TECHNICAL COMMUNICATIONS CORP - Quarter Report: 2018 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

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

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 ☒    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 ☒    No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. 1,849,025 shares of Common Stock, $0.10 par value, outstanding as of May 4, 2018.

INDEX

TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY

Consolidated Balance Sheets

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

TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY

Consolidated Statements of Operations

(Unaudited)

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

TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY

Consolidated Statements of Operations

(Unaudited)

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

TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY

Consolidated Statements of Cash Flows

(Unaudited)

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

TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 the effect of foreign political unrest; domestic and foreign government policies and economic conditions; future changes in export laws or regulations; changes in technology; 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 Annual Report on Form 10-K for the fiscal year ended September 30, 2017.

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 also sell 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 30, 2017, 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 Unaudited 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 30, 2017 as filed with the SEC.

Results of Operations

Three Months ended March 31, 2018 compared to Three Months ended April 1, 2017

Net Sales

Net sales for the quarter ended March 31, 2018 were $930,000, compared to $1,385,000 for the quarter ended April 1, 2017, a decrease of 33%. Sales for the second quarter of fiscal 2018 were all from domestic sources as compared to the same period in fiscal 2017, during which sales consisted of $1,252,000, or 90%, from domestic sources and $133,000, or 10%, from international customers.

Foreign sales consisted of shipments to three countries during the quarter ended April 1, 2017; there were no sales into foreign countries by the Company during the quarter ended March 31, 2018. 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 second quarter of fiscal 2018 and 2017:

For the three months ended March 31, 2018, revenue was derived primarily from sales of our engineering services amounting to $900,000.

For the three months ended April 1, 2017, product sales revenue was derived primarily from shipments of our narrowband radio encryptors to a domestic customer for deployment into Afghanistan amounting to $1,250,000. We sold our internet protocol encryptor to a customer in Saudi Arabia amounting to $95,000 and also made shipments of our secure telephone and fax encryptor to an international customer in Jordan amounting to $28,000 during the quarter.

Gross Profit

Gross profit for the second quarter of fiscal 2018 was $351,000, compared to gross profit of $1,147,000 for the same period of fiscal 2017, a decrease of 69%. Gross profit expressed as a percentage of sales was 38% for the second quarter of fiscal 2018 compared to 83% for the same period in fiscal 2017, which decrease was due to the lower margin engineering services sales in fiscal 2018.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the second quarter of fiscal 2018 were $531,000, compared to $545,000 for the same quarter in fiscal 2017. This decrease of $14,000, or 3%, was attributable to a decrease in selling and marketing expenses of $87,000, which was offset by an increase in general and administrative expenses of $73,000 during the three months ended March 31, 2018.

The decrease in selling and marketing expenses for the three months ended March 31, 2018 was attributable to decreases in product evaluation costs of $42,000, bid and proposal costs of $30,000, outside sales commissions of $19,000 and product demonstration costs of $11,000. These decreases were partially offset by an increase in personnel-related costs of $14,000.

The increase in general and administrative expenses for the three months ended March 31, 2018 was primarily attributable to increases in audit fees and other public company costs of $71,000.

Product Development Costs

Product development costs for the quarter ended March 31, 2018 were $135,000, compared to $477,000 for the quarter ended April 1, 2017. This decrease of $341,000, or 72%, was attributable to an increase in billable engineering services contracts during the second quarter of fiscal 2018 that resulted in decreased product development costs of $381,000 and reduced personnel related costs of $40,000. These decreased costs were partially offset by an increase in engineering project costs of $81,000 during the period.

Product development costs are charged to billable engineering services, bid and proposal efforts or 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 approximately $900,000 of billable engineering services revenue generated during the second quarter of fiscal 2018 and none in the second quarter of fiscal 2017.

Net Loss

The Company incurred a net loss of $313,000 for the second quarter of fiscal 2018, compared to net income of $128,000 for the same period of fiscal 2017. This net loss is primarily attributable to a 69% decrease in gross profit, which was partially offset by a decrease in operating expenses of 35% during the second quarter of fiscal 2018.

Six Months ended March 31, 2018 compared to Six Months ended April 1, 2017

Net Sales

Net sales for the six months ended March 31, 2018 were $2,046,000, compared to $2,017,000 for the six months ended April 1, 2017, an increase of 1%. Sales for the first six months of fiscal 2018 consisted of $1,917,000, or 94%, from domestic sources and $129,000, or 6%, from international customers as compared to the same period in fiscal 2017, during which sales consisted of $1,784,000, or 88%, from domestic sources and $233,000, or 12%, from international customers.

Foreign sales consisted of shipments to four countries during each of the six month periods ended March 31, 2018 and April 1, 2017. 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 six months of fiscal 2018 and 2017:

For the six months ended March 31, 2018, revenue was derived primarily from sales of our engineering services amounting to $1,800,000 and shipments of our narrowband radio encryptors to a customer in the Far East amounting to $70,000 and to a domestic customer for deployment into Afghanistan amounting to $57,000.

For the six months ended April 1, 2017, product sales revenue was derived primarily from shipments of our narrowband radio encryptors to a domestic customer for deployment into Afghanistan amounting to $1,781,000. The Company made shipments of our secure telephone and fax encryptor to an international customer in Jordan amounting to $106,000 during the period. We also sold our internet protocol encryptor to a customer in Saudi Arabia amounting to $95,000.

Gross Profit

Gross profit for the first six months of fiscal 2018 was $923,000, compared to gross profit of $1,590,000 for the same period of fiscal 2017, a decrease of 42%. Gross profit expressed as a percentage of sales was 45% for the first six months of fiscal 2018 compared to 79% for the same period in fiscal 2017, which decrease was due to the lower margin engineering services sales in fiscal 2018.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the first six months of fiscal 2018 were $991,000, compared to $1,191,000 for the same period in fiscal 2017. This decrease of $200,000, or 17%, was attributable to a decrease in selling and marketing expenses of $239,000, which was partially offset by an increase in general and administrative expenses of $39,000, during the six months ended March 31, 2018.

The decrease in selling and marketing expenses for the six months ended March 31, 2018 was attributable to decreases in product evaluation costs of $60,000, bid and proposal costs of $43,000 and product demonstration costs of $135,000. These decreases were partially offset by an increase in personnel-related costs of $21,000.

The increase in general and administrative expenses for the six months ended March 31, 2018 was primarily attributable to increases in audit fees and other public company costs of $75,000. These increases were partially offset by a decrease in personnel-related costs of $30,000 during the period.

Product Development Costs

Product development costs for the six months ended March 31, 2018 were $301,000, compared to $971,000 for the six months ended April 1, 2017. This decrease of $670,000, or 69%, was attributable to an increase in billable engineering services contracts during the first six months of fiscal 2018 that resulted in decreased product development costs of $673,000 and reduced personnel related costs of $85,000. These decreased costs were partially offset by an increase in engineering project costs of $94,000 during the period.

Product development costs are charged to billable engineering services, bid and proposal efforts or 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 approximately $1,800,000 of billable engineering services revenue generated during the first six months of fiscal 2018 and none in the first six months of fiscal 2017.

Net Loss

The Company incurred a net loss of $365,000 for the first six months of fiscal 2018, compared to a net loss of $567,000 for the same period of fiscal 2017. This decrease in net loss is primarily attributable to a 40% decrease in operating expenses and partially offset by a 42% decrease in gross profit during the first six months of fiscal 2018.

The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of March 31, 2018, 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

Our cash, cash equivalents and marketable securities (excluding restricted cash) at March 31, 2018 totaled $1,531,000 and we continue to have no debt.

Liquidity and Ability to Continue as a Going Concern

The Company has suffered recurring losses from operations and had an accumulated deficit of $1,188,000 at March 31, 2018. These factors raise substantial doubt about the Company's ability to continue as a going concern within one year from the issuance date of the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q. The unaudited consolidated financial statements included herein do not include any adjustments to reflect the uncertainty about the Company’s ability to continue as a going concern.

We anticipate that our principal sources of liquidity will only be sufficient to fund our activities through March 31, 2019. In order to have sufficient cash to fund our operations beyond March 31, 2019, we will need to secure new customer contracts, raise additional equity or debt capital, and reduce expenses, including payroll and payroll-related expenses.

In order to have sufficient capital resources to fund operations, the Company has been working diligently to secure several large orders with new and existing customers. In addition, we are pursuing raising capital through equity or debt arrangements. Although we believe our ability to secure such new business and raise new capital is likely, we cannot provide assurances we will be able to do so.

Should we be unsuccessful in these efforts, we would then be forced to implement headcount reductions, employee furloughs and/or reduced hours for certain employees.

Sources and Uses of Cash

The following table presents our abbreviated cash flows for the six month periods ended (unaudited):

Operating Activities

The Company used approximately $1,580,000 less cash for operating activities in the first six months of fiscal 2018 compared to the same period in fiscal 2017. This decrease was primarily attributable to a decrease in accounts receivable during the six month period ended March 31, 2018.

Investing Activities

Cash provided by investing activities during the first six months of fiscal 2018 increased by approximately $26,000 compared to the same period in fiscal 2017. This change is primarily attributable to the maturity of short-term investments in marketable securities of $150,000 and partially offset by a decrease in proceeds from the sale of cost method investment of $76,000 and an increase in additions equipment and leasehold improvements of $35,000, during the first six months of 2018.

Company Facilities

On April 1, 2014, the Company entered into a 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 initial term of the lease is for five years through March 31, 2019 at an annual rate of $171,000. In addition, the lease contains options to extend the lease for two and one half years through September 30, 2021 and another two and one half years through March 31, 2024 at an annual rate of $171,000. Rent expense for each of the six month periods ended March 31, 2018 and April 1, 2017 was $85,000.

Backlog

Backlog at March 31, 2018 and September 30, 2017 amounted to $2,157,000 and $1,975,000, respectively. The orders in backlog at March 31, 2018 are expected to ship and/or services are expected to be performed over the next six months depending on customer requirements and product availability.

Performance guaranties

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 March 31, 2018, the Company had one outstanding letter of credit in the amount of $12,000 and at September 30, 2017 the Company had two outstanding letters of credit in the amounts of $12,000 and $1,000. These collateralized bank accounts represent cash which has restrictions on its use.

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 improve existing products and develop new products, as well as attract and retain qualified personnel. 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 six months ended March 31, 2018 and April 1, 2017, the Company spent $301,000 and $971,000, respectively, on internal product development. The Company also spent $869,000 on billable development efforts during the first six months of fiscal 2018. There were no billable development efforts during the first six months of fiscal 2017. The Company’s total product development costs during the first six months of fiscal 2018 were 20% higher than the same period in fiscal 2017 but in line with its planned commitment to research and development, and reflected the costs of custom development, product capability enhancements and production readiness. It is expected that development expenses for fiscal 2018 will be consistent with fiscal 2017 levels.

It is anticipated that cash from operations will fund our near-term research and development and marketing activities through at least the end of calendar year 2018. We also believe that, in the long term, based on current billable activities, cash from operations will be sufficient to meet the development goals of the Company, although we can give no assurances. Any increase in development activities - either billable or new product related - will require additional resources, which we may not be able to fund through cash from operations. In circumstances where resources will be insufficient, the Company will look to other sources of financing, including debt and/or equity investments; however, we can provide no guarantees that we will be successful in securing such additional financing.

Other than those stated above, there are no plans for significant internal product development or material commitments for capital expenditures during the remainder of fiscal 2018.

New Accounting Pronouncements

ASU 2014-09, Revenue from Contracts with Customers, amended by ASU 2015-14 (Topic 606), ASU 2016-10, ASU 2016-11 and ASU 2016-12

In May 2014, the FASB and the International Accounting Standards Board issued guidance on the principles for recognizing revenue and developing a common revenue standard for U.S. GAAP and International Financial Reporting Standards that would: (1) remove inconsistencies and weaknesses in revenue requirements, (2) provide a more robust framework for addressing revenue issues, (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, (4) provide more useful information to users of financial statements through improved disclosure requirements, and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. This guidance is effective prospectively for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently evaluating the impact of this guidance and is still considering whether it will have a material effect on the Company’s consolidated financial statements. This guidance will become effective for TCC as of the beginning of our 2019 fiscal year.

ASU 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern

In August 2014, the FASB updated U.S. GAAP to eliminate a critical gap in existing standards regarding disclosure of uncertainties about an entity’s ability to continue as a going concern. The new guidance clarifies the disclosures management must make in the organization’s financial statement footnotes when management has substantial doubt about its ability to continue as a “going concern.” The Company adopted this standard for its fiscal year ended September 30, 2017. The adoption of this standard requires the Company to evaluate its ability to meet its obligations as they become due for a period of one year from the date that the financial statements are issued. As a result of this requirement, management has determined that substantial doubt exists about our ability to continue as a going concern. See further discussion in the footnotes to the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q.

ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory

In July 2015, the FASB issued guidance with respect to inventory measurement. This ASU requires inventory to be measured at the lower of cost and net realizable value. The provisions of this ASU became effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The amendment is required to be applied prospectively, and early adoption is permitted. This guidance was adopted by the Company in the first quarter of fiscal 2018; the adoption of this standard did not have a material impact on our financial statements.

ASU No. 2016-02, Leases

In February 2016, the FASB issued guidance with respect to leases. This ASU requires entities to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. This guidance offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We are currently evaluating the potential impact this standard will have on our financial statements and related disclosure.

ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting,

In March 2016, the FASB issued guidance that simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new guidance is effective for annual periods beginning after December 15, 2016, including interim periods within those fiscal years. This guidance was adopted by the Company in the first quarter of fiscal 2018; the adoption of this standard did not have a material impact on our financial statements.

Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force), the AICPA and the SEC during the first six months of our 2018 fiscal year but such pronouncements are not believed by management to have a material impact on the Company’s present or future financial statements.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements.

Not applicable.

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 quarterly report. 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.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. Other Information

There were no legal proceedings pending against or involving the Company or its subsidiary during the period covered by this quarterly report.

Not applicable.

Not applicable.

Not applicable.

Not applicable.

On February 12, 2018, the Company held its 2018 annual meeting of shareholders (the “Meeting”) at its executive offices in Concord, MA. Set forth below are the matters voted upon at the Meeting and the voting results:

Proposal 1 - The Company’s shareholders voted to elect two Class III Directors to serve on the Board of Directors for a term of three years expiring at the 2021 Annual Meeting of Stockholders. The votes cast were as follows:

There were 1,115,848 broker non-votes with respect to Proposal 1.

Proposal 2 - The Company's shareholders approved on an advisory, non-binding basis, the compensation of the Company's named executive officers as disclosed in the proxy statement for the Meeting, with 563,824 shares voting for and 28,302 shares voting against the proposal. There were 12,455 shares abstaining and 1,115,848 broker non-votes on this proposal.

Proposal 3 - The Company's shareholders voted to ratify the appointment of Moody, Famiglietti & Andronico, LLP as the Company's independent registered public accounting firm for the fiscal year ending September 29, 2018 with 1,655,160 shares voting for, 60,994 shares voting against, and 4,275 shares abstaining with respect to this proposal.

SIGNATURES

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

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