UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
| x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| For the quarterly period ended July 1, 2017 |
| ¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| For the transition period from ____________________ to ____________________ |
Commission File Number: 001-34816
TECHNICAL COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
| Massachusetts | 04-2295040 | ||
| (State or other jurisdiction of | (I.R.S. Employer Identification No.) | ||
| incorporation or organization) | |||
| 100 Domino Drive, Concord, MA | 01742-2892 | ||
| (Address of principal executive offices) | (Zip Code) |
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. Yesx 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). Yesx 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):
| Large accelerated filer | ¨ | Accelerated filer | ¨ |
| Non-accelerated filer | ¨ | Smaller reporting company | x |
| Emerging growth company | ¨ |
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. 1,839,877 shares of Common Stock, $0.10 par value, outstanding as of August 5, 2017.
INDEX
| 2 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Balance Sheets
| July 1, 2017 | October 1, 2016 | |||||||
| (unaudited) | ||||||||
| Assets | ||||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 1,529,870 | $ | 2,589,036 | ||||
| Restricted cash | 12,930 | 27,592 | ||||||
| Marketable securities - held to maturity | 415,426 | 362,170 | ||||||
| Accounts receivable - trade | 421,572 | 111,849 | ||||||
| Inventories, net | 1,771,462 | 1,643,922 | ||||||
| Other current assets | 157,029 | 214,047 | ||||||
| Total current assets | 4,308,289 | 4,948,616 | ||||||
| Marketable securities - held to maturity | - | 373,668 | ||||||
| Equipment and leasehold improvements | 4,534,839 | 4,531,264 | ||||||
| Less: accumulated depreciation and amortization | (4,465,476 | ) | (4,382,335 | ) | ||||
| Equipment and leasehold improvements, net | 69,363 | 148,929 | ||||||
| Total Assets | $ | 4,377,652 | $ | 5,471,213 | ||||
| Liabilities and Stockholders’ Equity | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | 102,332 | $ | 119,087 | ||||
| Accrued liabilities: | ||||||||
| Accrued compensation and related expenses | 201,911 | 238,144 | ||||||
| Customer deposits | 8,644 | 118,983 | ||||||
| Other current liabilities | 51,020 | 80,635 | ||||||
| Total current liabilities | 363,907 | 556,849 | ||||||
| Commitments and contingencies | ||||||||
| Stockholders’ Equity: | ||||||||
| Common stock, par value $0.10 per share; 7,000,000 shares authorized; 1,839,877 shares issued and outstanding at July 1, 2017 and October 1, 2016 | 183,988 | 183,988 | ||||||
| Additional paid-in capital | 4,134,815 | 4,124,006 | ||||||
| (Accumulated deficit)/Retained earnings | (305,058 | ) | 606,370 | |||||
| Total stockholders’ equity | 4,013,745 | 4,914,364 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 4,377,652 | $ | 5,471,213 | ||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 3 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
| Three Months Ended | ||||||||
| July 1, 2017 | July 2, 2016 | |||||||
| Net sales | $ | 1,067,786 | $ | 581,377 | ||||
| Cost of sales | 528,322 | 626,280 | ||||||
| Gross profit (loss) | 539,464 | (44,903 | ) | |||||
| Operating expenses: | ||||||||
| Selling, general and administrative | 478,654 | 717,561 | ||||||
| Product development | 407,106 | 214,988 | ||||||
| Total operating expenses | 885,760 | 932,549 | ||||||
| Operating loss | (346,296 | ) | (977,452 | ) | ||||
| Other income: | ||||||||
| Interest income | 1,806 | 2,580 | ||||||
| Total other income | 1,806 | 2,580 | ||||||
| Loss before benefit from income taxes | (344,490 | ) | (974,872 | ) | ||||
| Benefit from income taxes | - | (43,464 | ) | |||||
| Net loss | $ | (344,490 | ) | $ | (931,408 | ) | ||
| Net loss per common share: | ||||||||
| Basic | $ | (0.19 | ) | $ | (0.51 | ) | ||
| Diluted | $ | (0.19 | ) | $ | (0.51 | ) | ||
| Weighted average shares: | ||||||||
| Basic | 1,839,877 | 1,839,877 | ||||||
| Diluted | 1,839,877 | 1,839,877 | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 4 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
| Nine Months Ended | ||||||||
| July 1, 2017 | July 2, 2016 | |||||||
| Net sales | $ | 3,084,493 | $ | 2,118,211 | ||||
| Cost of sales | 955,209 | 1,397,236 | ||||||
| Gross profit | 2,129,284 | 720,975 | ||||||
| Operating expenses: | ||||||||
| Selling, general and administrative | 1,669,293 | 2,126,655 | ||||||
| Product development | 1,377,889 | 720,796 | ||||||
| Total operating expenses | 3,047,182 | 2,847,451 | ||||||
| Operating loss | (917,898 | ) | (2,126,476 | ) | ||||
| Other income: | ||||||||
| Gain on sale of cost method investment | - | 462,283 | ||||||
| Interest income | 6,470 | 8,780 | ||||||
| Total other income | 6,470 | 471,063 | ||||||
| Loss before benefit from income taxes | (911,428 | ) | (1,655,413 | ) | ||||
| Benefit from income taxes | - | (43,464 | ) | |||||
| Net loss | $ | (911,428 | ) | $ | (1,611,949 | ) | ||
| Net loss per common share: | ||||||||
| Basic | $ | (0.50 | ) | $ | (0.88 | ) | ||
| Diluted | $ | (0.50 | ) | $ | (0.88 | ) | ||
| Weighted average shares: | ||||||||
| Basic | 1,839,877 | 1,839,877 | ||||||
| Diluted | 1,839,877 | 1,839,877 | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 5 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
| Nine Months Ended | ||||||||
| July 1, 2017 | July 2, 2016 | |||||||
| Operating Activities: | ||||||||
| Net loss | $ | (911,428 | ) | $ | (1,611,949 | ) | ||
| Adjustments to reconcile net loss to net cash (used in) provided by operating activities: | ||||||||
| Depreciation and amortization | 83,141 | 118,273 | ||||||
| Stock-based compensation | 10,809 | 10,632 | ||||||
| Amortization of premium on held to maturity securities | 20,412 | 24,736 | ||||||
| Gain on sale of cost method investment | - | (462,283 | ) | |||||
| Changes in certain operating assets and liabilities: | ||||||||
| Accounts receivable | (309,723 | ) | 1,404,645 | |||||
| Inventories | (127,540 | ) | 84,138 | |||||
| Other current assets | (18,799 | ) | (35,725 | ) | ||||
| Customer deposits | (110,339 | ) | 12,205 | |||||
| Accounts payable and other accrued liabilities | (82,603 | ) | (191,336 | ) | ||||
| Net cash used in operating activities | (1,446,070 | ) | (646,664 | ) | ||||
| Investing Activities: | ||||||||
| Proceeds from sale of cost method investment | 75,817 | 661,466 | ||||||
| Additions to equipment and leasehold improvements | (3,575 | ) | (31,000 | ) | ||||
| Decrease in restricted cash | 14,662 | 7,034 | ||||||
| Proceeds from maturities of marketable securities | 300,000 | 200,000 | ||||||
| Net cash provided by investing activities | 386,904 | 837,500 | ||||||
| Net (decrease) increase in cash and cash equivalents | (1,059,166 | ) | 190,836 | |||||
| Cash and cash equivalents at beginning of the period | 2,589,036 | 2,276,511 | ||||||
| Cash and cash equivalents at end of the period | $ | 1,529,870 | $ | 2,467,347 | ||||
| Supplemental Disclosures: | ||||||||
| Income taxes paid | $ | 856 | $ | 1,856 | ||||
| Escrow deposit held on sale of cost method investment | - | 75,817 | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 6 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Interim Financial Statements
The accompanying unaudited consolidated financial statements of Technical Communications Corporation and its wholly-owned subsidiary (collectively the “Company” or “TCC” or “We”) 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 30, 2017.
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 consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and the notes thereto in the Company’s Annual Report on Form 10-K for the fiscal year ended October 1, 2016 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 theFASB Accounting Standards CodificationTM- sometimes referred to as the Codification or ASC.
It is anticipated that cash from operations will fund our near-term research and development and marketing activities at least through July 1, 2018. We also believe that in the long term, based on current and anticipated 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. We plan to continue to closely monitor operating expenses and will continue to make strategic reductions as appropriate. In circumstances where resources may be insufficient, the Company will look to other sources of financing, including debt and/or equity investments, although we can give no assurances that the Company will be successful in obtaining such financing.
| NOTE 1. | Summary of Significant Accounting Policies and Significant Judgments and Estimates |
Basis of Presentation
The accompanying unaudited 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 unaudited consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these unaudited consolidated financial statements requires management to make estimates and judgments 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, going concern, inventory reserves, receivable reserves, marketable securities, impairment of long-lived assets, income taxes, fair value of financial instruments and stock-based compensation. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from these estimates under different assumptions or conditions.
| 7 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
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 and passage of title to the customer has occurred and we have determined that collection of the fee is probable. Title to the product generally passes upon shipment of the product, as the products are shipped freight on board 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, or other acceptance criteria exist, all revenue related to the product is deferred and recognized upon completion of the installation or satisfaction of the customer acceptance criteria. 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 cost 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 date 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. There have been no government audits in recent years and the Company believes the result of such audits, should they occur, would not have a material adverse effect on its financial position or results of operations. 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 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. Product development costs consist primarily of costs associated with personnel, outside contractor and engineering services, supplies and materials.
Inventories
We value our inventory at the lower of actual cost (based on the first-in, first-out method) 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. The Company evaluates the carrying value of inventory on a quarterly basis to determine if the carrying value is recoverable at estimated selling prices. To the extent that estimated selling prices are less than the associated carrying values, inventory carrying values are written down. In addition, the Company makes judgments as to future demand requirements and compares those with the current or committed inventory levels. Reserves are established for inventory levels that exceed future demand. It is possible that additional reserves above those already established may be required in the future if market conditions for our products should deteriorate.
| 8 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
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 no allowance currently is needed, 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. In addition, if the Company becomes aware of a customer’s inability to meet its financial obligations to TCC, a specific write-off is recorded in that amount.
Accounting for Income Taxes
The preparation of our unaudited 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 inventory obsolescence and stock-based compensation, 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. At July 1, 2017 and October 1, 2016, we recorded a full valuation allowance against our net deferred tax assets of approximately $4.1 million due to uncertainties related to our ability to realize these assets. The valuation allowance is based on our estimates of taxable income by jurisdiction and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could materially impact our financial position and results of operations.
The Company follows FASB ASC 740-10,Accounting for Uncertainty in Income Taxes, relative to uncertain tax positions. This standard provides detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in the financial statements. Uncertain tax positions must meet a recognition threshold of more-likely-than-not in order for those tax positions to be recognized in the financial statements.
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, and it is not anticipated that we will be subject to foreign taxes in the near future.
Fair Value Measurements
In determining fair value measurements, 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. At July 1, 2017 and October 1, 2016, the carrying amounts of cash and cash equivalents, restricted cash, accounts receivable, marketable securities, other current assets, accounts payable and accrued liabilities approximate fair value because of their short-term nature.
| 9 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
The three-level hierarchy is as follows:
| Level 1 - | Pricing inputs are quoted prices available in active markets for identical assets or liabilities as of the measurement date. | |
| Level 2 - | Pricing inputs are quoted prices for similar assets or liabilities, or inputs that are observable, either directly or indirectly, for substantially the full term through corroboration with observable market data. | |
| Level 3 - | Pricing inputs are unobservable for the assets or liabilities, that is, inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability. |
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an asset’s or liability’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 asset or liability.
The Company’s held to maturity securities are comprised of investments in municipal bonds. These securities represent ownership in individual bonds issued by municipalities within the United States. The value of these securities is disclosed in Note 6. The Company also holds money market mutual funds in a brokerage account, which are classified as cash equivalents and measured at fair value. The fair value of these investments is based on quoted prices from recognized pricing services (e.g. Standard & Poor’s, Bloomberg, etc.) or, in the case of money market mutual funds, at their closing published 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 nine month period ended July 1, 2017 and the year ended October 1, 2016, there were no transfers between levels.
As of July 1, 2017 and October 1, 2016, the Company did not hold any assets or liabilities measured at fair value on a recurring basis classified as Level 2 or Level 3. At July 1, 2017 and October 1, 2016, the Level 1 assets measured at fair value consisted of money market mutual funds valued at $794,228 and $978,746, respectively.
There were no assets or liabilities measured at fair value on a nonrecurring basis at July 1, 2017 or October 1, 2016.
Stock-Based Compensation
Stock-based compensation cost is measured at the grant date based on the calculated fair value of the award. The expense is recognized over the participant’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. There were no excess tax benefits recorded during the nine month periods ended July 1, 2017 and July 2, 2016.
The Company uses 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.
| 10 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
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.
There were 14,000 options granted during each of the nine month periods ended July 1, 2017 and July 2, 2016.
The following table summarizes stock-based compensation costs included in the Company’s consolidated statements of operations for the three and nine month periods ended July 1, 2017 and July 2, 2016:
| July 1, 2017 | July 2, 2016 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Selling, general and administrative expenses | 3,896 | 9,998 | 3,896 | 8,576 | ||||||||||||
| Product development expenses | 272 | 811 | 344 | 2,056 | ||||||||||||
| Total share-based compensation expense before taxes | $ | 4,168 | $ | 10,809 | $ | 4,240 | $ | 10,632 | ||||||||
As of July 1, 2017 and July 2, 2016, there was $58,468 and $50,421, respectively, of unrecognized compensation expense related to options outstanding. The unrecognized compensation expense will be recognized over the remaining requisite service period. As of July 1, 2017 and July 2, 2016, the weighted average periodover which the compensation expense is expected to be recognized is 4.1 and 4.2 years, respectively.
The Technical Communications Corporation 2005 Non-Statutory Stock Option Plan and 2010 Equity Incentive Plan were outstanding at July 1, 2017. There are an aggregate of 600,000 shares authorized for issuance under these plans, of which options to purchase 251,714 shares were outstanding at July 1, 2017. 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 July 1, 2017, there were 236,853 shares available for grant under the 2010 Equity Incentive Plan. On May 5, 2015 the 2005 Non-Statutory Stock Option Plan expired and options are no longer available for grant under such plan.
| 11 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
The following table summarizes stock option activity during the first nine months of fiscal 2017:
| Options Outstanding | ||||||||||||||||||
| Number of Shares | Weighted Average | Weighted Average | ||||||||||||||||
| Unvested | Vested | Total | Exercise Price | Contractual Life | ||||||||||||||
| Outstanding, October 1, 2016 | 26,700 | 216,981 | 243,681 | $ | 8.69 | 4.57 years | ||||||||||||
| Grants | - | - | - | |||||||||||||||
| Vested | - | - | - | |||||||||||||||
| Exercises | - | - | - | |||||||||||||||
| Cancellations/forfeitures | (600 | ) | (900 | ) | (1,500 | ) | 4.88 | |||||||||||
| Outstanding, December 31, 2016 | 26,100 | 216,081 | 242,181 | $ | 8.71 | 4.31 years | ||||||||||||
| Grants | 14,000 | - | 14,000 | 2.50 | ||||||||||||||
| Vested | (2,800 | ) | 2,800 | - | 2.90 | |||||||||||||
| Exercises | - | - | - | |||||||||||||||
| Cancellations/forfeitures | - | (4,067 | ) | (4,067 | ) | 6.89 | ||||||||||||
| Outstanding, April 1, 2017 | 37,300 | 214,814 | 252,114 | $ | 8.40 | 4.43 years | ||||||||||||
| Grants | - | - | - | |||||||||||||||
| Vested | (3,100 | ) | 3,100 | - | 4.25 | |||||||||||||
| Exercises | - | - | - | |||||||||||||||
| Cancellations/forfeitures | - | (400 | ) | (400 | ) | 5.15 | ||||||||||||
| Outstanding, July 1, 2017 | 34,200 | 217,514 | 251,714 | $ | 8.40 | 4.18 years | ||||||||||||
Information related to the stock options vested and expected to vest as of July 1, 2017 is as follows:
| Weighted-Average | Exercisable | |||||||||||||||||||
| Remaining | Weighted | Exercisable | Weighted- | |||||||||||||||||
| Range of | Number of | Contractual | Average | Number of | Average | |||||||||||||||
| Exercise Prices | Shares | Life (years) | Exercise Price | Shares | Exercise Price | |||||||||||||||
| $2.01 - $3.00 | 28,000 | 9.12 | $ | 2.70 | 2,800 | $ | 2.90 | |||||||||||||
| $4.01 - $5.00 | 40,500 | 5.13 | $ | 4.52 | 32,100 | $ | 4.65 | |||||||||||||
| $5.01 - $10.00 | 61,000 | 3.18 | $ | 7.58 | 60,400 | $ | 7.60 | |||||||||||||
| $10.01 - $15.00 | 122,214 | 3.24 | $ | 11.41 | 122,214 | $ | 11.41 | |||||||||||||
| 251,714 | 4.18 | $ | 8.40 | 217,514 | $ | 9.24 | ||||||||||||||
The aggregate intrinsic value of the Company’s “in-the-money” outstanding and exercisable options as of July 1, 2017 and July 2, 2016 was $0. Nonvested stock options are subject to the risk of forfeiture until the fulfillment of specified conditions.
| NOTE 2. | Inventories |
Inventories consisted of the following:
| July 1, 2017 | October 1, 2016 | |||||||
| Finished goods | $ | 8,015 | $ | 19,167 | ||||
| Work in process | 526,554 | 360,738 | ||||||
| Raw materials | 1,236,893 | 1,264,017 | ||||||
| $ | 1,771,462 | $ | 1,643,922 | |||||
| 12 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
| NOTE 3. | Income Taxes |
The Company has not recorded an income tax benefit on its net loss for the nine month period ended July 1, 2017 due to its uncertain realizability. During the nine months ended July 2, 2016 the Company recorded a tax benefit as a result of expiring statutes of limitations related to uncertain tax positions of $43,464. During previous fiscal years, the Company recorded a valuation allowance for the full amount of its net deferred tax assets since it could not predict the realization of these assets.
| NOTE 4. | Net Loss Per Common Share |
Outstanding potentially dilutive stock options, which were not included in the net loss per common share amounts as their effect would have been anti-dilutive, were as follows: 251,714 shares at July 1, 2017 and 253,881 shares at July 2, 2016.
| NOTE 5. | Major Customers and Export Sales |
During the three months ended July 1, 2017, the Company had two customers that represented 97% (63% and 34%, respectively) of net sales as compared to the three months ended July 2, 2016, during which the Company had one customer that represented 95% of net sales. During the nine months ended July 1, 2017, the Company had two customers that represented 91% (79% and 12%, respectively) of net sales as compared to the nine months ended July 2, 2016, during which two customers represented 90% (68% and 22%, respectively) of net sales. At July 1, 2017 and July 2, 2016 the Company had one customer that represented 87% of accounts receivable and one customer that represented 99% of accounts receivable, respectively.
A breakdown of foreign and domestic net sales for the three and nine month periods ended July 1, 2017 and July 2, 2016 is as follows:
| July 1, 2017 | July 2, 2016 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Domestic | $ | 1,057,061 | $ | 2,840,783 | $ | 533,093 | $ | 1,967,194 | ||||||||
| Foreign | 10,725 | 243,710 | 48,284 | 151,017 | ||||||||||||
| Total sales | $ | 1,067,786 | $ | 3,084,493 | $ | 581,377 | $ | 2,118,211 | ||||||||
The Company sold products into one foreign country during the three month period ended July 1, 2017 and two foreign countries during the three month period ended July 2, 2016. The Company sold products into five foreign countries during the nine month period ended July 1, 2017 and four foreign countries during the nine month period ended July 2, 2016. A sale is attributed to a foreign country based on the location of the contracting party. Domestic sales may include the sale of products shipped through domestic resellers or manufacturers to international destinations. The table below summarizes our foreign sales by country as a percentage of total foreign sales.
| July 1, 2017 | July 2, 2016 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Bahrain | 100 | % | 4 | % | - | - | ||||||||||
| Saudi Arabia | - | 42 | % | - | 29 | % | ||||||||||
| Jordan | - | 43 | % | - | - | |||||||||||
| Philippines | - | 4 | % | 49 | % | 29 | % | |||||||||
| Egypt | - | - | - | 26 | % | |||||||||||
| Serbia | - | - | 51 | % | 16 | % | ||||||||||
| Other | - | 7 | % | - | - | |||||||||||
| 13 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
A summary of foreign sales,as a percentage of total foreign sales by geographic area, is as follows:
| July 1, 2017 | July 2, 2016 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Europe | - | - | 51 | % | 16 | % | ||||||||||
| Mid-East and Africa | 100 | % | 89 | % | - | 55 | % | |||||||||
| Far East | - | 11 | % | 49 | % | 29 | % | |||||||||
| NOTE 6. | Cash Equivalents and Marketable Securities |
The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents. 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 either available for sale or held to maturity.
Available for sale securities are carried at fair value, with unrealized holding gains and losses reported in stockholders’ equity as a separate component of accumulated other comprehensive income (loss). Held to maturity securities are carried at amortized cost. 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 July 1, 2017, available for sale securities consisted of the following:
| Gross Unrealized | Estimated | |||||||||||||||
| Cost | Gains | Losses | Fair Value | |||||||||||||
| Money market mutual funds | $ | 794,228 | $ | - | $ | - | $ | 794,228 | ||||||||
As of July 1, 2017, held to maturity securities consisted of the following:
| Accrued | Amortization | Amortized | Unrealized | Estimated | ||||||||||||||||||||
| Cost | Interest | Bond Premium | Cost | Gains | Fair Value | |||||||||||||||||||
| Municipal bonds | $ | 469,464 | $ | 6,194 | $ | 60,232 | $ | 415,426 | $ | 489 | $ | 415,915 | ||||||||||||
As of October 1, 2016, available for sale securities consisted of the following:
| Gross Unrealized | Estimated | |||||||||||||||
| Cost | Gains | Losses | Fair Value | |||||||||||||
| Money market mutual funds | $ | 978,746 | $ | - | $ | - | $ | 978,746 | ||||||||
As of October 1, 2016, held to maturity securities consisted of the following:
| Accrued | Amortization | Amortized | Unrealized | Estimated | ||||||||||||||||||||
| Cost | Interest | Bond Premium | Cost | Gains | Fair Value | |||||||||||||||||||
| Municipal bonds | $ | 823,730 | $ | 11,569 | $ | 99,461 | $ | 735,838 | $ | 2,503 | $ | 738,341 | ||||||||||||
The contractual maturities of held to maturity securities as of July 1, 2017 were all within one year.
| 14 |
The Company’s available for sale securities were included in cash and cash equivalents at July 1, 2017 and October 1, 2016.
| NOTE 7 | Cost Method Investment |
On October 30, 2014, the Company made an investment of $275,000 to purchase 11,000 shares of common stock of PulsedLight, Inc., an early stage start-up company located in Bend, Oregon. The investment represented a 10.8% ownership stake in the company at the time of purchase and was accounted for utilizing the cost method of accounting. On January 12, 2016, the Company entered into an agreement to sell its shares in PulsedLight, Inc. The net proceeds to the Company after closing costs and certain liabilities amounted to $737,283, of which the Company received $661,466 at closing and of which $75,817 was deposited in an escrow account in accordance with the terms of the sale that required 10% of the proceeds to be held in escrow for one year. The escrow balance as of October 1, 2016 is included in other current assets within the accompanying consolidated balance sheet. The escrow balance was received by the Company in January 2017.
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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 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 October 1, 2016.
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 October 1, 2016, 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 October 1, 2016 as filed with the SEC.
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Results of Operations
Three Months ended July 1, 2017 compared to Three Months ended July 2, 2016
Net Sales
Net sales for the quarter ended July 1, 2017were $1,068,000, compared to $581,000 for the quarter ended July 2, 2016, an increase of 84%. Sales for the thirdquarter of fiscal 2017 consisted of $1,057,000, or 99%, from domestic sources and $11,000, or 1%, from international customers as compared to the same period in fiscal 2016, during which sales consisted of $533,000, or 92%, from domestic sources and $48,000, or 8%, from international customers.
Foreign sales consisted of shipments to one country during the quarter ended July 1, 2017and two countries during the quarter ended July 2, 2016. A sale is attributed to a foreign country based on the location of the contracting party. Domestic sales 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 2017 and 2016:
| 2017 | 2016 | |||||||
| Bahrain | $ | 11,000 | $ | - | ||||
| Serbia | - | 25,000 | ||||||
| Philippines | - | 23,000 | ||||||
| $ | 11,000 | $ | 48,000 | |||||
For the three months ended July 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 $669,000. We also recorded sales under an engineering services contract amounting to $300,000.
For the three months ended July 2, 2016, we recorded sales under an engineering services contract amounting to $552,000. Product sales revenue for the quarter was derived primarily from shipments of our narrowband radio encryptors to a foreign customer amounting to $23,000 and our telephone fax encryptors amounting to $25,000.
Gross Profit (Loss)
Gross profit for the third quarter of fiscal 2017 was $539,000, compared to gross loss of $(45,000) for the same period of fiscal 2016. Gross profit expressed as a percentage of sales was 51% and (8%) for the third quarters of fiscal 2017 and 2016, respectively.
Operating Costs and Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the third quarter of fiscal 2017 were $479,000, compared to $718,000 for the same quarter in fiscal 2016. This decrease of $239,000, or 33%, was attributable to a decrease in general and administrative expenses of $52,000 and a decrease in selling and marketing expenses of $187,000 during the three months ended July 1, 2017.
The decrease in general and administrative expenses for the three months ended July 1, 2017 was primarily attributable to decreases in personnel-related costs of $38,000 and other public company expenses of $13,000 and offset by an increase in legal fees of $8,000.
The decrease in selling and marketing expenses for the three months ended July 1, 2017 was primarily attributable to decreases in product demonstration costs of $62,000, outside sales and marketing agreements of $45,000, product evaluation costs of $36,000, engineering sales support of $16,000, bid and proposal efforts of $10,000 and marketing expenses of $10,000.
| 17 |
Product Development Costs
Product development costs for the quarter ended July 1, 2017 were $407,000, compared to $215,000 for the quarter ended July 2, 2016. This increase of $192,000, or 89%, was primarily attributable to a reduction in billable engineering services contracts during the third quarter of fiscal 2017 that resulted in increased product development costs of $187,000. There were also increases in outside consulting costs of $11,000 and recruiting fees of $14,000. These increases were offset by a decrease in personnel related costs of $11,000 during the quarter.
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 $300,000 of billable engineering services revenue generated during the third quarter of fiscal 2017 and $552,000 in the third quarter of fiscal 2016.
Net Loss
The Company generated a net loss of $344,000 for the third quarter of fiscal 2017, compared to a net loss of $931,000 for the same period of fiscal 2016. This decrease in net loss is primarily attributable to a $584,000 increase in gross profit and a 33% decrease in selling, general and administrative expenses, partially offset by an 89% increase in product development costs during the third quarter of fiscal 2017.
The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of July 1, 2017, 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.
Nine Months ended July 1, 2017 compared to Nine Months ended July 2, 2016
Net Sales
Net sales for the nine months ended July 1, 2017were $3,084,000, compared to $2,118,000 for the nine months ended July 2, 2016, an increase of 46%. Sales for the first nine months of fiscal 2017 consisted of $2,841,000, or 92%, from domestic sources and $243,000, or 8%, from international customers as compared to the same period in fiscal 2016, during which sales consisted of $1,967,000, or 93%, from domestic sources and $151,000, or 7%, from international customers.
Foreign sales consisted of shipments to five countries during the nine months ended July 1, 2017and four countries during the nine months ended July 2, 2016. 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.
| 18 |
The table below summarizes our principal foreign sales by country during the first nine months of fiscal 2017 and 2016:
| 2017 | 2016 | |||||||
| Jordan | $ | 106,000 | $ | - | ||||
| Saudi Arabia | 101,000 | 44,000 | ||||||
| Philippines | 10,000 | 44,000 | ||||||
| Egypt | - | 38,000 | ||||||
| Serbia | - | 25,000 | ||||||
| Other | 26,000 | - | ||||||
| $ | 243,000 | $ | 151,000 | |||||
For the nine months ended July 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 $2,450,000. The Company made shipments of our secure telephone and fax encryptor to an international customer in Jordan amounting to $106,000. We also sold our internet protocol encryptor to a customer in Saudi Arabia amounting to $95,000 during the period.
For the nine months ended July 2, 2016, we recorded revenue under an engineering services contract amounting to $1,443,000. Product sales revenue was derived primarily from shipments of our narrowband radio encryptors to a domestic customer for deployment into Afghanistan amounting to $464,000 during the period.
Gross Profit
Gross profit for the first nine months of fiscal 2017 was $2,129,000, compared to gross profit of $721,000 for the same period of fiscal 2016. Gross profit expressed as a percentage of sales was 69% for the first nine months of fiscal 2017 compared to 34% for the same period in fiscal 2016, which increase was due to the lower margin engineering services sales in fiscal 2016.
Operating Costs and Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the first nine months of fiscal 2017 were $1,669,000, compared to $2,127,000 for the same period in fiscal 2016. This decrease of $458,000, or 22%, was primarily attributable to a decrease in and general and administrative expenses of $161,000 and a decrease in selling and marketing expenses of $296,000 during the nine months ended July 1, 2017.
The decrease in general and administrative expenses for the nine months ended July 1, 2017 was primarily attributable to decreases in personnel-related costs of $98,000, charitable contributions of $20,000, other public company expenses of $40,000 and training expenses of $7,000.
The decrease in selling and marketing expenses for the nine months ended July 1, 2017 was primarily attributable to decreases in outside sales and marketing agreements of $135,000, product evaluation costs of $113,000, engineering sales support of $58,000, personnel-related costs of $20,000, travel expenses of $9,000, marketing expenses of $21,000 and bank fees of $10,000. These decreases were offset by increases in product demonstration costs of $67,000, bid and proposal efforts of $15,000 and outside commissions of $13,000 during the period.
Product Development Costs
Product development costs for the nine months ended July 1, 2017 were $1,378,000, compared to $721,000 for the nine months ended July 2, 2016. This increase of $657,000, or 91%, was attributable to a reduction in billable engineering services contracts during the first nine months of fiscal 2017 that resulted in increased product development costs of $663,000.
| 19 |
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 $300,000 of billable engineering services revenue generated during the first nine months of fiscal 2017 and $1,443,000 in the first nine months of fiscal 2016.
Net Loss
The Company incurred a net loss of $911,000 for the first nine months of fiscal 2017, compared to a net loss of $1,612,000 for the same period of fiscal 2016. This decrease in net loss is primarily attributable to a 195% increase in gross profit and a 22% decrease in selling, general and administrative expenses, which were offset by a 91% increase in product development costs during the first nine months of fiscal 2017.
The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of July 1, 2017, 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
We believe that our overall financial condition remains reasonably strong. Our cash, cash equivalents and marketable securities (excluding restricted cash) at July 1, 2017 totaled $1,945,000 and we continue to have no long-term debt. It is anticipated that our cash balances and cash generated from operations will be sufficient to fund our near-term research and development and marketing activities.
Cash Requirements
We believe that the combination of existing cash, cash equivalents, and highly liquid short-term investments, together with future cash to be generated by operations, will be sufficient to meet our ongoing operating and capital expenditure requirements for the foreseeable future and at least through July 1, 2018. We also believe that, in the long term, an anticipated improvement of business prospects, current billable activities and cash from operations will be sufficient to meet the Company’s investment in product development, although we can give no assurances. Delays in the timing of significant sales transactions with foreign governments, U.S. government agencies and other organizations may have a significant negative effect on the Company’s operations. 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. The Company has some ability to mitigate this effect through cost-cutting measures. 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.
| 20 |
Sources and Uses of Cash
The following table presents our abbreviated cash flows for the nine month periods ended (unaudited):
| July 1, | July 2, | |||||||
| 2017 | 2016 | |||||||
| Net loss | $ | (911,000 | ) | $ | (1,612,000 | ) | ||
| Changes not affecting cash | 114,000 | (309,000 | ) | |||||
| Changes in assets and liabilities | (649,000 | ) | 1,274,000 | |||||
| Cash used in operating activities | (1,446,000 | ) | (647,000 | ) | ||||
| Cash provided by investing activities | 387,000 | 838,000 | ||||||
| Net change in cash and cash equivalents | (1,059,000 | ) | 191,000 | |||||
| Cash and cash equivalents - beginning of period | 2,589,000 | 2,276,000 | ||||||
| Cash and cash equivalents - end of period | $ | 1,530,000 | $ | 2,467,000 | ||||
Operating Activities
The Company used approximately $799,000 more cash for operating activities in the first nine months of fiscal 2017 compared to the same period in fiscal 2016. This increase was primarily attributable to an increase in accounts receivable of $310,000 at July 1, 2017 as compared to a decrease in accounts receivable of $1,405,000 at July 2, 2016, resulting in an increase in net use of cash of $1,714,000. This increase in use of cash was partially offset by the gain on sale of cost method investment of $462,000 during the nine month period ended July 2, 2016 and the decrease in net loss of $701,000 during the nine month period ended July 1, 2017 as compared to the nine month period ended July 2, 2016.
Investing Activities
Cash provided by investing activities during the first nine months of fiscal 2017 decreased by approximately $451,000 compared to the same period in fiscal 2016. This change is primarily attributable to the proceeds from the sale of the cost method investment which was $586,000 greater during the first nine months of 2016 compared to the same period of 2017.
Company Facilities
On July 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 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 nine month periods ended July 1, 2017 and July 2, 2016 was $128,000.
Backlog
Backlog at July 1, 2017 and October 1, 2016 amounted to $2,765,000 and $313,000, respectively. The orders in backlog at July 1, 2017 are expected to ship over the next 12 months depending on customer requirements and product availability.
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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 July 1, 2017, the Company had two outstanding letters of credit in the amounts of $12,000 and $1,000 and at October 1, 2016, the Company had three outstanding letters of credit in the amounts of $15,000, $12,000 and $1,000, which are secured by collateralized bank accounts totaling $13,000 and $28,000, respectively. 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 attract and retain qualified personnel, improve existing products and develop new products. No assurances can be given that the Company will be able to hire and train such technical management and sales personnel or successfully improve and develop its products.
During the nine months ended July 1, 2017 and July 2, 2016, the Company spent $1,378,000 and $721,000, respectively, on internal product development. The Company also spent $152,000 on billable development efforts during the first nine months of fiscal 2017 and $822,000 on billable development efforts during the first nine months of fiscal 2016. The Company’s total product development costs during the first nine months of fiscal 2017 were in line with total product development costs for the same period in fiscal 2016, which is consistent 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 the total development expenses for fiscal 2017 will continue to be consistent with fiscal 2016 levels.
It is anticipated that cash from operations will fund our near-term research and development and marketing activities through at least July 1, 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 in fiscal 2017.
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.
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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 is currently evaluating the impact of this guidance.The guidance applies to all companies and is effective for annual reporting periods ending after December 15, 2016 and for annual periods and interim periods thereafter.The adoption of this standard is not expected to have a material impact on our financial statements.
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 are 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 amendment is applicable for the Company beginning in the first quarter of our 2018 fiscal year, and the adoption of this standard is not expected to 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 entitiesto 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 thepotential 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 is applicable for the Company beginning in the first quarter of our 2018 fiscal year. We are currently evaluating the method of adoption and the potential impact this standard will have on our financial statements and related disclosure.
Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force), the AICPA and the SEC during the first nine months of fiscal 2017 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.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable.
| 23 |
| Item 4. | Controls and Procedures |
Evaluation of disclosure controls and procedures. The Company’s chief executive officer and chief financial officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this 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 endedJuly 1, 2017that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
| 24 |
| Item 1. | Legal Proceedings |
There were no legal proceedings pending against or involving the Company or its subsidiary during the period covered by this quarterly report.
| Item 1A. | Risk Factors |
Not applicable.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Not applicable.
| Item 3. | Defaults Upon Senior Securities |
Not applicable.
| Item 4. | Mine Safety Disclosures |
Not applicable.
| Item 5. | Other Information |
Not applicable.
| Item 6. | Exhibits |
| 31.1 | Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2 | Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 101.INS | XBRL Report Instance Document | |
| 101.SCH | XBRL Taxonomy Extension Schema Document | |
| 101.CAL | XBRL Taxonomy Calculation Linkbase Document | |
| 101.LAB | XBRL Taxonomy Label Linkbase Document | |
| 101.PRE | XBRL Presentation Linkbase Document | |
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |
| 25 |
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.
| TECHNICAL COMMUNICATIONS CORPORATION | ||
| (Registrant) | ||
| August 15, 2017 | By: | /s/ Carl H. Guild, Jr. |
| Date | Carl H. Guild, Jr., President and Chief | |
| Executive Officer | ||
| August 15, 2017 | By: | /s/ Michael P. Malone |
| Date | Michael P. Malone, Chief Financial Officer | |
| 26 |