders. We anticipate that we will disclose the deadline for shareholders to submit proposals for the 2021 annual meeting of shareholders under Rule 14a-8 on a Current Report on Form 8-K, Quarterly Report on Form 10-Q or Annual Report on Form 10-K once such deadline is known.

 

Pursuant to our bylaws, except in the case of proposals made in accordance with Rule 14a-8, at the annual meeting only such business may be conducted as is of a nature that is appropriate for consideration at an annual meeting and has been either specified in the notice of the meeting, otherwise properly brought before the meeting by or at the direction of the CSI board of directors, or otherwise properly brought before the meeting by a shareholder who has given timely written notice to the Secretary of CSI of the shareholder’s intention to bring the business before the meeting. To be timely, the notice must be given by such shareholder to the Secretary of the Company not less than 45 days or more than 75 days prior to a meeting date corresponding to the previous year’s annual meeting. Notice relating to the conduct of such business at an annual meeting must contain certain information as described in Section 2.9 of our bylaws.

 

WHERE YOU CAN FIND MORE INFORMATION

 

We file annual, quarterly and current reports, proxy statements and other information with the SEC. Our SEC filings are available to the public over the Internet at the SEC’s website at www.sec.gov. The reports and other information that we file with the SEC are also available in the “Financial Reports” section of our corporate website at www.commsystems.com. Our website address is provided as an inactive textual reference only. The information provided on our website is not part of this proxy statement.

 

Any person, including any beneficial owner, to whom this proxy statement is delivered may request a copy of this proxy statement or any of its appendices, without charge, by written request directed to the attention of our Secretary at Communications Systems, Inc., 10900 Red Circle Drive, Minnetonka, MN 55343, or by calling our Secretary at (952) 996-1674.

 

This proxy statement does not constitute the solicitation of a proxy in any jurisdiction to or from any person to whom or from whom it is unlawful to make such proxy solicitation in that jurisdiction. You should rely only on the information contained in this proxy statement to vote your shares at the special meeting. We have not authorized anyone to provide you with information that is different from what is contained in this proxy statement.

 

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This proxy statement is dated June 14, 2021. You should not assume that the information contained in this proxy statement is accurate as of any date other than that date, and the mailing of this proxy statement to shareholders does not create any implication to the contrary.

 

FINANCIAL STATEMENTS

 

The following is an index to the financial statements of Communications Systems, Inc. and its subsidiaries included in this proxy statement:

 

Three Months Ended March 31, 2021    
Condensed Consolidated Balance Sheets as of March 31, 2021 and December 31, 2020   F-1
Condensed Consolidated Statements of Income (Loss) and Compressive Income (Loss) for the Three Months Ended March 31, 2021 and March 31, 2020   F-2
Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2021 and March 31, 2020   F-3
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2021 and March 31, 2020   F-4
Notes to Condensed Consolidated Financial Statements   F-5
Years Ended December 31, 2020 and 2019    
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements   F-20
Consolidated Balance Sheets as of December 31, 2020 and December 31, 2019   F-23
Consolidated Statements of Income (Loss) and Compressive Income (Loss) for the Years Ended December 31, 2020 and December 31, 2019   F-24
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2020 and December 31, 2019   F-25
Consolidated Statements of Cash Flows for the Years Ended December 31, 2020 and December 31, 2019   F-26
Notes to Consolidated Financial Statements   F-27

 

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COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(Unaudited)

 

ASSETS
    March 31     December 31  
    2021     2020  
CURRENT ASSETS:                
  Cash and cash equivalents   $ 14,747,054     $ 13,092,484  
  Investments     693,424       2,759,024  
  Trade accounts receivable, less allowance for                
    doubtful accounts of $137,000 and $121,000, respectively     8,673,414       10,177,445  
  Inventories     8,218,822       8,696,880  
  Prepaid income taxes           35,948  
  Other current assets     1,330,487       996,472  
      TOTAL CURRENT ASSETS     33,663,201       35,758,253  
                 
PROPERTY, PLANT AND EQUIPMENT,  net     7,088,892       7,242,072  
OTHER ASSETS:                
  Investments     7,064,665       7,109,212  
  Goodwill     2,086,393       2,086,393  
  Operating lease right of use asset     362,812       413,415  
  Intangible assets, net     2,661,541       2,775,361  
  Other assets, net     180,734       171,619  
    TOTAL OTHER ASSETS     12,356,145       12,556,000  
TOTAL ASSETS   $ 53,108,238     $ 55,556,325  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:                
  Accounts payable   $ 2,685,775     $ 2,378,449  
  Accrued compensation and benefits     1,776,982       2,298,075  
  Operating lease liability     217,133       213,553  
  Other accrued liabilities     1,440,107       1,524,515  
  Accrued consideration           550,000  
  Income taxes payable     2,225        
  Dividends payable     5,387       16,147  
  Deferred revenue     589,444       456,912  
    TOTAL CURRENT LIABILITIES     6,717,053       7,437,651  
LONG TERM LIABILITIES:                
  Long-term compensation plans     142,835       116,460  
  Operating lease liability     140,105       197,308  
  Deferred revenue     386,314       310,179  
    TOTAL LONG-TERM LIABILITIES     669,254       623,947  
COMMITMENTS AND CONTINGENCIES  (Footnote 9)                
STOCKHOLDERS' EQUITY                
  Preferred stock, par value $1.00 per share;
3,000,000 shares authorized; none issued
               
  Common stock, par value $.05 per share; 30,000,000 shares                
    authorized; 9,448,129 and 9,321,927 shares issued and                
    outstanding, respectively     472,406       466,096  
  Additional paid-in capital     43,969,776       43,572,114  
  Retained earnings     1,948,084       4,135,284  
  Accumulated other comprehensive loss     (668,335 )     (678,767 )
    TOTAL STOCKHOLDERS' EQUITY     45,721,931       47,494,727  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY   $ 53,108,238     $ 55,556,325  

 

The accompanying notes are an integral part of the condensed consolidated financial statements.   

 

 

F-1 

 

 

 

COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)

 

(Unaudited)

 

    Three Months Ended March 31  
    2021     2020  
             
Sales   $ 10,159,315     $ 9,162,742  
Cost of sales     5,942,677       5,425,595  
  Gross profit     4,216,638       3,737,147  
Operating expenses:                
  Selling, general and administrative expenses     5,219,731       4,960,890  
  Acquisition-related costs     1,143,423        
      Total operating expenses     6,363,154       4,960,890  
Operating loss from continuing operations     (2,146,516 )     (1,223,743 )
Other income (expenses):                
  Investment and other (expense) income     (10,855 )     111,757  
  Gain on sale of assets           308,403  
  Interest and other expense     (2,277 )     (9,593 )
    Other (expense) income,  net     (13,132 )     410,567  
Operating loss from continuing operations before income taxes     (2,159,648 )     (813,176 )
Income tax expense (benefit)     1,203       (4,457 )
Net loss from continuing operations     (2,160,851 )     (808,719 )
Net income from discontinued operations, net of tax           2,313,352  
Net (loss) income     (2,160,851 )     1,504,633  
                 
Other comprehensive income (loss), net of tax:                
    Unrealized loss on available-for-sale securities     (9,299 )     (14,452 )
    Foreign currency translation adjustment     19,731       (132,103 )
Total other comprehensive income (loss)     10,432       (146,555 )
Comprehensive (loss) income   $ (2,150,419 )   $ 1,358,078  
                 
                 
Basic net (loss) income per share:                
Continuing operations   $ (0.23 )   $ (0.09 )
Discontinued operations           0.25  
    $ (0.23 )   $ 0.16  
                 
Diluted net (loss) income per share:                
Continuing operations   $ (0.23 )   $ (0.09 )
Discontinued operations           0.25  
    $ (0.23 )   $ 0.16  
                 
Weighted Average Basic Shares Outstanding     9,332,589       9,265,590  
Weighted Average Dilutive Shares Outstanding     9,332,589       9,445,299  
Dividends declared per share   $     $ 0.02  

 

The accompanying notes are an integral part of the condensed consolidated financial statements. 

 

 

F-2 

 

 

 

COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

 

(Unaudited)

 

For the Three Months Ended March 31, 2021                              
                            Accumulated