UNITED STATES
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 June 25, 2005
| ¨ | Transition report under Section 13 or 15(d) of the Exchange Act |
For the transition period from 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 August 5, 2005: 1,364,758.
| Page | ||||
| PART I |
Financial Information | |||
| Item 1. |
Financial Statements: | |||
| Condensed Consolidated Balance Sheets as of June 25, 2005 (unaudited) and September 25, 2004 | 2 | |||
| Condensed Consolidated Statements of Operations for the Three months ended June 25, 2005 and June 26, 2004 (unaudited) | 3 | |||
| Condensed Consolidated Statements of Operations for the Nine months ended June 25, 2005 and June 26, 2004 (unaudited) | 4 | |||
| Condensed Consolidated Statements of Cash Flows for the Nine months ended June 25, 2005 and June 26, 2004 (unaudited) | 5 | |||
| Notes to Condensed Consolidated Financial Statements | 6 | |||
| Item 2. |
Management’s Discussion and Analysis or Plan of Operation | 12 | ||
| Item 3. |
Controls and Procedures | 18 | ||
| PART II |
Other Information | |||
| Item 1. |
Legal Proceedings | 19 | ||
| Item 2. |
Unregistered Sales of Equity Securities and Use of Proceeds | 19 | ||
| Item 3. |
Defaults Upon Senior Securities | 19 | ||
| Item 4. |
Submission of Matters to a Vote of Security Holders | 19 | ||
| Item 5. |
Other Information | 19 | ||
| Item 6. |
Exhibits | 19 | ||
| Signatures | 20 | |||
Page 1
| Item 1. | Financial Statements |
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
| June 25, 2005 |
September 25, 2004 |
|||||||
| (unaudited) | ||||||||
| Assets |
||||||||
| Current Assets: |
||||||||
| Cash and cash equivalents |
$ | 1,471,683 | $ | 2,238,319 | ||||
| Accounts receivable - trade, less allowance for doubtful accounts of $70,000 |
388,969 | 329,950 | ||||||
| Inventories |
1,484,937 | 1,246,292 | ||||||
| Other current assets |
117,485 | 178,315 | ||||||
| Total current assets |
3,463,074 | 3,992,876 | ||||||
| Equipment and leasehold improvements |
5,061,527 | 4,995,618 | ||||||
| Less: accumulated depreciation and amortization |
4,956,032 | 4,918,775 | ||||||
| Equipment and leasehold improvements, net |
105,495 | 76,843 | ||||||
| Total Assets |
$ | 3,568,569 | $ | 4,069,719 | ||||
| Liabilities and Stockholders’ Equity |
||||||||
| Current Liabilities: |
||||||||
| Accounts payable |
$ | 197,525 | $ | 165,867 | ||||
| Accrued liabilities |
||||||||
| Accrued payroll |
268,773 | 214,521 | ||||||
| Accrued expenses |
138,266 | 364,701 | ||||||
| Total current liabilities |
604,564 | 745,089 | ||||||
| Stockholders’ Equity: |
||||||||
| Common stock, par value $.10 per share; 7,000,000 shares authorized; 1,364,990 shares issued and outstanding at June 25, 2005 and 1,349,859 shares issued and outstanding at September 25, 2004 |
136,499 | 134,986 | ||||||
| Treasury stock at cost, 232 shares |
(1,934 | ) | (1,934 | ) | ||||
| Additional paid-in capital |
1,398,581 | 1,381,785 | ||||||
| Retained earnings |
1,430,859 | 1,809,793 | ||||||
| Total stockholders’ equity |
2,964,005 | 3,324,630 | ||||||
| Total Liabilities and Stockholders’ Equity |
$ | 3,568,569 | $ | 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 Statements of Operations
(Unaudited)
| Three Months Ended |
||||||||
| June 25, 2005 |
June 26, 2004 |
|||||||
| Net sales |
$ | 751,377 | $ | 1,413,385 | ||||
| Cost of sales |
267,070 | 347,319 | ||||||
| Gross profit |
484,307 | 1,066,066 | ||||||
| Operating expenses: |
||||||||
| Selling, general and administrative expenses |
366,417 | 368,537 | ||||||
| Product development costs |
187,623 | 95,612 | ||||||
| Total operating expenses |
554,040 | 464,149 | ||||||
| Operating (loss) income |
(69,733 | ) | 601,917 | |||||
| Other income (expense): |
||||||||
| Interest income |
9,638 | 4,192 | ||||||
| Interest expense |
(201 | ) | (456 | ) | ||||
| Other |
420 | 450 | ||||||
| Total other income: |
9,857 | 4,186 | ||||||
| (Loss) income before income taxes |
(59,876 | ) | 606,103 | |||||
| Provision for income taxes |
— | — | ||||||
| Net (loss) income |
$ | (59,876 | ) | $ | 606,103 | |||
| Net (loss) income per common share: |
||||||||
| Basic |
$ | (0.04 | ) | $ | 0.45 | |||
| Diluted |
$ | (0.04 | ) | $ | 0.39 | |||
| Weighted average shares: |
||||||||
| Basic |
1,363,176 | 1,346,963 | ||||||
| Diluted |
1,363,176 | 1,574,429 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 3
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
| Nine Months Ended |
||||||||
| June 25, 2005 |
June 26, 2004 |
|||||||
| Net sales |
$ | 2,492,984 | $ | 3,573,185 | ||||
| Cost of sales |
958,092 | 1,349,024 | ||||||
| Gross profit |
1,534,892 | 2,224,161 | ||||||
| Operating expenses: |
||||||||
| Selling, general and administrative expenses |
1,207,479 | 1,052,133 | ||||||
| Product development costs |
742,710 | 250,218 | ||||||
| Total operating expenses |
1,950,189 | 1,302,351 | ||||||
| Operating (loss) income |
(415,297 | ) | 921,810 | |||||
| Other income (expense): |
||||||||
| Interest income |
27,454 | 9,222 | ||||||
| Interest expense |
(1,116 | ) | (1,183 | ) | ||||
| Other |
10,010 | 32,288 | ||||||
| Total other income: |
36,348 | 40,327 | ||||||
| (Loss) income before income taxes |
(378,949 | ) | 962,137 | |||||
| Provision for income taxes |
— | — | ||||||
| Net (loss) income |
$ | (378,949 | ) | $ | 962,137 | |||
| Net (loss) income per common share: |
||||||||
| Basic |
$ | (0.28 | ) | $ | 0.72 | |||
| Diluted |
$ | (0.28 | ) | $ | 0.62 | |||
| Weighted average shares: |
||||||||
| Basic |
1,358,162 | 1,339,947 | ||||||
| Diluted |
1,358,162 | 1,549,293 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 4
TECHNICAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| Nine Months Ended |
||||||||
| June 25, 2005 |
June 26, 2004 |
|||||||
| Operating Activities: |
||||||||
| Net (loss) income |
$ | (378,949 | ) | $ | 962,137 | |||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
||||||||
| Depreciation and amortization |
37,257 | 43,865 | ||||||
| Gain on sale of trading securities |
— | (30,838 | ) | |||||
| Changes in assets and liabilities: |
||||||||
| Accounts receivable |
(59,019 | ) | 53,030 | |||||
| Inventories |
(238,645 | ) | 67,054 | |||||
| Other current assets |
60,830 | (95,112 | ) | |||||
| Accounts payable and other accrued liabilities |
(140,525 | ) | 209,649 | |||||
| Net cash (used in) provided by operating activities |
(719,051 | ) | 1,209,785 | |||||
| Investing Activities: |
||||||||
| Additions to equipment and leasehold improvements |
(65,909 | ) | (21,963 | ) | ||||
| Proceeds from sale of trading securities |
— | 30,838 | ||||||
| Net cash (used in) provided by investing activities |
(65,909 | ) | 8,875 | |||||
| Financing Activities: |
||||||||
| Proceeds from stock issuance |
18,324 | 5,483 | ||||||
| Net cash provided by financing activities |
18,324 | 5,483 | ||||||
| Net (decrease) increase in cash and cash equivalents |
(766,636 | ) | 1,224,143 | |||||
| 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 |
$ | 1,471,683 | $ | 2,321,990 | ||||
| Supplemental Disclosures: |
||||||||
| Interest paid |
$ | 1,115 | $ | 1,183 | ||||
| Income taxes paid |
20,956 | 11,100 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 5
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
Page 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
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 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 change 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 7
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 Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (SFAS No. 148) encourage, but do 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 Opinion 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 and nine month periods ended June 25, 2005 and June 26, 2004 would have been as follows:
| June 25, 2005 |
June 26, 2004 | |||||||||||||
| 3 months |
9 months |
3 months |
9 months | |||||||||||
| (unaudited) | (unaudited) | |||||||||||||
| Net (loss) income, as reported |
$ | (59,876 | ) | $ | (378,949 | ) | $ | 606,103 | $ | 962,137 | ||||
| Pro forma impact of expensing stock options |
17,428 | 68,677 | 52,689 | 293,377 | ||||||||||
| Pro forma net (loss) income |
$ | (77,304 | ) | $ | (447,626 | ) | $ | 553,414 | $ | 668,760 | ||||
| Basic (loss) income per common share, as reported |
$ | (0.04 | ) | $ | (0.28 | ) | $ | 0.45 | $ | 0.72 | ||||
| Pro forma impact of expensing stock options |
0.02 | 0.05 | 0.04 | 0.22 | ||||||||||
| Pro forma net (loss) income per share |
$ | (0.06 | ) | $ | (0.33 | ) | $ | 0.41 | $ | 0.50 | ||||
| Diluted (loss) income per common share, as reported |
$ | (0.04 | ) | $ | (0.28 | ) | $ | 0.39 | $ | 0.62 | ||||
| Pro forma impact of expensing stock options |
0.02 | 0.05 | 0.03 | 0.19 | ||||||||||
| Pro forma net (loss) income per share |
$ | (0.06 | ) | $ | (0.33 | ) | $ | 0.36 | $ | 0.43 | ||||
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 3.83% and 3.66% for 2005 and 2004, respectively; expected life equal to 5 years for each of 2005 and 2004; expected volatility of 168% and 189% in 2005 and 2004, respectively; and an expected dividend yield of 0% for both 2005 and 2004.
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 8
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 June 25, 2005 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 condition 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” (SFAS No. 123(R)), which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25, 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 the first fiscal year 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:
| June 25, 2005 |
September 25, 2004 | |||||
| (unaudited) | ||||||
| Finished Goods |
$ | 4,304 | $ | 66,036 | ||
| Work in Process |
456,687 | 382,152 | ||||
| Raw Materials |
1,023,946 | 798,104 | ||||
| $ | 1,484,937 | $ | 1,246,292 | |||
| NOTE 3. | Income taxes |
Although the Company recorded net income for the nine months ended June 26, 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 also not recorded an income tax benefit on its net loss for the nine months ended June 25, 2005 due to its uncertain realizability. 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 9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
| NOTE 4. | Earnings (Loss) Per Share |
In accordance with SFAS No. 128, “Earnings Per Share,” basic and diluted earnings per share were calculated as follows:
| June 25, 2005 |
June 26, 2004 | |||||||||||||
| 3 months |
9 months |
3 months |
9 months | |||||||||||
| (unaudited) | (unaudited) | |||||||||||||
| Net income (loss) |
$ | (59,876 | ) | $ | (378,949 | ) | $ | 606,103 | $ | 962,138 | ||||
| Average shares outstanding - basic |
1,367,614 | 1,358,162 | 1,346,963 | 1,339,947 | ||||||||||
| Dilutive effect of stock options |
— | — | 227,466 | 209,346 | ||||||||||
| Weighted average shares - diluted |
1,367,614 | 1,358,162 | 1,574,429 | 1,549,293 | ||||||||||
| Basic income (loss) per share |
$ | (0.04 | ) | $ | (0.28 | ) | $ | 0.45 | $ | 0.72 | ||||
| Diluted income (loss) per share |
$ | (0.04 | ) | $ | (0.28 | ) | $ | 0.39 | $ | 0.62 | ||||
Outstanding potentially dilutive stock options, which were not included in the earnings per share calculations, as their inclusion would have been anti-dilutive, were 575,745 for both the three and nine month periods ended June 25, 2005 and 225,099 for the three month period and 376,044 for the nine month period ended June 26, 2004.
| NOTE 5. | Major Customers and Export Sales |
During the quarter ended June 25, 2005, the Company had four customers that represented 82% (26%, 20%, 19% and 17%) of net sales as compared to the same period in fiscal 2004 where three customers represented 79% (42%, 24% and 13%) of net sales. During the nine months ended June 25, 2005, the Company had three customers that represented 58% (26%, 16% and 16%, respectively) of net sales as compared to the same period in fiscal 2004 where four customers represented 71% (27%, 21%, 12% and 11%) of net sales.
A breakdown of foreign and domestic net sales is as follows:
| June 25, 2005 |
June 26, 2004 | |||||||||||
| 3 months |
9 months |
3 months |
9 months | |||||||||
| (unaudited) | (unaudited) | |||||||||||
| Domestic |
$ | 729,961 | $ | 1,390,622 | $ | 751,469 | $ | 1,784,118 | ||||
| Foreign |
21,416 | 1,102,362 | 661,916 | 1,789,067 | ||||||||
| Total sales |
$ | 751,377 | $ | 2,492,984 | $ | 1,413,385 | $ | 3,573,185 | ||||
Page 10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Cont’d)
The Company sold products into 15 countries during the nine months ended June 25, 2005 and 13 countries during the nine months ended June 26, 2004. 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.
| June 25, 2005 |
June 26, 2004 |
|||||||||||
| 3 months |
9 months |
3 months |
9 months |
|||||||||
| (unaudited) | (unaudited) | |||||||||||
| Indonesia |
— | 36.3 | % | — | 24.6 | % | ||||||
| Morocco |
— | 33.8 | % | — | — | |||||||
| Slovakia |
39.1 | % | 13.6 | % | — | 6.1 | % | |||||
| Egypt |
— | — | 90.6 | % | 41.4 | % | ||||||
| Colombia |
1.1 | % | 1.0 | % | 3.0 | % | 21.0 | % | ||||
| Austria |
21.3 | % | 0.4 | % | 5.9 | % | — | |||||
| Mexico |
11.2 | % | 1.2 | % | — | 1.6 | % | |||||
| Venezuela |
14.0 | % | 0.3 | % | — | 0.2 | % | |||||
| Other |
13.3 | % | 13.4 | % | 0.5 | % | 5.1 | % | ||||
A summary of foreign revenue, as a percentage of total foreign revenue by geographic area, is as follows:
| June 25, 2005 |
June 26, 2004 |
|||||||||||
| 3 months |
9 months |
3 months |
9 months |
|||||||||
| (unaudited) | (unaudited) | |||||||||||
| North America (excluding the U.S.) |
11.2 | % | 0.4 | % | — | 1.6 | % | |||||
| Central and South America |
15.1 | % | 2.1 | % | 3.0 | % | 21.3 | % | ||||
| Europe |
60.4 | % | 18.4 | % | 5.9 | % | 10.1 | % | ||||
| Mid-East and Africa |
13.3 | % | 42.5 | % | 90.6 | % | 42.1 | % | ||||
| Far East |
— | 36.6 | % | 0.5 | % | 24.9 | % | |||||
Page 11
| 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 purely 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 Company’s ability to achieve growth and profitability. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, including but not limited to 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, the Quarterly Report on Form 10-QSB for the quarter ended December 25, 2004, the Quarterly Report on Form 10-QSB for the quarter ended March 26, 2005 and this Quarterly Report on Form 10-QSB for the quarter ended June 25, 2005.
Overview
The Company is in the business of designing, developing, manufacturing, distributing, marketing and selling communications security devices and equipment that utilize 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.
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 any 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.
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Results of Operations
Quarter ended June 25, 2005 as compared to the Quarter ended June 26, 2004
Net Sales
Net sales for the quarter ended June 25, 2005 were $751,000, as compared to $1,413,000 for the quarter ended June 26, 2004, a 47% decrease. Sales for the third quarter of fiscal 2005 consisted of $730,000, or 97%, from domestic sources and $21,000, or 3%, from international customers as compared to the same period in fiscal 2004, during which sales consisted of $751,000, or 53%, from domestic sources and $662,000, or 47%, from international customers.
Foreign sales consisted of shipments to eight different countries during the quarter ended June 25, 2005 and 13 different countries during the quarter ended June 26, 2004. A sale is attributed to a foreign country based on the location of the contracting party.
Revenue for the third quarter of fiscal 2005 was primarily derived from the sale of our narrowband radio encryptors to two domestic customers amounting to $269,000. We also sold our Executive Secure Telephones to two domestic customers amounting to $180,000. Additional revenue was derived from an amendment to our on-going efforts to provide engineering services to the U.S. government; revenue recorded under this program during the third quarter amounted to $198,000.
This compares to the third quarter of the previous fiscal year where revenue was derived in part from our efforts to provide engineering services to the U.S. government. Revenue recorded under this program amounted to $340,000 for the quarter. In addition, the Company achieved the first milestone of a $1 million international upgrade program received in October 2003 resulting in the recognition of $600,000 of revenue ($400,000 of which was previously deferred). Additional revenue for the third quarter of fiscal 2004 consisted of three domestic orders amounting to $388,000 for our narrowband radio encryptors.
Gross Profit
Gross profit for the third quarter of fiscal 2005 was $484,000 as compared to gross profit of $1,066,000 for the same period of fiscal 2004, a decrease of 55%. Gross profit expressed as a percentage of sales was 65% for the third quarter of fiscal 2005 as compared to 75% for the same period in fiscal 2004. The decrease in gross profit as a percentage of sales was primarily attributable to the first milestone completion under the $1 million international upgrade program referenced above, which generated a higher than normal gross profit during the third quarter of fiscal 2004.
Operating Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for the third quarter of fiscal 2005 were $366,000, as compared to $369,000 for the same quarter in fiscal 2004.
The increase in selling costs was primarily attributable to an increase in bid and proposal costs of $39,000, which was partially offset by a decrease in personnel-related costs of $37,000
General and administrative costs had a decrease in personnel-related costs of $50,000 and were offset by increases in consulting services performed during the second quarter of fiscal 2005 amounting to $6,000 related to the implementation of Section 404 of the Sarbanes-Oxley Act and an increase in professional fees of $33,000 and travel expenses of $7,000.
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Research and Development
Product development costs for the quarter ended June 25, 2005 were $188,000, compared to $96,000 for the quarter ended June 26, 2004. This increase of 96% was attributable to a decrease in billable contract engineering and bid and proposal work during the third quarter of fiscal 2005, which increased product development costs by approximately $50,000. In addition, the Company had an increase in payroll and benefit-related costs of approximately $33,000 as a result of the hiring of new personnel.
Engineering costs are charged to billable engineering services, bid and proposal efforts and product development. Engineering costs charged to billable projects are recorded as cost of sales and engineering costs charged to bid and proposal efforts are recorded as 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 third quarter of fiscal 2005, engineering services work accounted for approximately $198,000 of revenue compared to $345,000 for the same period in fiscal 2004. This revenue was generated under a program with the U.S. government, which was amended in March 2005 to increase funding by approximately $600,000. The work under this program is expected to be completed in fiscal 2005.
Net Income
The Company’s net loss was $60,000 for the third quarter of fiscal 2005, as compared to net income of $606,000 for the same period of fiscal 2004. This 110% decrease in profitability is attributable to a 55% decrease in gross profit and a 19% increase in operating expenses. The uncertainty of the timing of customer orders can result in periods with losses, sometimes significant, such as this quarter. This uncertainty will continue to make future results 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 June 25, 2005, 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.
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Nine months ended June 25, 2005 as compared to the Nine Months ended June 26, 2004
Net Sales
Net sales for the nine months ended June 25, 2005 were $2,493,000, as compared to $3,573,000 for the nine months ended June 26, 2004, a 30% decrease. Sales for the first nine months of fiscal 2005 consisted of $1,391,000, or 56%, from domestic sources and $1,102,000, or 44%, from international customers as compared to the same period in fiscal 2004, during which sales consisted of $1,784,000, or 50%, from domestic sources and $1,789,000, or 50%, from international customers.
Foreign sales consisted of shipments to 15 different countries during the nine months ended June 25, 2005 and 16 different countries during the nine months ended June 26, 2004. 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 during the periods:
| June 25, 2005 |
June 26, 2004 | |||||
| Indonesia |
$ | 400,000 | 441,000 | |||
| Morocco |
373,000 | — | ||||
| Colombia |
11,000 | 376,000 | ||||
| Egypt |
— | 740,000 | ||||
| Slovakia |
149,000 | 109,000 | ||||
| Other |
169,000 | 123,000 | ||||
| $ | 1,102,000 | $ | 1,789,000 | |||
Revenue for the first nine months of fiscal 2005 was primarily derived from the sale of our secure telephone, fax and data encryptors to an Indonesian customer amounting to $400,000 and the sale of our narrowband radio encryptors for use by the Moroccan government amounting to $373,000. Additional revenue was derived from our on-going efforts to provide engineering services to the U.S. government. Revenue recorded under this program during the first nine months of fiscal 2005 amounted to approximately $640,000. Additional revenue for the period was generated by orders from four domestic customers amounting to $391,000 for our narrowband radio encryptors, $142,000 from a customer order for our high speed bulk encryptors and $180,000 for our Executive Secure Telephones from two domestic customers.
This compares to the same period of the previous fiscal year where revenue was derived in part from our efforts to provide engineering services to the U.S. government. Revenue recorded under this program amounted to $977,000 for the period. In addition, the Company achieved the first milestone of a $1 million international upgrade program received in October 2003 resulting in the recognition of $600,000 of revenue. Additional revenue for the period consisted of four domestic orders amounting to $520,000 and a foreign order sold into South America amounting to $293,000 for our narrowband radio encryptors and a foreign order sold into the Middle East amounting to $139,000 for our fax encryptors. We also shipped three orders to a Southeast Asian country for our secure telephones amounting to $441,000.
Gross Profit
Gross profit for the first nine months of fiscal 2005 was $1,535,000 as compared to gross profit of $2,224,000 for the same period of fiscal 2004, a decrease of 31%. Gross profit expressed as a percentage of sales was 62% for the nine month periods of fiscal 2005 and 2004. The decrease in gross profit was a result of the lower sales volume.
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Operating Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for the first nine months of fiscal 2005 were $1,207,000, as compared to $1,052,000 for the same period in fiscal 2004. This increase of 15% was attributable to an increase of $175,000 in general and administrative expenses, offset by a decrease of $20,000 in selling and marketing costs.
The increase in general and administrative costs was primarily attributable to charges for consulting services performed during the first nine months of fiscal 2005 amounting to $76,000 related to the implementation of Section 404 of the Sarbanes-Oxley Act, an increase in professional fees of $115,000 and partially offset by a $19,000 decrease in personnel-related costs.
The decrease in selling costs was primarily attributable to a decrease in personnel-related costs of $61,000 and partially offset by an increase in bid and proposal costs of $52,000.
Research and Development
Product development costs for the nine months ended June 25, 2005 were $743,000, compared to $250,000 for the nine months ended June 26, 2004. This increase of 197% was attributable to a decrease in billable contract engineering and bid and proposal work during the first nine months of fiscal 2005, which increased product development costs by approximately $232,000. In addition, the Company had an increase in payroll and benefit-related costs of approximately $228,000 as a result of the hiring of new personnel.
Engineering costs are charged to billable engineering services, bid and proposal efforts and product development. Engineering costs charged to billable projects are recorded as cost of sales and engineering costs charged to bid and proposal efforts are recorded as 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 nine months of fiscal 2005, engineering services work accounted for approximately $640,000 of revenue compared to $1,010,000 for the same period in fiscal 2004. This revenue was generated under a program with the U.S. government, which was amended in March 2005 to increase funding by approximately $600,000. The work under this program is expected to be completed in fiscal 2005.
Net Income
The Company’s net loss was $379,000 for the first nine months of fiscal 2005, as compared to net income of $962,000 for the same period of fiscal 2004. This 139% decrease in profitability is attributable to a 31% decrease in gross profit and a 50% increase in operating expenses. The uncertainty of the timing of customer orders can cause periods with significant losses such as the first nine months of fiscal 2005. This uncertainty will continue to make future results 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 June 25, 2005, 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.
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Liquidity and Capital Resources
Cash and cash equivalents decreased by $767,000, or 34%, to $1,472,000 as of June 25, 2005, from a balance of $2,238,000 at September 25, 2004. This decrease was attributable in part to the Company’s net loss of $379,000 during the nine-month period as well as an increase in inventory and accounts receivable and decreases in accounts payable and accrued expenses of $239,000, $59,000 and $141,000, 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 $61,000.
The engineering services order originally received in March 2003 and amended several times to a total $2.1 million was increased again during the second quarter to $2.7 million and generated approximately $198,000 of revenue during the third quarter of fiscal 2005. This contract is expected to be completed by the end of fiscal 2005. It is the Company’s intention to aggressively pursue new contracts of this nature, and anticipates receiving such contracts in the future.
An 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 June 25, 2005 amounted to approximately $851,000. This amount consists, in part, of the remainder of the order to upgrade the encryption algorithm amounting to approximately $400,000 and the remainder of the amendment to the engineering services order of approximately $371,000, mentioned above. The backlog is expected to ship over the next 12 months depending on customer requirements and product availability.
In November 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 has not yet borrowed against this line of credit. 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 is expected to continue. The Company believes that the current mix of employees and billable versus non-billable production efforts is sufficient to accomplish its near term goals.
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.
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, even though the Company experienced a substantial loss over the past two quarters as compared to our profitability during the ten prior 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 on favorable terms, if at all.
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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 June 25, 2005, the Company had one outstanding standby letter of credit amounting to $100,000, expiring January 31, 2006. The standby letters of credit are secured by the Company’s line of credit facility with the Bank.
The Company does not anticipate any significant capital expenditures during the remainder of fiscal 2005.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements with any party.
| 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 current 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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PART II. Other Information
| Item 1. | Legal Proceedings |
There were no legal proceedings pending against or involving the Company during the period covered by this quarterly report.
| 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 |
Not applicable.
| Item 5. | Other Information |
Not applicable.
| Item 6. | Exhibits |
| 3.1 | Articles of Amendment to Articles of Organization | |
| 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) | ||||||||
| August 9, 2005 | By: | /s/ Carl H. Guild, Jr. | ||||||
| Date | Carl H. Guild, Jr., President and Chief Executive Officer | |||||||
| August 9, 2005 | By: | /s/ Michael P. Malone | ||||||
| Date | Michael P. Malone, Chief Financial Officer | |||||||
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