TECHNICAL COMMUNICATIONS CORP - Quarter Report: 2020 December (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: None.

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 February 5, 2021.

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 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 impact of the COVID-19 pandemic (including its duration and severity) and governmental actions in response thereto; 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 26, 2020.

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 26, 2020 and we have not adopted any accounting policies that have had 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 26, 2020 as filed with the SEC.

Results of Operations

Three Months ended December 26, 2020 compared to Three Months ended December 28, 2019

Net Revenue

Total net revenue for the quarter ended December 26, 2020 was $167,000, compared to $666,000 for the quarter ended December 28, 2019, a decrease of 75%. Revenue for the first quarter of fiscal 2021 consisted of 100% from international customers as compared to the same period in fiscal 2020, during which revenue consisted of $492,000, or 74%, from domestic sources and $174,000, or 26%, from international customers.

Foreign sales consisted of a shipment to two countries during the quarter ended December 26, 2020 and one country during the quarter ended December 28, 2019. 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 quarters of fiscal 2021 and 2020:

For the three months ended December 26, 2020, revenue was derived from sales of our DSP9000 radio ciphering equipment amounting to $148,000 and shipments of our internet protocol data encryptors amounting to $19,000.

For the three months ended December 28, 2019, revenue was derived primarily from sales of our engineering services amounting to $409,000 and shipments of our internet protocol data encryptors to a customer in a Middle Eastern country amounting to $172,000.

Gross Profit

Gross profit for the first quarter of fiscal 2021 was $123,000, compared to gross profit of $309,000 for the same period of fiscal 2020, a decrease of 60%. Gross profit expressed as a percentage of total net revenue was 74% for the first quarter of fiscal 2021 compared to 46% for the same period in fiscal 2020. This increase in gross profit expressed as a percentage of total net revenue was primarily due to the higher sales volume of higher margin equipment sales in fiscal 2021.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the first quarter of fiscal 2021 were $545,000, compared to $583,000 for the same quarter in fiscal 2020. This decrease of $38,000, or 7%, was attributable to decreases in general and administrative expenses of $36,000 and decreases in selling and marketing expenses of $2,000 during the three months ended December 26, 2020.

The decrease in general and administrative expenses for the three months ended December 26, 2020 was primarily attributable to decreases in payroll and payroll related expenses of $13,000, audit and legal fees of $7,000, director fees of $10,000 and a decrease in insurance of $7,000. These decreases were partially offset by an increase in outside certification costs of $6,000 during the quarter.

The decrease in selling and marketing expenses for the three months ended December 26, 2020 was primarily attributable to decreases in third party sales support and outside commissions of $31,000 and product demonstration costs of $19,000. These decreases were offset by increases in engineering support of sales efforts of $41,000 and bid and proposal costs of $6,000 for the period.

Product Development Costs

Product development costs for the quarter ended December 26, 2020 were $392,000, compared to $205,000 for the quarter ended December 28, 2019. This increase of $187,000, or 91%, was attributable to a decrease in billable engineering services contracts during the first quarter of fiscal 2021 that resulted in increased product development costs of $217,000. These increased costs were partially offset by a decrease in payroll and payroll-related expenses of $46,000 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 no engineering services revenue generated during the first quarter of fiscal 2021 and $409,000 generated during the first quarter of fiscal 2020.

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 $342,000 for the first quarter of fiscal 2021, compared to a net loss of $480,000 for the same period of fiscal 2020. This decrease in net loss is primarily attributable to grant income associated with the forgiveness of a Small Business Administration loan of $474,000 during the first quarter of fiscal 2021.

Liquidity and Capital Resources

Our cash and cash equivalents at December 26, 2020 totaled $666,000 and we had a SBA note payable in the amount of $150,000.

Liquidity and Ability to Continue as a Going Concern

For the quarter ended December 26, 2020, the Company generated a net loss of $342,000. For the fiscal year ended September 26, 2020, the Company generated a net loss of $911,000 and, although the company generated $631,000 of net income in the fiscal year ended September 28, 2019, the Company suffered recurring losses from operations during the prior seven year period from fiscal 2012 to fiscal 2018 and had an accumulated deficit of $3,408,000 at December 26, 2020. These factors continue to raise substantial doubt about the Company's ability to continue as a going concern. Such consolidated financial statements do not include any adjustments to reflect the substantial doubt about the Company’s ability to continue as a going concern.

In December 2020 the Company implemented a partial furlough plan for the majority of salaried employees. This plan reduced the workweek to 24 hours and salaries have been reduced commensurately. With this furlough plan in place we anticipate that our principal sources of liquidity will be sufficient to fund our activities to June 2021. 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 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. The receipt of these orders has been significantly delayed and will continue to be difficult to predict due to the impact of the COVID-19 pandemic on our customers, as a result of their operations being reduced or shut down. TCC has been able to maintain operations during this sustained period of disruption, but a continuation of the disruption in either our customers’ operations or those of the Company will continue to have a material adverse impact on sales activity and revenue.

Since the start of the pandemic, the Company has been able to secure capital in the form of debt financing to assist with funding its operations. On February 1, 2021, the Company received a loan from bankHometown, under the U.S. Small Business Administration's Paycheck Protection Program as authorized under the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”). The loan, evidenced by a promissory note, is in the principal amount of $474,400 and all or a portion of the loan is expected to be forgiven under the provisions of the Economic Aid Act. Any amounts not forgiven will be paid back over five years at an interest rate of 1%. Loan payments will be deferred for borrowers who apply for loan forgiveness until SBA remits the borrower's loan forgiveness amount to the lender. If a borrower does not apply for loan forgiveness, payments are deferred 10 months after the end of the covered period for the borrower’s loan forgiveness (either 8 weeks or 24 weeks).This loan is designed to provide assistance in covering the Company’s payroll-related expenses and a portion of certain other costs, such as rent and utilities, for a 24 week period following the loan date.

During fiscal year 2020, the Company was granted a loan from the SBA in the principal amount of $150,000 pursuant to the Economic Injury Disaster Loan program. This loan is payable monthly over 30 years at an annual interest rate of 3.75% commencing one year from the date of issuance. Also in fiscal year 2020, the Company received a $474,400 PPP loan under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The entire PPP loan amount was forgiven by the SBA on January 11, 2021.

The Company is considering raising capital through equity or debt arrangements in addition to the funding received from the SBA, although we cannot provide assurances we will be able to secure such new funding, especially in light of the tightening of the credit markets and volatility of the capital markets as a result of the coronavirus. Moreover, the Company’s common stock was delisted from the NASDAQ Capital Market effective January 25, 2021; while TCC expects its common stock to be quoted on the OTC Bulletin Board, the change in listing may have a negative impact on the liquidity of the stock and the Company’s ability to raise capital through offerings of its equity securities.

Should the Company be unsuccessful in these efforts, it would be forced to implement headcount reductions, additional 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 three month periods ended (unaudited):

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 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. The lease expense for each of the three month periods ended December 26, 2020 and December 28, 2019 was $43,000.

Debt Instruments

On April 17, 2020, the Company was granted a loan (the “Loan”) from bankHometown in the principal amount of $474,400 pursuant to the PPP under the CARES Act. The Loan, which was in the form of a Note dated April 17, 2020, was payable over eighteen months at an annual interest rate of 1%, commencing on October 17, 2020 to the extent not forgiven. The Company used the entire Loan amount for qualifying expenses and the SBA forgave the Loan in its entirety on January 11, 2021.

The Company also was granted a loan by the SBA in August 2020. This loan was evidenced by a promissory note issued on August 10, 2020 under the Economic Injury Disaster Loan program of the SBA in the amount of $150,000. This note is payable monthly over 30 years at an annual interest rate of 3.75% commencing one year from the date of issuance.

Backlog

Backlog at December 26, 2020 and September 26, 2020 amounted to $660,000 and $701,000, respectively. The orders in backlog at December 26, 2020 are expected to ship and/or services are expected to be performed over the next nine 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 December 26, 2020 and September 26, 2020, 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 three month periods ended December 26, 2020 and December 28, 2019 the Company spent $392,000 and $205,000, respectively, on internal product development. The Company also spent $236,000 on billable development efforts during the first three months of fiscal 2020. The Company’s total product development costs during the first three months of fiscal 2021 were 11% lower than the same period in fiscal 2020 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 product development expenses will remain lower until we secure a new billable research and development contract.

It is anticipated that cash from operations will fund our near-term research and development and marketing activities. 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 2021.

New Accounting Pronouncements

ASU No. 2019-12, Simplifying the Accounting for Income Taxes

In December 2019, the FASB issued guidance under ASU No. 2019-12, Simplifying the Accounting for Income Taxes, with respect to leases. The decisions reflected in this ASU update specific areas of ASC 740, Income Taxes, to reduce complexity while maintaining or improving the usefulness of the information provided to users of financial statements. This guidance is effective for annual reporting periods beginning after December 15, 2020, including interim periods within that reporting period and is not expected to have a material impact on the Company’s financial statements.

Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force) and the SEC during the first three months of the Company’s 2021 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. Based on that review and evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of December 26, 2020 as a result of the material weaknesses in our internal control over financial reporting discussed below.

As previously disclosed under Item 9A, Controls and Procedures in our Annual Report on Form 10-K for the fiscal year ended September 26, 2020, as well as prior fiscal years, management had concluded that the Company did not maintain effective internal control over financial reporting due to material weaknesses in such internal control related to the misapplication of generally accepted accounting principles associated with revenue recognition, inventory reserves, accruals and the preparation of the consolidated financial statements, as well as the classification and disclosure of financial information, caused by an error in judgment by, or a lack of adequate skills and experience within, the accounting department. In addition, management also previously identified a material weakness due to a lack of sufficient staff to segregate accounting duties.

Nonetheless, management believes that our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared in accordance with generally accepted accounting principles. Our Chief Executive Officer and Chief Financial Officer have certified that, based on such officer’s knowledge, the financial statements and other financial information included in this Quarterly Report on Form 10-Q fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report. In addition, we initiated a remediation plan for the material weaknesses, described below.

Our management, with oversight from the Audit Committee, is actively engaged in remediating the identified material weaknesses. As part of these remediation efforts management has undertaken education and training for TCC’s accounting staff and management to address certain core competencies that resulted in the lack of operational effectiveness. Management will continue to assess the design of controls to determine if enhancements are needed to increase effectiveness of our internal control over financial reporting. Management has retained a subject matter expert in the area of income tax accounting and is assessing the need to retain additional subject matter experts to ensure compliance with generally accepted accounting principles and SEC rules and regulations. Both management and the Audit Committee have increased their oversight of non-routine transactions. This includes oversight of large revenue contracts as well as judgement areas, including inventory reserves and accruals. This oversight will contribute to the assessment of the need to retain additional subject matter experts.

The Company continues to make significant progress in improving its internal control over financial reporting but remediation efforts are ongoing; the Company’s goal is to have all material weaknesses remediated by the end of its 2021 fiscal year.

Changes in internal control over financial reporting. The changes in the aforementioned internal control over financial reporting and the remediation efforts undertaken as of the end of fiscal 2020 and undertaken in the first quarter of TCC’s fiscal 2021 have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. No other changes in the Company’s internal control over financial reporting occurred during the first quarter of its 2021 fiscal year.

PART II. Other Information

There were no material pending legal proceedings to which the Company or its subsidiary was a party or which any of their property was subject during the period covered by this quarterly report.

Investors may find it difficult to trade or obtain quotations for our common stock.

Effective January 25, 2021, shares of our common stock were no longer listed on the NASDAQ Capital Market.  Although our common stock is now quoted on the Over the Counter Bulletin Board, investors may find that trading of our common stock is limited.  There can be no assurance a more active market for our common stock will develop. Accordingly, investors may be required to bear the economic risk of an investment in our common stock for an indefinite period of time.  In addition, the Company may find it more difficult to raise capital through offerings of its capital stock because its securities are no longer listed on a national securities exchange, and may suffer reputational damage due to the delisting action.

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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