TECHNICAL COMMUNICATIONS CORP - Quarter Report: 2019 June (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

Securities registered pursuant to Section 12(b) of the Act:

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 every Interactive Data File required to be submitted 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, 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.

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   X  

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. 1,850,403 shares of Common Stock, $0.10 par value, outstanding as of August 9, 2019.

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

Consolidated Statements of Changes in Stockholders' Equity

(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

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)

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 29, 2018.

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

Except for the adoption of ASC 606 and the Company’s revisions to estimated gross profits on an engineering services contract, as discussed below, there have been no material changes in the Company’s critical accounting policies or critical accounting estimates since September 29, 2018, nor have we adopted any accounting policies that have or will have a material impact on our consolidated financial statements. For further discussion of our accounting policies see Note 2, 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 29, 2018 as filed with the SEC.

The Company restated its unaudited consolidated financial statements as of and for the three and nine month periods ended June 30, 2018 as set forth in its Quarterly Report on Form 10-Q/A as filed with the SEC on June 24, 2019; the unaudited consolidated financial statements for the three and nine month periods ended June 30, 2018 included in this Quarterly Report on Form 10-Q reflect such restated amounts.

On September 30, 2018, the Company adopted ASC 606 using the modified retrospective method for all contracts. Results for reporting periods beginning September 30, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under Topic 605, Revenue Recognition. The adoption of ASC 606 did not have a significant impact on the Company’s consolidated unaudited condensed financial statements as of and for the three and nine month periods ended June 29, 2019.

Revisions in the estimated gross profits on contracts and contract amounts are made in the period in which the circumstances requiring the revisions become known. During the period ended June 29, 2019, the effect of such revisions in estimated contract profits resulted in a decrease to gross profit of approximately $111,000.

Results of Operations

Three Months ended June 29, 2019 compared to Three Months ended June 30, 2018 (restated)

Total Net Revenue

Total net revenue for the quarter ended June 29, 2019 was $1,235,000, compared to $907,000 for the quarter ended June 30, 2018, an increase of 36%. Revenue for the third quarter of fiscal 2019 consisted of $1,232,000, or 99%, from domestic sources and $3,000, or 1%, from international customers as compared to the same period in fiscal 2018, during which revenue consisted of $832,000, or 92%, from domestic sources and $75,000, or 8%, from international customers.

Foreign sales consisted of a shipment to a customer in one country during the quarter ended June 29, 2019 and two countries during the quarter ended June 30, 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 third quarters of fiscal 2019 and 2018:

For the three months ended June 29, 2019, revenue was derived primarily from sales of our engineering services amounting to $953,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a Middle Eastern country amounting to $280,000.

For the three months ended June 30, 2018, revenue was derived primarily from sales of our engineering services amounting to $759,000. The Company also sold its internet protocol encryptor to a customer in Saudi Arabia amounting to $55,000 during the period.

Gross Profit

Gross profit for the third quarter of fiscal 2019 was $445,000, compared to gross profit of $194,000 for the same period of fiscal 2018, an increase of 129%. Gross profit expressed as a percentage of total net revenue was 36% for the third quarter of fiscal 2019 compared to 21% for the same period in fiscal 2018. This increase was primarily due to the higher sales volume of higher margin equipment sales in fiscal 2019.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the third quarter of fiscal 2019 were $732,000, compared to $522,000 for the same quarter in fiscal 2018. This increase of $210,000, or 40%, was attributable to increases in general and administrative expenses of $212,000 partially offset by a decrease in selling and marketing expenses of $2,000 during the three months ended June 29, 2019.

The increase in general and administrative expenses for the three months ended June 29, 2019 was primarily attributable to increases in audit and legal fees of $239,000, partially offset by a decrease in director fees of $8,000.

The decrease in selling and marketing expenses for the three months ended June 29, 2019 was primarily attributable to decreases in third party sales support and outside commissions of $32,000, bid and proposal costs of $21,000 and outside consulting costs of $19,000. These decreases were offset by increases in payroll and payroll related expenses of $50,000 and product demonstration costs of $16,000 during the period.

Product Development Costs

Product development costs for the quarter ended June 29, 2019 were $43,000, compared to $124,000 for the quarter ended June 30, 2018. This decrease of $81,000, or 65%, was attributable to an increase in billable engineering services contracts during the third quarter of fiscal 2019 that resulted in decreased product development costs of $124,000. These decreased costs were partially offset by an increase in engineering project costs of $50,000 during the period.

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 $953,000 of billable engineering services revenue generated during the third quarter of fiscal 2019 and $759,000 in the third quarter of fiscal 2018.

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 revenue; 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.

Net Loss

The Company generated a net loss of $326,000 for the third quarter of fiscal 2019, compared to a net loss of $450,000 for the same period of fiscal 2018. This decrease in net loss is primarily attributable to a 129% increase in gross profit partially offset by an increase in operating expenses of 20% during the third quarter of fiscal 2019.

Nine Months ended June 29, 2019 compared to Nine Months ended June 30, 2018 (restated)

Total Net Revenue

Total net revenue for the nine months ended June 29, 2019 were $4,275,000, compared to $2,548,000 for the nine months ended June 30, 2018, an increase of 68%. Revenue for the first nine months of fiscal 2019 consisted of $4,076,000, or 95%, from domestic sources and $199,000, or 5%, from international customers, compared to the same period in fiscal 2018, during which revenue consisted of $2,344,000, or 92%, from domestic sources and $204,000, or 8%, from international customers.

Foreign revenue consisted of shipments to customers in four countries during the nine months ended June 29, 2019 and to customers in four countries during the same period in fiscal 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 first nine months of fiscal 2019 and 2018:

For the nine months ended June 29, 2019, revenue was derived primarily from sales of our engineering services amounting to $2,820,000, shipments of our narrowband radio encryptors to a domestic customer for deployment into a North African country amounting to $936,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a Middle Eastern country amounting to $280,000.

For the nine months ended June 30, 2018, revenue was derived primarily from sales of our engineering services amounting to $2,218,000 and shipments of our narrowband radio encryptors to a customer in the Far East amounting to $90,000 and to a domestic customer for deployment into Afghanistan amounting to $57,000. We also sold our internet protocol encryptor to a customer in Saudi Arabia amounting to $89,000 during the period.

Gross Profit

Gross profit for the first nine months of fiscal 2019 was $1,644,000, compared to gross profit of $729,000 for the same period of fiscal 2018, an increase of 125%. Gross profit expressed as a percentage of total net revenue was 38% for the first nine months of fiscal 2019 compared to 29% for the same period in fiscal 2018. This increase was primarily due to the higher sales volume of higher margin equipment sales in fiscal 2019.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the first nine months of fiscal 2019 were $1,872,000, compared to $1,513,000 for the same period in fiscal 2018. This increase of $359,000, or 24%, was attributable to increases in general and administrative expenses of $325,000 and selling and marketing expenses of $34,000 during the nine months ended June 29, 2019.

The increase in general and administrative expenses for the nine months ended June 29, 2019 was attributable to increases in audit and legal fees of $366,000. This increase was offset by decreases in director’s fees of $22,000 and other public company related expenses of $16,000.

The increase in selling and marketing expenses for the nine months ended June 29, 2019 was primarily attributable to increases in payroll and payroll related expenses of $55,000, product evaluation costs of $27,000 and product demonstration costs of $16,000. These increases were partially offset by a decrease in outside consulting costs of $33,000, a decrease in travel expenses of $8,000 and an increase in sales service support of product development, which reduced selling and marketing expense by $25,000 during the period.

Product Development Costs

Product development costs for the nine months ended June 29, 2019 were $187,000, compared to $442,000 for the nine months ended June 30, 2018. This decrease of $255,000, or 58%, was attributable to an increase in billable engineering services contracts during the first nine months of fiscal 2019 that resulted in decreased product development costs of $615,000. These decreased costs were partially offset by an increase in engineering project costs of $355,000 during the period.

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 $2,820,000 of billable engineering services revenue generated during the first nine months of fiscal 2019 and $2,218,000 in the same period of fiscal 2018.

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 revenue; 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.

Net Loss

The Company generated a net loss of $401,000 for the first nine months of fiscal 2019, compared to a net loss of $1,221,000 for the same period of fiscal 2018. This decrease in net loss is primarily attributable to a 125% increase in gross profit, partially offset by a 5% increase in operating expenses during the first nine months of fiscal 2019.

The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of June 29, 2019, 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 and cash equivalents at June 29, 2019 totaled $765,000 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 $3,187,000 at June 29, 2019. 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. The unaudited consolidated financial statements do not include any adjustments to reflect the substantial doubt 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 to March 2020. In order to have sufficient cash to fund our operations beyond that point, we will need to secure new customer contracts, raise additional equity or debt capital and/or 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 also pursuing raising capital. Although we believe our ability to secure such new business or 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 or cease operations completely.

Sources and Uses of Cash

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

Operating Activities

The Company used approximately $1,062,000 more cash for operating activities in the first nine months of fiscal 2019 compared to the same period in fiscal 2018. This increase was primarily attributable to a decrease in deferred revenue of $1,769,000. This increase was partially offset by a decrease in net loss of $820,000, a decrease in inventory of $286,000 during the nine month period ended June 29, 2019 as compared to an increase in inventory of $141,000 during the nine month period ended June 30, 2018, and a decrease in accounts receivable of $515,000 during the nine month period ended June 29, 2019 as compared to a decrease in accounts receivable of $132,000 during the nine month period ended June 30, 2018.

Investing Activities

Cash provided by investing activities during the first nine months of fiscal 2019 decreased by approximately $320,000 compared to the same period in fiscal 2018. This change is attributable to the maturity of short-term investments in marketable securities during the first nine months of 2018.

Company Facilities

On April 1, 2014, 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 initial term of the lease was 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. In September 2018, the Company exercised its option to extend the term of the lease through September 2021. Rent expense for each of the nine month periods ended June 29, 2019 and June 30, 2018 was $128,000.

Backlog

Backlog at June 29, 2019 and September 29, 2018 amounted to $2,434,000 and $2,118,000, respectively. The orders in backlog at June 29, 2019 are expected to ship and/or services are expected to be performed over the next three 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 June 29, 2019 and September 29, 2018, the Company had no outstanding letters of credit.

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 nine month periods ended June 29, 2019 and June 30, 2018, the Company spent $187,000 and $442,000, respectively, on internal product development. The Company also spent $1,994,000 and $1,424,000, respectively, on billable development efforts during the first nine months of fiscal 2019 and 2018. The Company’s total product development costs during the first nine months of fiscal 2019 were 17% higher than the same period in fiscal 2018 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 total development expenses will remain higher as we complete a billable project during the remainder of fiscal 2019.

It is anticipated that cash from operations will fund our near-term research and development and marketing activities to January 2020. 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 2019.

New Accounting Pronouncements

ASU No. 2016-02, Leases

In February 2016, the FASB issued guidance in ASU No. 2016-02, Leases, 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 and believe that the most notable impact to our financial statements upon adoption will be the recognition of a right-of-use asset and a lease liability for our leased facility in Concord, MA. The Company expects to adopt this standard during its 2020 fiscal year.

Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force) and the SEC during the first nine months of the Company’s 2019 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 on Form 10-Q.

As previously disclosed under Item 9A, Controls and Procedures in our Annual Report on Form 10-K for our fiscal year ended September 29, 2018, in conjunction with the auditor’s findings, management identified a material weakness in our internal control over financial reporting related to, among other things, the misapplication of generally accepted accounting principles associated with revenue recognition, inventory reserves, accruals and the preparation of the consolidated financial statements, specifically the classification and disclosure of financial information, all caused by a lack of adequate expertise within the Company’s accounting department. As a result, management determined that the Company’s disclosure controls and procedures were not effective at September 29, 2018.

Management had previously reported in the Company’s Form 10-K for the fiscal year ended September 30, 2017, as well as prior fiscal periods, its conclusion that the Company’s failure to maintain effective internal control over financial reporting due to a lack of sufficient staff to segregate accounting duties, more specifically, a lack of an adequately trained accounting department and lack of an independent review of financial reporting, constituted a material weakness as of the end of such fiscal periods. Management also identified a material weakness in internal control over significant non-routine transactions at June 30, 2018. Specifically, management determined that there was a lack of operating effectiveness of internal controls over significant non-routine transactions related to the Company’s inadequate evaluation of the underlying effective rate implications related to the Tax Cuts and Jobs Act passed in December 2017, which management determined constituted a material weakness.

Based on their assessment in connection with the filing of this Form 10-Q, the Chief Executive Officer and Chief Financial Officer have concluded that the material weaknesses described above were also material weaknesses for the quarter ended June 29, 2019 and therefore TCC’s disclosure controls and procedures were not effective as of June 29, 2019. For a more comprehensive discussion of the Company’s internal control over financial reporting and the material weaknesses noted above, as well as the remedial efforts to be undertaken by TCC to address such material weaknesses, see Item 9A, Controls and Procedures, in our Annual Report on Form 10-K for the year ended September 29, 2018 as filed with the SEC.

Changes in internal control over financial reporting. The were no changes in the Company’s internal control over financial reporting during the quarter ended June 29, 2019 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.

Not applicable.

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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