U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
| x | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended September 25, 2004
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-8588
Technical Communications Corporation
(Name of small business issuer in its charter)
| Massachusetts | 04-2295040 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
| 100 Domino Drive, Concord, MA | 01742-2892 | |
| (Address of principal executive offices) | (Zip code) | |
(978) 287-5100
(Issuer’s telephone number)
Securities registered under Section 12 (b) of the Exchange Act:
| None | None | |
| (Title of each class) | (Name of each exchange on which registered) |
Securities registered under Section 12 (g) of the Exchange Act:
Common Stock, $.10 par value
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 ¨
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. x
Total revenue of the registrant for the fiscal year end September 25, 2004 was $4,876,436.
Based on the closing price as of December 10, 2004, the aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant as of December 10, 2004, was approximately $7,368,990.
The number of shares of the registrant’s Common Stock, par value $.10 per share, outstanding as of December 10, 2004 was 1,355,360.
Portions of the Company’s Definitive Proxy Statement dated on or about January 7, 2005 to be delivered to shareholders in connection with the Company’s 2005 Annual Meeting of Shareholders to be held February 7, 2005 are incorporated by reference into Part III of this Form 10-KSB.
PART I
Item 1. DESCRIPTION OF BUSINESS
Technical Communications Corporation (“TCC” or the “Company”) was organized in 1961 as a Massachusetts corporation to engage primarily in consulting activities. Since the late 1960s the business has consisted entirely of the design, development, manufacture, distribution, marketing and sale of communications security devices and systems. The secure communications solutions provided by TCC protect vital information transmitted over a wide range of data, fax and voice networks. TCC’s products have been sold into over 100 countries and are in service with governments, military agencies, telecommunications carriers, financial institutions and multinational corporations. The Company’s business consists of only one industry segment, which is the design, development, manufacture, distribution, marketing and sale of communications security devices and systems.
Overview
The Company’s products consist of sophisticated electronic devices that enable users to transmit information in an encrypted format and permit receivers to reconstitute the information in a deciphered format. The Company’s products can be used to protect confidentiality in communications between radios, telephones, facsimile machines and data processing equipment over wires, fiber optic cables, radio waves and microwave and satellite links. A customer may order and receive equipment that is specially programmed to scramble transmissions in accordance with a code to which only the customer has access. The principal markets for the Company’s products are foreign and domestic governmental agencies, law enforcement agencies, financial institutions, and multinational companies requiring protection of mission-critical information.
TCC historically and presently designs and develops its own equipment and software to meet the requirements of general secure communications applications, as well as the custom-tailored requirements of specific users. Management believes the coordinated development of cryptographic software and associated hardware allows TCC to provide high-strength encryption security with efficient processing and transmission. Both criteria, the Company believes, are essential to customer satisfaction.
TCC manufactures most of its own products using multiple vendors for the supply of components and selected processing with final assembly, software loading, testing and quality assurance being performed by TCC at its’ factory. This manufacturing approach allows TCC to competitively procure the components from multiple suppliers while maintaining control of the manufacture and performance of the final product.
TCC’s products are sold worldwide through a variety of channels depending on the country and the customer. Generally, TCC does not use stocking distributors since the Company’s products are required to be sold under an applicable U.S. government license, which generally requires end-user information. Rather, the Company sells directly to customers, original equipment manufacturers and value-added resellers, using its in-house sales force as well as domestic and international representatives, consultants and distributors. The marketing and selling approach varies with each country and often involves extensive test and demonstration activity prior to the consummation of a sale. TCC has a network of in-country representatives and consultants, who conduct performance demonstrations, market the TCC product benefits and close the sale, covering many of the ancillary requirements pertaining to importation duties, taxes, registration fees, and product receipt and acceptance. After-sale, in-country support by the representatives maintains customer satisfaction and provides a liaison for the Company’s customer support services.
The worldwide market for our Government Systems products remains a principal focus for TCC, as the Company believes increasing concerns with security will generate demand for increased protection of both voice and data networks. Management plans selected, evolutionary upgrades to government/military products both to meet new requirements of the market and to provide entry into new markets. We believe the ability of TCC to custom-tailor cryptographic functions and control systems to meet unique customer requirements will meet a growing demand as governments become more sophisticated in defining their communications security needs.
The U.S. government controls, through a licensing process, the distribution of encryption technology and the sale of encryption products. The procedure for obtaining the applicable license, from either the Department of Commerce or Department of State, is relatively straightforward. Many of TCC’s products can be sold under existing “blanket” licenses, while some products and end-users must be submitted for specific approval. A more detailed discussion of the licensing process is included below in the “Regulatory Matters” section.
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Recent Events
During fiscal 2004, TCC actively participated in national trials for two secure telephone systems and one strategic information system. It is expected that these trials will conclude in 2005 and additional trials will be initiated in other countries. TCC has focused an increased portion of its marketing effort on targeted opportunities where TCC can become the selected national supplier for encrypted communications. Expanding this element of our business is intended to result in long term relationships that generate annual procurements and help stabilize the often unpredictable timing of sales.
Our results in this past fiscal year have continued a favorable trend that began in the fourth quarter of fiscal year 2002. Profitability has been sustained due to positive order flow, which has resulted in a sizeable backlog, currently valued at $950,000. This trend has allowed our revenue results to remain consistent and, in conjunction with cost controls, has lead to a growth in profitability and cash flow. Product-related orders have improved over the past fiscal year, contributing significantly to the backlog and revenue. In addition, the engineering services component of our business has remained constant, providing a steady stream of revenue for technology development. We anticipate that government network systems will continue to be a strong sales component but will exhibit the timing unpredictability that is typical of this business area.
On August 6, 2004 the Company adopted a Shareholder Rights Plan and declared a dividend distribution of one common stock purchase right for each outstanding share of common stock of the Company, payable to stockholders of record at the close of business on August 13, 2004, and for each share of common stock issued thereafter. The rights will become exercisable only in the event, with certain exceptions, that a person or group of affiliated or associated persons acquires 15% or more of the Company’s voting stock, or a person or group of affiliated or associated persons commences a tender or exchange offer which, if successfully consummated, would result in such person or group owning 15% or more of the Company’s voting stock. Each right, once exercisable, will entitle the holder (other than an acquiring person or group) to buy one share of the Company’s Common Stock at a price of $25 per share, subject to certain adjustments.
On November 5, 2004 the Company entered into a line of credit agreement with Fleet National Bank, a Bank of America company (the “Bank”) for a line of credit not to exceed the principal amount of $600,000, and a financing promissory note with respect thereto. The loan is a demand loan with interest payable at the Bank’s prime rate plus 1% on all outstanding balances. The loan is secured by all assets of the Company (excluding consumer goods) and requires the Company to maintain its deposit accounts with the Bank, as well as comply with certain other covenants.
Products
The products described below are currently available and provide communications security solutions for mission-critical networks, voice and facsimile, centralized key and device management, and military ciphering applications.
The Government Systems product line has traditionally been the Company’s core product base and has generated the majority of revenue for the Company in recent years. These products have proven to be highly durable, which has led to significant repeat business from our customers. The Company believes that these products and their derivatives will continue to be the Company’s most significant source of future revenues.
The Company’s Secure Office Systems products were originally acquired through an asset purchase from a subsidiary of AT&T in 1995. These products have produced modest revenues since their acquisition. Although these products are readily available and still profitable, demand for them has diminished in recent years. We will continue to offer these products from our existing inventory, which we anticipate will be sufficient for several more years.
Although we believe our Network Security Systems products to be a competitive product line, the demand for this product line has been difficult to establish. The strong competition in this market area coupled with weak overall demand for network security products both domestically and overseas have hampered the Company’s efforts to develop an active and consistent market for these products. These products are currently available and we believe we will be able to fulfill any customer requirements for the foreseeable future.
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Government Systems
The Company’s High Speed Data Encryptor is a rugged military system that provides a maximum level of cryptographic security for data networks operating at up to 34 million bits per second. The product supports a wide variety of interfaces and integrates into existing networks. Reliable secure communication is ensured with communication synchronization methods built to maintain connections in error and jamming environments such as radio relay networks, missile systems and microwave systems.
The Company’s Narrowband Radio Security family of products provides strategic security for voice and data communications sent over HF (high frequency), VHF (very high frequency) and UHF (ultra high frequency) channels. Designed for military environments, we believe these products provide high voice quality over poor line connections, making them an attractive security solution for military aircraft, naval, base station and manpack radio applications. These products provide automated key distribution for security and ease of use. They are also radio independent because software programmable interfaces allow radio interface levels to be changed without configuring the hardware. Base station, handset and implant board configurations are available options and the products are compatible with the Company’s secure telephone systems to enable “office-to-field” communications.
The Company’s Secure Telephone, Fax and Data system is a comprehensive office communications security system that provides voice, fax and data encryption in a telephone package. The product has a fallback mode, which was originally developed for poor high frequency channels. As a result, secure communications are possible even over poor line conditions. TCC’s high-level encryption and automated key distribution system protects sensitive information, and internal storage of 400 keys provides hands-off security.
Secure Office Systems
The Company’s Secure Portable Telephone Attachment may be placed between any telephone and handset worldwide to provide digital security. The attachment is small and portable, operates over both digital and analog telephone lines, and is designed to ensure protection through new and unique random keys negotiated with each communication session.
The Company’s Fax Security System is a secure, automatic transmission fax system that connects to any standard facsimile machine. Security protection is achieved using key technology, which provides randomly generated keys that are unique to each communication session. Open and closed networks are supported by the device to enable an open exchange of secure documents in the industrial marketplace or restrict secure communications to only authorized parties in highly confidential or government applications.
The Company’s Executive Secure Telephone offers strategic level voice and data security in a full-featured executive telephone package. Exceptional voice quality can be achieved with three different voice-coding algorithms. The product provides ease-of-use security features such as automated key management, authentication, certification and access control.
Network Security Systems
The CipherONETM family of Network Security Systems consists of high-performance hardware and software-based encryption products for local area network, wide area network and Internet applications and includes a network security management system.
All of the systems have been designed for node-to-node protection and therefore provide node authentication and access control, as well as data integrity. This family of products also utilizes a modular architecture that permits the software to be updated as networks migrate to emerging protocols, thereby protecting the user’s investment. Network transparent, the products support U.S. government-backed and proprietary encryption algorithms as well as industry-standard specifications for security key management.
The Company’s Frame Relay Network Encryptor is an end-to-end frame relay encryption system and is configured locally with Cipher Site Manager, its accompanying software configuration tool, or remotely with KEYNET (discussed below).
The Company’s IP Network Encryptor provides encryption security at the Internet Protocol layer and is configured locally with Cipher Site Manager, its accompanying software configuration tool, or remotely with KEYNET.
The Company’s KEYNET Network Security Management System is a Windows NT-based key and security device management system that can centrally and simultaneously manage an entire CipherONE™ Security Systems Network, including those on mixed networks. KEYNET has an intuitive graphical user interface, making it easy to use. The system securely generates, distributes and exchanges keys, sets address tables, provides diagnostics and performs automatic polling and alarms from a central and remote location. KEYNET also provides instant alarm notification. These high security measures facilitate central management while maintaining security for mission-critical networks worldwide.
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Competition
The communications security devices and systems market is highly competitive and characterized by rapid technological change. The Company has several competitors, including foreign-based companies, in the communications security device field. Many of these competitors are companies that have greater financial and other resources than the Company. The Company believes its principal competitors include Crypto AG, Thales Plc, Motorola Inc., General Dynamics Corp., Omnisec AG, Cisco Systems, Inc., SafeNet, Inc. and Alcatel.
The Company competes based on its service, the operational and technical features of its products, its sales expertise and pricing. The Company sells directly to customers, original equipment manufacturers and value-added resellers, using its in-house sales force as well as domestic and international representatives, consultants and distributors.
Many of TCC’s competitors have substantially greater financial, technical, marketing, distribution and other resources, greater name recognition and longer standing relationships with customers. Competitors with greater financial resources can be more aggressive in marketing campaigns and can survive sustained price reductions in order to gain market share. Any period of sustained price reductions in our products would have a material adverse effect on the Company’s financial condition and results of operations. TCC may not be able to compete successfully in the future and competitive pressures may result in price reductions, loss of market share or otherwise have a material adverse effect on the Company’s financial condition and results of operations.
Our competitive position will also depend on our ability to attract and retain qualified personnel, to obtain intellectual property protection or otherwise develop proprietary products or processes, and secure sufficient capital resources for product, research and development efforts.
Sales and Backlog
In fiscal year 2004, the Company had two customers representing 40% of total net sales. These sales consisted of an ongoing engineering services effort with the U.S. government, which represented 25% of sales, and an ongoing effort to upgrade its encryption algorithm for a government in the Middle East, representing 15% of sales. In fiscal year 2003, the Company had three customers representing 50% of total net sales. These sales consisted of the ongoing engineering services effort with the U.S. government, which represented 20% of sales, a sale to a customer in Italy for bulk encryptors amounting to 17% of sales and the sale of secure telephones to a South American government representing 13% of sales.
The Company sells directly to customers, original equipment manufacturers and value-added resellers, using its in-house sales force as well as domestic and international representatives, consultants and distributors. International sales are made primarily through our main office. We seldom have long-term contractual relationships with our customers and, therefore, generally have no assurance of a continuing relationship within a given market.
Orders for our products are usually placed by customers on an as-needed basis and we typically ship products within 30 to 120 days of receipt of a customer’s firm purchase order. Our backlog consists of all orders received, where the anticipated shipping date is within 12 months. Because of the possibility of customer changes in delivery schedules or cancellation of orders, our backlog as of any particular date may not be indicative of sales in any future period. We seldom maintain long-term contracts with our customers that require them to purchase our products. Our backlog for continuing operations as of September 25, 2004 and September 27, 2003 was approximately $950,000 and $500,000, respectively.
The Company expects that sales to relatively few customers will continue to account for a high percentage of the Company’s revenues in any accounting period in the foreseeable future. A reduction in orders from any such customer, or the cancellation of any significant order and failure to replace such order with orders from other customers, would have a material adverse effect on the Company’s business, financial condition, and results of operations.
Regulatory Matters
As a party to a number of contracts with the U.S. government and its agencies, the Company must comply with extensive regulations with respect to bid proposals and billing practices. Should the U.S. government or its agencies conclude that the Company has not adhered to federal regulations, any contracts to which the Company is a party could be canceled and the Company could be prohibited from bidding on future contracts. Such a prohibition would have a material adverse effect on the Company.
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All payments to the Company for work performed on contracts with agencies of the U.S. government are subject to adjustment upon audit by the U.S. Defense Contract Audit Agency, the General Accounting Office, and other agencies. The Company could be required to return any payments received from U.S. government agencies if it is found to have violated federal regulations. In addition, U.S. government contracts may be canceled at any time by the government with limited or no penalty. Contract awards are also subject to funding approval from the U.S. government, which involves political, budgetary and other considerations over which the Company has no control.
The Company’s security products are subject to export restrictions administered by the U.S. Department of Commerce and Department of State, which license the export of encryption products, subject to certain technical restrictions. In addition, U.S. export laws prohibit the export of encryption products to a number of hostile countries. Although to date the Company has been able to secure necessary U.S. government export licenses, there can be no assurance that the Company will continue to be able to secure such licenses in a timely manner in the future, or at all.
The U.S. government controls, through a licensing process, the distribution of encryption technology and the sale of encryption products. The procedure for obtaining the applicable license from either the Department of Commerce or the Department of State (depending on the U.S. government’s determination of jurisdiction) is well documented. The Company submits a license request application, which contains information pertaining to: the type of equipment being sold; detailed technical description (if required); the buyer; the end-user and use; quantity; and destination location. The appropriate departments of the U.S. government review the application and a licensing decision is provided to the Company. Pursuant to the receipt of the license, the Company may ship the product.
Many of TCC’s products can be sold under existing “blanket” licenses which have been obtained through a variant of the licensing process that approves products for sale to certain classes of customers (e.g. financial institutions, civilian government entities, commercial users). The Company has obtained “blanket” licenses for its secure telephone, office system products and its family of network encryptors. Licenses for sales of some products and/or to certain end users must be submitted for specific approval as described above. Although the U.S. government retains the right and ability to restrict product exports, the Company does not believe that U.S. government licensing will become more restrictive or an impediment to its business. The trend, since the mid-nineties, has been for the U.S. government to reduce the restrictions on the foreign sale of cryptographic equipment. This trend is driven by the U.S. government’s recognition of the technology available from foreign sources and the need to allow U.S. corporations to compete in foreign markets. However, should the regulations become more restrictive, it would have a negative effect on the Company’s international business.
Manufacturing
TCC has several manufacturing subcontractors and suppliers that provide outside processing of electronic circuit boards, fabrication of metal components, and supply of electronic components. For the majority of purchased materials and services, TCC has multiple suppliers that are able to deliver materials and services under short-term delivery purchase orders. Payment is typically made after delivery, based upon standard credit arrangements. For a small minority of parts, there are limited sources of supply. In such cases TCC monitors source availability and usually stocks for anticipated long-term requirements to assure manufacturing continuity. Notwithstanding the Company’s efforts to maintain material supplies, shortages can and do develop, necessitating delays in production, significant engineering development effort to find alternative solutions and, if production cannot be maintained, the discontinuation of the effected product design.
The Company subcontracts a large portion of its manufacturing operations. Many of the components used in the Company’s products are standard components available from more than one supplier. The Company has, or believes that it could develop without significant delay, alternative sources for almost all materials and components used in the manufacture of its products. The Company’s internal manufacturing process consists primarily of adding critical components, final assembly, quality control, testing and system burn-in. Delivery time varies depending on the products and options ordered.
Technical Expertise
The Company’s technological expertise and experience, including certain proprietary rights, which it has developed and maintains as trade secrets, are crucial to the conduct of the Company’s business. Management is of the opinion that, while patent protection is desirable with respect to certain of its products, none of the Company’s patents are material to the conduct of its business. Eight patents have been issued to the Company. The Company has a number of trademarks for various products, none of which are material to the conduct of TCC’s business.
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TCC has an on-going technology license for communications protocol software used in the CipherONE family of Network Security System products. The license is royalty-based and runs without a specified termination date. The cost effect of this license is considered not material.
TCC has been designing and producing secure, cryptography-based communications systems for over 40 years, during which time the Company has developed many technology techniques and practices. This expertise and experience is in the areas of cryptographic algorithm design and implementation, key distribution and management systems, cryptographic processors, voice and fax encryption and electronic hardware design. TCC relies on its internal technical expertise and experience, which TCC considers to be proprietary. These proprietary technologies are owned by TCC, are under TCC’s control, and have been documented consistent with standard engineering practices. It is estimated that the majority of sales during the past two years and during the next two years will be of products that are based upon TCC-proprietary designs.
Such technological experience and expertise is important as it enables an efficient design and development process. Loss of this experience and expertise would have an adverse impact on the Company. However, TCC’s practices governing the internal documentation of design data mitigate some of the risk associated with the loss of personnel who are skilled in the core competencies described above.
With the exception of the technology license referred to above, TCC has no third party rights upon which the Company relies. Sales of the products associated with this license have not been and are not anticipated to be significant to the Company’s revenues.
Research and Development
Research and development is undertaken by the Company primarily on its own initiative. In order to develop the technology needed to compete successfully, the Company must attract and retain qualified personnel, improve existing products and develop new products. No assurances can be given that the Company will be able to hire and train such technical management and sales personnel or successfully improve and develop its products. During the years ended September 25, 2004 and September 27, 2003, the Company spent $444,000 and $471,000, respectively, on product development. In addition, the Company accepts product development work on a contract specific basis; the development costs associated with these contracts are included in cost of sales.
During fiscal 2004 and 2003, a substantial portion of product development efforts were focused on billable work. Billable engineering services work accounted for approximately $1,212,000 of revenue for the fiscal year ended September 25, 2004 and $800,000 for the fiscal year ended September 27, 2003. This revenue was primarily generated under a program with the U.S. government. This program will be completed in fiscal 2005.
In fiscal 2005, the Company expects to expand its investment in product development in secure applications for the voice wireless market and new network interfaces for our high speed bulk encryptors, which will be developed for selected military requirements. Upgrades and the evolution of the Company’s secure voice office products will also be continued. The Company believes that the current mix of employees and billable versus non-billable production efforts is sufficient to accomplish its near term goals.
Other than those stated above, there are no plans for major product development in fiscal 2005.
Foreign Operations
The Company is dependent upon its foreign sales. Although foreign sales were more profitable than domestic sales during fiscal years 2004 and 2003 because the mix of products sold abroad included more products with higher profit margins than the mix of products sold domestically, this does not represent a predictable trend. Sales to foreign markets have been and will continue to be affected by, among other things, the stability of foreign governments, economic conditions, export and other governmental regulations, and changes in technology. The Company attempts to minimize the financial risks normally associated with foreign sales by utilizing letters of credit confirmed by U.S. banks and by using foreign credit insurance. Foreign sales contracts are usually in U.S. dollars.
The Company utilizes the services of sales representatives, consultants and distributors in connection with foreign sales. Typically, representatives are paid commissions and consultants are paid fixed amounts on a stipulated schedule in return for services rendered. Distributors are granted discounted pricing.
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The export from the United States of many of the Company’s products may require the issuance of a license by the Department of State under the Arms Export Control Act of 1976, as amended, or by the Department of Commerce under the Export Administration Act as kept in force by the International Emergency Economic Powers Act of 1977, as amended.
In fiscal years 2004 and 2003, sales to international customers accounted for approximately 48% and 57%, respectively, of our net sales. We expect that international sales will continue to account for a significant portion of our revenues for the foreseeable future. As a result, we are subject to risks of doing business internationally, including:
| • | changes in regulatory requirements |
| • | domestic and foreign government policies, including requirements to expend a portion of program funds locally and governmental industrial cooperation requirements |
| • | fluctuations in foreign currency exchange rates |
| • | delays in placing orders |
| • | the complexity and necessity of using foreign representatives and consultants |
| • | the uncertainty of the ability of foreign customers to finance purchases |
| • | uncertainties and restrictions concerning the availability of funding credit or guarantees |
| • | imposition of tariffs or embargoes, export controls and other trade restrictions |
| • | the difficulty of managing and operating an enterprise spanning several countries |
| • | compliance with a variety of foreign laws, as well as U.S. laws affecting the activities of U.S. companies abroad, and |
| • | economic and geopolitical developments and conditions, including international hostilities, acts of terrorism and governmental reactions, inflation, trade relationships and military and political alliances |
While these factors and their impact are difficult to predict, any one or more of these factors could adversely affect our operations in the future.
We also may not be successful in obtaining the necessary licenses to conduct operations abroad, and Congress may prevent proposed sales to foreign governments.
Employees
As of September 25, 2004, the Company employed one part-time and 24 full-time persons. The Company believes that its relationship with its employees is good.
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Item 2. DESCRIPTION OF PROPERTY
On January 1, 2003, the Company entered into an operating lease for its current facilities. This lease is for 22,800 square feet located at 100 Domino Drive, Concord, MA. The property is approximately 23 years old, well maintained and in good condition. 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 lease is for a three-year period with rents payable at an annual rate of $142,169 through December 31, 2005. At its option the Company may extend the lease for two more years at an annual rate of $147,855.
The Company does not have any current policies regarding investing in real estate. The Company has not in the past nor is it contemplating investing in real estate in the near future.
Item 3. LEGAL PROCEEDINGS
There are no current legal proceedings pending against TCC.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to security holders for a vote during the fourth quarter of the fiscal year covered by this report.
PART II
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company’s Common Stock, par value $0.10 per share, is traded on the over-the-counter bulletin board, under the symbol “TCCO.OB”. The following table presents low and high bid information for the time periods specified. The over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. The NASDAQ Stock Market, Inc. has furnished the over-the-counter market quotations.
| Title of Class |
Quarter Ending |
Price | ||||||
| Low |
High | |||||||
| Common Stock, $.10 par value |
||||||||
| 9/25/2004 | $ | 3.00 | $ | 5.00 | ||||
| 6/26/2004 | 3.05 | 4.75 | ||||||
| 3/27/2004 | 2.49 | 5.00 | ||||||
| 12/27/2003 | 1.90 | 5.10 | ||||||
| 9/27/2003 | $ | 0.80 | $ | 2.80 | ||||
| 6/28/2003 | 0.52 | 1.05 | ||||||
| 3/29/2003 | 0.32 | 0.95 | ||||||
| 12/28/2002 | 0.25 | 0.65 | ||||||
The Company has paid no cash dividends in the past and has no plans to pay cash dividends in the foreseeable future. In addition, pursuant to the loan agreement entered into on November 5, 2004 with Fleet National Bank, the Company is prohibited from paying dividends. As of December 10, 2004, there were approximately 1,000 record holders of our Common Stock. On December 10, 2004, the closing price of the Common Stock was $5.55.
Equity Compensation Plan Information
During 1995 the Company established the Technical Communications Corporation 1995 Employees’ Stock Purchase Plan (the Plan) which is available to all employees who have at least one year of continuous employment with TCC, work more than 20 hours per week or more than five months per year, and whose ownership will not exceed 5% as a result of participation in the Plan. The plan allows for employees to purchase, through the grant of options, Common Stock of the Company at a discounted price through payroll withholdings.
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The purchase price is 85% of the lesser of the Market Value of the Company’s Common Stock as of the grant date or the exercise date. For executive officers, the purchase price is the average of the Market Value of the Company’s Common Stock as of the grant date and the exercise date. Market Value is defined as, of a particular date, the last sale price of our Common Stock if quoted on an exchange or, if not so quoted, the average of bid and asked prices for the Common Stock last quoted by NASDAQ in the over-the-counter market. The Plan has 100,000 shares authorized for distribution of which 44,268 are still available for issuance. The Plan is administered by the Company’s Board of Directors, and expires on September 30, 2005
See also the discussion of the Company’s stock option plans included in footnote 2 to the Company’s financial statements at and as of September 25, 2004.
The following table presents information about the Technical Communications Corporation 2001 Stock Option Plan and the Technical Communications Corporation 1991 Stock Option Plan (which plan has expired but under which there are still options outstanding, hereinafter referred to as the “1991 Plan”) as of fiscal year-end September 25, 2004.
| Plan category |
Number of securities to be issued upon exercise of outstanding options, warrants and rights |
Weighted average exercise price of outstanding options, warrants and rights |
Number of future issuance |
||||||
| Equity compensation plans approved by stockholders |
609,043 | (1) | $ | 3.27 | 0 | (2) | |||
| Equity compensation plans not approved by stockholders |
0 | — | 0 | ||||||
| Total |
609,043 | $ | 3.27 | 0 | |||||
| (1) | Of the 609,043 options outstanding as of September 25, 2004, 436,619 were exercisable as of such date at an exercise price of $3.55 per share. |
| (2) | Amount does not include the number of shares of Common Stock available for purchase under the Purchase Plan, which was 44,268 as of the end of the fiscal year. There are no shares available for new options grants under either the Plan or the 1991 Plan as of the end of the fiscal year. |
Sales of Unregistered Securities and Issuer Repurchases
There were no sales of unregistered shares or repurchases of stock by the Company during the fiscal year covered by this report.
Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion of the financial condition and the results of operations should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto appearing elsewhere herein.
Forward-Looking Statements
The following discussion in this Form 10-KSB may contain statements that are not historical. Certain statements contained herein or as may otherwise be incorporated by reference herein 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 ability to achieve growth and profitability of the Company. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, including but not limited to future changes in export laws or regulations; changes in technology; the effect of foreign political unrest; 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
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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 Securities and Exchange Commission, including this Form 10-KSB for the fiscal year ended September 25, 2004.
Overview
The Company is in the business of designing, manufacturing, marketing and selling 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 primarily from the sale of these products. The sales of these products have traditionally been to foreign governments. However, we have also sold these products to commercial entities and U.S. government agencies. We also generate revenues from contract engineering services performed for certain government agencies both domestic and foreign.
Critical Accounting Policies and Significant Judgments and Estimates
The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires management to make estimates and assumptions 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 reported periods.
On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, receivable reserves, inventory reserves and income taxes. 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 value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The accounting policies that management believes are most critical to aid in fully understanding and evaluating our reported financial results include the following:
Revenue Recognition
We recognize revenue from product sales in accordance with SEC Staff Accounting Bulleting No.101, “Revenue Recognition,” as updated by Staff Accounting Bulletin No. 104 and Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has occurred and we have determined that collection of the fee is probable. Title to the product generally passes upon shipment of the product, as the products are shipped FOB shipping point, except for certain foreign shipments. If the product requires installation to be performed by TCC, all revenue related to the product is deferred and recognized upon the completion of the installation. We provide for a warranty reserve at the time the product revenue is recognized.
If a contract involves the provision of multiple elements and the elements qualify for separation under EITF 00-21, total estimated contract revenue is allocated to each element based on the relative fair value of each element provided. The amount of revenue allocated to each element is limited to the amount that is not contingent upon the delivery of another element in the future. Revenue is then recognized for each element as described above for product revenue.
We perform funded research and development and product development for commercial companies and government agencies under both cost reimbursement and fixed-price contracts. Cost
11
reimbursement contracts provide for the reimbursement of allowable costs and, in some situations, the payment of a fee. These contracts may contain incentive clauses providing for increases or decreases in the fee depending on how costs compare with a budget. Revenue from reimbursement contracts is recognized as services are performed. On fixed-price contracts, revenue is generally recognized pursuant to the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. In each type of contract, we receive periodic progress payments or payment upon reaching interim milestones and retain the rights to the intellectual property developed in government contracts. All payments to TCC for work performed on contracts with agencies of the U.S. government are subject to audit and adjustment by the Defense Contract Audit Agency. Adjustments are recognized in the period made. When the current estimates of total contract revenue and contract costs for commercial product development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in performing funded research and development projects are recognized as funded research and development expenses as incurred.
Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development and other revenue arrangements are included in cost of sales.
Inventory
We value our inventory at the lower of actual cost to purchase and/or manufacture or the current estimated market value of the inventory. We periodically review inventory quantities on hand and record a provision for excess and/or obsolete inventory based primarily on our estimated forecast of product demand, as well as historical usage. Due to the custom and specific nature of certain of our products, demand and usage for products and materials can fluctuate significantly. A significant decrease in demand for our products could result in a short-term increase in the cost of inventory purchases and an increase of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence, any of which could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant negative impact on the value of our inventory and would reduce our reported operating results.
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 the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required.
Accounting for Income Taxes
The preparation of our consolidated financial statements requires us to estimate our income taxes in each of the jurisdictions in which we operate, including those outside the United States, which may be subject to certain risks that ordinarily would not be expected in the United States. The income tax accounting process involves estimating our actual current exposure together with assessing temporary differences resulting from differing treatments of items, such as deferred revenue, for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. We must then record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.
Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against deferred tax assets. We have recorded a full valuation allowance against our deferred tax assets of $3.9 million as of September 25, 2004, due to uncertainties related to our ability to utilize these assets. The valuation allowance is based on our estimates of taxable income by jurisdiction and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could materially impact our financial position and results of operation.
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Due to the nature of our current operations in foreign countries (selling products into these countries with the assistance of local representatives), the Company has not been subject to any foreign taxes in recent years. Also, it is not anticipated that we will be subject to foreign taxes in the near future.
Results of Operations
Year ended September 25, 2004 as compared to year ended September 27, 2003
Net Sales
Net sales for the years ended September 25, 2004 and September 27, 2003 were $4,876,000 and $4,051,000, respectively. Sales for fiscal 2004 consisted of $2,519,000, or 52%, from domestic sources and $2,357,000, or 48%, from international customers as compared to fiscal 2003, which consisted of $1,735,000, or 43%, from domestic sources and $2,316,000, or 57%, from international customers.
Foreign sales consisted of shipments to 24 different countries during the year ended September 25, 2004 and 27 different countries during the year ended September 27, 2003. A sale is attributed to a foreign country based on the location of the contracting party. The table below summarizes our principal foreign sales by country:
| 2004 |
2003 | |||||
| Egypt |
$ | 740,000 | $ | 91,000 | ||
| Indonesia |
441,000 | 9,000 | ||||
| Columbia |
397,000 | 512,000 | ||||
| Italy |
— | 686,000 | ||||
| Mauritania |
— | 264,000 | ||||
| Other |
779,000 | 754,000 | ||||
| $ | 2,357,000 | $ | 2,316,000 | |||
A significant portion of sales for fiscal year 2004 included the efforts related to engineering services work for the U.S. government. This program was amended during the year and the total value was increased to $1,900,000. Revenue recognized for this program during fiscal 2004 amounted to $1,212,000. It is anticipated this program will be completed in fiscal 2005. Another major effort which began in fiscal 2004 was a project to upgrade the encryption algorithm for a Middle Eastern customer with a total value of $1,000,000. Revenue recognized for this project during fiscal 2004 amounted to $600,000 and it is expected to be completed in fiscal 2005.
Additional sales in fiscal 2004 included $438,000 of our secure telephone, fax and data encryptors sold to a customer in Indonesia and $185,000 sold into the Middle East for use by governments. Sales of our narrowband radio encryptors included sales to four domestic customers amounting to $833,000 and three foreign customers (South America - $293,000, Africa - $190,000 and Southeast Asia - $95,000) amounting to $578,000. We also sold fax encryptors to two foreign customers (Middle East - $140,000 and Eastern Europe - $107,000) amounting to $247,000.
Sales for fiscal year 2003 included three major orders: a single order shipped to a customer in Italy, for ultimate deployment into the Middle East, for our high-speed bulk encryptors amounting to $686,000; two orders for our secure telephone, fax and data encryptors sold into South America for use by governments totaling $637,000; and a single order of $264,000 for various data, voice and narrowband radio encryptors shipped to an African nation. The Company also sold narrowband radio encryptors to nine different customers totaling $659,000, of which $459,000 was to domestic customers and $200,000 was for foreign use. The domestic sales consisted primarily of $227,000 sold to commercial manufacturing companies for integration and resale and $202,000 to various U.S. government agencies and departments. The foreign sales consisted primarily of $76,000 sold for use by a South American government and $67,000 sold to an African nation. Additionally, the Company received an order in fiscal 2003 to provide engineering services to the U.S. government. Revenue recorded under this program during fiscal 2003 amounted to $652,000 and total revenue from engineering services amounted to $796,000 in fiscal 2003.
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Other fiscal year 2003 sales included $432,000 of our secure office systems product line, $111,000 of which was a sale of our executive secure telephones sold to a commercial manufacturing company for resale to an African nation and a sale of our fax encryptors into the Middle East amounting to $91,000.
Gross Profit
Gross profit for fiscal year 2004 was $3,073,000 as compared to $2,505,000 in fiscal year 2003, an increase of 23%. This increase in gross profit was primarily attributable to higher sales volume. Gross profit expressed as a percentage of sales was 63% in fiscal year 2004 compared to 62% in the prior year. A higher gross margin on the algorithm upgrade project helped improve the gross profit in fiscal 2004. These higher gross margin sales were partially offset by lower gross margins on engineering services revenue. Engineering services revenue contributed an additional $244,000 to gross profit in fiscal year 2004 as compared to fiscal year 2003.
Operating Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for fiscal year 2004 were $1,542,000 as compared to $1,586,000 in fiscal year 2003, a decrease of 3%. This decrease was attributable to a decrease in selling costs of approximately $162,000, offset by an increase in general & administrative costs of approximately $118,000.
The decrease in selling costs was primarily attributable to a reduction in sales commissions and marketing contracts of approximately $223,000 in fiscal 2004. The Company sells its products through a distribution network it has established in various countries. The relationship with these distributors takes two forms: as a reseller or as an agent for the Company. Resellers purchase our products from us and then resell the product to an end user. These sales are made at a reduced price and involve no commissions or other selling costs. Agents act as our representative in their respective countries to facilitate a sale from us directly to the end user. These representatives are paid a commission for their efforts and this cost is reflected as a selling expense. During fiscal year 2004, a higher percentage of sales were made through resellers than agents resulting in the reduced selling costs. This reduction was partially offset by an increase in payroll and benefit-related costs of approximately $41,000 as a result of returning all employees to full-time status.
The increase in general and administrative costs was primarily attributable to a $178,000 increase in personnel-related costs as a result of returning all employees to full-time status. This increase was partially offset by a decrease in professional fees of $59,000. The Company also incurred approximately $20,000 of consulting fees in fiscal 2004 associated with the implementation of Section 404 of the Sarbanes-Oxley Act. These fees were related to the initial stages of a long-term project to document the Company’s system of internal controls. This project is expected to continue in fiscal year 2005 and cost an estimated $100,000 in aggregate consulting costs and approximately 100 hours of internal labor.
Research and Development
Product development costs for the fiscal year ended September 25, 2004 were $444,000, compared to $471,000 for fiscal year 2003. This decrease of 6% was attributable to an increase in billable contract engineering during fiscal year 2004, which decreased product development costs by approximately $192,000. In addition, a reduction in overhead expenses and facility costs as a result of company cost-cutting measures amounted to savings of approximately $38,000. These reductions were substantially offset by an increase in payroll and benefit-related costs of approximately $221,000 as a result of returning all employees to full-time status and the hiring during the year of a new engineer and product manager.
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. During fiscal year 2004, a substantial portion
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of product development efforts were focused on billable work. Engineering services work accounted for approximately $1,212,000 of revenue for the fiscal year ended September 25, 2004. This revenue was primarily generated under a program with the U.S. government, which will be completed in fiscal year 2005.
It is anticipated that cash from operations will fund our near-term research and development and marketing activities. However, any increase in activities - either billable or new product related - will require additional resources which we may not be able to fund through cash from operations. We believe that, in the long term, based on current billable activities and the recent improvement in business prospects, cash from operations will be sufficient to meet the development goals of the Company, although we can give no assurances. In circumstances where resources will be insufficient, the Company will look to other sources of financing including debt and/or equity investments.
In fiscal 2005, the Company expects to expand its investment in product development. Secure applications for the voice wireless market will be evaluated and new network interfaces for our high speed bulk encryptors will be developed for selected military requirements. Work with respect to upgrades and the evolution of the Company’s secure voice office products will also be continued. The Company believes that the current mix of employees and billable versus non-billable production efforts is sufficient to accomplish these near term goals.
Net Income
The Company’s net income was $1,134,000 for fiscal year 2004 as compared to $457,000 for fiscal year 2003, a 148% increase. This increase in profitability is attributable to a 23% increase in gross profits and a 3% decrease in operating expense. This trend in net income is encouraging. However, due to the uncertainty of the timing of customer orders, future results remain difficult to predict. Receiving orders and contracts in a timely manner is essential to the Company’s ability to sustain operations.
The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of September 25, 2004, 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
Cash and cash equivalents increased by $1,140,000, or 104%, to $2,238,000 as of September 25, 2004, from a balance of $1,098,000 at September 27, 2003. This increase was primarily attributable to net income from operations of $1,134,000 and an increase in current liabilities of $161,000. These increases were slightly offset by increases in inventory of $57,000, accounts receivable of $60,000 and other current assets of $77,000.
The $1,000,000 engineering services order for the U.S. government received in March of 2003 was modified in fiscal 2004 and the value was increased to $1,900,000. This order has generated approximately $1,212,000 of revenue this fiscal year and $652,000 of revenue in fiscal 2003, and has also contributed to earnings by reducing product development expenditures by $550,000 and $300,000, in fiscal 2004 and 2003, respectively, as these expenses were charged to cost of goods sold. This consistent source of cash flow is expected to continue in the early part of fiscal 2005. A new order to upgrade the encryption algorithm for a government in the Middle East has generated approximately $600,000 of revenue this fiscal year. This program is expected to be completed in fiscal 2005 and is expected to generate an additional $400,000 of revenue.
Backlog at September 25, 2004 amounted to approximately $950,000. This amount consists of the balance of the order to upgrade the encryption algorithm, received in fiscal 2004 amounting to $400,000 as noted above, and an order of approximately $382,000 for our radio encryptors to an African nation. The orders in backlog are expected to ship during the early part of fiscal 2005 depending on customer requirements and product availability.
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On November 5, 2004, the Company entered into a line of credit agreement with Fleet National Bank, a Bank of America company (the “Bank”) for a line of credit not to exceed the principal amount of $600,000, and executed a financing promissory note with respect thereto. The loan is a demand loan with interest payable at the Bank’s prime rate plus 1% on all outstanding balances. The loan is secured by all assets of the Company (excluding consumer goods) and requires the Company to maintain its deposit accounts with the Bank, as well as comply with certain other covenants.
In fiscal 2005, the Company expects to expand its investment in product development in secure applications for the voice wireless market and new network interfaces for our high speed bulk encryptors for selected military requirements. Upgrades and the evolution of the Company’s secure voice office products will also be continued. The Company believes that the current mix of employees and billable versus non-billable production efforts is sufficient to accomplish its near term goals.
Based on today’s product cost structure and operating expenses, we believe that current cash and accounts receivable balances along with the current backlog are sufficient to provide resources to operate the Company through the end of fiscal year 2005. Further, based on our profitability during the past nine quarters, we are optimistic about future sales growth and other possible sources of financing, including private equity funding or future public stock offerings. However, there is no assurance that any of these goals can be achieved.
Certain foreign customers require the Company to guarantee 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. As of September 25, 2004, the Company had two outstanding standby letters of credit amounting to $114,000, expiring through January 31, 2005. The standby letters of credit are secured by compensating cash collateral, which is classified as other current assets on our balance sheet.
On January 1, 2003, the Company entered into an operating lease for its current facilities. This lease is for 22,800 square feet and is the Company’s only facility and houses all manufacturing, research and development, and corporate operations. The lease is for a three-year period with rents payable at an annual rate of $142,169 through December 31, 2005. At its option the Company may extend the lease for two more years at an annual rate of $147,855.
The Company does not anticipate any significant capital expenditures during fiscal 2005.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
Recent Accounting Pronouncements
In January 2003, Financial Accounting Standards Board issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (FIN No. 46), which addressed accounting for special-purpose and variable interest entities. This interpretation was effective for financial statements issued after December 31, 2002. In December 2003, the FASB issued FIN No. 46R “Consolidation of Variable Interest Entities,” which addressed accounting for special-purpose and variable interest entities and which supersedes FIN No. 46. The Company adopted the provisions of FIN No. 46R during fiscal 2004 and it had no effect on the Company’s financial statements and related disclosures.
Item 7. FINANCIAL STATEMENTS
The financial statements and notes thereto listed in the accompanying index to financial statements (Item 13) are filed as part of this Annual Report on Form 10-KSB and are incorporated herein by reference.
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Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 8A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this annual report on Form 10-KSB, the Company’s chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and are operating in an effective manner.
Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting that occurred during its fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 8B. OTHER INFORMATION
Not applicable.
Part III
Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information required by this Item 9 is incorporated herein by reference to our Definitive Proxy Statement, under the captions “Members of the Board of Directors, Nominees and Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance,” with respect to our 2005 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company’s 2004 fiscal year.
The Company has adopted a Code of Business Conduct and Ethics, which applies to all of its employees, officers and directors. A copy of this code can be found on the Company’s website at www.tccsecure.com.
Item 10. EXECUTIVE COMPENSATION
The information required by this Item 10 is incorporated herein by reference to our Definitive Proxy Statement, under the caption “Executive Compensation and Other Information,” with respect to our 2005 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company’s 2004 fiscal year.
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item 11 is incorporated herein by reference to our Definitive Proxy Statement, under the captions “Equity Compensation Plan Information” and “Security Ownership of Certain Beneficial Owners and Management,” with respect to our 2005 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company’s 2004 fiscal year.
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Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 12 is incorporated herein by reference to our Definitive Proxy Statement, under the caption “Certain Relationships and Related Transactions,” with respect to our 2005 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company’s 2004 fiscal year.
Item 13. EXHIBITS
(2) Financial Statement Schedules The following Consolidated Financial Statement Schedule is included herein:
| 37 | ||
| 37 | ||
(3) List of Exhibits
| 3.1 | Articles of Organization of the Company, incorporated by reference to the Company’s Registration Statement of Form S-1, filed on December 1, 1969 |
| 3.2 | By-laws of the Company (1) |
| 4 | Rights Agreement, dated as of August 6, 2004, by and between the Company and American Stock Transfer & Trust Company, as Rights Agent (2) |
| 10.1 | Employment Agreement, effective November 19, 1998, with Carl H. Guild, Jr. (3) |
| 10.2 | Standstill Agreement, dated as of November 1998, by and among the Company and individuals named therein (3) |
| 10.3 | Loan and Security Agreement, dated July 31, 2000, between the Company and Coast Business Credit, a division of Southern Pacific Bank (4) |
| 10.4 | Amendment to Loan and Security Agreement, dated December 28, 2000, between the Company and Coast Business Credit, a division of Southern Pacific Bank (4) |
| 10.5 | Employment Agreement, effective February 12, 2001, with Michael P. Malone (6) |
| 10.6 | Employment Agreement, effective February 12, 2001, with John I. Gill (6) |
| 10.7 | Second Amendment to Loan and Security Agreement, dated August 13, 2001, between the Company and Coast Business Credit, a division of Southern Pacific Bank (5) |
| 10.8 | Third Amendment to Loan and Security Agreement, dated December 27, 2001, between the Company and Coast Business Credit, a division of Southern Pacific Bank (5) |
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| 10.9 | Amendment to Employment Agreement between the Company and Carl H. Guild Jr., as of November 8, 2001 (7) |
| 10.10 | 1995 Employee Stock Purchase Plan (8) |
| 10.11 | 2001 Stock Option Plan (9) |
| 10.12 | Standard Form Commercial Lease, dated October 25, 2002, between the Company and Domino Realty Trust(10) |
| 10.13 | Line of Credit Agreement with Letter of Credit and/or Acceptance Financing Agreement, dated November 5, 2004, between the Company and Fleet National Bank, a Bank of America Company (11) |
| 10.14 | Line of Credit with Letter of Credit and/or Acceptance Financing Promissory Note, dated November 5, 2004, between the Company and Fleet National Bank, a Bank of America Company (11) |
| 14 | Code of Business Conduct and Ethics* |
| 21 | List of Subsidiaries of the Company* |
| 23 | Consent of Vitale, Caturano and Company LTD* |
| 31.1 | Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* |
| 31.2 | Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* |
| 32 | Certifications of Chief Executive and Chief Financial Officers pursuant to 18 U.S.C. Section 1350.* |
Footnotes:
| * | Attached to this filing |
| (1) | Incorporated by reference to the Company’s 8-K filed with the Securities and Exchange Commission on May 5, 1998. |
| (2) | Incorporated by reference to the Company’s 8-K filed with the Securities and Exchange Commission on August 5, 2004. |
| (3) | Incorporated by reference to the Company’s Annual Report for 1998 Form 10-K, as amended, filed with the Securities and Exchange Commission on December 21, 1998. |
| (4) | Incorporated by reference to the Company’s Annual Report for 2000 Form 10-K, filed with the Securities and Exchange Commission on December 29, 2000. |
| (5) | Incorporated by reference to the Company’s Annual Report for 2001 Form 10-K, filed with the Securities and Exchange Commission on December 28, 2001. |
| (6) | Incorporated by reference to the Company’s Form 10-QSB filed with the Securities and Exchange Commission on May 15, 2001. |
| (7) | Incorporated by reference to the Company’s Form 10-QSB filed with the Securities and Exchange Commission on August 13, 2002. |
| (8) | Incorporated by reference to the Company’s Registration Statement on Form S-8, filed with the Securities and Exchange Commission on May 23, 1996. |
| (9) | Incorporated by reference to the Company’s Registration Statement on Form S-8, filed with the Securities and Exchange Commission on December 28, 2001. |
| (10) | Incorporated by reference to the Company’s Annual Report for 2003 Form 10-K, filed with the Securities and Exchange Commission on December 23, 2003. |
| (11) | Incorporated by reference to the Company’s 8-K filed with the Securities and Exchange Commission on November 11, 2004. |
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 is incorporated herein by reference to our Definitive Proxy Statement, under the caption “Proposal V – Fees,” with respect to our 2005 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company’s 2004 fiscal year.
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SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on December 22, 2004.
| TECHNICAL COMMUNICATIONS CORPORATION | ||
| By: | /s/ Carl H. Guild, Jr. | |
| Carl H. Guild, Jr. | ||
| Chief Executive Officer and President | ||
| Chairman of the Board, Director | ||
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature |
Title |
Date | ||
| /s/ Carl H. Guild, Jr. |
Chief Executive Officer and President | December 22, 2004 | ||
| Carl H. Guild, Jr. | Chairman of the Board, Director | |||
| (Principal Executive Officer) | ||||
| /s/ Michael P. Malone |
Treasurer and Chief Financial Officer | December 22, 2004 | ||
| Michael P. Malone | (Principal Financial | |||
| and Accounting Officer) | ||||
| /s/ Mitchell B. Briskin |
Director | December 22, 2004 | ||
| Mitchell B. Briskin | ||||
| /s/ Robert T. Lessard |
Director | December 22, 2004 | ||
| Robert T. Lessard | ||||
| /s/ Thomas E. Peoples |
Director | December 22, 2004 | ||
| Thomas E. Peoples | ||||
20
Technical Communications Corporation
Consolidated Balance Sheets
September 25, 2004 and September 27, 2003
| 2004 |
2003 |
|||||||
| ASSETS |
||||||||
| Current assets: |
||||||||
| Cash and cash equivalents |
$ | 2,238,319 | $ | 1,097,847 | ||||
| Accounts receivable - trade, less allowance for doubtful accounts of $70,000 |
329,950 | 269,892 | ||||||
| Inventories |
1,246,292 | 1,189,284 | ||||||
| Other current assets |
178,315 | 101,031 | ||||||
| Total current assets |
3,992,876 | 2,658,054 | ||||||
| Equipment and leasehold improvements |
4,995,618 | 4,971,395 | ||||||
| Less accumulated depreciation |
(4,918,775 | ) | (4,862,241 | ) | ||||
| Equipment and leasehold improvements, net |
76,843 | 109,154 | ||||||
| $ | 4,069,719 | $ | 2,767,208 | |||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
| Current liabilities: |
||||||||
| Accounts payable |
$ | 165,867 | $ | 105,821 | ||||
| Accrued liabilities: |
||||||||
| Compensation and related expenses |
214,521 | 61,390 | ||||||
| Other |
364,701 | 416,562 | ||||||
| Total current liabilities |
745,089 | 583,773 | ||||||
| Stockholders’ equity |
||||||||
| Common stock - par value $.10 per share; authorized 3,500,000 shares, issued 1,349,859 and 1,337,627 shares at September 25, 2004 and September 27, 2003, respectively |
134,986 | 133,763 | ||||||
| Treasury stock at cost, 232 shares |
(1,934 | ) | (1,934 | ) | ||||
| Additional paid-in capital |
1,381,785 | 1,376,088 | ||||||
| Retained earnings |
1,809,793 | 675,518 | ||||||
| Total stockholders’ equity |
3,324,630 | 2,183,435 | ||||||
| $ | 4,069,719 | $ | 2,767,208 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
21
Technical Communications Corporation
Consolidated Income Statements
Years Ended September 25, 2004 and September 27, 2003
| 2004 |
2003 |
|||||||
| Net sales |
$ | 4,876,436 | $ | 4,050,916 | ||||
| Cost of sales |
1,803,404 | 1,545,972 | ||||||
| Gross profit |
3,073,032 | 2,504,944 | ||||||
| Operating expenses: |
||||||||
| Selling, general and administrative expenses |
1,541,602 | 1,585,958 | ||||||
| Product development costs |
444,497 | 470,730 | ||||||
| Total operating expenses |
1,986,999 | 2,056,688 | ||||||
| Operating income |
1,086,933 | 448,256 | ||||||
| Other income (expense) |
||||||||
| Investment income |
15,641 | 5,874 | ||||||
| Interest expense |
(1,640 | ) | (1,833 | ) | ||||
| Other |
33,341 | 4,216 | ||||||
| Total other income |
47,342 | 8,257 | ||||||
| Income before income taxes |
1,134,275 | 456,513 | ||||||
| Provision for income taxes |
— | — | ||||||
| Net income |
$ | 1,134,275 | $ | 456,513 | ||||
| Net income per common share |
||||||||
| Basic |
$ | 0.84 | $ | 0.34 | ||||
| Diluted |
$ | 0.75 | $ | 0.34 | ||||
| Weighted average shares |
||||||||
| Basic |
1,344,087 | 1,336,703 | ||||||
| Diluted |
1,515,554 | 1,342,863 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
22
Technical Communications Corporation
Consolidated Statements of Cash Flows
Years Ended September 25, 2004 and September 27, 2003
| 2004 |
2003 |
|||||||
| Operating activities: |
||||||||
| Net income |
$ | 1,134,275 | $ | 456,513 | ||||
| Adjustments to reconcile net income to cash provided by (used for) operating activities: |
||||||||
| Depreciation and amortization |
56,534 | 106,979 | ||||||
| Changes in current assets and current liabilities: |
||||||||
| Accounts receivable |
(60,058 | ) | 2,067 | |||||
| Inventories |
(57,008 | ) | 182,081 | |||||
| Other current assets |
(77,284 | ) | 53,702 | |||||
| Accounts payable and accrued liabilities |
161,316 | (110,240 | ) | |||||
| Cash provided by operating activities |
1,157,775 | 691,102 | ||||||
| Investing activities: |
||||||||
| Additions to equipment and leasehold improvements |
(24,223 | ) | (31,633 | ) | ||||
| Cash used for investing activities |
(24,223 | ) | (31,633 | ) | ||||
| Financing activities: |
||||||||
| Proceeds from stock issuance |
6,920 | 685 | ||||||
| Cash provided by financing activities |
6,920 | 685 | ||||||
| Net increase in cash and cash equivalents |
1,140,472 | 660,154 | ||||||
| Cash and cash equivalents at beginning of year |
1,097,847 | 437,693 | ||||||
| Cash and cash equivalents at end of year |
$ | 2,238,319 | $ | 1,097,847 | ||||
| , |
||||||||
| Supplemental disclosures: |
||||||||
| Interest paid |
$ | 1,638 | $ | 1,834 | ||||
| Income taxes paid |
11,100 | 3,656 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
23
Technical Communications Corporation
Consolidated Statements of Stockholders’ Equity
Years Ended September 25, 2004 and September 27, 2003
| 2004 |
2003 |
|||||||
| Stockholders’ Equity |
||||||||
| Shares of common stock: |
||||||||
| Beginning balance |
1,333,627 | 1,333,185 | ||||||
| Issuance of shares to ESPP participants |
— | 1,942 | ||||||
| Exercise of stock options |
12,232 | 2,500 | ||||||
| Ending balance |
1,349,859 | 1,337,627 | ||||||
| Common stock at par value: |
||||||||
| Beginning balance |
$ | 133,763 | $ | 133,319 | ||||
| Issuance of shares to ESPP participants |
— | 194 | ||||||
| Exercise of stock options |
1,223 | 250 | ||||||
| Ending balance |
134,986 | 133,763 | ||||||
| Treasury stock: |
||||||||
| Beginning balance |
(1,934 | ) | (1,934 | ) | ||||
| Ending balance |
(1,934 | ) | (1,934 | ) | ||||
| Additional paid-in capital: |
||||||||
| Beginning balance |
1,376,088 | 1,375,847 | ||||||
| Issuance of shares to ESPP participants |
— | 466 | ||||||
| Exercise of stock options |
5,697 | — | ||||||
| Issuance of below market value stock options |
— | (225 | ) | |||||
| Ending balance |
1,381,785 | 1,376,088 | ||||||
| Retained earnings: |
||||||||
| Beginning balance |
675,518 | 219,005 | ||||||
| Net income |
1,134,275 | 456,513 | ||||||
| Ending balance |
1,809,793 | 675,518 | ||||||
| Total stockholders’ equity |
$ | 3,324,630 | $ | 2,183,435 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
24
Notes to Consolidated Financial Statements
(1) Company Operations
Technical Communications Corporation was incorporated in Massachusetts in 1961; its subsidiary, TCC Investment Corp., was organized in that jurisdiction in 1982. The Company’s business consists of only one industry segment, which is the design, development, manufacture, distribution, marketing and sale of communications security devices and systems. The secure communications solutions provided by TCC protect vital information transmitted over a wide range of data, fax and voice networks. TCC’s products have been sold into over 100 countries and are in service with governments, military agencies, telecommunications carriers, financial institutions and multinational corporations.
The Company’s revenues have historically included significant transactions with foreign governments, U.S. government agencies and other organizations. The Company expects this trend to continue. The timing of these transactions has in the past and will in the future have a significant impact on the cash flow of the Company. Delays in the timing of significant expected sales transactions would cause a significant negative effect on the Company’s operations. The Company has some ability to mitigate this effect through cost-cutting measures.
(2) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, TCC Investment Corp., a Massachusetts 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 other investments (including mutual funds) readily convertible into cash. Cash equivalents are stated at cost, which approximates market value.
Inventories
The Company values its inventory at the lower of actual cost to purchase and/or manufacture the inventory or the current market value (based on estimated selling prices) of the inventory. The Company periodically reviews inventory quantities on hand and records a provision for excess and/or obsolete inventory based primarily on our estimated forecast of product demand, as well as historical usage. The Company evaluates the carrying value of inventory on a quarterly basis to determine if the carrying value is recoverable at estimated selling prices. To the extent that estimated selling prices do not exceed the associated carrying values, inventory carrying values are written down. In addition, the Company makes judgments as to the future demand requirements and compares that with the current or committed inventory levels. Reserves are established for inventory levels that exceed future demand. It is possible that reserves over and above those already established may be required in the future if market conditions for our products should deteriorate.
25
Notes to Consolidated Financial Statements (continued)
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 operations for the period. The cost of maintenance and repairs is charged to operations as incurred; significant renewals and betterments are capitalized.
Long-lived Assets
The Company accounts for long-lived assets in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company’s only long-lived assets are equipment and leasehold improvements. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Recognition of Revenue
The Company recognizes revenue from product sales in accordance with SEC Staff Accounting Bulleting No.101, “Revenue Recognition,” as updated by Staff Accounting Bulletin No. 104 and Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has occurred and we have determined that collection of the fee is probable. Title to the product generally passes upon shipment of the product, as the products are shipped FOB shipping point, except for certain foreign shipments. If the product requires installation to be performed by TCC, all revenue related to the product is deferred and recognized upon the completion of the installation. We provide for a warranty reserve at the time the product revenue is recognized.
If a contract involves the provision of multiple elements and the elements qualify for separation under EITF 00-21, total estimated contract revenue is allocated to each element based on the relative fair value of each element provided. The amount of revenue allocated to each element is limited to the amount that is not contingent upon the delivery of another element in the future. Revenue is then recognized for each element as described above for product revenue.
The Company performs funded research and development and product development for commercial companies and government agencies under both cost reimbursement and fixed-price contracts. Cost reimbursement contracts provide for the reimbursement of allowable costs and, in some situations, the payment of a fee. These contracts may contain incentive clauses providing for increases or decreases in the fee depending on how costs compare with a budget. Revenue from reimbursement contracts is recognized as services are performed. On fixed-price contracts, revenue is generally recognized pursuant to the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. In each type of contract, the Company receives periodic progress payments or payment upon reaching interim milestones. All payments to the Company for work performed on contracts with agencies of the U.S. government are subject to audit and adjustment by the Defense Contract Audit Agency. Adjustments are recognized in the period made. When the current estimates of total contract revenue and contract costs for commercial product development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in performing funded research and development projects are recognized as funded research and development expenses as incurred.
Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development and other revenue arrangements are included in cost of sales.
26
Notes to Consolidated Financial Statements (continued)
Stock-Based Compensation
At the August 2001 Board of Directors meeting, the Company adopted the Technical Communications Corporation 2001 Stock Option Plan (the “2001 Plan”) to replace the 1991 Stock Option Plan (discussed below), which by its terms had expired. The Company reserved 350,000 shares of common stock for issuance under the 2001 Plan to employees, directors and consultants. In 2004, the Board approved an increase in the number of authorized shares under the 2001 Plan to 450,000, subject to stockholder approval at the 2005 Annual Meeting of Stockholders. 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.
In 1992, the Company adopted the Technical Communications Corporation 1991 Stock Option Plan (the “1991 Plan”). The Company allocated 250,000 shares of common stock for issuance to employees at prices not less than the fair market value on the date of grant. In 1997, the Company increased the allocated shares under the 1991 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.
Employee stock awards under the Company’s compensation plans are accounted for in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123) and Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation - An Amendment of SFAS No. 123.” Had compensation cost for the Company’s stock option plans been determined based on the fair value at the grant date for awards under these plans, consistent with the methodology prescribed under SFAS 123, the Company’s pro forma net income would have changed to the pro forma amounts indicated below:
| September 25, 2004 |
September 27, 2003 | |||||
| Net income, as reported |
$ | 1,134,275 | $ | 456,513 | ||
| Stock-based employee compensation expense determined under fair-value method |
347,743 | 123,789 | ||||
| Pro forma net income |
$ | 786,532 | $ | 332,724 | ||
| Basic income per share |
||||||
| As reported |
$ | 0.84 | $ | 0.34 | ||
| Pro forma |
$ | 0.59 | $ | 0.25 | ||
| Diluted income per share |
||||||
| As reported |
$ | 0.75 | $ | 0.34 | ||
| Pro forma |
$ | 0.52 | $ | 0.25 | ||
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 3.35% and 3.0% in 2004 and 2003, respectively; expected life equal to 5 years for each of 2004 and 2003; expected volatility of 173% and 172% in 2004 and 2003, respectively; and an expected dividend yield of 0%.
27
Notes to Consolidated Financial Statements (continued)
Because the method prescribed by SFAS No. 123 has not been applied to options granted prior to September 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.
A summary of the Company’s stock option activity under the 2001 Plan and 1991 Plan is as follows:
| September 25, 2004 |
September 27, 2003 | |||||||||||
| Number of Shares |
Average Exercise Price |
Number of Shares |
Average Exercise Price | |||||||||
| Options outstanding, beginning of year |
500,075 | $ | 3.12 | 393,799 | $ | 3.82 | ||||||
| Options granted: |
||||||||||||
| Option Price = Fair Market Value |
152,200 | $ | 3.54 | 151,700 | $ | 0.99 | ||||||
| Option Price < Fair Market Value |
7,500 | $ | 2.02 | 7,500 | $ | 0.54 | ||||||
| Options exercised |
(12,232 | ) | $ | 0.57 | (2,500 | ) | $ | 0.01 | ||||
| Options forfeited |
(38,500 | ) | $ | 2.95 | (50,424 | ) | $ | 1.93 | ||||
| Options outstanding, end of year |
609,043 | $ | 3.27 | 500,075 | $ | 3.12 | ||||||
| Options exercisable |
436,619 | $ | 3.55 | 379,202 | $ | 3.74 | ||||||
| Weighted average fair value per share of options granted during the year |
$ | 3.37 | $ | 0.98 | ||||||||
The following summarizes certain data for options outstanding and exercisable at September 25, 2004:
| Options Outstanding |
||||||||||||
| Weighted Average |
Options Exercisable | |||||||||||
| Range of Exercise Prices |
Number of Shares |
Exercise Price |
Remaining Contractual Life |
Number of Shares |
Exercise Price | |||||||
| $ 0.01 -$ 1.00 |
185,768 | $ | 0.93 | 8.0 | 121,527 | $ | 0.94 | |||||
| $ 1.01 -$ 2.00 |
17,200 | $ | 1.60 | 4.0 | 16,000 | $ | 1.61 | |||||
| $ 2.01 -$ 3.00 |
37,200 | $ | 2.18 | 7.1 | 35,750 | $ | 2.18 | |||||
| $ 3.01 -$ 4.00 |
261,000 | $ | 3.72 | 4.8 | 156,666 | $ | 3.83 | |||||
| $ 4.01 -$ 5.00 |
22,000 | $ | 4.96 | 4.6 | 21,600 | $ | 4.96 | |||||
| $ 5.01 -$ 10.00 |
73,875 | $ | 6.62 | 3.8 | 73,075 | $ | 6.62 | |||||
| $ 10.01 -$ 15.00 |
12,000 | $ | 11.85 | 2.9 | 12,000 | $ | 11.85 | |||||
| 609,043 | $ | 3.27 | 6.1 | 436,618 | $ | 3.55 | ||||||
Reclassification
Certain reclassifications have been made to the prior year’s consolidated financial statements to conform with the fiscal year 2004 presentation.
Income Taxes
The Company records income tax expense (benefit) in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” which requires the use of the asset/liability method in accounting for income taxes. Under the asset/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 basis and tax basis of assets and liabilities.
28
Notes to Consolidated Financial Statements (continued)
Warranty Costs
The Company provides for warranty costs at the time of sale based upon historical experience.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents, Accounts Receivable and Accounts Payable - the carrying amount of these assets and liabilities on the Company’s consolidated balance sheet approximates their fair value because of the short-term nature of these instruments.
Earnings per Share (“EPS”)
In accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share,” the Company presents both a “basic” and a “diluted” EPS. Basic EPS has been computed by dividing net income by a weighted average number of shares of common stock outstanding during the period. In computing diluted EPS, only stock options that are dilutive (those that reduce earnings per share) have been included in the calculation of EPS using the treasury stock method. Exercise of outstanding stock options is not assumed if the result would be antidilutive, such as when a net loss is reported for the period or the option exercise price is greater than the average market price for the period presented.
Fiscal Year-End Policy
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. The fiscal years 2004 and 2003 ended on September 25, 2004 and September 27, 2003, respectively, and each included 52 weeks.
Comprehensive Income
In accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” the Company reports and displays comprehensive income and its components. In general, comprehensive income combines net income and “other comprehensive income.” There were no “other comprehensive income” items during fiscal year 2004 and 2003.
Operating Segments
The Company reports on operating segments in accordance with Statement of Financial Accounting Standards No. 131, “Disclosures About Segments of an Enterprise and Related Information” (SFAS No. 131). SFAS No. 131 established standards for public companies to report information about operating segments and geographic distribution of sales in financial statements. The Company currently has only one operating segment, which is the design, development, manufacture, distribution, marketing and sale of communications security devices and systems.
Newly Issued Pronouncements
In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (FIN No. 46), which addressed accounting for special-purpose and variable interest entities. This interpretation was effective for financial statements issued after December 31, 2002. In December 2003, the FASB issued FIN No. 46R “Consolidation of Variable Interest Entities,” which addressed accounting for special-purpose and variable interest entities and which supersedes FIN No. 46. The Company adopted the provisions of FIN No. 46R during fiscal year 2004 and it had no effect on the Company’s financial statements and related disclosures.
29
Notes to Consolidated Financial Statements (continued)
(3) Earning Per Share
In accordance with SFAS No. 128, “Earnings Per Share,” basic and diluted EPS were calculated as follows:
| September 25, 2004 |
September 27, 2003 | |||||
| Net Income |
$ | 1,134,275 | $ | 456,513 | ||
| Average Shares Outstanding - Basic |
1,344,087 | 1,336,703 | ||||
| Dilutive effect of stock options |
171,467 | 6,160 | ||||
| Weighted Average Shares - Diluted |
1,515,554 | 1,342,863 | ||||
| Basic Income Per Share |
$ | 0.84 | $ | 0.34 | ||
| Diluted Income Per Share |
$ | 0.75 | $ | 0.34 | ||
Outstanding potentially dilutive stock options, which were not included in the above calculations for the respective fiscal years because they were anti-dilutive, were as follows: 218,544 in fiscal year 2004 and 493,915 in fiscal year 2003.
(4) Inventories
Inventories consist of the following:
| September 25, 2004 |
September 27, 2003 | |||||
| Finished goods |
$ | 66,036 | $ | 280,959 | ||
| Work in process |
382,152 | 222,588 | ||||
| Raw materials and supplies |
798,104 | 685,737 | ||||
| Total inventories |
$ | 1,246,292 | $ | 1,189,284 | ||
(5) Equipment and Leasehold Improvements
Equipment and leasehold improvements consist of the following:
| September 25, 2004 |
September 27, 2003 |
Estimated Useful Life | ||||||||
| Engineering and manufacturing equipment |
$ | 2,553,754 | $ | 2,543,822 | 3-8 years | |||||
| Demonstration equipment |
848,083 | 848,083 | 3 years | |||||||
| Furniture and fixtures |
1,159,565 | 1,145,274 | 3-8 years | |||||||
| Leasehold improvements |
434,216 | 434,216 | Remaining term of lease | |||||||
| Total equipment and leasehold improvements |
4,995,618 | 4,971,395 | 3-8 years | |||||||
| Less accumulated depreciation |
(4,918,775 | ) | (4,862,241 | ) | ||||||
| Equipment and leasehold improvements, net |
$ | 76,843 | $ | 109,154 | ||||||
30
Notes to Consolidated Financial Statements (continued)
(6) Other Accrued Liabilities
Other accrued liabilities consist of the following:
| September 25, 2004 |
September 27, 2003 | |||||
| Product warranty costs |
$ | 42,849 | $ | 51,473 | ||
| Professional service fees |
29,234 | 107,683 | ||||
| Annual report and investor relation fees |
23,115 | 71,326 | ||||
| Customer support agreements and commissions |
82,965 | 96,866 | ||||
| Customer deposits |
145,383 | 58,618 | ||||
| Other |
41,155 | 30,596 | ||||
| Total other accrued liabilities |
$ | 364,701 | $ | 416,562 | ||
(7) Leases
On January 1, 2003, the Company entered into an operating lease for its current facilities. This lease is for 22,800 square feet and is the Company’s only facility and houses all manufacturing, research and development, and corporate operations. The lease is for a three-year period with rents payable at an annual rate of $142,169 through December 31, 2005. At its option the Company may extend the lease for two more years at an annual rate of $147,855.
(8) Guarantees
The Company’s products generally carry a standard 15 month warranty. The Company sets aside a reserve based on anticipated warranty claims at the time product revenue is recognized. Factors that affect the Company’s product warranty liability include the number of installed units, the anticipated cost of warranty repairs and historical and anticipated rates of warranty claims.
The following table reflects changes in the Company’s accrued warranty account:
| September 25, 2004 |
September 27, 2003 |
|||||||
| Beginning Balance |
$ | 51,473 | $ | 48,706 | ||||
| Plus: accruals related to new sales |
29,816 | 32,433 | ||||||
| Less: payments and adjustments to prior period accruals |
(38,440 | ) | (29,666 | ) | ||||
| Ending Balance |
$ | 42,849 | $ | 51,473 | ||||
(9) Income Taxes
The provisions for income taxes are different from those that would be obtained by applying the statutory federal income tax rate to income before income taxes due to the following:
| September 25, 2004 |
September 27, 2003 |
|||||||
| Tax provision at U.S. statutory rate |
$ | 388,757 | $ | 155,215 | ||||
| State income taxes, net of Federal benefits |
66,648 | 26,309 | ||||||
| Extraterritorial income exclusion |
(27,345 | ) | (12,546 | ) | ||||
| Increase (decrease) in valuation allowance |
(428,060 | ) | (168,978 | ) | ||||
| Total provision |
$ | — | $ | — | ||||
31
Notes to Consolidated Financial Statements (continued)
Deferred income taxes consist of the following:
| September 25, 2004 |
September 27, 2003 |
|||||||
| NOL Carryforward |
$ | 2,383,368 | $ | 2,817,213 | ||||
| Goodwill |
116,413 | 136,956 | ||||||
| Inventory differences |
1,163,192 | 1,068,521 | ||||||
| Warranty accruals |
14,179 | 17,651 | ||||||
| Payroll related accruals |
65,731 | 10,661 | ||||||
| Tax credits |
58,452 | 59,766 | ||||||
| Other |
144,313 | 172,215 | ||||||
| Total |
3,945,648 | 4,282,983 | ||||||
| Less: valuation allowance |
(3,945,648 | ) | (4,282,983 | ) | ||||
| Total |
$ | — | $ | — | ||||
The valuation allowance relates to uncertainty with respect to the Company’s ability to realize its deferred tax assets. The change in the valuation allowance was $(337,335) and $(323,686) in fiscal years 2004 and 2003, respectively.
As of September 25, 2004, the Company has available tax loss carryforwards for federal income tax purposes of approximately $5,600,000, expiring through 2022. The Company also has available tax loss carryfowards for state income tax purposes of approximately $7,600,000, expiring through 2007.
Due to the nature of our current operations in foreign countries (selling products into these countries with the assistance of local representatives), the Company has not been subject to any foreign taxes in recent years. Also, it is not anticipated that we will be subject to foreign taxes in the near future.
(10) Employee Benefit Plans
The Company has a qualified, contributory, 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. There were no Company profit sharing contributions during fiscal years 2004 and 2003. However, the Board of Directors approved a corporate match of 25 cents per dollar of the first 6% of each participant’s contributions to the plan. The Company’s matching contributions were $20,765 and $16,391 in fiscal years 2004 and 2003, respectively.
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 by the plan. No bonuses were earned or accrued under the plan in fiscal years 2004 or 2003.
32
Notes to Consolidated Financial Statements (continued)
(11) Business, Credit and Off-Balance Sheet Risks
The Company is exposed to a number of business risks. These include, but are not limited to, concentration of its business among a relatively small number of customers, 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, and the loss of key personnel. The Company attempts to protect itself in various ways against such risks, but its success cannot be guaranteed.
At September 25, 2004 and September 27, 2003, the Company was contingently liable under open standby letters of credit totaling $114,000 and $22,000, respectively. These letters of credit were issued in the ordinary course of business to secure the Company’s performance under contracts with its customers. Cash collateral deposits are held by the Company’s lender to secure the letters of credit outstanding at September 25, 2004. These letters of credit expire as provided for in the contracts, unless exercised or renewed. To date, no letters of credit have been drawn down. The Company does not expect to incur any loss associated with these letters of credit.
As of September 25, 2004, 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.
(12) Major Customers and Export Sales
In fiscal year 2004, the Company had two customers representing 40% (25% and 15%) of total net sales and at September 25, 2004 had four customers representing 100% (47%, 25%, 18%, and 10%) of accounts receivable. In fiscal year 2003, the Company had three customers representing 50% (20%, 17% and 13%) of total net sales and at September 27, 2003 had four customers representing 91% (41%, 22%, 18%, 10%) of accounts receivable.
A breakdown of net sales is as follows:
| September 25, 2004 |
September 27, 2003 | |||||
| Domestic |
$ | 2,519,287 | $ | 1,735,303 | ||
| Foreign |
2,357,149 | 2,315,613 | ||||
| Total Sales |
$ | 4,876,436 | $ | 4,050,916 | ||
A summary of foreign sales, as a percentage of total foreign revenue by geographic area, is as follows:
| September 25, 2004 |
September 27, 2003 |
|||||
| North America, excluding the U.S. |
1.6 | % | 1.1 | % | ||
| Central and South America |
17.0 | % | 26.9 | % | ||
| Europe |
9.4 | % | 36.7 | % | ||
| Mid-East and Africa |
49.0 | % | 29.1 | % | ||
| Far East |
23.0 | % | 6.2 | % |
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Notes to Consolidated Financial Statements (continued)
The Company sold products to 24 different countries during the year ended September 25, 2004 and 27 different countries during the year ended September 27, 2003. A sale is attributed to a foreign country based on the location of the contracting party. The table below summarizes our foreign revenues by country as a percentage of total foreign revenue.
| September 25, 2004 |
September 27, 2003 |
|||||
| Egypt |
31.4 | % | 3.9 | % | ||
| Indonesia |
18.7 | % | 0.4 | % | ||
| Colombia |
16.8 | % | 22.1 | % | ||
| Italy |
— | 29.6 | % | |||
| Mauritania |
— | 11.4 | % | |||
| Other |
33.1 | % | 32.6 | % |
(13) Shareholder Rights Plan
The Company has adopted a Shareholder Rights Plan and declared a dividend distribution of one common stock purchase right for each outstanding share of common stock of the Company, payable to stockholders of record at the close of business on August 13, 2004, and for each share of common stock issued thereafter. Until the rights become exercisable, they will trade automatically with the Company’s common stock and separate rights certificates will not be issued. The rights will become exercisable only in the event, with certain exceptions, that a person or group of affiliated or associated persons acquires 15% or more of the Company’s voting stock, or a person or group of affiliated or associated persons commences a tender or exchange offer which, if successfully consummated, would result in such person or group owning 15% or more of the Company’s voting stock.
Each right, once exercisable, will entitle the holder (other than an acquiring person or group) to buy one share of the Company’s Common Stock at a price of $25 per share, subject to certain adjustments. In addition, upon the occurrence of specified events, holders of the rights (other than rights owned by an acquiring person or group) would be entitled to purchase either the Company’s Common Stock or shares in an “acquiring entity” at approximately half of market value. Further, at any time after a person or group acquires 15% or more (but less than 50%) of the Company’s outstanding voting stock, subject to certain exceptions, the Board of Directors may, at its option, exchange part or all of the rights (other than rights held by an acquiring person or group) for shares of the Company’s Common Stock having a fair market value on the date of such acquisition equal to the excess of (i) the fair market value of Common Stock issuable upon exercise of the rights over (ii) the exercise price of the rights.
The Company generally will be entitled to redeem the rights at $.001 per right at any time prior to the close of business on the tenth business day after there has been a public announcement of the beneficial ownership by any person or group of 15% or more of the Company’s voting stock, subject to certain exceptions. The rights will expire on August 5, 2014 unless earlier redeemed.
(14) Subsequent Events
On November 5, 2004 the Company entered into a line of credit agreement with Fleet National Bank, a Bank of America company (the “Bank”) for a line of credit not to exceed the principal amount of $600,000, and executed a promissory note with respect thereto. The loan is a demand loan with interest payable at the Bank’s prime rate plus 1% on all outstanding balances. The loan is secured by all assets of the Company (excluding consumer goods) and requires the Company to maintain its deposit accounts with the Bank, as well as comply with certain other covenants.
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Selected Quarterly Financial Data (Unaudited)
For the fiscal years ended September 25, 2004 and September 27, 2003:
| Fiscal Year 2004 |
First Quarter December 27, 2003 |
Second Quarter March 27, 2004 |
Third Quarter June 26, 2004 |
Fourth Quarter September 25, 2004 | ||||||||
| Net sales |
$ | 1,053,892 | $ | 1,105,908 | $ | 1,413,385 | $ | 1,303,251 | ||||
| Gross profit |
501,245 | 656,852 | 1,066,066 | 848,869 | ||||||||
| Net income |
90,843 | 265,192 | 606,103 | 172,137 | ||||||||
| Net income per share |
||||||||||||
| Basic |
$ | 0.07 | $ | 0.20 | $ | 0.45 | $ | 0.13 | ||||
| Diluted |
$ | 0.06 | $ | 0.17 | $ | 0.39 | $ | 0.11 | ||||
| Fiscal Year 2003 |
First Quarter December 28, 2002 |
Second Quarter March 29, 2003 |
Third Quarter June 28, 2003 |
Fourth Quarter September 27, 2003 | ||||||||
| Net sales |
$ | 1,135,459 | $ | 1,014,690 | $ | 985,994 | $ | 914,773 | ||||
| Gross profit |
758,996 | 694,320 | 551,998 | 499,631 | ||||||||
| Net income |
62,961 | 83,700 | 124,522 | 185,330 | ||||||||
| Net income per share |
||||||||||||
| Basic |
$ | 0.05 | $ | 0.06 | $ | 0.09 | $ | 0.14 | ||||
| Diluted |
$ | 0.05 | $ | 0.06 | $ | 0.09 | $ | 0.14 | ||||
35
To the Board of Directors of
Technical Communications Corporation:
We have audited the accompanying consolidated balance sheets of Technical Communications Corporation and subsidiaries as of September 25, 2004 and September 27, 2003, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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 consolidated financial position of Technical Communications Corporation and subsidiaries at September 25, 2004 and September 27, 2003, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
VITALE, CATURANO & COMPANY, LTD
November 5, 2004
Boston, Massachusetts
36
| Technical Communications Corporation | Schedule II |
Valuation and Qualifying Accounts
| Balance at Beginning of year |
Additions Charged to Expense |
Deductions from Reserves |
Balance at End of year | |||||||
| Allowance for doubtful accounts: |
||||||||||
| Year Ended September 25, 2004 |
$ | 70,000 | — | — | $ | 70,000 | ||||
| Year Ended September 27, 2003 |
$ | 70,000 | — | — | $ | 70,000 | ||||
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE TO THE CONSOLIDATED FINANCIAL STATEMENTS
Board of Directors
Technical Communications Corporation
In connection with our audits of the consolidated financial statements of Technical Communications Corporation referred to in our report dated November 5, 2004, which is included in the annual report to security holders and incorporated by reference in Part II of this form, we have also audited Schedule II as it relates to the years ended September 25, 2004 and September 27, 2003. In our opinion, this schedule presents fairly, in all material respects, the financial data as of and for the years ended September 25, 2004 and September 27, 2003, required to be set forth therein.
VITALE, CATURANO & COMPANY, LTD
November 5, 2004
Boston, Massachusetts
37