U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(Mark One)
| x | Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended December 25, 2004
| ¨ | Transition report under Section 13 or 15(d) of the Exchange Act |
For the transition period to
Commission File Number: 0-8588
TECHNICAL COMMUNICATIONS CORPORATION
(Exact name of small business issuer as specified 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) |
Issuer’s telephone number, including area code: (978) 287-5100
N/A
(Former name, former address and former fiscal year, if changed since last report)
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 ¨
State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Number of shares of Common Stock, $.10 par value, outstanding as of February 4, 2005: 1,358,426.
Page 1
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
| December 25, 2004 |
September 25, 2004 |
|||||||
| (unaudited) | ||||||||
| Assets |
||||||||
| Current Assets: |
||||||||
| Cash and cash equivalents |
$ | 2,019,971 | $ | 2,238,319 | ||||
| Accounts receivable - trade, less allowance for doubtful accounts of $70,000 |
507,054 | 329,950 | ||||||
| Inventories |
1,355,004 | 1,246,292 | ||||||
| Other current assets |
88,566 | 178,315 | ||||||
| Total current assets |
3,970,595 | 3,992,876 | ||||||
| Equipment and leasehold improvements |
5,043,596 | 4,995,618 | ||||||
| Less: accumulated depreciation and amortization |
4,932,706 | 4,918,775 | ||||||
| 110,890 | 76,843 | |||||||
| Total Assets |
$ | 4,081,485 | $ | 4,069,719 | ||||
| Liabilities and Stockholders’ Equity |
||||||||
| Current Liabilities: |
||||||||
| Accounts payable |
$ | 194,253 | $ | 165,867 | ||||
| Accrued liabilities |
||||||||
| Accrued payroll |
197,520 | 214,521 | ||||||
| Accrued expenses |
238,640 | 364,701 | ||||||
| Total current liabilities |
630,413 | 745,089 | ||||||
| Stockholders’ Equity: |
||||||||
| Common stock, par value $.10 per share; 3,500,000 shares authorized; 1,355,592 shares issued and outstanding at December 25, 2004 and 1,349,859 shares issued and outstanding at September 25, 2004 |
135,559 | 134,986 | ||||||
| Treasury stock at cost, 232 shares |
(1,934 | ) | (1,934 | ) | ||||
| Additional paid-in capital |
1,389,905 | 1,381,785 | ||||||
| Retained earnings |
1,927,542 | 1,809,793 | ||||||
| Total stockholders’ equity |
3,451,072 | 3,324,630 | ||||||
| Total Liabilities and Stockholders’ Equity |
$ | 4,081,485 | $ | 4,069,719 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 2
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Income Statements
(Unaudited)
| Three Months Ended |
||||||||
| December 25, 2004 |
December 27, 2003 |
|||||||
| Net sales |
$ | 1,186,584 | $ | 1,053,892 | ||||
| Cost of sales |
373,800 | 552,647 | ||||||
| Gross profit |
812,784 | 501,245 | ||||||
| Operating expenses: |
||||||||
| Selling, general and administrative expenses |
454,756 | 363,874 | ||||||
| Product development costs |
248,674 | 48,724 | ||||||
| Total operating expenses |
703,430 | 412,598 | ||||||
| Operating income |
109,354 | 88,647 | ||||||
| Other income (expense): |
||||||||
| Interest income |
8,387 | 2,110 | ||||||
| Interest expense |
(457 | ) | (364 | ) | ||||
| Other |
450 | 450 | ||||||
| Total other income: |
8,380 | 2,196 | ||||||
| Income before income taxes |
117,734 | 90,843 | ||||||
| Provision for income taxes |
— | — | ||||||
| Net income |
$ | 117,734 | $ | 90,843 | ||||
| Net income per common share: |
||||||||
| Basic |
$ | 0.09 | $ | 0.07 | ||||
| Diluted |
$ | 0.07 | $ | 0.06 | ||||
| Weighted average shares: |
||||||||
| Basic |
1,353,338 | 1,337,395 | ||||||
| Diluted |
1,587,032 | 1,529,319 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 3
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| Three Months Ended |
||||||||
| December 25, 2004 |
December 27, 2003 |
|||||||
| Operating Activities: |
||||||||
| Net income |
$ | 117,734 | $ | 90,843 | ||||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
||||||||
| Depreciation and amortization |
13,931 | 15,522 | ||||||
| Changes in assets and liabilities: |
||||||||
| Accounts receivable |
(177,104 | ) | (473,918 | ) | ||||
| Inventories |
(108,712 | ) | 146,550 | |||||
| Other current assets |
89,749 | (127,436 | ) | |||||
| Accounts payable and other accrued liabilities |
(114,676 | ) | 98,568 | |||||
| Deferred revenue |
— | 400,000 | ||||||
| Net cash (used in) provided by operating activities |
(179,078 | ) | 150,129 | |||||
| Investing Activities: |
||||||||
| Additions to equipment and leasehold improvements |
(47,978 | ) | (9,565 | ) | ||||
| Net cash used in investing activities |
(47,978 | ) | (9,565 | ) | ||||
| Financing Activities: |
||||||||
| Proceeds from stock issuance |
8,708 | 527 | ||||||
| Net cash provided by financing activities |
8,708 | 527 | ||||||
| Net (decrease) increase in cash and cash equivalents |
(218,348 | ) | 141,091 | |||||
| Cash and cash equivalents at beginning of the period |
2,238,319 | 1,097,847 | ||||||
| Cash and cash equivalents at the end of the period |
$ | 2,019,971 | $ | 1,238,938 | ||||
| Supplemental Disclosures: |
||||||||
| Interest paid |
$ | 456 | $ | 364 | ||||
| Income taxes paid |
20,956 | 8,000 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 4
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
STATEMENT OF FAIR PRESENTATION
Interim Financial Statements. The accompanying unaudited condensed consolidated financial statements of Technical Communications Corporation (the “Company” or “TCC”) and its wholly-owned subsidiary include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results of operations for the periods presented and in order to make the financial statements not misleading. All such adjustments are of a normal recurring nature. Interim results are not necessarily indicative of the results to be expected for the fiscal year ending September 24, 2005.
Certain footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted as allowed by Securities and Exchange Commission rules and regulations. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto in the Company’s Annual Report on Form 10-KSB for the fiscal year ended September 25, 2004.
Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
NOTE 1: Summary of Significant 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 but not limited to 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.
Page 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
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 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. 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.
Page 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (SFAS No. 123) and No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS No. 148) encourage, but not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based employee compensation using the intrinsic value method prescribed in Accounting Principles Board No. 25, “Accounting for Stock Issued to Employees,” under which no compensation expense for stock options is recognized for stock option awards granted to employees at or above fair market value.
The Company has adopted the disclosure-only provisions of SFAS No. 123 and SFAS No. 148. Had stock compensation expense been determined based on the fair value at the grant dates for awards granted under the Company’s stock option plans, consistent with the provisions of SFAS No. 123, the Company’s net income and income per share for the three month periods ended December 25, 2004 and December 27, 2003 would have been as follows:
| December 25, 2004 |
December 27, 2003 | |||||
| (unaudited) | (unaudited) | |||||
| Net income, as reported |
$ | 117,734 | $ | 90,843 | ||
| Pro forma impact of expensing stock options |
50,547 | 16,687 | ||||
| Pro forma net income |
$ | 67,187 | $ | 74,156 | ||
| Basic income per common share, as reported |
$ | 0.09 | $ | 0.07 | ||
| Pro forma impact of expensing stock options |
0.04 | 0.01 | ||||
| Pro forma net income per share |
$ | 0.05 | $ | 0.06 | ||
| Diluted income per common share, as reported |
$ | 0.07 | $ | 0.06 | ||
| Pro forma impact of expensing stock options |
0.03 | 0.01 | ||||
| Pro forma net income per share |
$ | 0.04 | $ | 0.05 | ||
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 3.46% and 2.6% for 2004 and 2003, respectively; expected life equal to 5.15 years and 9.45 years for 2004 and 2003, respectively; expected volatility of 171% and 176% in 2004 and 2003, respectively; and an expected dividend yield of 0% for both 2004 and 2003.
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.
Accounting for Income Taxes
The preparation of consolidated financial statements requires an estimate of 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
Page 7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
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 December 25, 2004 and 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 in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could materially impact our financial position and results of operations.
Because we sell products into foreign 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.
Newly Issued Pronouncements
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) is effective for small business issuer public companies for the first annual reporting period beginning after December 15, 2005. The Company is currently evaluating the impact that this statement will have on its financial condition and results of operations.
NOTE 2. Inventories
Inventories consisted of the following:
| December 25, 2004 |
September 25, 2004 | |||||
| (unaudited) | ||||||
| Finished Goods |
$ | 16,633 | $ | 66,036 | ||
| Work in Process |
379,725 | 382,152 | ||||
| Raw Materials |
958,646 | 798,104 | ||||
| $ | 1,355,004 | $ | 1,246,292 | |||
NOTE 3. Income taxes
Although the Company recorded net income for the three months ended December 25, 2004, the Company had no income tax expense due to the reversal of the valuation allowance on net operating loss carryforwards to offset current earnings. The Company has recorded a valuation allowance for the full amount of its net deferred tax assets since it cannot currently predict the realization of these assets.
Page 8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
NOTE 4. Earnings Per Share
In accordance with SFAS No. 128, “Earnings Per Share,” basic and diluted earnings per share were calculated as follows:
| December 25, 2004 |
December 27, 2003 | |||||
| (unaudited) | (unaudited) | |||||
| Net income |
$ | 117,734 | $ | 90,843 | ||
| Average shares outstanding-basic |
1,353,338 | 1,337,395 | ||||
| Dilutive effect of stock options |
233,694 | 191,924 | ||||
| Weighted average shares-diluted |
1,587,032 | 1,529,319 | ||||
| Basic income per share |
$ | 0.09 | $ | 0.07 | ||
| Diluted income per share |
$ | 0.07 | $ | 0.06 | ||
Outstanding potentially dilutive stock options, which were not included in the earnings per share calculations, as their inclusion would have been anti-dilutive were 102,875 at December 25, 2004 and were 231,432 at December 27, 2003.
NOTE 5. Major Customers and Export Sales
During the quarter ended December 25, 2004, the Company had three customers that represented 77% (34%, 31% and 12%, respectively) of net sales as compared to the same period in fiscal 2004 where four customers represented 93% (31%, 30%, 19% and 13%) of net sales.
A breakdown of foreign and domestic net sales is as follows:
| December 25, 2004 |
December 27, 2003 | |||||
| (unaudited) | (unaudited) | |||||
| Domestic |
$ | 584,519 | $ | 472,152 | ||
| Foreign |
602,065 | 581,740 | ||||
| Total sales |
$ | 1,186,584 | $ | 1,053,892 | ||
The Company sold products into nine countries during the quarter ended December 25, 2004 and eleven countries during the quarter ended December 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.
| December 25, 2004 |
December 27, 2003 |
|||||
| (unaudited) | (unaudited) | |||||
| Morocco |
62.0 | % | — | |||
| Slovakia |
23.2 | % | 0.1 | % | ||
| Indonesia |
— | 34.8 | % | |||
| Colombia |
1.2 | % | 53.6 | % | ||
| Other |
13.6 | % | 11.5 | % |
Page 9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
A summary of foreign revenue, as a percentage of total foreign revenue by geographic area, is as follows:
| December 25, 2004 |
December 27, 2003 |
|||||
| (unaudited) | (unaudited) | |||||
| North America (excluding the U.S.) |
0.3 | % | 3.4 | % | ||
| Central and South America |
1.2 | % | 54.3 | % | ||
| Europe |
27.2 | % | 5.7 | % | ||
| Mid-East and Africa |
70.6 | % | 1.6 | % | ||
| Far East |
0.7 | % | 35.0 | % |
Page 10
Item 2. Management’s Discussion and Analysis or Plan of Operation
Forward-Looking Statements
The following discussion in this Quarterly Report on Form 10-QSB 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 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 its Annual Report on Form 10-KSB for the fiscal year ended September 25, 2004.
Overview
The Company is in the business of designing, developing, manufacturing, distributing, marketing and selling communications security devices and 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, and 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.
Results of Operations
Quarter ended December 25, 2004 as compared to the Quarter ended December 27, 2003
Net Sales
Net sales for the quarter ended December 25, 2004 were $1,187,000, as compared to $1,054,000 for the quarter ended December 27, 2003, a 13% increase. Sales for the first quarter of fiscal 2005 consisted of $585,000, or 49%, from domestic sources and $602,000, or 51%, from international customers as compared to the same period in fiscal 2004, during which sales consisted of $472,000, or 45%, from domestic sources and $582,000, or 55%, from international customers.
Page 11
Foreign sales consisted of shipments to nine different countries during the quarter ended December 25, 2004 and eleven different countries during the quarter ended December 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:
| December 25, 2004 |
December 27, 2003 | |||||
| Morocco |
$ | 373,000 | $ | — | ||
| Slovakia |
140,000 | 1,000 | ||||
| Indonesia |
— | 202,000 | ||||
| Columbia |
7,000 | 312,000 | ||||
| Other |
82,000 | 67,000 | ||||
| $ | 602,000 | $ | 582,000 | |||
Revenue for the first quarter of fiscal 2005 was derived in part from our on-going efforts to provide engineering services to the U.S. government. Revenue recorded under this program amounted to $259,000 for the quarter. Another major order shipped during the quarter, for our narrowband radio encryptors for use by the Moroccan government, amounted to $373,000. Additional revenue for the quarter was generated by domestic orders amounting to $123,000 for our narrowband radio encryptors and $142,000 for our high speed bulk encryptors.
This compares to the first quarter of the previous fiscal year where revenue was derived in part from the on-going efforts to provide engineering services to the U.S. government amounting to $329,000; a domestic order amounting to $132,000 and a foreign order sold into South America amounting to $293,000 for our narrowband radio encryptors. We also shipped an order to a Southeast Asian country for our secure telephone, fax and data encryptors amounting to $202,000 during the first quarter of fiscal 2004.
Gross Profit
Gross profit for the first quarter of fiscal 2005 was $813,000 as compared to gross profit of $501,000 for the same period of fiscal 2004, an increase of 62%. Gross profit expressed as a percentage of sales was 68% for the first quarter of fiscal 2005 as compared to 48% for the same period in fiscal 2004. The increase in gross profit as a percentage of sales was primarily associated with a decrease in engineering services revenue, a decrease in manufacturing overhead variances, and several sales in the first quarter of fiscal 2005 at a higher than normal profit percentage.
Operating Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for the first quarter of fiscal 2005 were $455,000, as compared to $364,000 for the same quarter in fiscal 2004. This increase of 25% was primarily attributable to an increase of $118,000 in general and administrative expenses, offset by a decrease of $27,000 in selling and marketing costs.
The increase in general and administrative costs was primarily attributable to charges for consulting services performed during the first quarter of fiscal 2005 amounting to $59,000 related to the implementation of Section 404 of the Sarbanes-Oxley Act, an increase in professional fees of $42,000 and a $5,000 increase in personnel-related costs.
The decrease in selling costs was primarily attributable to a reduction in bid and proposal costs of $18,000, a decrease in third-party sales commissions and marketing contracts totaling $4,000 and a decrease in product demonstration costs of $3,000. This decrease was partially offset by an increase in personnel-related costs of $6,000.
Page 12
Research and Development
Product development costs for the first quarter ended December 25, 2004 were $249,000, compared to $49,000 for the same period of fiscal 2004. This increase of 410% was attributable to a decrease in billable contract engineering and bid and proposal work during the first quarter of fiscal 2005, which increased product development costs by approximately $84,000. In addition, the Company had an increase in payroll and benefit-related costs of approximately $123,000 as a result of returning all employees to full-time status and the hiring of new personnel.
Engineering costs are allocated among billable engineering services, bid and proposal efforts and product development. Engineering costs allocated to billable projects are charged to cost of sales and engineering costs allocated to bid and proposal efforts are charged to selling expenses.
The Company actively sells its engineering services in support of funded research and development. The receipt of these orders is sporadic, although such programs can span over several months. In addition to these programs, the Company also invests in research and development to enhance its existing products or to develop new products, as it deems appropriate. During the first quarter of fiscal 2005, engineering services work accounted for approximately $259,000 of revenue. This revenue was generated under a program with the U.S. government, which will be completed in fiscal 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 are being 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 $118,000 for the first quarter of fiscal 2005, as compared to $91,000 for the same period of fiscal 2004. This 30% increase in profitability is attributable to a 62% increase in gross profit and offset by a 70% increase in operating expenses. 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 December 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 decreased by $218,000, or 10%, to $2,020,000 as of December 25, 2004, from a balance of $2,238,000 at September 25, 2004. This decrease was attributable in part to an increase in inventory and accounts receivable and a decrease in accounts payable and accrued expenses of $109,000,
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$177,000 and $115,000, respectively. These decreases were partially offset by a decrease in other current assets primarily as a result of customer performance guarantees that no longer required cash deposits as collateral in the amount of $90,000. Also offsetting the decrease in cash was income from operations of $118,000 for the three months ended December 25, 2004.
The $1.9 million engineering services order received in March 2003 was increased again this quarter to $2.1 million and generated approximately $259,000 of revenue during the first quarter of fiscal 2005. This contract was, however, essentially complete as of December 25, 2004. It is the Company’s intention to aggressively pursue new contracts of this nature, and anticipates receiving such contracts in fiscal 2005.
A new order to upgrade the encryption algorithm for a government in the Middle East generated approximately $600,000 of revenue during the previous 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 December 25, 2004 amounted to approximately $472,000. This amount consists, in part, of the remainder of the order to upgrade the encryption algorithm amounting to approximately $400,000, mentioned above. The backlog is expected to ship over the next twelve months depending on customer requirements and product availability.
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. The Company believes this line of credit provides it with a source of liquidity available on favorable terms, if and when necessary for Company operations and development.
During the remainder of 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 2005. Further, based on our profitability during the past ten 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 guarantees typically take the form of standby letters of credit. Guarantees 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 December 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 the Company’s line of credit facility with Fleet National Bank.
The Company does not anticipate any significant capital expenditures during fiscal 2005.
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Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements with any party.
Critical Accounting Estimates
There have been no material changes in our critical accounting policies or critical accounting estimates since September 25, 2004, nor have we adopted an accounting policy that has or will have a material impact on our consolidated financial statements. For further discussion of our accounting policies see Footnote 1 “Summary of Significant Accounting Policies” in this Quarterly Report on Form 10-QSB and the Notes to Consolidated Financial Statements in our Annual Report on Form 10-KSB for the fiscal year ended September 25, 2004.
Item 3. Controls and Procedures
Evaluation of disclosure and controls and procedure: With the participation of management, the Company’s chief executive officer and chief financial officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report. Based on that evaluation, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures, as designed and implemented, are reasonably adequate 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 controls: During the period covered by this quarterly report, there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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| Item 1. | Legal Proceedings |
There are no current legal proceedings pending against or involving the Company.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Not applicable.
| Item 3. | Defaults Upon Senior Securities |
Not applicable.
| Item 4. | Submission of Matters to a Vote of Security Holders |
None.
| Item 5. | Other Information |
None.
| Item 6. | Exhibits |
| 31.1 | Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certifications of Chief Executive and Chief Financial Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
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In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| TECHNICAL COMMUNICATIONS CORPORATION | ||||
| (Registrant) | ||||
| February 8, 2005 Date |
By: |
/s/ Carl H. Guild, Jr. | ||
| Carl H. Guild, Jr., President and Chief Executive Officer | ||||
| February 8, 2005 Date |
By: |
/s/ Michael P. Malone | ||
| Michael P. Malone, Chief Financial Officer | ||||
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