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 June 29, 2019 | ||
| 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) |
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common | TCCO | NASDAQ Capital Market |
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.
| Large accelerated filer | ☐ | Accelerated filer | ☐ | Emerging growth company | ☐ |
| Non-accelerated filer | ☒ | Smaller reporting 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. 1,850,403 shares of Common Stock, $0.10 par value, outstanding as of August 9, 2019.
INDEX
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
| June 29, 2019 | September 29, 2018 | |||||||
| Assets | (Unaudited) | |||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 764,786 | $ | 1,982,434 | ||||
| Accounts receivable - trade | 44,358 | 559,493 | ||||||
| Inventories, net | 1,082,338 | 1,368,696 | ||||||
| Other current assets | 122,814 | 142,279 | ||||||
| Total current assets | 2,014,296 | 4,052,902 | ||||||
| Equipment and leasehold improvements | 4,591,756 | 4,578,501 | ||||||
| Less: accumulated depreciation and amortization | (4,547,830 | ) | (4,529,298 | ) | ||||
| Equipment and leasehold improvements, net | 43,926 | 49,203 | ||||||
| Total Assets | $ | 2,058,222 | $ | 4,102,105 | ||||
| Liabilities and Stockholders’ Equity | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | 318,186 | $ | 187,958 | ||||
| Deferred revenue | 337,939 | 2,106,514 | ||||||
| Accrued liabilities: | ||||||||
| Accrued compensation and related expenses | 191,406 | 220,544 | ||||||
| Customer deposits | 21,082 | 35,628 | ||||||
| Other current liabilities | 14,421 | 18,405 | ||||||
| Total current liabilities | 883,034 | 2,569,049 | ||||||
| Commitments and contingencies | ||||||||
| Stockholders’ Equity: | ||||||||
| Common stock, par value $0.10 per share; 7,000,000 shares authorized; 1,850,403 shares issued and outstanding at June 29, 2019 and September 29, 2018 | 185,041 | 185,041 | ||||||
| Additional paid-in capital | 4,177,451 | 4,134,371 | ||||||
| Accumulated deficit | (3,187,304 | ) | (2,786,356 | ) | ||||
| Total stockholders’ equity | 1,175,188 | 1,533,056 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 2,058,222 | $ | 4,102,105 | ||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| Page 1 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
| Three Months Ended | ||||||||
| June 29, 2019 | June 30, 2018 | |||||||
| Net revenue | ||||||||
| Engineering services | $ | 952,602 | $ | 758,670 | ||||
| Equipment sales | 282,060 | 148,507 | ||||||
| Total net revenue | 1,234,662 | 907,177 | ||||||
| Cost of revenue | ||||||||
| Engineering services | 662,602 | 573,028 | ||||||
| Equipment sales | 126,748 | 139,691 | ||||||
| Total cost of revenue | 789,350 | 712,719 | ||||||
| Gross profit | 445,312 | 194,458 | ||||||
| Operating expenses: | ||||||||
| Selling, general and administrative | 731,728 | 522,097 | ||||||
| Product development | 43,092 | 124,234 | ||||||
| Total operating expenses | 774,820 | 646,331 | ||||||
| Operating loss | (329,508 | ) | (451,873 | ) | ||||
| Other income: | ||||||||
| Interest income | 3,543 | 2,118 | ||||||
| Net loss | $ | (325,965 | ) | $ | (449,755 | ) | ||
| Net loss per common share: | ||||||||
| Basic | $ | (0.18 | ) | $ | (0.24 | ) | ||
| Diluted | $ | (0.18 | ) | $ | (0.24 | ) | ||
| Weighted average shares: | ||||||||
| Basic | 1,850,403 | 1,849,025 | ||||||
| Diluted | 1,850,403 | 1,849,025 | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| Page 2 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
| Nine Months Ended | ||||||||
| June 29, 2019 | June 30, 2018 | |||||||
| Net revenue | ||||||||
| Engineering services | $ | 2,819,676 | $ | 2,218,375 | ||||
| Equipment sales | 1,455,799 | 329,297 | ||||||
| Total net revenue | 4,275,475 | 2,547,672 | ||||||
| Cost of revenue | ||||||||
| Engineering services | 1,994,102 | 1,424,384 | ||||||
| Equipment sales | 637,405 | 394,078 | ||||||
| Total cost of revenue | 2,631,507 | 1,818,462 | ||||||
| Gross profit | 1,643,968 | 729,210 | ||||||
| Operating expenses: | ||||||||
| Selling, general and administrative | 1,871,659 | 1,513,052 | ||||||
| Product development | 186,785 | 442,470 | ||||||
| Total operating expenses | 2,058,444 | 1,955,522 | ||||||
| Operating loss | (414,476 | ) | (1,226,312 | ) | ||||
| Other income: | ||||||||
| Interest income | 13,528 | 5,601 | ||||||
| Net loss | $ | (400,948 | ) | $ | (1,220,711 | ) | ||
| Net loss per common share: | ||||||||
| Basic | $ | (0.22 | ) | $ | (0.66 | ) | ||
| Diluted | $ | (0.22 | ) | $ | (0.66 | ) | ||
| Weighted average shares: | ||||||||
| Basic | 1,850,403 | 1,845,706 | ||||||
| Diluted | 1,850,403 | 1,845,706 | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| Page 3 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
| Nine Months Ended | ||||||||
| June 29, 2019 | June 30, 2018 | |||||||
| Operating Activities: | ||||||||
| Net loss | (400,948 | ) | (1,220,711 | ) | ||||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Depreciation and amortization | 21,498 | 38,384 | ||||||
| Stock-based compensation | 43,080 | 18,416 | ||||||
| Amortization of premium on held to maturity securities | - | 10,253 | ||||||
| Payment of tax on exercise of stock options | - | (33,870 | ) | |||||
| Changes in certain operating assets and liabilities: | ||||||||
| Accounts receivable | 515,135 | 132,270 | ||||||
| Inventories | 286,358 | (140,777 | ) | |||||
| Other current assets | 19,465 | (36,216 | ) | |||||
| Customer deposits | (14,546 | ) | (795 | ) | ||||
| Deferred revenue | (1,768,575 | ) | 1,042,675 | |||||
| Accounts payable and other accrued liabilities | 97,106 | 47,868 | ||||||
| Net cash used in operating activities | (1,201,427 | ) | (142,503 | ) | ||||
| Investing Activities: | ||||||||
| Additions to equipment and leasehold improvements | (16,221 | ) | (43,662 | ) | ||||
| Proceeds from maturities of marketable securities | - | 350,000 | ||||||
| Net cash (used in) provided by investing activities | (16,221 | ) | 306,338 | |||||
| Net (decrease) increase in cash, cash equivalents and restricted cash | (1,217,648 | ) | 163,835 | |||||
| Cash, cash equivalents and restricted cash at beginning of the period | 1,982,434 | 1,296,603 | ||||||
| Cash, cash equivalents and restricted cash at end of the period | $ | 764,786 | $ | 1,460,438 | ||||
| Supplemental Disclosures: | ||||||||
| Income taxes paid | $ | 912 | $ | - | ||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| Page 4 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
(Unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
| Shares of common stock: | ||||||||||||||||
| Beginning balance | 1,850,403 | 1,849,025 | 1,850,403 | 1,839,877 | ||||||||||||
| Cashless exercise of stock options | - | - | - | 9,148 | ||||||||||||
| Ending balance | 1,850,403 | 1,849,025 | 1,850,403 | 1,849,025 | ||||||||||||
| Common stock at par value: | ||||||||||||||||
| Beginning balance | $ | 185,041 | $ | 184,903 | $ | 185,041 | $ | 183,988 | ||||||||
| Cashless exercise of stock options | - | - | - | 915 | ||||||||||||
| Ending balance | $ | 185,041 | $ | 184,903 | $ | 185,041 | $ | 184,903 | ||||||||
| Additional paid-in capital: | ||||||||||||||||
| Beginning balance | $ | 4,151,955 | $ | 4,114,597 | $ | 4,134,371 | $ | 4,139,002 | ||||||||
| Exercise of stock options | - | - | - | (915 | ) | |||||||||||
| Cashless exercise of stock options to pay taxes | - | - | - | (33,870 | ) | |||||||||||
| Stock-based compensation | 25,496 | 8,036 | 43,080 | 18,416 | ||||||||||||
| Ending balance | $ | 4,177,451 | $ | 4,122,633 | $ | 4,177,451 | $ | 4,122,633 | ||||||||
| Accumulated deficit: | ||||||||||||||||
| Beginning balance | $ | (2,861,339 | ) | $ | (2,077,713 | ) | $ | (2,786,356 | ) | $ | (1,306,757 | ) | ||||
| Net loss | (325,965 | ) | (449,755 | ) | (400,948 | ) | (1,220,711 | ) | ||||||||
| Ending balance | $ | (3,187,304 | ) | $ | (2,527,468 | ) | $ | (3,187,304 | ) | $ | (2,527,468 | ) | ||||
| Total stockholders’ equity | $ | 1,175,188 | $ | 1,780,068 | $ | 1,175,188 | $ | 1,780,068 | ||||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| Page 5 |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
| NOTE 1. | Description of the Business and Basis of Presentation |
Company Operations
Technical Communications Corporation (“TCC”) was incorporated in Massachusetts in 1961; its wholly-owned subsidiary, TCC Investment Corp., was organized in that jurisdiction in 1982. Technical Communications Corporation and TCC Investment Corp. are sometimes collectively referred to herein as the “Company”. The Company’s business consists of only one industry segment, which is the design, development, manufacture, distribution, marketing and sale of communications security devices, systems and services. The secure communications solutions provided by TCC protect vital information transmitted over a wide range of data, video, fax and voice networks. TCC’s products have been sold into over 115 countries and are in service with governments, military agencies, telecommunications carriers, financial institutions and multinational corporations.
Interim Financial Statements
The accompanying unaudited consolidated financial statements of Technical Communications Corporation and its wholly-owned subsidiary include all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented and in order to make the financial statements not misleading. All such adjustments are of a normal recurring nature. Interim results are not necessarily indicative of the results to be expected for the fiscal year ending September 28, 2019.
The September 29, 2018 consolidated balance sheet contained herein was derived from the Company’s September 29, 2018 audited consolidated balance sheet as contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 29, 2018 as filed with the U.S. Securities and Exchange Commission (“SEC”). Certain footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted as allowed by SEC rules and regulations. The accompanying unaudited consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto for the fiscal year ended September 29, 2018 included in its Annual Report on Form 10-K as filed with the SEC on June 24, 2019.
The Company restated its unaudited consolidated financial statements as of and for the three and nine month periods ended June 30, 2018 as set forth in its Quarterly Report on Form 10-Q/A as filed with the SEC on June 24, 2019; the unaudited consolidated financial statements for the three and nine month periods ended June 30, 2018 included in this Quarterly Report on Form 10-Q reflect such restatements.
The Company follows accounting standards set by the Financial Accounting Standards Board, commonly referred to as the FASB. The FASB sets generally accepted accounting principles (“GAAP”) that the Company follows to ensure it consistently reports its financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards CodificationTM - sometimes referred to as the Codification or ASC.
Liquidity and Ability to Continue as a Going Concern
The Company has suffered recurring losses from operations and had an accumulated deficit of $3,187,000 at June 29, 2019. These factors raise substantial doubt about the Company's ability to continue as a going concern within one year from the issuance date of the unaudited consolidated financial statements included in this Quarterly Report. The unaudited consolidated financial statements do not include any adjustments to reflect the substantial doubt about the Company’s ability to continue as a going concern.
The Company anticipates that its principal sources of liquidity will only be sufficient to fund activities to March 2020. In order to have sufficient cash to fund operations beyond that point, the Company will need to secure new customer contracts, raise additional equity or debt capital and/or reduce expenses, including payroll and payroll-related expenses.
| Page 6 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
In order to have sufficient capital resources to fund operations, the Company has been working diligently to secure several large orders with new and existing customers. In addition, the Company is also pursuing raising capital. Although the Company believes its ability to secure such new business or raise new capital is likely, the Company cannot provide assurances it will be able to do so.
Should the Company be unsuccessful in these efforts, it would then be forced to implement headcount reductions, employee furloughs and/or reduced hours for certain employees or cease operations completely.
Reporting Period
The Company’s by-laws call for its fiscal year to end on the Saturday closest to the last day of September, unless otherwise decided by its Board of Directors.
Basis of Presentation
The accompanying unaudited consolidated financial statements include the accounts of TCC and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
The discussion and analysis of the Company’s financial condition and results of operations are based on the 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, 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.
| NOTE 2. | Summary of Significant Accounting Policies and Significant Judgments and Estimates |
The accounting policies that management believes are most critical to aid in fully understanding and evaluating the reported financial results include the following:
Accounting Standards Recently Adopted - Revenue
In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which superseded nearly all then-existing revenue recognition guidance. Subsequent to the issuance of Topic 606, the FASB clarified the guidance through several Accounting Standard Updates; the collection of such revenue guidance is referred to herein as “ASC 606”. The core principle of ASC 606 is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
On September 30, 2018, the Company adopted ASC 606 using the modified retrospective method for all contracts. Results for reporting periods beginning September 30, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under Topic 605, Revenue Recognition.
| Page 7 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
The adoption of ASC 606 did not have a significant impact on the Company’s unaudited consolidated financial statements as of and for the three and nine month periods ended June 29, 2019 and, as a result, comparisons of revenues and operating profit between periods are not affected by the adoption of this ASU. The adoption of ASC 606 did not change judgements or affect the determination of the amounts and timing of revenue, the timing of satisfaction of performance obligations, the transaction price or the amounts allocated to performance obligations. Refer to Note 3 for additional disclosures required by ASC 606.
The Company’s products consist of communications security solutions for critical voice, data and video networks for military, government and corporate/industrial applications. The Company derives revenue primarily from the sale of secure communications equipment and the provision of long-term engineering services. The Company’s typical contracts with customers do not contain variable consideration.
Revenue from long-term contracts for engineering services is generally recognized based upon the cost-to-cost measure of progress, provided that the Company meets the criteria associated with transferring control of the service over time. The Company transfers control of the service over time as the customer simultaneously receives and consumes the benefits provided by the Company’s performance. Long-term contracts for engineering services are fixed price contracts, which provide for monthly fixed payments. The transaction price is allocated based on the monthly costs incurred as compared to the total costs expected to be incurred. Revenue is recognized based on this allocation of the transaction price. We recognize revenue over time by measuring the progress toward complete satisfaction of the specific performance obligation using an input method that measures the costs incurred to date compared to the total costs expected to be incurred over the life of the contract. Management believes this method best depicts the Company’s performance in the transfer of services because it represents the level of effort expended in providing those services and appropriately reflects the value to the customer.
Equipment sales revenue is recognized when control of the promised products is transferred to the Company’s customer, in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those products or services (the transaction price). For product sales, control transfers to the customer at a point in time. To indicate the transfer of control, the Company must have a present right to payment, legal title must have passed to the customer, the customer must have the significant risks and rewards of ownership and, where acceptance is not a formality, the customer must have accepted the product. The Company typically establishes pricing for products principally based on its established price book and/or quoted prices. The Company’s principal terms of sale are free on board (“FOB”) shipping point (Company facilities), or equivalent, and, as such, the Company primarily transfers control and records revenue for product sales upon shipment. Sales arrangements with delivery terms that are not FOB shipping point (Company facilities) are not recognized upon shipment; rather, the transfer of control for revenue recognition is evaluated based on the associated shipping terms and customer obligations. If a performance obligation to the customer with respect to a sales transaction remains to be fulfilled following shipment (typically, installation or acceptance by the customer), revenue recognition for that performance obligation is deferred until such commitments have been fulfilled. Returns for products sold are estimated and recorded as a reduction of revenue at the time of sale. Product returns are estimated based on historical experience and known trends. Revenue for extended warranty, service and post-contract support is recognized based upon the period of time elapsed under the arrangement.
Costs to Obtain and Fulfill a Contract
The guidance in FASB ASC 340-40, Other Assets and Deferred Costs – Contracts with Customers provides additional capitalization, amortization and impairment requirements for certain costs associated with obtaining or fulfilling contracts subject to ASC 606. The Company’s costs incurred to fulfill contracts have been immaterial to date.
Inventories
The Company values its inventory at the lower of cost (based on the first-in, first-out method) to purchase and/or manufacture and net realizable value (based on the estimated selling prices, less reasonably predictable costs of completion, disposal, and transportation) of the inventory. The Company periodically reviews inventory quantities on hand and records a provision for excess and/or obsolete inventory based primarily on an estimated forecast of product demand, as well as historical usage. The Company evaluates the carrying value of inventory on a quarterly basis to determine whether the carrying value is in excess of net realizable value. To the extent that net realizable value is 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 expected future demand. It is possible that additional reserves above those already established may be required in the future if market conditions for the Company’s products should deteriorate.
| Page 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 is currently needed, if the financial condition of the Company’s 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, a specific write-off is recorded in that amount.
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 that 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 June 29, 2019 and September 29, 2018, the carrying amounts of cash and cash equivalents, accounts receivable, other current assets, accounts payable and accrued liabilities approximate fair value because of their short-term nature.
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 investment.
The Company’s available for sale securities consist of mutual funds held in money market funds in a brokerage account, which are classified as cash equivalents and measured at fair value. The Company historically also has had held to maturity securities, comprised of investments in municipal bonds and carried at amortized cost, although TCC did not hold any such held to maturity securities at June 29, 2019 or September 29, 2018.
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 June 29, 2019 and the fiscal year ended September 29, 2018, there were no transfers between levels.
The following table sets forth by level, within the fair value hierarchy, the assets measured at fair value on a recurring basis as of June 29, 2019 and September 29, 2018, in accordance with the fair value hierarchy as defined above. As of June 29, 2019 and September 29, 2018, the Company did not hold any assets classified as Level 2 or Level 3.
| Page 9 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | |||||||
| June 29, 2019 | ||||||||
| Cash Equivalents | ||||||||
| Mutual funds: | ||||||||
| Money market funds | $ | 432,363 | $ | 432,363 | ||||
| Total mutual funds | 432,363 | 432,363 | ||||||
| Total assets | $ | 432,363 | $ | 432,363 | ||||
| September 29, 2018 | ||||||||
| Cash Equivalents | ||||||||
| Mutual funds: | ||||||||
| Money market funds | $ | 1,020,039 | $ | 1,020,039 | ||||
| Total mutual funds | 1,020,039 | 1,020,039 | ||||||
| Total assets | $ | 1,020,039 | $ | 1,020,039 | ||||
There were no assets or liabilities measured at fair value on a nonrecurring basis at June 29, 2019 or September 29, 2018.
Stock-Based Compensation
| Page 10 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
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 June 29, 2019 and June 30, 2018:
| June 29, 2019 | June 30, 2018 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Selling, general and administrative expenses | $ | 24,461 | 39,644 | $ | 7,596 | 17,352 | ||||||||||
| Product development expenses | 1,035 | 3,436 | 356 | 1,064 | ||||||||||||
| Total share-based compensation expense before taxes | $ | 25,496 | $ | 43,080 | $ | 7,952 | $ | 18,416 | ||||||||
As of June 29, 2019, there was $160,187 of unrecognized compensation expense related to options outstanding. The unrecognized compensation expense will be recognized over the remaining requisite service period. As of June 29, 2019, the weighted average period over which the compensation expense is expected to be recognized is 3.8 years.
As of June 29, 2019, there were 193,863 shares available for grant under the 2010 Equity Incentive Plan. The 2005 Non-Statutory Stock Option Plan has expired and options are no longer available for grant under such plan.
The following table summarizes stock option activity during the first nine months of fiscal 2019:
| Options Outstanding | ||||||||||||||||||||
| Number of Shares | Weighted Average | Weighted Average Contractual Life | ||||||||||||||||||
| Unvested | Vested | Total | Exercise Price | (in years) | ||||||||||||||||
| Outstanding, September 29, 2018 | 44,700 | 182,437 | 227,137 | $ | 8.50 | 3.76 | ||||||||||||||
| Grants | - | - | - | |||||||||||||||||
| Vested | - | - | - | |||||||||||||||||
| Cancellations/forfeitures | - | (3,500 | ) | (3,500 | ) | 4.95 | ||||||||||||||
| Outstanding, December 29, 2018 | 44,700 | 178,937 | 223,637 | $ | 8.50 | 3.51 | ||||||||||||||
| Grants | - | - | - | |||||||||||||||||
| Vested | (6,300 | ) | 6,300 | - | ||||||||||||||||
| Cancellations/forfeitures | - | (8,500 | ) | (8,500 | ) | 4.92 | ||||||||||||||
| Outstanding, March 30, 2019 | 38,400 | 176,737 | 215,137 | $ | 8.70 | 3.45 | ||||||||||||||
| Grants | 34,500 | 6,000 | 40,500 | 3.58 | ||||||||||||||||
| Vested | (2,400 | ) | 2,400 | - | ||||||||||||||||
| Cancellations/forfeitures | - | (24,300 | ) | (24,300 | ) | 6.89 | ||||||||||||||
| Outstanding, June 29, 2019 | 70,500 | 160,837 | 231,337 | $ | 8.00 | 4.24 | ||||||||||||||
| Page 11 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
Information related to the stock options vested and expected to vest as of June 29, 2019 is as follows:
| Range of Exercise Prices | Number of Shares | Weighted-Average Remaining Contractual Life (years) | Weighted Average Exercise Price | Exercisable Number of Shares | Exercisable Weighted- Average Exercise Price | |||||||||||||||||
| $2.01 | - | $3.00 | 20,300 | 7.14 | $ | 2.69 | 9,800 | $ | 2.73 | |||||||||||||
| $3.01 | - | $4.00 | 46,500 | 9.78 | 3.61 | 7,200 | 3.61 | |||||||||||||||
| $4.01 | - | $5.00 | 16,600 | 4.98 | 4.34 | 14,100 | 4.36 | |||||||||||||||
| $5.01 | - | $10.00 | 37,000 | 4.45 | 7.75 | 28,600 | 7.89 | |||||||||||||||
| $10.01 | - | $15.00 | 110,937 | 1.21 | 11.44 | 110,937 | 11.44 | |||||||||||||||
| 231,337 | 4.24 | $ | 8.00 | 170,637 | $ | 9.43 | ||||||||||||||||
The aggregate intrinsic value of the Company’s “in-the-money” outstanding and exercisable options as of June 29, 2019 and June 30, 2018 was $15,390 and $15,270, respectively. Nonvested stock options are subject to the risk of forfeiture until the fulfillment of specified conditions.
New Accounting Pronouncements
ASU No. 2016-02, Leases
In February 2016, the FASB issued guidance under ASU No. 2016-02, Leases, with respect to leases. This ASU requires an entity to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. This guidance offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. The Company is currently evaluating the potential impact this standard will have on its financial statements and related disclosure and believes that the most notable impact to the financial statements upon adoption will be the recognition of a right-of-use asset and a lease liability for the Company’s leased real property in Concord, MA. The Company expects to adopt this standard during its 2020 fiscal year.
Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force) and the SEC during the first nine months of the Company’s 2019 fiscal year but such pronouncements are not believed by management to have a material impact on the Company’s present or future financial statements.
| NOTE 3. | Revenue |
The following table presents the Company’s revenues disaggregated by revenue type for the three and nine month periods ended June 29, 2019 and June 30, 2018:
| June 29, 2019 | June 30, 2018 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Engineering services | $ | 952,603 | $ | 2,819,676 | $ | 758,670 | $ | 2,218,375 | ||||||||
| Equipment sales | 282,060 | 1,455,799 | 148,507 | 329,297 | ||||||||||||
| Total | $ | 1,234,663 | $ | 4,275,475 | $ | 907,177 | $ | 2,547,672 | ||||||||
| Page 12 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
Engineering services revenue consists of funded research and development and technology development for commercial companies and government agencies primarily under fixed-price contracts. The Company also derives revenue from developing and designing custom cryptographic solutions for customers’ unique secure voice, data and video communications requirements and integrating such solutions into existing systems. These contracts can vary but typically call for fixed monthly payments or payments due upon meeting certain milestones. Customers are billed monthly or upon achieving the milestone and payments are due on a net basis after the billing date.
Equipment sales revenue consists of sales of communications security equipment for voice, data and video networks for military, government and corporate/industrial applications. Equipment sales are billed to the customer upon shipment with typical payment terms requiring a down payment at the time of order with the balance due prior to shipment. For government and certain long term customers, we may grant net payment terms.
Remaining Performance Obligations
Remaining performance obligations represent the aggregate transaction price allocated to performance obligations with an original contract term greater than one year that are fully or partially unsatisfied at the end of the period. The Company has elected to exclude contracts with customers with an original term of one year or less from remaining performance obligations.
As of June 29, 2019, the aggregate amount of the transaction price allocated to remaining unsatisfied performance obligations was $337,939, which is shown as deferred revenue on the Company’s consolidated balance sheet. The Company expects to recognize revenue on the remaining performance obligations over the next three months.
Contract Balances
The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), deferred revenue, customer deposits and billings in excess of revenue recognized (contract liabilities) on the consolidated balance sheets.
Contract assets - Most of the Company’s long-term contracts are billed as work progresses in accordance with the contracts’ terms and conditions, either at periodic intervals or upon achievement of certain milestones. This may cause billing to occur subsequent to revenue recognition, resulting in contract assets. In addition, certain contracts provide for monthly billings and cash collections, which are recorded independent of revenue recognition. These billings are contract assets and are generally classified as current assets in the consolidated balance sheet. Contract assets as of September 29, 2018 consisted of accounts receivable of $532,493. There were no contract assets as of June 29, 2019. The decrease in contract assets during the nine month period ended June 29, 2019 is primarily the result of a decrease in monthly billing amounts under the contract. There were no impairment losses recognized on contract assets or receivables during the three or nine month periods ended June 29, 2019.
Contract liabilities - The Company often receives cash payments from customers in advance of the Company’s performance, resulting in contract liabilities. These contract liabilities are classified as either current or long-term in the consolidated condensed balance sheet based on the timing of when the Company expects to recognize revenue. As of June 29, 2019 and at the date of adoption of ASC 606 on September 30, 2018, contract liabilities were $337,939 and $2,106,514, respectively, and are included in deferred revenue in the accompanying consolidated balance sheets. Engineering services revenue of $2,106,514 recognized during the nine month period ended June 29, 2019 was included in deferred revenue at September 29, 2018. The decrease in the contract liability balance during the three month period ended June 29, 2019 is primarily the result of satisfying performance obligations.
| Page 13 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
| NOTE 4. | Inventories |
Inventories consisted of the following:
| June 29, 2019 | September 29, 2018 | |||||||
| Finished goods | $ | 25,698 | $ | - | ||||
| Work in process | �� | 20,184 | 356,278 | |||||
| Raw materials | 1,036,456 | 1,012,418 | ||||||
| $ | 1,082,338 | $ | 1,368,696 | |||||
| NOTE 5. | Income Taxes |
The Company has not recorded an income tax benefit on its net loss for the nine month periods ended June 29, 2019 and June 30, 2018 due to its uncertain realizability. 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.
On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law by the President of the United States. The Tax Act includes a number of changes, including the lowering of the U.S. corporate tax rate from 35% to 21%, effective January 1, 2018. The Company has determined and completed the accounting for certain income tax effects of the Tax Act to the current reporting period. Because the Company records a valuation allowance for its entire deferred income tax asset, there was no impact on the reported amounts in the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q as a result of the Tax Act.
| NOTE 6. | Loss Per Share |
Outstanding potentially dilutive stock options, which were not included in the net loss per share amounts as their effect would have been anti-dilutive, were as follows: 231,337 shares at June 29, 2019 and 201,037 shares at June 30, 2018.
| NOTE 7. | Major Customers and Export Sales |
During the three months ended June 29, 2019, the Company had two customers that represented 99% (77% and 22%, respectively) of net revenue as compared to the three months ended June 30, 2018, during which one customer represented 97% of net revenue. During the nine month period ended June 29, 2019, the Company had two customers that represented 88% (66% and 22%, respectively) of net revenue as compared to the nine months ended June 30, 2018, during which one customer represented 87% of net revenue.
A breakdown of foreign and domestic net revenue for first three and nine months of fiscal 2019 and 2018 is as follows:
| June 29, 2019 | June 30, 2018 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Domestic | $ | 1,232,187 | $ | 4,076,652 | $ | 832,441 | $ | 2,343,878 | ||||||||
| Foreign | 2,475 | 198,823 | 74,736 | 203,794 | ||||||||||||
| Total net revenue | $ | 1,234,662 | $ | 4,275,475 | $ | 907,177 | $ | 2,547,672 | ||||||||
The Company sold products into one country during the three month period ended June 29, 2019 and two countries during the three month period ended June 30, 2018. The Company sold products into four countries during each of the nine month periods ended June 29, 2019 and June 30, 2018. A sale is attributed to a foreign country based on the location of the contracting party. Domestic revenue may include the sale of products shipped through domestic resellers or manufacturers to international destinations. The table below summarizes foreign revenues by country as a percentage of total foreign revenue.
| Page 14 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
| June 29, 2019 | June 30, 2018 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Saudi Arabia | - | 57 | % | 73 | % | 44 | % | |||||||||
| Egypt | - | 37 | % | - | - | |||||||||||
| Philippines | - | 5 | % | 27 | % | 44 | % | |||||||||
| Jordan | - | - | - | 6 | % | |||||||||||
| Other | 100 | % | 1 | % | - | 6 | % | |||||||||
A summary of foreign revenue, as a percentage of total foreign revenue by geographic area, is as follows:
| June 29, 2019 | June 30, 2018 | |||||||||||||||
| 3 months | 9 months | 3 months | 9 months | |||||||||||||
| Mid-East and Africa | 100 | % | 95 | % | 73 | % | 56 | % | ||||||||
| Far East | - | 5 | % | 27 | % | 44 | % | |||||||||
| NOTE 8. | 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, of which there were none at June 29, 2019 or September 29, 2018, 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 June 29, 2019, available for sale securities consisted of the following:
| Gross Unrealized | Estimated | |||||||||||||||
| Cost | Gains | Losses | Fair Value | |||||||||||||
| Money market mutual funds | $ | 432,363 | $ | - | $ | - | $ | 432,363 | ||||||||
As of September 29, 2018, available for sale securities consisted of the following:
| Gross Unrealized | Estimated | |||||||||||||||
| Cost | Gains | Losses | Fair Value | |||||||||||||
| Money market mutual funds | $ | 1,020,039 | $ | - | $ | - | $ | 1,020,039 | ||||||||
| Page 15 |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Certain statements contained herein or as may otherwise be incorporated by reference herein that are not purely historical constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include but are not limited to statements regarding anticipated operating results, future earnings, and the Company’s ability to achieve growth and profitability. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, including but not limited to the effect of foreign political unrest; domestic and foreign government policies and economic conditions; future changes in export laws or regulations; changes in technology; the ability to hire, retain and motivate technical, management and sales personnel; the risks associated with the technical feasibility and market acceptance of new products; changes in telecommunications protocols; the effects of changing costs, exchange rates and interest rates; and the Company's ability to secure adequate capital resources. Such risks, uncertainties and other factors could cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. For a more detailed discussion of the risks facing the Company, see the Company’s filings with the SEC, including its Annual Report on Form 10-K for the fiscal year ended September 29, 2018.
Overview
The Company designs, manufactures, markets and sells communications security equipment that utilizes various methods of encryption to protect the information being transmitted. Encryption is a technique for rendering information unintelligible, which information can then be reconstituted if the recipient possesses the right decryption “key”. The Company manufactures several standard secure communications products and also provides custom-designed, special-purpose secure communications products for both domestic and international customers. The Company’s products consist primarily of voice, data and facsimile encryptors. Revenue is generated principally from the sale of these products, which have traditionally been to foreign governments either through direct sale, pursuant to a U.S. government contract, or made as a sub-contractor to domestic corporations under contract with the U.S. government. We also sell these products to commercial entities and U.S. government agencies. We generate additional revenues from contract engineering services performed for certain government agencies, both domestic and foreign, and commercial entities.
Critical Accounting Policies and Significant Judgments and Estimates
Except for the adoption of ASC 606 and the Company’s revisions to estimated gross profits on an engineering services contract, as discussed below, there have been no material changes in the Company’s critical accounting policies or critical accounting estimates since September 29, 2018, nor have we adopted any accounting policies that have or will have a material impact on our consolidated financial statements. For further discussion of our accounting policies see Note 2, Summary of Significant Accounting Policies and Significant Judgments and Estimates in the Notes to Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q and the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended September 29, 2018 as filed with the SEC.
The Company restated its unaudited consolidated financial statements as of and for the three and nine month periods ended June 30, 2018 as set forth in its Quarterly Report on Form 10-Q/A as filed with the SEC on June 24, 2019; the unaudited consolidated financial statements for the three and nine month periods ended June 30, 2018 included in this Quarterly Report on Form 10-Q reflect such restated amounts.
On September 30, 2018, the Company adopted ASC 606 using the modified retrospective method for all contracts. Results for reporting periods beginning September 30, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under Topic 605, Revenue Recognition. The adoption of ASC 606 did not have a significant impact on the Company’s consolidated unaudited condensed financial statements as of and for the three and nine month periods ended June 29, 2019.
| Page 16 |
Revisions in the estimated gross profits on contracts and contract amounts are made in the period in which the circumstances requiring the revisions become known. During the period ended June 29, 2019, the effect of such revisions in estimated contract profits resulted in a decrease to gross profit of approximately $111,000.
Results of Operations
Three Months ended June 29, 2019 compared to Three Months ended June 30, 2018 (restated)
Total Net Revenue
Total net revenue for the quarter ended June 29, 2019 was $1,235,000, compared to $907,000 for the quarter ended June 30, 2018, an increase of 36%. Revenue for the third quarter of fiscal 2019 consisted of $1,232,000, or 99%, from domestic sources and $3,000, or 1%, from international customers as compared to the same period in fiscal 2018, during which revenue consisted of $832,000, or 92%, from domestic sources and $75,000, or 8%, from international customers.
Foreign sales consisted of a shipment to a customer in one country during the quarter ended June 29, 2019 and two countries during the quarter ended June 30, 2018. A sale is attributed to a foreign country based on the location of the contracting party. Domestic revenue may include the sale of products shipped through domestic resellers or manufacturers to international destinations. The table below summarizes our principal foreign sales by country during the third quarters of fiscal 2019 and 2018:
| 2019 | 2018 | |||||||
| Saudi Arabia | $ | - | $ | 55,000 | ||||
| Philippines | - | 20,000 | ||||||
| Other | 3,000 | - | ||||||
| $ | 3,000 | $ | 75,000 | |||||
For the three months ended June 29, 2019, revenue was derived primarily from sales of our engineering services amounting to $953,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a Middle Eastern country amounting to $280,000.
For the three months ended June 30, 2018, revenue was derived primarily from sales of our engineering services amounting to $759,000. The Company also sold its internet protocol encryptor to a customer in Saudi Arabia amounting to $55,000 during the period.
Gross Profit
Gross profit for the third quarter of fiscal 2019 was $445,000, compared to gross profit of $194,000 for the same period of fiscal 2018, an increase of 129%. Gross profit expressed as a percentage of total net revenue was 36% for the third quarter of fiscal 2019 compared to 21% for the same period in fiscal 2018. This increase was primarily due to the higher sales volume of higher margin equipment sales in fiscal 2019.
Operating Costs and Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the third quarter of fiscal 2019 were $732,000, compared to $522,000 for the same quarter in fiscal 2018. This increase of $210,000, or 40%, was attributable to increases in general and administrative expenses of $212,000 partially offset by a decrease in selling and marketing expenses of $2,000 during the three months ended June 29, 2019.
The increase in general and administrative expenses for the three months ended June 29, 2019 was primarily attributable to increases in audit and legal fees of $239,000, partially offset by a decrease in director fees of $8,000.
| Page 17 |
The decrease in selling and marketing expenses for the three months ended June 29, 2019 was primarily attributable to decreases in third party sales support and outside commissions of $32,000, bid and proposal costs of $21,000 and outside consulting costs of $19,000. These decreases were offset by increases in payroll and payroll related expenses of $50,000 and product demonstration costs of $16,000 during the period.
Product Development Costs
Product development costs for the quarter ended June 29, 2019 were $43,000, compared to $124,000 for the quarter ended June 30, 2018. This decrease of $81,000, or 65%, was attributable to an increase in billable engineering services contracts during the third quarter of fiscal 2019 that resulted in decreased product development costs of $124,000. These decreased costs were partially offset by an increase in engineering project costs of $50,000 during the period.
The Company actively sells its engineering services in support of funded research and development. The receipt of these orders is sporadic, although such programs can span over several months. In addition to these programs, the Company also invests in research and development to enhance its existing products or to develop new products, as it deems appropriate. There was approximately $953,000 of billable engineering services revenue generated during the third quarter of fiscal 2019 and $759,000 in the third quarter of fiscal 2018.
Product development costs are charged to billable engineering services, bid and proposal efforts or business development activities, as appropriate. Product development costs charged to billable projects are recorded as cost of revenue; engineering costs charged to bid and proposal efforts are recorded as selling expenses; and product development costs charged to business development activities are recorded as marketing expenses.
Net Loss
The Company generated a net loss of $326,000 for the third quarter of fiscal 2019, compared to a net loss of $450,000 for the same period of fiscal 2018. This decrease in net loss is primarily attributable to a 129% increase in gross profit partially offset by an increase in operating expenses of 20% during the third quarter of fiscal 2019.
Nine Months ended June 29, 2019 compared to Nine Months ended June 30, 2018 (restated)
Total Net Revenue
Total net revenue for the nine months ended June 29, 2019 were $4,275,000, compared to $2,548,000 for the nine months ended June 30, 2018, an increase of 68%. Revenue for the first nine months of fiscal 2019 consisted of $4,076,000, or 95%, from domestic sources and $199,000, or 5%, from international customers, compared to the same period in fiscal 2018, during which revenue consisted of $2,344,000, or 92%, from domestic sources and $204,000, or 8%, from international customers.
Foreign revenue consisted of shipments to customers in four countries during the nine months ended June 29, 2019 and to customers in four countries during the same period in fiscal 2018. A sale is attributed to a foreign country based on the location of the contracting party. Domestic revenue may include the sale of products shipped through domestic resellers or manufacturers to international destinations. The table below summarizes our principal foreign sales by country during the first nine months of fiscal 2019 and 2018:
| 2019 | 2018 | |||||||
| Saudi Arabia | $ | 112,000 | $ | 89,000 | ||||
| Egypt | 73,000 | - | ||||||
| Philippines | 11,000 | 90,000 | ||||||
| Jordan | - | 13,000 | ||||||
| Other | 3,000 | 12,000 | ||||||
| $ | 199,000 | $ | 204,000 | |||||
| Page 18 |
For the nine months ended June 29, 2019, revenue was derived primarily from sales of our engineering services amounting to $2,820,000, shipments of our narrowband radio encryptors to a domestic customer for deployment into a North African country amounting to $936,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a Middle Eastern country amounting to $280,000.
For the nine months ended June 30, 2018, revenue was derived primarily from sales of our engineering services amounting to $2,218,000 and shipments of our narrowband radio encryptors to a customer in the Far East amounting to $90,000 and to a domestic customer for deployment into Afghanistan amounting to $57,000. We also sold our internet protocol encryptor to a customer in Saudi Arabia amounting to $89,000 during the period.
Gross Profit
Gross profit for the first nine months of fiscal 2019 was $1,644,000, compared to gross profit of $729,000 for the same period of fiscal 2018, an increase of 125%. Gross profit expressed as a percentage of total net revenue was 38% for the first nine months of fiscal 2019 compared to 29% for the same period in fiscal 2018. This increase was primarily due to the higher sales volume of higher margin equipment sales in fiscal 2019.
Operating Costs and Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the first nine months of fiscal 2019 were $1,872,000, compared to $1,513,000 for the same period in fiscal 2018. This increase of $359,000, or 24%, was attributable to increases in general and administrative expenses of $325,000 and selling and marketing expenses of $34,000 during the nine months ended June 29, 2019.
The increase in general and administrative expenses for the nine months ended June 29, 2019 was attributable to increases in audit and legal fees of $366,000. This increase was offset by decreases in director’s fees of $22,000 and other public company related expenses of $16,000.
The increase in selling and marketing expenses for the nine months ended June 29, 2019 was primarily attributable to increases in payroll and payroll related expenses of $55,000, product evaluation costs of $27,000 and product demonstration costs of $16,000. These increases were partially offset by a decrease in outside consulting costs of $33,000, a decrease in travel expenses of $8,000 and an increase in sales service support of product development, which reduced selling and marketing expense by $25,000 during the period.
Product Development Costs
Product development costs for the nine months ended June 29, 2019 were $187,000, compared to $442,000 for the nine months ended June 30, 2018. This decrease of $255,000, or 58%, was attributable to an increase in billable engineering services contracts during the first nine months of fiscal 2019 that resulted in decreased product development costs of $615,000. These decreased costs were partially offset by an increase in engineering project costs of $355,000 during the period.
The Company actively sells its engineering services in support of funded research and development. The receipt of these orders is sporadic, although such programs can span over several months. In addition to these programs, the Company also invests in research and development to enhance its existing products or to develop new products, as it deems appropriate. There was approximately $2,820,000 of billable engineering services revenue generated during the first nine months of fiscal 2019 and $2,218,000 in the same period of fiscal 2018.
Product development costs are charged to billable engineering services, bid and proposal efforts or business development activities, as appropriate. Product development costs charged to billable projects are recorded as cost of revenue; engineering costs charged to bid and proposal efforts are recorded as selling expenses; and product development costs charged to business development activities are recorded as marketing expenses.
| Page 19 |
Net Loss
The Company generated a net loss of $401,000 for the first nine months of fiscal 2019, compared to a net loss of $1,221,000 for the same period of fiscal 2018. This decrease in net loss is primarily attributable to a 125% increase in gross profit, partially offset by a 5% increase in operating expenses during the first nine months of fiscal 2019.
The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of June 29, 2019, none of the Company’s monetary assets or liabilities was subject to foreign exchange risks. The Company usually includes an inflation factor in its pricing when negotiating multi-year contracts with customers.
Liquidity and Capital Resources
Our cash and cash equivalents at June 29, 2019 totaled $765,000 and we continue to have no debt.
Liquidity and Ability to Continue as a Going Concern
The Company has suffered recurring losses from operations and had an accumulated deficit of $3,187,000 at June 29, 2019. These factors raise substantial doubt about the Company’s ability to continue as a going concern within one year from the issuance date of the unaudited consolidated financial statements included in this Quarterly Report. The unaudited consolidated financial statements do not include any adjustments to reflect the substantial doubt about the Company’s ability to continue as a going concern.
We anticipate that our principal sources of liquidity will only be sufficient to fund our activities to March 2020. In order to have sufficient cash to fund our operations beyond that point, we will need to secure new customer contracts, raise additional equity or debt capital and/or reduce expenses, including payroll and payroll-related expenses.
In order to have sufficient capital resources to fund operations, the Company has been working diligently to secure several large orders with new and existing customers. In addition, we are also pursuing raising capital. Although we believe our ability to secure such new business or raise new capital is likely, we cannot provide assurances we will be able to do so.
Should we be unsuccessful in these efforts, we would then be forced to implement headcount reductions, employee furloughs and/or reduced hours for certain employees or cease operations completely.
Sources and Uses of Cash
The following table presents our abbreviated cash flows for the nine month periods ended (unaudited):
| June 29, 2019 | June 30, 2018 | |||||||
| Net loss | $ | (401,000 | ) | $ | (1,221,000 | ) | ||
| Changes not affecting cash | 65,000 | 33,000 | ||||||
| Changes in assets and liabilities | (865,000 | ) | 1,045,000 | |||||
| Cash used in operating activities | (1,204,000 | ) | (143,000 | ) | ||||
| Cash (used in) provided by investing activities | (16,000 | ) | 306,000 | |||||
| Net change in cash, cash equivalents and restricted cash | (1,217,000 | ) | 163,000 | |||||
| Cash, cash equivalents and restricted cash - beginning of period | 1,982,000 | 1,297,000 | ||||||
| Cash, cash equivalents and restricted cash - end of period | $ | 765,000 | $ | 1,460,000 | ||||
| Page 20 |
Operating Activities
The Company used approximately $1,062,000 more cash for operating activities in the first nine months of fiscal 2019 compared to the same period in fiscal 2018. This increase was primarily attributable to a decrease in deferred revenue of $1,769,000. This increase was partially offset by a decrease in net loss of $820,000, a decrease in inventory of $286,000 during the nine month period ended June 29, 2019 as compared to an increase in inventory of $141,000 during the nine month period ended June 30, 2018, and a decrease in accounts receivable of $515,000 during the nine month period ended June 29, 2019 as compared to a decrease in accounts receivable of $132,000 during the nine month period ended June 30, 2018.
Investing Activities
Cash provided by investing activities during the first nine months of fiscal 2019 decreased by approximately $320,000 compared to the same period in fiscal 2018. This change is attributable to the maturity of short-term investments in marketable securities during the first nine months of 2018.
Company Facilities
On April 1, 2014, the Company entered into a new lease for its current facilities. This lease is for 22,800 square feet located at 100 Domino Drive, Concord, MA. The Company has been a tenant in this space since 1983. This is the Company’s only facility and houses all manufacturing, research and development, and corporate operations. The initial term of the lease was for five years through March 31, 2019 at an annual rate of $171,000. In addition, the lease contains options to extend the lease for two and one-half years through September 30, 2021 and another two and one-half years through March 31, 2024 at an annual rate of $171,000. In September 2018, the Company exercised its option to extend the term of the lease through September 2021. Rent expense for each of the nine month periods ended June 29, 2019 and June 30, 2018 was $128,000.
Backlog
Backlog at June 29, 2019 and September 29, 2018 amounted to $2,434,000 and $2,118,000, respectively. The orders in backlog at June 29, 2019 are expected to ship and/or services are expected to be performed over the next three months depending on customer requirements and product availability.
Performance guaranties
Certain foreign customers require the Company to guarantee bid bonds and performance of products sold. These guaranties typically take the form of standby letters of credit. Guaranties are generally required in amounts of 5% to 10% of the purchase price and last in duration from three months to one year. At June 29, 2019 and September 29, 2018, the Company had no outstanding letters of credit.
Research and development
Research and development efforts are undertaken by the Company primarily on its own initiative. In order to compete successfully, the Company must improve existing products and develop new products, as well as attract and retain qualified personnel. No assurances can be given that the Company will be able to hire and train such technical management and sales personnel or successfully improve and develop its products.
During the nine month periods ended June 29, 2019 and June 30, 2018, the Company spent $187,000 and $442,000, respectively, on internal product development. The Company also spent $1,994,000 and $1,424,000, respectively, on billable development efforts during the first nine months of fiscal 2019 and 2018. The Company’s total product development costs during the first nine months of fiscal 2019 were 17% higher than the same period in fiscal 2018 but in line with its planned commitment to research and development, and reflected the costs of custom development, product capability enhancements and production readiness. It is expected that total development expenses will remain higher as we complete a billable project during the remainder of fiscal 2019.
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It is anticipated that cash from operations will fund our near-term research and development and marketing activities to January 2020. We also believe that, in the long term, based on current billable activities, cash from operations will be sufficient to meet the development goals of the Company, although we can give no assurances. Any increase in development activities - either billable or new product related - will require additional resources, which we may not be able to fund through cash from operations. In circumstances where resources will be insufficient, the Company will look to other sources of financing, including debt and/or equity investments; however, we can provide no guarantees that we will be successful in securing such additional financing.
Other than those stated above, there are no plans for significant internal product development or material commitments for capital expenditures during the remainder of fiscal 2019.
New Accounting Pronouncements
ASU No. 2016-02, Leases
In February 2016, the FASB issued guidance in ASU No. 2016-02, Leases, with respect to leases. This ASU requires entities to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. This guidance offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We are currently evaluating the potential impact this standard will have on our financial statements and related disclosure and believe that the most notable impact to our financial statements upon adoption will be the recognition of a right-of-use asset and a lease liability for our leased facility in Concord, MA. The Company expects to adopt this standard during its 2020 fiscal year.
Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force) and the SEC during the first nine months of the Company’s 2019 fiscal year but such pronouncements are not believed by management to have a material impact on the Company’s present or future financial statements.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable.
| 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 on Form 10-Q.
As previously disclosed under Item 9A, Controls and Procedures in our Annual Report on Form 10-K for our fiscal year ended September 29, 2018, in conjunction with the auditor’s findings, management identified a material weakness in our internal control over financial reporting related to, among other things, the misapplication of generally accepted accounting principles associated with revenue recognition, inventory reserves, accruals and the preparation of the consolidated financial statements, specifically the classification and disclosure of financial information, all caused by a lack of adequate expertise within the Company’s accounting department. As a result, management determined that the Company’s disclosure controls and procedures were not effective at September 29, 2018.
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Management had previously reported in the Company’s Form 10-K for the fiscal year ended September 30, 2017, as well as prior fiscal periods, its conclusion that the Company’s failure to maintain effective internal control over financial reporting due to a lack of sufficient staff to segregate accounting duties, more specifically, a lack of an adequately trained accounting department and lack of an independent review of financial reporting, constituted a material weakness as of the end of such fiscal periods. Management also identified a material weakness in internal control over significant non-routine transactions at June 30, 2018. Specifically, management determined that there was a lack of operating effectiveness of internal controls over significant non-routine transactions related to the Company’s inadequate evaluation of the underlying effective rate implications related to the Tax Cuts and Jobs Act passed in December 2017, which management determined constituted a material weakness.
Based on their assessment in connection with the filing of this Form 10-Q, the Chief Executive Officer and Chief Financial Officer have concluded that the material weaknesses described above were also material weaknesses for the quarter ended June 29, 2019 and therefore TCC’s disclosure controls and procedures were not effective as of June 29, 2019. For a more comprehensive discussion of the Company’s internal control over financial reporting and the material weaknesses noted above, as well as the remedial efforts to be undertaken by TCC to address such material weaknesses, see Item 9A, Controls and Procedures, in our Annual Report on Form 10-K for the year ended September 29, 2018 as filed with the SEC.
Changes in internal control over financial reporting. The were no changes in the Company’s internal control over financial reporting during the quarter ended June 29, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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| 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 |
| 31.2 | 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 |
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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 13, 2019 | By: | /s/ Carl H. Guild, Jr. | ||||
| Date | Carl H. Guild, Jr., President and Chief | |||||
| Executive Officer | ||||||
| August 13, 2019 | By: | /s/ Michael P. Malone | ||||
| Date | Michael P. Malone, Chief Financial Officer | |||||
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