EXHIBIT 13
CONSOLIDATED BALANCE SHEETS:
September 27, 1997, and September 28, 1996.
1997 1996
------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents...................................................... $ 1,876,748 $ 6,381,026
Accounts receivable - trade, less allowance for doubtful accounts of $25,000 in
1997 and $53,707 in 1996..................................................... 3,259,549 3,219,124
Unbilled revenue............................................................... 198,038 --
Inventories (Note 4)........................................................... 3,423,979 2,615,772
Refundable income taxes (Note 6)............................................... 609,812 --
Other current assets........................................................... 117,947 199,122
------------- -------------
Total current assets......................................................... 9,486,073 12,415,044
------------- -------------
Equipment and leasehold improvements (Note 16)................................... 4,382,655 4,223,816
Less accumulated depreciation and amortization................................. 3,200,075 2,646,683
------------- -------------
Equipment and leasehold improvements--net.................................... 1,182,580 1,577,133
------------- -------------
Goodwill......................................................................... 1,614,131 1,614,131
Less accumulated amortization.................................................. 501,533 286,623
------------- -------------
Goodwill--net................................................................ 1,112,598 1,327,508
------------- -------------
Deferred income taxes (Note 6)................................................... 76,553 221,640
Other assets..................................................................... 598,449 458,708
------------- -------------
$ 12,456,253 $ 16,000,033
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable............................................................... $ 861,633 $ 504,860
Long-term debt--current portion (Note 5)....................................... -- 1,145,175
Accrued liabilities:
Compensation and related expenses............................................ 290,093 597,938
Other (Note 3)............................................................... 1,794,481 2,019,303
------------- -------------
Total current liabilities.................................................... 2,946,207 4,267,276
------------- -------------
Long-term debt (Note 5).......................................................... -- 1,200,000
Commitments and contingencies (Notes 10, 12, 14 and 16)
Stockholders' Equity
Common stock--par value $.10 per share; authorized 3,500,000 shares, issued
1,273,703 shares in 1997 and 1,264,496 in 1996............................... 127,370 126,450
Additional paid-in capital..................................................... 1,526,110 1,473,643
ESOP deferred compensation (Note 5)............................................ (527,772) (695,175)
Retained earnings.............................................................. 8,464,338 9,707,839
Less treasury stock at cost, 10,000 shares................................... (80,000) (80,000)
------------- -------------
Total stockholders' equity................................................... 9,510,046 10,532,757
------------- -------------
$ 12,456,253 $ 16,000,033
------------- -------------
------------- -------------
The accompanying notes are an integral part of these consolidated financial
statements.
Page AR-7
CONSOLIDATED STATEMENTS OF OPERATIONS:
Years Ended September 27, 1997, September 28, 1996, and September 30, 1995.
1997 1996 1995
------------- ------------- -------------
Net sales........................................................... $ 12,258,638 $ 14,012,802 $ 10,227,565
Cost of sales....................................................... 5,153,663 5,781,414 4,875,683
------------- ------------- -------------
Gross profit.................................................... 7,104,975 8,231,388 5,351,882
------------- ------------- -------------
Operating expenses:
Selling, general and administrative expenses...................... 6,282,108 5,582,553 3,826,778
Product development costs......................................... 2,378,564 1,955,852 1,492,370
------------- ------------- -------------
Total operating expenses........................................ 8,660,672 7,538,405 5,319,148
------------- ------------- -------------
Operating profit (loss)......................................... (1,555,697) 692,983 32,734
Other income (expense):
Investment income................................................. 128,722 239,142 271,815
Interest expense.................................................. (63,979) (243,472) (158,570)
Other............................................................. (167,047) 20,876 (27,652)
------------- ------------- -------------
Total other income (expense).................................... (102,304) 16,546 85,593
------------- ------------- -------------
Income (loss) before income taxes................................... (1,658,001) 709,529 118,327
Provision (benefit) for income taxes (Note 6)....................... (414,500) 177,382 29,582
------------- ------------- -------------
Net income (loss)................................................... $ (1,243,501) $ 532,147 $ 88,745
------------- ------------- -------------
------------- ------------- -------------
Net income (loss) per common share (Note 2)......................... $ (0.98) $ 0.42 $ 0.07
Weighted average common shares outstanding.......................... 1,270,625 1,257,384 1,252,567
The accompanying notes are an integral part of these consolidated financial
statements.
Page AR-8
CONSOLIDATED STATEMENTS OF CASH FLOWS:
Years Ended September 27, 1997, September 28, 1996, and September 30, 1995.
1997 1996 1995
------------- ------------ -----------
Operating Activities:
Net Income (loss)...................................................... $ (1,243,501) $ 532,147 $ 88,745
Adjustments to reconcile net income (loss) to net cash provided (used)
by operating activities:
Depreciation and amortization........................................ 911,331 882,905 500,850
Net loss on disposal of fixed assets................................. 192,425 -- --
Non-cash compensation associated with ESOP........................... 167,403 246,136 246,136
Changes in assets and liabilities, net of the acquisition of Datotek:
Decrease (increase) in accounts receivable........................... (40,425) 1,792,842 (992,005)
(Increase) in unbilled revenue....................................... (198,038) -- --
Decrease (increase) in inventories................................... (808,207) (187,944) 136,602
Decrease (increase) in refundable income taxes....................... (609,812) 139,944 (55,604)
Decrease (increase) in other current assets.......................... 81,175 143,634 (253,904)
Decrease (increase) in other assets and deferred income taxes........ 5,346 (277,780) (256,216)
Increase (decrease) in accounts payable and other accrued
liabilities........................................................ (175,894) 483,728 187,235
------------- ------------ -----------
Net cash provided (used) by operating activities..................... (1,718,197) 3,755,612 (398,161)
------------- ------------ -----------
Investing Activities:
Additions to equipment and leasehold improvements.................... (533,177) (597,452) (366,300)
Proceeds from disposal of equipment.................................. 38,884 -- --
Cash paid for Datotek acquisition.................................... -- (44,511) (3,687,000)
------------- ------------ -----------
Net cash provided (used) by investing activities....................... (494,293) (641,963) (4,053,300)
------------- ------------ -----------
Financing Activities:
Proceeds from exercise of stock options.............................. 53,387 85,723 14,500
Proceeds from bank loan.............................................. -- -- 2,250,000
Borrowings under line of credit...................................... 500,000 -- --
Payment of line of credit............................................ (500,000) -- --
Payment of debt...................................................... (2,345,175) (696,136) (396,136)
------------- ------------ -----------
Net cash provided (used) by financing activities..................... (2,291,788) (610,413) 1,868,364
------------- ------------ -----------
Net increase (decrease) in cash and cash equivalents................. (4,504,278) 2,503,236 (2,583,097)
Cash and cash equivalents at beginning of year......................... 6,381,026 3,877,790 6,460,887
------------- ------------ -----------
Cash and cash equivalents at end of year............................... $ 1,876,748 $ 6,381,026 $ 3,877,790
------------- ------------ -----------
------------- ------------ -----------
Supplemental disclosures:
Interest paid........................................................ $ 70,991 $ 243,472 $ 158,570
Income taxes paid (net of refunds received).......................... 408,193 103,497 (24,401)
The accompanying notes are an integral part of these consolidated financial
statements.
Page AR-9
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY:
Years Ended September 27, 1997, September 28, 1996, and September 30, 1995
1997 1996 1995
----------- ------------- -----------
Shares of Common Stock:
Beginning balance.................................................... 1,264,496 1,254,426 1,251,176
Exercise of stock options............................................ 9,207 10,070 3,250
----------- ------------- -----------
Ending balance..................................................... 1,273,703 1,264,496 1,254,426
----------- ------------- -----------
----------- ------------- -----------
Common Stock at par value:
Beginning balance.................................................... $ 126,450 $ 125,443 $ 125,118
Exercise of stock options............................................ 920 1,007 325
----------- ------------- -----------
Ending balance..................................................... 127,370 126,450 125,443
----------- ------------- -----------
Additional Paid-In Capital
Beginning balance.................................................... 1,473,643 1,388,927 1,374,752
Exercise of stock options............................................ 52,467 84,716 14,175
----------- ------------- -----------
Ending balance..................................................... 1,526,110 1,473,643 1,388,927
----------- ------------- -----------
ESOP Deferred Compensation:
Beginning balance.................................................... (695,175) (941,311) (1,187,447)
Principal payments on ESOP debt (Note 5)............................. 167,403 246,136 246,136
----------- ------------- -----------
Ending balance..................................................... (527,772) (695,175) (941,311)
----------- ------------- -----------
Retained Earnings:
Beginning balance.................................................... 9,707,839 9,175,692 9,086,947
Net income (loss).................................................... (1,243,501) 532,147 88,745
----------- ------------- -----------
Ending balance..................................................... 8,464,338 9,707,839 9,175,692
----------- ------------- -----------
Treasury Stock:
Beginning balance (10,000 shares).................................... (80,000) (80,000) (80,000)
----------- ------------- -----------
Ending balance....................................................... (80,000) (80,000) (80,000)
----------- ------------- -----------
Total stockholders' equity............................................. $ 9,510,046 $ 10,532,757 $ 9,668,751
----------- ------------- -----------
----------- ------------- -----------
The accompanying notes are an integral part of these consolidated financial
statements.
Page AR-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) COMPANY OPERATIONS
Technical Communications Corporation and its wholly-owned subsidiaries
(the Company) operate in one industry segment: the design, development,
manufacture, marketing, distribution and sale of communications security
devices and systems.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, TCC Foreign Sales Corporation, a
qualified Foreign Sales Corporation (FSC), and TCC Investment Corporation, a
Massachusetts Security Corporation. All significant intercompany accounts
and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include demand deposits at banks, and
certificates of deposit and other investments (including mutual funds)
readily convertible into cash. Cash equivalents are stated at cost, which
approximates market value.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out method.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost. Depreciation
and amortization are computed using the straight-line method over the
estimated useful life of the asset. When assets are retired or otherwise
disposed of, the cost and related accumulated depreciation are removed from
the accounts, and any resulting gain or loss is recognized in income for the
period. The cost of maintenance and repairs is charged to income as
incurred; significant renewals and betterments are capitalized.
Page AR-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CAPITALIZED SOFTWARE COSTS
Certain computer software costs are capitalized in accordance with
Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," and
are reported at the lower of unamortized cost or net realizable value. Upon
initial product release, these costs are amortized based upon the higher of
(a) the ratio of current revenues to total anticipated revenues of the
products, or (b) the straight-line method, over two or three years.
RECOGNITION OF REVENUE
The Company generally recognizes revenue upon shipment of products,
except in the case of long-term contracts for which the revenue is
recognized under the percentage-of-completion method.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," encourages, but does not require, companies to
record compensation cost for stock-based employee compensation plans at fair
value. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board No. 25, "Accounting for Stock Issued to Employees," and
related Interpretations.
INCOME TAXES
The Company records income tax expense in accordance with Statement of
Financial Accounting Standards No. 109 "Accounting for Income Taxes," which
requires the use of the liability method in accounting for income taxes.
Under the liability method, deferred income taxes are recognized at current
income tax rates to reflect the tax effect of temporary differences between
the consolidated financial reporting and tax basis of assets and
liabilities.
WARRANTY COSTS
The Company provides for warranty costs based on a percentage of sales.
The percentage is adjusted periodically in accordance with actual
experience.
EARNINGS PER SHARE
Earnings per common share are based on the weighted average number of
shares outstanding during the year using the treasury stock method. The
effect of assumed conversion of dilutive stock options is not material.
In March 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share,"
which establishes standards for computing and presenting earnings per share
for entities with publicly held common stock. SFAS No. 128 is effective for
periods ending after December 15, 1997 and early adoption is not permitted.
Had SFAS No. 128 been adopted as of September 29, 1996, there would have
been no effect on the Company's reported earnings per share for the year
ended September 27, 1997, including all quarterly earnings per share.
Page AR-12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FISCAL YEAR-END POLICY
The Company 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. Fiscal years 1997, 1996, and 1995 ended on September 27, 1997,
September 28, 1996, and September 30, 1995, respectively.
(3) OTHER ACCRUED LIABILITIES
Other accrued liabilities consist of the following:
SEPTEMBER 27, SEPTEMBER 28,
1997 1996
------------- -------------
Reserve for product warranty........................................................ $ 163,480 $ 386,175
Reserve for product installation.................................................... -- 141,650
Customer advance payments........................................................... 149,011 108,402
Sales representative commissions.................................................... 746,833 340,928
Customer support agreements......................................................... 519,839 344,520
Income taxes payable................................................................ 101,212 463,227
Other............................................................................... 114,106 234,401
------------- -------------
Total accrued liabilities........................................................... $ 1,794,481 $ 2,019,303
------------- -------------
------------- -------------
(4) INVENTORIES
Inventories consist of the following:
SEPTEMBER 27, SEPTEMBER 28,
1997 1996
------------- -------------
Finished goods...................................................................... $ 64,781 $ 10,557
Work in process..................................................................... 1,220,152 853,422
Raw materials and supplies.......................................................... 2,139,046 1,751,793
------------- -------------
Total inventories................................................................... $ 3,423,979 $ 2,615,772
------------- -------------
------------- -------------
(5) DEBT
On November 17, 1989, the Company established the Technical
Communications Corporation Employees' Stock Ownership Trust (the "Trust")
for the benefit of its employees. During 1990 and 1991, the Trust borrowed
$1,212,500 and $1,287,488, respectively, from two banks, and purchased
190,350 shares of the Company's common stock at fair market value. The
Company acted as guarantor on these loans and, as a result, recorded the
principal balance of such loans on its balance sheet as long-term debt with
an offsetting charge to "ESOP deferred compensation" within the
Stockholders' Equity section.
Page AR-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On April 30, 1997, the Company provided a loan of $82,702 to the Trust
in order to pay off the remaining balance of the 1990 bank loan. This new
loan, which bears interest at 9% per annum, requires equal monthly payments
of principal of $3,446, commencing on May 31, 1997. On August 28, 1997, the
Company provided a second loan of $472,222 to the Trust in order to pay off
the 1991 bank loan. This second Company loan to the Trust bears interest at
13.6% per annum and requires equal monthly principal payments of $9,838
beginning on September 28, 1997.
The Company makes contributions to the Trust equal to the monthly
payment of principal and interest on the ESOP loans as they become due.
Because the payment of principal results in the release of shares from
collateral, which shares are then available for allocation to employees, the
principal portion of these contributions is recorded as compensation
expense. Such contributions are, therefore, expensed to compensation and
interest when they are made or accrued. The compensation and interest
elements are as follows:
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
FOR THE FISCAL YEARS ENDED: 1997 1996 1995
- -------------------------------------------------------------------- ------------- ------------- -------------
Compensation........................................................ $ 167,403 $ 246,136 $ 246,136
Interest............................................................ 49,104 71,996 88,305
------------- ------------- -------------
Total contributions................................................. $ 216,507 $ 318,132 $ 334,441
------------- ------------- -------------
------------- ------------- -------------
At its August 27, 1997 meeting, the Board of Directors voted to
terminate the Employee Stock Ownership Plan effective October 1, 1997.
On May 31, 1995, the Company completed an asset purchase of the secure
communications business of Datotek, Inc., a subsidiary of AT&T Corp., for
$3,687,000 (see Note 15). This acquisition was funded partly by the
Company's cash reserves and partly through loans amounting to $2,250,000
from two banks. These loans, payable in equal installments of principal over
a period of five years, plus interest at The First National Bank of Boston's
prime rate plus 1/2 of 1%, were paid in full during November 1996.
At September 27, 1997, the Company had a $3,500,000 line of credit at a
rate of prime plus 1/2 of 1%. Availability under the line of credit has been
reduced by $839,158 for outstanding standby letters of credit (see Note 10).
During June 1997, the Company borrowed $500,000 against its credit line,
subsequently paying the amount back in full during August 1997 upon receipt
of certain large trade receivables. Other than outstanding standby letters
of credit, the Company had no borrowing under the line of credit in 1996 or
1995.
The foregoing bank loans and line of credit are secured by a pledge of
substantially all the assets of the Company. This line of credit expires on
May 1, 1998, unless renewed.
Page AR-14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) INCOME TAXES
The provisions (credits) for income taxes consist of the following:
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
FOR THE FISCAL YEARS ENDED: 1997 1996 1995
- -------------------------------------------------------------------- ------------- ------------- -------------
Current:
Federal........................................................... $ (426,692) $ 473,672 $ 21,983
State............................................................. (143,164) 123,027 7,599
------------- ------------- -------------
Total current taxes................................................. (569,856) 596,699 29,582
------------- ------------- -------------
Deferred:
Federal........................................................... 116,149 (336,330) --
State............................................................. 39,207 (82,987) --
------------- ------------- -------------
Total deferred taxes................................................ 155,356 (419,317) --
------------- ------------- -------------
Total provision (benefit)........................................... $ (414,500) $ 177,382 $ 29,582
------------- ------------- -------------
------------- ------------- -------------
The provisions for income taxes are different from those that would be
obtained by applying the statutory federal income tax rate to earnings
before income taxes due to the following:
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
FOR THE FISCAL YEARS ENDED: 1997 1996 1995
- -------------------------------------------------------------------- ------------- ------------- -------------
Tax at U.S. statutory rate.......................................... $ (563,720) $ 241,240 $ 40,231
Benefit of Foreign Sales Corp....................................... -- (23,604) (29,898)
State income taxes, net of Federal benefit.......................... (103,957) 28,260 3,600
Tax-exempt interest................................................. -- (6,875) (7,480)
Accruals and other.................................................. (17,912) 5,861 23,129
Increase (reduction) in valuation allowance......................... 271,089 (67,500) --
------------- ------------- -------------
Total............................................................... $ (414,500) $ 177,382 $ 29,582
------------- ------------- -------------
------------- ------------- -------------
Deferred income taxes consist of the following:
SEPTEMBER 27, SEPTEMBER 28,
1997 1996
------------- -------------
NOL carryforward.................................................................... $ 263,242 --
Goodwill............................................................................ 88,823 54,874
Inventory reserve................................................................... 154,723 201,140
Warranty reserve.................................................................... 98,237 243,629
Payroll related accruals............................................................ 144,589 37,590
Other............................................................................... (48,141) 38,238
------------- -------------
Total............................................................................... 701,473 575,471
Less: Valuation allowance........................................................... (624,920) (353,831)
------------- -------------
Total............................................................................... $ 76,553 $ 221,640
------------- -------------
------------- -------------
Page AR-15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The valuation allowance relates to uncertainty with respect to the
Company's ability to realize prepaid tax assets against future profits.
Refundable income taxes represent estimated refunds from the Federal
government from carryback claims. All refunds are expected to be received
within the next fiscal year.
(7) STOCK OPTIONS
At the February 1992 Annual Meeting of Stockholders, the Company adopted
the Technical Communications Corporation 1991 Stock Option Plan (the SOP
Plan) to replace a previous, expired plan. The Company reserved 250,000
shares of common stock for issuance to employees at prices not less than the
fair market value on the date of grant. At the February 1997 Annual Meeting
of Stockholders, the Company increased the reserve for shares under the SOP
Plan to 350,000. Options under this plan generally expire ten years from the
date of grant and are exercisable in cumulative annual increments commencing
one year after the date of grant.
The Company had previously adopted an Incentive Stock Option Plan (the
ISO Plan) which reserved shares of common stock for issuance to employees at
prices not less than the fair market value on the date of grant. The ISO
Plan expired December 15, 1991. Options are still outstanding, generally
expire ten years from the date of grant, and are exercisable in cumulative
annual increments commencing one year after the date of grant.
In 1991, the stockholders approved a Non-Qualified Stock Option Plan
which reserved 50,000 shares of common stock for issuance to non-employee
Directors of the Company at prices not less than the fair market value on
the date of grant. This plan was discontinued in February 1997, but options
are still outstanding and are exercisable at any time after the date of the
grant until expiration, which is five years from the date of grant.
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," which sets forth a fair-value based method of
recognizing stock-based compensation expense. As permitted by SFAS No. 123,
the Company has elected to continue to apply Accounting Principles Board
Opinion No. 25 to account for its stock-based compensation plans. Had
compensation for awards in fiscal years 1995 through 1997 under the
Company's stock-based compensation been determined based on the fair value
at the grant dates consistent with the method set forth under SFAS No. 123,
the effect on the Company's net income and earnings per share would have
been as follows:
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
FOR THE FISCAL YEARS ENDED: 1997 1996 1995
- -------------------------------------------------------------------- ------------- ------------- -------------
Net Income (loss)
As reported....................................................... $(1,243,501) $ 532,147 $ 88,745
Pro forma......................................................... $(1,432,295) $ 376,293 $ (24,782)
Earnings per common share
As reported....................................................... $ (0.98) $ 0.42 $ 0.07
Pro forma......................................................... $ (1.23) $ 0.31 $ (0.02)
------------- ------------- -------------
------------- ------------- -------------
AR-16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to October 1, 1994, the resulting pro forma
compensation expense may not be representative of the amount to be expensed
in future years. Pro forma compensation expense for options granted is
reflected over the vesting period; future pro forma compensation expense may
be greater as additional options are granted.
The fair value of each option granted was estimated on the grant date
using the Black-Scholes option pricing model with the following weighted
average assumptions: risk-free interest rates of 6.00%, 6.43%, and 6.00% for
1997, 1996, and 1995, respectively, expected life equal to each grant's
vesting period (1 to 9 years), expected volatility of 100%, and an expected
dividend yield of 0%.
A summary of the Company's stock option activity by fiscal year follows:
1997 1996 1995
------------------------ ------------------------ -----------
AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF
SHARES PRICE SHARES PRICE SHARES
----------- ----------- ----------- ----------- -----------
Options outstanding, beginning of year.................. 233,905 $ 10.13 167,550 $ 10.24 78,950
Options granted
Option price = Fair Market Value...................... 34,700 $ 9.33 46,950 $ 8.71 22,250
Option price > Fair Market Value...................... 16,000 $ 11.45 50,000 $ 11.24 80,000
Options exercised....................................... (7,500) $ 6.90 (10,070) $ 11.26 (3,250)
Options forfeited....................................... (15,950) $ 10.92 (20,525) $ 11.03 (10,400)
----------- ----------- ----------- ----------- -----------
Options outstanding, end of year........................ 261,155 $ 10.14 233,905 $ 10.13 167,550
Options exercisable..................................... 72,965 $ 9.50 51,470 $ 9.78 33,055
Weighted average fair value per share of options granted
during the year....................................... $ 7.76 $ 6.77
AVERAGE
EXERCISE
PRICE
-----------
Options outstanding, beginning of year.................. $ 11.58
Options granted
Option price = Fair Market Value...................... $ 7.45
Option price > Fair Market Value...................... $ 9.68
Options exercised....................................... $ 4.40
Options forfeited....................................... $ 12.54
-----------
Options outstanding, end of year........................ $ 10.24
Options exercisable..................................... $ 10.25
Weighted average fair value per share of options granted
during the year....................................... $ 6.36
The following summarizes certain data for options outstanding at
September 27, 1997:
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
NUMBER OF RANGE OF EXERCISE CONTRACTUAL
SHARES EXERCISE PRICES PRICE LIFE
----------- ----------------- ----------- ---------------
Options outstanding, end of year 25,850 $ 4.00--$8.00 $ 7.22 7.83
207,195 $ 8.01--$12.00 $ 9.96 8.46
28,110 $ 12.01--$16.75 $ 13.13 7.78
-----------
261,155 $ 10.14 8.33
Options exercisable 24,750 $ 4.00--$8.00 $ 7.20
37,245 $ 8.01--$12.00 $ 9.19
10,970 $ 12.01--$16.75 $ 13.02
-----------
72,965 $ 9.50
AR-17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) PROFIT-SHARING PLAN
The Company has a qualified, contributory, trusteed profit-sharing plan
covering substantially all employees. The Company's policy is to fund
contributions as they are accrued. The contributions are allocated based on
the employee's proportionate share of total compensation.
The Company's contributions to the plan are determined by the Board of
Directors and are subject to other specified limitations. No provision for a
contribution has been made for 1997. However, the Board of Directors, at its
August 27, 1997 meeting approved a corporate match of 25 cents per dollar of
the first 6% of each participant's contributions to the plan for fiscal
1998. Provisions of approximately $46,000, and $40,000 were recorded in 1996
and 1995, respectively, for the Company's contributions to the plan.
The Company offers no post-retirement benefits as defined in the
Statement of Financial Accounting Standards No. 106, "Employers' Accounting
for Post-Retirement Benefits other than Pensions."
(9) EXECUTIVE INCENTIVE BONUS PLAN
The Company has an Executive Incentive Bonus Plan for the benefit of key
management employees. The bonus pool is determined based on the Company's
performance as defined in the plan. In fiscal 1997 and 1995, no bonuses were
earned. Bonuses of $104,500 accrued in fiscal 1996 for key management
employees were dis-tributed during fiscal 1997.
(10) OFF-BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
At September 27, 1997, and September 28, 1996, the Company was
contingently liable under open standby letters of credit totaling $839,158
and $66,910, respectively. These letters of credit are issued in the
ordinary course of business to secure the Company's performance under
contracts with its customers. These letters of credit expire as provided for
in the contracts, unless exercised or renewed. To date, no letters of credit
have been exercised. The Company does not expect to incur any loss
associated with these letters of credit.
As of September 27, 1997, management believes it has no significant
concentrations of credit risk due to placement of its cash equivalents with
high-credit-quality financial institutions, and the fact that the majority
of its foreign trade receivables are secured by letters of credit or foreign
credit insurance.
(11) RELATED PARTY TRANSACTIONS
Herbert A. Lerner, Company Director and Treasurer, and James A.
McCalmont, Director, are Trustees of the Technical Communications
Corporation Employees' Stock Ownership Trust. At its August 27, 1997
meeting, the Board of Directors voted to terminate the Employee Stock
Ownership Plan effective October 1, 1997.
Edward E. Hicks, Esq., the Company's Secretary and Clerk, is a member of
a law firm that provides legal services to the Company.
Page AR-18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Lawrence A. Kletter, Esq., who resigned as a director during fiscal year
1997, is a member of a law firm that provided legal services to the Company.
Carl H. Guild, Jr., elected to the Board of Directors effective May 1,
1997, serves as a consultant for the Company, earning $52,500 in this
capacity during fiscal 1997.
During fiscal years 1997 and 1996, the Company incurred expenses of
$116,038 and $96,360, respectively, to FutureComms, Inc., a privately held
telecommunications software consulting services company. FutureComms is
owned and operated by Michelle D. Gerard, the wife of the Company's
President and CEO. FutureComms' work ended on August 29, 1997.
During 1996 and 1995, the Company leased a sales office from its
Chairman; lease payments were $1.00 in each year. The fair market value of
such rent was estimated to be below $5,000 per year.
On June 27, 1995, the Company invested $250,800 for a minority interest
in Series B Preferred Stock of Net2Net Corporation, a privately held company
that develops high performance management and analysis systems for
Asynchronous Transfer Mode (ATM) networks. The Company also paid a deposit
for inventory, purchased at a discounted price, valued at $244,200 as well
as entered into an eighteen month distribution agreement with Net2Net that
gave the Company the exclusive right to sell Net2Net products to certain
U.S. Government departments. As of September 27, 1997, $144,283 of the
inventory has been sold and the remain-ing amount of $99,917 has been either
written-down or fully reserved. Net2Net's president is Stephen McCalmont,
son of Arnold McCalmont, and brother to James McCalmont. Arnold and James
McCalmont, as well as Herbert Lerner, are also investors in Net2Net
Corporation. This investment, which represents less than a 5% interest, has
been accounted for using the cost method.
(12) COMMITMENTS AND CONTINGENCIES
The Board of Directors has authorized payments of $30,000 per year for
five years to the wife of the Chairman of the Board of Directors, provided
that she survives him, in the event of his death at a time when he is
employed by the Company. The Company carries insurance on the life of the
Chairman sufficient to fund this contingent liability in full.
The Company is party to various claims arising in the normal course of
business. Management believes that these are adequately provided for or will
result in no significant additional liability to the Company.
On December 12, 1997, the Board of Directors announced that it has
undertaken an internal review of certain of its historical service
contracts. On January 13, 1998 the Company announced that the results
from its internal review concluded that certain of TCC's internal
approval and control procedures were not followed in connection with such
contracts. However, the Company does not believe that this will result in
a material liability or asset impairment to the Company or otherwise have
any material effect on the financial position or results of operations of
the Company.
(13) MAJOR CUSTOMERS AND EXPORT SALES
In fiscal 1997, the Company had three customers representing 51% (25%,
13%, and 13%) of net sales. In fiscal 1996, the Company had three customers,
including the U.S. Government as one customer, representing 54% (26%, 16%,
and 12%) of net sales. In fiscal 1995, the Company had three customers,
including the U.S. Government, representing 57% (24%, 20%, and 13%) of net
sales.
Page AR-19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A breakdown of net sales is as follows:
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
FOR THE FISCAL YEARS ENDED: 1997 1996 1995
- -------------------------------------------------------------------- ------------- ------------- -------------
Domestic............................................................ $ 2,734,690 $ 3,633,425 $ 1,535,015
Foreign............................................................. 9,523,948 10,379,377 8,692,550
------------- ------------- -------------
Total............................................................... $ 12,258,638 $ 14,012,802 $ 10,227,565
------------- ------------- -------------
------------- ------------- -------------
A summary of foreign sales by geographic area follows:
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
FOR THE FISCAL YEARS ENDED: 1997 1996 1995
- -------------------------------------------------------------------- --------------- --------------- ---------------
North America (excluding the U.S.).................................. 1.0% 1.3% 2.9%
Central and South America........................................... 33.8% 6.7% 6.5%
Europe.............................................................. 6.1% 11.6% 14.2%
Mid-East and Africa................................................. 53.8% 46.0% 59.7%
Far East............................................................ 5.3% 34.4% 16.7%
----- ----- -----
Total............................................................... 100.0% 100.0% 100.0%
----- ----- -----
----- ----- -----
(14) LEASES
The Company leases its headquarters under an operating lease.
The Company has renewed the lease on its headquarters located in
Concord, Massachusetts through June 30, 2000. Future minimum lease payments
depend on the Consumer Price Index at December 31, 1997, but are estimated
at $158,700 a year through fiscal 1999 and $119,000 for the first nine
months of fiscal 2000. This lease may be further renewed for an additional
two and one-half years through December 31, 2002. The Company also retains
an option to purchase the building at fair market value, but not to exceed
$2,262,000, exercisable at the end of the current renewal term, and of the
additional renewal term, if elected. Annual rental expense amounted to
$146,160 during fiscal years 1995 through 1997.
(15) ACQUISITION
Effective May 31, 1995, the Company acquired substantially all of the
assets of Datotek, Inc., a subsidiary of AT&T Corp. Total consideration paid
by the Company was $3,687,000, plus acquisition and financing costs. The
acquisition was financed by the Company's own capital and a loan from two
banks. These bank loans were subsequently paid off in November 1996.
Operations resulting from this acquisition are included in the accompanying
consolidated financial statements from the date of acquisition. The
acquisition was accounted for as a purchase, and accordingly, an allocation
of purchase cost to the Company's assets and liabilities (accounts
receivable, inventory, fixed assets, accounts payable, and accruals)
was made to reflect fair values. The allocation resulted in
unallocated excess purchase cost over net assets acquired (goodwill) of
Page AR-20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
$1,614,131, which is being amortized on a straight-line basis over 7 1/2
years. The parties made an election under the Internal Revenue Code to treat
the purchase and sale agreement as a purchase of assets and assumption of
liabilities.
On an unaudited pro forma basis, giving effect to the transaction as if
it occurred as of October 1, 1994, net sales for fiscal 1995 would have been
$11,605,000 with a net loss of $235,000 or $.19 per share.
The pro forma net sales and net loss do not purport to represent what
the Company's results of operations would have been if such transactions in
fact had occurred on such date or at the beginning of the period indicated
or to project the Company's financial position or results of operations for
any future date or period.
(16) EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
ESTIMATED
SEPTEMBER 27, SEPTEMBER 28, USEFUL
1997 1996 LIFE
------------- ------------- ------------
Engineering and manufacturing equipment................ $ 1,920,289 $ 1,942,723 3--8 years
Demonstration equipment................................ 922,696 785,178 3--5 years
Furniture and fixtures................................. 1,036,423 1,000,354 3--8 years
Automobiles............................................ 89,899 89,899 5 years
Leasehold improvements................................. 413,348 405,662 2--5 years
------------- ------------- ------------
Total equipment and leasehold improvements............. $ 4,382,655 $ 4,223,816 2--8 years
------------- ------------- ------------
------------- ------------- ------------
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair
value of each class of financial instrument for which it is practicable to
estimate that value.
a.) Cash and Cash Equivalents--The carrying amount of these assets on the
Company's Consolidated Balance Sheet approximates their fair value because
of the short maturity of these instruments.
b.) Long-term Debt--The fair value of this long-term indebtedness approximates
the carrying amount since the variable interest rate paid reflects fair
value.
Page AR-21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(18) RISKS
The Company is exposed to a number of business risks. These include, but
are not limited to, concentration of its business amongst a relatively small
number of customers (see Note 13), technological change (which can cause
obsolescence of the Company's products and inventories), actions of
competitors (some of whom have access to considerably greater financial
resources than the Company), cancellation of major contracts (either before
or after award), variations in market demand, the loss of key personnel,
etc. The Company attempts to protect itself in various ways against such
risks, but its success cannot be guaranteed.
(19) FORWARD-LOOKING STATEMENTS
The foregoing footnotes contain forward-looking statements, such as, but
not by way of limitation, expectations of future debt service requirements,
lease payments, etc. In addition, the financial statements contain estimates
by management that also constitute forward-looking statements, including but
not limited to depreciation rates, adequate levels of inventory, warranty
and other reserves, current values of assets and liabilities, etc., that
involve risks and uncertainties. Actual values and results may be materially
different. In particular, the value of assets and the adequacy of reserves
depend upon future events which cannot be foreseen at this time because they
may be affected by changes in the needs of the Company's customers, the
products and pricing offered by the Company's competitors, general economic
conditions and other factors.
Page AR-22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Technical Communications Corporation:
We have audited the accompanying consolidated balance sheets of Technical
Communications Corporation (a Massachusetts corporation) and its subsidiaries
as of September 27, 1997, and September 28, 1996, and the related
consolidated statements of operations, cash flows, and stockholders' equity
for the years ended September 27, 1997, September 28, 1996, and September 30,
1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Technical
Communications Corporation and subsidiaries as of September 27, 1997 and
September 28, 1996, and the results of their operations and their cash flows
for the years ended September 27, 1997, September 28, 1996 and September 30,
1995, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
- -----------------------
Boston, Massachusetts
October 29, 1997 (except with respect to the matter
discussed in Note 12 as to which the date
is January 15, 1998)
Page AR-23