Table of Contents







|                                    |  | 
|----------------------------------- |  | 
|UNITED
 STATES                     
|SECURITIES
 AND EXCHANGE COMMISSION
|Washington,
 D.C. 20549            
|                                    |  | 
|                                    |  | 
|                                    |  | 
|FORM 10-Q                          
|                                    |  | 
|                                   
|(Mark One)                         

|                                                                                                             |                                                                                         
|------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------
|x                                                                                                            | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|                                                                                                            
|For the quarterly period
 endedSeptember 30, 2009                                                           
|                                                                                                            
|OR                                                                                                          
|o                                                                                                            | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                                                                                            
|For the transition period
 from ________________________________ to ________________________________________



|                        |           | 
|----------------------- | --------- | 
|Commission File Number: | 001-31588 | 



| |  | 
| |  | 
| |  | 



|                                                       
|-------------------------------------------------------
|COMMUNICATIONS SYSTEMS, INC.                           
|(Exact
 name of registrant as specified in its charter)



|                                          |                     
|----------------------------------------- | --------------------
|MINNESOTA                                 | 41-0957999          
|(State
 or other jurisdiction of          | (Federal
 Employer  
|incorporation
 or organization)           | Identification
 No.)
|                                          |                     
|10900
 Red Circle Drive, Minnetonka, MN   | 55343               
|(Address
 of principal executive offices) | (Zip
 Code)         



|                                                   
|---------------------------------------------------
|(952)
 996-1674                                    
|Registrants
 telephone number, including area code



| |  | 
| |  | 
| |  | 

Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past 90 days. YES x   NO o

Indicate by check mark
whether the registrant has submitted electronically and posted on its corporate
Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post
such files). YES o   NO o

Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act.  YES o  NO x

Indicate by a check mark
whether the registrant is a large accelerated filer, an accelerated filer or a
non-accelerated filer (as defined by Rule 12b-2 of the Exchange Act).

Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer o Smaller Reporting Company x

|                                                                                                                               
|-------------------------------------------------------------------------------------------------------------------------------
|APPLICABLE
 ONLY TO CORPORATE ISSUERS:                                                                                         
|Indicate the number of
 shares outstanding of each of the issuers classes of common stock, as of the
 latest practicable date.

|                                         |  |                                       |  |                                
|---------------------------------------- |  | ------------------------------------- |  | -------------------------------
|Class                                    |  | Name of Exchange
 On Which Registered |  | Outstanding at November 1, 2009
|Common
 Stock, par value
 $.05 per share |  | NASDAQ                                |  | 8,350,371                      





|                                             
|---------------------------------------------
|COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
|                                             
|INDEX                                        

|                               |                                                                                                |                                                                      |          | 
|------------------------------ | ---------------------------------------------------------------------------------------------- | -------------------------------------------------------------------- | -------- | 
|                               |                                                                                                |                                                                      | Page No.
|                               |                                                                                                |                                                                     
|Part I.
 Financial Information |                                                                                                |                                                                     
|                               |                                                                                                |                                                                      |          | 
|                               | Item 1.
 Financial Statements (Unaudited)                                                      |                                                                      |         
|                               |                                                                                                |                                                                      |          | 
|                               |                                                                                                | Condensed Consolidated Balance Sheets                                | 3        | 
|                               |                                                                                                |                                                                      |          | 
|                               |                                                                                                | Condensed Consolidated Statements of Income and Comprehensive Income | 4        | 
|                               |                                                                                                |                                                                      |          | 
|                               |                                                                                                | Condensed Consolidated Statements of Changes in Stockholders Equity | 5        | 
|                               |                                                                                                |                                                                      |          | 
|                               |                                                                                                | Condensed Consolidated Statements of Cash Flows                      | 6        | 
|                               |                                                                                                |                                                                      |          | 
|                               |                                                                                                | Notes to Condensed Consolidated Financial Statements                 | 7        | 
|                               |                                                                                                |                                                                      |          | 
|                               | Item 2. Managements Discussion and Analysis of Financial Condition
 and Results of Operations | 16                                                                   |         
|                               |                                                                                                |                                                                      |          | 
|                               | Item 3. Quantitative and Qualitative Disclosures about Market Risk                             | 24                                                                   |         
|                               |                                                                                                |                                                                      |          | 
|                               | Item 4. Controls and Procedures                                                                | 25                                                                   |         
|                               |                                                                                                |                                                                      |          | 
|Part II. Other Information     | 25                                                                                             |                                                                     
|                               |                                                                                                |                                                                      |          | 
|SIGNATURES                     |                                                                                                |                                                                     
|                               |                                                                                                |                                                                      |          | 
|CERTIFICATIONS                 |                                                                                                |                                                                     

2

---

Table of Contents

COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

|                                                                                                                                           |  |                    |             |                   |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------ | ----------- | ----------------- | - | ---------- | -
|                                                                                                                                           |  | September 30
 2009 |             | December 31
 2008 |  
|ASSETS                                                                                                                                     | 
|CURRENT ASSETS:                                                                                                                            |  |                    |             |                   |   |            |  
|Cash and cash equivalents                                                                                                                  |  | $                  | 23,862,138  |                   | $ | 29,951,561 |  
|Investments                                                                                                                                |  |                    | 8,977,650   |                   |   |            |  
|Trade accounts receivable, less allowance for doubtful accounts of
 $466,000 and $219,000, respectively                                    |  |                    | 14,769,941  |                   |   | 17,243,788 |  
|Inventories                                                                                                                                |  |                    | 24,801,537  |                   |   | 29,398,443 |  
|Other current assets                                                                                                                       |  |                    | 775,218     |                   |   | 861,039    |  
|Deferred income taxes                                                                                                                      |  |                    | 3,824,664   |                   |   | 3,364,297  |  
|TOTAL CURRENT ASSETS                                                                                                                       |  |                    | 77,011,148  |                   |   | 80,819,128 |  
|PROPERTY, PLANT AND EQUIPMENT, net                                                                                                         |  |                    | 13,959,122  |                   |   | 12,014,541 |  
|OTHER ASSETS:                                                                                                                              |  |                    |             |                   |   |            |  
|Investments                                                                                                                                |  |                    | 6,113,776   |                   |   |            |  
|Goodwill                                                                                                                                   |  |                    | 4,560,217   |                   |   | 4,560,217  |  
|Deferred income taxes                                                                                                                      |  |                    | 436,721     |                   |   | 643,667    |  
|Prepaid pensions                                                                                                                           |  |                    |             |                   |   | 566,137    |  
|Other assets                                                                                                                               |  |                    | 125,785     |                   |   | 134,101    |  
|TOTAL OTHER ASSETS                                                                                                                         |  |                    | 11,236,499  |                   |   | 5,904,122  |  
|                                                                                                                                           |  |                    |             |                   |   |            |  
|                                                                                                                                          
|TOTAL ASSETS                                                                                                                               |  | $                  | 102,206,769 |                   | $ | 98,737,791 |  
|                                                                                                                                           |  |                    |             |                   |   |            |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                       | 
|                                                                                                                                           |  |                    |             |                   |   |            |  
|CURRENT LIABILITIES:                                                                                                                       |  |                    |             |                   |   |            |  
|Current portion of long-term debt                                                                                                          |  | $                  | 366,630     |                   | $ | 348,373    |  
|Accounts payable                                                                                                                           |  |                    | 3,961,128   |                   |   | 4,126,756  |  
|Accrued compensation and benefits                                                                                                          |  |                    | 4,511,003   |                   |   | 2,985,233  |  
|Other accrued liabilities                                                                                                                  |  |                    | 1,811,806   |                   |   | 1,624,971  |  
|Income taxes payable                                                                                                                       |  |                    | 906,897     |                   |   | 11,430     |  
|Dividends payable                                                                                                                          |  |                    | 1,168,856   |                   |   | 994,169    |  
|TOTAL CURRENT LIABILITIES                                                                                                                  |  |                    | 12,726,320  |                   |   | 10,090,932 |  
|                                                                                                                                           |  |                    |             |                   |   |            |  
|LONG TERM LIABILITIES:                                                                                                                     |  |                    |             |                   |   |            |  
|Long-term compensation plans                                                                                                               |  |                    | 753,920     |                   |   | 1,410,559  |  
|Income taxes payable                                                                                                                       |  |                    | 627,140     |                   |   | 733,683    |  
|Pension Liabilities                                                                                                                        |  |                    | 47,766      |                   |   |            |  
|Long term debt - mortgage payable                                                                                                          |  |                    | 2,497,174   |                   |   | 2,774,474  |  
|TOTAL LONG-TERM LIABILITIES                                                                                                                |  |                    | 3,926,000   |                   |   | 4,918,716  |  
|                                                                                                                                           |  |                    |             |                   |   |            |  
|COMMITMENTS AND CONTINGENCIES                                                                                                              |  |                    |             |                   |   |            |  
|                                                                                                                                           |  |                    |             |                   |   |            |  
|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;
 8,348,538 and 8,282,348 shares issued and outstanding, respectively |  |                    | 417,427     |                   |   | 414,117    |  
|Additional paid-in capital                                                                                                                 |  |                    | 33,597,984  |                   |   | 33,019,154 |  
|Retained earnings                                                                                                                          |  |                    | 51,965,943  |                   |   | 50,503,410 |  
|Accumulated other comprehensive income, net of tax                                                                                         |  |                    | (426,905    | )                 |   | (208,538   | )
|TOTAL STOCKHOLDERS EQUITY                                                                                                                 |  |                    | 85,554,449  |                   |   | 83,728,143 |  
|                                                                                                                                           |  |                    |             |                   |   |            |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                 |  | $                  | 102,206,769 |                   | $ | 98,737,791 |  

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

3

---

Table of Contents

COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
INCOME AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)

|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|------------------------------------------------------------ |  | ------------------------------- | ---------- | ------------------------------ | - | ---------- | - | ---- | ---------- | - | - | ---------- | -
|                                                             |  | Three Months Ended September 30 |            | Nine Months Ended September 30 |  
|                                                            
|                                                             |  | 2009                            |            | 2008                           |   | 2009       |   | 2008 |           
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Sales from operations                                        |  | $                               | 28,107,200 |                                | $ | 32,682,521 |   | $    | 83,456,557 |   | $ | 94,294,798 |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Costs and expenses:                                          |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Cost of sales                                                |  |                                 | 17,239,281 |                                |   | 19,155,707 |   |      | 52,159,098 |   |   | 58,055,730 |  
|Selling, general and administrative expenses                 |  |                                 | 7,518,709  |                                |   | 8,291,013  |   |      | 23,403,906 |   |   | 24,875,451 |  
|Impairment and other charges related to JDL (Notes 4 and 11) |  |                                 |            |                                |   |            |   |      |            |   |   | 2,999,441  |  
|Total costs and expenses                                     |  |                                 | 24,757,990 |                                |   | 27,446,720 |   |      | 75,563,004 |   |   | 85,930,622 |  
|Operating income                                             |  |                                 | 3,349,210  |                                |   | 5,235,801  |   |      | 7,893,553  |   |   | 8,364,176  |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Other income and (expenses):                                 |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Investment and other income                                  |  |                                 | 201,841    |                                |   | 121,847    |   |      | 692,624    |   |   | 441,106    |  
|Gain on sale of assets                                       |  |                                 | 32,594     |                                |   | 194,755    |   |      | 65,266     |   |   | 280,959    |  
|Interest and other expense                                   |  |                                 | (61,826    | )                              |   | (57,276    | ) |      | (178,621   | ) |   | (145,037   | )
|Other income, net                                            |  |                                 | 172,609    |                                |   | 259,326    |   |      | 579,269    |   |   | 577,028    |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Income before income taxes                                   |  |                                 | 3,521,819  |                                |   | 5,495,127  |   |      | 8,472,822  |   |   | 8,941,204  |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Income tax expense                                           |  |                                 | 1,660,485  |                                |   | 2,701,000  |   |      | 3,640,175  |   |   | 3,700,000  |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Net income                                                   |  |                                 | 1,861,334  |                                |   | 2,794,127  |   |      | 4,832,647  |   |   | 5,241,204  |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Other comprehensive income (loss), net of tax:               |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Additional minimum pension liability adjustments             |  |                                 | (387,357   | )                              |   | (55,825    | ) |      | (615,635   | ) |   | (127,915   | )
|Unrealized gains on available-for-sale securities            |  |                                 | (3,594     | )                              |   |            |   |      | 63,181     |   |   |            |  
|Foreign currency translation adjustment                      |  |                                 | (149,993   | )                              |   | (365,484   | ) |      | 334,087    |   |   | (502,504   | )
|Total other comprehensive income (loss), net of tax          |  |                                 | (540,944   | )                              |   | (421,309   | ) |      | (218,367   | ) |   | (630,419   | )
|Comprehensive net income (loss)                              |  | $                               | 1,320,390  |                                | $ | 2,372,818  |   | $    | 4,614,280  |   | $ | 4,610,785  |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Basic net income per share:                                  |  | $                               | .22        |                                | $ | .33        |   | $    | .58        |   | $ | .61        |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Diluted net income per share:                                |  | $                               | .22        |                                | $ | .32        |   | $    | .58        |   | $ | .61        |  
|                                                             |  |                                 |            |                                |   |            |   |      |            |   |   |            |  
|Average Basic Shares Outstanding                             |  |                                 | 8,347,701  |                                |   | 8,579,530  |   |      | 8,336,027  |   |   | 8,599,558  |  
|Average Dilutive Shares Outstanding                          |  |                                 | 8,371,155  |                                |   | 8,612,194  |   |      | 8,345,290  |   |   | 8,638,465  |  
|Dividends per share                                          |  | $                               | .14        |                                | $ | .12        |   | $    | .38        |   | $ | .36        |  

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

4

---

Table of Contents

COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS
EQUITY
(Unaudited)

|                                                            |  |              |           |        |                    |                            |   |   |            |                                             |   |            |   |   |          |   |   |            |  
|----------------------------------------------------------- |  | ------------ | --------- | ------ | ------------------ | -------------------------- | - | - | ---------- | ------------------------------------------- | - | ---------- | - | - | -------- | - | - | ---------- | -
|                                                            |  |              |           |        |                    | AdditionalPaid-in
 Capital |   |   |            | CumulativeOtherComprehensive
 Income (Loss) |   |            |  
|                                                            |  | Common Stock |           |        | Retained
 Earnings |                            |   |   |           
|                                                            |  | Shares       |           | Amount |                    |                            |   |   | Total      |                                            
|BALANCE AT DECEMBER 31, 2008                                |  |              | 8,282,349 |        | $                  | 414,117                    |   | $ | 33,019,154 |                                             | $ | 50,503,410 |   | $ | (208,538 | ) | $ | 83,728,143 |  
|Net income                                                  |  |              |           |        |                    |                            |   |   |            |                                             |   | 4,832,647  |   |   |          |   | $ | 4,832,647  |  
|Issuance of common stock under Employee Stock Purchase Plan |  |              | 12,327    |        |                    | 616                        |   |   | 101,450    |                                             |   |            |   |   |          |   | $ | 102,066    |  
|Issuance of common stock to Employee Stock Ownership Plan   |  |              | 55,100    |        |                    | 2,755                      |   |   | 427,025    |                                             |   |            |   |   |          |   | $ | 429,780    |  
|Issuance of common stock under Employee Stock Option Plan   |  |              | 3,800     |        |                    | 190                        |   |   | 38,080     |                                             |   |            |   |   |          |   | $ | 38,270     |  
|Tax benefit from non-qualified employee stock options       |  |              |           |        |                    |                            |   |   | 952        |                                             |   |            |   |   |          |   | $ | 952        |  
|Share based compensation                                    |  |              |           |        |                    |                            |   |   | 31,571     |                                             |   |            |   |   |          |   | $ | 31,571     |  
|Purchase of common stock                                    |  |              | (5,038    | )      |                    | (251                       | ) |   | (20,248    | )                                           |   | (31,618    | ) |   |          |   | $ | (52,117    | )
|Shareholder dividends                                       |  |              |           |        |                    |                            |   |   |            |                                             |   | (3,338,496 | ) |   |          |   | $ | (3,338,496 | )
|Other comprehensive income                                  |  |              |           |        |                    |                            |   |   |            |                                             |   |            |   |   | (218,367 | ) | $ | (218,367   | )
|BALANCE AT SEPTEMBER 30, 2009                               |  |              | 8,348,538 |        | $                  | 417,427                    |   | $ | 33,597,984 |                                             | $ | 51,965,943 |   | $ | (426,905 | ) | $ | 85,554,449 |  

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

5

---

Table of Contents

COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

|                                                                                   |  |                                |             |      |   |            |  
|---------------------------------------------------------------------------------- |  | ------------------------------ | ----------- | ---- | - | ---------- | -
|                                                                                   |  | Nine Months Ended September 30 |            
|                                                                                  
|                                                                                   |  | 2009                           |             | 2008 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                              |  |                                |             |      |   |            |  
|Net income                                                                         |  | $                              | 4,832,647   |      | $ | 5,241,204  |  
|Adjustments to reconcile net income to net
 cash provided by operating activities: |  |                                |             |      |   |            |  
|Depreciation and amortization                                                      |  |                                | 1,238,362   |      |   | 1,450,817  |  
|Share based compensation                                                           |  |                                | 31,571      |      |   | 41,824     |  
|Deferred income taxes                                                              |  |                                | (253,421    | )    |   | (857,088   | )
|Impairment and other charges related to JDL
 (Notes 4 and 11)                      |  |                                | 0           |      |   | 2,999,441  |  
|Gain on sale of assets                                                             |  |                                | (65,266     | )    |   | (280,959   | )
|Excess tax benefit from stock based
 payments                                      |  |                                | (952        | )    |   | (34,216    | )
|Changes in assets and liabilities:                                                 |  |                                |             |      |   |            |  
|Trade receivables                                                                  |  |                                | 2,561,915   |      |   | (7,134,383 | )
|Inventories                                                                        |  |                                | 4,708,781   |      |   | 1,650,990  |  
|Prepaid income taxes                                                               |  |                                | 0           |      |   | 145,736    |  
|Other current assets                                                               |  |                                | 100,652     |      |   | 2,444      |  
|Accounts payable                                                                   |  |                                | (193,643    | )    |   | 815,742    |  
|Accrued compensation and benefits                                                  |  |                                | 1,298,911   |      |   | (645,806   | )
|Other accrued expenses                                                             |  |                                | 173,271     |      |   | 726,653    |  
|Income taxes payable                                                               |  |                                | 789,876     |      |   | 2,572,207  |  
|Net cash provided by operating activities                                          |  |                                | 15,222,704  |      |   | 6,694,606  |  
|                                                                                   |  |                                |             |      |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                              |  |                                |             |      |   |            |  
|Capital expenditures                                                               |  |                                | (3,159,536  | )    |   | (2,455,660 | )
|Purchases of investments                                                           |  |                                | (26,819,245 | )    |   |            |  
|Proceeds from sale of fixed assets                                                 |  |                                | 77,726      |      |   | 395,116    |  
|Proceeds from the sale of investments                                              |  |                                | 11,791,000  |      |   |            |  
|Net cash used in investing activities                                              |  |                                | (18,110,055 | )    |   | (2,060,544 | )
|                                                                                   |  |                                |             |      |   |            |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                              |  |                                |             |      |   |            |  
|Cash dividends paid                                                                |  |                                | (3,163,810  | )    |   | (3,098,385 | )
|Mortgage principal payments                                                        |  |                                | (259,043    | )    |   | (238,860   | )
|Proceeds from issuance of common stock                                             |  |                                | 140,336     |      |   | 350,267    |  
|Excess tax benefit from stock based
 payments                                      |  |                                | 952         |      |   | 34,216     |  
|Purchase of common stock                                                           |  |                                | (52,117     | )    |   | (466,763   | )
|Net cash used in financing activities                                              |  |                                | (3,333,682  | )    |   | (3,419,525 | )
|                                                                                   |  |                                |             |      |   |            |  
|EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON
 CASH                                   |  |                                | 131,610     |      |   | (212,635   | )
|NET (DECREASE) INCREASE IN CASH AND CASH
 EQUIVALENTS                              |  |                                | (6,089,423  | )    |   | 1,001,902  |  
|                                                                                   |  |                                |             |      |   |            |  
|CASH AND CASH EQUIVALENTS AT BEGINNING OF
 PERIOD                                  |  |                                | 29,951,561  |      |   | 29,427,879 |  
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                                         |  | $                              | 23,862,138  |      | $ | 30,429,781 |  
|                                                                                   |  |                                |             |      |   |            |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW
 INFORMATION:                                |  |                                |             |      |   |            |  
|Income taxes paid                                                                  |  | $                              | 3,103,719   |      | $ | 1,350,443  |  
|Interest paid                                                                      |  |                                | 171,610     |      |   | 151,070    |  
|Dividends declared not paid                                                        |  |                                | 1,168,856   |      |   | 1,034,428  |  

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

6

---

Table of Contents

COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of businessCommunications Systems, Inc. (herein collectively
called CSI, our or the Company) is a Minnesota corporation organized in
1969 which operates directly and through its subsidiaries located in the United
States, Costa Rica, the United Kingdom and China. CSI is principally engaged
through its Suttle and Austin Taylor business units in the manufacture and sale
of modular connecting and wiring devices for voice and data communications,
digital subscriber line filters, and structured wiring systems and through its
Transition Networks business unit in the manufacture of media and rate conversion
products for telecommunications networks. CSI also provides through its JDL
Technologies business unit IT solutions including network design, computer
infrastructure installations, IT service management, change management, network
security and network operations services.

Financial statement presentationThe condensed consolidated balance sheets and
condensed consolidated statement of changes in stockholders equity as of
September 30, 2009 and 2008 and the related condensed consolidated statements of
income and comprehensive income, and the condensed consolidated statements of
cash flows for the periods ended September 30, 2009 and 2008 have been prepared
by Company management. In the opinion of management, all adjustments (which
include only normal recurring adjustments except where noted) necessary to
present fairly the financial position, results of operations, and cash flows at
September 30, 2009 and 2008 and for the periods then ended have been made.

Certain
information and footnote disclosures normally included in consolidated
financial statements prepared in accordance with generally accepted accounting
principles in the United States of America have been condensed or omitted. We
recommend these condensed consolidated financial statements be read in
conjunction with the financial statements and notes thereto included in the
Companys December 31, 2008 Annual Report to Shareholders on Form 10-K. The
results of operations for the periods ended September 30 are not necessarily
indicative of operating results for the entire year.

The
presentation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, and disclosure of
contingent assets and liabilities at the balance sheet date, and the reported
amounts of revenues and expenses during the reporting period. The estimates and
assumptions used in the accompanying condensed consolidated financial
statements are based upon managements evaluation of the relevant facts and
circumstances as of the time of the financial statements. Actual results could
differ from those estimates.

Except to the
extent updated or described below, the significant accounting policies set forth
in Note 1 to the consolidated financial statements in the Companys Annual
Report on Form 10-K for the year
ended December 31, 2008, appropriately represent, in all material respects, the
current status of accounting policies, and are incorporated herein by
reference.

7

---

Table of Contents

Cash equivalents and investments

For purposes
of the condensed consolidated statements of cash flows, the Company considers
all highly liquid investments with a maturity of three months or less at the
time of purchase to be cash equivalents. As of September 30, 2009, the Company
had $23.9 million in cash and cash equivalents. Of this amount, $9.8 million
was invested in short-term money market funds that are not considered to be
bank deposits and are not insured or guaranteed by the federal deposit
insurance company (FDIC) or other government agency. These money market funds
seek to preserve the value of the investment at $1.00 per share; however, it is
possible to lose money investing in these funds. The remainder is operating
cash and certificates of deposit which are fully insured through the FDIC.

The Company
had $15.1 million in investments which consist of certificates of deposit that
are traded on the open market and are classified as available-for-sale at
September 30, 2009. Of the $15.1 million in investments, $9.0 million mature in
12 months or less and are classified as current assets. Available-for-sale
investments are reported at fair value with unrealized gains and losses net of
tax excluded from operations and reported as a separate component of
stockholders equity (See Comprehensive income below).

Revenue Recognition

The Companys
manufacturing operations (Suttle, Transition Networks and Austin Taylor)
recognize revenue when the earnings process is complete, evidenced by
persuasive evidence of an agreement, delivery has occurred or services have
been rendered, the price is fixed or determinable, and collectability is
reasonably assured. Revenue is recognized for domestic and international sales
at the shipping point or delivery to customers, based on the related shipping
terms. Risk of loss transfers at the point of shipment or delivery to
customers. Sales are made directly to customers and through distributors.
Payment terms for distributors are consistent with the terms of the Companys
direct customers. The Company records a provision for sale returns, sales
incentives and warranty costs at the time of the sale based on historical
experience and current trends.

JDL
Technologies generally records revenue on hardware, software and related
equipment sales and installation contracts when the revenue recognition
criteria are met and products are installed and accepted by the customer.

JDL records
revenue on service contracts on a straight-line basis over the contract period,
unless evidence suggests the revenue is earned in a different pattern. Each
contract is individually reviewed to determine when the earnings process is
complete. Contracts in effect through June 30, 2008 with the United States
Virgin Islands Department of Education (VIDE) required funding under the
federal governments E-RATE program and approval by the Schools and Libraries
Division (SLD) of the Universal Service Administration Company before payment
was made. For the periods covered by this report, we did not recognize E-RATE
revenue on our VIDE contracts until approval is received from the SLD.

8

---

Table of Contents

Comprehensive income

The components
of accumulated other comprehensive income, net of tax, are as follows:

|                                                   |  |                    |          |                   |   |          |  
|-------------------------------------------------- |  | ------------------ | -------- | ----------------- | - | -------- | -
|                                                   |  | September 30
 2009 |          | December 31
 2008 |  
|Foreign
 currency translation                      |  | $                  | (518,287 | )                 | $ | (852,374 | )
|Unrealized
 gain on available-for-sale investments |  |                    | 63,181   |                   |   |          |  
|Minimum
 pension liability                         |  |                    | 28,201   |                   |   | 643,836  |  
|                                                   |  | $                  | (426,905 | )                 | $ | (208,538 | )

NOTE 2 -
STOCK-BASED COMPENSATION

Common shares
are reserved in connection with the Companys 1992 Stock Plan under which
2,500,000 shares of common stock may be issued pursuant to stock options, stock
appreciation rights, restricted stock or deferred stock granted to officers and
key employees. Exercise prices of stock options under the Stock Plan cannot be
less than fair market value of the stock on the date of grant. Rules and
conditions governing awards of stock options, stock appreciation rights and
restricted stock are determined by the Compensation Committee of the Board of
Directors, subject to certain limitations incorporated into the Stock Plan. At
September 30, 2009, 1,074,239 shares remained available to be issued under the
Stock Plan. All currently outstanding awards under the Stock Plan are vested.
The options expire five years from date of grant.

Shares of
common stock are also reserved for issuance in connection with a nonqualified
stock option plan under which up to 200,000 shares may be issued to nonemployee
directors (the Director Plan). The Director Plan provides for the automatic
grant of nonqualified options for 3,000 shares of common stock annually to each
nonemployee director concurrent with the annual stockholders meeting. Exercise
price is the fair market value of the stock at the date of grant. Options
granted under the Director Plan vest six months after grant and expire 10 years
from date of grant. At September 30, 2009, 31,000 shares are available to be
issued under the Director Plan.

The Company also
has an Employee Stock Purchase Plan (ESPP) for which 500,000 common shares have
been reserved. Employees are able to acquire shares under the ESPP Plan at 95%
of the price at the end of the two semi-annual plan terms, which are June 30
and December 31. The ESPP Plan is non-compensatory under current rules and does
not give rise to compensation cost.

Stock
compensation expense recognized for the nine month period ended September 30,
2009 was $32,000 before income taxes and $20,000 after income taxes. Stock
compensation expense recognized for the nine month period ended September 30,
2008 was $42,000 before income taxes and $27,000 after income taxes. Excess tax
benefits from the exercise of stock options included in financing cash flows
for the nine month periods ended September 30, 2009 and 2008, were $1,000 and
$34,000, respectively.

The following
table summarizes the stock option transactions for the nine months ended
September 30, 2009. All outstanding stock options are currently exercisable.

9

---

Table of Contents

|                                  |  |         |          |                                             |   |                                               |  |            |  | 
|--------------------------------- |  | ------- | -------- | ------------------------------------------- | - | --------------------------------------------- |  | ---------- |  | 
|                                  |  | Options |          | Weighted average
 exercise price
 per share |   | Weighted average
 remaining
 contractual term | 
|Outstanding
  December 31, 2008  |  |         | 351,350  |                                             | $ | 9.99                                          |  | 2.78 years | 
|Issued                            |  |         | 18,000   |                                             |   | 9.73                                          |  |            |  | 
|Exercised                         |  |         | (3,800   | )                                           |   | 10.07                                         |  |            |  | 
|Canceled                          |  |         | (124,450 | )                                           |   | 9.51                                          |  |            |  | 
|Outstanding
  September 30, 2009 |  |         | 241,900  |                                             |   | 10.22                                         |  | 4.22 years | 

18,000
director stock options were granted during the nine month period ended
September 30, 2009. The aggregate intrinsic value of all options (the amount by
which the market price of the stock on the last day of the period exceeded the
market price of the stock on the date of grant) outstanding at September 30,
2009 was $421,000. The intrinsic value of all options exercised during the nine
months ended September 30, 2009 was $3,000. Net cash proceeds from the exercise
of all stock options were $0 and $239,000 for the nine months ended September
30, 2009 and 2008, respectively.

NOTE 3 -
INVENTORIES

Inventories
summarized below are priced at the lower of first-in, first-out cost or market:

|                             |  |                    |            |                   |   |            | 
|---------------------------- |  | ------------------ | ---------- | ----------------- | - | ---------- | 
|                             |  | September 30
 2009 |            | December 31
 2008 |  
|Finished
 goods              |  | $                  | 15,859,725 |                   | $ | 17,924,907 | 
|Raw and
 processed materials |  |                    | 8,941,812  |                   |   | 11,473,536 | 
|Total                        |  | $                  | 24,801,537 |                   | $ | 29,398,443 | 

NOTE 4 
GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill is
required to be evaluated for impairment on an annual basis and between annual
tests upon the occurrence of certain events or circumstances. A two-step
process is performed to analyze whether or not goodwill has been impaired. Step
one is to test for potential impairment, and requires that the fair value of
the reporting unit be compared to its book value including goodwill. If the
fair value is higher than the book value, no impairment is recognized. If the
fair value is lower than the book value, a second step must be performed. The
second step is to measure the amount of impairment loss, if any, and requires
that a hypothetical purchase price allocation be done to determine the implied
fair value of goodwill. This fair value is then compared to the carrying value
of goodwill. If the implied fair value is lower than the carrying value, an
impairment adjustment must be recorded.

On January 17,
2008, VIDE, at that time a major customer of the JDL Technologies segment under
successive one year contracts since 1998, notified the company that JDL was not
selected as a vendor to provide services to VIDE effective June 1, 2008. The
loss of the VIDE contract represented an event that required goodwill to be tested
for impairment. The Company completed the
evaluation at March 31, 2008 and recorded a goodwill impairment for the JDL
Technologies segment of $704,000.

10

---

Table of Contents

No events or
circumstances occurred during the quarter ended September 30, 2009 that
required an impairment test or adjustment to the financial statements.

NOTE 5 
WARRANTY

We provide
reserves for the estimated cost of product warranties at the time revenue is
recognized. We estimate the costs of our warranty obligations based on our
warranty policy or applicable contractual warranty, historical experience of
known product failure rates, and use of materials and service delivery costs
incurred in correcting product failures. Management reviews the estimated
warranty liability on a quarterly basis to determine its adequacy. The actual
warranty expense could differ from the estimates made by the company based on
product performance.

The following
table presents the changes in the Companys warranty liability for the nine
months ended September 30, 2009 and 2008, the majority of which relates to a
five-year obligation to provide for potential future liabilities for network
equipment sales.

|                            |  |      |          |      |   |          |  
|--------------------------- |  | ---- | -------- | ---- | - | -------- | -
|                            |  | 2009 |          | 2008 |  
|Beginning
 Balance          |  | $    | 593,000  |      | $ | 518,000  |  
|Actual
 warranty costs paid |  |      | (277,000 | )    |   | (350,000 | )
|Amounts
 charged to expense |  |      | 540,000  |      |   | 537,000  |  
|Ending
 balance             |  | $    | 856,000  |      | $ | 705,000  |  

NOTE 6 
CONTINGENCIES

In the
ordinary course of business, the Company is subject to legal actions and claims
and incurs costs to defend against such actions and claims. At September 30,
2009, no legal actions or claims were outstanding or pending that would
materially affect the Companys financial position or results of operations.

NOTE 7 
INCOME TAXES

In the
preparation of the Companys condensed consolidated financial statements,
management calculates income taxes based upon the estimated effective rate
applicable to operating results for the full fiscal year. This includes
estimating the current tax liability as well as assessing differences resulting
from different treatment of items for tax and book accounting purposes. These
differences result in deferred tax assets and liabilities, which are recorded
on the balance sheet. These assets and liabilities are analyzed regularly and
management assesses the likelihood that deferred tax assets will be recovered
from future taxable income. At September 30, 2009 there was $510,000 of net
uncertain tax benefit positions that would reduce the effective income tax rate
if recognized. The Company records interest and penalties related to income
taxes as income tax expense in the condensed consolidated statements of income.

11

---

Table of Contents

The Company is
subject to U.S. federal income tax as well as income tax of multiple state and
foreign jurisdictions. The tax years 2006-2008 remain open to examination by
the Internal Revenue Service and the years 2005-2008 remain open to examination
by various state tax departments. The tax years from 2006-2008 remain open in
Costa Rica. The Companys effective income tax rate was 43% for the first nine
months of 2009. The effective tax rate differs from the federal tax rate of 35%
due to state income taxes, foreign losses not currently deductible for U.S.
income tax purposes, return to provision adjustment, and provisions for
interest charges on uncertain tax positions. The foreign operating losses may
ultimately be deductible in the countries which they occurred, however the
Company has not recorded a deferred tax asset for these losses due to
uncertainty regarding eventual realization of the benefit. The effect of the
foreign operations is an overall rate increase of approximately 4.6% for the
nine months ended September 30, 2009. The Company filed its 2008 federal and
state income tax returns during the third quarter of 2009. The effect of the
2008 return to provision adjustment is a rate increase of 2.4%. There were no
additional uncertain tax positions identified in the third quarter of 2009. The
Companys effective income tax rate was approximately 41% for the nine months
ended September 30, 2008, and differed from the federal tax rate due to state
income taxes, foreign losses not deductible for U.S. income tax purposes,
provisions for interest charges, and settlement of uncertain tax positions.

NOTE 8  SEGMENT
INFORMATION

The Company
classifies its businesses into four segments: Suttle, which manufactures U.S.
standard modular connecting and wiring devices for voice and data
communications and structured cabling products; Transition Networks, which
designs and markets data transmission, computer network and media conversion
products and print servers; JDL Technologies (JDL), which provides IT services;
and Austin Taylor which manufactures British standard telephone equipment and
equipment enclosures for the U.K and international markets. Non-allocated
corporate general and administrative expenses are categorized as Other in the
Companys segment reporting. Management has chosen to organize the enterprise
and disclose reportable segments based on products and services. There are no
material intersegment revenues.

Information
concerning the Companys continuing operations in the various segments for the
nine-month and three-month periods ended September 30, 2009 and 2008 is as
follows:

12

---

Table of Contents

SEGMENT INFORMATION - NINE
MONTHS

|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|-------------------------------------------- |  | ------ | ---------- | -------------------- | - | ----------------- |  | -------------- | --------- | ----- | - | --------- | - | - | ---------- | - | - | ----------- | 
|                                             |  | Suttle |            | Transition
 Networks |   | JDL
 Technologies |  | Austin
 Taylor |           | Other |   | Total     |  
|Nine months ended September 30, 2009:        |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Sales                                        |  | $      | 33,159,219 |                      | $ | 39,809,867        |  | $              | 8,106,662 |       | $ | 2,380,809 |   | $ |           |   | $ | 83,456,557  | 
|Cost of sales                                |  |        | 25,613,432 |                      |   | 18,873,905        |  |                | 5,391,549 |       |   | 2,280,212 |   |   |           |   | $ | 52,159,098  | 
|Gross profit                                 |  |        | 7,545,787  |                      |   | 20,935,962        |  |                | 2,715,113 |       |   | 100,597   |   |   |           |   |   | 31,297,459  | 
|Selling, general and administrative expenses |  |        | 4,639,869  |                      |   | 14,462,999        |  |                | 948,362   |       |   | 838,149   |   |   | 2,514,527  |   | $ | 23,403,906  | 
|Operating income (loss)                      |  | $      | 2,905,918  |                      | $ | 6,472,963         |  | $              | 1,766,751 |       | $ | (737,552  | ) | $ | (2,514,527 | ) | $ | 7,893,553   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Depreciation and amortization                |  | $      | 473,404    |                      | $ | 434,714           |  | $              | 118,140   |       | $ | 48,300    |   | $ | 163,804    |   | $ | 1,238,362   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Capital expenditures                         |  | $      | 2,735,553  |                      | $ | 261,141           |  | $              | 14,051    |       | $ | 85,457    |   | $ | 63,334     |   | $ | 3,159,536   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Assets                                       |  | $      | 22,433,288 |                      | $ | 26,652,702        |  | $              | 3,209,269 |       | $ | 4,390,817 |   | $ | 45,520,693 |   | $ | 102,206,769 | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|                                             |  | Suttle |            | Transition
 Networks |   | JDL
 Technologies |  | Austin
 Taylor |           | Other |   | Total     |  
|Nine months ended September 30, 2008:        |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Sales                                        |  | $      | 34,020,297 |                      | $ | 46,899,360        |  | $              | 8,848,574 |       | $ | 4,526,567 |   | $ |           |   | $ | 94,294,798  | 
|Cost of sales                                |  |        | 25,334,699 |                      |   | 24,261,867        |  |                | 4,748,568 |       |   | 3,710,596 |   |   |           |   | $ | 58,055,730  | 
|Gross profit                                 |  |        | 8,685,598  |                      |   | 22,637,493        |  |                | 4,100,006 |       |   | 815,971   |   |   |           |   |   | 36,239,068  | 
|Selling, general and administrative expenses |  |        | 5,172,635  |                      |   | 15,292,429        |  |                | 729,054   |       |   | 849,208   |   |   | 2,832,125  |   | $ | 24,875,451  | 
|Impairment and other charges related to JDL  |  |        |            |                      |   |                   |  |                | 2,999,441 |       |   |           |   |   |            |   | $ | 2,999,441   | 
|Operating income (loss)                      |  | $      | 3,512,963  |                      | $ | 7,345,064         |  | $              | 371,511   |       | $ | (33,237   | ) | $ | (2,832,125 | ) | $ | 8,364,176   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Depreciation and amortization                |  | $      | 503,189    |                      | $ | 437,172           |  | $              | 268,763   |       | $ | 79,170    |   | $ | 162,523    |   | $ | 1,450,817   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Capital expenditures                         |  | $      | 443,990    |                      | $ | 348,491           |  | $              | 12,262    |       | $ | 22,561    |   | $ | 1,628,356  |   | $ | 2,455,660   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Assets                                       |  | $      | 23,429,661 |                      | $ | 27,192,230        |  | $              | 7,857,624 |       | $ | 5,097,267 |   | $ | 41,809,369 |   | $ | 105,386,151 | 

13

---

Table of Contents

SEGMENT INFORMATION - THREE
MONTHS

|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|-------------------------------------------- |  | ------ | ---------- | -------------------- | - | ----------------- |  | -------------- | --------- | ----- | - | --------- | - | - | ---------- | - | - | ----------- | 
|                                             |  | Suttle |            | Transition
 Networks |   | JDL
 Technologies |  | Austin
 Taylor |           | Other |   | Total     |  
|Three months ended September 30, 2009:       |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Sales                                        |  | $      | 10,548,663 |                      | $ | 14,001,891        |  | $              | 2,723,361 |       | $ | 833,285   |   | $ |           |   | $ | 28,107,200  | 
|Cost of sales                                |  |        | 8,044,494  |                      |   | 6,484,737         |  |                | 1,888,195 |       |   | 821,855   |   |   |           |   | $ | 17,239,281  | 
|Gross profit                                 |  |        | 2,504,169  |                      |   | 7,517,154         |  |                | 835,166   |       |   | 11,430    |   |   |           |   |   | 10,867,919  | 
|Selling, general and administrative expenses |  |        | 1,502,589  |                      |   | 4,668,015         |  |                | 287,797   |       |   | 248,675   |   |   | 811,633    |   | $ | 7,518,709   | 
|Operating income (loss)                      |  | $      | 1,001,580  |                      | $ | 2,849,139         |  | $              | 547,369   |       | $ | (237,245  | ) | $ | (811,633   | ) | $ | 3,349,210   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Depreciation and amortization                |  | $      | 160,527    |                      | $ | 139,852           |  | $              | 36,363    |       | $ | 16,893    |   | $ | 70,271     |   | $ | 423,906     | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Capital expenditures                         |  | $      | 727,561    |                      | $ | 101,082           |  | $              | 5,509     |       | $ | 2,106     |   | $ | 5,153      |   | $ | 841,411     | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Assets                                       |  | $      | 22,433,288 |                      | $ | 26,652,702        |  | $              | 3,209,269 |       | $ | 4,390,817 |   | $ | 45,520,693 |   | $ | 102,206,769 | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|                                             |  | Suttle |            | Transition
 Networks |   | JDL
 Technologies |  | Austin
 Taylor |           | Other |   | Total     |  
|Three months ended September 30, 2008:       |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Sales                                        |  | $      | 11,419,056 |                      | $ | 16,574,727        |  | $              | 3,274,044 |       | $ | 1,414,694 |   | $ |           |   | $ | 32,682,521  | 
|Cost of sales                                |  |        | 8,315,965  |                      |   | 8,340,108         |  |                | 1,356,498 |       |   | 1,143,136 |   |   |           |   | $ | 19,155,707  | 
|Gross profit                                 |  |        | 3,103,091  |                      |   | 8,234,619         |  |                | 1,917,546 |       |   | 271,558   |   |   |           |   |   | 13,526,814  | 
|Selling, general and administrative expenses |  |        | 1,680,869  |                      |   | 5,191,670         |  |                | 244,368   |       |   | 299,990   |   |   | 874,116    |   | $ | 8,291,013   | 
|Impairment and other charges related to JDL  |  |        |           |                      |   |                  |  |                |          |       |   |          |   |   |           |   | $ |            | 
|Operating income (loss)                      |  | $      | 1,422,222  |                      | $ | 3,042,949         |  | $              | 1,673,178 |       | $ | (28,432   | ) | $ | (874,116   | ) | $ | 5,235,801   | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Depreciation and amortization                |  | $      | 137,040    |                      | $ | 152,099           |  | $              | (17,437   | )     | $ | 34,693    |   | $ | 37,083     |   | $ | 343,478     | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Capital expenditures                         |  | $      | 5,416      |                      | $ | 8,523             |  | $              | 38,262    |       | $ | 11,405    |   | $ | (16,931    | ) | $ | 46,675      | 
|                                             |  |        |            |                      |   |                   |  |                |           |       |   |           |   |   |            |   |   |             | 
|Assets                                       |  | $      | 23,429,661 |                      | $ | 27,192,230        |  | $              | 7,857,624 |       | $ | 5,097,267 |   | $ | 41,809,369 |   | $ | 105,386,151 | 

NOTE 9 
PENSIONS

The Companys
U.K. based subsidiary Austin Taylor maintains defined benefit pension plans
that cover approximately 10 active employees. The Company does not provide any
other post-retirement benefits to its employees. Components of net periodic
benefit cost of the pension plans were:

|                                          |  |                                |          |      |   |          |  
|----------------------------------------- |  | ------------------------------ | -------- | ---- | - | -------- | -
|                                          |  | Nine months Ended September 30 |         
|                                          |  | 2009                           |          | 2008 |  
|Service cost                              |  | $                              | 29,000   |      |   | 39,000   |  
|Interest
 cost                            |  |                                | 201,000  |      |   | 235,000  |  
|Expected
 return on plan assets           |  |                                | (196,000 | )    |   | (234,000 | )
|Amortization
 of unrecognized (gain)/loss |  |                                |         |      |   |         |  
|                                          |  | $                              | 34,000   |      | $ | 40,000   |  

14

---

Table of Contents

NOTE 10  NET
INCOME PER SHARE

Basic net
income per common share is based on the weighted average number of common
shares outstanding during each year. Diluted net income per common share takes
into effect the dilutive effect of potential common shares outstanding. The
Companys only potential common shares outstanding are stock options, which
resulted in a dilutive effect of 23,454 shares and 9,263 shares for the
respective three and nine month periods ended September 30, 2009. The dilutive
effect of stock options for the three and nine month periods ended September
30, 2008 was 32,664 shares and 38,907 shares, respectively. The Company
calculates the dilutive effect of outstanding options using the treasury stock
method. The number of shares not included in the computation of diluted earnings
per share because the options exercise price was greater than the average
market price of common stock during the period was 151,100 and 116,900 at
September 30, 2009 and 2008, respectively.

NOTE 11 
ASSET IMPAIRMENT

We are
required to test for asset impairment relating to property and equipment
whenever events or changes in circumstances indicate that the carrying value of
an asset might not be recoverable. An impairment analysis is performed when
indicators of impairment are present. If such indicators are present and if the
sum of the future expected cash flows from a companys asset, undiscounted and
without interest charges, is less than the carrying value, an asset impairment
must be recognized in the financial statements. The amount of the impairment is
the difference between the fair value of the asset and the carrying value of
the asset.On January 17, 2008 the Company was notified by VIDE, a customer of
JDL Technologies under successive one year contracts since 1998,
that the Company was not selected as VIDEs vendor effective June 1, 2008. The
decision of VIDE to select another vendor for the next contract year
represented an event that required the related asset group to be tested for
impairment. The Company completed this evaluation in the first quarter of
fiscal 2008 and identified an impairment of the network infrastructure
supporting services provided to VIDE to the extent of its total net book value
of $2,295,000.

NOTE 12  FAIR
VALUE MEASUREMENTS

On January 1,
2008, we adopted new accounting guidance on fair value measurements. The new
guidance defines fair value, established a framework for measuring fair value
under U.S. generally accepted accounting principles, and expands disclosures
about fair value measurements. The new guidance was effective for us beginning
January 1, 2008 for certain financial assets and liabilities. The new guidance
is effective for non-financial assets and liabilities recognized or disclosed
at fair value on a nonrecurring basis beginning January 1, 2009. The accounting
guidance establishes a valuation hierarchy for disclosure of the inputs to
valuation used to measure fair value. This hierarchy prioritizes the inputs
into three broad levels as follows: Level 1  Observable inputs that reflect
unadjusted quoted prices for identical assets or liabilities in active markets
that the Company has the ability to access at the measurement date. The
Companys financial instruments categorized as Level 1 relate to cash
equivalents. Level 2  Observable inputs such as quoted prices for similar
instruments and quoted prices in markets that are not active, and inputs that
are directly observable or can be corroborated by observable market data. The
types of assets and liabilities included in Level 2 are typically either comparable
to actively

15

---

Table of Contents

traded
securities or contracts, such as treasury securities with pricing interpolated
from recent trades of similar securities, or priced with models using highly
observable inputs, such as commodity options priced using observable forward
prices and volatilities. Level 3  Significant inputs to pricing have little or
no observability as of the reporting date. The types of assets and liabilities
included in Level 3 are those with inputs requiring significant management
judgment or estimation, such as the complex and subjective models and forecasts
used to determine the fair value of financial instruments. The Companys assets
and liabilities that are measured at fair value on a recurring basis as of
September 30, 2009 include cash equivalents and investments of $28,636,000
classified as level one within the hierarchy. The Company does not have any
assets or liabilities classified as level two or three within the hierarchy.

NOTE 13 
SUBSEQUENT EVENTS

The Company
has evaluated subsequent events through the date of this filing, November 12,
2009. We do not believe there are any material subsequent events which would
require further disclosure.

Item 2. Managements Discussion and
Analysis of Financial Condition and Results of Operations

Forward looking statements

In this report
and, from time to time, in reports filed with the Securities and Exchange
Commission, in press releases, and in other communications to shareholders or
the investing public, the Company may make forward looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 concerning
possible or anticipated future financial performance, business activities,
plans, pending claims, investigations or litigation which are typically preceded
by the words believes, expects, anticipates, intends or similar
expressions. For such forward-looking statements, the Company claims the
protection of the safe harbor for forward-looking statements contained in
federal securities laws. Shareholders and the investing public should
understand that such forward looking statements are subject to risks and
uncertainties which could cause actual performance, activities, anticipated
results, outcomes or plans to differ significantly from those indicated in the
forward-looking statements. Such risks and uncertainties include, but are not
limited to: lower sales to major telephone companies and other major customers;
the introduction of competitive products and technologies; our ability to
successfully reduce operating expenses at certain business units; the general
health of the telecom sector, successful integration and profitability of
acquisitions; delays in new product introductions; higher than expected expense
related to new sales and marketing initiatives; unfavorable resolution of
claims and litigation, availability of adequate supplies of raw materials and
components; fuel prices; government funding of education technology spending;
and other factors discussed from time to time in the Companys filings with the
Securities and Exchange Commission, including risk factors presented under Item
1A of the Companys most recently filed report on Form 10-K.

16

---

Table of Contents

Nine Months Ended September 30, 2009 Compared
toNine Months Ended September 30, 2008

Consolidated
sales decreased in 2009 to $83,457,000 compared to $94,295,000 in 2008.
Consolidated operating income in 2009 decreased to $7,894,000 compared to
$8,364,000 in the first nine months of 2008. 2008 operating income was reduced
by impairment charges totaling $2,999,000 related to JDL Technologies not being
selected as a vendor to provide services to VIDE effective July 1, 2008.

Net income in
2009 decreased to $4,833,000 compared to $5,241,000 in the first nine months of
2008.

Suttle

Suttle sales
decreased 3% in the first nine months of 2009 to $33,159,000 compared to
$34,020,000 in the same period of 2008. Sales by customer groups in the first
nine months of 2009 and 2008 were:

|                           |  |                                |            |      |   |            | 
|-------------------------- |  | ------------------------------ | ---------- | ---- | - | ---------- | 
|                           |  | Suttle Sales by Customer Group |           
|                           |  | 2009                           |            | 2008 |  
|Major
 telephone companies |  | $                              | 18,983,000 |      | $ | 15,565,000 | 
|Distributors/OEMs          |  |                                | 9,754,000  |      |   | 12,812,000 | 
|International              |  |                                | 1,573,000  |      |   | 1,910,000  | 
|Other                      |  |                                | 2,849,000  |      |   | 3,733,000  | 
|                           |  | $                              | 33,159,000 |      | $ | 34,020,000 | 

Suttles sales
by product groups in first nine months of 2009 and 2008 were:

|                             |  |                               |            |      |   |            | 
|---------------------------- |  | ----------------------------- | ---------- | ---- | - | ---------- | 
|                             |  | Suttle Sales by Product Group |           
|                             |  | 2009                          |            | 2008 |  
|Modular
 connecting products |  | $                             | 12,446,000 |      | $ | 15,067,000 | 
|DSL products                 |  |                               | 10,111,000 |      |   | 7,150,000  | 
|Structured
 cabling products |  |                               | 10,092,000 |      |   | 11,168,000 | 
|Other
 products              |  |                               | 510,000    |      |   | 635,000    | 
|                             |  | $                             | 33,159,000 |      | $ | 34,020,000 | 

Sales to the
major telephone companies increased 22% in 2009 due to increased sales of DSL
products. Sales to these customers accounted for 57% of Suttles sales in the
first nine months of 2009 compared to 46% of sales in the same period in 2008.
Sales to distributors, original equipment manufacturers (OEMs), and electrical
contractors decreased 24% in 2009 primarily due to the contraction of the
housing and building sectors of the economy. This customer segment accounted
for 29% and 38% of sales in the first nine months of 2009 and 2008,
respectively. International sales decreased 18% and accounted for 5% of
Suttles first nine months 2009 sales. Suttles products do not have a large
international market due to different product specifications in non-US markets.
Sales to other customers decreased 24% to $2,849,000.

Modular
connecting product sales have decreased 17% while structured cabling products
have declined by 10%, due to a slowing of the home building business and
accelerated decline in the voice market, whereas DSL products have increased
41% as a result of a new contract with a major telephone company.

17

---

Table of Contents

Suttles gross
margin decreased 13% in the first nine months of 2009 to $7,546,000 compared to
$8,686,000 in the same period of 2008. Gross margin percentage decreased to 23%
in 2009 from 26% in 2008 due to product mix changes. Suttle realizes its
highest selling margins on modular connecting products. DSL products are the
least profitable. Suttle also earns better margins on sales to distributor and
OEM customers where pricing is usually based on Company list prices than from
major telephone customers where pricing is usually based on negotiated
contracts. Selling, general and administrative expenses decreased $533,000 or
10% in the first nine months of 2009 compared to the same period in 2008, due
to cost reduction efforts. Suttles operating income was $2,906,000 in
the first nine months of 2009 compared to operating income of $3,513,000 in
2008.

Transition Networks

Transition
Networks sales decreased 15% to $39,810,000 in the first nine months of 2009
compared to $46,899,000 in 2008.

First nine
months sales by region are presented in the following table:

|                             |  |                                     |            |      |   |            | 
|---------------------------- |  | ----------------------------------- | ---------- | ---- | - | ---------- | 
|                             |  | Transition Networks Sales by Region |           
|                             |  | 2009                                |            | 2008 |  
|North
 America               |  | $                                   | 32,609,000 |      | $ | 32,092,000 | 
|Europe,
 Middle East, Africa |  |                                     | 3,444,000  |      |   | 7,060,000  | 
|Rest of
 world               |  |                                     | 3,757,000  |      |   | 7,747,000  | 
|                             |  | $                                   | 39,810,000 |      | $ | 46,899,000 | 

Sales in North
America increased $517,000 or 2% due to projects with the US Federal
Government. Overall sales have either remained flat or declined in most markets
in the US, but declines have not been as significant as in international
markets. International sales decreased $7,606,000, or 51% primarily due to the
impact of the global economic crisis and currency fluctuations. Customers have
either delayed or canceled projects, but the Company is continuing to invest in
the region because long term projects are promising.

The following
table summarizes Transition Networks 2009 and 2008 first nine months sales by
its major product groups:

|                   |  |                                            |            |      |   |            | 
|------------------ |  | ------------------------------------------ | ---------- | ---- | - | ---------- | 
|                   |  | Transition Networks Sales by Product Group |           
|                   |  | 2009                                       |            | 2008 |  
|Media
 converters  |  | $                                          | 29,120,000 |      | $ | 35,402,000 | 
|Ethernet
 switches |  |                                            | 2,570,000  |      |   | 4,889,000  | 
|Ethernet
 adapters |  |                                            | 5,776,000  |      |   | 4,588,000  | 
|Other
 products    |  |                                            | 2,344,000  |      |   | 2,020,000  | 
|                   |  | $                                          | 39,810,000 |      | $ | 46,899,000 | 

Gross margin
on the first nine months of Transition Networks sales decreased to $20,936,000
in 2009 from $22,637,000 in 2008. Gross margin as a percentage of sales was 53%
in 2009, compared to 48% in the 2008 period, due to decreased manufacturing
costs related to an inventory cost reduction plan started in 2008 and change in
product mix. The increase in sales of Ethernet adapters and decrease in media
converters is one of the contributors to the increased margins. Furthermore,
the decline in sales of media converters is attributed to the slowing economy
around the world. The increase in sales of Ethernet adapters is due to ongoing
projects in North America. Selling, general and administrative expenses decreased 5%
to $14,463,000 in 2009 compared to $15,292,000 in 2008 due to open positions
that have not been filled due to the uncertainty of the economy and lower
revenues offset by increases in research and development costs related to the
creation of new prototypes. Operating income decreased to $6,473,000 in 2009
compared to $7,345,000 in 2008.

18

---

Table of Contents

JDL Technologies, Inc.

JDL
Technologies, Inc. reported 2009 first nine months sales of $8,107,000 compared
to $8,849,000 in 2008.

JDLs revenues
by customer group were as follows:

|                           |  |                               |           |      |   |           | 
|-------------------------- |  | ----------------------------- | --------- | ---- | - | --------- | 
|                           |  | JDL Revenue by Customer Group |          
|                           |  | 2009                          |           | 2008 |  
|Broward
 County FL schools |  | $                             | 7,982,000 |      | $ | 4,185,000 | 
|VIDE                       |  |                               |          |      |   | 4,661,000 | 
|All other                  |  |                               | 125,000   |      |   | 3,000     | 
|                           |  | $                             | 8,107,000 |      | $ | 8,849,000 | 

Revenues earned
in Broward County FL increased $3,797,000 or 91% in 2009. Part of the increase
was the result of network refresh work originally scheduled for 2008 that was
performed in the first quarter of 2009 due to customer budget limitations in
the fourth quarter of 2008. Overall, in 2009 the Company booked installation
business above 2008 levels. The decrease in VIDE revenue in 2009 was due to
losing VIDE as a customer for the 2008-2009 school year.

JDL gross
margin was $2,715,000 in the first nine months of 2009 compared to $4,100,000
in the same period in 2008. Gross margin in 2008 was significantly impacted by
the timing of the recognition of revenues from JDLs VIDE contracts as expenses
related to the revenue recognized in the first and third quarters of 2008 were
booked in 2007. More specifically, costs of $1.4 million were recorded in 2007,
when the services were provided, while the $2.0 million revenue received for
such services was recognized in the first nine months of 2008 when the E-Rate
funding was approved. Selling, general and administrative expenses increased in 2009 to
$948,000 compared to $729,000 in 2008 due to an increase in compensation
expenses and sales activities. JDL reported operating income of $1,767,000 in
the first nine months of 2009 compared $372,000 in the same period of 2008.

Austin Taylor

Austin
Taylors revenues decreased to $2,381,000 for the first nine months of 2009,
compared to $4,527,000 in 2008. This decrease is primarily due to the general
market and economy slowdown, specifically with overseas customers. Gross margin
decreased 88% to $101,000 in 2009 from $816,000 in 2008. Gross margin as a
percentage of sales was 4% in 2009 compared to 18% in 2008. This decrease was
due to greatly increased material costs compounded by an unfavorable currency
exchange rate during the first nine months of 2009. Additionally, Austin Taylor
was burdened with the impact of product quality issues from two of its major
vendors. Austin Taylor reported an operating loss in 2009 of $738,000 compared
to $33,000 in 2008.

19

---

Table of Contents

Other

Net investment
income remained stable at $579,000 in 2009 as compared to $577,000 in 2008.
Income before income taxes decreased to $8,473,000 in 2009 compared to
$8,941,000 in 2008. The Companys effective income tax rate was 43% in 2009
compared to 41% in 2008. This effective rate was higher than the standard rate
of 35% due to state income taxes, foreign losses not deductible for U.S. income
tax purposes, income tax return to provision adjustments, and provisions for interest
charges as explained in Note 7 to the condensed consolidated financial
statements.

Three Months Ended September 30, 2009
Compared toThree Months Ended September 30, 2008

Consolidated
sales decreased 14% in 2009 to $28,107,000 compared to $32,683,000 in 2008.
Consolidated operating income in 2009 decreased to $3,349,000 compared to
$5,236,000 in the third quarter of 2008.

Net income in
2009 decreased to $1,861,000 compared to $2,794,000 in the third quarter of
2008.

Suttle

Suttle sales
decreased 8% in the third quarter of 2009 to $10,549,000 compared to
$11,419,000 in the same period of 2008 due the ongoing decline in the voice
market and the US housing market. Sales by customer groups in the third quarter
of 2009 and 2008 were:

|                           |  |                                |            |      |   |            | 
|-------------------------- |  | ------------------------------ | ---------- | ---- | - | ---------- | 
|                           |  | Suttle Sales by Customer Group |           
|                           |  | 2009                           |            | 2008 |  
|Major
 telephone companies |  | $                              | 5,986,000  |      | $ | 5,248,000  | 
|Distributors/OEM           |  |                                | 3,223,000  |      |   | 4,492,000  | 
|International              |  |                                | 564,000    |      |   | 652,000    | 
|Other                      |  |                                | 776,000    |      |   | 1,027,000  | 
|                           |  | $                              | 10,549,000 |      | $ | 11,419,000 | 

Suttles sales
by product groups in third quarter of 2009 and 2008 were:

|                             |  |                               |            |      |   |            | 
|---------------------------- |  | ----------------------------- | ---------- | ---- | - | ---------- | 
|                             |  | Suttle Sales by Product Group |           
|                             |  | 2009                          |            | 2008 |  
|Modular
 connecting products |  | $                             | 3,943,000  |      | $ | 4,936,000  | 
|DSL products                 |  |                               | 3,396,000  |      |   | 2,628,000  | 
|Structured
 cabling products |  |                               | 3,014,000  |      |   | 3,671,000  | 
|Other
 products              |  |                               | 196,000    |      |   | 184,000    | 
|                             |  | $                             | 10,549,000 |      | $ | 11,419,000 | 

Sales to the
major telephone companies increased 14% in 2009 due to increased sales of DSL
products. Sales to these customers accounted for 57% of Suttles sales in the
third quarter of 2009 compared to 46% of sales in the same period of 2008.
Sales to distributors, original equipment manufacturers (OEMs), and electrical
contractors decreased 28% in 2009 primarily due to the contraction of the
housing and building sectors of the economy. This customer segment accounted
for 31% and 39% of sales in the third quarters of 2009 and
2008, respectively. International sales decreased 13% and accounted for 5% of
Suttles third quarter 2009 sales. Suttles products do not have a large
international market due to different product specifications in non-US markets.
Sales to other customers decreased 24% to $776,000.

20

---

Table of Contents

Modular
connecting products sales have decreased 20% due to a slowing of the home
building business and accelerated decline in the voice market, whereas DSL
products have increased 29% as a result of a new contract with a major
telephone company.

Suttles gross
margin decreased 19% in the third quarter of 2009 to $2,504,000 compared to
$3,103,000 in the same period of 2008. Gross margin percentage decreased to 24%
in 2009 as compared to 27% in 2008. Suttle realizes its highest selling margins
on modular connecting products. DSL products are the least profitable. Suttle
also earns better margins on sales to distributor and OEM customers where
pricing is usually based on Company list prices than from major telephone
customers where pricing is usually based on negotiated contracts. Selling,
general and administrative expenses decreased $178,000 or 11% in the third
quarter of 2009 compared to the same period in 2008, but remained consistent as
a percentage of sales. Suttles operating income was $1,002,000 in the third
quarter of 2009 compared to operating income of $1,422,000 in 2008.

Transition Networks

Transition
Networks sales decreased 16% to $14,002,000 in the third quarter of 2009
compared to $16,575,000 in 2008.

Third quarter
sales by region are presented in the following table:

|                             |  |                                     |            |      |   |            | 
|---------------------------- |  | ----------------------------------- | ---------- | ---- | - | ---------- | 
|                             |  | Transition Networks Sales by Region |           
|                             |  | 2009                                |            | 2008 |  
|North
 America               |  | $                                   | 11,416,000 |      | $ | 11,545,000 | 
|Europe,
 Middle East, Africa |  |                                     | 1,374,000  |      |   | 2,306,000  | 
|Rest of
 world               |  |                                     | 1,212,000  |      |   | 2,724,000  | 
|                             |  | $                                   | 14,002,000 |      | $ | 16,575,000 | 

Sales in North
America decreased $129,000 or 1% due to the fluctuation in projects with the US
Federal Government. International sales decreased $2,444,000, or 49% due to
decreased sales from one large customer because the customer elected to delay
purchases to subsequent quarters, and another customer that had large projects
in 2008 with business that may not repeat in subsequent quarters. Additionally,
business is lower in Japan, greater Asia and South America due to downturns in
these economies.

The following
table summarizes Transition Networks 2009 and 2008 third quarter sales by its
major product groups:

|                   |  |                                            |            |      |   |            | 
|------------------ |  | ------------------------------------------ | ---------- | ---- | - | ---------- | 
|                   |  | Transition Networks Sales by Product Group |           
|                   |  | 2009                                       |            | 2008 |  
|Media
 converters  |  | $                                          | 9,698,000  |      | $ | 12,216,000 | 
|Ethernet
 switches |  |                                            | 1,110,000  |      |   | 1,962,000  | 
|Ethernet
 adapters |  |                                            | 2,229,000  |      |   | 2,016,000  | 
|Other
 products    |  |                                            | 965,000    |      |   | 381,000    | 
|                   |  | $                                          | 14,002,000 |      | $ | 16,575,000 | 

21

---

Table of Contents

Gross margin
on third quarter Transition Networks sales decreased to $7,517,000 in 2009
from $8,235,000 in 2008. Gross margin as a percentage of sales was 54% in 2009,
compared to 50% in the 2008 period, due to decreased manufacturing costs
related to the inventory cost reduction plan started in 2008 and lower revenue
from some international accounts that are at a lower gross margin. Furthermore,
the decline in sales of media converters and Ethernet switches is attributed to
the slowing economy around the world. The increase in sales of Ethernet
adapters is due to ongoing projects in North America. Selling, general and
administrative expenses decreased 10% to $4,668,000 in 2009 compared to
$5,192,000 in 2008 due to open positions that have not been filled due to the
uncertainty of the economy and lower revenues as well as other cost containment
initiatives in marketing and other departments. Operating income decreased to
$2,849,000 in 2009 compared to $3,043,000 in 2008.

JDL Technologies, Inc.

JDL
Technologies, Inc. reported 2009 third quarter sales of $2,723,000 compared to
$3,274,000 in 2008.

JDLs revenues
by customer group were as follows:

|                           |  |                               |           |      |   |           | 
|-------------------------- |  | ----------------------------- | --------- | ---- | - | --------- | 
|                           |  | JDL Revenue by Customer Group |          
|                           |  | 2009                          |           | 2008 |  
|Broward
 County FL schools |  | $                             | 2,682,000 |      | $ | 1,575,000 | 
|VIDE                       |  |                               |          |      |   | 1,696,000 | 
|All other                  |  |                               | 41,000    |      |   | 3,000     | 
|                           |  | $                             | 2,723,000 |      | $ | 3,274,000 | 

Revenues
earned in Broward County FL increased $1,107,000 or 70% in 2009. The increase
was the result of higher funding for LAN/WAN/Wire work in 2009 than in 2008.
The decrease in VIDE revenue in 2009 was due to losing VIDE as a customer.

JDL gross
margin was $835,000 in the third quarter of 2009 compared to $1,918,000 in the
same period in 2008. Gross margin as a percentage of sales was 31% in 2009,
compared to 59% in the 2008 period due to the impact of the timing of the
recognition of revenues from JDLs VIDE contracts in 2008. Approximately $1.5
million in revenue was received in the third quarter of 2008 in which cost of
sales were recognized in previous quarters. Selling, general and administrative
expenses increased in 2009 to $288,000 compared to $244,000 in 2008 due to an
increase in compensation expenses. JDL reported operating income of $547,000 in
the third quarter of 2009 compared to $1,673,000 in the same period of 2008.

Austin Taylor

Austin
Taylors revenues decreased to $833,000 for the third quarter of 2009, compared
to $1,415,000 in 2008. This decrease is primarily due to the general market and
economy slowdown. Gross margin decreased 96% to $11,000 in 2009 from $272,000
in 2008. Gross margin as a percentage of sales was 1% in 2009 compared to 19%
in 2008. This decrease was due to greatly increased material costs compounded
by an unfavorable currency exchange rate during the third quarter of 2009.
Additionally, Austin Taylor was burdened with the impact of product quality
issues from two of its major vendors. Austin Taylor reported an operating loss
in 2009 of $237,000 compared to $28,000 in 2008.

22

---

Table of Contents

Other

Net investment
income decreased 33% to $173,000 in 2009 as compared to $259,000 in 2008 due to
lower interest rates. Income before income taxes decreased 36% to $3,522,000 in
2009 compared to $5,495,000 in 2008. The Companys effective income tax rate
was 47% in 2009 compared to 49% in 2008. This effective rate was higher than
our expected tax rate of 36.5% in 2009 due primarily to uncertainties regarding
our ability to realize the benefits of foreign losses not deductible for U.S.
income tax purposes and income tax return to provision adjustments during the
third quarter.

Liquidity and Capital Resources

At September
30, 2009, the Company had approximately $38,954,000 of cash, cash equivalents
and investments compared to $29,952,000 of cash, cash equivalents and
investments at December 31, 2008. The Company had current assets of
approximately $77,011,000 and current liabilities of $12,726,000 at September
30, 2009 compared to current assets of $80,819,000 and current liabilities of
$10,091,000 at December 31, 2008.

Net cash
provided by operating activities was $15,223,000 in the first nine months of
2009 compared to $6,695,000 provided in the same period in 2008. Significant
working capital changes from December 31, 2008 to September 30, 2009 included decreased
inventory of $4,709,000 and a decrease in accounts receivable of $2,562,000
related to increased collections and lower revenues during the year.

Net cash used
in investing activities was $18,110,000 in the first nine months in 2009
compared to cash used of $2,061,000 in the same period in 2008, due to the
purchase of certificates of deposit with maturities of greater than 90 days,
offset by the sale of such investments. Additionally, capital expenditures
during the first nine months of 2009 were $3,160,000 compared to $2,456,000 in
the prior 2008 period. In 2008, there were additional purchases equipping the
Companys new building in Minnetonka, Minnesota. In 2009, the Company spent
approximately $2,258,000 on new machinery at the Suttle facility.

Net cash used
in financing activities was $3,334,000 and $3,420,000 in the first nine months
of 2009 and 2008, respectively. Cash dividends paid in the first nine months of
2009 were $3,164,000 ($.38 per common share) compared to $3,098,000 ($.36 per
common share) in the same period in 2008. Proceeds from common stock issuances,
principally issuances to the ESOP and ESPP plans, totaled approximately
$140,000 in the first nine months of 2009 and $350,000 in the same period in
2008. The Companys Board of Directors has authorized the purchase and
retirement, from time to time, of shares of the Companys stock on the open
market, or in private transactions consistent with overall market and financial
conditions. In the first nine months of 2009, the Company purchased and retired
5,038 of its common shares at a cost of $52,000. At September 30, 2009, 482,026
additional shares could be repurchased under outstanding Board authorizations.
The Company has a $10,000,000 line of credit from U.S. Bank. Interest on
borrowings on the credit line is at the LIBOR rate plus 1.5% (1.8% at September
30, 2009). There were no borrowings on the line of credit during the first
three months of 2009 or 2008. The credit agreement expires September 30, 2010
and is secured by assets of the Company. As part of the acquisition of the new
Minnetonka headquarters building in July 2007, the Company assumed an
outstanding mortgage of $4,380,000. The mortgage is payable in monthly
installments and carries an interest rate of 6.83%. The mortgage matures on March
1, 2016. Mortgage payments on principal totaled $88,000 during the third
quarter of 2009. The outstanding balance on the mortgage was $2,864,000 at
September 30, 2010.

23

---

Table of Contents

In the opinion
of management, based on the Companys current financial and operating position
and projected future expenditures, sufficient funds are available to meet the
Companys anticipated operating and capital expenditure needs.

Critical Accounting Policies

Our critical
accounting policies, including the assumptions and judgments underlying them,
are discussed in our 2008 Form 10-K in Note 1 Summary of Significant Accounting
Policies included in our Consolidated Financial Statements. There were no
significant changes to our critical accounting policies during the nine months
ended September 30, 2009.

The Companys
accounting policies have been consistently applied in all material respects and
disclose such matters as allowance for doubtful accounts, sales returns,
inventory valuation, warranty expense, income taxes, revenue recognition, asset
and goodwill impairment recognition and foreign currency translation. On an
ongoing basis, we evaluate our estimates based on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the result of which form the basis for making judgments about
the carrying value of assets and liabilities that are not readily apparent from
other sources. Results may differ from these estimates due to actual outcomes
being different from those on which we based our assumptions. Management on an
ongoing basis reviews these estimates and judgments.

Recently Issued Accounting Pronouncements

In June 2009,
the Financial Accounting Standards Board (FASB) Accounting Standards
Codification (Codification) became the single source of authoritative US GAAP.
The Codification did not create any new GAAP standards but incorporated
existing accounting and reporting standards into a new topical structure with a
new referencing system to identify authoritative accounting standards,
replacing the prior references to Statement of Financial Accounting Standards
(SFAS), Emerging Issues Task Force (EITF), FASB Staff Position (FSP), etc.
Authoritative standards included in the Codification are designated by their
Accounting Standards Codification (ASC) topical reference, and new standards
will be designated as Accounting Standards Updates (ASU), with a year and
assigned sequence number. Beginning with this interim report for the third
quarter of 2009, references to prior standards have been removed.

Item 3. Quantitative and Qualitative
Disclosures about Market Risk.

The Company
has no freestanding or embedded derivatives. The Companys policy is to not use
freestanding derivatives and to not enter into contracts with terms that cannot
be designated as normal purchases or sales.

The vast
majority of our transactions are denominated in U.S. dollars; as such,
fluctuations in foreign currency exchange rates have historically not been
material to the Company. At September 30, 2009 our bank line of credit carried
a variable interest rate based on the London Interbank Offered Rate (Libor)
plus 1.5%. The Companys investments are either money market type of
investments that earn interest at prevailing market rates or certificates of
deposits insured through the federal deposit insurance company and as such do
not have material risk exposure.

24

---

Table of Contents

Based on the
Companys operations, in the opinion of management, no material future losses
or exposure exist relative to market risk.

Item 4. Controls and Procedures

Our management
is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rule 13a-15(f).
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we conducted an
evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal control -- Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Operating Effectiveness of Accounting and Control Procedures.
We concluded that, in the aggregate, no material weakness existed as of
September 30, 2009 related to documentation and review of significant
accounting judgments and estimates, balance sheet account reconciliations,
financial closing processes and financial reporting processes at period ends.

Changes in Internal Control over Financial Reporting.
During the period covered by this Report there was no additional change in our
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.

PART
II. OTHER INFORMATION

Item 1. Not Applicable

Item 1A. Risk Factors

In addition to
the risk factors disclosed elsewhere in this report or in the Companys 2008
Annual Report on Form 10-K, the following risk factor should be considered when
reviewing other information set forth in this report and previously filed
reports.

Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that disclosure controls and procedures will prevent all
possible error or fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within our Company have been detected. These inherent limitations,
include, the realities that judgments in decision-making can be faulty, and
that breakdowns can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of persons, by collusion of
two or more persons, or by management override of the control. The design of
any system of controls is also based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions;
over time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies and procedures may deteriorate.

25

---

Table of Contents

Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and may not be detected.

Items 2  5. Not
Applicable

Item 6 Exhibits.

| |                                              |                                                                                                                                                    
| | -------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | The
 following exhibits are included herein:
| |                                             
| | 31.1                                         | Certification
 of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
 of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act).
| | 31.2                                         | Certification
 of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
 of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act).
| | 32.                                          | Certifications
 pursuant Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350).                                                          

26

---

Table of Contents

Signatures

Pursuant to
the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereto
duly authorized.

|                         |    |                                        | 
|------------------------ | -- | -------------------------------------- | 
|                         |    | Communications
 Systems, Inc.          | 
|                         |    |                                        | 
|                         | By | /s/ Jeffrey
 K. Berg                   | 
|                         |    | Jeffrey K.
 Berg                       | 
|                         |    |                                        | 
|Date:
 November 12, 2009 |    | President
 and Chief Executive Officer
|                         |    |                                        | 
|                         |    | /s/ David T.
 McGraw                   | 
|                         |    | David T.
 McGraw                       | 
|                         |    |                                        | 
|Date:
 November 12, 2009 |    | Chief
 Financial Officer               | 

27

---