TECHNICAL COMMUNICATIONS CORP - Annual Report: 2008 (Form 10-K)
Table of Contents
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended September 27, 2008
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-8588
Technical Communications Corporation
(Exact name of registrant as specified in its charter)
| Massachusetts | 04-2295040 | |
| (State or other jurisdiction of incorporation | (I.R.S. Employer Identification No.) | |
| or organization) | ||
| 100 Domino Drive, Concord, MA | 01742-2892 | |
| (Address of principal executive offices) | (Zip code) |
(978) 287-5100
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| None | None | |
| (Title of each class) | (Name of each exchange | |
| on which registered) |
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value
(Title of Class)
(Title of Class)
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 þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or 15(d) of the Exchange Act. YES o NO þ
Indicate by check mark whether the registrant (1) 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 þ 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 the 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. þ
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 the definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). o
Based on the closing price as of March 29, 2008, the aggregate market value of the
registrant’s Common Stock held by non-affiliates of the registrant as of March 29, 2008, was
approximately $6,799,931.
The number of shares of the registrant’s Common Stock, par value $ .10 per share, outstanding
as of December 12, 2008 was 1,448,995.
Portions of the Company’s Definitive Proxy Statement to be delivered to shareholders in
connection with the Company’s 2009 Annual Meeting of Shareholders to be held February 9, 2009 are
incorporated by reference into Part III of this Form 10-K.
TECHNICAL COMMUNICATIONS CORPORATION
Annual Report on Form 10-K
For the Year Ended September 27, 2008
For the Year Ended September 27, 2008
Table of Contents
| 2 | ||||||||
| 9 | ||||||||
| 13 | ||||||||
| 14 | ||||||||
| 14 | ||||||||
| 14 | ||||||||
| 14 | ||||||||
| 15 | ||||||||
| 16 | ||||||||
| 22 | ||||||||
| 22 | ||||||||
| 22 | ||||||||
| 22 | ||||||||
| 23 | ||||||||
| 24 | ||||||||
| 24 | ||||||||
| 24 | ||||||||
| 24 | ||||||||
| 24 | ||||||||
| 25 | ||||||||
| 27 | ||||||||
| Exhibit 21 | ||||||||
| Exhibit 23 | ||||||||
| Exhibit 31.1 | ||||||||
| Exhibit 31.2 | ||||||||
| Exhibit 32 | ||||||||
1
Table of Contents
PART I
Item 1. BUSINESS
Technical Communications Corporation (“TCC” or the “Company”) was organized in 1961 as a
Massachusetts corporation to engage primarily in consulting activities. Since the late 1960s, the
business has consisted entirely of the design, development, manufacture, distribution, marketing
and sale of communications security devices and systems. The secure communications solutions
provided by TCC protect vital information transmitted over a wide range of data, fax and voice
networks. TCC’s products have been sold into over 110 countries and are in service with
governments, military agencies, telecommunications carriers, financial institutions and
multinational corporations. The Company’s business consists of one industry segment, which is the
design, development, manufacture, distribution, marketing and sale of communications security
devices and systems.
Overview
The Company’s products consist of sophisticated electronic devices that enable users to
transmit information in an encrypted format and permit receivers to reconstitute the information in
a deciphered format if the recipient possesses the right decryption “key”. The Company’s products
can be used to protect confidentiality in communications between radios, telephones, facsimile
machines and data processing equipment over wires, fiber optic cables, radio waves and microwave
and satellite links. A customer may order and receive equipment that is specially programmed to
scramble transmissions in accordance with a code to which only the customer has access. The
principal markets for the Company’s products are foreign and domestic governmental agencies, law
enforcement agencies, financial institutions, and multinational companies requiring protection of
mission-critical information.
TCC historically and presently designs and develops its own equipment and software to meet the
requirements of general secure communications applications, as well as the custom-tailored
requirements of specific users. Management believes the coordinated development of cryptographic
software and associated hardware allows TCC to provide high-strength encryption security products
with efficient processing and transmission. Both criteria, the Company believes, are essential to
customer satisfaction.
TCC manufactures most of its own products using third-party vendors for the supply of
components and selected processing. Final assembly, software loading, testing and quality assurance
are performed by TCC at its factory. This manufacturing approach allows TCC to competitively
procure the components from multiple suppliers while maintaining control of the manufacture and
performance of the final product.
TCC’s products are sold worldwide through a variety of channels depending on the country and
the customer. Generally, TCC does not use stocking distributors because the Company’s products are
required to be sold under an applicable U.S. government license, which generally requires end-user
information. Rather, the Company sells directly to customers, original equipment manufacturers and
value-added resellers, using its in-house sales force as well as domestic and international
representatives, consultants and distributors. The marketing and selling approach varies with each
country and often involves extensive test and demonstration activity prior to the consummation of a
sale. TCC has a network of in-country representatives and consultants who conduct performance
demonstrations, market the products and close the sale, and who handle on behalf of TCC many of
the ancillary requirements pertaining to importation duties, taxes, registration fees, and product
receipt and acceptance. After-sale, in-country support by the representatives maintains customer
satisfaction and provides a liaison for the Company’s customer support services.
The worldwide market for our Government Systems products remains a principal focus for TCC, as
the Company believes increasing concerns with security will generate demand for increased
protection of both voice and data networks. Management plans selected, evolutionary upgrades to our
government/military products both to meet new requirements of the market and to provide entry into
new markets. We believe the ability of TCC to custom-tailor cryptographic functions and control
systems to meet unique customer requirements will meet a growing demand as governments become more
sophisticated in defining their communications security needs.
The U.S. government controls, through a licensing process, the distribution of encryption
technology and the sale of encryption products. The procedure for obtaining the applicable license,
from either the Department of Commerce or Department of State, is relatively straightforward. Many
of TCC’s products can be sold under existing “blanket” licenses, while some products and end-users
must be submitted for specific approval. A more detailed discussion of the licensing process is
included below in the “Regulatory Matters” section.
2
Table of Contents
2008 Highlights and Recent Events
Fiscal 2008 produced positive financial performance with improvements in both revenues and
profitability. These results reflect our successes in developing new international projects that
have a sustainable follow-on business base combined with new opportunities for the introduction of
the entire TCC product line. Both the radio and network encryption product lines produced
significant sales and orders during the year, boosting our revenues in 2008 and our business
outlook for fiscal 2009.
Revenues in fiscal 2008 increased to $6,900,000, which is a 39% increase over fiscal 2007, and
we produced a profit of $1,061,000 for the period, up 25% from 2007. These results are largely due
to continuing strong sales of our radio encryption products. In addition to the improved sales and
profit performance, TCC’s backlog at the end of the year was $7,146,000, which is a 93% increase
from the fiscal 2007 year-end position. Subsequent orders have increased backlog to approximately
$9,500,000 as of mid-December 2008, which provides a strong foundation for revenue performance in
2009 and 2010. For the fiscal year ended September 27, 2008, the Company reported revenues of
$6,852,000 as compared to $4,920,000 for the previous year. Income for fiscal year 2008 was
$1,061,000 or $0.75 per share, as compared to a net income of $846,000 or $0.62 per share in fiscal
2007.
During fiscal 2008, significant sales were generated by our DSP9000 radio encryption product
line with shipments to several customers in South America and a continuation of sales destined for
use in Afghanistan by both the coalition and indigenous forces. TCC’s DSP9000 family of radio
encryption products is a large success in many countries where the need for high quality,
ruggedized encryption is required for secure communication over the HF, UHF and VHF radio bands.
The DSP9000 products have the very attractive feature that they mate to a wide variety of radios,
providing end-to-end security between differing regions, vehicles and forces which may be using
radios produced by different manufacturers. We believe that the DSP9000 provides a universal
encryption solution that is readily deployable, cost effective and adaptable to meet unique user
requirements.
TCC’s network products also performed well in 2008. During the year, we received a contract,
currently valued at $6,300,000, for production of our DSD72A-SP Military Bulk Encryptors in support
of a major customer in the Middle East. This U.S. government foreign military sales contract will
continue the expansion of the customer’s networks and provide improved features for the user’s key
management system. We also expect that the evolution of this customer’s radio systems will provide
opportunities for upgrades and adaptations of the deployed bulk encryptors in the future. TCC
maintains a strong record of being supportive of our customers’ requirements and providing unique
customized solutions to maintain a high security level as the transmission systems change.
In the area of internal product development, TCC continues to invest in the development of new
products that expand the application and roles of our product lines. We expect that future network
encryption needs in the international government markets will be met with a new generation of very
high speed military encryptors currently under development. These encryptors are capable of
providing high speed, fiber optic connectivity combined with rugged field environment reliability
for the most demanding military applications. Other ongoing product developments are expected to
focus on creating new connectivity options that allow insertion of our encryptors into additional
networks. New universal encryption solutions for field radio security are also being researched to
provide imbedded interoperability and an expanded feature set. The
CipherTalkÒ and
CipherSMSÒ wireless products continue to evolve to meet customer requirements for new
platforms and capabilities.
TCC’s other product lines — secure telephony, custom network encryption and military data
encryption — are all performing to plan and continue to provide a solid business base for the
company. With these products and those highlighted above, TCC continues to provide a broad range of
high quality encryption equipment that meets the demanding requirements of a growing worldwide
market.
Products
The products described below are currently available and provide communications security
solutions for mission-critical networks, voice and facsimile, centralized key and device
management, and military ciphering applications.
The Government Systems product line has traditionally been the Company’s core product base and
has generated the majority of revenue for the Company in recent years. These products have proven
to be highly durable, which has led to significant repeat business from our customers. The Company
believes that these products and their derivatives will continue to be the Company’s most
significant source of future revenues.
3
Table of Contents
The Company’s Secure Office Systems products primarily consist of products that were
originally acquired through an asset and rights purchase from a subsidiary of AT&T in 1995. These
products have produced modest revenues since their acquisition. Although these products are readily
available and remain profitable, demand for them has diminished in recent years. We will continue
to offer our Secure Office Systems products from existing inventory, which we anticipate will be
sufficient for several more years. In 2005, we introduced the first in a new line of secure
wireless products as part of our Secure Office Systems product line. During 2007 we introduced a
new flip phone model for this product line. The market for this product line has developed more
slowly than we anticipated and we expect it will take the greater part of fiscal 2009 before this
product line generates consistent revenue.
Although we believe our Network Security Systems products are competitive, the demand for this
product line has been difficult to establish. Strong competition in this market coupled with weak
overall demand for network security products both domestically and overseas have hampered the
Company’s efforts to develop an active and consistent market. These products are currently
available and we believe we will be able to fulfill any customer requirements for the foreseeable
future.
Government Systems
The Company’s High Speed Data Encryptor is a rugged military system that provides a high level
of cryptographic security for data networks operating at up to 34 million bits per second. The
product supports a wide variety of interfaces and integrates into existing networks. Reliable
secure communication is achieved with communication synchronization methods built to maintain
connections in error and jamming environments such as radio relay networks, missile systems and
microwave systems.
The Company’s Narrowband Radio Security family of products provides strategic security for
voice and data communications sent over HF, VHF and UHF channels. Designed for military
environments, we believe these products provide high voice quality over poor line connections,
making them an attractive security solution for military aircraft, naval, base station and manpack
radio applications. These products provide automated key distribution for security and ease of
use. They are also radio independent because software programmable interfaces allow radio
interface levels to be changed without configuring the hardware. Base station, handset and implant
board configurations are available options and the products are compatible with the Company’s
secure telephone systems to enable “office-to-field” communications.
The Company’s Secure Telephone, Fax and Data system is a comprehensive office communications
security system that provides voice, fax and data encryption in a telephone package. The product
has a fallback mode, which was originally developed for poor HF channels. As a result, secure
communications are possible even over poor line conditions. TCC’s high-level encryption and
automated key distribution system protect sensitive information, and internal storage of 400 keys
provides hands-off security.
Secure Office Systems
The Company’s Secure Portable Telephone Attachment may be placed between any telephone and
handset worldwide to provide digital security. The attachment is small and portable, operates over
both digital and analog telephone lines, and is designed to ensure protection through new and
unique random keys negotiated with each communication session.
The Company’s Fax Security System is a secure, automatic transmission fax system that connects
to any standard facsimile machine. Security protection is achieved using key technology, which
provides randomly generated keys that are unique to each communication session. Open and closed
networks are supported by the device to enable an open exchange of secure documents in the
industrial marketplace or restrict secure communications to only authorized parties in highly
confidential or government applications.
The Company’s Executive Secure Telephone offers strategic-level voice and data security in a
full-featured executive telephone package. Exceptional voice quality can be achieved with three
different voice-coding algorithms. The product provides ease-of-use security features such as
automated key management, authentication, certification and access control.
The CipherTalk8000 is a wireless secure mobile telephone designed to provide encrypted mobile
communications anywhere in the world. Its radio interface will operate on the North American,
Latin American 850 MHz GSM band; the European, Asian, Latin American 900 MHz GSM band; the
European,
Latin American 1800 MHz GSM band; and the North American, Latin American 1900 MHz GSM band.
The CipherTalk8000, introduced in 2005, is the first product in what the Company expects to be a
new line of secure wireless products.
4
Table of Contents
Network Security Systems
The CipherONE® family of Network Security Systems consists of high-performance
hardware and software-based encryption products for local area network, wide area network and
Internet applications and includes a network security management system.
All of the CipherONE systems have been designed for node-to-node protection and therefore
provide node authentication and access control, as well as data integrity. This family of products
also utilizes a modular architecture that permits the software to be updated as networks migrate to
emerging protocols, thereby protecting the user’s investment. Network transparent, the products
support U.S. government-backed and proprietary encryption algorithms as well as industry-standard
specifications for security key management.
The Company’s Frame Relay Network Encryptor is an end-to-end frame relay encryption system and
is configured locally with Cipher Site Manager, its accompanying software configuration tool, or
remotely with KEYNETTM (discussed below).
The Company’s IP Network Encryptor provides encryption security at the Internet protocol layer
and is configured locally with Cipher Site Manager or remotely with KEYNET.
The Company’s KEYNET Network Security Management System is a Windows NT-based key and security
device management system that can centrally and simultaneously manage an entire CipherONE Security
Systems Network, including those on mixed networks. KEYNET has an intuitive graphical user
interface, making it easy to use. The system securely generates, distributes and exchanges keys,
sets address tables, provides diagnostics and performs automatic polling and alarms from central
and remote locations. KEYNET also provides instant alarm notification. These high security
measures facilitate central management while maintaining security for mission-critical networks
worldwide.
Competition
The market for communications security devices and systems is highly competitive and
characterized by rapid technological change. The Company has several competitors, including
foreign-based companies, in the communications security device field. The Company believes its
principal competitors include Crypto AG, Thales Plc, Motorola Inc., General Dynamics Corporation,
Omnisec AG, Cisco Systems, Inc., SafeNet, Inc. and Alcatel-Lucent.
The Company competes based on its service, the operational and technical features of its
products, its sales expertise and pricing. Many of TCC’s competitors have substantially greater
financial, technical, sales and marketing, distribution and other resources, greater name
recognition and longer standing relationships with customers. Competitors with greater financial
resources can be more aggressive in marketing campaigns, can survive sustained price reductions in
order to gain market share and can devote greater resources to support existing products and
develop new competing products. Any period of sustained price reductions for our products would
have a material adverse effect on the Company’s financial condition and results of operations. TCC
may not be able to compete successfully in the future and competitive pressures may result in price
reductions, loss of market share or otherwise have a material adverse effect on the Company’s
financial condition and results of operations.
Our competitive position will also depend on our ability to attract and retain qualified
personnel, obtain intellectual property protection or otherwise develop proprietary products or
processes, and secure sufficient capital resources for product, research and development efforts.
Sales and Backlog
In fiscal year 2008, the Company had two customers representing 78% of total net sales. These
consisted of sales of radio encryptors to one customer for deployment in Afghanistan amounting to
51% of sales and fees generated by our engineering services efforts for one customer representing
27% of sales. In fiscal year 2007, the Company had two customers representing 59% of total net
sales. These consisted of sales of radio encryptors to one customer for deployment in Afghanistan
amounting to 43% of sales and fees generated by our engineering services efforts for one customer
representing 16% of sales.
The Company sells directly to customers, original equipment manufacturers and value-added
resellers, using its in-house sales force as well as domestic and international representatives,
consultants
and distributors. International sales are made primarily through our main office. We seldom
have long-term contractual relationships with our customers and, therefore, generally have no
assurance of a continuing relationship within a given market.
5
Table of Contents
Orders for our products are usually placed by customers on an as-needed basis and we typically
ship products within 30 to 120 days of receipt of a customer’s firm purchase order. Our backlog
consists of all orders received where the anticipated shipping date is within 12 months. Because
of the possibility of customer changes in delivery schedules or cancellation of orders, our backlog
as of any particular date may not be indicative of sales in any future period. Our backlog as of
September 27, 2008 and September 29, 2007 was approximately $7,146,000 and $3,626,000,
respectively.
The Company expects that sales to relatively few customers will continue to account for a high
percentage of the Company’s revenues in any accounting period in the foreseeable future. A
reduction in orders from any such customer, or the cancellation of any significant order and
failure to replace such order with orders from other customers, would have a material adverse
effect on the Company’s financial condition and results of operations.
Regulatory Matters
As a party to a number of contracts with the U.S. government and its agencies, the Company
must comply with extensive regulations with respect to bid proposals and billing practices. Should
the U.S. government or its agencies conclude that the Company has not adhered to federal
regulations, any contracts to which the Company is a party could be canceled and the Company could
be prohibited from bidding on future contracts. Such a prohibition would have a material adverse
effect on the Company.
All payments to the Company for work performed on contracts with agencies of the U.S.
government are subject to adjustment upon audit by the U.S. Defense Contract Audit Agency, the
General Accountability Office, and other agencies. The Company could be required to return any
payments received from U.S. government agencies if it is found to have violated federal
regulations. In addition, U.S. government contracts may be canceled at any time by the government
with limited or no notice or penalty. Contract awards are also subject to funding approval from
the U.S. government, which involves political, budgetary and other considerations over which the
Company has no control.
The Company’s security products are subject to export restrictions administered by the U.S.
Department of Commerce and Department of State, which license the export of encryption products,
subject to certain technical restrictions. In addition, U.S. export laws prohibit the export of
encryption products to a number of hostile countries. Although to date the Company has been able
to secure necessary U.S. government export licenses, there can be no assurance that the Company
will continue to be able to secure such licenses in a timely manner in the future, or at all.
The U.S. government controls, through a licensing process, the distribution of encryption
technology and the sale of encryption products. The procedure for obtaining the applicable license
from either the Department of Commerce or the Department of State (depending on the U.S.
government’s determination of jurisdiction) is well documented. The Company submits a license
request application, which contains information pertaining to: the type of equipment being sold;
detailed technical description (if required); the buyer; the end-user and use; quantity; and
destination location. The appropriate departments of the U.S. government review the application and
a licensing decision is provided to the Company. Pursuant to the receipt of the license, the
Company may ship the product.
Many of TCC’s products can be sold under existing “blanket” licenses which have been obtained
through a variant of the licensing process that approves products for sale to certain classes of
customers (e.g. financial institutions, civilian government entities, commercial users). The
Company has obtained “blanket” licenses for its secure telephone and office system products and its
family of network encryptors. Licenses for sales of certain other products and/or to certain end
users must be submitted for specific approval as described above. Although the U.S. government
retains the right and ability to restrict product exports, the Company does not believe that U.S.
government licensing will become more restrictive or an impediment to its business. The trend,
since the mid-nineties, has been for the U.S. government to reduce the restrictions on the foreign
sale of cryptographic equipment. This trend is driven by the U.S. government’s recognition of the
technology available from foreign sources and the need to allow U.S. corporations to compete in
foreign markets. However, should the regulations become more restrictive, it would have a negative
impact on the Company’s international business, which impact could be material.
Manufacturing
TCC has several manufacturing subcontractors and suppliers that provide outside processing of
electronic circuit boards, fabrication of metal components, and supply of electronic components.
For the majority of purchased materials and services, TCC has multiple suppliers that are able to
deliver materials and services under short-term delivery purchase orders. Payment is typically made
after delivery, based upon standard credit arrangements. For a small minority of parts, there are
limited sources of supply. In such cases, TCC monitors source availability and usually stocks for
anticipated long-term requirements to
assure manufacturing continuity. Notwithstanding the Company’s efforts to maintain material
supplies, shortages can and do develop, necessitating delays in production, significant engineering
development effort to find alternative solutions and, if production cannot be maintained, the
discontinuation of the affected product design.
6
Table of Contents
The Company subcontracts a large portion of its manufacturing operations. Many of the
components used in the Company’s products are standard components available from more than one
supplier. The Company has, or believes that it could develop without significant delay,
alternative sources for almost all materials and components used in the manufacture of its
products. The Company’s internal manufacturing process consists primarily of adding critical
components, final assembly, quality control, testing and system burn-in. Delivery time varies
depending on the products and options ordered.
Technological Expertise
The Company’s technological expertise and experience, including certain proprietary rights
which it has developed and maintains as trade secrets, are crucial to the conduct of the Company’s
business. Management is of the opinion that, while patent protection is desirable with respect to
certain of its products, none of the Company’s patents are material to the conduct of its business.
Eight patents have been issued to the Company. The Company also has a number of registered and
unregistered trademarks for various products, none of which are material to the conduct of TCC’s
business.
TCC has an on-going technology license for communications protocol software used in the
CipherONE family of Network Security System products. The license is royalty-based and runs without
a specified termination date. The cost effect of this license is immaterial.
TCC has been designing and producing secure, cryptography-based communications systems for
over 40 years, during which time the Company has developed many technology techniques and
practices. This expertise and experience is in the areas of cryptographic algorithm design and
implementation, key distribution and management systems, cryptographic processors, voice and fax
encryption and electronic hardware design. TCC relies on its internal technical expertise and
experience, which TCC considers to be proprietary. These proprietary technologies are owned by
TCC, are under TCC’s control, and have been documented consistent with standard engineering
practices. It is estimated that the majority of sales during the past two years and during the next
two years will be of products that are based upon TCC-proprietary designs.
Such technological experience and expertise are important as they enable an efficient design
and development process. Loss of this experience and expertise would have an adverse impact on the
Company. However, TCC’s practices governing the internal documentation of design data mitigate some
of the risk associated with the loss of personnel who are skilled in the core competencies
described above.
With the exception of the technology license referred to above, TCC has no material third
party rights upon which the Company relies. Sales of the products associated with this license have
not been and are not anticipated to be significant to the Company’s revenues.
Research and Development
Research and development efforts are undertaken by the Company primarily on its own
initiative. In order to compete successfully, the Company must attract and retain qualified
personnel, improve existing products and develop new products. No assurances can be given that the
Company will be able to hire and train such technical management and sales personnel or
successfully improve and develop its products. During the years ended September 27, 2008 and
September 29, 2007, the Company spent $942,000 and $891,000, respectively, on product development.
In fiscal 2009, the Company expects to increase its investment in internal product
development. Our plan is to evaluate several technical options for enhancing the radio encryption
product line, which may include cryptography modifications, hardware and software changes and
partnering with radio manufacturers to incorporate imbedded solutions. The products comprising the
CT8000 secure wireless product line will likely continue to evolve and respond to new customer
requirements. It is also expected that CiperTalk Secure Voice encryption and CipherSMS Secure Text
Messaging will be applied to additional mobile platforms and that customer-specific features will
be developed. Depending on customer demand, TCC may also proceed with the development of variants
of its DSD72A-SP Military Bulk Encryptor, which would address higher speeds and additional
interfaces. On-going research and development in support of product improvements and application
variants also is expected to continue. Should the Company choose to embark on a major development
program in addition to its traditional research and development activities, engineering staff will
have to be added. The Company has sufficient
physical resources to support the added staff and believes that adequate technical resources
exist in the Boston area to meet potential needs; however we may need financial resources, in
addition to cash from operations, to fund a major new development program.
7
Table of Contents
Other than those stated above, there are no plans for significant internal product development
in fiscal 2009.
Foreign Operations
The Company is dependent upon its foreign sales. Although foreign sales were more profitable
than domestic sales during fiscal years 2008 and 2007 because the mix of products sold abroad
included more products with higher profit margins, this does not represent a predictable trend.
Sales to foreign markets have been and will continue to be affected by, among other things, the
stability of foreign governments, economic conditions, export and other governmental regulations,
and changes in technology. The Company attempts to minimize the financial risks normally associated
with foreign sales by utilizing letters of credit confirmed by U.S. banks and by using foreign
credit insurance. Foreign sales contracts are usually denominated in U.S. dollars.
The Company utilizes the services of sales representatives, consultants and distributors in
connection with foreign sales. Typically, representatives are paid commissions and consultants are
paid fixed amounts on a stipulated schedule in return for services rendered. Distributors are
granted discounted pricing.
The export from the United States of many of the Company’s products may require the issuance
of a license by the Department of State under the Arms Export Control Act of 1976, as amended, or
by the Department of Commerce under the Export Administration Act as kept in force by the
International Emergency Economic Powers Act of 1977, as amended. The licensing process is discussed
in more detail under the “Regulatory Matters” section above.
In fiscal years 2008 and 2007, sales to international customers accounted for approximately
14% and 18%, respectively, of our net sales. In fiscal 2008 a significant portion of domestic
sales (59%) were made to a domestic radio manufacturer who shipped our radio encryption products
overseas for use in Afghanistan. Based on our historical results we expect that international sales
will continue to account for a significant portion of our revenues for the foreseeable future. As a
result, we are subject to the risks of doing business internationally, including:
| • | changes in regulatory requirements, |
||
| • | domestic and foreign government policies, including requirements to expend a
portion of program funds locally and governmental industrial cooperation requirements, |
||
| • | fluctuations in foreign currency exchange rates, |
||
| • | delays in placing orders, |
||
| • | the complexity and necessity of using foreign representatives, consultants and distributors, |
||
| • | the uncertainty of the ability of foreign customers to finance purchases, |
||
| • | uncertainties and restrictions concerning the availability of funding credit or guarantees, |
||
| • | imposition of tariffs or embargoes, export controls and other trade restrictions, |
||
| • | the difficulty of managing and operating an enterprise spanning several countries, |
||
| • | compliance with a variety of foreign laws, as well as U.S. laws affecting the
activities of U.S. companies abroad, and |
||
| • | economic and geopolitical developments and conditions, including
international hostilities, acts of terrorism and governmental reactions, inflation,
trade relationships and military and political alliances. |
While these factors and their impact are difficult to predict, any one or more of these
factors could adversely affect our operations in the future.
We also may not be successful in obtaining the necessary licenses to conduct operations
abroad, and the U.S. government may prevent proposed sales to foreign governments.
Employees
As of September 27, 2008, the Company employed 27 full-time persons and two part-time
employees, as well as several part-time consultants. The Company believes that its relationships
with its employees is good.
8
Table of Contents
Item 1A. RISK FACTORS
You should carefully consider the following risk factors that affect our business. Such risk
factors could cause our actual results to differ materially from those that are expressed or
implied by forward-looking statements contained herein. The risks and uncertainties described below
are not the only ones facing us. Additional risks and uncertainties that we are unaware of, or that
we currently deem immaterial, also may become important factors that affect us. If any of the
following risks occur, our business, financial condition or results of operations could be
materially and adversely affected. You should also consider the other information included in this
Annual Report on Form 10-K for the fiscal year ended September 27, 2008 and subsequent quarterly
reports filed with the SEC.
Our quarterly operating results may fluctuate and our future revenues and profitability are
uncertain.
We have experienced significant fluctuations in our quarterly operating results during the
last five years and anticipate continued substantial fluctuations in our future operating results.
A number of factors have contributed to these quarterly fluctuations including, but not limited to:
| • | introduction and market acceptance of new products and product enhancements
by us and our competitors; |
| • | budgeting cycles of customers, including the U.S. government; |
| • | timing and execution of individual contracts; |
| • | competitive conditions in the information security industry; |
| • | changes in general economic conditions; and |
| • | shortfall of revenues in relation to expectations that formed the basis for
the calculation of fixed expenses. |
Our future success will depend on our ability to respond to rapid technological changes in the
markets in which we compete.
The markets for TCC’s products and services are characterized by rapid technological
developments, changing customer technological requirements and preferences, frequent new product
introductions, enhancements and modifications and evolving industry standards. Our success will
depend in large part on our ability to correctly identify emerging technological trends, enhance
capabilities, and develop and manufacture new technologies and products quickly, in a
cost-effective manner, and at competitive prices. The development of new and enhanced products is
a complex and costly process. We may need to make substantial capital expenditures and incur
significant research and development costs to develop and introduce such new products and
enhancements. Our choices for developing technologies may prove incorrect if customers do not
adopt the products we develop or if the technologies ultimately prove to be technically or
commercially unviable. Development schedules also may be adversely affected as the result of the
discovery of performance problems. If we fail to timely develop and introduce competitive new
technologies, our business, financial condition and results of operations would be adversely
affected.
Existing or new competitors may develop competing or superior technologies.
The industry in which the Company competes is highly competitive, and the Company has several
domestic and foreign competitors. Many of these competitors have substantially greater financial,
technical, sales and marketing, distribution and other resources, greater name recognition and
longer standing relationships with customers. Competitors with greater financial resources can be
more aggressive in marketing campaigns, can survive sustained price reductions in order to gain
market share, and can devote greater resources to support existing products and develop new
competing products. Any period of sustained price reductions for our products would have a material
adverse effect on the Company’s financial condition and results of operations. TCC may not be able
to compete successfully in the future and competitive pressures may result in price reductions,
loss of market share or otherwise have a material adverse effect on the Company’s financial
condition and results of operations. It is also possible that competing products will emerge that
may be superior in quality and performance and/or less expensive than those of the Company, or that
similar technologies may render TCC’s products obsolete or uncompetitive and prevent the Company
from achieving or sustaining profitable operations.
9
Table of Contents
The operating performance of our products is critical to our business and reputation.
The sale and use of our products entail a risk of product failure, product liability or other
claims. Occasionally, some of our products have quality issues resulting from the design or
manufacture of the product or the software used in the product. Often these issues are discovered
prior to shipment and may result in shipping delays or even cancellation of orders by customers.
Other times problems are discovered after the products have shipped, requiring us to resolve issues
in a manner that is timely and least disruptive to our customers. Such pre-shipment and
post-shipment problems have ramifications for TCC, including cancellation of orders, product
returns, increased costs associated with product repair or replacement, and a negative impact on
our goodwill and reputation.
Once our products are in use, any product failure, including software or hardware failure,
which causes a breach of security with respect to our customer’s confidential communications could
have a material adverse effect on TCC. There is no guarantee of product performance or that our
products are adequate to protect against all security breaches. While we attempt to mitigate such
risks by maintaining insurance and including warranty disclaimers and liability limitation clauses
in our agreements with customers, such mitigation devices may not protect us against liability in
all instances. If our products failed for any reason, our clients could experience data loss,
financial loss, personal and property losses, harm to reputation, and significant business
interruption. Such events may expose us to substantial liability, increased regulation and/or
penalties, as well as loss of customer business and a diminished reputation. Any product liability
claims and related litigation would likely be time-consuming and expensive, may not be adequately
covered by insurance coverage, and may delay or terminate research and development efforts,
regulatory approvals and commercialization activities.
If our products and services do not interoperate with our end-users’ products, orders could be
delayed or cancelled, which could significantly reduce our revenues.
Our products are designed to interface with our end-users’ existing products, each
of which has different specifications and utilizes multiple protocol standards. Many of our
end-users’ systems contain multiple generations of products that have been added over time as these
systems have grown and evolved. Our products and services must interoperate with all of these
products and services as well as with future products and services that might be added to meet our
end-users’ requirements. If our products do not interface with those within our end-users’ products
and systems, orders for our products could be delayed or cancelled, which could significantly
reduce our revenues.
Government regulation and legal uncertainties could harm our business.
As a party to a number of contracts with the U.S. government and its agencies, the Company
must comply with extensive regulations with respect to bid proposals and billing practices. Should
the U.S. government or its agencies conclude that the Company has not adhered to federal
regulations, any contracts to which the Company is a party could be canceled and the Company could
be prohibited from bidding on future contracts. Moreover, payments to the Company for work
performed on contracts with agencies of the U.S. government are subject to audit and adjustment.
The Company could be required to return any payments received from U.S. government agencies if it
is found to have violated federal regulations. In addition, U.S. government contracts may be
canceled at any time by the government with limited or no notice or penalty. Contract awards are
also subject to funding approval from the U.S. government, which involves political, budgetary and
other considerations over which the Company has no control.
The Company’s security products are subject to export restrictions administered by the U.S.
Department of Commerce and Department of State, which license the export of encryption products,
subject to certain technical restrictions. In addition, U.S. export laws prohibit the export of
encryption products to a number of hostile countries and some end-users. Although to date the
Company has been able to secure necessary U.S. government export licenses, there can be no
assurance that the Company will continue to be able to secure such licenses in a timely manner in
the future, or at all. Delays in obtaining necessary approvals could be costly in terms of lost
sales opportunities and compliance costs. Should export restrictions and regulations become more
restrictive, or should new laws be enacted, it could have a negative impact on the Company’s
international business, which impact could be material.
10
Table of Contents
Contracts with the U.S. government may not be fully funded at inception and are subject to
termination.
A portion of our revenues has historically been generated under agreements with the U.S.
government. Any changes or delays in the budget of the U.S. government, and in particular defense
spending, could affect our business, and funding levels are difficult to predict with any
certainty. Moreover, certain multi-year contracts are conditioned on the continuing availability
of appropriations. However, funds are typically appropriated on a fiscal-year basis, even though
contract performance may extend over many years, making future sales and revenues under multi-year
contracts uncertain. Changes in appropriations and budgets as well as economic conditions
generally in subsequent years may impact the funding for these contracts. In addition, changes in
funding and other factors may lead to the termination of such contracts. The U.S. government
typically has the right to terminate agreements for convenience with little or no penalty. Adverse
changes in funding and the termination of government contracts could have a material adverse impact
on the Company’s financial condition and results of operations.
Our international operations expose us to additional risks.
The Company is dependent upon its foreign sales and we expect that international sales will
continue to account for a significant portion of our revenues for the foreseeable future. As a
result, we are subject to the risks of doing business internationally, including imposition of
tariffs or embargoes, export controls, trade barriers and trade disputes, regulations related to
customs and export/import matters, fluctuations in foreign economies and currency exchange rates,
longer payment cycles and difficulties in collecting accounts receivable, the complexity and
necessity of using foreign representatives, consultants and distributors, tax uncertainties and
unanticipated tax costs due to foreign taxing regimes, the difficulty of managing and operating an
enterprise spanning several countries, including difficulties in maintaining effective
communications with employees and customers due to distance, language and cultural barriers, the
uncertainty of protection for intellectual property rights and differing legal systems generally,
compliance with a variety of laws and economic and geopolitical developments and conditions,
including international hostilities, armed conflicts, acts of terrorism and governmental reactions,
inflation, trade relationships and military and political alliances.
We also may not be successful in obtaining the necessary licenses to conduct operations
abroad, including the export of many of the Company’s products, and the U.S. government may prevent
proposed sales to foreign governments. Export restrictions, compliance with which imposes
additional burdens on the Company, may further provide a competitive advantage to foreign
competitors facing less stringent controls on their products and services.
Finally, an increasing focus of our business is in emerging markets, including South America
and Southwest Asia. In many of these emerging markets, we may be faced with risks that are more
significant than if we were to do business in other countries, including undeveloped legal systems,
unstable governments and economies, and potential governmental actions affecting the flow of goods
and currency.
If the protection of our intellectual property is inadequate, our competitors may gain access
to our technologies.
The Company’s technological expertise and experience, including certain proprietary rights
that it has developed and maintains as trade secrets, are crucial to the conduct of the Company’s
business and its ability to compete in the marketplace. Such technological expertise and
experience are important as they enable an efficient design and development process. Loss of this
experience and expertise would have an adverse impact on the Company. To protect our proprietary
information, we rely primarily on a combination of internal procedures, contractual provisions, and
patent, copyright, trademark and trade secret laws. Such internal procedures and contractual
provisions may not prove sufficient to maintain the confidentiality and proprietary nature of such
information and may not provide meaningful protection in the event of any unauthorized use or
disclosure. Trade secret and copyright laws afford only limited protection. Current and potential
patents and trademarks may not provide us with any competitive advantage and patents and trademarks
must be enforced and maintained to provide protection, which may prove costly and time-consuming.
11
Table of Contents
Despite our efforts to safeguard and maintain our proprietary rights, we may not be successful
in doing so or the steps taken by us may be inadequate to deter unauthorized parties from
misappropriating our technologies or prevent them from obtaining and using our proprietary
information, products and technologies. Moreover, our competitors may independently develop
similar technologies or design around patents issued to us.
Other parties may have patent rights relating to the same subject matter covered by our
products or technologies, enabling them to prevent us from operating without obtaining a license
and paying royalties. Third parties also may challenge our patents or proprietary rights or claim
we are infringing on their rights. Any claims of infringement or misappropriation, with or without
merit, would likely be time-consuming, result in costly litigation and diversion of resources, and
cause delays in the development and commercialization of our products. We may be required to
expend significant resources to develop non-infringing intellectual property, pay royalties or
obtain licenses to the intellectual property that is the subject of such litigation. Royalties may
be costly and licenses, if required, may not be available on terms acceptable to us, the absence of
which could seriously harm our business.
In addition, the laws and enforcement mechanisms of some foreign countries may not offer the
same level of protection as do the laws of the United States. Legal protections of our rights may
be ineffective in such countries, and technologies developed in such countries may not be protected
in jurisdictions where protection is ordinarily available. Our inability to protect our
intellectual property both in the United States and abroad would have a material adverse effect on
our financial condition and results of operations.
The Company relies on a small number of customers for a large percentage of its revenues.
We will be successful only if a significant number of customers adopt our secure
communications products. Historically the Company has had a small number of customers representing
a large percentage of its total sales. Although the Company endeavors to expand its customer base,
we expect that sales to relatively few customers will continue to account for a high percentage of
our revenues in any given period for the foreseeable future. This reliance makes us particularly
susceptible to factors affecting those customers. If such customers’ business declines and as a
result our sales to such customers decline without corresponding sales orders from other customers,
our financial condition and results of operations could be adversely affected. It is difficult to
predict the rate at which customers will use our products, even in the case of repeat customers,
and we do not typically have long-term contractual arrangements.
We may not be able to maintain effective product distribution channels.
We rely on both an in-house sales force as well as domestic and international representatives,
consultants and distributors for the sale and distribution of our products. Our sales and
marketing organization may be unable to successfully compete against more extensive and well-funded
operations of certain of our competitors. In addition, we must manage sales and marketing
personnel in numerous countries around the world with the concomitant difficulties in maintaining
effective communications due to distance, language and cultural barriers. Further, certain of our
distributors may carry competing products lines, which may negatively impact our sales revenues.
We rely on single or limited sources for the manufacture and supply of certain product
components.
For a small percentage of parts, we rely upon a single or a limited number of
manufacturers and suppliers. Moreover, because we depend on third party manufacturers and
suppliers, we do not directly control product delivery schedules or product quality. In addition,
we cannot assure you that we will be able to maintain satisfactory contractual relations with our
manufacturers and suppliers. A significant delay in delivering products to our customers, whether
from unforeseen events such as natural disasters or otherwise, could have a material adverse effect
on our results of operations and financial condition. If we lose any of our manufacturers or
suppliers, we expect that it would take from three to six months for a new manufacturer or supplier
to begin full-scale production of one of our products. The delay and expense associated with
qualifying a new manufacturer or supplier and commencing production could result in a material loss
of revenue and reduced operating margins and harm our relationships with customers. While we have
not experienced any significant supply problems or problems with the quality of the manufacturing
process of our suppliers and there have been no materially late deliveries of components or parts
to date, it
is possible that in the future we may encounter problems in the manufacturing process or shortages
in parts, components or other elements vital to the manufacture, production and sale of our
products.
12
Table of Contents
The loss of existing key management and technical personnel or the inability to attract new
hires could have a detrimental effect on the Company.
Our success depends on identifying, hiring, training, and retaining qualified professionals.
Competition for qualified employees in our industry is intense and we expect this to remain so for
the foreseeable future. If we were unable to attract and hire a sufficient number of employees, or
if a significant number of our current employees or any of our senior managers resign, we may be
unable to complete or maintain existing projects or bid for new projects of similar scope and
revenue. The Company’s success is particularly dependent on the retention of existing management
and technical personnel, including Carl H. Guild, Jr., the Company’s President and Chief Executive
Officer. Although the Company has entered into an employment agreement with Mr. Guild, the loss or
unavailability of his services could impede our ability to effectively manage our operations.
We may need to expand our operations and we may not effectively manage any future growth.
As of December 12, 2008, we employed 28 full-time and two part-time people as well as several
part-time consultants. In the event our products and services obtain greater market acceptance, we
may be required to expand our management team and hire and train additional technical and skilled
personnel. We may need to scale up our operations in order to service our customers, which may
strain our resources, and we may be unable to manage our growth effectively. If our systems,
procedures, and controls are inadequate to support our operations, growth could be delayed or
halted, and we could lose our opportunity to gain significant market share. In order to achieve and
manage growth effectively, we must continue to improve and expand our operational and financial
management capabilities. Any inability to manage growth effectively could have a material adverse
effect on our business, results of operations, and financial condition.
Item 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
13
Table of Contents
Item 2. PROPERTIES
In April 2007, the Company entered into a new lease for its current facilities. This lease is
for 22,800 square feet located at 100 Domino Drive, Concord, MA. The Company has been a tenant in
this space since 1983 and believes its condition is good. This is the Company’s only facility and
houses all manufacturing, research and development, and corporate operations. The term of the
lease is for five years through March 31, 2012 at an annual rate of $159,000. In addition the lease
contains options to extend the lease for two and one half years through September 30, 2014 and
another two and one half years through March 31, 2017, at an annual rate of $171,000. Rent expense
for the years ended September 27, 2008 and September 29, 2007 was $159,000 and $154,000,
respectively.
Item 3. LEGAL PROCEEDINGS
There are no current legal proceedings as to which TCC is a party.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to security holders for a vote during the fourth quarter of
the Company’s 2008 fiscal year.
PART II
| Item 5. | MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES |
The Company’s Common Stock, par value $0.10 per share, is traded on the Over-The-Counter
Bulletin Board, under the symbol “TCCO.OB”. The following table presents low and high bid
information for the time periods specified. The over-the-counter market quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily
represent actual transactions. The NASDAQ Stock Market, Inc. has furnished the over-the-counter
market quotations.
| Price | ||||||||||||
| Title of Class | Quarter Ending | Low | High | |||||||||
Common Stock,
$.10 par value |
9/27/2008 | $ | 4.51 | $ | 6.40 | |||||||
| 6/28/2008 | 5.00 | 7.30 | ||||||||||
| 3/29/2008 | 4.40 | 7.49 | ||||||||||
| 12/29/2007 | 4.05 | 5.95 | ||||||||||
| 9/29/2007 | $ | 4.00 | $ | 6.30 | ||||||||
| 6/30/2007 | 2.95 | 5.60 | ||||||||||
| 3/31/2007 | 3.00 | 4.25 | ||||||||||
| 12/30/2006 | 2.71 | 3.30 | ||||||||||
The Company has paid no cash dividends in the past and has no plans to pay cash dividends in
the foreseeable future. In addition, pursuant to the loan agreement entered into on November 5,
2004 with Bank of America, the Company is prohibited from paying dividends.
As of December 12, 2008, there were approximately 800 record holders of our Common Stock.
On December 12, 2008, the closing price of the Common Stock was $3.98.
14
Table of Contents
Equity Compensation Plan Information
The following table presents information about the Technical Communications Corporation 2005
Non-Statutory Stock Option Plan, the Technical Communications Corporation 2001 Stock Option Plan
and the Technical Communications Corporation 1991 Stock Option Plan (which plan has expired but
under which there are still options outstanding) as of the fiscal year ended September 27, 2008.
For more information on these plans, see the discussion of the Company’s stock option plans and
stock-based compensation plans included in Note 2 to the Company’s financial statements at and as
of September 27, 2008, included herewith.
| Number of | ||||||||||||
| Number of securities to | Weighted average | securities | ||||||||||
| be issued upon exercise | exercise price of | remaining | ||||||||||
| of outstanding options, | outstanding options, | available for | ||||||||||
| Plan category | warrants and rights | warrants and rights | future issuance | |||||||||
Equity compensation plans approved by stockholders |
447,534 | (1) | $ | 2.54 | — | |||||||
Equity compensation plans not approved by
stockholders |
133,500 | (2) | $ | 4.54 | 16,500 | |||||||
Total |
581,034 | $ | 3.05 | 16,500 | ||||||||
| (1) | Of the 447,534 options outstanding as of September 27, 2008, 441,994 were exercisable as of
such date at an average exercise price of $2.53 per share. |
|
| (2) | Of the 133,500 options outstanding as of September 27, 2008, 73,400 were exercisable as of such
date at an average exercise price of $4.24 per share. |
During 1995 the Company established the Technical Communications Corporation 1995 Employees’
Stock Purchase Plan (the “Purchase Plan”), which was available to all employees who had at least
one year of continuous employment with TCC, worked more than 20 hours per week or more than five
months per year, and whose ownership did not exceed 5% as a result of participation in the Purchase
Plan. The plan allowed employees to purchase, through the grant of options, Common Stock of the
Company at a discounted price through payroll withholdings. The purchase price was set at 85% of
the lesser of the market value of the Company’s Common Stock as of the grant date or the exercise
date. For executive officers, the purchase price was set at the average of the market value of the
Company’s Common Stock as of the grant date and the exercise date. Market value was defined as, as
of a particular date, the last sale price of our Common Stock if quoted on an exchange or, if not
so quoted, the average of bid and asked prices for the Common Stock last quoted by NASDAQ in the
over-the-counter market. The Purchase Plan had 100,000 shares authorized for distribution of which
44,268 were still available for issuance as of September 30, 2006. The Purchase Plan expired on
September 30, 2006 and there is no current intention to renew such plan.
Sales of Unregistered Securities and Repurchases by Issuer and Affiliated Purchasers
There were no sales by the Company of unregistered shares of the Company’s Common Stock during
the 2008 fiscal year or repurchases of such stock by or on behalf of the Company or any affiliated
purchaser during the fourth fiscal quarter of the 2008 fiscal year.
Item 6. SELECTED FINANCIAL DATA
Not applicable.
15
Table of Contents
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the Company’s financial condition and results of operations should
be read in conjunction with the Company’s audited consolidated financial statements and notes
thereto appearing elsewhere herein.
Forward-Looking Statements
The following discussion may contain statements that are not purely historical. Such
statements contained herein or as may otherwise be incorporated by reference herein constitute
“forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements include but are not limited to statements regarding anticipated
operating results, future earnings, and the ability to achieve growth and profitability. Such
forward-looking statements involve known and unknown risks, uncertainties and other factors,
including but not limited to future changes in export laws or regulations; changes in technology;
the effect of foreign political unrest; the ability to hire, retain and motivate technical,
management and sales personnel; the risks associated with the technical feasibility and market
acceptance of new products; changes in telecommunications protocols; the effects of changing costs,
exchange rates and interest rates; and the Company’s ability to secure adequate capital resources.
Such risks, uncertainties and other factors could cause the actual results, performance or
achievements of the Company, or industry results, to be materially different from any future
results, performance or achievements expressed or implied by such forward-looking statements. For
a more detailed discussion of the risks facing the Company, see the Company’s filings with the
Securities and Exchange Commission, including this Form 10-K for the fiscal year ended September
27, 2008 and the “Risk Factors” section included herein.
Overview
TCC designs, manufactures, markets and sells communications security equipment that utilizes
various methods of encryption to protect the information being transmitted. Encryption is a
technique for rendering information unintelligible, which information can then be reconstituted if
the recipient possesses the right decryption “key”. The Company manufactures several standard
secure communications products and also provides custom-designed, special-purpose secure
communications products for both domestic and international customers. The Company’s products
consist primarily of voice, data and facsimile encryptors. Revenue is generated primarily from the
sale of these products, which have traditionally been to foreign governments. However, we have also
sold these products to commercial entities and U.S. government agencies. We also generate revenues
from contract engineering services performed for certain government agencies, both domestic and
foreign.
Critical Accounting Policies and Significant Judgments and Estimates
The discussion and analysis of our financial condition and results of operations are based on
our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these consolidated
financial statements requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and expenses during the
reporting periods.
On an ongoing basis, management evaluates its estimates and judgments, including those related
to revenue recognition, receivable reserves, inventory reserves, income taxes and stock-based
compensation. Management bases its estimates on historical experience and on various other factors
that are believed to be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that are not readily apparent
from other sources. By their nature estimates are subject to an inherent degree of uncertainty.
Actual results may differ from these estimates under different assumptions or conditions and such
differences may be material.
The accounting policies that management believes are most critical to aid in fully
understanding and evaluating our reported financial results include those listed below. For a more
detailed discussion, see Note 2 in the Notes to Consolidated Financial Statements included
herewith.
16
Table of Contents
Revenue Recognition
We recognize revenue from product sales in accordance with SEC Staff Accounting Bulletin No.
101, “Revenue Recognition,” as updated by Staff Accounting Bulletin No. 104. Product revenue is
recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable,
delivery of the product to the customer has occurred and we have determined that collection of the
fee is probable. Title to the product generally passes upon shipment of the product, as the
products are shipped FOB shipping point, except for certain foreign shipments. If the product
requires installation to be performed by TCC, all revenue related to the product is deferred and
recognized upon completion of the installation. We provide for a warranty reserve at the time the
product revenue is recognized.
We perform funded research and development and technology development for commercial companies
and government agencies under both cost reimbursement and fixed-price contracts. Cost
reimbursement contracts provide for the reimbursement of allowable costs and, in some situations,
the payment of a fee. These contracts may contain incentive clauses providing for increases or
decreases in the fee depending on how costs compare with a budget. Revenue from reimbursement
contracts is recognized as services are performed. On fixed-price contracts that are expected to
exceed one year in duration, revenue is recognized pursuant to the percentage of completion method
based upon the proportion of costs incurred to the total estimated costs for the contract. In each
type of contract, we receive periodic progress payments or payments upon reaching interim
milestones, and retain the rights to the intellectual property developed in government contracts.
All payments to TCC for work performed on contracts with agencies of the U.S. government are
subject to audit and adjustment by the Defense Contract Audit Agency. Adjustments are recognized
in the period made. When the current estimates of total contract revenue and contract costs for
product development contracts indicate a loss, a provision for the entire loss on the contract is
recorded. Any losses incurred in performing funded research and development projects are
recognized as funded research and development expenses.
Cost of product revenue includes material, labor and overhead. Costs incurred in connection
with funded research and development and other revenue arrangements are included in cost of sales.
Inventory
We value our inventory at the lower of actual cost to purchase and/or manufacture or the
current estimated market value (based on the estimated selling prices, less the cost to sell) of
the inventory. We periodically review inventory quantities on hand and record a provision for
excess and/or obsolete inventory based primarily on our estimated forecast of product demand, as
well as historical usage. Due to the custom and specific nature of certain of our products, demand
and usage for products and materials can fluctuate significantly. A significant decrease in demand
for our products could result in a short-term increase in the cost of inventory purchases and an
increase of excess inventory quantities on hand. In addition, our industry is characterized by
rapid technological change, frequent new product development and rapid product obsolescence, any of
which could result in an increase in the amount of obsolete inventory quantities on hand.
Therefore, although we make every effort to ensure the accuracy of our forecasts of future product
demand, any significant unanticipated changes in demand or technological developments could have a
significant negative impact on the value of our inventory and would reduce our reported operating
results.
Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in
the future. The estimated allowance for uncollectible amounts is based primarily on a specific
analysis of accounts in the receivable portfolio and historical write-off experience. While
management believes the allowance to be adequate, if the financial condition of our customers were
to deteriorate, resulting in an impairment of their ability to make payments, additional allowances
may be required, which would reduce net income.
17
Table of Contents
Accounting for Income Taxes
The preparation of our consolidated financial statements requires us to estimate our income
taxes in each of the jurisdictions in which we operate, including those outside the United States,
which may subject the Company to certain risks that ordinarily would not be expected in the United
States. The income tax accounting process involves estimating our actual current exposure together
with assessing temporary differences resulting from differing treatments of items, such as deferred
revenue, for tax and accounting purposes. These differences result in the recognition of deferred
tax assets and liabilities. We must then record a valuation allowance to reduce our deferred tax
assets to the amount that is more likely than not to be realized.
Significant management judgment is required in determining our provision for income taxes, our
deferred tax assets and liabilities, and any valuation allowance recorded against deferred tax
assets. We have recorded a valuation allowance against our deferred tax assets of $3.0 million as
of September 27, 2008, due to uncertainties related to our ability to utilize these assets. The
valuation allowance is based on our estimates of taxable income by jurisdiction and the period over
which our deferred tax assets will be recoverable. In the event that actual results differ from
these estimates or we adjust these estimates in future periods, we may need to adjust our valuation
allowance, which could materially impact our financial position and results of operation.
Due to the nature of our current operations in foreign countries (selling products into these
countries with the assistance of local representatives), the Company has not been subject to any
foreign taxes in recent years. Also, it is not anticipated that we will be subject to foreign taxes
in the near future.
Stock Based Compensation
Effective October 1, 2006, we adopted the provisions of the SFAS No. 123R, “Share-Based
Payment” (“SFAS No. 123R”). Under SFAS No. 123R, we are required to record compensation cost for
all share-based payments granted after the date of adoption based on the grant date fair value,
estimated in accordance with the provisions of SFAS No. 123R, and for the unvested portion of all
share-based payments previously granted that remain outstanding based on the grant date fair value,
estimated in accordance with the original provisions of SFAS No. 123. We expense share-based
compensation under the straight-line method.
The choice of a valuation technique, and the approach utilized to develop the underlying
assumptions for that technique, involve significant judgments. These judgments reflect management’s
assessment of the most accurate method of valuing the stock options we issue, based on our
historical experience, knowledge of current conditions and beliefs of what could occur in the
future given available information. Our judgments could change over time as additional information
becomes available to us, or the facts underlying our assumptions change over time. Any change in
our judgments could have a material effect on our financial statements. We believe that our
estimates incorporate all relevant information and represent a reasonable approximation in light of
the difficulties involved in valuing non-traded stock options.
Results of Operations
Year ended September 27, 2008 as compared to year ended September 29, 2007
Net Sales
Net sales for the years ended September 27, 2008 and September 29, 2007 were $6,852,000 and
$4,920,000, respectively, an increase of $1,932,000 or 39%. Sales for fiscal 2008 consisted of
$5,865,000, or 86%, from domestic sources and $987,000, or 14%, from international customers as
compared to fiscal 2007, in which sales consisted of $4,018,000, or 82%, from domestic sources and
$902,000, or 18%, from international customers.
18
Table of Contents
Foreign sales consisted of shipments to 13 different countries during the year ended September
27, 2008 and 15 different countries during the year ended September 29, 2007. A sale is attributed
to a foreign country based on the location of the contracting party. Domestic revenue may include
the sale of products shipped through domestic resellers or manufacturers to international
destinations. The table below summarizes our principal foreign sales by country:
| 2008 | 2007 | |||||||
Columbia |
$ | 639,000 | $ | 478,000 | ||||
Indonesia |
— | 117,000 | ||||||
Saudi Arabia |
94,000 | 6,000 | ||||||
Sweden |
— | 99,000 | ||||||
Other |
254,000 | 202,000 | ||||||
| $ | 987,000 | $ | 902,000 | |||||
Revenue for fiscal 2008 was primarily derived from the sale of our narrowband radio encryptors
to a U.S. radio manufacturer amounting to $3,486,000. There were additional sales of our narrowband
radio encryptors to five (two domestic and three foreign) customers amounting to $461,000. We also
sold our data link encryptors to two domestic customers amounting to $157,000 during the 2008
fiscal year. Foreign sales for fiscal 2008 included a sale of our secure telephone, fax, and data
encryptors to a South American customer amounting to $400,000 and a sale of our frame relay and
internet protocol encryptor product line to two customers amounting to $183,000. In addition, we
had billings under two programs with the U.S. government for engineering services work amounting to
$1,887,000.
Revenue for fiscal 2007 was primarily derived from the sale of our narrowband radio encryptors
to three domestic customers amounting to $2,674,000 and to a customer in Colombia amounting to
$462,000. Additional sales during the period included a sale of our secure telephone, fax, and
data encryptors to a customer in Indonesia amounting to $120,000, an order from a customer in
Bahrain for our fax encryptors amounting to $71,000 and the sale of $99,000 worth of encryption
equipment used in missile testing systems to a customer in Sweden. We also generated $338,000 in
revenue as a result of a license agreement with a large domestic radio manufacturer. This customer
also purchased $119,000 worth of integrated circuit chips during the period. In addition, we had
billings under two programs with the U.S. government for engineering services work amounting to
$769,000.
Gross Profit
Gross profit for fiscal year 2008 was $4,189,000, an increase of $784,000 or 23%, compared to
gross profit of $3,405,000 for fiscal year 2007. Gross profit expressed as a percentage of sales
was 61% in fiscal year 2008 compared to 69% in the prior year. The decrease in gross profit as a
percentage of sales was primarily associated with revenue generated from the license agreement in
the second quarter of fiscal 2007 with a military radio manufacturer and several other sales of
higher margin products in fiscal 2007.
Operating Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for fiscal 2008 were $2,335,000, as compared to
$1,748,000 for fiscal 2007. This increase of 34% was primarily attributable to an increase in
general and administrative expenses of $198,000 and an increase in selling and marketing expenses
of $389,000 during the 2008 fiscal year.
The increase in general and administrative costs during 2008 was primarily attributable to an
increase in personnel-related costs of approximately $26,000 and an increase in the recognition of
stock-based compensation expense of $28,000. There was also an increase in consulting and
professional fees of approximately $95,000 and an increase in bad debt expense of $25,000 during
the 2008 fiscal year.
The increase in selling and marketing costs was primarily attributable to an increase in third
party sales and marketing activities of $304,000 and an increase in new product evaluation
activities of $62,000, and a slight increase in personnel-related costs of $17,000 as compared to
fiscal 2007.
19
Table of Contents
Product Development
Product development costs for the year ended September 27, 2008 were $942,000, compared to
$891,000 for the year ended September 29, 2007, an increase of $51,000 or 6%. This increase was
primarily attributable to an increase in personnel-related costs of $299,000, an increase in the
recognition of stock-based compensation expense of $18,000 and an increase in outside consulting
costs of $69,000 during the year ended September 27, 2008. There was also an increase in materials
utilized on internal product development projects of approximately $18,000 and an increase in
employee training of approximately $10,000. These fiscal 2008 increases were partially offset by
an increase in billable contract engineering work and engineering efforts for bid and proposal work
and new product evaluation, which decreased product development costs by approximately $384,000, as
personnel were redeployed from internal product development efforts to support these other efforts.
The Company actively sells its engineering services in support of funded research and
development. The receipt of these orders is sporadic, although such programs can span over several
months. In addition to these programs, the Company also invests in research and development to
enhance its existing products or to develop new products, as it deems appropriate. During fiscal
2008, the level of billable engineering services work increased to $1,887,000 from $799,000 for the
fiscal year ended September 29, 2007. This revenue was generated under two programs with the U.S.
government.
It is anticipated that cash from operations will fund our near-term research and development
and marketing activities. However, any increase in activities — either billable or new product
related — will require additional resources, which we may not be able to fund through cash from
operations. We believe that, in the long term, based on current billable activities and the recent
improvement in business prospects, cash from operations will be sufficient to meet the development
goals of the Company, although we can give no assurances. In circumstances where resources will be
insufficient, the Company will look to other sources of financing including debt and/or equity
investments.
Net Income
The Company generated net income of $1,061,000 for fiscal year 2008 as compared to net income
of $846,000 for fiscal year 2007, a $215,000 increase in profits. This 25% increase in
profitability is primarily attributable to an increase in gross profits of $784,000, offset by an
increase in operating expenses of $638,000 as compared to fiscal year 2008. During fiscal year
2008, $75,000 of the prior year deferred tax valuation allowance was reversed, due to the
determination by the Company that the benefits of the deferred tax asset will more likely than not
be realized in future years. This amount related to prior year operating activities and was
recorded as a reduction of current year income tax expense.
The effects of inflation and changing costs have not had a significant impact on sales or
earnings in recent years. As of September 27, 2008, none of the Company’s monetary assets or
liabilities was subject to foreign exchange risks. The Company usually includes an inflation
factor in its pricing when negotiating multi-year contracts with customers.
Liquidity and Capital Resources
Cash and cash equivalents increased by $1,001,000, or 38%, to $3,623,000 as of September 27,
2008, from a balance of $2,622,000 at September 29, 2007. This increase was primarily attributable
to cash generated from operations of $939,000 and proceeds from stock issuances of $283,000.
Non-cash stock-based compensation of $146,000 and a reduction of accounts payable and other accrued
expenses of $70,000 were offset by an increase in accounts receivable of $302,000, an increase in
deferred tax assets of $75,000 and fixed asset additions of $221,000 during the period.
Our results during fiscal 2008 met our expectations. We were able to secure several large
orders for our radio encryption products which are being deployed in Afghanistan by our customer, a
domestic radio manufacturer. Approximately $3,500,000 in orders shipped to this customer during
fiscal 2008. In fiscal 2007, we secured two new programs for our engineering services work
amounting to $2,400,000. During the third quarter ended June 28, 2008 we received an amendment to
one of these contracts adding
an additional $1,200,000 in funding. These programs are billed monthly for time and materials
incurred and are expected to be completed in fiscal 2009. We billed a total of $1,887,000 during
2008 under these programs. In addition, we had previously completed the development of a major
upgrade program for our customer in Egypt, which was important to the Company because it opened the
door for future hardware procurements of our upgraded product line. The results of this effort were
realized in April 2008 with the award of a contract from the U.S. Army, Communications and
Electronics Command (CECOM) for upgrades and supplies to be shipped to Egypt amounting to
$5,750,000. During the first quarter of fiscal 2009 we received an amendment to this contract for
an additional $610,000 of encryption equipment. These orders are expected to ship over the next 24
months.
20
Table of Contents
Backlog at September 27, 2008 amounted to $7,146,000. The orders in backlog are expected to
ship during fiscal 2009 and 2010 depending on customer requirements and product availability.
The Company has a line of credit agreement with Bank of America (the “Bank”), for a line of
credit not to exceed the principal amount of $600,000. The line is supported by a financing
promissory note. The loan is a demand loan with interest payable at the Bank’s prime rate plus 1%
on all outstanding balances. The loan is secured by all assets of the Company (excluding consumer
goods) and requires the Company to maintain its deposit accounts with the Bank, as well as comply
with certain other covenants. The Company believes this line of credit agreement provides it with
an important external source of liquidity, if necessary. There were no cash borrowings against the
line during fiscal years 2008 and 2007.
Certain foreign customers require the Company to guarantee bid bonds and performance of
products sold. These guaranties typically take the form of standby letters of credit. Guaranties
are generally required in amounts of 5% to 10% of the purchase price and last in duration from
three months to one year. At September 27, 2008 and September 29, 2007 there were no outstanding
standby letters of credit. The Company secures its outstanding standby letters of credit with the
line of credit facility with the Bank.
In April 2007, the Company entered into a new lease for its current facilities. This lease is
for 22,800 square feet located at 100 Domino Drive, Concord, MA. The Company has been a tenant in
this space since 1983. This is the Company’s only facility and houses all manufacturing, research
and development, and corporate operations. The term of the lease is for five years through March
31, 2012 at an annual rate of $159,000. In addition the lease contains options to extend the lease
for two and one half years through September 30, 2014 and another two and one half years through
March 31, 2017, at an annual rate of $171,000. Rent expense for the years ended September 27, 2008
and September 29, 2007 was $159,000 and $154,000, respectively.
The Company does not anticipate any significant capital expenditures during fiscal 2009.
In fiscal 2009, the Company expects to increase its investment in internal product
development. Our plan is to evaluate several technical options for enhancing the radio encryption
product line which may include cryptography modifications, hardware and software changes and
partnering with radio manufacturers to incorporate imbedded solutions. The products comprising the
CT8000 secure wireless product line will likely continue to evolve and respond to new customer
requirements. It is also expected that CiperTalk Secure Voice encryption and CipherSMS Secure Text
Messaging will be applied to additional mobile platforms and that customer-specific features will
be developed. Depending on customer demand, TCC may also proceed with the development of variants
of its DSD72A-SP Military Bulk Encryptor, which would address higher speeds and additional
interfaces. On-going research and development in support of product improvements and application
variants also is expected to continue. Should the Company choose to embark on a major development
program in addition to its traditional research and development activities, engineering staff will
have to be added. The Company has sufficient physical resources to support the added staff and
believes that adequate technical resources exist in the Boston area to meet potential needs;
however we may need financial resources, in addition to cash from operations, to fund a major new
development program.
Other than those stated above, there are no plans for significant internal product development
in fiscal 2009.
Based on today’s product cost structure and operating expenses, we believe that current cash
and accounts receivable balances along with the current backlog are sufficient to provide resources
to operate the Company through the end of fiscal year 2009. As a result of our profitability during
fiscal 2008 and the backlog at September 27, 2008 we are optimistic about future sales growth and
other possible sources of financing, including private equity funding or future public stock
offerings. However, there is no assurance that any of these goals can be achieved. Due to the
uncertainty of the timing of customer orders, future results remain difficult to predict. Receiving
orders and contracts in a timely manner is essential to the Company’s ability to sustain
operations.
21
Table of Contents
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
Recent Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair
Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosure requirements regarding fair value measurement. SFAS
No. 157 initially became effective for fiscal years beginning after November 15, 2007. In November
2007, the FASB deferred the effective date of SFAS No. 157 until November 15, 2008 for all
non-financial assets and liabilities, except those that are recognized or disclosed at fair value
in the financial statements on a recurring basis. The Company is currently reviewing the statement
to determine the impact and materiality of its adoption by the Company, if any.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of
Statement of Financial Accounting Standards No. 115” (“SFAS No. 159”), which permits companies to
choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is
effective for fiscal years beginning after November 15, 2007 and interim periods within those
fiscal years. The Company is currently reviewing the statement to determine the impact and
materiality of its adoption by the Company, if any.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and notes thereto listed in the accompanying index to financial
statements (Item 15) are filed as part of this Annual Report on Form 10-K and are incorporated
herein by reference.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 9A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. The Company’s chief executive officer and
chief financial officer have reviewed and evaluated the effectiveness of the Company’s disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period
covered by this Annual Report on Form 10-K. Based on that review and evaluation, the chief
executive officer and chief financial officer have concluded that the Company’s current disclosure
controls and procedures, as designed and implemented, are effective to ensure that such officers
are provided with information relating to the Company required to be disclosed in the reports the
Company files or submits under the Exchange Act and that such information is recorded, processed,
summarized and reported within the specified time periods.
Management’s report on internal control over financial reporting. Our disclosure controls and
procedures include components of our internal control over financial reporting. In designing and
evaluating our disclosure controls and procedures management recognizes that any controls, no
matter how well designed and operated, can provide only reasonable, but not absolute, assurance
that misstatements
due to error or fraud will not occur or that all control issues and instances of fraud, if any,
with our Company have been detected.
22
Table of Contents
Under the supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, we conducted an assessment of the effectiveness
of our internal control over financial reporting as of September 27, 2008. In making this
assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) in Internal Control—Integrated Framework.
A goal of the assessment was to determine whether any material weaknesses or significant
deficiencies existed with respect to the Company’s internal control over financial reporting. A
“material weakness” is defined as a significant deficiency, or a combination of significant
deficiencies, that results in more than a remote likelihood that a material misstatement of the
annual or interim financial statements will not be prevented or detected. A “significant
deficiency” is a control deficiency, or a combination of control deficiencies, that adversely
affects a company’s ability to initiate, authorize, record, process or report external financial
data reliably in accordance with generally accepted accounting principles such that there is more
than a remote likelihood that a misstatement of the annual or interim financial statements that is
more than inconsequential will not be prevented or detected.
In the course of our assessment our management identified a control deficiency because we
lacked sufficient staff to segregate accounting duties.
Based on this assessment, we believe the control deficiency resulted primarily because we have
the equivalent of one and one- half persons performing all accounting-related on-site duties. As a
result, we did not maintain adequate segregation of duties within our critical financial reporting
applications, the related modules and financial reporting processes. This control deficiency could
result in a misstatement of balance sheet and income statement accounts in our interim or annual
consolidated financial statements that would not be detected. Accordingly, management has
determined that this control deficiency constitutes a material weakness.
Our management is in the process of actively addressing and remediating the material weakness
in internal control over financial reporting described above. During the fiscal year ending
September 26, 2009, we intend to undertake actions to remediate the material weakness identified to
allow for appropriate checks and reviews of internal control record-keeping and reporting.
We believe that the steps outlined above will strengthen our internal control over financial
reporting and address the identified material weakness. As part of our 2009 assessment of internal
control over financial reporting, our management will test and evaluate any additional controls
implemented to assess whether they are operating effectively.
We intend to continue to remediate material weaknesses and enhance our internal controls but
cannot guarantee that our efforts will result in remediation of our material weakness or that new
issues will not be exposed in this process.
This annual report does not include an attestation report of our independent registered public
accounting firm regarding internal control over financial reporting. Management’s report was not
subject to attestation by our independent registered public accounting firm pursuant to the
temporary rules of the Securities and Exchange Commission that permit us to provide only
management’s report in this annual report.
Changes in internal control over financial reporting. There were no changes in the Company’s
internal control over financial reporting that occurred during its fourth quarter of fiscal 2008
that have materially affected, or are reasonably likely to materially affect, the Company’s
internal control over financial reporting.
Item 9B. OTHER INFORMATION
Not applicable.
23
Table of Contents
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item 10 is incorporated herein by reference to our Definitive
Proxy Statement, under the captions “Members of the Board of Directors, Nominees and Executive
Officers,” “Certain Relationships and Related Person Transactions,” “Corporate Governance,” and
“Section 16(a) Beneficial Ownership Reporting Compliance,” with respect to our 2009 Annual Meeting
of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days
after the end of the Company’s 2008 fiscal year.
The Company has adopted a Code of Business Conduct and Ethics, which applies to all of its
employees, officers and directors. A copy of this code can be found on the Company’s website at
www.tccsecure.com.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated herein by reference to our Definitive
Proxy Statement, under the captions “Compensation” and “Compensation Discussion and Analysis” with
respect to our 2009 Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the Company’s 2008 fiscal year.
| Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS |
The information required by this Item 12 is incorporated herein by reference to Part II, Item
5 herein under the caption “Equity Compensation Plan Information” and by reference to our
Definitive Proxy Statement, under the caption “Security Ownership of Certain Beneficial Owners and
Management,” with respect to our 2009 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission not later than 120 days after the end of the Company’s 2008
fiscal year.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this Item 13 is incorporated herein by reference to our Definitive
Proxy Statement, under the captions “Certain Relationships and Related Person Transactions” and
“Corporate Governance” with respect to our 2009 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission not later than 120 days after the end of the Company’s 2008
fiscal year.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 is incorporated herein by reference to our Definitive
Proxy Statement, under the captions “Fees,” and “Pre-Approval Policies” in Proposal II with respect
to our 2009 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission
not later than 120 days after the end of the Company’s 2008 fiscal year.
24
Table of Contents
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
| (1) | Financial Statements The following Consolidated Financial Statements, Notes
thereto and Report of Independent Registered Public Accounting Firm of the Company are filed
as part of Part II, Item 8 of this report: |
| Page | ||||
| 28 | ||||
| 29 | ||||
| 30 | ||||
| 31 | ||||
| 32-41 | ||||
| 42 | ||||
| (2) | List of Exhibits |
| 3.1 | Articles of Organization of the Company (incorporated by reference to the Company’s
Annual Report for 2005 on Form 10-KSB, filed with the Securities and Exchange Commission
on December 21, 2005) |
|||
| 3.2 | By-laws of the Company (incorporated by reference to the Company’s 8-K filed with the
Securities and Exchange Commission on May 5, 1998) |
|||
| 4 | Rights Agreement, dated as of August 6, 2004, by and between the Company and American
Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to the
Company’s 8-K filed with the Securities and Exchange Commission on August 5, 2004) |
|||
| 10.1 | + | Employment Agreement, effective November 19, 1998, with Carl H. Guild, Jr.
(incorporated by reference to the Company’s Annual Report for 1998 on Form 10-K, as
amended, filed with the Securities and Exchange Commission on December 21, 1998) |
||
| 10.2 | + | Employment Agreement, effective February 12, 2001, with Michael P. Malone
(incorporated by reference to the Company’s Form 10-QSB filed with the Securities and
Exchange Commission on May 15, 2001) |
||
| 10.3 | + | Amendment to Employment Agreement between the Company and Carl H. Guild Jr.,
as of November 8, 2001 (incorporated by reference to the Company’s Form 10-QSB filed with
the Securities and Exchange Commission on August 13, 2002) |
||
| 10.4 | + | 1995 Employee Stock Purchase Plan (incorporated by reference to the Company’s
Registration Statement on Form S-8, filed with the Securities and Exchange Commission on
May 23, 1996) |
||
| 10.5 | + | 2001 Stock Option Plan (incorporated by reference to the Company’s
Registration Statement on Form S-8, filed with the Securities and Exchange Commission on
December 28, 2001) |
||
| 10.6 | Standard Form Commercial Lease, dated April 4, 2007, between the Company and Batstone
LLC (incorporated by reference to the Company’s 8-K filed with the Securities and Exchange
Commission on April 6, 2007) |
|||
| 10.7 | Line of Credit Agreement with Letter of Credit and/or Acceptance Financing Agreement,
dated November 5, 2004, between the Company and Fleet National Bank, a Bank of America
Company (incorporated by reference to the Company’s 8-K filed with the Securities and
Exchange Commission on November 11, 2004) |
25
Table of Contents
| (2) | List of Exhibits (cont’d) |
| 10.8 | Line of Credit with Letter of Credit and/or Acceptance Financing Promissory Note,
dated November 5, 2004, between the Company and Fleet National Bank, a Bank of America
Company (incorporated by reference to the Company’s 8-K filed with the Securities and
Exchange Commission on November 11, 2004) |
|||
| 10.9 | + | 2005 Non-Statutory Stock Option Plan (incorporated by reference to the
Company’s Form 10-QSB filed with the Securities and Exchange Commission on May 10, 2005) |
||
| 10.10 | Contract with US Army CECOM Acquisitions Center dated April 18, 2008 (incorporated
by reference to Exhibit 10.1 to the Company’s Form 10-QSB filed with the Securities and
Exchange Commission on August 13, 2008) |
|||
| 14 | Code of Business Conduct and Ethics (incorporated by reference to the Company’s
Annual Report for 2003 on Form 10-KSB, filed with the Securities and Exchange Commission
on December 22, 2004) |
|||
| 21 | * | List of Subsidiaries of the Company |
||
| 23 | * | Consent of Vitale, Caturano and Company Ltd |
||
| 31.1 | * | Certification of principal executive officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
||
| 31.2 | * | Certification of principal financial officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
||
| 32 | * | Certifications of Chief Executive and Chief Financial Officers pursuant to 18 U.S.C.
Section 1350 |
Footnotes:
| * | Attached to this filing. |
|
| + | Denotes a management
contract or compensatory plan or arrangement. |
26
Table of Contents
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.
| TECHNICAL COMMUNICATIONS CORPORATION
|
||||
| By: | /s/ Carl H. Guild, Jr. | |||
| Carl H. Guild, Jr. | ||||
| Chief Executive Officer and
President Chairman of the Board, Director |
||||
| Date: December 19, 2008 | ||||
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 and in the capacities and on the
dates indicated.
| Signature | Title | Date | ||
/s/ Carl H. Guild, Jr.
|
Chief Executive Officer and President Chairman of the Board, Director (Principal Executive Officer) | December 19, 2008 | ||
/s/ Michael P. Malone
|
Treasurer and Chief
Financial Officer
(Principal Financial
and Accounting Officer) |
December 19, 2008 | ||
/s/ Mitchell B. Briskin
|
Director | December 19, 2008 | ||
Mitchell B. Briskin |
||||
/s/ Robert T. Lessard
|
Director | December 19, 2008 | ||
Robert T. Lessard |
||||
/s/ Thomas E. Peoples
|
Director | December 19, 2008 | ||
Thomas E. Peoples |
27
Table of Contents
Technical Communications Corporation
Consolidated Balance Sheets
September 27, 2008 and September 29, 2007
| 2008 | 2007 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 3,622,903 | $ | 2,622,288 | ||||
Accounts receivable — trade, less allowance of
$25,000 and $35,000 at September 27, 2008
and September 29, 2007, respectively |
722,261 | 420,527 | ||||||
Inventories |
1,920,724 | 1,908,157 | ||||||
Deferred income taxes |
75,000 | — | ||||||
Other current assets |
105,666 | 96,051 | ||||||
Total current assets |
6,446,554 | 5,047,023 | ||||||
Equipment and leasehold improvements |
3,182,522 | 2,961,268 | ||||||
Less accumulated depreciation and amortization |
(2,915,050 | ) | (2,853,906 | ) | ||||
Equipment and leasehold improvements, net |
267,472 | 107,362 | ||||||
| $ | 6,714,026 | $ | 5,154,385 | |||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 173,070 | $ | 253,683 | ||||
Accrued liabilities: |
||||||||
Compensation and related expenses |
448,179 | 449,111 | ||||||
Other |
415,090 | 263,235 | ||||||
Total current liabilities |
1,036,339 | 966,029 | ||||||
Stockholders’ equity |
||||||||
Common stock — par value $.10 per share; authorized
7,000,000 shares, issued and outstanding 1,433,767
and 1,382,767 shares at September 27, 2008
and September 29, 2007, respectively |
143,377 | 138,277 | ||||||
Additional paid-in capital |
1,941,020 | 1,517,599 | ||||||
Retained earnings |
3,593,290 | 2,532,480 | ||||||
Total stockholders’ equity |
5,677,687 | 4,188,356 | ||||||
| $ | 6,714,026 | $ | 5,154,385 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
28
Table of Contents
Technical Communications Corporation
Consolidated Statements of Operations
Years Ended September 27, 2008 and September 29, 2007
| 2008 | 2007 | |||||||
Net sales |
$ | 6,852,313 | $ | 4,920,004 | ||||
Cost of sales |
2,663,218 | 1,515,411 | ||||||
Gross profit |
4,189,095 | 3,404,593 | ||||||
Operating expenses: |
||||||||
Selling, general and
administrative expenses |
2,334,911 | 1,747,907 | ||||||
Product development costs |
942,041 | 890,914 | ||||||
Total operating expenses |
3,276,952 | 2,638,821 | ||||||
Operating income |
912,143 | 765,772 | ||||||
Other income (expense) |
||||||||
Investment income |
90,047 | 90,487 | ||||||
Interest expense |
— | (624 | ) | |||||
Total other income |
90,047 | 89,863 | ||||||
Income before income taxes |
1,002,190 | 855,635 | ||||||
Provision (benefit) for income taxes |
(58,620 | ) | 9,160 | |||||
Net income |
$ | 1,060,810 | $ | 846,475 | ||||
Net income per common share |
||||||||
Basic |
$ | 0.75 | $ | 0.62 | ||||
Diluted |
$ | 0.63 | $ | 0.55 | ||||
Weighted average shares |
||||||||
Basic |
1,414,101 | 1,376,706 | ||||||
Diluted |
1,679,531 | 1,534,703 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
29
Table of Contents
Technical Communications Corporation
Consolidated Statements of Cash Flows
Years Ended September 27, 2008 and September 29, 2007
| 2008 | 2007 | |||||||
Operating activities: |
||||||||
Net income |
$ | 1,060,810 | $ | 846,475 | ||||
Adjustments to reconcile net income
to cash provided by operating activities: |
||||||||
Depreciation and amortization |
61,144 | 34,381 | ||||||
Stock-based compensation |
145,661 | 99,953 | ||||||
Deferred income taxes |
(75,000 | ) | — | |||||
Changes in current assets and current liabilities: |
||||||||
Accounts receivable |
(301,734 | ) | (214,207 | ) | ||||
Inventories |
(12,567 | ) | (403,544 | ) | ||||
Other current assets |
(9,615 | ) | (3,753 | ) | ||||
Accounts payable and accrued liabilities |
70,310 | 438,566 | ||||||
Cash provided by operating activities |
939,009 | 797,871 | ||||||
Investing activities: |
||||||||
Additions to equipment and leasehold improvements |
(221,254 | ) | (58,350 | ) | ||||
Cash used for investing activities |
(221,254 | ) | (58,350 | ) | ||||
Financing activities: |
||||||||
Proceeds from stock issuance |
282,860 | 12,054 | ||||||
Cash provided by financing activities |
282,860 | 12,054 | ||||||
Net increase in cash and cash equivalents |
1,000,615 | 751,575 | ||||||
Cash and cash equivalents at beginning of year |
2,622,288 | 1,870,713 | ||||||
Cash and cash equivalents at end of year |
$ | 3,622,903 | $ | 2,622,288 | ||||
Supplemental disclosures: |
||||||||
Interest paid |
$ | — | $ | 624 | ||||
Income taxes paid |
24,000 | 503 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
30
Table of Contents
Technical Communications Corporation
Consolidated Statements of Changes in Stockholders’ Equity
Years Ended September 27, 2008 and September 29, 2007
| 2008 | 2007 | |||||||
Stockholders’ Equity |
||||||||
Shares of common stock: |
||||||||
Beginning balance |
1,382,767 | 1,371,691 | ||||||
Issuance of shares to ESPP participants |
— | 376 | ||||||
Exercise of stock options |
51,000 | 10,700 | ||||||
Ending balance |
1,433,767 | 1,382,767 | ||||||
Common stock at par value: |
||||||||
Beginning balance |
$ | 138,277 | $ | 137,169 | ||||
Issuance of shares to ESPP participants |
— | 38 | ||||||
Exercise of stock options |
5,100 | 1,070 | ||||||
Ending balance |
143,377 | 138,277 | ||||||
Additional paid-in capital: |
||||||||
Beginning balance |
1,517,599 | 1,406,700 | ||||||
Issuance of shares to ESPP participants |
— | 1,019 | ||||||
Exercise of stock options |
277,760 | 9,927 | ||||||
Stock-based compensation |
145,661 | 99,953 | ||||||
Ending balance |
1,941,020 | 1,517,599 | ||||||
Retained earnings: |
||||||||
Beginning balance |
2,532,480 | 1,686,005 | ||||||
Net income |
1,060,810 | 846,475 | ||||||
Ending balance |
3,593,290 | 2,532,480 | ||||||
Total stockholders’ equity |
$ | 5,677,687 | $ | 4,188,356 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
31
Table of Contents
Notes to Consolidated Financial Statements
| (1) | Company Operations |
|
Technical Communications Corporation was incorporated in Massachusetts in 1961; its
subsidiary, TCC Investment Corp., was organized in that jurisdiction in 1982. The Company’s
business consists of only one industry segment, which is the design, development,
manufacture, distribution, marketing and sale of communications security devices and systems.
The secure communications solutions provided by TCC protect vital information transmitted
over a wide range of data, fax and voice networks. TCC’s products have been sold into over
110 countries and are in service with governments, military agencies, telecommunications
carriers, financial institutions and multinational corporations. |
||
The Company’s revenues have historically included significant transactions with foreign
governments, U.S. government agencies and other organizations. The Company expects this to
continue. The timing of these transactions has in the past and will in the future have a
significant impact on the cash flow of the Company. Delays in the timing of significant
expected sales transactions would have a significant negative effect on the Company’s
operations. The Company has some ability to mitigate this effect through cost-cutting
measures. |
||
| (2) | Summary of Significant Accounting Policies |
|
Principles of Consolidation |
||
The accompanying consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, TCC Investment Corp., a Massachusetts corporation. All
significant intercompany accounts and transactions have been eliminated in consolidation. |
||
Use of Estimates |
||
The preparation of financial statements in conformity with generally accepted accounting
principles in the United States 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. Actual results could differ from those estimates. |
||
Cash and Cash Equivalents |
||
Cash and cash equivalents include demand deposits at banks and other investments (including
mutual funds) readily convertible into cash. Cash equivalents are stated at cost, which
approximates market value. |
||
Accounts Receivable |
||
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in
the future. The estimated allowance for uncollectible amounts is based primarily on a
specific analysis of accounts in the receivable portfolio and historical write-off
experience. While management believes the allowance to be adequate, if the financial
condition of our customers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances may be required, which would reduce net income. |
32
Table of Contents
Notes to Consolidated Financial Statements (continued)
Inventories
The Company values its inventory at the lower of actual cost to purchase and/or manufacture
the inventory or the current market value (based on estimated selling prices, less the cost
to sell) of the inventory. The Company periodically reviews inventory quantities on hand and
records a provision for excess and/or obsolete inventory based primarily on our estimated
forecast of product demand, as well as historical usage. The Company evaluates the carrying
value of inventory on a quarterly basis to determine if the carrying value is recoverable at
estimated selling prices. To the extent that estimated selling prices do not exceed the
associated carrying values, inventory carrying values are written down. In addition, the
Company makes judgments as to future demand requirements and compares those with the current
or committed inventory levels. Reserves are established for inventory levels that exceed
future demand. It is possible that additional reserves above those already established may be
required in the future if market conditions for our products should deteriorate.
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost. Depreciation and amortization are
computed using the straight-line method over the estimated useful life of the asset. When
assets are retired or otherwise disposed of, the cost and related accumulated depreciation
are removed from the accounts, and any resulting gain or loss is recognized in operations for
the period. The costs of maintenance and repairs are charged to operations as incurred;
significant renewals and betterments are capitalized.
Long-lived Assets
The Company accounts for long-lived assets in accordance with Statement of Financial
Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets.” The Company’s only long-lived assets are equipment and leasehold improvements.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of the asset to
the estimated undiscounted future cash flows expected to be generated by such asset. If the
carrying amount of the asset exceeds its estimated undiscounted future cash flows, an
impairment charge is recognized in the amount by which the carrying amount of such asset
exceeds the fair value of the asset.
Recognition of Revenue
The Company recognizes revenue from product sales in accordance with SEC Staff Accounting
Bulletin No. 101, “Revenue Recognition,” as updated by Staff Accounting Bulletin No. 104
“Revenue Recognition, corrected copy”. Product revenue is recognized when there is persuasive
evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the
customer has occurred and the Company has determined that collection of the fee is probable.
Title to the product generally passes upon shipment of the product, as the products are
shipped FOB shipping point, except for certain foreign shipments. If the product requires
installation to be performed by TCC, all revenue related to the product is deferred and
recognized upon completion of the installation. The Company provides for a warranty reserve
at the time the product revenue is recognized.
The Company performs funded research and development and technology development for
commercial companies and government agencies under both cost reimbursement and fixed-price
contracts. Cost reimbursement contracts provide for the reimbursement of allowable costs
and, in some situations, the payment of a fee. These contracts may contain incentive clauses
providing for increases or decreases in the fee depending on how costs compare with a budget.
Revenue from reimbursement contracts is recognized as services are performed. On fixed-price
contracts that are expected to exceed one year in duration, revenue is recognized pursuant to
the percentage of
completion method based upon the proportion of costs incurred to the total estimated costs
for the contract. In each type of contract, the Company receives periodic progress
33
Table of Contents
Notes to Consolidated Financial Statements (continued)
payments
or payments upon reaching interim milestones. All payments to the Company for work performed on
contracts with agencies of the U.S. government are subject to audit and adjustment by the
Defense Contract Audit Agency. Adjustments are recognized in the period made. When the
current estimates of total contract revenue and contract costs for product development
contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any
losses incurred in performing funded research and development projects are recognized as
funded research and development expenses as incurred.
Cost of product revenue includes material, labor and overhead. Costs incurred in connection
with funded research and development and other revenue arrangements are included in cost of
sales.
Share-Based Compensation
Effective October 1, 2006, the Company adopted the provisions of Statement of Financial
Accounting Standards
No. 123(R), “Share-Based Payment” and related interpretations (“SFAS
No. 123R”) using the modified prospective method and accordingly has not restated prior
period results. SFAS No. 123R establishes the method for accounting for equity instruments
issued in exchange for employee services. Under SFAS No. 123R, share-based compensation cost
is measured at the grant date based on the calculated fair value of the award. The expense is
recognized over the employee’s requisite service period, generally the vesting period of the
award. SFAS No. 123R also requires the related excess tax benefit received upon exercise of
stock options, if any, to be reflected in the statement of cash flows as a financing activity
rather than an operating activity.
Upon adoption of SFAS No. 123R, in accordance with Staff Accounting Bulletin No. 107,
“Share-based Payment”, the Company selected the Black-Scholes option pricing model as the
most appropriate method for determining the estimated fair value for stock awards. The
Black-Scholes method of valuation requires several assumptions: (1) the expected term of the
stock award, (2) the expected future stock price volatility over the expected term and (3)
risk-free interest rate. The expected term represents the expected period of time the Company
believes the options will be outstanding based on historical information. Estimates of
expected future stock price volatility are based on the historic volatility of the Company’s
Common Stock and the risk free interest rate is based on the U.S. Treasury Note rate. The
Company utilizes a forfeiture rate based on an analysis of its actual experience. The
forfeiture rate is not material to the calculation of share-based compensation. The fair
value of options at date of grant was estimated with the following assumptions:
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Assumptions: |
||||||||
Option life |
5 years | 5 years | ||||||
Risk-free interest rate |
3.21 | % | 4.54 | % | ||||
Stock volatility |
81 | % | 128 | % | ||||
Dividend yield |
-0- | -0- | ||||||
There were 41,000 options granted during the year ended September 27, 2008. The following
table summarizes share-based compensation costs included in the Company’s consolidated
statements of operations for the years ended September 27, 2008 and September 29, 2007:
| 2008 | 2007 | |||||||
Cost of sales |
$ | 6,809 | $ | 7,118 | ||||
Selling, general and administrative |
89,869 | 61,397 | ||||||
Product development |
48,983 | 31,438 | ||||||
Total share-based compensation expense before taxes |
$ | 145,661 | $ | 99,953 | ||||
As of September 27, 2008, there was $227,293 of unrecognized compensation cost related to
options granted. The unrecognized compensation will be recognized over a period of
approximately five years.
34
Table of Contents
Notes to Consolidated Financial Statements (continued)
The Company had the following stock option plans outstanding as of September 27, 2008: the
Technical Communications Corporation 1991 Stock Option Plan, the 2001 Stock Option Plan and
the 2005 Non-Statutory Stock Option Plan. There are an aggregate of 850,000 shares authorized
under these plans, of which 581,034 were outstanding at September 27, 2008. Vesting periods
are at the discretion of the Board of Directors and typically range between one and five
years. Options under these plans are granted with an exercise price equal to fair market
value at time of grant and have a term of five or ten years from the date of grant. As of
September 27, 2008, there were no shares available for new option grants under the of 1991
Stock Option Plan or the 2001 Stock Option Plan, and there were 16,500 shares available for
grant under the 2005 Non-Statutory Stock Option Plan.
The following tables summarize stock option activity during fiscal years 2007 and 2008:
| Options Outstanding | ||||||||||||
| Number of | Weighted Average | Weighted Average | ||||||||||
| Shares | Exercise Price | Contractual Life | ||||||||||
Outstanding at October 1, 2006 |
627,234 | $ | 3.29 | |||||||||
Grants |
16,500 | |||||||||||
Exercises |
(10,700 | ) | ||||||||||
Cancellations |
(21,000 | ) | ||||||||||
Outstanding at September 29, 2007 |
612,034 | $ | 3.12 | 4.55 years | ||||||||
Grants |
41,000 | |||||||||||
Exercises |
(51,000 | ) | ||||||||||
Cancellations |
(21,000 | ) | ||||||||||
Outstanding at September 27, 2008 |
581,034 | $ | 3.05 | 4.46 years | ||||||||
Information related to the stock options outstanding as of September 27, 2008 is as follows:
| Weighted- | ||||||||||||||||||||
| Average | Exercisable | |||||||||||||||||||
| Remaining | Weighted- | Exercisable | Weighted- | |||||||||||||||||
| Range of | Number of | Contractual | Average | Number of | Average | |||||||||||||||
| Exercise Prices | Shares | Life (years) | Exercise Price | Shares | Exercise Price | |||||||||||||||
$0.01 – $1.00 |
160,334 | 4.05 | $ | 0.96 | 161,334 | $ | 0.96 | |||||||||||||
$1.01 – $2.00 |
1,200 | 3.30 | 1.27 | 1,200 | 1.27 | |||||||||||||||
$2.01 – $3.00 |
68,200 | 4.36 | 2.56 | 55,320 | 2.51 | |||||||||||||||
$3.01 – $4.00 |
302,800 | 3.98 | 3.73 | 256,000 | 3.74 | |||||||||||||||
$4.01 – $5.00 |
3,500 | 4.71 | 4.71 | 22,000 | 4.57 | |||||||||||||||
$5.01 – $10.00 |
45,000 | 9.36 | 6.62 | 50,000 | 7.28 | |||||||||||||||
| 581,034 | 4.46 | 3.05 | 545,854 | 2.83 | ||||||||||||||||
The aggregate intrinsic value of the Company’s “in-the-money” outstanding and exercisable
options as of September 27, 2008 was $1,532,355. The intrinsic value of the options exercised
during the year ended September 27, 2008 was $50,990. Nonvested common stock options are
subject to the risk of forfeiture until the fulfillment of specified conditions.
Income Taxes
The Company records income tax expense (benefit) in accordance with Statement of Financial
Accounting Standards No. 109, “Accounting for Income Taxes,” which requires the use of the
asset/liability method in accounting for income taxes. Under the asset/liability method,
deferred income taxes are recognized at current income tax rates to reflect the tax effect of
temporary differences between the consolidated financial reporting basis and tax basis of
assets and liabilities.
Warranty Costs
The Company provides for warranty costs at the time product revenue is recognized based in
part upon historical experience.
35
Table of Contents
Notes to Consolidated Financial Statements (continued)
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents, Accounts Receivable and Accounts Payable — the carrying amount
of these assets and liabilities on the Company’s consolidated balance sheet approximates
their fair value because of the short-term nature of these instruments.
Earnings per Share (“EPS”)
In accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share”
(“SFAS No. 128”), the Company presents both a “basic” and a “diluted” EPS. Basic EPS has been
computed by dividing net income by a weighted average number of shares of common stock
outstanding during the period. In computing diluted EPS, stock options that are dilutive
(those that reduce earnings per share) are included in the calculation of EPS using the
treasury stock method. Exercise of outstanding stock options is not assumed if the result
would be antidilutive, such as when a net loss is reported for the period or the option
exercise price is greater than the average market price for the period presented.
Fiscal Year-End Policy
The Company’s by-laws call for its fiscal year to end on the Saturday closest to the last day
of September, unless otherwise decided by its Board of Directors. The fiscal year 2008 ended
on September 27, 2008 and included 52 weeks. The fiscal year 2007 ended on September 29, 2007
and included 52 weeks.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,”
requires disclosure of all components of comprehensive income on an annual basis.
Comprehensive income is defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances from non-owners sources.
The Company’s comprehensive income for the years ended September 27, 2008 and September 29,
2007 was equal to its net income for the same periods.
Operating Segments
The Company reports on operating segments in accordance with Statement of Financial
Accounting Standards No. 131, “Disclosure About Segments of an Enterprise and Related
Information” (“SFAS No. 131”). SFAS No. 131 established standards for public companies to
report information about operating segments and geographic distribution of sales in financial
statements. The Company currently has only one operating segment, which is the design,
development, manufacture, distribution, marketing and sale of communications security devices
and systems.
Newly Issued Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair
Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosure requirements regarding fair value
measurement. SFAS No. 157 initially became effective for fiscal years beginning after
November 15, 2007. In November 2007, the FASB deferred the effective date of SFAS No. 157
until November 15, 2008 for all non-financial assets and liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring basis. The
Company is currently reviewing the statement to determine the impact and materiality of its
adoption by the Company, if any.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of
Statement of Financial Accounting Standards No. 115” (“SFAS No. 159”), which permits
companies to choose to measure many financial instruments and certain other items at fair
value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and
interim periods within those fiscal years. The Company is currently reviewing the statement
to determine the impact and materiality of its adoption by the Company, if any.
36
Table of Contents
Notes to Consolidated Financial Statements (continued)
| (3) | Income Per Share |
|
In accordance with SFAS No. 128, basic and diluted EPS were calculated as follows: |
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Net Income |
$ | 1,060,810 | $ | 846,475 | ||||
Average Shares Outstanding — Basic |
1,414,101 | 1,376,706 | ||||||
Dilutive effect of stock options |
265,430 | 157,997 | ||||||
Weighted Average Shares — Diluted |
1,679,531 | 1,534,703 | ||||||
Basic Income Per Share |
$ | 0.75 | $ | 0.62 | ||||
Diluted Income Per Share |
$ | 0.63 | $ | 0.55 | ||||
Outstanding potentially dilutive stock options, which were not included in the above
calculations for the respective fiscal years because they were anti-dilutive, were as
follows: 41,000 in fiscal year 2008 and 267,000 in fiscal year 2007. |
||
| (4) | Inventories |
|
Inventories consist of the following: |
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Finished goods |
$ | 77,444 | $ | 408,995 | ||||
Work in process |
589,700 | 478,883 | ||||||
Raw materials and supplies |
1,253,580 | 1,020,279 | ||||||
Total inventories |
$ | 1,920,724 | $ | 1,908,157 | ||||
| (5) | Equipment and Leasehold Improvements |
|
Equipment and leasehold improvements consist of the following: |
| September 27, | September 29, | Estimated | ||||||||||
| 2008 | 2007 | Useful Life | ||||||||||
Engineering and
manufacturing equipment |
$ | 1,416,678 | $ | 1,351,066 | 3-8 years | |||||||
Demonstration equipment |
635,932 | 634,081 | 3 years | |||||||||
Furniture and fixtures |
654,711 | 539,779 | 3-8 years | |||||||||
Leasehold improvements |
475,201 | 436,342 | Lesser of useful life or term of lease |
|||||||||
Total equipment and
leasehold improvements |
3,182,522 | 2,961,268 | ||||||||||
Less accumulated
depreciation and
amortization |
(2,915,050 | ) | (2,853,906 | ) | ||||||||
Equipment and leasehold
improvements, net |
$ | 267,472 | $ | 107,362 | ||||||||
37
Table of Contents
Notes to Consolidated Financial Statements (continued)
| (6) | Other Accrued Liabilities |
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Product warranty costs |
$ | 61,708 | $ | 49,121 | ||||
Professional service fees |
37,514 | 41,734 | ||||||
Annual report and investor relations fees |
19,526 | 18,347 | ||||||
Customer support agreements and commissions |
50,158 | — | ||||||
Customer deposits |
246,184 | 137,890 | ||||||
Income taxes |
— | 7,977 | ||||||
Other |
— | 8,166 | ||||||
Total other accrued liabilities |
$ | 415,090 | $ | 263,235 | ||||
| (7) | Leases |
|
In April 2007, the Company entered into a new lease for its current facilities. This lease is
for 22,800 square feet located at 100 Domino Drive, Concord, MA. The Company has been a
tenant in this space since 1983. This is the Company’s only facility and houses all
manufacturing, research and development, and corporate operations. The term of the lease is
for five years through March 31, 2012 at an annual rate of $159,000. In addition the lease
contains options to extend the lease for two and one half years through September 30, 2014
and another two and one half years through March 31, 2017, at an annual rate of $171,000.
Rent expense for the years ended September 27, 2008 and September 29, 2007 was $159,000 and
$154,000, respectively. |
||
| (8) | Guarantees |
|
The Company’s products generally carry a standard 15 month warranty. The Company sets aside a
reserve based on anticipated warranty claims at the time product revenue is recognized.
Factors that affect the Company’s product warranty liability include the number of installed
units, the anticipated cost of warranty repairs and historical and anticipated rates of
warranty claims. |
||
The following table reflects changes in the Company’s accrued warranty account: |
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Beginning Balance |
$ | 49,121 | $ | 48,865 | ||||
Plus: accruals related to new sales |
49,433 | 40,974 | ||||||
Less: payments and adjustments to prior period accruals |
(36,846 | ) | (40,718 | ) | ||||
Ending Balance |
$ | 61,708 | $ | 49,121 | ||||
| (9) | Income Taxes |
|
The provision (benefit) for income taxes consists of the following: |
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Current: |
||||||||
Federal |
$ | 8,275 | $ | 7,201 | ||||
State |
8,105 | 1,959 | ||||||
Total current taxes |
16,380 | 9,160 | ||||||
Deferred: |
||||||||
Federal |
(75,000 | ) | — | |||||
State |
— | — | ||||||
Total deferred taxes |
(75,000 | ) | — | |||||
Total provision (benefit) |
$ | (58,620 | ) | $ | 9,160 | |||
38
Table of Contents
Notes to Consolidated Financial Statements (continued)
The provisions for income taxes are different from those that would be obtained by applying the
statutory federal income tax rate to income before income taxes due to the following:
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Tax provision at U.S. statutory rate |
$ | 340,745 | $ | 290,916 | ||||
State income tax provision, net of federal
benefit |
5,349 | 1,293 | ||||||
Tax credits |
— | (43,128 | ) | |||||
Other |
(394 | ) | 1,231 | |||||
Release of valuation allowance |
(75,000 | ) | — | |||||
Decrease in valuation allowance |
(329,320 | ) | (241,152 | ) | ||||
Total (benefit) provision |
$ | (58,620 | ) | $ | 9,160 | |||
Deferred income taxes consist of the following:
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
NOL Carryforward |
$ | 1,489,057 | $ | 1,827,693 | ||||
Inventory differences |
1,121,516 | 1,116,209 | ||||||
Goodwill |
34,241 | 54,784 | ||||||
Warranty accruals |
24,850 | 19,781 | ||||||
Payroll related accruals |
14,308 | 60,468 | ||||||
Tax credits |
169,916 | 279,715 | ||||||
Other |
197,064 | 104,596 | ||||||
Total |
3,050,951 | 3,463,246 | ||||||
Less: valuation allowance |
(2,975,951 | ) | (3,463,246 | ) | ||||
Total |
$ | 75,000 | $ | — | ||||
During fiscal 2008, $75,000 of the prior year deferred tax valuation allowance was reversed,
due to the determination by the Company that the benefits of the deferred tax asset will more
likely than not be realized in future years. The prior year valuation allowance was
established by prior year operating activities and was recorded as a reduction of current
year income tax expense.
The valuation allowance relates to uncertainty with respect to the Company’s ability to
realize its deferred tax assets. The change in the valuation allowance was $487,295 and
$276,104 in fiscal years 2008 and 2007, respectively.
As of September 27, 2008, the Company had available tax loss carryforwards for federal income
tax purposes of approximately $4,380,000, expiring through 2026.
Due to the nature of our current operations in foreign countries (selling products into these
countries with the assistance of local representatives), the Company has not been subject to
any foreign taxes in recent years. Also, it is not anticipated that the Company will be
subject to foreign taxes in the near future.
39
Table of Contents
Notes to Consolidated Financial Statements (continued)
| (10) | Employee Benefit Plans |
|
The Company has a qualified, contributory, profit sharing plan covering substantially all
employees. The Company’s policy is to fund contributions as they are accrued. The
contributions are allocated based on the employee’s proportionate share of total
compensation. The Company’s contributions to the plan are determined by the Board of
Directors and are subject to other specified limitations. There were no Company profit
sharing contributions during fiscal years 2008 or 2007. However, the Board of Directors
approved a corporate match of 25 cents per dollar of the first 6% of each participant’s
contributions to the plan. The Company’s matching contributions were $29,632 and $25,706 in
fiscal years 2008 and 2007, respectively. |
||
The Company has an Executive Incentive Bonus Plan for the benefit of key management
employees. The bonus pool is determined based on the Company’s performance as defined by the
plan. Under the plan, bonuses totaling $110,000 were accrued for executives at September 27,
2008 and $163,000 at September 29, 2007. |
||
| (11) | Commitments and contingencies |
|
The Company has a line of credit agreement with Bank of America (the “Bank”), for a line of
credit not to exceed the principal amount of $600,000. The line is supported by a financing
promissory note. The loan is a demand loan with interest payable at the Bank’s prime rate
plus 1% on all outstanding balances. The loan is secured by all assets of the Company
(excluding consumer goods) and requires the Company to maintain its deposit accounts with the
Bank, as well as comply with certain other covenants. The Company believes this line of
credit agreement provides it with an important external source of liquidity, if necessary.
There were no cash borrowings against the line during fiscal years 2008 and 2007. |
||
The Company did not have any open standby letters of credit at September 27, 2008 or
September 29, 2007. |
||
The Company maintains its cash and cash equivalents in bank deposit accounts and money market
mutual funds that, at times, may exceed federally insured limits. The Company has not
experienced any losses in such accounts. The Company believes it is not exposed to any
significant credit risk on cash and cash equivalents. |
||
| (12) | Major Customers and Export Sales |
|
In fiscal year 2008, the Company had two customers representing 78% (51% and 27%) of total
net sales and at September 27, 2008 had two customers representing 95% (54% and 41%) of
accounts receivable. In fiscal year 2007, the Company had two customers representing 59% (43%
and 16%) of total net sales and at September 29, 2007 had two customers representing 95% (51%
and 44%) of accounts receivable. |
||
A breakdown of net sales is as follows: |
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Domestic |
$ | 5,864,789 | $ | 4,018,368 | ||||
Foreign |
987,524 | 901,636 | ||||||
Total Sales |
$ | 6,852,313 | $ | 4,920,004 | ||||
40
Table of Contents
Notes to Consolidated Financial Statements (continued)
A summary of foreign sales, as a percentage of total foreign revenue by geographic area, is
as follows:
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
North America, excluding the U.S. |
0.8 | % | — | |||||
Central and South America |
64.7 | % | 53.7 | % | ||||
Europe |
9.6 | % | 20.4 | % | ||||
Mid-East and Africa |
19.5 | % | 12.3 | % | ||||
Far East |
5.4 | % | 13.6 | % | ||||
The Company sold products to 13 different countries during the year ended September 27, 2008
and 15 different countries during the year ended September 29, 2007. A sale is attributed to
a foreign country based on the location of the contracting party. Domestic revenue may
include the sale of products shipped through domestic resellers or manufacturers to
international destinations. The table below summarizes our foreign revenues by country as a
percentage of total foreign revenue.
| September 27, | September 29, | |||||||
| 2008 | 2007 | |||||||
Colombia |
64.7 | % | 53.0 | % | ||||
Saudi Arabia |
9.6 | % | 0.7 | % | ||||
Indonesia |
— | 12.9 | % | |||||
Sweden |
— | 10.9 | % | |||||
Other |
25.7 | % | 22.5 | % | ||||
| (13) | Shareholder Rights Plan |
|
The Company has adopted a Shareholder Rights Plan and declared a dividend distribution of one
common stock purchase right for each outstanding share of Common Stock of the Company,
payable to stockholders of record at the close of business on August 13, 2004, and for each
share of Common Stock issued thereafter. Until the rights become exercisable, they will
trade automatically with the Company’s Common Stock and separate rights certificates will not
be issued. The rights will become exercisable only in the event, with certain exceptions,
that a person or group of affiliated or associated persons acquires 15% or more of the
Company’s voting stock, or a person or group of affiliated or associated persons commences a
tender or exchange offer which, if successfully consummated, would result in such person or
group owning 15% or more of the Company’s voting stock. |
||
Each right, once exercisable, will entitle the holder (other than an acquiring person or
group) to buy one share of the Company’s Common Stock at a price of $25 per share, subject to
certain adjustments. In addition, upon the occurrence of specified events, holders of the
rights (other than rights owned by an acquiring person or group) would be entitled to
purchase either the Company’s Common Stock or shares in an “acquiring entity” at
approximately half of market value. Further, at any time after a person or group acquires
15% or more (but less than 50%) of the Company’s outstanding voting stock, subject to certain
exceptions, the Board of Directors may, at its option, exchange part or all of the rights
(other than rights held by an acquiring person or group) for shares of the Company’s Common
Stock having a fair market value on the date of such acquisition equal to the excess of (i)
the fair market value of Common Stock issuable upon exercise of the rights over (ii) the
exercise price of the rights. |
||
The Company generally will be entitled to redeem the rights at $.001 per right at any time
prior to the close of business on the tenth business day after there has been a public
announcement of the beneficial ownership by any person or group of 15% or more of the
Company’s voting stock, subject to certain exceptions. The rights will expire on August 5,
2014 unless earlier redeemed. |
41
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of
Technical Communications Corporation:
Technical Communications Corporation:
We have audited the accompanying consolidated balance sheets of Technical Communications
Corporation and subsidiaries as of September 27, 2008 and September 29, 2007 and the related
consolidated statements of operations, changes in stockholders’ equity and cash flows for the years
then ended. These financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements 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 audits 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 controls
over financial reporting. Our audits included consideration of internal controls 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 consolidated
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, the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Technical Communications Corporation and
subsidiaries at September 27, 2008 and September 29, 2007 and the consolidated results of its
operations and its cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
/s/ Vitale, Caturano & Company, LTD.
|
Boston, Massachusetts
December 19, 2008
December 19, 2008
42
Table of Contents
EXHIBIT INDEX
| Exhibit | ||||
| Number | Description | |||
| 3.1 | Articles of Organization of the Company (incorporated by reference to the Company’s
Annual Report for 2005 on Form 10-KSB, filed with the Securities and Exchange Commission
on December 21, 2005) |
|||
| 3.2 | By-laws of the Company (incorporated by reference to the Company’s 8-K filed with the
Securities and Exchange Commission on May 5, 1998) |
|||
| 4 | Rights Agreement, dated as of August 6, 2004, by and between the Company and American
Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to the
Company’s 8-K filed with the Securities and Exchange Commission on August 5, 2004) |
|||
| 10.1 | + | Employment Agreement, effective November 19, 1998, with Carl H. Guild, Jr.
(incorporated by reference to the Company’s Annual Report for 1998 on Form 10-K, as
amended, filed with the Securities and Exchange Commission on December 21, 1998) |
||
| 10.2 | + | Employment Agreement, effective February 12, 2001, with Michael P. Malone
(incorporated by reference to the Company’s Form 10-QSB filed with the Securities and
Exchange Commission on May 15, 2001) |
||
| 10.3 | + | Amendment to Employment Agreement between the Company and Carl H. Guild Jr.,
as of November 8, 2001 (incorporated by reference to the Company’s Form 10-QSB filed with
the Securities and Exchange Commission on August 13, 2002) |
||
| 10.4 | + | 1995 Employee Stock Purchase Plan (incorporated by reference to the Company’s
Registration Statement on Form S-8, filed with the Securities and Exchange Commission on
May 23, 1996) |
||
| 10.5 | + | 2001 Stock Option Plan (incorporated by reference to the Company’s
Registration Statement on Form S-8, filed with the Securities and Exchange Commission on
December 28, 2001) |
||
| 10.6 | Standard Form Commercial Lease, dated April 4, 2007, between the Company and Batstone
LLC (incorporated by reference to the Company’s 8-K filed with the Securities and Exchange
Commission on April 6, 2007) |
|||
| 10.7 | Line of Credit Agreement with Letter of Credit and/or Acceptance Financing Agreement,
dated November 5, 2004, between the Company and Fleet National Bank, a Bank of America
Company (incorporated by reference to the Company’s 8-K filed with the Securities and
Exchange Commission on November 11, 2004) |
|||
| 10.8 | Line of Credit with Letter of Credit and/or Acceptance Financing Promissory Note,
dated November 5, 2004, between the Company and Fleet National Bank, a Bank of America
Company (incorporated by reference to the Company’s 8-K filed with the Securities and
Exchange Commission on November 11, 2004) |
|||
| 10.9 | + | 2005 Non-Statutory Stock Option Plan (incorporated by reference to the
Company’s Form 10-QSB filed with the Securities and Exchange Commission on May 10, 2005) |
||
| 10.10 | Contract with US Army CECOM Acquisitions Center dated April 18, 2008 (incorporated
by reference to Exhibit 10.1 to the Company’s Form 10-QSB filed with the Securities and
Exchange Commission on August 13, 2008) |
|||
| 14 | Code of Business Conduct and Ethics (incorporated by reference to the Company’s
Annual Report for 2003 on Form 10-KSB, filed with the Securities and Exchange Commission
on December 22, 2004) |
|||
| 21 | * | List of Subsidiaries of the Company |
||
| 23 | * | Consent of Vitale, Caturano and Company Ltd |
||
| 31.1 | * | Certification of principal executive officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
||
| 31.2 | * | Certification of principal financial officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
||
| 32 | * | Certifications of Chief Executive and Chief Financial Officers pursuant to 18 U.S.C.
Section 1350 |
||
Footnotes:
| * | Attached to this filing. |
|
| + | Denotes a management
contract or compensatory plan or arrangement. |
43