|                                  
|----------------------------------
|UNITED STATES                     
|SECURITIES AND EXCHANGE COMMISSION
|Washington, D.C. 20549            
|                                  
|                                  
|                                  
|FORM 10-K                         
|                                  
|                                  

|           |   |                                                                                      
|---------- | - | -------------------------------------------------------------------------------------
|(Mark One) |  
|           | x | ANNUAL REPORT PURSUANT TO
 SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

|                                                       
|-------------------------------------------------------
|For the fiscal year ended December 31, 2009            
|                                                       
|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 incorporation or organization) |  | (Federal
 Employer
 Identification No.)   | 
|                                                                    |                                                                  |  |                                           | 
|10900 Red Circle Drive, Minnetonka, MN 55343                       
|(Address of principal executive offices and
 zip code)             
|                                                                   
|Registrants
 telephone number, including area code: (952) 996-1674
|                                                                   
|Securities
 registered pursuant to Section 12(b) of the Act:       
|                                                                    |                                                                  |  |                                           | 
|                                                                    | Title of each class                                              |  | Name of each exchange on which registered | 
|                                                                    |                                                                  |  |                                           | 
|                                                                    | Common Stock, $.05 par value                                     |  | NASDAQ                                    | 
|                                                                   
|Securities
 registered pursuant to Section 12(g) of the Act: None  
|                                                                   
|                                                                   

Indicate by check mark if
the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. YES o   NO
x

Indicate by check mark if
the registrant is not required to file reports pursuant to Section 13 or 15(d)
of the Act. YES o   NO x

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 if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

|                                                                                                                                                            |                     |                         |                         
|----------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------- | ----------------------- | ------------------------
|Indicate by check mark
 whether the registrant is a large accelerated filer, an accelerated filer, a
 non-accelerated filer or a smaller reporting company.
|See definition of
 accelerated filer, large accelerated filer and smaller reporting company
 in Rule 12b-2 of the Act.                               
|Large Accelerated Filer o                                                                                                                                   | Accelerated Filer o | Non-Accelerated Filer o | Smaller Report Company x

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

The aggregate market value
of the voting and non-voting common equity held by non-affiliates of the
Registrant was approximately $63,805,000 based upon the closing sale price of
the Companys common stock on the NASDAQ on June 30, 2009.

As of March 15, 2010 there
were outstanding 8,357,559 shares of the Registrants common stock.

|                                      |                                                                                                                                                                              
|------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Documents
 Incorporated by Reference: | Portions of
 the Companys Proxy Statement for its Annual Meeting of Shareholders to be
 held on May 18, 2010 are incorporated by reference into Part III of this Form
 10-K.







PART I

|        |         
|------- | --------
|ITEM 1. | BUSINESS

(a) GENERAL DEVELOPMENT OF BUSINESS

Communications Systems, Inc.
(herein collectively referred to as CSI, our, we 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 and sale of media and rate conversion products for
telecommunications networks. CSI also provides IT solutions through its JDL
Technologies business unit including network design, computer infrastructure
installations, IT service management, change management, network security, and
network operation services.

The Company maintains a
website at www.commsystems.com.
Our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our
periodic reports on Form 8-K (and any amendments to these reports) are
available free of charge by linking from our website to the Securities &
Exchange Commission website.

(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The Company classifies its
businesses into four segments: Suttle,
which manufactures U.S. standard modular connecting and wiring devices for
voice and data communications; Transition
Networks,which designs and markets media conversion products,
Ethernet switches, and other connectivity and data transmission products; Austin Taylor,which manufactures British
standard line jacks, patch panels, metal boxes, distribution and central office
frames; and JDL Technologies, (JDL),
which provides IT solutions. Non-allocated general and administrative expenses
are separately accounted for as Other in the Companys segment reporting.
There are no material intersegment revenues. Further information regarding the
various segments is set forth in Note 9 of the Notes to Consolidated Financial
Statements under Item 8, herein.

(c) NARRATIVE DESCRIPTION OF BUSINESS

(1) Information Regarding Business Segments

(i) Suttle

Suttle manufactures and
markets connectors and wiring devices for voice, data and video communications
under the Suttle brand name in the United States (U.S.) and internationally.
Suttle also manufactures and markets a line of residential structured wiring
products under the SOHO (Small Office Home Office) Access  brand name. Suttle
also markets a line of DSL (Digital Subscriber Line) filters for the
telecommunications market. Approximately 54% of Suttles products are
manufactured at its plants in Hector, Minnesota (Suttle Apparatus Minnesota
Division), and San Jose, Costa Rica (Suttle Costa Rica, S.A.). The other 46%
are purchased from offshore contract manufacturers. Segment sales were
$42,867,000 (39% of consolidated revenues) in 2009 and $44,421,000 (36% of
consolidated revenues) in 2008.

Products

Suttles products are used in
on-premise connection of voice, data, and video devices. The core product line
consists primarily of modular connecting devices and includes numerous types of
jacks, connecting blocks and assemblies, adapters, cords and related equipment,
which are offered in a variety of colors, styles and wiring configurations.
Many of the products are used in voice applications but Suttle continues to
develop an expanding line of products for full communications and entertainment
connectivity. A significant portion of Suttles revenue is derived from sales
of a line of corrosion-resistant connectors, which utilize a water-resistant
gel to offer superior performance in harsh environments. Suttle connectivity
products generally range in price from $0.30 to $30.00 per unit. A majority of
Suttles sales volume, both in units and revenues, is derived from products
selling for under $5.00 per unit.

2

---



Suttle produces a full
product line of residential structured wiring equipment used for customer
premise applications for voice, data, video, and entertainment distribution.
This line of products consists of structured wiring enclosures which are
recessed or surface mounted in a residence or small business, and a series of
plug-and-play modules which snap into the enclosures to complete the system.
The modules selected determine the application of service and the number of
ports or connections can be scaled up by adding more modules. These products
are marketed under the SOHO AccessTM line of products. Suttles residential
wiring systems range in price from $5.42 to $95.00.

Suttle also sells DSL filters
for home and business applications that are procured from offshore sources.
These filters permit the user to receive both analog and digital signals
simultaneously and allow a single telephone line to support uninterrupted
voice, fax and internet capabilities.

Markets
and Marketing

Suttle competes in all major
areas of the telecommunications connector market utilizing traditional modular
jacks.

Suttle markets DSL filtering
devices to telephone companies for use with their DSL home install kits. The
products include both inline filters for deployment in the home and DSL
splitters which are typically mounted outside the home near the telephone
demarcation point.

Suttle markets residential
structured cabling system products which are an increasingly important part of
its product line. Service providers such as the telephone and cable companies
have extended their traditional services to include comprehensive
communications and entertainment offerings which require enhanced premise
cabling. Suttle markets its products to service providers, residential
builders, and low voltage installers through distributors, and through the
Companys sales staff.

Suttles customers include
the major communication companies including both telephone and cable service
provider companies. The Companys major telephone company customers include
Verizon, ATT (formerly Bell South and SBC Communications), and Qwest. Major
telephone companies are served directly by Suttles sales staff and through a
select group of distributors. As a group, sales to the major telephone
companies (including DSL), both directly and through distribution, represented
58% of Suttles sales in 2009 and 46% in 2008. The Companys cable company
customers include Comcast, Time Warner, Cox Communications, and Charter, as
well as other cable companies. Other customers include smaller telephone
companies, electrical/low voltage contractors, home builders, original
equipment manufacturers, and retailers. These customers are served primarily
through distributors but are also served directly by Suttles sales staff.
Sales to cable customers and original equipment manufacturers (OEM) are made
through a nationwide network of distributors and through the Suttle sales
staff. Sales to cable television distributors represented 5% of Suttles sales
in 2009 and 8% in 2008. Sales to OEMs and other distributors were 18% of
Suttles sales in 2009 and 20% in 2008. Sales to international customers and
other customers represented 19% of Suttles sales in 2009 and 26% in 2008.

The Companys Suttle brand
name is important to its business. Suttle regularly supports this name by trade
advertising and believes it is well known in the marketplace.

Competition

Suttle encounters strong
competition in all its product lines and competes primarily on the basis of the
broad lines of products offered, product performance, quality, price and
delivery. In addition, distributors of Suttles products also market products
for one or more of these competitors.

Order
Book

Suttle manufactures its
products on the basis of estimated customer requirements. Outstanding customer
orders at March 1, 2010 were approximately $3,373,000 compared to approximately
$3,333,000 at March 1, 2009. New orders are generally filled within 60 days.
Suttle does not believe its order book is a significant indicator of future
results.

3

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Manufacturing and Sources of Supply

Suttles products are
manufactured using plastic parts, wire sub-assemblies, fasteners, brackets,
electronic circuit boards and other components, most of which are fabricated by
Suttle. There are multiple sources of supply for the materials and parts
required and the Company is not dependent upon any single supplier, except that
Suttles corrosion-resistant products utilize a moisture-resistant gel-filled
fig available only from Tyco Electronics. Suttle has not generally experienced
significant problems in obtaining its required supplies, although from time to
time spot shortages are experienced and additional order lead times are
required from the offshore suppliers.

Research and Development; Patents

Suttle continually monitors
industry requirements and creates new products to improve its existing product
line. Historically, Suttle has generally not relied on patents to protect its
competitive position in its market. However, duplication of its designs by
foreign apparatus manufacturers has caused Suttle to apply for design patents
on a number of products.

(ii) Transition Networks

Transition Networks, Inc.
(Transition Networks) is based in Minnetonka, Minnesota and also maintains an
engineering center and sales office in Shanghai, China. Transition designs,
assembles and markets media converters, transceivers, network interface cards,
Ethernet switches, Small Form factor Pluggable modules (SFP)s, and other
connectivity products under the Transition Networks and MILAN brand names.
Transition sells its product through distributors, resellers, integrators, and
OEMs. These media converter and Ethernet Switch products permit voice and data
networks to move information between copper-wired equipment and fiber-optic
cable. Sales by Transition Networks were $55,098,000 (50% of consolidated
sales) in 2009 compared to 62,924,000 (51% of consolidated sales) in 2008.
International sales accounted for 18% of Transitions sales, or $9,886,000 in
2009, compared to $17,061,000, or 27% of Transitions sales in 2008.

Products

Transition Networks designs,
assembles and sells media converter devices, Ethernet switches and other
connectivity products that make it possible to transmit telecommunications
signals between systems using different types of media (for example, between
copper and fiber optic networks). These products assist customers to integrate
fiber optics into their existing network infrastructure as their networks grow,
and extend data services to customers or remote locations. Protocols supported
include Gigabit Ethernet, Fast Ethernet, Ethernet, T1/E1, DS3, RS232, RS485,
OC3, OC12, and more. The company uses proprietary Application Specific
Integrated Circuits (ASIC) for development of some products, as well as ASICs
from integrated circuit manufacturers such as Marvell® and Broadcomm® for the
development of new products. Product hardware and software development is done
internally and is expensed when incurred. The software that Transition Networks
utilizes to manage its products is provided free with the product. Transition
Networks product development is focused on hardware, with software developed to
support hardware sales. The Company has been developing and marketing Ethernet
based networking products for approximately 22 years. Transition Networks continues
to develop products that address the enterprise, service provider, industrial,
and security markets and, in addition, targets the specific vertical markets of
government and education.

Manufacturing
and Sources of Supply

Transition Networks
outsources most of its manufacturing. In 2009, approximately 60% of its
products were manufactured offshore, principally in Asia. Offshore sources of
supply are subject to certain risks, including interference from political
sources. The balance of its products are manufactured in the United States. The
Company has alternate sources of supply for its products and to date has not
had problems obtaining necessary product.

Markets
and Marketing

Transition Networks products
are used in a broad array of markets, including enterprise networks, service
providers networks, security and industrial environments such as in
manufacturing processes. Transition Networks has a broad customer base and its
products are used in a variety of applications.

The media conversion product
line addresses and is utilized in a variety of applications. The chassis based
system, the Point System, is used primarily in telecommunications closets for
high-density applications and when multiple protocols need to be supported.
Stand alone media converters are used typically at a workstation or for lower
density applications. The line of Ethernet switches is used in both the central
closet and at the end user station.

4

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Marketing primarily consists
of direct marketing utilizing a sales force, tradeshows, trade magazine
advertising, on-line advertising, web site, social media and public relations
activities. Transition Networks also provides and participates in advertising
and cooperative marketing campaigns with distribution partners.

The Companys Transition
Networks and MILAN brand names are important to its business. The Company
regularly supports these names by trade advertising and believes them to be
well known in the marketplace.

Research
and Development

Transition Networks continues
to develop products that address the enterprise, service provider, security and
industrial markets. This includes developing converters for emerging protocols
and existing protocols in new markets, as well as new industry standards. Some
of these products include remote management devices built on the IEEE® 802.3AH
standard, Metro Ethernet Forum (MEF)® standards and Power Over Ethernet based
on the IEEE® 802.3AF standard. Some design efforts are paced by the development
of critical components such as integrated circuits and optical transceivers.

Research and development
consists primarily of testing, equipment and supplies associated with enhancing
existing products and developing new products. Research and development costs
are expensed when incurred and were $1,707,000 in 2009 compared to $1,792,000
in 2008.

Transition Networks research
and development operations are conducted in the United States and China.
Transition opened an engineering and sales office in China (Transition
Networks Shanghai) in the third quarter of 2007. The China operation focuses
primarily on engineering, including hardware and software development and
testing. In the near future, additional operations will include marketing,
purchasing, and potentially sales support.

Competition

Transition Networks faces
strong competition across its entire product line. A large number of
competitors exist for the highest volume products in the Fast Ethernet and
Gigabit Ethernet family. Low cost competitors from China and Taiwan are
strongest in the developing Asian markets, but have had limited success in the
North American market for the media converter products. A deeper penetration of
these competitors poses a potential threat to sales and profit margins.
Competition also exists from substitutes such as lower cost fiber switches. The
Fast Ethernet and Gigabit Ethernet switch market is filled with a large number
of domestic and Asian competitors. Transition Networks also faces new
competitors as it enters new markets for industrial products, security market,
and higher performance devices for the service provider market.

Order
Book

Outstanding customer orders
for Transition Networks products were approximately $8,190,000 at March 1, 2010
and $2,000,000 at March 1, 2009. Transition Networks orders are fulfilled on a
relatively short-term basis and therefore the order book is not considered a
significant indicator of future results.

(iii) JDL Technologies, Inc.

JDL Technologies, Inc., located
in Fort Lauderdale, FL (JDL), provides IT solutions including network design,
network infrastructure installations, IT service management, change management,
network security, desktop virtualization and network operation services. JDLs
2009 sales were $8,765,000 (8% of consolidated sales) compared to 2008 sales of
$9,838,000 (8% of consolidated sales). Project revenue totaled $7,357,000 in
2009 or 84% of JDL sales compared to $4,482,000 in 2008 or 46% of JDL sales.
Managed services revenues were $1,408,000 and $5,355,000 in 2009 and 2008,
respectively.

5

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During the past several years
JDL derived most of its revenues from two major customers, Broward County,
Florida school district and the Virgin Islands Department of Education
(VIDE). As discussed below, VIDE ceased being a customer after June 2008.
While the Broward County school district is currently the primary source of
JDLs revenues, JDL has embarked on a new strategic initiative to diversify its
customer base and solution offerings to address the rapidly emerging needs of
the IT market of the future.

Impairment
of VIDE Assets

On January 17, 2008 the
Company was notified that JDL was not selected as a vendor to provide services
to VIDE for the 2008  2009 school year and ceased operations in the Virgin
Islands July 1, 2008. As a result, the Company determined that assets,
including goodwill, related to its VIDE operations were impaired. See
Managements Discussion and Analysis in Item 7 herein for further information.

Order
Book

Outstanding customer orders
and contracts for JDL products and services were approximately $18,564,000 at
March 1, 2010 and $4,400,000 at March 1, 2009. Approved amounts could vary from
the original contracts.

(iv) Austin Taylor

Austin Taylor Communications,
Ltd. is located in Bethesda, North Wales, United Kingdom. Austin Taylor is a
provider of telephony and data networking products to telecommunications
companies, distributors and installers throughout the U.K., Europe and the
Middle East. Austin Taylor sales were $3,062,000 (3% of consolidated revenues)
in 2009 and $5,516,000 (5% of consolidated revenues) in 2008.

At its plant in Bethesda the
company designs and manufactures external metal cabinets and internal metal
boxes to industry standards and to customer specifications and procures other
products from offshore sources. All manufacturing and supply line products are
supported to ISO: 9001:2000 approved standards to guarantee customer quality,
consistency and reliability. Approximately 72% and 59% of Austin Taylor sales
were to U.K. customers in 2009 and 2008.

Outstanding customer orders
for Austin Taylor products were approximately $265,000 at March 1, 2010
compared to $193,000 at March 1, 2009. Because Austin Taylor fills new orders on
a relatively short timetable, the Company does not believe its order book is a
significant indicator of future results.

(2) Employment Levels

As of March 1, 2010 the
Company employed 429 people. Of this number, 223 were employed by Suttle
(including 92 in Hector, Minnesota and 131 in Costa Rica), 133 by Transition
Networks, Inc. (116 in Minnetonka, MN and 17 in China), 21 by JDL Technologies,
Inc., 33 by Austin Taylor Communications, Ltd and 19 corporate general and
administrative positions. Nine of the Companys Austin Taylor employees are
represented under collective and individual bargaining agreements. The Company
considers its employee relations to be good.

6

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(3) Executive Officers of Registrant

The executive officers of the
Company and their ages at March 1, 2010 were as follows:

| |                      |     |                                                                        |  |  |  | 
| | -------------------- | --- | ---------------------------------------------------------------------- |  |  |  | 
| | Name                 | Age | Position1                                                             
| |                      |     |                                                                        |  |  |  | 
|
| | Jeffrey K. Berg      | 67  | President and Chief
 Executive Officer [2007]2                        
|
| | David T. McGraw      | 58  | Vice President, Treasurer
 and Chief Financial Officer [2008]3        
|
| | William G. Schultz   | 41  | Vice President and General
 Manager, Transition Networks, Inc. [2007]5
|
| | Bruce Blackwood      | 47  | Vice President and General
 Manager, Suttle [2007]6                   
|
| | Michael J. Skucius   | 56  | Vice President, Information
 Technology [2010]7                       
|
| | Karen Nesburg Bleick | 45  | Vice President, Human
 Resources [2009]8                              
|
| | Vince Geraci         | 63  | Managing Director, Austin
 Taylor Inc [2008]9                         
|
| | Melvyn J. Albiston   | 64  | Vice President and General
 Manager JDL Technologies, Inc [2010]10    

| |    |                                                                                                                                                                                                                                                                                                                                                          | 
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |    |                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 1  | Dates in brackets indicate
 period during which officers began serving in such capacity. Executive
 officers serve at the pleasure of the Board of Directors and are elected
 annually for one-year terms.                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 2  | Mr. Berg was appointed
 Chief Executive Officer of the Company in June 2007. From November 2000 to
 June 2007 he served as the Companys Chief Operating Officer and was named
 President of the Company in March 2002. Prior to November 2000, Mr. Berg
 served as President of the Companys Suttle operations.                                       
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 3  | Mr. McGraw was appointed
 Chief Financial Officer in January 2008. From September 2002 to December 2007
 he served as President of Suttle. From May 2001 to August 2002, he served as
 Chief Operating Officer of JDL Technologies, Inc. Prior to May 2001, he was
 Vice President-General Manager of Precision Diversified Industries in
 Plymouth, MN.
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 5  | Mr. Schultz was appointed
 Vice President and General Manager of Transition Networks, Inc. in October
 2007. From May 2000 to September 2007, he served as Transition Networks Vice
 President of Marketing. Prior to May 2000, he was Distribution Business
 Manager for AMP Division of Tyco International, Ltd.                                      
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 6  | Mr. Blackwood was appointed
 Vice President and General Manager of Suttle in December 2007. From July 2001
 to November 2007 he served as Suttles Vice President of Sales. Prior to July
 2001 he was Vice President of Sales for Americable.                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 7  | Mr. Skucius was appointed
 Vice President of Information Technology in January 2010. From July 2007 to
 December 2009 he served as Vice President and General Manager of JDL. From
 1980 to 2007 he was the Companys Director of Management Information
 Services.                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 8  | Ms. Nesburg Bleick was
 appointed Vice President, Human Resources in January 2009. From October 2002
 to December 2008, she served as Director of Human Resources.                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 9  | Mr. Geraci was appointed
 Managing Director of Austin Taylor in November 2008. From April 2005 to
 October 2008 he was Regional Sales Manager for Suttle. Prior to April 2005,
 he was an independent consultant.                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                         
| | 10 | Mr. Albiston was appointed
 Vice President and General Manager of JDL Technologies in January 2010. For
 the preceding five years he was an independent consultant.                                                                                                                                                                                     

(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC
OPERATIONS AND EXPORT SALES

Financial information about
domestic and foreign operations and export sales may be obtained by reference
to Note 9 of the Notes to Consolidated Financial Statements under Item 8
herein.

7

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|         |             
|-------- | ------------
|ITEM 1A. | RISK FACTORS

Forward Looking Statements

Certain
statements contained in this Annual Report on Form 10-K are forward-looking
statements within the meaning of and in reliance on the Private Securities
Litigation Reform Act of 1995, which provides a safe harbor for
forward-looking statements. Actual events and results may differ materially
from those expressed or forecasted in forward-looking statements due to a
number of factors. The principal important risk factors that could cause our
actual performance and future events and actions to differ materially from such
forward-looking statements include, but are not limited to, the risk factors
discussed below.

Risks Related to Our Business

The primary markets we serve are highly competitive,
and our ability to compete requires continual focus on delivering high quality,
competitively priced products and the regular introduction of new products that
meet evolving customer requirements.

Competition
in the markets for voice and data communications products is intense. Our
ability to compete with other manufacturers of these products depends primarily
on our engineering, manufacturing and marketing skills; the price, quality and
reliability of our products; our delivery and service capabilities; and our
control of operating expenses. We have experienced, and anticipate continuing
to experience, pricing pressures from our customers as well as our competitors.
The markets we serve are characterized by rapid technological advances and
evolving industry standards. These markets can be significantly affected by new
product introductions and marketing activities of industry participants.
Certain of our competitors and potential competitors may have greater
financial, technological, manufacturing, marketing, and personnel resources
than us. Present and future competitors may be able to identify new markets and
develop products more quickly, which are superior to those developed by us.
They may also adapt new technologies faster, devote greater resources to
research and development, promote products more aggressively, and price
products more competitively than us. There are no assurances that competition
will not intensify or that we will be able to compete effectively in the
markets in which we compete.

We face many challenges in maintaining
acceptable margins, and our level of gross margin may not be sustainable.

Gross
margins among our products vary and are subject to fluctuation from quarter to
quarter. The factors that may impact our gross margins adversely are numerous
and include:

| |   |                                                                                  
| | - | ---------------------------------------------------------------------------------
| |  | Changes in customer,
 geographic, or product mix;                                
| |   |                                                                                  
| |  | Our ability to reduce
 product costs;                                            
| |   |                                                                                  
| |  | Increases in material or
 labor costs;                                           
| |   |                                                                                  
| |  | Expediting costs incurred
 to meet customer delivery requirements;               
| |   |                                                                                  
| |  | Excess inventory and
 inventory carrying charges;                                
| |   |                                                                                  
| |  | Obsolescence charges;                                                            
| |   |                                                                                  
| |  | Changes in shipment
 volume;                                                     
| |   |                                                                                  
| |  | Changes in component
 pricing;                                                   
| |   |                                                                                  
| |  | Increased price
 competition;                                                    
| |   |                                                                                  
| |  | Changes in distribution
 channels;                                               
| |   |                                                                                  
| |  | Increased warranty cost;
 and                                                    
| |   |                                                                                  
| |  | Our ability to manage the
 impact of foreign currency exchange rate fluctuations.

8

---



Consolidation among our customers has
occurred and further consolidation may occur and result in the loss of some
customers and may reduce revenue during the pendency of business combinations
and related integration activities.

We
believe consolidation among our customers in the future may occur in order for
them to increase market share and achieve greater economies of scale.
Consolidation has impacted our business as our customers focus on completing
business combinations and integrating their operations. In certain instances,
customers integrating large-scale acquisitions have reduced their purchases of
our products during the integration period.

The
impact of significant mergers among our customers on our business is likely to
be unclear until sometime after such transactions are completed. After a
consolidation occurs, a customer may choose to reduce the number of vendors
from which it purchases equipment and may choose one of our competitors as its
preferred vendor. There can be no assurance that we will continue to supply
equipment to the surviving communications service provider after a business
combination is completed.

Our profitability could be impacted
negatively if one or more of our key customers substantially reduces orders for
our products and/or transitions their purchases towards lower gross margin
products.

Our
customer base is somewhat concentrated, with our top ten customers accounting
for 72%, 60% and 54% of net sales for fiscal 2009, 2008 and 2007, respectively.
One of our largest customers, Verizon, accounted for 9%, 5% and 5% of our net
sales for the fiscal years 2009, 2008 and 2007. The merger of AT&T and
BellSouth in our fiscal 2007 created another large customer for us. In fiscal
2009, 2008 and 2007, this combined company accounted for approximately 12%, 12%
and 10% of our sales, respectively. If we lose a significant customer for any
reason, our sales and gross profit will be impacted negatively.

Our market is subject to rapid
technological change and, to compete effectively, we must continually introduce
new products that achieve market acceptance.

The
communications equipment industry is characterized by rapid technological
changes, evolving industry standards, changing market conditions, short product
life cycles and rapidly changing customer requirements and frequent new product
and service introductions and enhancements. The introduction of products using
new technologies or the adoption of new industry standards can make our
existing products, or products under development, obsolete or unmarketable. Our
future success will depend on our ability to enhance our existing products, to
introduce new products to meet changing customer requirements and emerging
technologies, and to demonstrate the performance advantages and
cost-effectiveness of our products over competing products. Failure by us to
modify our products to support new alternative technologies or failure to
achieve widespread customer acceptance of such modified products could cause us
to lose market share and cause our revenues to decline.

We
may not predict technological trends or the success of new products in the
communications equipment market accurately. New product development often
requires forecasting of market trends, development and implementation of new
technologies and processes and substantial capital commitments. We do not know
whether other new products we develop will gain market acceptance or result in
profitable sales.

Certain
of our competitors have greater engineering and product development resources
than we have. Although we expect to continue to invest significant resources in
product development activities, our efforts to achieve and maintain
profitability will require us to be selective and focused with our research and
development expenditures. If we fail to anticipate or respond in a
cost-effective and timely manner to technological developments, changes in
industry standards or customer requirements, or if we experience any
significant delays in product development or introduction, our business,
operating results and financial condition could be affected adversely.

We
may experience delays in developing and marketing product enhancements or new
products that respond to technological change, evolving industry standards and
changing customer requirements. There can be no assurance that we will not
experience difficulties that could delay or prevent the successful development,
introduction, and marketing of these products or product enhancements, or that
our new products and product enhancements will adequately meet the requirements
of the marketplace and achieve any significant or sustainable degree of market
acceptance in existing or additional markets. In addition, the future
introductions or announcements of products by us or one of our competitors
embodying new technologies or changes in industry standards or customer
requirements could render our then-existing products obsolete or unmarketable.
There can be no assurance that the introduction or announcement of new product
offerings by us or one or more of our competitors will not cause customers to
defer their purchase of our existing products, which could cause our revenues
to decline.

9

---



We evaluate and frequently pursue
acquisitions, but we may not successfully close the acquisitions and, if these
acquisitions are completed, we may have difficulty integrating the acquired
businesses with our existing operations.

We
regularly consider the acquisition of complementary companies and/or product
lines. We cannot, however, provide assurances that we will be able to find
appropriate candidates for acquisitions, reach agreement to acquire them, or
obtain requisite shareholder or regulatory approvals needed to close strategic
acquisitions, despite the effort and management attention invested.

The
impact of future acquisitions on our business, operating results and financial
condition is uncertain. In the case of businesses we may acquire in the future,
we may have difficulty assimilating these businesses and their products,
services, technologies and personnel into our operations. These difficulties
could disrupt our ongoing business, distract our management and workforce,
increase our expenses and materially adversely affect our operating results and
financial condition. Also, we may not be able to retain key management and
other critical employees after an acquisition. We may also acquire
unanticipated liabilities. In addition to these risks, we may not realize all
of the anticipated benefits of these acquisitions.

Our operating results fluctuate from
quarter to quarter.

Our
operating results are difficult to predict and may fluctuate significantly from
quarter to quarter. Fluctuations in our quarterly operating results may be
caused by many factors, including the following:

| |   |                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------
| |  | the volume and timing of
 orders from shipments to our customers;                                     
| |   |                                                                                                       
| |  | the overall level of
 capital expenditures by our customers;                                          
| |   |                                                                                                       
| |  | work stoppages and other
 developments affecting the operations of our customers;                     
| |   |                                                                                                       
| |  | the timing of and our ability
 to obtain new customer contracts and the timing of revenue recognition;
| |   |                                                                                                       
| |  | the timing of new product
 and service announcements;                                                 
| |   |                                                                                                       
| |  | the availability of
 products and services;                                                           
| |   |                                                                                                       
| |  | market acceptance of new
 and enhanced versions of our products and services;                         
| |   |                                                                                                       
| |  | variations in the mix of
 products and services we sell;                                              
| |   |                                                                                                       
| |  | the location and
 utilization of our production capacity and employees; and                           
| |   |                                                                                                       
| |  | the availability and cost
 of key components of our products.                                         

Our
expense levels are based in part on expectations of future revenues. If revenue
levels in a particular quarter are lower than expected, our operating results
will be affected adversely.

We depend on manufacturing relationships
and on limited-source suppliers and any disruptions in these relationships may
cause damage to our customer relationships.

We
procure all parts and certain services involved in the production of our
products and subcontract much of our product manufacturing to outside firms
that specialize in such services. Although most of the components of our
products are available from multiple vendors, we have several single-source
supplier relationships, either because alternative sources are not available or
because the relationship is advantageous to us. There can be no assurance that
our suppliers will be able to meet our future requirements for products and
components in a timely fashion. In addition, the availability of many of these
components to us is dependent in part on our ability to provide our suppliers
with accurate forecasts of our future requirements. Delays or lost sales could
be caused by other factors beyond our control, including defects in the quality
of components or products supplied by others.

10

---



We are dependent upon our senior management
and other critical employees.

Like
all communications technology companies, our success is dependent on the
efforts and abilities of our senior management personnel and other critical
employees, including those in sales, marketing and product development
functions. Our ability to attract, retain and motivate these employees is
critical to our success. In addition, because we may acquire one or more
businesses in the future, our success will depend, in part, upon our ability to
retain and integrate our own personnel with personnel from acquired entities
that are necessary to the continued success or the successful integration of
the acquired businesses.

Managing our inventory is complex and may
include write-downs of excess or obsolete inventory.

Managing
our inventory of components and finished products is complicated by a number of
factors, including the need to maintain a significant inventory of finished
goods for orders we anticipate but may not be received. These issues may cause
us to purchase and maintain significant amounts of inventory. If this inventory
is not used as expected based on anticipated requirements, it may become excess
or obsolete. The existence of excess or obsolete inventory can result in sales
price reductions and/or inventory write-downs, which could adversely affect our
business and results of operations.

We face risks associated with expanding our
sales outside of the United States.

We
believe that our future growth is dependent in part upon our ability to
increase sales in international markets. These sales are subject to a variety
of risks, including fluctuations in currency exchange rates, tariffs, import
restrictions and other trade barriers, unexpected changes in regulatory
requirements, longer accounts receivable payment cycles and potentially adverse
tax consequences, and export license requirements. In addition, we are subject
to the risks inherent in conducting business internationally, including
political and economic instability and unexpected changes in diplomatic and
trade relationships. There can be no assurance that one or more of these
factors will not have a material adverse effect on our business strategy and
financial condition.

Compliance with internal control
requirements is expensive and poses certain risks.

We
expect to incur significant continuing costs, including accounting fees and
staffing costs, in order to maintain compliance with the internal control
requirements of the Sarbanes-Oxley Act of 2002. Expansion of our business,
particularly internationally, will necessitate ongoing changes to our internal
control systems, processes and information systems. In addition, if we complete
acquisitions in the future, our ability to integrate operations of the acquired
company could impact our compliance with Section 404 of the Sarbanes-Oxley Act.
We cannot be certain that as our business changes, our current design for
internal control over financial reporting will be sufficient to enable management
to determine that our internal controls are effective for any period, or on an
ongoing basis.

In
the future, if we fail to complete the annual Section 404 evaluation in a
timely manner, we could be subject to regulatory scrutiny and a loss of public
confidence in our internal controls. In addition, any failure to implement
required new or improved controls, or difficulties encountered in their
implementation, could harm our operating results or cause us to fail to meet
our reporting obligations.

Product defects or the failure of our
products to meet specifications could cause us to lose customers and revenue or
to incur unexpected expenses.

If
our products do not meet our customers performance requirements, our customer
relationships may suffer. Also, our products may contain defects or fail to
meet product specifications. Any failure or poor performance of our products
could result in:

| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |  | delayed market acceptance
 of our products;                                                                                 
| |   |                                                                                                                             
| |  | delayed product shipments;                                                                                                  
| |   |                                                                                                                             
| |  | unexpected expenses and
 diversion of resources to replace defective products or identify and correct
 the source of errors;
| |   |                                                                                                                             
| |  | damage to our reputation
 and our customer relationships;                                                                   

11

---



| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | delayed recognition of
 sales or reduced sales; and                                                                      
| |   |                                                                                                                          
| |  | product liability claims
 or other claims for damages that may be caused by any product defects or
 performance failures.

Our sales and operations may continue to be
impacted adversely by current global economic conditions.

For
more than a year, financial markets globally have experienced extreme
disruption. This includes, among other things, extreme volatility in security
prices, severely diminished liquidity and credit availability, ratings
downgrades of certain investments and declining valuations of others. The
severity and length of the present disruptions in the financial markets and the
global economy are unknown. There can be no assurance that there will not be a
further deterioration in financial markets and in business conditions
generally. These economic developments have adversely affected our business in
a number of ways and will likely continue to adversely impact our business
during the foreseeable future.

Risks Related to Our Common Stock

Our stock price has been volatile
historically and the price of our common stock may fluctuate significantly in
the future.

The
trading price of our common stock has been and may continue to be subject to
wide fluctuations. Our stock price may fluctuate in response to a number of
events and factors, such as quarterly variations in operating results,
announcements of technological innovations or new products by us or our
competitors, the operating and stock price performance of other companies that
investors may deem comparable to us, and new reports relating to trends in our
markets or general economic conditions.

In
addition, the stock market in general, and prices for companies in our industry
in particular, have experienced extreme volatility that often has been
unrelated to the operating performance of such companies. These broad market
and industry fluctuations may adversely affect the price of our common stock,
regardless of our operating performance.

Anti-takeover provisions in our charter
documents, our shareholder rights agreement and Minnesota law could prevent or
delay a change in control of our company.

Provisions
of our articles of incorporation and bylaws, our shareholder rights agreement
(also known as a poison pill) and Minnesota law may discourage, delay or
prevent a merger or acquisition that a shareholder may consider favorable, and
could limit the price that investors are willing to pay for our common stock.
These provisions include the following:

| |   |                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | advance notice requirements
 for shareholder proposals;                                                                                                                              
| |   |                                                                                                                                                                                      
| |  | authorization for our
 board of directors to issue preferred stock without shareholder approval;                                                                                     
| |   |                                                                                                                                                                                      
| |  | authorization for our
 board of directors to issue preferred stock purchase rights upon a third
 partys acquisition of 16.5% or more of our outstanding shares of common
 stock; and
| |   |                                                                                                                                                                                      
| |  | limitations on business
 combinations with interested shareholders                                                                                                                   
| |   |                                                                                                                                                                                      
| |  | classification of Board of
 Directors that serve staggered, three year terms.                                                                                                        

Some
of these provisions may discourage a future acquisition of our company even
though our shareholders would receive an attractive value for their shares, or
a significant number of our shareholders believe such a proposed transaction
would be in their best interest.

|         |                           
|-------- | --------------------------
|ITEM 1B. | UNRESOLVED
 STAFF COMMENTS

None.

12

---



|        |           
|------- | ----------
|ITEM 2. | PROPERTIES

Administrative,
manufacturing and engineering functions of CSI are conducted at the following
facilities:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | - | In
 Minnetonka, Minnesota the Company owns a 105,000 square foot building where
 its executive and administrative offices are located. In addition, Transition
 Networks uses this facility for its warehouse, assembly, engineering and
 administrative operations, JDL Technologies, Inc. uses this facility for its
 executive and some administrative operations, and Suttle uses this facility
 for its sales, marketing and product development.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | Suttles
 manufacturing is conducted at two locations. At Hector, Minnesota, the
 Company owns three plants totaling 88,000 feet of manufacturing space. The
 Company leases 40,000 square feet of manufacturing space in San Jose, Costa
 Rica.                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | Austin
 Taylor Communications, Ltd. owns a 40,000 square foot facility in Bethesda,
 Wales, U.K.                                                                                                                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | Transition
 Networks leases 1,000 square feet of office space for engineering and sales
 activities in Shanghai, China.                                                                                                                                                                                                                                                                                                                               

CSI believes
these facilities will be adequate to accommodate its administrative,
manufacturing and distribution needs for the foreseeable future.

|        |                  
|------- | -----------------
|ITEM 3. | LEGAL PROCEEDINGS

No material
litigation or other material claim is presently pending against the Company.

|        |         
|------- | --------
|ITEM 4. | RESERVED

Not
applicable.

PART II

|        |                                                                                                                
|------- | ---------------------------------------------------------------------------------------------------------------
|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 AND ISSUER PURCHASE OF EQUITY SECURITIES

|    |                   
|--- | ------------------
|(a) | MARKET INFORMATION

The Companys
common stock trades on the NASDAQ under the trading symbol JCS.

The table
below presents the price range of high and low trades of the Companys common
stock for each quarterly period indicated as reported by NASDAQ for 2009 and
2008.

|       |  |      |       |      |   |       |  |     |       |  |   |       | 
|------ |  | ---- | ----- | ---- | - | ----- |  | --- | ----- |  | - | ----- | 
|       |  | 2009 |       | 2008 |  
|       |  |      |       |      |  
|       |  | High |       | Low  |   | High  |  | Low |      
|       |  |      |       |      |   |       |  |     |      
|       |  |      |       |      |   |       |  |     |       |  |   |       | 
|First  |  | $    | 9.54  |      | $ | 6.95  |  | $   | 12.15 |  | $ | 9.75  | 
|Second |  |      | 11.96 |      |   | 7.52  |  |     | 11.75 |  |   | 10.02 | 
|Third  |  |      | 13.05 |      |   | 9.61  |  |     | 11.62 |  |   | 9.61  | 
|Fourth |  |      | 13.70 |      |   | 10.47 |  |     | 11.00 |  |   | 6.93  | 

|    |        
|--- | -------
|(b) | HOLDERS

At March 15,
2010 there were approximately 603 registered holders of record of
Communications Systems, Inc. common stock.

13

---



|    |          
|--- | ---------
|(c) | DIVIDENDS

Communications
Systems, Inc. paid regular quarterly dividends to its shareholders on the dates
and at the rates indicated below:

|                 |  |   |                    |  | 
|---------------- |  | - | ------------------ |  | 
|Payment
 Date    |  |   | Dividend per Share | 
|                 |  |   |                    | 
|January 1,
 2010 |  | $ | .14                | 
|October 1,
 2009 |  |   | .14                | 
|July 1, 2009     |  |   | .14                | 
|April 1,
 2009   |  |   | .12                | 
|January 1,
 2009 |  |   | .12                | 
|October 1,
 2008 |  |   | .12                | 
|July 1, 2008     |  |   | .12                | 
|April 1, 2008    |  |   | .12                | 
|January 1,
 2008 |  |   | .12                | 

The payment of
future dividends will be determined at the discretion of the Board of
Directors.

|    |                                                
|--- | -----------------------------------------------
|(d) | INFORMATION REGARDING EQUITY COMPENSATION PLANS

The following
table presents information about the Companys equity compensation plans, under
which equity securities of the Company are authorized for issuance, as of
December 31, 2009:

Securities Authorized for Issuance Under
Equity Compensation Plans

|                                                         |  |  |                                                                                                              |  |                                                                               |  |                                                                                                                                                 |       |  |  |  |           |  |  | 
|-------------------------------------------------------- |  |  | ------------------------------------------------------------------------------------------------------------ |  | ----------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------- | ----- |  |  |  | --------- |  |  | 
|Plan
 Category (1)                                       |  |  | Number of shares of
 common stock to be
 issued upon exercise
 of outstanding
 options, warrants and
 rights |  | Weighted-average
 exercise price of
 outstanding options
 warrants and rights |  | Number of shares of
 common stock remaining
 available for future
 issuance under equity
 compensation plans
 (excluding shares in
 column (a)) |      
|                                                         |  |  |                                                                                                              |  |                                                                               |  |                                                                                                                                                 |      
|                                                         |  |  |                                                                                                              |  |                                                                               |  |                                                                                                                                                 |       |  |  |  |           |  | 
|Equity
 compensation plans approved by security holders: |  |  |                                                                                                              |  |                                                                               |  |                                                                                                                                                 |       |  |  |  |           |  | 
|                                                         |  |  |                                                                                                              |  |                                                                               |  |                                                                                                                                                 |       |  |  |  |           |  | 
|1992 Stock
 Plan-Employee Plan                           |  |  |                                                                                                             |  |                                                                               |  | $                                                                                                                                               |      |  |  |  | 1,123,739 |  | 
|1992 Stock
 Plan-Nonemployee Director Plan               |  |  | 189,000                                                                                                      |  |                                                                               |  | $                                                                                                                                               | 9.77  |  |  |  | 31,000    |  | 
|1990
 Employee Stock Purchase Plan                       |  |  | 4,675                                                                                                        |  |                                                                               |  | $                                                                                                                                               | 11.81 |  |  |  | 87,828    |  | 

Equity compensation plans not approved by security holders:

None

|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(1) | The Company
 does not have individual compensation arrangements involving the grant of options,
 warrants and rights.
|    |                                                                                                                      
|(e) | REGULATION S-K, ITEM 201 (e) INFORMATION                                                                             

The following
graph presents, at the end of each of the Companys last five fiscal years, the
cumulative total return on the common stock of the Company as compared to the
cumulative total return reported for the NASDAQ (U.S.), and the NASDAQ
Telecommunications Index. Company information and each index assume the
investment of $100 on the last business day before January 1, 2004 and the
reinvestment of all dividends.

14

---



(LINE GRAPH)

Comparison of Five-Year Cumulative Total Return

|                              |  |   |         |  |      |         |      |   |         |  |      |         |      |   |        |  |   |         |  | 
|----------------------------- |  | - | ------- |  | ---- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------ |  | - | ------- |  | 
|Company or
 Index             |  |   | 2004    |  | 2005 |         | 2006 |   | 2007    |  | 2008 |         | 2009 |  
|                              |  |   |         |  |      |         |      |   |         |  |      |         |      |  
|Communications Systems,
 Inc. |  | $ | 100.000 |  | $    | 104.770 |      | $ | 89.450  |  | $    | 107.454 |      | $ | 75.039 |  | $ | 126.135 | 
|NASDAQ US                     |  |   | 100.000 |  |      | 102.135 |      |   | 112.187 |  |      | 121.681 |      |   | 58.639 |  |   | 84.282  | 
|NASDAQ TELCOM                 |  |   | 100.000 |  |      | 95.037  |      |   | 124.968 |  |      | 111.157 |      |   | 63.868 |  |   | 95.770  | 

|    |                                         
|--- | ----------------------------------------
|(f) | RECENT
 SALES OF UNREGISTERED SECURITIES

Not applicable.

|    |                                                                        
|--- | -----------------------------------------------------------------------
|(g) | PURCHASES
 OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

In 2009 the Company
repurchased a total of 5,126 shares of common stock since January 1, 2009
pursuant to Rule 10b-18 under the Exchange Act. The following table presents
the repurchases for the three months ending December 31, 2009:

|                                          |  |    |                                                     |  |                                                |   |                                                                                                      |  |                                                                                                                                  |    |  |  |         |  |  | 
|----------------------------------------- |  | -- | --------------------------------------------------- |  | ---------------------------------------------- | - | ---------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------- | -- |  |  | ------- |  |  | 
|ISSUER PURCHASES OF EQUITY SECURITIES (1) | 
|                                          | 
|Period                                    |  |    | (a) Total
 Number of
 Shares (or
 Units)
 Purchased |  | (b)
 Average
 Price Paid
 per Share
 (or Unit) |   | (c) Total Number
 of Shares (or
 Units) Purchased
 as Part of Publicly
 Announced Plans
 or Programs |  | (d) Maximum Number
 (or Approximate Dollar
 Value) of Shares (or
 Units) that May Yet Be
 Purchased Under the
 Plans or Programs |   
|                                          |  |    |                                                     |  |                                                |   |                                                                                                      |  |                                                                                                                                  |   
|October 2009                              |  |   |                                                     |  |                                                |   |                                                                                                     |  |                                                                                                                                  |   |  |  | 482,026 |  | 
|                                          |  |    |                                                     |  |                                                |   |                                                                                                      |  |                                                                                                                                  |    |  |  |         |  | 
|November 2009                             |  |   |                                                     |  |                                                |   |                                                                                                     |  |                                                                                                                                  |   |  |  | 482,026 |  | 
|                                          |  |    |                                                     |  |                                                |   |                                                                                                      |  |                                                                                                                                  |    |  |  |         |  | 
|December 2009                             |  | 88 |                                                     |  |                                                | $ | 11.35                                                                                                |  |                                                                                                                                  | 88 |  |  | 481,938 |  | 
|                                          |  |    |                                                     |  |                                                |   |                                                                                                      |  |                                                                                                                                  |    |  |  |         |  | 
|Total                                     |  | 88 |                                                     |  |                                                |   |                                                                                                      |  |                                                                                                                                  | 88 |  |  |         |  | 

|    |                                                                                                                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Shares repurchased in 2009
 were repurchased pursuant to a Board approved program to repurchase a total
 of 500,000 shares that was publicly announced in November 2008. All of the
 shares repurchased were repurchased pursuant to this authorization and in
 compliance with Rule 10b-18.

15

---



|        |                         
|------- | ------------------------
|ITEM 6. | SELECTED
 FINANCIAL DATA

COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
SELECTED FINANCIAL INFORMATION(in thousands except
per share amounts)

|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|----------------------------------------------------- |  | ---------------------- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | ------- | -
|                                                      |  | Year Ended December 31 |        
|                                                      |  |                        |        
|                                                      |  | 2009                   |         | 2008 |   | 2007    |  | 2006 |         | 2005 |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |  
|Selected Income Statement Data                        |  |                        |         |      |   | (1)     |  |      | (1)     |      |   |         |  |   |         |  
|Sales from Continuing Operations                      |  | $                      | 109,792 |      | $ | 122,700 |  | $    | 121,243 |      | $ | 115,440 |  | $ | 115,382 |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Costs and Expenses:                                   |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Cost of Sales                                         |  |                        | 67,944  |      |   | 76,008  |  |      | 78,357  |      |   | 76,853  |  |   | 77,861  |  
|Selling, General and Administrative Expenses          |  |                        | 31,433  |      |   | 33,109  |  |      | 32,623  |      |   | 33,562  |  |   | 31,651  |  
|Impairment Loss                                       |  |                        | 196     |      |   | 2,999   |  |      |         |      |   |         |  |   |         |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Total Costs and Expenses                              |  |                        | 99,573  |      |   | 112,116 |  |      | 110,980 |      |   | 110,415 |  |   | 109,512 |  
|Operating Income from Continuing Operations           |  |                        | 10,219  |      |   | 10,584  |  |      | 10,263  |      |   | 5,025   |  |   | 5,870   |  
|Other income (expense), Net                           |  |                        | 581     |      |   | 597     |  |      | 1,760   |      |   | 698     |  |   | 448     |  
|Income from Continuing Operations Before Income Taxes |  |                        | 10,800  |      |   | 11,181  |  |      | 12,023  |      |   | 5,723   |  |   | 6,318   |  
|Income Tax Expense                                    |  |                        | 4,756   |      |   | 4,570   |  |      | 4,512   |      |   | 1,228   |  |   | 1,728   |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Income from Continuing Operations                     |  |                        | 6,044   |      |   | 6,611   |  |      | 7,511   |      |   | 4,495   |  |   | 4,590   |  
|Net Loss from Discontinued
 Operations                |  |                        |         |      |   |         |  |      |         |      |   |         |  |   | (120    | )
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Net Income                                            |  | $                      | 6,044   |      | $ | 6,611   |  | $    | 7,511   |      | $ | 4,495   |  | $ | 4,470   |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Basic Net Income (loss) Per Share                     |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Continuing Operations                                 |  | $                      | .72     |      | $ | .77     |  | $    | .86     |      | $ | .52     |  | $ | .53     |  
|Discontinued Operations                               |  |                        |         |      |   |         |  |      |         |      |   |         |  |   | (.01    | )
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|                                                      |  | $                      | .72     |      | $ | .77     |  | $    | .86     |      | $ | .52     |  | $ | .52     |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Diluted Net Income (loss) Per Share                   |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Continuing Operations                                 |  | $                      | .72     |      | $ | .77     |  | $    | .85     |      | $ | .51     |  | $ | .52     |  
|Discontinued Operations                               |  |                        |         |      |   |         |  |      |         |      |   |         |  |   | (.01    | )
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|                                                      |  | $                      | .72     |      | $ | .77     |  | $    | .85     |      | $ | .51     |  | $ | .51     |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Cash Dividends Per Share                              |  | $                      | .52     |      | $ | .48     |  | $    | .42     |      | $ | .34     |  | $ | .27     |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Average Dilutive Shares
 Outstanding                  |  |                        | 8,352   |      |   | 8,563   |  |      | 8,831   |      |   | 8,807   |  |   | 8,716   |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|                                                      |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Selected Balance Sheet Data                           |  |                        |         |      |   |         |  |      |         |      |   |         |  |   |         |  
|Total Assets                                          |  | $                      | 102,914 |      | $ | 98,738  |  | $    | 100,760 |      | $ | 92,723  |  | $ | 92,883  |  
|Property, Plant and Equipment, Net                    |  |                        | 13,322  |      |   | 12,015  |  |      | 13,945  |      |   | 8,580   |  |   | 8,300   |  
|Long-term liabilities                                 |  |                        | 4,220   |      |   | 4,919   |  |      | 4,045   |      |   | 724     |  |   | 1,332   |  
|Stockholders Equity                                  |  |                        | 85,939  |      |   | 83,728  |  |      | 84,931  |      |   | 82,545  |  |   | 79,851  |  

(1) During the first and
third quarters of fiscal 2008, the Company recognized approximately $2.0
million of revenue related to services that were invoiced and expensed in
fiscal 2007

16

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|        |                                                                                      
|------- | -------------------------------------------------------------------------------------
|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Communications
Systems, Inc. is a global company with sales in over 90 countries and
facilities supporting design, manufacturing and distribution in the United
States, Costa Rica, China and the United Kingdom.. We sell a growing family of
physical and electronic connectivity products and infrastructure, as well as IT
services for voice, video and data communications. Our product families
encompass a broad range of passive and active products, including copper-based
and fiber optic connection devices, digital subscriber line filters and
connection devices, structured wiring systems that support Local Area Networks,
media conversion devices and switches.

The voice,
video and data markets in which our products are sold provide services that are
vital to the modern world. Therefore, we expect the size of these markets will,
generally, continue to expand, although the pace of growth will be affected by
economic conditions in the United States and around the world. This growth,
along with inevitable technological change, will generate innumerable
opportunities for the type of products we sell.

From the
prospective of our customers, our goal is to be a leading company in the
markets we serve by providing high quality products and services that are
competitively priced. From the prospective of our shareholders, our goal is to
steadily and consistently increase our revenues and profits. Achieving these
goals will require success in the following areas. We must apply our financial
resources to support increased sales, maintain brand loyalty, improve product
quality and develop new products. At the same time, we must maintain price
levels and control expenses to provide adequate margins and superior bottom
line results. Finally, to accelerate our growth we must expand our sales
outside of the US and prudently acquire complementary businesses and product
lines.

While we face
many challenges and risks that are presented earlier in this report, the
intense competition we face in the markets we serve and successfully
introducing new products are, perhaps, our greatest challenges. Some of our
competitors are larger and better capitalized, and some are based outside the
US. These firms often have greater capacity to absorb lower margins that are
inconsistent with our financial goals and are able support a higher level of
new product development using their greater resources or lower cost structure.
In order to achieve profitable growth in the face of these challenges, we must
constantly validate the value of our products to existing and new customers and
select and pursue new product development opportunities and product line
acquisitions that best fit our capabilities, resources and competitive
position.

We are
currently pursuing these objectives through the following four business units:

Austin Taylor

Located in
Bethesda, Wales, United Kingdom, Austin Taylor manufactures cabling
installation and connection products for copper and fiber optic media. Austin
Taylor serves the government and commercial markets throughout Europe and the
Middle East with British standard products. Austin Taylors broad catalog of
products ranges from telephony linejacks to structured cabling and from plastic
connection boxes to metal cabinets.

JDL Technologies

JDL
Technologies is an IT services company that provides outsourced technical
services in the education and business market segments. JDL provides studies
and analysis, design, installation, maintenance and operational support for
network based, server centered systems. JDLs largest customer is the School
Board of Broward County, Florida (SBBC). JDL runs SBBCs Network Operation
Center which monitors all network elements (servers, switches, routers) and
over 60,000 computers in 265 buildings for the nations 6th largest school
district.

Suttle

Founded in
1910, Suttle is one of the worlds largest suppliers of high-volume copper
connection products used by North Americas largest telcos. Suttle also
designs, manufactures and markets a full line of structured wiring components
for small office, home office (SOHO) for voice, video and high-speed data
communications convergent solutions. Suttles products are used throughout the
telco, multi-service cable operators (MSOs), and installer/contractor
markets.

17

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Transition Networks

Transition
Networks offers a full suite of networking connectivity solutions including
media converters, network interface cards, switches, and coarse-wave division
multiplexing (CWDM). Utilizing engineering resources in the U.S. and its
Product Design and Development Facility in Shanghai, China, Transition Networks
designs and markets products for a broad spectrum of protocols including
Ethernet, Fast Ethernet, Gigabit Ethernet, T1/E1, DS3, and serial. Transition
Networks distributes these hardware-based connectivity solutions through a
network of resellers in 90 countries and is the preferred choice among industry
IT professionals for high-end media conversion devices.

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, there may be forward looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. The Company
may make forward looking statements 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. For a detailed discussion of
a number of such risk factors, please see Item 1A above.

Critical Accounting Policies

Sales Returns and Allowances:
An allowance is established for possible return of products, rebates and
advertising allowances. The amount of the allowance is an estimate, which is
based on historical ratios of returns to sales, the historical average length
of time between the sale and the return and other factors. Though management
considers these allowances adequate and proper, changes in customers behavior
versus historical experience or changes in the Companys return policies are
among the factors that could affect the adequacy of this allowance.

Inventory Valuation:
The Companys inventories are valued at the lower of cost or market. Reserves
for overstock and obsolescence are estimated and recorded to reduce the
carrying value to estimated net realizable value. The amount of the reserve is
determined based on projected sales information, plans for discontinued
products and other factors. Though management considers these reserves adequate
and proper, changes in sales volumes due to unexpected economic or competitive
conditions are among the factors that could materially affect the adequacy of
this reserve.

Income Taxes: In the
preparation of the Companys consolidated financial statements, management
calculates income taxes. This includes estimating the Companys current tax
liability as well as assessing temporary 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 realized
from future taxable income. The valuation allowance for deferred income tax
benefits is determined based upon the expectation of whether the benefits are
more likely than not to be realized. The Company records interest and penalties
related to income taxes as income tax expense in the Consolidated Statements of
Income.

Warranty: The
Companys warranty programs vary by business groups and by product lines.
Reserves for the estimated cost of product warranties are established at the
time revenue is recognized. The costs of our warranty obligations are estimated
based on warranty policy and the applicable contractual warranty, our
historical experience of known product failure rates, our vendors experience
and material and service delivery costs incurred in correcting product
failures. Management reviews the estimated warranty liability on a quarterly
basis to determine its adequacy. Though management considers these balances
adequate and proper, changes in the Companys warranty policy or a significant
change in product defects versus historical experience are among the factors
that could affect the adequacy of this reserve.

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.

18

---



We believe the
accounting estimates related to potential asset impairments are critical as
they require management to make assumptions about future cash flows and the
impact of recognizing an impairment could have a significant effect on
operations.

Goodwill Impairment:
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. The Company estimates the fair value of each reporting unit based
on a discounted cash flow analysis. 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.

The Company
believes that accounting estimates related to goodwill impairment are critical
because the underlying assumptions used for the discounted cash flow can change
from period to period and could potentially cause a material impact to the
income statement. Managements assumptions about inflation rates and other
internal and external economic conditions, such as earnings growth rate,
require significant judgment based on fluctuating rates and expected revenues.

Revenue Recognition:
The Company recognizes 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. In the Suttle, Transition Networks and Austin Taylor
segments, the earning process completion is evidenced through the shipment of
goods, based on the sales terms of these segments, the risk of loss is
transferred upon shipment or delivery to customers and there are no significant
obligations subsequent to that point. Other than the sales returns as discussed
above, there are not significant estimates related to revenue recognition for
these segments.

JDL
Technologies records revenue on hardware, software and related equipment sales
and installation contracts when the revenue recognition criteria are met and
the 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 that 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 was received from the SLD.

Foreign Currency Translation:
Assets and liabilities of the foreign subsidiary are translated to U.S. dollars
at year-end rates, and the statements of operations are translated at average
exchange rates during the year. Translation adjustments arising from the
translation of the foreign affiliates net assets into U.S dollars are recorded
in other comprehensive income.

Results of Operations

2009 Compared to 2008

Sales were
$109,792,000 in 2009, an 11% decrease from sales of $122,700,000 in 2008.
Operating income decreased 3% to $10,219,000 in 2009 as compared to $10,584,000
in 2008. Income before income taxes decreased 3% to $10,799,000 from
$11,181,000 in 2008. Net income decreased 9% to $6,044,000 in 2009 compared to
$6,611,000 in 2008.

19

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Suttle

Suttle sales
decreased 3% to $42,867,000 in 2009 compared to $44,421,000 in 2008. Sales by
product groups in 2009 and 2008 were:

|                            |  |                               |            |      |   |            | 
|--------------------------- |  | ----------------------------- | ---------- | ---- | - | ---------- | 
|                            |  | Suttle Sales by Product Group |           
|                            |  |                               |           
|                            |  | 2009                          |            | 2008 |  
|                            |  |                               |            |      |  
|Modular connecting products |  | $                             | 16,120,000 |      | $ | 18,834,000 | 
|DSL products                |  |                               | 13,310,000 |      |   | 10,270,000 | 
|Structured cabling products |  |                               | 12,821,000 |      |   | 14,445,000 | 
|Other products              |  |                               | 616,000    |      |   | 872,000    | 
|                            |  |                               |            |      |  
|                            |  | $                             | 42,867,000 |      | $ | 44,421,000 | 
|                            |  |                               |            |      |  

Suttles sales
by customer groups in 2009 and 2008 were:

|                          |  |                                |            |      |   |            | 
|------------------------- |  | ------------------------------ | ---------- | ---- | - | ---------- | 
|                          |  | Suttle Sales by Customer Group |           
|                          |  |                                |           
|                          |  | 2009                           |            | 2008 |  
|                          |  |                                |            |      |  
|Major telephone companies |  | $                              | 24,829,000 |      | $ | 20,624,000 | 
|Distributors/OEM          |  |                                | 9,861,000  |      |   | 12,459,000 | 
|International             |  |                                | 4,802,000  |      |   | 6,382,000  | 
|Other                     |  |                                | 3,375,000  |      |   | 4,956,000  | 
|                          |  |                                |            |      |  
|                          |  | $                              | 42,867,000 |      | $ | 44,421,000 | 
|                          |  |                                |            |      |  

The decrease
in sales was due primarily to the erosion in the number of land-line customers
served by the major telephone customers and the severe downturn in the domestic
housing market. Sales to the major telephone companies increased 20% to
$24,829,000 in 2009 compared to $20,624,000 in 2008 due to increased sales of
DSL products. Sales to these customers accounted for 58% of Suttles sales in
2009 compared to 46% of sales in 2008. The land-line loss experienced by the
major telephone companies caused a faster than expected decline in the
traditional and Corroshield product lines. However, sales of DSL products and
structured cabling products to these same customers increased as investment
remained strong into FTTP networks. Sales to distributors, original equipment
manufacturers (OEMs), and electrical contractors decreased 21% and accounted
for 23% of sales in 2009 compared to 28% in 2008. The decline in this segment
is a direct result of reduced opportunities in the domestic market for new
single-family unit (SFU) construction and multi-dwelling unit (MDU)
construction. International sales accounted for 11% of Suttles 2009 sales but
declined 25% compared to 2008. International telephone customers also faced
land-line loss causing decreased sales of voice products. DSL product sales
into this segment did increase as customers increased investments in broadband.

Suttles gross
margins decreased 9% to $9,771,000 in 2009 compared to $10,778,000 in 2008. The
gross margin percentage was 23% in 2009 compared to 24% in 2008. This decrease
in gross margin was due to a change in product mix as sales of higher margin
products, such as the traditional and Corroshield product lines declined as
compared to lower margin DSL sales.

Selling,
general and administrative expenses remained stable at $6,054,000 in 2009
compared to $6,045,000 in 2008.

Suttles operating
income declined 21% to $3,717,000 in 2009 from $4,733,000 in 2008 due to the
decreased revenues and margins noted above.

Transition Networks

Transition
Networks is a provider of active networking hardware devices. Characteristics
of the business include a rapid pace of change in technologies and alternative
solutions to our products. Transition Networks derives revenues from one time
product sales and non-recurring revenue streams from service contracts. The
majority of the business is derived from one time network projects that do not
repeat. The core markets for the products are enterprise, service providers,
and industrial users. Roughly 82% of Transition Networks revenue comes from
North America, but we continue to see opportunity for long term growth outside
of North America and we will invest resources in sales, marketing, and
infrastructure to grow that business.

20

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Transition
Networks sales decreased 12% to $55,098,000 compared to $62,924,000 in 2008.
Transition Networks organizes its sales force and segments its customers
geographically. Sales by customer groups in 2009 and 2008 were:

|                                    |  |                                     |            |      |   |            | 
|----------------------------------- |  | ----------------------------------- | ---------- | ---- | - | ---------- | 
|                                    |  | Transition Networks Sales by Region |           
|                                    |  |                                     |           
|                                    |  | 2009                                |            | 2008 |  
|                                    |  |                                     |            |      |  
|North
 America                      |  | $                                   | 45,213,000 |      | $ | 45,863,000 | 
|Europe,
 Middle East, Asia (EMEA) |  |                                     | 4,818,000  |      |   | 8,352,000  | 
|Rest of
 world                      |  |                                     | 5,067,000  |      |   | 8,709,000  | 
|                                    |  |                                     |            |      |   |            | 
|                                    |  | $                                   | 55,098,000 |      | $ | 62,924,000 | 
|                                    |  |                                     |            |      |   |            | 

Sales in North
America decreased 1% compared to 2008. 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
$7,176,000, or 42%, due to the impact of the severe global recession and
currency fluctuations. Customers have either delayed or canceled projects, but
the Company is continuing to invest in international sales and marketing
because long term projects are promising.

The following
table summarizes Transition Networks 2009 and 2008 sales by product group:

|                   |  |                                            |            |      |   |            | 
|------------------ |  | ------------------------------------------ | ---------- | ---- | - | ---------- | 
|                   |  | Transition Networks Sales by Product Group |           
|                   |  |                                            |           
|                   |  | 2009                                       |            | 2008 |  
|                   |  |                                            |            |      |  
|Media
 converters  |  | $                                          | 39,251,000 |      | $ | 47,196,000 | 
|Ethernet
 switches |  |                                            | 3,786,000  |      |   | 5,809,000  | 
|Ethernet
 adapters |  |                                            | 8,903,000  |      |   | 7,220,000  | 
|Other
 products    |  |                                            | 3,158,000  |      |   | 2,699,000  | 
|                   |  |                                            |            |      |   |            | 
|                   |  | $                                          | 55,098,000 |      | $ | 62,924,000 | 
|                   |  |                                            |            |      |   |            | 

Gross margin
decreased 5% to $29,329,000 in 2009 compared to $30,972,000 in 2008 due to
decreases in revenues, but represented a lower percentage decline compared to
revenues due to gross margin improvements. Gross margin as a percentage of
sales increased to 53% in 2009 compared to 49% in 2008 due to new lower cost
designs and outsourcing of production to lower cost offshore suppliers and
fewer sales of lower margin products. The increase in sales of Ethernet
adapters and decrease in sales of media converters is one of the contributors
to the increased margins. The decline in sales of media converters is due 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 6% to $19,371,000 in 2009 from
$20,673,000 in 2008 due to the decline in revenue which resulted in lower
commission expense and cost containment efforts some of which were offset by
increases in research and development costs related to the creation of new
products. Operating income decreased 3% to $9,958,000 in 2009 compared to
$10,299,000 in 2008.

Transition
Networks will continue to develop product based on market needs as well as
following industry standards set by such organizations as the Institute of
Electrical and Electronics Engineers (IEEE) and the Metro Ethernet Forum (MEF).
We will also continue to invest in sales and marketing to grow revenues in our
target markets and expand sales outside of North America.

JDL Technologies, Inc.

Sales by JDL
Technologies, Inc. (the Companys IT services business unit) decreased 11% to
$8,765,000 in 2009 compared to $9,838,000 in 2008. The following table
summarizes JDLs revenues by customer group in 2009 and 2008:

|                                               |  |                               |           |      |   |           | 
|---------------------------------------------- |  | ----------------------------- | --------- | ---- | - | --------- | 
|                                               |  | JDL Revenue by Customer Group |          
|                                               |  |                               |          
|                                               |  | 2009                          |           | 2008 |  
|                                               |  |                               |           |      |  
|Broward
 County FL schools                     |  | $                             | 8,594,000 |      | $ | 5,186,000 | 
|U.S. Virgin
 Islands Dept. of Education (VIDE) |  |                               |          |      |   | 4,649,000 | 
|All other                                      |  |                               | 171,000   |      |   | 3,000     | 
|                                               |  |                               |           |      |   |           | 
|                                               |  | $                             | 8,765,000 |      | $ | 9,838,000 | 
|                                               |  |                               |           |      |   |           | 

21

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Revenues
earned in Broward County FL increased $3,408,000 or 66% 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 as of June 30, 2008.

JDL gross
margin was $2,753,000 in 2009 compared to $4,212,000 in 2008. Gross margin in
2008 was significantly impacted by the timing of the recognition of revenues
from JDLs VIDE contracts as costs of $1.4 million were recorded in 2007, when
VIDE 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 18% in 2009 to $1,299,000
compared to $1,105,000 in 2008 due to an increase in compensation expenses and
sales activities. Operating income increased to $1,455,000 in 2009 compared to
$108,000 in 2008. Operating income in 2008 was impacted by a $2,999,000
impairment charge related to goodwill and network infrastructure assets due to
the loss of VIDE as a customer.

Austin Taylor

Austin
Taylors revenues decreased 45% to $3,061,000 in 2009, compared to $5,516,000
in 2008. This decrease is primarily due to difficulties in securing connector
products from Far East contract manufacturers and the general market and
economy slowdown, primarily outside of the U.K.. Gross margin decreased 101% to
a loss of $6,000 in 2009 from income of $730,000 in 2008. Gross margin as a
percentage of sales was 0% in 2009 compared to 13% in 2008. This decrease was
due to greatly increased material costs compounded by an unfavorable currency
exchange rate during 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 $1,214,000 compared to $85,000 in 2008.
Included in the 2009 operating loss is a $196,000 impairment charge related to
Austin Taylors machinery and equipment assets. Management is currently
implementing measures to improve Austin Taylors performance. Consideration is
also being given to various strategic alternatives, but no decision to
implement any particular strategic alternative has been made.

Other

Net investment
and other income decreased slightly to $581,000 in 2009 compared to $597,000 in
2008. Income before income taxes decreased to $10,799,000 in 2009 compared to
$11,181,000 in 2008. The Companys effective income tax rate was 44% 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 8 to the condensed consolidated financial
statements.

2008 Compared to 2007

Sales were
$122,700,000 in 2008, a 1% increase from sales of $121,243,000 in 2007.
Operating income increased 3% to $10,584,000 in 2008 as compared to $10,263,000
in 2007. Income before income taxes decreased 7% to $11,181,000 from
$12,023,000 in 2007. Net income decreased 12% to $6,611,000 in 2008 compared to
$7,511,000 in 2007.

Suttle

Suttle sales
decreased 8% to $44,421,000 in 2008 compared to $48,135,000 in 2007. Sales by
product groups in 2008 and 2007 were:

|                             |  |                               |            |      |   |            | 
|---------------------------- |  | ----------------------------- | ---------- | ---- | - | ---------- | 
|                             |  | Suttle Sales by Product Group |           
|                             |  |                               |           
|                             |  | 2008                          |            | 2007 |  
|                             |  |                               |            |      |  
|Modular
 connecting products |  | $                             | 18,834,000 |      | $ | 24,146,000 | 
|DSL products                 |  |                               | 10,270,000 |      |   | 12,278,000 | 
|Structured
 cabling products |  |                               | 14,445,000 |      |   | 10,866,000 | 
|Other
 products              |  |                               | 872,000    |      |   | 845,000    | 
|                             |  |                               |            |      |   |            | 
|                             |  | $                             | 44,421,000 |      | $ | 48,135,000 | 
|                             |  |                               |            |      |   |            | 

22

---



Suttles sales
by customer groups in 2008 and 2007 were:

|                           |  |                                |            |      |   |            | 
|-------------------------- |  | ------------------------------ | ---------- | ---- | - | ---------- | 
|                           |  | Suttle Sales by Customer Group |           
|                           |  |                                |           
|                           |  | 2008                           |            | 2007 |  
|                           |  |                                |            |      |  
|Major
 telephone companies |  | $                              | 20,624,000 |      | $ | 20,581,000 | 
|Distributors/OEM           |  |                                | 16,367,000 |      |   | 18,482,000 | 
|International              |  |                                | 2,474,000  |      |   | 3,940,000  | 
|Other                      |  |                                | 4,956,000  |      |   | 5,132,000  | 
|                           |  |                                |            |      |   |            | 
|                           |  | $                              | 44,421,000 |      | $ | 48,135,000 | 
|                           |  |                                |            |      |   |            | 

The decrease
in sales was due primarily to the accelerated land-line loss by the major
telephone customers, the severe downturn in the domestic housing market, and
the loss of the Bellsouth DSL contract during the course of the acquisition by
ATT. Sales to the major telephone companies remained stable at $20,624,000 in
2008 compared to $20,581,000 in 2007. Sales to these customers accounted for
46% of Suttles sales in 2008 compared to 43% of sales in 2007. The land-line
loss in the major telephone companies forced a faster than expected decline in
the traditional and Corroshield product lines. Additionally, the lost DSL
contract at Bellsouth was valued at $2.9 million in 2007. However, sales of
structured cabling products to these same customers increased as investment
remained strong into FTTP networks. Sales to distributors, original equipment
manufacturers (OEMs), and electrical contractors decreased 28% and accounted
for 37% of sales in 2008 compared to 38% in 2007. The decline in this segment
is a direct result of reduced opportunities in the domestic market for new
single-family unit (SFU) construction and multi-dwelling unit (MDU)
construction. International sales decreased 37% and accounted for 6% of
Suttles 2008 sales. International telephone customers also faced land-line
loss causing decreased sales of voice products. DSL product sales into this
segment did increase as customers increased investment into broadband.

Suttles gross
margins decreased 17% to $10,778,000 in 2008 compared to $13,030,000 in 2007.
The gross margin percentage was 24% in 2008 compared to 27% in 2007. This
decrease in gross margin was due to a change in product mix attributed to
declining sales in higher margin product, such as the traditional and Corroshield
product lines.

Selling,
general and administrative expenses decreased 16% to $6,045,000 in 2008 from
$7,202,000 in 2007. This decrease was due to reduction in staff, lower
commissions and bonus expense.

Suttles
operating income declined 19% to $4,733,000 in 2008 from $5,828,000 in 2007 due
to the decreased revenues and margins noted above.

Transition Networks

Transition
Networks sales increased 19% to $62,924,000 compared to $53,063,000 in 2007.
Transition Networks organizes its sales force and segments its customers
geographically. Sales by customer groups in 2008 and 2007 were:

|                                    |  |                                     |            |      |   |            | 
|----------------------------------- |  | ----------------------------------- | ---------- | ---- | - | ---------- | 
|                                    |  | Transition Networks Sales by Region |           
|                                    |  |                                     |           
|                                    |  | 2008                                |            | 2007 |  
|                                    |  |                                     |            |      |  
|North
 America                      |  | $                                   | 45,863,000 |      | $ | 38,126,000 | 
|Europe,
 Middle East, Asia (EMEA) |  |                                     | 8,352,000  |      |   | 6,890,000  | 
|Rest of
 world                      |  |                                     | 8,709,000  |      |   | 8,047,000  | 
|                                    |  |                                     |            |      |   |            | 
|                                    |  | $                                   | 62,924,000 |      | $ | 53,063,000 | 
|                                    |  |                                     |            |      |   |            | 

Sales in North
America increased 20% compared to 2007. Sales in Europe, Middle East and Asia
grew approximately 21% and all other sales increased 8% compared to 2007. A
large portion of the growth in North America sales came from the U.S. Federal
Government which accounted for the majority of the increase in our Ethernet
adapter sales. Transition also experienced good growth in sales to the service
provider space and traditional enterprise also grew. There is inherent risk in
the federal government of projects reaching completion and thereby no longer
requiring our product, funding can be cut, or the technology platform can
change eliminating the need for our products.

Growth outside
the North America region came mostly from the service provider space which is
traditionally a larger portion of sales outside of North America.

23

---



The following
table summarizes Transition Networks 2008 and 2007 sales by product group:

|                   |  |                                            |            |      |   |            | 
|------------------ |  | ------------------------------------------ | ---------- | ---- | - | ---------- | 
|                   |  | Transition Networks Sales by Product Group |           
|                   |  |                                            |            |      |   |            | 
|                   |  | 2008                                       |            | 2007 |  
|                   |  |                                            |            |      |   |            | 
|Media
 converters  |  | $                                          | 47,196,000 |      | $ | 44,500,000 | 
|Ethernet
 switches |  |                                            | 5,809,000  |      |   | 5,720,000  | 
|Ethernet
 adapters |  |                                            | 7,220,000  |      |   | 2,516,000  | 
|Other
 products    |  |                                            | 2,699,000  |      |   | 327,000    | 
|                   |  |                                            |            |      |   |            | 
|                   |  | $                                          | 62,924,000 |      | $ | 53,063,000 | 
|                   |  |                                            |            |      |   |            | 

Gross margin
increased 28% to $30,972,000 in 2008 compared to $24,211,000 in 2007 due to increase
in revenues and lower cost of goods sold. Gross margin as a percentage of sales
increased to 49% in 2008 compared to 46% in 2007 due to additional outsourcing
of production to lower cost offshore suppliers through an inventory cost
reduction plan of $1.2 million in 2008 and an increase in sales of higher
margin products (such as converters and adapters). Selling, general and
administrative expenses increased 11% to $20,673,000 in 2008 from $18,608,000
in 2007 due to increases in the sales force headcount and marketing program
incentives and expenses. While overall SG&A costs increased over 2007,
there was a decrease as a percentage of sales down to 33% in 2008 versus 35% in
2007. Operating income for the combined units increased 84% to $10,299,000 in 2008
compared to $5,603,000 in 2007.

Transition
Networks will continue to develop product based on market needs as well as
following industry standards set by such organizations as the Institute of
Electrical and Electronics Engineers (IEEE) and the Metro Ethernet Forum (MEF).
We will also continue to invest in sales and marketing to grow revenues in our
target markets and expand sales outside of North America.

JDL Technologies, Inc.

Sales by JDL
Technologies, Inc. (the Companys IT services business unit) decreased 26% to
$9,838,000 in 2008 compared to $13,219,000 in 2007. The following table
summarizes JDLs revenues by customer group in 2008 and 2007:

|                                               |  |                               |           |      |   |            | 
|---------------------------------------------- |  | ----------------------------- | --------- | ---- | - | ---------- | 
|                                               |  | JDL Revenue by Customer Group |          
|                                               |  |                               |          
|                                               |  | 2008                          |           | 2007 |  
|                                               |  |                               |           |      |  
|Broward
 County FL schools                     |  | $                             | 5,186,000 |      | $ | 5,716,000  | 
|U.S. Virgin
 Islands Dept. of Education (VIDE) |  |                               | 4,649,000 |      |   | 6,223,000  | 
|All other                                      |  |                               | 3,000     |      |   | 1,280,000  | 
|                                               |  |                               |           |      |   |            | 
|                                               |  | $                             | 9,838,000 |      | $ | 13,219,000 | 
|                                               |  |                               |           |      |   |            | 

In 2007,
funding commitments for several contracts were received for work performed in
earlier periods. As a result, the Company recognized $2,555,000 of revenue for
services performed in 2006. Revenue in 2008 includes $2.0 million for contracts
of services provided to the VIDE in 2007 that were not approved until 2008. JDL
does not expect any material revenue from the VIDE after December 31, 2008.

Revenues
earned in Broward County FL declined $530,000 or 9% in 2008. The decline was
the result of a delay in network refresh work due to customer budget
limitations. The revenue decline does not represent a loss of business as the
work was merely delayed into 2009. The decrease in other revenues from 2007 to
2008 was due to the sale of certain lines of business to a former officer in
2007.

Gross margins
earned by JDL in 2008 increased to $4,212,000 compared to $4,033,000 in 2007.
Gross margins in 2008 and 2007 were significantly impacted by the timing of the
recognition of E-RATE revenues from JDLs VIDE contracts. Costs of $1.4 million
were recorded in 2007, when the services were provided, however, the $2.0
million revenue related to these costs was recognized in 2008 when the E-Rate
funding was approved. Similarly, the Companys 2007 margins include $2,555,000
for services provided to the VIDE in 2006. The impact on 2007 gross margins due
to timing of revenue recognition was partially offset by increased depreciation
charges due to higher levels of plant investments in the U.S. Virgin Islands
and reduced volumes of equipment sales to Broward County. VIDEs decision to
select another vendor for the 2008-2009 contract year (discussed below)
resulted in reduced selling, general and administrative expenses. These costs
decreased 55% in 2008 to $1,105,000 from $2,466,000 in 2007. The decrease was
due to lower legal and professional fees, staff reductions and cuts in
marketing and administrative costs.

24

---



JDL had
operating income of $108,000 in 2008 compared to $1,567,000 in 2007. The sharp
decline in operating income for JDL stems from the decision of the VIDE, to
select another vendor to provide wireless network services for the contract
year beginning July 1, 2008. JDL had supplied network services to VIDE under
one year contracts since 2002. Notification of this decision by VIDE, which was
totally unexpected by the Company, was given to JDL on January 17, 2008, and
after unsuccessful attempts to reverse VIDEs decision, the Company decided to
terminate its operations in the Virgin Islands effective July 1, 2008. In
accordance with generally accepted accounting principles, the Company conducted
an evaluation of this event for impairment, and identified an impairment of
goodwill of $704,000 and impairment of the network infrastructure with a total
net book value of $2,295,000. The process of winding up JDLs Virgin Islands
operations is complete.

Austin Taylor

Austin
Taylors revenues decreased 19% in 2008 to $5,516,000 from $6,826,000 in 2007,
due to decreased order activity from its two major customers. Gross margin
decreased to $730,000 in 2008 from $1,611,000 in 2007. Gross margin as a
percentage of sales decreased to 13% in 2008 from 24% in 2007. This decrease
was due to greatly increased material costs during 2008 and certain quality
issues with two of its major vendors. Austin Taylor reported an operating loss
in 2008 of $85,000 compared to operating income of $479,000 in 2007.

Other

Net investment
and other income decreased to $597,000 in 2008 compared to $1,760,000 in 2007
due to an increase in interest expense on the Companys mortgage and a decrease
in earnings on cash investments. The Company paid a full year in interest
expense on the mortgage in 2008 while only a few months in 2007. The Company
generally invested its excess cash in money market funds and certificates of
deposit in 2008, which had lower rates than in the prior year. The combination
of the state and foreign income taxes increased the Companys 2008 tax rate to
41% compared to a normal U.S. rate of 35%.

Acquisitions and Dispositions

The Company is
a growth-oriented manufacturer of telecommunications connecting and networking
devices. The Company continually searches for acquisition candidates with
products that will enable the Company to better serve its target markets.

Effects of Inflation

Inflation has
not had a significant effect on operations. The Company does not have long-term
production or procurement contracts and has historically been able to adjust
pricing and purchasing decisions to respond to inflationary pressures.

Liquidity and Capital Resources

As of December
31, 2009, the Company had approximately $40,069,000 in cash, cash equivalents
and investments. Of this amount, $12,972,000 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 in cash and cash equivalents is operating cash and certificates
of deposit, which are fully insured through the FDIC. The Company has not
experienced any losses on its deposits of cash and cash equivalents. The
Company also had $18,776,000 in investments which consist of certificates of
deposit that are traded on the open market and are classified as
available-for-sale at December 31, 2009.

The Company
had current assets of approximately $76,967,000 and current liabilities of
$12,754,000 at December 31, 2009 compared to current assets of $80,819,000 and
current liabilities of $10,091,000 at the end of 2008.

25

---



Cash flow
provided by operating activities was approximately $17,637,000 in 2009 compared
to $10,223,000 provided by operations in 2008. Significant working capital
changes from 2008 to 2009 included decreased inventory of $4,909,000 and a
decrease in accounts receivable of $2,287,000 related to increased collections
and lower revenues during the year.

Investing
activities used $21,873,000 of cash in 2009 compared to using $2,065,000 of
cash in 2008 due to the purchase of certificates of deposit with original
maturities of greater than 90 days, offset by the sale of such investments.
Additionally, capital expenditures during 2009 were $3,238,000 compared to
$2,462,000 in 2008. 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 in Hector,
Minnesota.

Net cash used
by financing activities was $4,563,000 in 2009 compared to $7,262,000 in 2008.
Cash dividends paid on common stock increased to $4,333,000 in 2009 ($0.52 per
common share) from $4,133,000 in 2008 ($0.48 per common share). Proceeds from
common stock issuances, principally shares sold to the Companys Employee Stock
Ownership Plan and pursuant to options issued under the Companys Employee
Stock Purchase Plan, totaled approximately $171,000 in 2009 and $376,000 in
2008. The Company purchased and retired 5,126 shares for $53,000 in 2009 and
343,899 shares for $3,222,000 in 2008. At December 31, 2009, Board of Director
authority to purchase approximately 481,938 additional shares remained in
effect. 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. Remaining mortgage payments on
principal totaled $348,000 during 2009. The outstanding balance on the mortgage
was $2,774,000 at December 31, 2009.

The Company
expects that the effective income tax rate for fiscal 2010 will be
approximately 45%.

The Company
had no outstanding obligations under its line of credit at December 31, 2009
and 2008, and the Companys entire credit line ($10,000,000 at March 1, 2010)
is available for use. The current line of credit expires September 30, 2010.
Management believes that we will be able to renew the line on terms acceptable
to the Company; however this can not be assured. 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.

Contractual Obligation Summary

The following
table summarizes our contractual obligations at December 31, 2009 and the
effect these obligations are expected to have on our liquidity and cash flow in
future periods:

|                            |  |                     |           |             |   |             |  |                    |           |  |   |           | 
|--------------------------- |  | ------------------- | --------- | ----------- | - | ----------- |  | ------------------ | --------- |  | - | --------- | 
|                            |  | Less than
 One Year |           | 1  3 Years |   | 3  5 Years |  | More Than
 5 Years |          
|                            |  |                     |           |             |   |             |  |                    |          
|Long-term
 debt             |  | $                   | 373,000   |             | $ | 827,000     |  | $                  | 947,000   |  | $ | 628,000   | 
|Interest on
 long-term debt |  |                     | 178,000   |             |   | 275,000     |  |                    | 155,000   |  |   | 28,000    | 
|Pensions                    |  |                     | 247,000   |             |   | 385,000     |  |                    | 648,000   |  |   | 1,814,000 | 
|Operating
 leases           |  |                     | 142,000   |             |   | 144,000     |  |                    |           |  |   |           | 
|Compensation
 plans         |  |                     | 1,257,000 |             |   | 887,000     |  |                    |           |  |   |           | 
|                            |  |                     |           |             |   |             |  |                    |           |  |   |           | 
|Total                       |  | $                   | 2,197,000 |             | $ | 2,518,000   |  | $                  | 1,750,000 |  | $ | 2,470,000 | 
|                            |  |                     |           |             |   |             |  |                    |           |  |   |           | 

As of December
31, 2009, the Company had no other material commitments (either cancelable or
non-cancelable) for capital expenditures, short or long term debt, capital
leases or other purchase commitments related to ongoing operations.

Recently Issued Accounting Pronouncements

We do not
believe there are any recently issued accounting standards that have not yet
been adopted that will have a material impact on the Companys financial
statements.

26

---



Off Balance Sheet Arrangements

None.

|         |                                                           
|-------- | ----------------------------------------------------------
|ITEM 7A. | 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
December 31, 2009 our bank line of credit carried a variable interest rate
based on our banks average certificate of deposit rate plus 1.5%. The
Companys investments are money market and certificates of deposit types of
investments that earn interest at prevailing market rates and as such do not
have material risk exposure.Based on the Companys operations, in the opinion
of management, the Company is not exposed to material future losses due to
market risk.

At December
31, 2009 approximately $279,000 of assets were invested in the Companys
assembly plant subsidiary in Costa Rica. The Company expects to maintain assets
in Costa Rica as needed to support the continued operation of the Suttle
subsidiary. The Company uses the U.S. dollar as its functional currency in
Costa Rica. Accordingly, the Company believes its risk of material loss due to
fluctuations in foreign currency markets to be small.

27

---



|        |                                            
|------- | -------------------------------------------
|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

(a) FINANCIAL STATEMENTS

REPORT OF MANAGEMENT

The management of
Communications Systems, Inc. and its subsidiary companies is responsible for
the integrity and objectivity of the financial statements and other financial
information contained in the annual report. The financial statements and
related information were prepared in accordance with accounting principles
generally accepted in the United States of America and include amounts that are
based on managements informed judgments and estimates.

In fulfilling its
responsibilities for the integrity of financial information, management
maintains accounting systems and related controls. These controls provide
reasonable assurance, at appropriate costs, that assets are safeguarded against
losses and that financial records are reliable for use in preparing financial
statements. Management recognizes its responsibility for conducting the
Companys affairs according to the highest standards of personal and corporate
conduct.

The Audit Committee of the
Board of Directors, comprised solely of outside directors, meets with the
independent auditors and management periodically to review accounting,
auditing, financial reporting and internal control matters. The independent
auditors have free access to this committee, without management present, to
discuss the results of their audit work and their opinion on the adequacy of
internal financial controls and the quality of financial reporting.

|                        |                         |                     | 
|----------------------- | ----------------------- | ------------------- | 
|/s/ Jeffrey
K. Berg     |                         | /s/ David T.
McGraw | 
|                        |                         |                     | 
|Jeffrey K.
Berg         | David T.
McGraw        
|Chief
Executive Officer | Chief
Financial Officer

28

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors of 
Communications Systems, Inc.:

We have audited the
accompanying consolidated balance sheets of Communications Systems, Inc. and
subsidiaries (the Company) as of December 31, 2009 and 2008, and the related
consolidated statements of income and comprehensive income, changes in
stockholders equity, and cash flows for each of the three years in the period
ended December 31, 2009. Our audits also included the financial statement
schedule listed in the Index at Item 15. These financial statements and
financial statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits.

We conducted our audits in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. The Company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our opinion, such
consolidated financial statements present fairly, in all material respects, the
financial position of the Company as of December 31, 2009 and 2008, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2009, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, such
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

|                          | 
|------------------------- | 
|/s/
Deloitte & Touche LLP | 
|                          | 
|Minneapolis,
Minnesota   
|March
18, 2010           

29

---



COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

|                                                                                                                                          |  |                  |             |                  |   |            |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ----------- | ---------------- | - | ---------- | -
|                                                                                                                                          |  | December 31
2009 |             | December 31
2008 |  
|                                                                                                                                          |  |                  |             |                  |  
|ASSETS                                                                                                                                    |  |                  |             |                  |   |            |  
|                                                                                                                                         
|CURRENT ASSETS:                                                                                                                           |  |                  |             |                  |   |            |  
|Cash and cash equivalents                                                                                                                 |  | $                | 21,293,448  |                  | $ | 29,951,561 |  
|Investments                                                                                                                               |  |                  | 11,236,940  |                  |   |            |  
|Trade accounts receivable, less allowance for doubtful accounts of
$505,000 and $219,000, respectively                                    |  |                  | 15,042,411  |                  |   | 17,243,788 |  
|Inventories                                                                                                                               |  |                  | 24,598,317  |                  |   | 29,398,443 |  
|Prepaid income taxes                                                                                                                      |  |                  | 337,274     |                  |   |            |  
|Other current assets                                                                                                                      |  |                  | 884,555     |                  |   | 861,039    |  
|Deferred income taxes                                                                                                                     |  |                  | 3,574,501   |                  |   | 3,364,297  |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|TOTAL CURRENT ASSETS                                                                                                                      |  |                  | 76,967,446  |                  |   | 80,819,128 |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|PROPERTY, PLANT AND EQUIPMENT, net                                                                                                        |  |                  | 13,321,825  |                  |   | 12,014,541 |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|OTHER ASSETS:                                                                                                                             |  |                  |             |                  |   |            |  
|Investments                                                                                                                               |  |                  | 7,538,903   |                  |   |            |  
|Goodwill                                                                                                                                  |  |                  | 4,560,217   |                  |   | 4,560,217  |  
|Deferred income taxes                                                                                                                     |  |                  |             |                  |   | 643,667    |  
|Funded pension assets                                                                                                                     |  |                  | 399,743     |                  |   | 566,137    |  
|Other assets                                                                                                                              |  |                  | 125,560     |                  |   | 134,101    |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|TOTAL OTHER ASSETS                                                                                                                        |  |                  | 12,624,423  |                  |   | 5,904,122  |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|TOTAL ASSETS                                                                                                                              |  | $                | 102,913,694 |                  | $ | 98,737,791 |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|LIABILITIES
AND STOCKHOLDERS EQUITY                                                                                                      |  |                  |             |                  |   |            |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|CURRENT LIABILITIES:                                                                                                                      |  |                  |             |                  |   |            |  
|Current portion of long-term debt                                                                                                         |  | $                | 372,926     |                  | $ | 348,373    |  
|Accounts payable                                                                                                                          |  |                  | 4,986,028   |                  |   | 4,126,756  |  
|Accrued compensation and benefits                                                                                                         |  |                  | 4,855,899   |                  |   | 2,985,233  |  
|Other accrued liabilities                                                                                                                 |  |                  | 1,370,105   |                  |   | 1,624,971  |  
|Income taxes payable                                                                                                                      |  |                  |             |                  |   | 11,430     |  
|Dividends payable                                                                                                                         |  |                  | 1,169,040   |                  |   | 994,169    |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|TOTAL CURRENT LIABILITIES                                                                                                                 |  |                  | 12,753,998  |                  |   | 10,090,932 |  
|                                                                                                                                         
|LONG TERM LIABILITIES:                                                                                                                    |  |                  |             |                  |   |            |  
|Long-term compensation plans                                                                                                              |  |                  | 887,210     |                  |   | 1,410,559  |  
|Income taxes payable                                                                                                                      |  |                  | 723,534     |                  |   | 733,683    |  
|Deferred income taxes                                                                                                                     |  |                  | 208,111     |                  |   |            |  
|Long term debt - mortgage payable                                                                                                         |  |                  | 2,401,548   |                  |   | 2,774,474  |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|TOTAL LONG-TERM LIABILITIES                                                                                                               |  |                  | 4,220,403   |                  |   | 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;
8,352,883 and 8,282,348 shares issued and outstanding, respectively |  |                  | 417,644     |                  |   | 414,117    |  
|Additional paid-in capital                                                                                                                |  |                  | 33,641,510  |                  |   | 33,019,154 |  
|Retained earnings                                                                                                                         |  |                  | 52,007,261  |                  |   | 50,503,410 |  
|Accumulated other comprehensive income                                                                                                    |  |                  | (127,122    | )                |   | (208,538   | )
|                                                                                                                                          |  |                  |             |                  |   |            |  
|TOTAL STOCKHOLDERS EQUITY                                                                                                                |  |                  | 85,939,293  |                  |   | 83,728,143 |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|                                                                                                                                          |  |                  |             |                  |   |            |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                |  | $                | 102,913,694 |                  | $ | 98,737,791 |  
|                                                                                                                                          |  |                  |             |                  |   |            |  

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

30

---



COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

|                                                  |  |                        |             |      |   |             |   |   |             |  
|------------------------------------------------- |  | ---------------------- | ----------- | ---- | - | ----------- | - | - | ----------- | -
|                                                  |  | Year Ended December 31 |            
|                                                  |  |                        |            
|                                                  |  | 2009                   |             | 2008 |   | 2007        |  
|                                                  |  |                        |             |      |   |             |  
|Sales                                             |  | $                      | 109,792,207 |      | $ | 122,699,678 |   | $ | 121,243,248 |  
|                                                 
|Costs and expenses:                               |  |                        |             |      |   |             |   |   |             |  
|Cost of sales                                     |  |                        | 67,943,557  |      |   | 76,008,162  |   |   | 78,357,538  |  
|Selling, general and administrative expenses      |  |                        | 31,434,097  |      |   | 33,108,488  |   |   | 32,623,142  |  
|Impairment loss                                   |  |                        | 196,020     |      |   | 2,999,441   |   |   |             |  
|                                                  |  |                        |             |      |   |             |   |   |             |  
|Total costs and expenses                          |  |                        | 99,573,674  |      |   | 112,116,091 |   |   | 110,980,680 |  
|                                                  |  |                        |             |      |   |             |   |   |             |  
|Operating income                                  |  |                        | 10,218,533  |      |   | 10,583,587  |   |   | 10,262,568  |  
|                                                 
|Other income and (expenses):                      |  |                        |             |      |   |             |   |   |             |  
|Investment and other income                       |  |                        | 810,039     |      |   | 706,202     |   |   | 954,011     |  
|Gain on sale of assets                            |  |                        | 39,919      |      |   | 84,513      |   |   | 834,165     |  
|Interest and other expense                        |  |                        | (269,151    | )    |   | (193,010    | ) |   | (27,978     | )
|                                                  |  |                        |             |      |   |             |   |   |             |  
|Other income, net                                 |  |                        | 580,807     |      |   | 597,705     |   |   | 1,760,198   |  
|                                                 
|Income from operations before income taxes        |  |                        | 10,799,340  |      |   | 11,181,292  |   |   | 12,022,766  |  
|                                                 
|Income tax expense                                |  |                        | 4,755,695   |      |   | 4,569,875   |   |   | 4,512,000   |  
|                                                  |  |                        |             |      |   |             |   |   |             |  
|Net income                                        |  |                        | 6,043,645   |      |   | 6,611,417   |   |   | 7,510,766   |  
|                                                 
|Other comprehensive income (loss):                |  |                        |             |      |   |             |   |   |             |  
|Additional minimum pension liability adjustments  |  |                        | 285,000     |      |   | (60,226     | ) |   | 571,226     |  
|Unrealized gains on available-for-sale securities |  |                        | 33,802      |      |   |             |   |   |             |  
|Foreign currency
translation adjustment           |  |                        | (237,386    | )    |   | (1,345,278  | ) |   | 209,129     |  
|                                                  |  |                        |             |      |   |             |   |   |             |  
|Total other comprehensive
income (loss)           |  |                        | 81,416      |      |   | (1,405,504  | ) |   | 780,355     |  
|                                                  |  |                        |             |      |   |             |   |   |             |  
|Comprehensive income                              |  | $                      | 6,125,061   |      | $ | 5,205,913   |   | $ | 8,291,121   |  
|                                                  |  |                        |             |      |   |             |   |   |             |  
|                                                  |  |                        |             |      |   |             |   |   |             |  
|Basic net income per
share:                       |  | $                      | .72         |      | $ | .77         |   | $ | .86         |  
|Diluted net income per
share:                     |  | $                      | .72         |      | $ | .77         |   | $ | .85         |  
|                                                 
|Average Basic Shares Outstanding                  |  |                        | 8,339,566   |      |   | 8,539,396   |   |   | 8,761,300   |  
|Average Dilutive Shares
Outstanding               |  |                        | 8,352,084   |      |   | 8,562,533   |   |   | 8,830,713   |  
|Dividends per share                               |  | $                      | .52         |      | $ | .48         |   | $ | .42         |  

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

31

---



COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

|                                                             |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   |            |   |   |            |  
|------------------------------------------------------------ |  | ------------ | --------- | -------------------------- | - | ----------------- | - | -------------------------------------------- | ---------- | - | - | ---------- | - | - | ---------- | - | - | ---------- | -
|                                                             |  | Common Stock |           | Additional
Paid-in
Capital |   | Retained
Earnings |   | Cumulative
Other
Comprehensive
Income (Loss) |            |   |   |           
|                                                             |  |              |           |                            |   |                   |   |                                              |           
|                                                             |  | Shares       |           | Amount                     |   |                   |   |                                              | Total      |  
|                                                             |  |              |           |                            |   |                   |   |                                              |            |   |   |            |  
|BALANCE AT DECEMBER 31, 2006                                 |  |              | 8,732,429 |                            |   | 436,621           |   |                                              | 33,488,345 |   |   | 48,203,511 |   |   | 416,611    |   |   | 82,545,088 |  
|Adjustment to initially apply tax guidance                   |  |              |           |                            |   |                   |   |                                              |            |   |   | 427,302    |   |   |            |   |   | 427,302    |  
|Net income                                                   |  |              |           |                            |   |                   |   |                                              |            |   |   | 7,510,766  |   |   |            |   |   | 7,510,766  |  
|Issuance of common stock under Employee Stock Purchase Plan  |  |              | 9,851     |                            |   | 493               |   |                                              | 98,489     |   |   |            |   |   |            |   |   | 98,982     |  
|Issuance of common stock to Employee Stock Ownership Plan    |  |              | 41,745    |                            |   | 2,087             |   |                                              | 421,207    |   |   |            |   |   |            |   |   | 423,294    |  
|Issuance of common stock under Employee Stock Option Plan    |  |              | 128,415   |                            |   | 6,421             |   |                                              | 890,161    |   |   |            |   |   |            |   |   | 896,582    |  
|Tax benefit from non-qualified employee stock options        |  |              |           |                            |   |                   |   |                                              | 82,862     |   |   |            |   |   |            |   |   | 82,862     |  
|Share based compensation                                     |  |              |           |                            |   |                   |   |                                              | 49,205     |   |   |            |   |   |            |   |   | 49,205     |  
|Purchase of common stock                                     |  |              | (371,235  | )                          |   | (18,562           | ) |                                              | (1,508,306 | ) |   | (2,514,851 | ) |   |            |   |   | (4,041,719 | )
|Shareholder dividends                                        |  |              |           |                            |   |                   |   |                                              |            |   |   | (3,842,135 | ) |   |            |   |   | (3,842,135 | )
|Other comprehensive income                                   |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   | 780,355    |   |   | 780,355    |  
|                                                             |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   |            |   |   |            |  
|BALANCE AT DECEMBER 31, 2007                                 |  |              | 8,541,205 |                            | $ | 427,060           |   | $                                            | 33,521,963 |   | $ | 49,784,593 |   | $ | 1,196,966  |   | $ | 84,930,582 |  
|                                                             |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   |            |   |   |            |  
|Net income                                                   |  |              |           |                            |   |                   |   |                                              |            |   |   | 6,611,417  |   |   |            |   |   | 6,611,417  |  
|Issuance of common stock to Employee Stock Purchase Plan     |  |              | 7,947     |                            |   | 397               |   |                                              | 85,674     |   |   |            |   |   |            |   |   | 86,071     |  
|Issuance of common stock under Employee Stock Ownership Plan |  |              | 38,296    |                            |   | 1,915             |   |                                              | 452,659    |   |   |            |   |   |            |   |   | 454,574    |  
|Issuance of common stock under Employee Stock Option Plan    |  |              | 38,800    |                            |   | 1,940             |   |                                              | 288,205    |   |   |            |   |   |            |   |   | 290,145    |  
|Tax benefit from non-qualified employee stock options        |  |              |           |                            |   |                   |   |                                              | 39,384     |   |   |            |   |   |            |   |   | 39,384     |  
|Share based compensation                                     |  |              |           |                            |   |                   |   |                                              | 41,824     |   |   |            |   |   |            |   |   | 41,824     |  
|Purchase of common stock                                     |  |              | (343,899  | )                          |   | (17,195           | ) |                                              | (1,410,555 | ) |   | (1,794,746 | ) |   |            |   |   | (3,222,496 | )
|Shareholder dividends                                        |  |              |           |                            |   |                   |   |                                              |            |   |   | (4,097,854 | ) |   |            |   |   | (4,097,854 | )
|Other comprehensive loss                                     |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   | (1,405,504 | ) |   | (1,405,504 | )
|                                                             |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   |            |   |   |            |  
|BALANCE AT DECEMBER 31, 2008                                 |  |              | 8,282,349 |                            | $ | 414,117           |   | $                                            | 33,019,154 |   | $ | 50,503,410 |   | $ | (208,538   | ) | $ | 83,728,143 |  
|Net income                                                   |  |              |           |                            |   |                   |   |                                              |            |   |   | 6,043,645  |   |   |            |   |   | 6,043,645  |  
|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    |  |              | 56,933    |                            |   | 2,847             |   |                                              | 441,231    |   |   |            |   |   |            |   |   | 444,078    |  
|Issuance of common stock under Employee Stock Option Plan    |  |              | 6,400     |                            |   | 320               |   |                                              | 68,240     |   |   |            |   |   |            |   |   | 68,560     |  
|Tax benefit from non-qualified employee stock options        |  |              |           |                            |   |                   |   |                                              | 467        |   |   |            |   |   |            |   |   | 467        |  
|Share based compensation                                     |  |              |           |                            |   |                   |   |                                              | 31,571     |   |   |            |   |   |            |   |   | 31,571     |  
|Purchase of common stock                                     |  |              | (5,126    | )                          |   | (256              | ) |                                              | (20,603    | ) |   | (32,258    | ) |   |            |   |   | (53,117    | )
|Shareholder dividends                                        |  |              |           |                            |   |                   |   |                                              |            |   |   | (4,507,536 | ) |   |            |   |   | (4,507,536 | )
|Other comprehensive income                                   |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   | 81,416     |   |   | 81,416     |  
|                                                             |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   |            |   |   |            |  
|BALANCE AT DECEMBER 31, 2009                                 |  |              | 8,352,883 |                            | $ | 417,644           |   | $                                            | 33,641,510 |   | $ | 52,007,261 |   | $ | (127,122   | ) | $ | 85,939,293 |  
|                                                             |  |              |           |                            |   |                   |   |                                              |            |   |   |            |   |   |            |   |   |            |  

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

32

---



COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|--------------------------------------------------------------------------------- |  | ---------------------- | ----------- | ---- | - | ---------- | - | - | ---------- | -
|                                                                                  |  | Year Ended December 31 |            
|                                                                                  |  |                        |            
|                                                                                  |  | 2009                   |             | 2008 |   | 2007       |  
|                                                                                  |  |                        |             |      |   |            |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                        |             |      |   |            |   |   |            |  
|Net income                                                                        |  | $                      | 6,043,645   |      | $ | 6,611,417  |   | $ | 7,510,766  |  
|Adjustments to reconcile net income to net
cash provided by operating activities: |  |                        |             |      |   |            |   |   |            |  
|Depreciation and amortization                                                     |  |                        | 1,698,321   |      |   | 1,865,111  |   |   | 2,159,184  |  
|Share based compensation                                                          |  |                        | 31,571      |      |   | 41,824     |   |   | 49,205     |  
|Deferred taxes                                                                    |  |                        | 641,574     |      |   | (484,944   | ) |   | 837,263    |  
|Impairment loss                                                                   |  |                        | 196,020     |      |   | 2,999,441  |   |   |            |  
|Gain on sale of assets                                                            |  |                        | (39,919     | )    |   | (84,513    | ) |   | (650,852   | )
|Excess tax benefit from stock based
payments                                      |  |                        | (467        | )    |   | (39,384    | ) |   | (82,862    | )
|Changes in assets and liabilities net of
effects from acquisitions:               |  |                        |             |      |   |            |   |   |            |  
|Trade receivables                                                                 |  |                        | 2,287,237   |      |   | (112,150   | ) |   | 2,249,347  |  
|Inventories                                                                       |  |                        | 4,908,760   |      |   | (1,912,971 | ) |   | (2,740,228 | )
|Prepaid income taxes                                                              |  |                        | (337,274    | )    |   | 1,418,576  |   |   | 780,205    |  
|Other current assets                                                              |  |                        | (10,116     | )    |   | 116,415    |   |   | (237,824   | )
|Accounts payable                                                                  |  |                        | 827,562     |      |   | 305,782    |   |   | 741,144    |  
|Accrued compensation and benefits                                                 |  |                        | 1,791,395   |      |   | 33,524     |   |   | 821,362    |  
|Other accrued expenses                                                            |  |                        | (263,369    | )    |   | 249,802    |   |   | 96,193     |  
|Income taxes payable                                                              |  |                        | (21,112     | )    |   | (428,399   | ) |   | (694,370   | )
|Other                                                                             |  |                        | (116,707    | )    |   | (356,814   | ) |   | (246,480   | )
|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|Net cash provided by operating activities                                         |  |                        | 17,637,121  |      |   | 10,222,717 |   |   | 10,592,053 |  
|                                                                                 
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                        |             |      |   |            |   |   |            |  
|Capital expenditures                                                              |  |                        | (3,237,558  | )    |   | (2,462,145 | ) |   | (4,680,694 | )
|Purchases of investments                                                          |  |                        | (34,841,042 | )    |   |            |   |   |            |  
|Proceeds from the sale of fixed assets                                            |  |                        | 106,672     |      |   | 396,857    |   |   | 2,196,337  |  
|Proceeds from the sale of investments                                             |  |                        | 16,099,000  |      |   |            |   |   |            |  
|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|Net cash used in investing activities                                             |  |                        | (21,872,928 | )    |   | (2,065,288 | ) |   | (2,484,357 | )
|                                                                                 
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |                        |             |      |   |            |   |   |            |  
|Cash dividends paid                                                               |  |                        | (4,332,666  | )    |   | (4,132,815 | ) |   | (3,685,673 | )
|Mortgage principal payments                                                       |  |                        | (348,373    | )    |   | (322,309   | ) |   | (935,113   | )
|Proceeds from issuance of common stock                                            |  |                        | 170,626     |      |   | 376,218    |   |   | 995,565    |  
|Excess tax benefit from stock based
payments                                      |  |                        | 467         |      |   | 39,384     |   |   | 82,862     |  
|Purchase of common stock                                                          |  |                        | (53,117     | )    |   | (3,222,497 | ) |   | (4,041,719 | )
|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|Net cash used in financing activities                                             |  |                        | (4,563,063  | )    |   | (7,262,019 | ) |   | (7,584,079 | )
|                                                                                 
|EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON
CASH                                   |  |                        | 140,757     |      |   | (371,728   | ) |   | 153,090    |  
|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS                              |  |                        | (8,658,113  | )    |   | 523,682    |   |   | 676,707    |  
|                                                                                 
|CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                    |  |                        | 29,951,561  |      |   | 29,427,879 |   |   | 28,751,172 |  
|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|CASH AND CASH EQUIVALENTS AT END OF YEAR                                          |  | $                      | 21,293,448  |      | $ | 29,951,561 |   | $ | 29,427,879 |  
|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|                                                                                  |  |                        |             |      |   |            |   |   |            |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:                                |  |                        |             |      |   |            |   |   |            |  
|Income taxes paid                                                                 |  | $                      | 4,472,507   |      | $ | 4,031,223  |   | $ | 3,588,852  |  
|Interest paid                                                                     |  |                        | 225,883     |      |   | 211,723    |   |   | 267,176    |  
|Dividends declared not paid                                                       |  |                        | 1,169,040   |      |   | 994,169    |   |   | 1,029,130  |  
|                                                                                 
|NON-CASH INVESTING AND FINANCING INFORMATION:                                     |  |                        |             |      |   |            |   |   |            |  
|Mortgage assumed for acquisition of building                                      |  |                        |             |      |   |            |   |   | 4,380,269  |  

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

33

---



COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears Ended December 31, 2009, 2008 and 2007

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of business: Communications 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.

The Company classifies its
businesses into four segments: Suttle,
which manufactures U.S. standard modular connecting and wiring devices for
voice and data communications; Transition
Networks subsidiary that designs and markets media conversion
products, Ethernet switches, and other connectivity and data transmission
products; Austin Taylor,which
manufactures British standard line jacks, patch panels, metal boxes,
distribution and central office frames; and JDL Technologies, (JDL),
which provides IT services; Non-allocated general and administrative expenses
are separately accounted for as Other in the Companys segment reporting.
There are no material intersegment revenues.

Principles of consolidation: The consolidated financial statements include
the accounts of the Company and its subsidiaries. All material intercompany
transactions and accounts have been eliminated.

Use of estimates: The presentation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. The Company uses estimates based on
the best information available in recording transactions and balances resulting
from operations. Actual results could differ from those estimates. The
Companys estimates consist principally of reserves for doubtful accounts,
sales returns, warranty costs, asset impairment evaluations, accruals for
compensation plans, self insured medical and dental accruals, pension
liabilities, lower of cost or market inventory adjustments, provisions for
income taxes and deferred taxes and depreciable lives of fixed assets.

Cash equivalents: For purposes of the 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 December 31, 2009, the
Company had $21.3 million in cash and cash equivalents. Of this amount, $13.0
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.

Investments: Investments consist of certificates of deposit that are traded on the open
market and are classified as available-for-sale at December 31, 2009.
Available-for-sale investments are reported at fair value with unrealized gains
and losses excluded from operations and reported as a separate component of
stockholders equity, net of tax (See Accumulated Comprehensive income below).

Inventories: Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out method. Provision to reduce inventories
to the lower of cost or market is made based on a review of excess and obsolete
inventories, estimates of future sales, examination of historical consumption
rates and the related value of component parts.

Property, plant and equipment: Property, plant and equipment are recorded at
cost. Depreciation is computed using the straight-line method. Depreciation
included in cost of sales and selling, general and administrative expenses for
continuing operations was $1,698,000, $1,865,000 and $2,150,000 for 2009, 2008
and 2007, respectively. Maintenance and repairs are charged to operations and
additions or improvements are capitalized. Items of property sold, retired or
otherwise disposed of are removed from the asset and accumulated depreciation
accounts and any gains or losses on disposal are reflected in operations.

34

---



Goodwill: Goodwill represents the amount by which the purchase prices (including
liabilities assumed) of acquired businesses exceed the estimated fair value of
the net tangible assets and separately identifiable assets of these businesses.
Goodwill and intangible assets with indefinite useful lives are not amortized,
but are tested at least annually for impairment. The Company reassess the value
of our reporting units and related goodwill balances at the end of each fiscal
year and at other times if events have occurred or circumstances exist that
indicate the carrying amount of goodwill may not be recoverable.

Recoverability of long-lived assets: The Company reviews its long-lived assets
periodically to determine potential impairment by comparing the carrying value
of the assets with expected net cash flows expected to be provided by operating
activities of the business or related products. If the sum of the expected
future net cash flows is less than the carrying value, an impairment loss would
be measured by comparing the amount by which the carrying value exceeds the
fair value of the asset.

Warranty: The Company 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 following table presents
the changes in the Companys warranty liability for the years ended December
31, 2009 and 2008, which relate to normal product warranties and a five year
obligation to provide for potential future liabilities for certain network
equipment sales:

|                                             |  |                        |          |      |   |          |  
|-------------------------------------------- |  | ---------------------- | -------- | ---- | - | -------- | -
|                                             |  | Year Ended December 31 |         
|                                             |  |                        |         
|                                             |  | 2009                   |          | 2008 |  
|                                             |  |                        |          |      |  
|Beginning balance                            |  | $                      | 593,000  |      | $ | 518,000  |  
|Amounts charged to
 (recovered from) expense |  |                        | 407,000  |      |   | 467,000  |  
|Actual warranty costs paid                   |  |                        | (352,000 | )    |   | (392,000 | )
|                                             |  |                        |          |      |   |          |  
|Ending balance                               |  | $                      | 648,000  |      | $ | 593,000  |  
|                                             |  |                        |          |      |   |          |  

Accumulated Comprehensive income: The components of accumulated other
comprehensive income are as follows:

|                                                   |  |             |            |      |   |          |  
|-------------------------------------------------- |  | ----------- | ---------- | ---- | - | -------- | -
|                                                   |  | December 31 |           
|                                                   |  |             |           
|                                                   |  | 2009        |            | 2008 |  
|                                                   |  |             |            |      |  
|Foreign currency
 translation                      |  | $           | (1,089,760 | )    | $ | (852,374 | )
|Unrealized gain on
 available-for-sale investments |  |             | 33,802     |      |   |          |  
|Minimum pension liability                          |  |             | 928,836    |      |   | 643,836  |  
|                                                   |  |             |            |      |   |          |  
|                                                   |  | $           | (127,122   | )    | $ | (208,538 | )
|                                                   |  |             |            |      |   |          |  

The functional currency of
Austin Taylor is the British pound. Assets and liabilities denominated in this
foreign currency were translated into U.S. dollars at year-end exchange rates.
Revenue and expense transactions were translated using average exchange rates.
Suttle Costa Rica and Transition China use the U.S. dollar as its functional
currency.

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, and the Company has no further obligation after such
time. 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 with the Virgin Islands Department of Education (VIDE) are funded by
the federal governments E-RATE program and must be approved by the Schools and
Libraries Division (SLD) of the Universal Service Administration Company (USAC)
before payment can be received. Our policy is not to recognize E-RATE revenue
on our VIDE contracts until they are approved by the SLD.

35

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Research and development: Research and development costs consist of
outside testing services, equipment and supplies associated with enhancing
existing products and developing new products. Research and development costs
are expensed when incurred and totaled $1,707,000 in 2009, $1,792,000 in 2008
and $592,000 in 2007.

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 adjusts for 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 12,519
shares, 23,137 shares and 69,413 shares in 2009, 2008 and 2007, 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 year for 2009, 2008, and
2007 was 81,000, 155,900 and 116,900, respectively.

Stock compensation: The Company accounts for stock-based compensation awards on a fair
value basis. The estimated grant date fair value of each stock-based award is
recognized in income over the requisite service period (generally the vesting
period). The estimated fair value of each option is calculated using the
Black-Scholes option-pricing model.

NOTE 2 - INVENTORIES

Inventories consist of:

|                            |  |             |            |      |   |            | 
|--------------------------- |  | ----------- | ---------- | ---- | - | ---------- | 
|                            |  | December 31 |           
|                            |  |             |           
|                            |  | 2009        |            | 2008 |  
|                            |  |             |            |      |  
|Finished goods              |  | $           | 15,195,132 |      | $ | 17,924,907 | 
|Raw and processed materials |  |             | 9,403,185  |      |   | 11,473,536 | 
|                            |  |             |            |      |   |            | 
|                            |  | $           | 24,598,317 |      | $ | 29,398,443 | 
|                            |  |             |            |      |   |            | 

NOTE 3 - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment
and the estimated useful lives are as follows:

|                               |  |                        |      |             |             |   |   |             |  
|------------------------------ |  | ---------------------- | ---- | ----------- | ----------- | - | - | ----------- | -
|                               |  | Estimated
 useful life |      | December 31 |            
|                               |  |                        |      |            
|                               |  |                        | 2009 |             | 2008        |  
|                               |  |                        |      |             |             |   |  
|Land                           |  |                        |      | $           | 3,104,569   |   | $ | 3,051,600   |  
|Buildings and improvements     |  | 7-40
 years            |      |             | 8,335,344   |   |   | 8,107,132   |  
|Machinery and equipment        |  | 3-15
 years            |      |             | 21,482,373  |   |   | 22,355,113  |  
|Furniture and fixtures         |  | 5-10
 years            |      |             | 3,518,607   |   |   | 3,351,143   |  
|Construction in progress       |  |                        |      |             |             |   |   | 44,715      |  
|                               |  |                        |      |             |             |   |   |             |  
|                               |  |                        |      |             | 36,440,893  |   |   | 36,909,703  |  
|Less accumulated
 depreciation |  |                        |      |             | (23,119,068 | ) |   | (24,895,162 | )
|                               |  |                        |      |             |             |   |   |             |  
|                               |  |                        |      | $           | 13,321,825  |   | $ | 12,014,541  |  
|                               |  |                        |      |             |             |   |   |             |  

During 2009, Austin Taylor
suffered operating losses which represented an event that required the related
fixed assets to be tested for impairment. The Company completed an evaluation
at the end of 2009 and identified an impairment charge on machinery and
equipment assets totaling $196,000.

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 July 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 4 - EMPLOYEE RETIREMENT BENEFITS

The Company has an Employee
Savings Plan (401(k)) and matches a percentage of employee contributions up to
six percent of compensation. Contributions to the plan in 2009, 2008 and 2007
were $420,000, $410,000, and $407,000, respectively.

36

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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. The following table summarizes the
balance sheet impact, including benefit obligations, assets and funded status
of Austin Taylors pension plans at December 31, 2009 and 2008:

|                                                                            |                                                       |  |      |           |      |   |            |  
|--------------------------------------------------------------------------- | ----------------------------------------------------- |  | ---- | --------- | ---- | - | ---------- | -
|                                                                            |                                                       |  | 2009 |           | 2008 |  
|                                                                            |                                                       |  |      |           |      |  
|                                                                            | Change in benefit obligation:                         |  |      |           |      |   |            |  
|                                                                            | Benefit obligation at the beginning of the
 year      |  | $    | 3,891,000 |      | $ | 5,685,000  |  
|                                                                            | Service cost                                          |  |      | 37,000    |      |   | 35,000     |  
|                                                                            | Interest cost                                         |  |      | 261,000   |      |   | 243,000    |  
|                                                                            | Participant contributions                             |  |      | 16,000    |      |   | 9,000      |  
|                                                                            | Actuarial (gains)/losses                              |  |      | (199,000  | )    |   | (223,000   | )
|                                                                            | Benefits paid                                         |  |      | (169,000  | )    |   | (294,000   | )
|                                                                            | Foreign currency (gains)/losses                       |  |      | 388,000   |      |   | (1,564,000 | )
|                                                                            |                                                       |  |      |           |      |   |            |  
|                                                                            | Benefit obligation at the end of the year             |  |      | 4,623,000 |      |   | 3,891,000  |  
|                                                                            |                                                       |  |      |           |      |   |            |  
|                                                                            |                                                       |  |      |           |      |   |            |  
|                                                                            | Change in plan assets:                                |  |      |           |      |   |            |  
|                                                                            | Fair value of plan assets at beginning of
 year       |  |      | 4,457,000 |      |   | 6,080,000  |  
|                                                                            | Actual return on plan assets                          |  |      | 83,000    |      |   | 174,000    |  
|                                                                            | Employer contributions                                |  |      | 191,000   |      |   | 161,000    |  
|                                                                            | Participant contributions                             |  |      | 16,000    |      |   | 9,000      |  
|                                                                            | Benefits paid                                         |  |      | (169,000  | )    |   | (294,000   | )
|                                                                            | Foreign currency gains (losses)                       |  |      | 445,000   |      |   | (1,673,000 | )
|                                                                            |                                                       |  |      |           |      |   |            |  
|                                                                            | Fair value of plan assets at end of year              |  |      | 5,023,000 |      |   | 4,457,000  |  
|                                                                            |                                                       |  |      |           |      |   |            |  
|                                                                            |                                                       |  |      |           |      |   |            |  
|                                                                            | Funded status at end of year  net asset /(liability) |  | $    | 400,000   |      | $ | 566,000    |  
|                                                                            |                                                       |  |      |           |      |   |            |  
|                                                                            |                                                       |  |      |           |      |   |            |  
|Weighted average assumptions used to
 determine net periodic pension costs: |                                                       |  |      |           |      |   |           
|                                                                            | Discount rate                                         |  |      | 5.8       | %    |   | 6.3        | %
|                                                                            | Expected return on assets                             |  |      | 5.0       | %    |   | 5.4        | %

The plans are
funded through UK government gilts and an insurance contract both recorded in
the financial statements at fair value. The related amounts for each of these
investments were $2,711,000 and $2,312,000 as of December 31, 2009 and were
determined to be level 2 and level 3 investments, respectively. Level 2
investments are valued based on observable inputs such as quoted prices for
similar instruments and quoted prices in markets that are not active. Level 3
investments are valued based on significant unobservable inputs.

The Company
does not expect any plan assets to be returned to the Company during the twelve
months subsequent to December 31, 2009.

The Company
expects to make contributions of $57,000 to the plan in 2010.

The Company
estimates its future pension benefit payments will be as follows:

|                |  |   |           | 
|--------------- |  | - | --------- | 
|2010            |  | $ | 247,000   | 
|2011            |  |   | 180,000   | 
|2012            |  |   | 205,000   | 
|2013            |  |   | 274,000   | 
|2014            |  |   | 374,000   | 
|2015 thru
 2019 |  |   | 1,814,000 | 

Components of
the Companys net periodic pension costs are:

|                                          |  |      |          |      |   |          |   |   |          |  
|----------------------------------------- |  | ---- | -------- | ---- | - | -------- | - | - | -------- | -
|                                          |  | 2009 |          | 2008 |   | 2007     |  
|                                          |  |      |          |      |   |          |  
|Service cost                              |  | $    | 37,000   |      | $ | 35,000   |   | $ | 52,000   |  
|Interest
 cost                            |  |      | 261,000  |      |   | 243,000  |   |   | 314,000  |  
|Expected
 return on assets                |  |      | (226,000 | )    |   | (237,000 | ) |   | (312,000 | )
|Amortization
 of unrecognized (gain)/loss |  |      |          |      |   |          |   |   |          |  
|                                          |  |      |          |      |   |          |   |   |          |  
|Net periodic
 pension cost                |  | $    | 72,000   |      | $ | 41,000   |   | $ | 54,000   |  
|                                          |  |      |          |      |   |          |   |   |          |  

37

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NOTE 5  COMMITMENTS AND CONTINGENCIES

Operating leases:The
Company leases land, buildings and equipment under operating leases with
original terms from 1 to 5 years. Total rent expense was $440,000, $789,000 and
$1,328,000 in 2009, 2008 and 2007 respectively. Sublease income received was
$12,000, $12,000 and $28,000 in 2009, 2008 and 2007 respectively. At December
31, 2009, the Company was obligated under noncancelable operating leases to
make minimum annual future lease payments as follows:

|                          |  |   |         | 
|------------------------- |  | - | ------- | 
|Year
 Ending December 31: |  |   |         | 
|2010                      |  | $ | 142,000 | 
|2011                      |  |   | 77,000  | 
|2012                      |  |   | 67,000  | 
|Thereafter                |  |   |         | 
|                          |  |   |         | 
|                          |  | $ | 286,000 | 
|                          |  |   |         | 

Long-term debt:
As part of the purchase 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. The outstanding balance on the mortgage was
$2,774,000 at December 31, 2009. The mortgage is secured by the building.

The annual
requirements for principal payments on the mortgage are as follows:

|           |  |   |         | 
|---------- |  | - | ------- | 
|2010       |  | $ | 373,000 | 
|2011       |  |   | 399,000 | 
|2012       |  |   | 427,000 | 
|2013       |  |   | 457,000 | 
|2014       |  |   | 490,000 | 
|Thereafter |  |   | 628,000 | 

Line of credit:
The Company has a $10,000,000 line of credit from U.S. Bank. The Company had no
outstanding borrowings against the line of credit at December 31, 2009 and
2008. Interest on borrowings on the credit line is at the LIBOR rate plus 1.5%
(1.8% at December 31, 2009). The credit agreement expires September 30, 2010
and is secured by assets of the Company.

As of December
31, 2009, the Company had no other material commitments (either cancelable or
non-cancelable) for capital expenditures or other purchase commitments related
to ongoing operations. The Company had no outstanding obligations under its
line of credit at December 31, 2009 and 2008, and the entire credit line is
available for use.

Long-term
compensation plans: The Company has a performance unit
incentive plan (PUP). The plan provides long term competitive compensation to
enable the Company to attract and retain qualified executive talent and to
reward employees for achieving goals and improving company performance. The
plan provides grants of performance units made at the beginning of four year
performance periods and paid at the end of the period if return on asset goals
are met. Awards are made every other year and are given in the form of cash at
the end of the cycle with annual vesting. Payment in the case of retirement,
disability or death will be on a pro rata basis. Every other year a new
four-year cycle begins to create a potential pay out every other year. The
Company accrued PUP expense of $734,000, $775,000 and $421,000 in 2009, 2008
and 2007, respectively. Accrual balances for long-term compensation plans at
December 31, 2009 and 2008 was $2,144,000 and $1,410,000, respectively. PUP
awards paid were $0 in 2009, $679,000 in 2008 and $0 in 2007. Remaining PUP
awards will be paid out in 2010 and 2012.

Other contingencies:In
the ordinary course of business, the Company is exposed to legal actions and
claims and incurs costs to defend against such actions and claims. Company
management is not aware of any outstanding or pending legal actions or claims
that would materially affect the Companys financial position or results of
operations.

NOTE 6  STOCK
COMPENSATION

Stock-based
compensation expense is recognized based on the fair value of awards granted
over the vesting period of the award. Stock-based compensation expense
recognized under for 2009, 2008 and 2007 was $32,000, $42,000 and $49,000
before income taxes and $20,000, $27,000 and $32,000 after income taxes,
respectively. At December 31, 2009 all outstanding options were vested.

38

---



The fair value
of awards issued under the Companys stock option plan and Employee Stock
Purchase Plan transactions is estimated at grant date using the Black-Scholes
option-pricing model. The following table displays the assumptions used in the
model.

|                         |  |                        |  |      |         |      |  |         |      |   |  |  |  |      |   | 
|------------------------ |  | ---------------------- |  | ---- | ------- | ---- |  | ------- | ---- | - |  |  |  | ---- | - | 
|                         |  | Year Ended December 31 | 
|                         |  |                        | 
|                         |  | 2009                   |  | 2008 |         | 2007 | 
|                         |  |                        |  |      |         |      | 
|Expected
 volatility     |  |                        |  | 28.3 | %       |      |  |         | 26.6 | % |  |  |  | 31.4 | % | 
|Risk free
 interest rate |  |                        |  | 3.4  | %       |      |  |         | 3.8  | % |  |  |  | 5.2  | % | 
|Expected
 holding period |  | 7 years                |  |      | 7 years |      |  | 7 years |      |  
|Dividend
 yield          |  |                        |  | 4.9  | %       |      |  |         | 4.0  | % |  |  |  | 3.9  | % | 

Fair value of
all options granted was approximately $32,000, $42,000 and $49,000 in 2009,
2008 and 2007, respectively

Common shares
are reserved for issuance in connection with a nonqualified stock option plan
under which up to 300,000 shares may be issued to nonemployee directors. The
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 this plan vest when issued
and expire 10 years from date of grant. 31,000 shares are available to be
issued under the plan at December 31, 2009. Stock options were granted to
non-employee directors for 18,000 shares in 2009, 2008 and 2007.

Common shares
are also 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 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 or
deferred stock are determined by the Compensation Committee of the Board of
Directors, subject to certain limitations incorporated into the plan. 1,123,739
shares are available to be issued under the plan at December 31, 2009. Options
granted to officers and key employees expire five years from date of grant with
one-third of the options vesting after six months and the remaining two-thirds
vesting equally over the next two years. The Company did not issue any options
under this plan in 2009, 2008 or 2007.

Changes in
outstanding employee and director stock options during the three years ended
December 31, 2009 were as follows:

|                                  |  |                   |          |                                              |  |       | 
|--------------------------------- |  | ----------------- | -------- | -------------------------------------------- |  | ----- | 
|                                  |  | Number of
 shares |          | Weighted
 average
 exercise price
 per share | 
|                                  |  |                   |          |                                              |  |       | 
|Outstanding
 at December 31, 2006 |  |                   | 570,280  |                                              |  | 9.53  | 
|Granted                           |  |                   | 18,000   |                                              |  | 10.22 | 
|Exercised                         |  |                   | (175,930 | )                                            |  | 8.15  | 
|Canceled                          |  |                   | (14,900  | )                                            |  | 13.90 | 
|                                  |  |                   |          |                                              |  |       | 
|Outstanding
 at December 31, 2007 |  |                   | 397,450  |                                              |  | 10.01 | 
|Granted                           |  |                   | 18,000   |                                              |  | 11.41 | 
|Exercised                         |  |                   | (38,800  | )                                            |  | 7.48  | 
|Canceled                          |  |                   | (25,300  | )                                            |  | 15.04 | 
|                                  |  |                   |          |                                              |  |       | 
|Outstanding
 at December 31, 2008 |  |                   | 351,350  |                                              |  | 9.99  | 
|Granted                           |  |                   | 18,000   |                                              |  | 9.73  | 
|Exercised                         |  |                   | (6,400   | )                                            |  | 10.71 | 
|Canceled                          |  |                   | (173,950 | )                                            |  | 10.18 | 
|                                  |  |                   |          |                                              |  |       | 
|Outstanding
 at December 31, 2009 |  |                   | 189,000  |                                              |  | 9.77  | 
|                                  |  |                   |          |                                              |  |       | 

39

---



All
outstanding options were fully vested and currently exercisable at December 31,
2009. The aggregate intrinsic value of all outstanding in-the-money options was
$545,000 based on the Companys stock price at December 31, 2009. The intrinsic
value of options exercised during the year was $30,000, $142,000 and $521,000
in 2009, 2008 and 2007, respectively. The following table summarizes the status
of stock options outstanding at December 31, 2009:

|                          |  |        |        |                                          |  |                                   |  |   |       | 
|------------------------- |  | ------ | ------ | ---------------------------------------- |  | --------------------------------- |  | - | ----- | 
|Range of
 Exercise Prices |  | Shares |        | Weighted Average
 Remaining
 Option Life |  | Weighted
 Average
 Exercise Price | 
|                          |  |        |        |                                          |  |                                   | 
|$7.13 to
 $8.64           |  |        | 72,000 |                                          |  | 2.9 years                         |  | $ | 7.72  | 
|$8.65 to
 $9.99           |  |        | 36,000 |                                          |  | 7.9 years                         |  |   | 9.67  | 
|$10.00 to
 $12.00         |  |        | 57,000 |                                          |  | 7.0 years                         |  |   | 10.59 | 
|$12.01 to
 $15.00         |  |        | 24,000 |                                          |  | 0.4 years                         |  |   | 14.13 | 

The Company
receives an income tax benefit related to the gains received by officers and
key employees who make disqualifying dispositions of stock received on exercise
of qualified incentive stock options and on non-qualified options. The amount
of tax benefit received by the Company was $0, $108,000 and $83,000 in 2009,
2008 and 2007 respectively. The tax benefit amounts have been credited to
additional paid-in capital.

EMPLOYEE STOCK
PURCHASE PLAN

The Company
maintains an Employee Stock Purchase Plan for which 500,000 common shares have
been reserved. Employees are able to acquire shares through payroll deductions
at 95% of the price at the end of each semi-annual plan. 87,828 shares remain
available under the Plan for purchase as of December 31, 2009.

EMPLOYEE STOCK
OWNERSHIP PLAN (ESOP)

All eligible
employees of the Company participate in the ESOP after completing one year of
service. Contributions are allocated to each participant based on compensation
and vest 30% after three years of service and incrementally thereafter, with
full vesting after seven years. At December 31, 2009, the ESOP held 526,240
shares of the Companys common stock, all of which have been allocated to the
accounts of eligible employees. Contributions to the plan are determined by the
Board of Directors and can be made in cash or shares of the Companys stock.
The 2009 ESOP contribution was $471,563 for which the Company issued 37,907
shares in March 2010. The 2008 ESOP contribution was $444,077 for which the
Company issued 56,933 shares in 2009. The Companys 2007 ESOP contribution was
$454,754 for which the Company issued 38,296 shares of common stock to the ESOP
in March 2008.

NOTE 7  COMMON STOCK

PURCHASES OF
COMMUNICATIONS SYSTEMS, INC. COMMON STOCK

In September
2006 and October 2008, the Companys Board of Directors authorized the
repurchase of shares of the Companys stock pursuant to Exchange Act Rule
106-18 on the open market, in block trades or in private transactions. At
December 31, 2009, 481,938 additional shares could be repurchased under
outstanding Board authorizations.

SHAREHOLDER
RIGHTS PLAN

On December
23, 2009 the Board of Directors adopted a shareholders rights plan. Under this
plan, the Board of Directors declared a distribution of one right per share of
common stock. Each right entitles the holder to purchase 1/100th of
a share of a new series of Junior Participating Preferred Stock of the Company
at an initial exercise price of $41. The rights expire on December 23, 2019.
The rights will become exercisable only following the acquisition by a person
or group, without the prior consent of the Board of Directors, of 16.5% or more
of the Companys voting stock, or following the announcement of a tender offer
or exchange offer to acquire an interest of 16.5% or more. If the rights become
exercisable, each rightholder will be entitled to purchase, at the exercise
price, common stock with a market value equal to twice the exercise price.
Should the Company be acquired, each right would entitle the holder to
purchase, at the exercise price, common stock of the acquiring company with a
market value equal to twice the exercise price. Any rights owned by the
acquiring person or group would become void.

40

---



NOTE 8 - INCOME TAXES

Income tax expense from continuing operations consists of the following:

|                                 |  |                        |           |      |   |           |   |   |           | 
|-------------------------------- |  | ---------------------- | --------- | ---- | - | --------- | - | - | --------- | 
|                                 |  | Year Ended December 31 |          
|                                 |  |                        |          
|                                 |  | 2009                   |           | 2008 |   | 2007      |  
|                                 |  |                        |           |      |   |           |  
|Currently payable income
 taxes: |  |                        |           |      |   |           |   |   |           | 
|Federal                          |  | $                      | 3,766,000 |      | $ | 3,765,000 |   | $ | 3,082,000 | 
|State                            |  |                        | 362,000   |      |   | 492,000   |   |   | 385,000   | 
|Foreign                          |  |                        | (14,000   | )    |   | 798,000   |   |   | 208,000   | 
|                                 |  |                        |           |      |   |           |   |   |           | 
|                                 |  |                        | 4,114,000 |      |   | 5,055,000 |   |   | 3,675,000 | 
|                                 |  |                        |           |      |   |           |   |   |           | 
|Deferred income taxes
 (benefit) |  |                        | 642,000   |      |   | (485,000  | ) |   | 837,000   | 
|                                 |  |                        |           |      |   |           |   |   |           | 
|                                 |  | $                      | 4,756,000 |      | $ | 4,570,000 |   | $ | 4,512,000 | 
|                                 |  |                        |           |      |   |           |   |   |           | 

Austin Taylor
Communications, Ltd. operates in the United Kingdom (U.K.) and is subject to
U.K. rather than U.S. income taxes. Austin Taylor had pretax losses of
$1,252,000 and $64,000 in 2009 and 2008, respectively and pretax income of
$495,000 in 2007. As of December 31, 2009, Austin Taylors net operating loss
carry-forward was $4,416,000. The Company is uncertain that it will be able to
generate the future income needed to realize the tax benefit of the
carry-forward. Accordingly, the Company has a reserve against the potential
carry-forward benefit.

In 2007 Transition Networks
China began operations in China and is subject to Chinese taxes rather than
U.S. income taxes. Shanghai Ling had pretax losses of $190,000, $1,252,000, and
$196,000 in 2009, 2008, and 2007 respectively. At the end of 2009, Shanghai
Lings net operating loss carry-forward was $1,638,000. Due to the history of
losses in China the Company remains uncertain that it will be able to generate
the future income needed to realize the tax benefit of the carry-forward.
Accordingly, the Company has continued to a valuation allowance against the
full amount of the potential carry-forward benefit.

Suttle Costa Rica, S.A.
operates in Costa Rica and is subject to Costa Rica income taxes. It is the
Companys intention to maintain the remaining undistributed earnings in its
Costa Rica subsidiary to support continued operations there. No deferred taxes
have been provided for the undistributed earnings.

The provision for income
taxes for continuing operations varied from the federal statutory tax rate as
follows:

|                                                               |  |                        |      |      |  |      |   |  |      |  
|-------------------------------------------------------------- |  | ---------------------- | ---- | ---- |  | ---- | - |  | ---- | -
|                                                               |  | Year Ended December 31 |     
|                                                               |  |                        |     
|                                                               |  | 2009                   |      | 2008 |  | 2007 |  
|                                                               |  |                        |      |      |  |      |  
|Tax at U.S.
 statutory rate                                    |  |                        | 35.0 | %    |  | 35.0 | % |  | 35.0 | %
|Surtax
 exemption                                              |  |                        | (0.9 | )    |  | (0.9 | ) |  | (0.9 | )
|State income
 taxes, net of federal benefit                    |  |                        | 2.5  |      |  | 2.1  |   |  | 2.2  |  
|Foreign
 income taxes, net of operating loss valuation reserve |  |                        | 4.9  |      |  | 2.3  |   |  | 2.0  |  
|Tax exempt
 interest income                                    |  |                        |     |      |  |     |   |  | (2.1 | )
|Impairment
 of goodwill                                        |  |                        |     |      |  | 2.2  |   |  |     |  
|Other                                                          |  |                        | 2.5  |      |  | 0.2  |   |  | 1.3  |  
|                                                               |  |                        |      |      |  |      |   |  |      |  
|Effective
 tax rate                                            |  |                        | 44.0 | %    |  | 40.9 | % |  | 37.5 | %
|                                                               |  |                        |      |      |  |      |   |  |      |  

Deferred tax assets and
liabilities as of December 31 related to the following:

|                                                      |  |      |            |      |   |            |  
|----------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                      |  | 2009 |            | 2008 |  
|                                                      |  |      |            |      |  
|Deferred tax assets:                                  |  |      |            |      |   |            |  
|Allowance for doubtful accounts                       |  | $    | 186,000    |      | $ | 81,000     |  
|Inventory                                             |  |      | 2,706,000  |      |   | 2,435,000  |  
|Accrued and prepaid expenses                          |  |      | 683,000    |      |   | 848,000    |  
|Domestic net operating loss carry-forward             |  |      | 345,000    |      |   | 425,000    |  
|Long-term compensation plans                          |  |      | 331,000    |      |   | 331,000    |  
|Nonemployee director stock compensation               |  |      | 63,000     |      |   | 52,000     |  
|State income taxes                                    |  |      | 54,000     |      |   | 49,000     |  
|Foreign net operating loss carry-forwards and credits |  |      | 2,228,000  |      |   | 1,676,000  |  
|                                                      |  |      |            |      |   |            |  
|                                                      |  |      |            |      |   |            |  
|Gross deferred tax assets                             |  |      | 6,596,000  |      |   | 5,897,000  |  
|Valuation allowance                                   |  |      | (1,771,000 | )    |   | (1,382,000 | )
|                                                      |  |      |            |      |   |            |  
|Net deferred tax assets                               |  |      | 4,825,000  |      |   | 4,515,000  |  
|                                                      |  |      |            |      |   |            |  
|                                                      |  |      |            |      |   |            |  
|Deferred tax liabilities                              |  |      |            |      |   |            |  
|Depreciation                                          |  |      | (1,195,000 | )    |   | (361,000   | )
|Intangible assets                                     |  |      | (264,000   | )    |   | (146,000   | )
|                                                      |  |      |            |      |   |            |  
|                                                      |  |      |            |      |   |            |  
|Gross deferred tax
 liability                         |  |      | (1,459,000 | )    |   | (507,000   | )
|                                                      |  |      |            |      |   |            |  
|                                                      |  |      |            |      |   |            |  
|Total net deferred tax
 asset/(liability)             |  | $    | 3,366,000  |      | $ | 4,008,000  |  
|                                                      |  |      |            |      |   |            |  

41

---



As part of a previous
acquisition, the Company purchased net operating loss carry-forwards in the
amount of $3,790,000. At December 31, 2009, the Company has $986,000 remaining
net operating loss carry-forwards for income tax purposes which expire in 2014.
Utilization of net operating loss carry-forwards is limited to $228,000 per
year in future years.

The Company assesses
uncertain tax positions in accordance with current accounting guidance. Under
this guidance, the Company must recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities, based on the technical
merits of the position. The tax benefits recognized in the financial statements
from such uncertain tax positions are measured based on the largest benefit
that has a greater than fifty percent likelihood of being realized upon
ultimate resolution. The Companys practice is to recognize interest and
penalties related to income tax matters in income tax expense.

Changes in the Companys
unrecognized tax benefits are summarized as follows:

|                                                 |  |      |         |      |   |         |   |   |           |  
|------------------------------------------------ |  | ---- | ------- | ---- | - | ------- | - | - | --------- | -
|                                                 |  | 2009 |         | 2008 |   | 2007    |  
|                                                 |  |      |         |      |   |         |  
|                                                
|Unrecognized tax benefits
  January 1           |  | $    | 380,000 |      | $ | 656,000 |   | $ | 1,076,000 |  
|Gross increases - tax
 positions in prior period |  |      |        |      |   | 118,000 |   |   | 4,000     |  
|Gross decreases - tax
 positions in prior period |  |      |        |      |   |         |   |   | (430,000  | )
|Gross increases - current
 period tax positions  |  |      | 66,000  |      |   | 81,000  |   |   | 6,000     |  
|Settlements                                      |  |      |        |      |   |         |   |   | (430,000  | )
|Expiration of statute of
 limitations            |  |      | (97,000 | )    |   | (45,000 | ) |   |          |  
|                                                 |  |      |         |      |   |         |   |   |           |  
|Unrecognized tax benefits
  December 31, 2009   |  | $    | 349,000 |      | $ | 380,000 |   | $ | 656,000   |  
|                                                 |  |      |         |      |   |         |   |   |           |  

The Companys income tax
liability accounts included accruals for interest and penalties of $374,000 at
December 31, 2009. Included in the balance of unrecognized tax benefits at
December 31, 2009 are $583,000 of tax benefits that if recognized would affect
the tax rate. The Companys unrecognized tax benefits could be reduced by
$86,000 in the next twelve months due to statute of limitations expirations.

The Companys federal and
state tax returns and tax returns it has filed in Costa Rica and the United
Kingdom are open for review going back to the 2006 tax year. Puerto Rico has no
statute of limitations on tax returns.

NOTE 9- INFORMATION CONCERNING INDUSTRY SEGMENTS AND MAJOR
CUSTOMERS

The Company classifies its
businesses into four segments: Suttle, which manufactures U.S. standard modular
connecting and wiring devices for voice and data communications; 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 as 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.

Suttle products are sold
principally to United States (U.S.) customers. Suttle operates manufacturing
facilities in the U.S. and Costa Rica. Net long-lived assets held in Costa Rica
were approximately $279,000 at December 31, 2009. Transition Networks
manufactures its products in the United States and makes sales in both the U.S.
and international markets. JDL Technologies operates in the U.S. and makes
sales in the U.S. and the U.S. Virgin Islands. Austin Taylor operates a
manufacturing facility in the United Kingdom (U.K.) and makes sales in the U.K.
and internationally. Consolidated sales to U.S. customers were approximately
82%, 71% and 81% of sales from continuing operations in 2009, 2008 and 2007
respectively. In 2009, sales to one of Transition Networks customers accounted
for 16.7% and one of Suttles customers accounted for
12.2% of sales. In 2008, sales to one of Transition Networks customers
accounted for 11.7% and one of Suttles customers accounted for 12.4% of sales.
No customer accounted for more than 10% of sales in 2007.

42

---



Information
concerning the Companys continuing operations in the various segments for the
twelve-month periods ended December 31, 2009, 2008 and 2007 is as follows:

|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|-------------------------------------------- |  | ------ | ---------- | -------------------- | - | ----------------- |  | -------------- | ---------- | ----- | - | ---------- | - | - | ---------- | - | - | ----------- | 
|                                             |  | Suttle |            | Transition
 Networks |   | JDL
 Technologies |  | Austin
 Taylor |            | Other |   | Total      |  
|2009                                         |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Sales                                        |  | $      | 42,866,947 |                      | $ | 55,098,346        |  | $              | 8,765,415  |       | $ | 3,061,499  |   | $ |           |   | $ | 109,792,207 | 
|Cost of sales                                |  |        | 33,095,673 |                      |   | 25,768,865        |  |                | 6,011,918  |       |   | 3,067,101  |   |   |           |   |   | 67,943,557  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Gross profit                                 |  |        | 9,771,274  |                      |   | 29,329,481        |  |                | 2,753,497  |       |   | (5,602     | ) |   |           |   |   | 41,848,650  | 
|Selling, general and administrative expenses |  |        | 6,054,170  |                      |   | 19,371,120        |  |                | 1,298,790  |       |   | 1,012,194  |   |   | 3,697,823  |   |   | 31,630,117  | 
|Impairment                                   |  |        |            |                      |   |                   |  |                |            |       |   | 196,020    |   |   |            |   |   |            | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Operating income (loss)                      |  | $      | 3,717,104  |                      | $ | 9,958,361         |  | $              | 1,454,707  |       | $ | (1,213,816 | ) | $ | (3,697,823 | ) | $ | 10,218,533  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Depreciation and amortization                |  | $      | 651,407    |                      | $ | 579,816           |  | $              | 155,744    |       | $ | 76,495     |   | $ | 234,859    |   | $ | 1,698,321   | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Capital expenditures                         |  | $      | 2,667,916  |                      | $ | 355,129           |  | $              | 37,026     |       | $ | 114,153    |   | $ | 63,334     |   | $ | 3,237,558   | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Assets                                       |  | $      | 21,110,624 |                      | $ | 29,640,360        |  | $              | 1,548,930  |       | $ | 4,044,746  |   | $ | 46,569,034 |   | $ | 102,913,694 | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  | Suttle |            | Transition
 Networks |   | JDL
 Technologies |  | Austin
 Taylor |            | Other |   | Total      |  
|2008                                         |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Sales                                        |  | $      | 44,421,377 |                      | $ | 62,924,469        |  | $              | 9,837,526  |       | $ | 5,516,306  |   | $ |           |   | $ | 122,699,678 | 
|Cost of sales                                |  |        | 33,643,844 |                      |   | 31,952,354        |  |                | 5,625,666  |       |   | 4,786,298  |   |   |           |   |   | 76,008,162  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Gross profit                                 |  |        | 10,777,533 |                      |   | 30,972,115        |  |                | 4,211,860  |       |   | 730,008    |   |   |           |   |   | 46,691,516  | 
|Selling, general and administrative expenses |  |        | 6,044,718  |                      |   | 20,672,700        |  |                | 1,104,732  |       |   | 815,461    |   |   | 4,470,877  |   |   | 33,108,488  | 
|Impairment                                   |  |        |            |                      |   |                   |  |                | 2,999,441  |       |   |            |   |   |            |   |   | 2,999,441   | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Operating income (loss)                      |  | $      | 4,732,815  |                      | $ | 10,299,415        |  | $              | 107,687    |       | $ | (85,453    | ) | $ | (4,470,877 | ) | $ | 10,583,587  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Depreciation and amortization                |  | $      | 646,969    |                      | $ | 586,236           |  | $              | 308,936    |       | $ | 105,127    |   | $ | 217,843    |   | $ | 1,865,111   | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Capital expenditures                         |  | $      | 482,399    |                      | $ | 474,656           |  | $              | 12,262     |       | $ | 92,233     |   | $ | 1,400,595  |   | $ | 2,462,145   | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Assets                                       |  | $      | 22,722,488 |                      | $ | 30,291,569        |  | $              | 3,853,243  |       | $ | 4,323,044  |   | $ | 37,547,447 |   | $ | 98,737,791  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  | Suttle |            | Transition
 Networks |   | JDL
 Technologies |  | Austin
 Taylor |            | Other |   | Total      |  
|2007                                         |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Sales from continuing operations             |  | $      | 48,135,180 |                      | $ | 53,062,681        |  | $              | 13,219,376 |       | $ | 6,826,011  |   | $ |           |   | $ | 121,243,248 | 
|Cost of sales                                |  |        | 35,104,903 |                      |   | 28,851,469        |  |                | 9,186,070  |       |   | 5,215,096  |   |   |           |   |   | 78,357,538  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Gross Profit                                 |  |        | 13,030,277 |                      |   | 24,211,212        |  |                | 4,033,306  |       |   | 1,610,915  |   |   |           |   |   | 42,885,710  | 
|Selling, general and administrative expenses |  |        | 7,201,835  |                      |   | 18,608,291        |  |                | 2,466,044  |       |   | 1,132,015  |   |   | 3,214,957  |   |   | 32,623,142  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Operating income (loss)                      |  | $      | 5,828,442  |                      | $ | 5,602,921         |  | $              | 1,567,262  |       | $ | 478,900    |   | $ | (3,214,957 | ) | $ | 10,262,568  | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Depreciation and amortization                |  | $      | 746,474    |                      | $ | 491,481           |  | $              | 704,660    |       | $ | 145,319    |   | $ | 71,250     |   | $ | 2,159,184   | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Capital expenditures                         |  | $      | 643,029    |                      | $ | 1,484,977         |  | $              | 103,808    |       | $ | 135,967    |   | $ | 2,302,474  |   | $ | 4,670,255   | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 
|Assets                                       |  | $      | 27,102,439 |                      | $ | 26,149,088        |  | $              | 7,336,651  |       | $ | 5,273,183  |   | $ | 34,898,952 |   | $ | 100,760,313 | 
|                                             |  |        |            |                      |   |                   |  |                |            |       |   |            |   |   |            |   |   |             | 

43

---



NOTE 10  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.

Level 2 
Observable inputs such as quoted prices for similar instruments and quoted
prices in markets that are not active, and inputs that are directly observable
or can be corroborated by observable market data. The types of assets and
liabilities included in Level 2 are typically either comparable to actively
traded securities or contracts, such as treasury securities with pricing
interpolated from recent trades of similar securities, or priced with models
using highly observable inputs, such as commodity options priced using
observable forward prices and volatilities.

Level 3 
Significant inputs to pricing 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 December 31, 2009 include money market funds within cash equivalents of
$12,972,000 classified as level one within the hierarchy and certificate of
deposits within investments of $18,776,000 classified as level two. The Company
does not have any assets or liabilities classified as level three within the
hierarchy.

NOTE 11  GOODWILL

The changes in
the carrying amount of goodwill for the years ended December 31, 2009 and 2008
by segment are as follows:

|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  
|------------------------------ |  | ----------------- | -------- | ------ | - | -------------------- |  | ----- | --------- |  | - | --------- | -
|                               |  | JDL
 Technologies |          | Suttle |   | Transition
 Networks |  | Total |          
|                               |  |                   |          |        |   |                      |  |       |          
|                              
|January 1 2008                 |  | $                 | 703,878  |        | $ | 1,271,986            |  | $     | 3,288,231 |  | $ | 5,264,095 |  
|Impairment                     |  |                   | (703,878 | )      |   |                      |  |       |           |  |   | (703,878  | )
|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  
|December 31, 2008              |  |                   |         |        |   | 1,271,986            |  |       | 3,288,231 |  |   | 4,560,217 |  
|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  
|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  
|December 31, 2009              |  | $                 |         |        | $ | 1,271,986            |  | $     | 3,288,231 |  | $ | 4,560,217 |  
|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  
|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  
|Gross goodwill                 |  | $                 | 703,878  |        | $ | 1,271,986            |  | $     | 3,288,231 |  | $ | 5,264,095 |  
|Accumulated impairment
 losses |  |                   | (703,878 | )      |   |                      |  |       |           |  |   | (703,878  | )
|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  
|Balance at December 31,
 2009  |  | $                 |         |        | $ | 1,271,986            |  | $     | 3,288,231 |  | $ | 4,560,217 |  
|                               |  |                   |          |        |   |                      |  |       |           |  |   |           |  

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 July 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. The Company has determined that there were no additional impairments
as of December 31, 2008 and 2009.

NOTE 12  SUBSEQUENT EVENTS

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

44

---



(b) SUPPLEMENTAL FINANCIAL INFORMATION

Quarterly Operating Results(in thousands except per share amounts)

|                              |  |               |        |         |   |         |  |        |        |  |   |        | 
|----------------------------- |  | ------------- | ------ | ------- | - | ------- |  | ------ | ------ |  | - | ------ | 
|                              |  | Quarter Ended |       
|                              |  |               |       
|                              |  | March 31      |        | June 30 |   | Sept 30 |  | Dec 31 |       
|                              |  |               |        |         |   |         |  |        |       
|2009                          |  |               |        |         |   |         |  |        |        |  |   |        | 
|Sales                         |  | $             | 26,765 |         | $ | 28,584  |  | $      | 28,107 |  | $ | 26,336 | 
|Gross margins                 |  |               | 9,779  |         |   | 10,650  |  |        | 10,868 |  |   | 10,552 | 
|Operating income              |  |               | 1,777  |         |   | 2,768   |  |        | 3,349  |  |   | 2,325  | 
|Net income                    |  |               | 1,223  |         |   | 1,748   |  |        | 1,861  |  |   | 1,212  | 
|                              |  |               |        |         |   |         |  |        |        |  |   |        | 
|Basic net income per share    |  | $             | .15    |         | $ | .21     |  | $      | .22    |  | $ | .15    | 
|Diluted net income per
 share |  | $             | .15    |         | $ | .21     |  | $      | .22    |  | $ | .14    | 
|                              |  |               |        |         |   |         |  |        |        |  |   |        | 
|2008                          |  |               |        |         |   |         |  |        |        |  |   |        | 
|Sales                         |  | $             | 30,321 |         | $ | 31,291  |  | $      | 32,683 |  | $ | 28,405 | 
|Gross margins                 |  |               | 11,451 |         |   | 11,262  |  |        | 13,527 |  |   | 10,452 | 
|Operating income              |  |               | 199    |         |   | 2,930   |  |        | 5,236  |  |   | 2,219  | 
|Net income                    |  |               | 186    |         |   | 2,261   |  |        | 2,794  |  |   | 1,370  | 
|                              |  |               |        |         |   |         |  |        |        |  |   |        | 
|Basic net income per share    |  | $             | .02    |         | $ | .26     |  | $      | .33    |  | $ | .17    | 
|Diluted net income per
 share |  | $             | .02    |         | $ | .26     |  | $      | .32    |  | $ | .17    | 

During the first and third quarters of fiscal 2008,
the Company recognized approximately $2.0 million of revenue related to
services that were invoiced and expensed in fiscal 2007. See further discussion
in Note 1.

|             |                                                                                      
|------------ | -------------------------------------------------------------------------------------
|ITEM 9.      | CHANGES
 IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|             |                                                                                      
|None.        |                                                                                      
|             |                                                                                      
|ITEM 9A (T): | CONTROLS
 AND PROCEDURES                                                             

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, we evaluated the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934 (the Exchange Act)).

Our Chief Executive Officer and Chief Financial
Officer have concluded that, as of the end of the period covered by this
report, our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in the reports we file or submit
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the applicable rule and forms.

Managements Report on Internal Control over Financial
Reporting

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 December 31, 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.

45

---



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.

This annual report does not include an attestation
report of the Companys registered public accounting firm regarding internal
control over financial reporting. Managements report was not subject to
attestation by the Companys registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit the
Company to provide only managements report in this annual report.

|                |                                                        
|--------------- | -------------------------------------------------------
|ITEM
 9B.       | OTHER
 INFORMATION                                     
|                |                                                        
|Not applicable.
|                |                                                        
|PART III       
|                |                                                        
|ITEM
 10.       | DIRECTORS,
 EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information Incorporated by Reference

The information required by Item 401 under Regulation
S-K, to the extent applicable to the Companys directors, will be set forth
under the caption Election of Directors in the Companys definitive proxy
material for its May 18, 2010 Annual Meeting of Shareholders (2010 Proxy
Materials), which information is expressly incorporated by reference herein.
The information called for with respect to the Companys officers by paragraph
[b] of Item 401 is set forth under Item 1(c) (3) herein. The information called
for by Item 405 under Regulation S-K regarding Exchange Act, Section 16 (a)
compliance, to the extent applicable, will be set forth under the caption
Certain Transactions in the Companys 2010 Proxy Materials.

Code of Ethics

The Company has adopted a code of Ethics applicable to
all officers of the Company as well as certain other key accounting personnel.
A copy of the Code of Ethics can be obtained free of charge upon written
request directed to the Companys Assistant Secretary at the executive offices
of the Company.

Information required pursuant to Item 407 under
Regulation S-K will be presented in the Companys 2010 Proxy Materials.

|          |                        
|--------- | -----------------------
|ITEM
 11. | EXECUTIVE
 COMPENSATION

The information called for by Item 402 under
Regulation S-K to the extent applicable, will be set forth under the caption
Executive Compensation in the Companys 2010 Proxy Materials, which information
is expressly incorporated herein by reference.

|          |                                                                                                 
|--------- | ------------------------------------------------------------------------------------------------
|ITEM
 12. | SECURITY
 OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
 MATTERS

The information called for by Item 403 under
Regulation S-K will be set forth under the captions Security Ownership of
Certain Beneficial Owners and Management and Election of Directors in the
Companys 2010 Proxy Materials, which information is expressly incorporated
herein by reference.

|          |                                                                           
|--------- | --------------------------------------------------------------------------
|ITEM
 13. | CERTAIN
 RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by Items 404 and 407(a) under
Regulation S-K will be provided in the Companys 2010 Proxy Materials to the
extent applicable, and such information, if any, is incorporated herein by
reference.

46

---



|         |                                        
|-------- | ---------------------------------------
|ITEM 14. | PRINCIPAL ACCOUNTING FEES AND
 SERVICES

The information called for by Item 14 of Form 10K and
9(e) of Schedule 14A will be set forth under the caption Principal Accountant
Fees and Services in the Companys 2010 Proxy Materials, which information is
expressly incorporated herein by reference.

PART IV

|         |                                            
|-------- | -------------------------------------------
|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT
 SCHEDULES

(a) (1) Consolidated Financial Statements

The following Consolidated Financial Statements of
Communications Systems, Inc. and subsidiaries appear at pages 28 to 45 herein:

| |   |                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------
| |  | Report of Independent Registered Public Accounting
 Firm                                                        
| |   |                                                                                                                 
| |  | Consolidated Balance Sheets as of December 31, 2009
 and 2008                                                   
| |   |                                                                                                                 
| |  | Consolidated Statements of Income and Comprehensive
 Income for the years ended December 31, 2009, 2008 and 2007
| |   |                                                                                                                 
| |  | Consolidated Statements of Changes in Stockholders
 Equity for the years ended December 31, 2009, 2008 and 2007
| |   |                                                                                                                 
| |  | Consolidated Statements of Cash Flows for the years
 ended December 31, 2009, 2008 and 2007                     
| |   |                                                                                                                 
| |  | Notes to Consolidated Financial Statements                                                                      

(a) (2) Consolidated Financial Statement Schedule

The following financial statement schedule is being
filed as part of this Form 10-K Report:

Schedule
II - Valuation and Qualifying Accounts and Reserves

All other schedules are omitted as the required
information is inapplicable or the information is presented in the consolidated
financial statements or related notes.

(a) (3) Exhibits

The exhibits which accompany or are incorporated by
reference in this report, including all exhibits required to be filed with this
report pursuant to Item 601 of Regulation S-K, including each management or
compensatory plan or arrangement are described on the Exhibit Index, which is
at pages 52 and 53 of this report.

47

---



SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

|                      |                                             
|--------------------- | --------------------------------------------
|                      | COMMUNICATIONS SYSTEMS,
 INC.               
|                      |                                             
|Dated: March 18, 2010 | /s/ Jeffrey K. Berg                         
|                      |                                             
|                      | Jeffrey K. Berg, President,
 Chief Executive
|                      | Office and
 Director                        

Pursuant to the requirements
of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the Registrant in the capacities and on the
dates indicated:

Each person whose signature
appears below constitutes and appoints JEFFREY K. BERG and DAVID T. MCGRAW as
his true and lawful attorneys-in-fact and agents, each acting alone, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any or all amendments to this Annual
Report on Form 10-K and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, each acting alone, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
said attorneys-in-fact and agents, each acting alone, or his substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.

|                      |  |                                      |  |                
|--------------------- |  | ------------------------------------ |  | ---------------
|Signature             |  | Title                                |  | Date           
|                      |  |                                      |  |                
|                     
|/s/Jeffrey K. Berg    |  | President, Chief Executive
 Officer  |  | March
 18, 2010
|                      |  | and Director                         |  |                
|                      |  |                                      |  |                
|/s/David T. McGraw    |  | Vice President, Treasurer
 and       |  | March
 18, 2010
|                      |  | Chief Financial Officer
 (Principal  |  |                
|David T. McGraw       |  | Financial Officer and
 Principal     |  |                
|                      |  | Accounting Officer)                  |  |                
|                      |  |                                      |  |                
|/s/Curtis A. Sampson  |  | Chairman of the Board of
 Directors, |  | March
 18, 2010
|                      |  | and Director                         |  |                
|Curtis A. Sampson     |  |                                      |  |                
|                      |  |                                      |  |                
|/s/Randall D. Sampson |  | Director                             |  | March
 18, 2010
|                      |  |                                      |  |                
|Randall D. Sampson    |  |                                      |  |                
|                      |  |                                      |  |                
|/s/Edwin C. Freeman   |  | Director                             |  | March
 18, 2010
|                      |  |                                      |  |                
|Edwin C. Freeman      |  |                                      |  |                
|                      |  |                                      |  |                
|/s/Luella G. Goldberg |  | Director                             |  | March
 18, 2010
|                      |  |                                      |  |                
|Luella Gross Goldberg |  |                                      |  |                
|                      |  |                                      |  |                
|/s/Gerald D. Pint     |  | Director                             |  | March
 18, 2010
|                      |  |                                      |  |                
|Gerald D. Pint        |  |                                      |  |                
|                      |  |                                      |  |                
|/s/Roger H.D. Lacey   |  | Director                             |  | March
 18, 2010
|                      |  |                                      |  |                
|Roger H.D. Lacey      |  |                                      |  |                

48

---



|
|
|

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL
REPORT PURSUANT TO SECTION 13 or 15(d)

OF
THE SECURITIES EXCHANGE ACT OF 1934

OF

COMMUNICATIONS SYSTEMS, INC.

FOR

|                            
|----------------------------
|YEAR ENDED DECEMBER 31, 2009
|                            
|                            
|                            
|FINANCIAL STATEMENT SCHEDULE

|
|
|

49

---



COMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Schedule II - Valuation and Qualifying Accounts and Reserves

|                                  |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|--------------------------------- |  | -------------------------------- | ------- | ---------------------------------------- | - | -------------------------- |  | ---------------------------- | -------- | -------------------------- |  |  |  | - | ------- | 
|Description                       |  | Balance at
 Beginning of
 Period |         | Additions
 Charged to Cost
 and Expenses |   | Deductions
 from
 Reserves |  | Other
 Changes
 Add (Deduct) |          | Balance
 at End
 of Period | 
|                                  |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|Allowance for doubtful
 accounts: |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|                                  |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|Year ended:                       |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|                                  |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|December 31, 2009                 |  | $                                | 219,000 |                                          | $ | 310,000                    |  | $                            | (24,000  | ) (A)                      |  |  |  | $ | 505,000 | 
|                                  |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|December 31, 2008                 |  | $                                | 198,000 |                                          | $ | 79,000                     |  | $                            | (58,000  | ) (A)                      |  |  |  | $ | 219,000 | 
|                                  |  |                                  |         |                                          |   |                            |  |                              |          |                            |  |  |  |   |         | 
|December 31, 2007                 |  | $                                | 585,000 |                                          | $ | 22,000                     |  | $                            | (409,000 | ) (A)                      |  |  |  | $ | 198,000 | 

|    |                                                                          
|--- | -------------------------------------------------------------------------
|   
|(A) | Accounts
 determined to be uncollectible and charged off against reserve.

50

---



|
|
|

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.
20549

FORM 10-K

ANNUAL
REPORT PURSUANT TO SECTION 13 or 15(d)

OF
THE SECURITIES EXCHANGE ACT OF 1934

OF

COMMUNICATIONS SYSTEMS, INC.

FOR

YEAR ENDED DECEMBER 31, 2009

---

EXHIBITS

|
|
|

51

---



COMMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 2009

|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|---------------------------------------- | ---- | ------------------ | --------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Regulation S-K
 Exhibit Table
 Reference |      | Title of
 Document |                                                                                                                                   | Location
 in Consecutive Numbering
 System as Filed With the Securities
 and Exchange Commission
|                                         |      |                    |                                                                                                                                   |                                                                                                 
|                                         | 3.1  |                    | Articles of
 Incorporation, as amended                                                                                            |                                                                                                  | Filed as
 Exhibit 3.1 to the Form 10-K Report of the Company for its year ended
 December 31, 1989 (the 1989 Form 10-K) and incorporated herein by
 reference. 
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 3.2  |                    | Bylaws, as
 amended                                                                                                               |                                                                                                  | Filed as
 Exhibit 3.2 to the 1989 Form 10-K and incorporated herein by reference.                                                                                
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.1 |                    | 1987 Stock
 Plan                                                                                                                  |                                                                                                  | Filed as
 Exhibit 10.1 to the Form 10-K Report of the Company for its year ended
 December 31, 1993 (the 1993 Form 10-K) and incorporated herein by
 reference.
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.2 |                    | Employee
 Savings Plan                                                                                                            |                                                                                                  | Filed as
 Exhibit 10.2 to the 1993 Form 10-K and incorporated herein by reference.                                                                               
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.3 |                    | Employee
 Stock Ownership Plan                                                                                                    |                                                                                                  | Filed as
 Exhibit 10.3 to the 1993 Form 10-K and incorporated herein by reference.                                                                               
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.4 |                    | Employee
 Stock Purchase Plan, as amended to December 2008                                                                        |                                                                                                  | Filed as
 Exhibit 10.4 to the 2008 Form 10-K and incorporated herein by reference.                                                                               
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.5 |                    | Stock Option
 Plan for Nonemployee Directors                                                                                      |                                                                                                  | Filed as
 Exhibit 10.5 to the 1993 Form 10-K and incorporated herein by reference.                                                                               
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.6 |                    | 1992 Stock
 Plan                                                                                                                  |                                                                                                  | Filed as
 Exhibit 10.6 to the 1993 Form 10-K and incorporated herein by reference.                                                                               
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.7 |                    | Flexible
 Benefit Plan                                                                                                            |                                                                                                  | Filed as
 Exhibit 10.7 to the 1993 Form 10-K and incorporated herein by reference.                                                                               
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.8 |                    | Supplemental
 Executive Retirement Plan                                                                                           |                                                                                                  | Filed as
 Exhibit 10.8 to the 1993 Form 10-K and incorporated herein by reference.                                                                               
|                                         |      |                    |                                                                                                                                   |                                                                                                  |                                                                                                                                                                  
|                                         | 10.9 |                    | Form of
 Rights Agreement, dated as of October 26, 1999 between the Company and Wells
 Fargo Bank Minnesota, National Association |                                                                                                  | Filed as
 Exhibit 1 to the Companys Form 8-A on November 8, 1999 and incorporated
 herein by reference.                                                         

52

---



COMMMUNICATIONS SYSTEMS, INC. AND SUBSIDIARIES
Exhibit Index To 
Form 10-K for the Year Ended December 31, 2009

|                                         |      |                    |                                           |                                                                                                  |                                    
|---------------------------------------- | ---- | ------------------ | ----------------------------------------- | ------------------------------------------------------------------------------------------------ | -----------------------------------
|Regulation S-K
 Exhibit Table
 Reference |      | Title of
 Document |                                           | Location
 in Consecutive Numbering
 System as Filed With the Securities
 and Exchange Commission
|                                         |      |                    |                                           |                                                                                                 
|                                         |      |                    |                                           |                                                                                                  |                                    
|                                         | 21   |                    | Subsidiaries
 of the Registrant           |                                                                                                  | Filed
 herewith.                   
|                                         | 23   |                    | Independent
 Auditors Report             |                                                                                                  | Filed
 herewith.                   
|                                         | 24   |                    | Power of
 Attorney                        |                                                                                                  | Included in
 signatures at page 48.
|                                         | 31.1 |                    | Certification
 of Chief Executive Officer |                                                                                                  | Filed herewith.                    
|                                         | 31.2 |                    | Certification
 of Chief Financial Officer |                                                                                                  | Filed
 herewith.                   
|                                         | 32   |                    | Certification
 under USC § 1350           |                                                                                                  | § 1350 Filed
 herewith.            

The exhibits
referred to in this Exhibit Index will be supplied to a shareholder at a charge
of $.25 per page upon written request directed to CSIs Assistant Secretary at
the executive offices of the Company.

53

---