TECHNICAL COMMUNICATIONS CORP - Quarter Report: 2012 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 23, 2012

For the transition period from              to             

Commission File Number: 001-34816

TECHNICAL COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (978) 287-5100

N/A

(Former name, former address and former fiscal year, if changed since last report)

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

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

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):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. 1,832,287 shares of Common Stock, $0.10 par value, outstanding as of August 3, 2012.

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TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

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

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TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(Unaudited)

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

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TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(Unaudited)

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

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TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

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

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TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

STATEMENT OF FAIR PRESENTATION

Interim Financial Statements. The accompanying interim unaudited condensed consolidated financial statements of Technical Communications Corporation (the “Company” or “TCC”) and its wholly-owned subsidiary include all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented and in order to make the financial statements not misleading. All such adjustments are of a normal recurring nature. Interim results are not necessarily indicative of the results to be expected for the fiscal year ending September 29, 2012.

Certain footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted as allowed by Securities and Exchange Commission (“SEC”) rules and regulations. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and the notes thereto in the Company’s Quarterly Reports on Form 10-Q for the quarters ended March 24, 2012 and December 24, 2011 and its Annual Report on Form 10-K for the fiscal year ended September 24, 2011 as filed with the SEC.

We follow accounting standards set by the Financial Accounting Standards Board, commonly referred to as the FASB. The FASB sets generally accepted accounting principles (“GAAP”) that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards Codification^TM - sometimes referred to as the Codification or ASC.

Basis of Presentation. The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.

The discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires management to make estimates and judgements 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 revenues and expenses during the reporting periods.

On an ongoing basis, management evaluates its estimates and judgments, including but not limited to those related to revenue recognition, inventory reserves, receivable reserves, income taxes, fair value of financial instruments and share-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 values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The accounting policies that management believes are most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue Recognition

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

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 for which title passes upon entry of the product into the first port in the buyer’s country. 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 actual 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 proportional performance method based upon the proportion of actual 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 we 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 current estimates of total contract revenue and contract costs for a product development contract 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 are included in cost of sales. Product development costs are charged to billable engineering services, bid and proposal efforts or support of business development activities as appropriate. Product development costs charged to billable projects are recorded as cost of sales, engineering costs charged to bid and proposal efforts are recorded as selling expenses, and product development costs charged to business development activities are recorded as marketing expenses.

Inventory

We value our inventory at the lower of actual cost (based on first-in, first-out (FIFO)) 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 in 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Investment Securities

The Company accounts for investment securities in accordance with FASB ASC 320, Investments—Debt and Equity Securities. All investment securities must be classified as one of the following: held-to-maturity, available-for-sale, or trading. The Company holds certain marketable securities classified as available-for-sale and, as such, carries the investments at fair value, with unrealized holding gains and losses reported in stockholders’ equity as a separate component of accumulated other comprehensive income (loss). The cost of securities sold is determined based on the specific identification method. Realized gains and losses, and declines in value judged to be other than temporary, are included in investment income. The purchase discount or premium is amortized to income or expense, respectively, over the life of the securities.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains (losses) on securities available for sale.

Other comprehensive income is as follows, for the three and nine month periods (unaudited):

The component of accumulated other comprehensive income is as follows for the three and nine month periods ended (unaudited):

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 $1.1 million as of June 23, 2012 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. Any such adjustment 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Fair Value of Financial Instruments

In determining the fair value of financial instruments, the Company follows the provisions of FASB ASC 820, Fair Value Measurements and Disclosures. FASB ASC 820 defines fair value, establishes a framework for measuring fair value under GAAP and enhances disclosures about fair value measurements. The topic provides a consistent definition of fair value which focuses on an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The topic also prioritizes, within the measurement of fair value, the use of market-based information over entity specific information and establishes a three-level hierarchy for fair value measurements based on the nature of inputs used in the valuation of an asset or liability as of the measurement date. The three level hierarchy is as follows:

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.

The Company’s available-for-sale securities are comprised of investments in municipal bonds, brokered certificates of deposit and mutual funds. These securities represent ownership in individual bonds in municipalities within the United States, certificates of deposit in U.S. banks and money market funds held in a brokerage account. The fair value of these investments is based on quoted prices from recognized pricing services (e.g. Standard & Poors, Bloomberg, etc), or in the case of mutual funds at its closing net asset value.

The Company assesses the levels of the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer in accordance with the Company’s accounting policy regarding the recognition of transfers between levels of the fair value hierarchy. During the three and nine months ended June 23, 2012 and June 25, 2011 there were no transfers between levels.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

The following table sets forth by level, within the fair value hierarchy, the financial instruments carried at fair value as of June 23, 2012 and September 24, 2011, in accordance with the fair value hierarchy as defined above (unaudited):

Assets and liabilities measured at fair value on a nonrecurring basis are recognized at fair value subsequent to initial recognition when they are deemed to be impaired. As of June 23, 2012 and September 24, 2011, the Company’s assets and liabilities subject to measurement at fair value on a nonrecurring basis are equipment and leasehold improvements. Neither was deemed to be impaired or measured at fair value on a nonrecurring basis.

Share-Based Compensation

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. The related excess tax benefit received upon the exercise of stock options, if any, is reflected in the Company’s statement of cash flows as a financing activity rather than an operating activity. There were no excess tax benefits for the three and nine months ended June 23, 2012 and June 25, 2011.

The Company selected the Black-Scholes option pricing model as the method for determining the estimated fair value of its 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, (3) a risk-free interest rate and (4) the expected dividend 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

The fair value of options at date of grant was estimated with the following assumptions (unaudited):

There were 17,000 options, with a weighted average fair value of $4.47, granted during the nine months ended June 23, 2012 and 160,165 options, with a weighted average fair value of $5.46, granted during the nine months ended June 25, 2011.

The following table summarizes share-based compensation costs included in the Company’s condensed consolidated income statements for the three and nine month periods ended June 23, 2012 and June 25, 2011 (unaudited):

As of June 23, 2012 and June 25, 2011, there was $521,669 and $744,639, respectively, of unrecognized compensation cost related to options granted. The unrecognized compensation cost will be recognized as the options vest. The weighted average period over which the compensation cost is expected to be recognized is 3.2 years.

The Company had the following stock option plans outstanding as of June 23, 2012: the Technical Communications Corporation 2001 Stock Option Plan, the 2005 Non-Statutory Stock Option Plan and the 2010 Equity Incentive Plan. There were an aggregate of 750,000 options to acquire shares authorized under these plans, of which 268,852 options were outstanding at June 23, 2012. Vesting periods are at the discretion of the Board of Directors and typically range between zero 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 ten years from the date of grant.

As of June 23, 2012, there were no shares available for new option grants under the 2001 Stock Option Plan; there were 37,157 shares available for grant under the 2005 Non-Statutory Stock Option Plan; and there were 46,036 shares available for grant under the 2010 Equity Plan.

The following table summarizes stock option activity during the first nine months of fiscal 2012 (unaudited):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Information related to the stock options vested and expected to vest as of June 23, 2012 is as follows (unaudited):

The aggregate intrinsic value of the Company’s “in-the-money” outstanding and exercisable options as of June 23, 2012 and June 25, 2011 was $277,555 and $256,799, respectively. Unvested common stock options are subject to the risk of forfeiture until the fulfillment of specified conditions.

Inventories consisted of the following:

During the three and nine months ended June 23, 2012, the Company recorded an income tax benefit based on its expected effective tax rate for its 2012 fiscal year. The Company revised its effective tax rate from 41% to 41.8% during the three months ended June 23, 2012 based on a revision of the full year pre-tax forecast in the third fiscal quarter of 2012. The effective tax rate for fiscal year 2012 has not taken any benefit for the federal research credit beyond December 31, 2011.

During the three and nine months ended June 25, 2011, the Company recorded an income tax benefit based on its expected effective tax rate for the 2011 fiscal year, which was adjusted by an unutilized federal research credit from the 2010 fiscal year. Tax legislation extended the federal research credit, which was effective through the end of calendar year 2011.

Deferred tax assets consist of tax credits, inventory differences and other temporary differences. The Company’s valuation allowance is related to the temporary differences associated with its inventory. The Company has determined that the tax benefit related to its obsolete inventory will not likely be realized, and therefore has provided a full valuation allowance against the related deferred tax asset. It is the Company’s intention to maintain the related inventory items for the foreseeable future to support equipment in the field, and therefore cannot determine when the tax benefit, if any, will be realized.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

Basic and diluted earnings per share were calculated as follows (unaudited):

Outstanding potentially dilutive stock options, which were not included in the earnings per share calculations because their inclusion would have been anti-dilutive, were 268,852 at June 23, 2012 and 162,665 at June 25, 2011.

During the quarter ended June 23, 2012, the Company had three customers that represented 83% (42%, 24% and 17%, respectively) of net sales as compared to the quarter ended June 25, 2011, during which two customers represented 93% (78% and 15%, respectively) of net sales. During the nine months ended June 23, 2012, the Company had one customer that represented 84% of net sales as compared to the nine months ended June 25, 2011, during which two customers represented 82% (66% and 16%, respectively) of net sales.

A breakdown of foreign and domestic net sales is as follows (unaudited):

The Company sold products into six countries during the nine month period ended June 23, 2012 and five countries during the nine months ended June 25, 2011. 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 (unaudited).

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

A summary of foreign revenue, as a percentage of total foreign revenue by geographic area, is as follows (unaudited):

The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents. Substantially all cash equivalents are invested in money market mutual funds. Money market mutual funds held in a brokerage account are considered available-for-sale. The Company accounts for marketable securities in accordance with FASB ASC 320, Investments—Debt and Equity Securities. All marketable securities must be classified as one of the following: held-to-maturity, available-for-sale, or trading. The Company classifies its marketable securities as available-for-sale and, as such, carries the investments at fair value, with unrealized holding gains and losses reported in stockholders’ equity as a separate component of accumulated other comprehensive income (loss). The cost of securities sold is determined based on the specific identification method. Realized gains and losses, and declines in value judged to be other than temporary, are included in investment income.

As of June 23, 2012, available-for-sale securities consisted of the following (unaudited):

The contractual maturities of these investments as of June 23, 2012 were as follows (unaudited):

The Company’s available-for-sale securities were included in the following captions in the condensed consolidated balance sheets:

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

Forward-Looking Statements

Certain statements contained herein or as may otherwise be incorporated by reference herein that are not purely historical 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 Company’s 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 SEC, including its Quarterly Reports on Form 10-Q for the quarters ended March 24, 2012 and December 24, 2011 and its Annual Report on Form 10-K for the fiscal year ended September 24, 2011.

Overview

The Company 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 principally from the sale of these products, which have traditionally been to foreign governments either through direct sale, pursuant to a U.S. government contract or made as a sub-contractor to domestic corporations under contract with the U.S. government. We have also sold these products to commercial entities and U.S. government agencies. We generate additional revenues from contract engineering services performed for certain government agencies, both domestic and foreign, and commercial entities.

Critical Accounting Policies and Significant Judgments and Estimates

There have been no material changes in the Company’s critical accounting policies or critical accounting estimates since September 24, 2011, nor have we adopted any accounting policy that has or will have a material impact on our consolidated financial statements. For further discussion of our accounting policies see Note 1, Summary of Significant Accounting Policies and Significant Judgments and Estimates in the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q and the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended September 24, 2011 as filed with the SEC.

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Results of Operations

Three Months ended June 23, 2012 as compared to Three Months ended June 25, 2011

Net Sales

Net sales for the quarter ended June 23, 2012 were $734,000, as compared to $4,023,000 for the quarter ended June 25, 2011, a decrease of 82%. Sales for the third quarter of fiscal 2012 consisted of $377,000, or 51%, from domestic sources and $357,000, or 49%, from international customers as compared to the same period in fiscal 2011, during which sales consisted of $3,892,000, or 97%, from domestic sources and $131,000, or 3%, from international customers.

Foreign sales consisted of shipments to five countries during the quarter ended June 23, 2012 and two countries during the quarter ended June 25, 2011. 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 during the third quarters of fiscal 2012 and 2011:

Revenue for the third quarter of fiscal 2012 was primarily derived from the sale of the Company’s narrowband radio encryptors to a U.S. radio manufacturer for deployment into Afghanistan amounting to $311,000 and to an additional domestic customer amounting to $55,000. In addition, we sold spare parts to two foreign customers amounting to $229,000 and we had sales of our frame relay and internet protocol encryptor products to two customers amounting to $122,000.

Revenue for the third quarter of fiscal 2011 was primarily derived from the sale of the Company’s narrowband radio encryptors to a U.S. radio manufacturer for deployment into Afghanistan amounting to $3,151,000. We also had a sale of our link encryptors sold into the Middle East for $598,000 and a sale of our high speed bulk encryptors amounting to $65,000 under a contract with a domestic customer.

Gross Profit

Gross profit for the third quarter of fiscal 2012 was $572,000 as compared to gross profit of $3,257,000 for the same period of fiscal 2011. Gross profit expressed as a percentage of sales was 78% for the third quarter of fiscal 2012 and 81% for the third quarter of fiscal 2011. The decrease in the gross profit percentage was primarily the result of slightly lower margin sales during the quarter ended June 23, 2012.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the third quarter of fiscal 2012 were $788,000, as compared to $767,000 for the same quarter in fiscal 2011. This increase of 3% was attributable to an increase in selling and marketing expenses of $88,000, offset by a decrease in general and administrative expenses of $67,000, during the third quarter of the 2012 fiscal year.

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The increase in selling and marketing costs for the three months ended June 23, 2012 was attributable to increases in personnel-related costs, travel expenses, product demonstration costs and bid and proposal costs of $32,000, $23,000, $16,000 and $8,000, respectively. There was also an increase in engineering sales support expenses of $22,000, as well as an increase in outside commissions and sales and marketing agreements of $37,000. These increases were slightly offset by decreases in product evaluation costs and outside consulting costs of $42,000 and $11,000, respectively.

The decrease in general and administrative costs during the third quarter of 2012 was primarily attributable to a decrease in personnel-related costs of $59,000 and a decrease in professional fees of $10,000.

Product Development Costs

Product development costs for the quarter ended June 23, 2012 were $1,350,000, compared to $879,000 for the quarter ended June 25, 2011, an increase of $471,000 or 54%. The increase was attributable to project development cost increases in outside contractor costs of $473,000 and material costs of $61,000. There was also an increase in recruiting costs of $31,000 during the third quarter of fiscal 2012. The increase was partially offset by decreases in personnel-related costs of $47,000 and an increase in engineering support of business development activities, which decreased product development costs by approximately $57,000.

Product development costs are charged to billable engineering services, bid and proposal efforts or support of business development activities as appropriate. Product development costs charged to billable projects are recorded as cost of sales, engineering costs charged to bid and proposal efforts are recorded as selling expenses, and product development costs charged to business development activities are recorded as marketing expenses.

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. There was no billable engineering services revenue generated during the third quarters of fiscal 2012 and fiscal 2011.

Net Income

The Company generated a net loss of $915,000 for the third quarter of fiscal 2012, as compared to net income of $1,000,000 for the same period of fiscal 2011. This 192% decrease in net income is primarily attributable to an 82% decrease in sales volume and a 54% increase in product development expenses during the third quarter of fiscal 2012. The Company recorded an income tax benefit of $646,000 during the third quarter of fiscal 2012 based on its expected effective tax rate of 41.8% for the 2012 fiscal year. This compares to a tax provision of $611,000 recorded in the three month period ended June 25, 2011.

The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of June 23, 2012, 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.

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Nine Months ended June 23, 2012 as compared to Nine Months ended June 25, 2011

Net Sales

Net sales for the nine months ended June 23, 2012 were $6,791,000, as compared to $9,865,000 for the nine months ended June 23, 2011, a decrease of 31%. Sales for the nine months ended June 23, 2012 consisted of $5,907,000, or 87%, from domestic sources and $884,000, or 13%, from international customers as compared to the same period in fiscal 2011, during which sales consisted of $9,662,000, or 98%, from domestic sources and $203,000, or 2%, from international customers.

Foreign sales consisted of shipments to six countries during the nine months ended June 23, 2012 and four countries during the nine months ended June 25, 2011. 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 during the first nine months of fiscal 2012 and 2011: