U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| (X) | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the fiscal year ended September 28, 2019 | ||
| ( ) | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the transition period from ________ to ________ |
| Commission File Number 001-34816 | ||
| Technical Communications Corporation | ||
| (Exact name of registrant as specified in its charter) | ||
| Massachusetts | 04-2295040 | |
| (State or other jurisdiction of incorporation |
(I.R.S. Employer Identification No.) | |
| or organization) | ||
| 100 Domino Drive, Concord, MA | 01742-2892 | |
| (Address of principal executive offices) |
(Zip code) | |
| (978) 287-5100 | ||
| (Registrant’s telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common | TCCO | NASDAQ Capital Market |
Securities registered pursuant to Section 12(g) of the Act:
Not applicable
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐ NO ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. YES ☐ NO ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ☒ NO ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ☒ NO ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | |
| Accelerated filer | ☐ | |
| Non-accelerated filer | ☒ | |
| Smaller reporting company | ☒ | |
| Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES ☐ NO ☒
Based on the closing price as of March 29, 2019, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $5,108,710.
The number of shares of the registrant’s common stock, par value $0.10 per share, outstanding as of December 6, 2019 was 1,850,403.
Portions of the Company’s Definitive Proxy Statement to be delivered to shareholders in connection with the Company’s 2020 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.
TECHNICAL COMMUNICATIONS CORPORATION
Annual Report on Form 10-K
For the Year Ended September 28, 2019
Table of Contents
This Annual Report on Form 10-K contains or incorporates by reference not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are subject to the safe harbors created by those sections. We refer you to the disclosure under the heading “Forward-Looking Statements." As used in this Annual Report on Form 10-K, references to the "Company," “TCC,” "we," "our" or "us," unless the context otherwise requires, refer to Technical Communications Corporation and our subsidiary. All trademarks or trade names referred to in this report are the property of their respective owners.
| Item 1. | BUSINESS |
Technical Communications Corporation 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, systems and services. The secure communications solutions provided by TCC protect vital information transmitted over a wide range of data, video, fax and voice networks. TCC’s products have been sold into over 115 countries to governments, military agencies, telecommunications carriers, financial institutions and multinational corporations. The Company’s business consists of one industry segment, which is the design, development, manufacture, distribution, marketing and sale of communications security devices, systems and services.
Overview
The Government Systems product line has traditionally been the Company’s core product base and typically generates the majority of the Company’s revenue. During fiscal 2019, 52% of revenue was generated from our Government Systems product line and 46% was generated by our engineering services. Fiscal 2018 was unusual in that only 6% of the Company’s revenue was generated by our Government Systems product line; 85% of the Company’s revenue during fiscal year 2018 was generated by our engineering services. Although we expect engineering services to remain strong, we also expect that revenue from our Government Systems products will constitute the majority of our revenue in the future. These products, such as the internet protocol data encryption systems and the DSP 9000/HSE 6000 radio encryption system, have proven to be highly durable, and have led to significant repeat business from our government customers. The Company believes that these products and their derivatives will continue to be the Company’s most significant source of near-term future revenues.
The Company’s products consist of sophisticated electronic devices that enable users to transmit information in an encrypted format and permit recipients to reconstitute the information in a deciphered format if the recipient possesses the right decryption “key”. The Company’s products can be used to protect confidentiality in communications between radios, landline telephones, mobile phones, facsimile machines and data network equipment over wires, fiber optic cables, radio waves, and microwave and satellite links. The principal markets for the Company’s products are foreign and domestic governmental entities, law enforcement and military agencies, telecommunications carriers, 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. A customer may order equipment that is specially programmed to encrypt transmissions in accordance with a code to which only the customer has access. Management believes the coordinated development of cryptographic software and associated hardware allows TCC to provide high-strength encryption security products with efficient processing and transmission. Both criteria, the Company believes, are essential to customer satisfaction.
TCC manufactures most of its products using third-party vendors for the supply of components and selected processing. Final assembly, software loading, testing and quality assurance are 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.
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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 because 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 (“OEMs”) 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 products and close the sale, and who handle on behalf of TCC 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.
Providing secure communications systems and services for government and military markets worldwide remains a principal focus for TCC, as the Company believes continued concerns over security will sustain demand for increased protection of both voice and data networks. Our focus in the government market also now includes law enforcement special operations customers. Additionally, we see increased interest for secure communications in the corporate industrial sector. The Company is pursuing selected, evolutionary upgrades and product derivatives of our government/military products both to provide entry into these markets and meet new requirements of our existing customers.
2019 Highlights and Recent Events
Revenues for fiscal 2019 were $7,024,000, with net income of $631,000 or $0.34 per share, consisting of $3,785,000 generated by product sales and $3,239,000 generated from the sale of engineering services. While certain expected major domestic and international contracts did not materialize during the fiscal year due to protracted government procurement cycles, the Company did complete delivery of several foreign and domestic contracts for its DSP 9000/HSE 6000 radio encryption products and its CX digital encryption product line. It also provided significant engineering services under a contract received in fiscal 2018. TCC had backlog at the end of fiscal 2019 of $1,154,000 and no deferred revenue, as compared to $2,118,000 and $2,107,000 of backlog and deferred revenue, respectively, at the end of fiscal 2018.
Offering high-end custom cryptographic services and solutions is an established market niche for the Company and we believe an important competitive differentiator. In fiscal 2019, custom TCC equipment and services continued to provide recurring revenue opportunities within the Company’s established Government Systems product line. Such equipment sales consisted primarily of our DSP 9000/HSE 6000 radio encryption and digital encryption CX72XX products, along with custom solution engineering services.
The market for high-end communications security systems is competitive and subject to long government procurement cycles, unpredictable order fulfillment lead times and fluctuating market conditions. While TCC has a pipeline of potential contracts and initiatives in development, the timing and outcome of these potential contracts is unknown. As such, in fiscal 2019, TCC continued to closely monitor and reduce operating expenses as appropriate, while strategically investing in business development efforts.
Technical work continued to focus on three principal areas: development of solutions that meet the needs of OEMs; product enhancements that include expanded features, planned capability and applications growth; and custom solutions that tailor our products and services to meet the unique needs of our customers. Going forward, the Company expects to continue focusing technical efforts in these areas while also increasing our systems design and integration capabilities and services offering portfolio. The following are highlights of our product development efforts in fiscal 2019:
| • | Continuation of the development of the next generation IP encryptors, the Cipher X 7220 and 7210; | |
| • | Continuation of the development of the aircraft-compatible HSE 6000 radio encryption product variants; and | |
| • | Provision of custom engineering services. |
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Escalating and continued turmoil around the world presents both significant opportunities and challenges for TCC. The threat of terrorism and political unrest increase the demand for security products that provide both strategic and tactical benefits, and are readily available. At the same time, political disruptions can cause unpredictable and erratic delays in the processing of procurements, delivery of products and receipt of payments. The combined effects challenge both our sales capture teams and our production capabilities. The Company believes these market conditions will provide opportunities to build a successful future through its efforts to enlarge and enhance its product line and expand its customer base by both identifying new customers for existing and new products and offering such products to current customers.
Products and Services
Described below is TCC’s portfolio of communications security solutions for mission-critical voice, data, fax and video networks for military, government and corporate/industrial applications.
The Government Systems product line has traditionally been the Company’s core product base and typically generates the majority of the Company’s revenue, although in recent years the sale of our engineering services has also been a significant source of revenue for the Company. Although we expect engineering services sales to remain strong, we also expect that revenue from our Government Systems products will constitute the majority of our revenue in the future. These products, such as our internet protocol data encryption systems and DSP 9000/HSE 6000 radio encryption system, have proven to be highly durable, and have led to significant repeat business from our government customers. The Company believes that these products and their derivatives will continue to be the Company’s most significant source of near-term future revenues.
With the availability of our next-generation IP encryptors and the ability to integrate customer-specific national algorithms, the Company believes that its Network Security Systems are competitive for a growing niche of mission-critical government and industrial/corporate network applications worldwide. TCC expects that future derivatives of its IP encryptor and KEYNET IP Manager system will expand the market opportunity for these products.
The Company’s Secure Office Systems product line had primarily consisted of products that were originally acquired through an asset and rights purchase from a subsidiary of AT&T in 1995. These products are no longer being marketed. While one of these products, the CSD 4100 secure executive telephone, is still available and remains profitable, demand for it has diminished. We will continue to offer this product from existing inventory, which we anticipate will be sufficient for several more years. Remaining available is the CSD 3324 SE, our encrypted office telephone that offers secure voice, fax and radio communications. TCC also continues to offer CipherTalk® secure mobile phone communication solutions. The Cipher Talk 8500, a secure mobile IP-based phone that targets the high-end secure wireless mobile phone market, is competitive but product demand has not developed as expected. We will continue to market this product with reduced expectations.
The Company also provides customized tools, products and training upon a customer’s request, as well as design solutions for OEM requirements. In addition, the Company actively sells its engineering services in support of funded research and system development. These services are typically billed to a customer on a time and materials basis and can run for several months to several years depending on the scope of the project. As noted above, fiscal year 2018 was a significant year for sales of our engineering services and we expect demand for such services to remain strong in the future.
Government Systems
The Company’s DSP 9000 and HSE 6000 secure radio product lines offer strategic-level security for voice and data communications sent over HF, VHF and UHF channels. Designed for military environments, the Company believes these products provide high voice quality over poor line connections, making them an attractive security solution for military aircraft, naval, base station and man-pack 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 embedded board configurations are available options. All versions interoperate with TCC’s HSE 6000 Squad Radio Headset and Telephone Encryptor for cross-network secure voice conferencing. The DSP 9000 base station model also interoperates with the Company’s CSD 3324 SE secure telephone system to enable “office-to-field” communications.
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TCC’s HSE 6000 Squad Radio Headset and Telephone Encryptor is designed for public safety special operations, land mobile radio applications, as well as military applications. With the optional telephone interconnect kit, the HSE 6000 connects to corded handset telephones for secure voice communications and radio-to-telephone conferencing over Voice over IP, digital, and analog telephone networks. It is also interoperable with the DSP 9000 radio security product family, enabling secure voice communications and cross-network conferencing across and between air, land, sea and office.
The Company’s CSD 3324 SE Secure Telephone, Fax and Data system provides strategic-level communications security for voice, fax and data encryption in a telephone package designed for government applications needing high reliability. The product has a fallback mode, which was originally developed for poor HF channels. As a result, secure communications are possible even over poor line conditions. TCC's high-level encryption and automated key distribution system protect sensitive information, and internal storage of 800 keys provides hands-off security.
The Company’s CSD 3324 SP telephone and fax system provides integrated secure voice and fax security in a telephone package designed for government and corporate applications. The CSD 3324 SPV secure telephone secures voice communications over the public switched telephone network and interoperates with the CSD 3324 SP system.
Government customers can also utilize the Company’s Cipher X 7211 IP encryption systems, described below, to achieve superior-grade network encryption and secure communications.
The Government Systems product line also includes the Company’s DSD 72A-SP Military Bulk Ciphering System, a rugged military system that provides a high level of cryptographic security for military data networks operating at up to 34 million bits per second. The product supports a wide variety of interfaces and is designed to integrate into existing networks. Due to diminished demand in recent years, this product is no longer being marketed. However, we will continue to support a large installed base of such equipment still in use with our customers, as there remains a demand for spare parts and small network upgrades. Foreign military requirements for the DSD 72A-SP are expected to transition over time to the data encryption systems product line using the Internet Protocol, described below.
Network Security Systems
TCC offers network encryption systems with centralized key and device management for IP, SONET/SDH and frame relay networks to secure data in transit from local area network to local area network and across wide area networks. TCC’s KEYNET IP Manager is designed to centrally configure and manage a network of encryption appliances for secure communications and can be used globally. During 2014, the Company introduced KEYNET Lite, a version of KEYNET for small networks.
The Company supports the industry standard Advanced Encryption Standard (“AES”) 256-bit cryptographic algorithm and can integrate customer-specific national algorithms to meet customer-specific needs. All of TCC’s encryption systems are designed to seamlessly overlay onto existing networks without requiring infrastructure changes. Network performance impact is negligible and we believe the systems are easy to deploy, use, monitor and manage. Additionally, the Cipher X family offers scalable performance to higher speeds without changing hardware. This minimizes the entry cost of deploying a security solution and provides a cost-effective path to meet evolving business needs. Upgrades are licensed and made available on-demand via the KEYNET management system. All performance levels interoperate and are designed to have identical functionality.
Cipher X 7211 IP Encryption with KEYNET IP Manager provides strategic-level secure communications for large global IP networks for point-to-point and multicast applications such as video conferencing. It offers a unique combination of flexibility, scalable 1 gigabit per second performance and KEYNET IP Manager for ease of use. The Cipher X 7211 is a hardware-based, FIPS 140-2 Level 3 designed encryption device.
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Secure Office Systems
The CipherTalk 8500 secure mobile phone is designed to provide military-grade encrypted voice and text communications anywhere in the world over GSM and Wi-Fi networks. Introduced in fiscal 2016, the CipherTalk 8500 IP-based secure wireless phone is built on a hardened AndroidTM smartphone platform for security and ease of use. TCC also offers a server-based, network management system that provides the customer with total control of network connectivity.
The Company’s CSD 4100 Executive Secure Telephone offers strategic-level voice and data security in an 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. Due to diminished demand in recent years, this product is no longer being marketed but we continue to provide support to existing customers that have installed equipment bases requiring expansion or modification.
Services
The Company performs funded research and development and technology 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 actual costs compare with a budget. On fixed-price contracts that are expected to exceed one year in duration, revenue is recognized pursuant to the proportional performance method based upon the proportion of actual costs incurred to the total estimated costs for the contract. The Company typically receives periodic progress payments on these types of contracts.
TCC offers general communications security education for businesses and other users, including military and government entities, as well as product-specific training for its customers. TCC also specializes in developing and designing custom cryptographic solutions for customers’ unique secure voice, data and video communications requirements and integrating such solutions into existing systems. The Company has designed embedded secure radio encryption solutions, national algorithms for military data applications, cryptographic modules for National Secure Mode Identification Friend or Foe (IFF) systems, as well as rocket-borne telemetry encryption modules, and country-unique secure telephone and fax algorithms. In addition, TCC has partnered with network and telecommunications equipment providers to add security in unique applications.
Competition
The market for communications security devices and systems is highly competitive and characterized by rapid technological change. The Company has several competitors, including foreign-based companies, in the communications security device field. The Company believes its principal competitors include Crypto AG, Thales Group, Codan Limited, Omnisec AG, Certes Networks, Inc., and Gemalto N.V..
The Company competes based on its service, the operational and technical features of its products, its customization abilities, its sales expertise, and pricing. Many of TCC’s competitors have substantially greater financial, technical, sales and 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, can survive sustained price reductions in order to gain market share and can devote greater resources to support existing products and develop new competing products.
Our competitive position also depends on our ability to attract and retain qualified personnel, obtain and maintain intellectual property protection or otherwise develop proprietary products or processes, and secure sufficient capital resources for product, research and development efforts. We believe the ability of TCC to custom-tailor cryptographic functions and systems to satisfy unique customer requirements is an important competitive differentiator, and will meet a growing demand as customers become more sophisticated in defining their communications security needs.
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Net Revenue and Backlog
In fiscal 2019, the Company had three customers representing 96% of total net revenue. This revenue was derived primarily from sales of our engineering services amounting to $3,239,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a Middle Eastern country amounting to $2,499,000 and to a domestic customer for deployment into a North African country amounting to $936,000. In fiscal 2018, the Company had one customer representing 87% of total net revenue. This revenue consisted primarily of our engineering services.
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 180 days of receipt of a customer's firm purchase order. Our backlog consists of orders received where the anticipated shipping date or services to be performed are within 12 months of the order date. Because of the possibility of customer changes in delivery schedules or the cancellation of orders, our backlog as of any particular date may not be indicative of revenue in any future period. Our backlog as of September 28, 2019 and September 29, 2018 was approximately $1,154,000 and $2,118,000, respectively.
For certain services contracts, the Company will bill customers in accordance with the terms of the contract, but recognize revenue as the services are performed. The billings in excess of revenue are recorded as deferred revenue on the balance sheet. These deferred revenues will be recognized in future periods as we perform the services. Our deferred revenue as of September 29, 2018 was approximately $2,107,000. There was no deferred revenue at September 28, 2019.
Consistent with TCC’s historical experience, the Company expects that sales to a relatively small number of customers will continue to account for a high percentage of the Company’s revenues for 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 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 or participating in future contracts. Such a prohibition would have a material adverse effect on the Company.
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 U.S. Government Accountability 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. There have been no government audits in recent years and the Company believes the result of such audits, should they occur, would not have a material adverse effect on its financial position or results of operations, although we can give no assurances. In addition, U.S. government contracts may be canceled at any time by the government with limited or no notice or 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.
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The Company’s security products are subject to export restrictions administered by the U.S. Department of Commerce and U.S. 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 that 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 and commercial users). The Company has obtained “blanket” licenses for its secure telephone and office system products and its family of network encryptors. Licenses for sales of certain other 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 has been for the U.S. government to reduce the restrictions on the foreign sale of cryptographic equipment. TCC believes this trend is driven by the government’s recognition of the technology available from foreign sources and the need to allow domestic corporations to compete in foreign markets. However, should the regulations become more restrictive, it would have a negative impact on the Company’s international business, the impact of which could be material.
The costs and effects of compliance by the Company with applicable environmental laws during fiscal 2019 were, and historically have been, immaterial. In 2003, the European Union adopted the “Restriction of Hazardous Substances Directive 2002/95/EC”. In the event the Company’s sales to Europe increase, the Company may have to incur additional costs to provide for the disposal of its products in compliance with that directive.
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, resulting in delays in production, significant engineering development effort to find alternative solutions and, if production cannot be maintained, the discontinuation of the affected product design.
The Company’s internal manufacturing process consists primarily of adding critical components, final assembly, system burn-in, quality control and testing. Delivery times vary depending on the products and options ordered.
Technological Expertise
TCC’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. TCC has been designing and producing secure, cryptography-based communications systems for over 50 years, during which time the Company has developed many technological techniques and practices. This expertise and experience are 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 revenue during the past two years and during the next two years will be of products that are based upon TCC-proprietary designs.
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Such technological experience and expertise are important as they enable 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.
TCC’s existing intellectual property portfolio includes a number of registered and unregistered trademarks; while eight patents have been issued to the Company, such patents have expired. Management is of the opinion that, while patent protection was desirable with respect to certain products, none of the Company's patents are currently material to the conduct of its business and the expiration of such patents is not expected to have any significant impact.
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 of this license is immaterial.
With the exception of the technology license referred to above, TCC has no material third party rights upon which the Company relies. Revenue from the sale of products associated with this license has not been and is not anticipated to be significant to the Company’s revenues.
Research and Development
Research and development efforts are undertaken by the Company primarily on its own initiative. In order to compete successfully, the Company must improve existing products and develop new products as well as attract and retain qualified personnel. No assurances can be given that the Company will be able to hire and train such technical, management and sales personnel or successfully improve and develop its products.
During the fiscal years ended September 28, 2019 and September 29, 2018, the Company spent $333,000 and $521,000, respectively, on internal product development. The Company also spent $2,218,000 and $2,028,000 on billable development efforts during fiscal 2019 and 2018, respectively. In fiscal 2019, the Company’s total product development costs were consistent with fiscal 2018 levels and reflected the costs of custom development, product capability enhancements and production readiness. It is expected that product development expenses in fiscal 2020 will again be consistent with fiscal 2019 levels.
Technical work continued to focus on three principal areas: development of solutions that meet the needs of OEMs; product enhancements that include expanded features, planned capability and applications growth; and custom solutions that tailor our products and services to meet the unique needs of our customers. Going forward, the Company expects to continue focusing technical efforts in these areas while also increasing our systems design and integration capabilities and services offering portfolio. The following are highlights of our product development efforts in fiscal 2019:
| • | Continuation of the development of the next generation IP encryptors, the Cipher X 7220 and 7210; |
| • | Completion of the development of the aircraft-compatible HSE 6000 radio encryption product variants; and |
| • | Provision of custom engineering services. |
Foreign Operations
The Company’s results of operations are dependent upon its foreign revenue, including domestic sales shipped to foreign end-users. Sales to foreign markets have been and will continue to be affected by, among other things, the stability of foreign governments, foreign and domestic 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. and foreign banks. Foreign sales contracts are usually denominated in U.S. dollars.
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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.
The export from the United States of many of the Company’s products may require the issuance of a license by the U.S. Department of State under the Arms Export Control Act of 1976, as amended, or by the U.S. Department of Commerce under the Export Administration Act as kept in force by the International Emergency Economic Powers Act of 1977, as amended. The licensing process is discussed in more detail under the “Regulatory Matters” section above.
In fiscal years 2019 and 2018, sales directly to international customers accounted for approximately 4% and 7%, respectively, of our net revenue. During fiscal 2019, a significant portion of domestic revenue (36%) was made to a domestic logistics company that shipped our radio encryption products overseas for use in Saudi Arabia. Based on our historical results we expect that international revenue, including sales to domestic customers that ship to foreign end-users, will continue to account for a significant portion of our revenues for the foreseeable future. As a result, we are subject to the 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, | |
| • | delays in placing orders, | |
| • | fluctuations in foreign currency exchange rates, | |
| • | the complexity and necessity of using foreign representatives, consultants and distributors, | |
| • | 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 the U.S. government may prevent proposed sales to foreign governments or other end-users.
Employees
As of September 28, 2019, the Company employed 22 full-time employees and two part-time employees, as well as several consultants. The Company believes that its relationship with its employees is good.
Available Information
The U.S. Securities and Exchange Commission (the “SEC”) maintains an Internet site that contains current and periodic reports, proxy and information statements, and other information regarding issuers, including TCC, that file electronically with the SEC at www.sec.gov. Additional information about TCC’s filings can also be obtained at our website at www.tccsecure.com under “Investor Relations.” We make available free of charge on our website the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
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| Item 1A. | RISK FACTORS |
You should carefully consider the following risk factors that affect our business. Such risks could cause our actual results to differ materially from those that are expressed or implied by forward-looking statements contained herein. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. If any of the following risks occur, our business, financial condition or results of operations could be materially and adversely affected. You should also consider the other information included in this Annual Report on Form 10-K for the fiscal year ended September 28, 2019 and subsequent quarterly reports filed with the SEC.
We have suffered recurring operating losses from operations and there is doubt about our ability to continue as a going concern.
Although the Company generated a modest profit for fiscal year 2019, for a seven year period from 2012 to 2018, the Company suffered recurring losses from operations and had an accumulated deficit of $2,155,000 at September 28, 2019. In addition, prior to this year we experienced negative cash flows from operations. Due to the losses we have incurred and our current limited financial resources, management has concluded that these conditions raise substantial doubt as to our ability to continue as a going concern within one year of the issuance date of the financial statements included in this Annual Report on Form 10-K. Such financial statements do not include any adjustments to reflect the uncertainty about the Company’s ability to continue as a going concern. Moreover, the going concern explanatory paragraph included in the report of our independent registered public accounting firm may make obtaining financing more difficult or costly, which financing may be required should our efforts to raise capital resources from operations prove unsuccessful.
Our management has determined that the Company’s disclosure control and procedures and internal control over financial reporting were not effective at fiscal year-end.
Our management team, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, conducted an assessment of the effectiveness of the Company’s disclosure controls and procedures and internal control over financial reporting as of the end of the Company’s 2019 fiscal year. As previously reported for the fiscal year ended September 29, 2018, as well as prior fiscal years, management had concluded that the Company did not maintain effective internal control over financial reporting due to the misapplication of generally accepted accounting principles associated with revenue recognition, inventory reserves, accruals and the preparation of the consolidated financial statements, as well as the classification and disclosure of financial information, all caused by a lack of adequate skills and experience within the accounting department. In addition, management identified a material weakness due to a lack of sufficient staff to segregate accounting duties, as well as a material weakness in internal control over significant non-routine transactions, all as disclosed in the relevant quarterly reports filed during our 2018 fiscal year. These conditions have led management to conclude that neither the Company’s disclosure controls and procedures nor its internal control over financial reporting were effective at September 28, 2019.
The Company has made significant progress in improving its internal controls during the latter part of fiscal 2019 but until we are able to completely remediate the material weaknesses identified, such material weaknesses may materially and adversely affect our ability to report accurately our financial condition and results of operations in the future in a timely and reliable manner. In addition, although we review and evaluate our internal control systems to allow management to report on the effectiveness of our disclosure controls and procedures and the sufficiency of our internal control over financial reporting, we cannot assure you that we will not discover additional weaknesses in the future or that any corrective actions taken to remediate issues identified during the course of an assessment will be effective. Any such additional weaknesses or failure to remediate any existing weaknesses could materially adversely affect our financial condition or ability to comply with applicable financial reporting requirements.
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We have restated our financial statements for several prior periods, which reduces investor confidence and which may negatively impact our ability to raise capital in the future.
The Company restated its consolidated financial statements as of and for the fiscal year ended September 30, 2017 as well as the financial statements included in its quarterly reports for the fiscal quarters ended December 30, 2017, March 31, 2018 and June 30, 2018. The restatement of the Company’s financial statements primarily reflect the correction of certain errors related to the Company’s recognition of revenue, which errors resulted from the Company’s misapplication of its revenue recognition policy, as well as the adoption of new accounting standard for restricted cash and a correction in its inventory reserve. Investors should no longer rely on the financial statements included in the original filings.
Restatements may have the effect of eroding investor confidence in the Company, its financial reporting and its accounting practices and processes, and could negatively impact the trading price of the Company’s common stock. In addition, restatements may make it more difficult for the Company to raise capital on acceptable terms, if at all, and would likely increase the cost of such capital, and could expose the Company to liability, including the risk of litigation by shareholders and increased scrutiny of regulatory authorities.
Our quarterly operating results typically fluctuate and our future revenues and profitability are uncertain.
We have experienced significant fluctuations in our quarterly operating results during the last several years and anticipate continued substantial fluctuations in our future operating results. A number of factors have contributed to these quarterly fluctuations, including but not limited to:
| • | foreign political unrest; | |
| • | budgeting cycles of customers, including the U.S. government; | |
| • | introduction and market acceptance of new products and product enhancements by us and our competitors; | |
| • | timing and execution of individual contracts; | |
| • | competitive conditions in the communications security industry; | |
| • | changes in general economic conditions; and | |
| • | shortfalls of revenues in relation to expectations that formed the basis for the calculation of fixed expenses. |
Our international operations expose us to additional risks.
The Company is dependent upon its foreign revenue (including domestic sales shipped to foreign end-users) and we expect that revenue to foreign end-users will continue to account for a significant portion of our revenues for the foreseeable future. As a result, we are subject to the risks of doing business internationally, including imposition of tariffs or embargoes, export controls, trade barriers and trade disputes, regulations related to customs and export/import matters, fluctuations in foreign economies and currency exchange rates, longer payment cycles and difficulties in collecting accounts receivable, the complexity and necessity of using foreign representatives, consultants and distributors, tax uncertainties and unanticipated tax costs due to foreign taxing regimes, the difficulty of managing and operating an enterprise spanning several countries, the uncertainty of protection for intellectual property rights and differing legal systems generally, compliance with a variety of laws, and economic and geopolitical developments and conditions, including international hostilities, armed conflicts, acts of terrorism and governmental reactions, inflation, trade relationships, and military and political alliances.
We also may not be successful in obtaining the necessary licenses to conduct operations abroad, including the export of many of the Company’s products, and the U.S. government may prevent proposed sales to foreign governments or certain international end-users. Export restrictions, compliance with which imposes additional burdens on the Company, may further provide a competitive advantage to foreign competitors facing less stringent controls on their products and services.
We continue to focus efforts in emerging markets, including the Middle East, Northern Africa and Southwest Asia. In many of these emerging markets, we may be faced with risks that are more significant than if we were to do business in developed countries, including undeveloped legal systems, unstable governments and economies, and potential governmental actions affecting the flow of goods and currency.
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We continue to face a number of risks related to current global economic and political conditions that could unfavorably impact our business.
Global economic conditions continue to be challenging for the secure communications markets, as many economies and financial markets remain in a recession resulting from a number of factors, including adverse credit conditions, low economic growth rates, continuing high rates of unemployment, and reduced corporate capital spending. Economic growth in many other countries has remained low and the length of time these adverse economic conditions may persist is unknown. In addition, conflicts in the Middle East and elsewhere have created many economic and political uncertainties that have impacted worldwide markets. These global economic and political conditions have impacted and will continue to impact our business in a number of ways, including:
| • | Budgeting and forecasting are difficult: It is difficult to estimate changes in various parts of the U.S. and world economy, including the markets in which we participate. Components of our budgeting and forecasting are dependent upon estimates of demand for our products, and the prevailing economic and political uncertainties make estimating future income and expenditures difficult. |
| • | Potential deferment or cancellation of purchases and orders by customers: Uncertainty about current and future global economic and political conditions may cause, and in some cases has caused, governments and businesses to defer or cancel purchases. If future demand for our products declines due to deteriorating global economic and political conditions, it will negatively impact our financial results. |
| • | Customers' inability to obtain financing to make purchases: Some of our customers require substantial financing, including government financing, in order to fund their operations and make purchases from us. The inability of these customers to obtain sufficient credit or other funds to finance purchases and/or meet their payment obligations could have a negative impact on our financial results. |
Our future success will depend on our ability to respond to rapid technological changes in the markets in which we compete.
The markets for TCC’s products and services are characterized by rapid technological developments, changing customer technological requirements and preferences, frequent new product introductions, enhancements and modifications, and evolving industry standards. Our success will depend in large part on our ability to correctly identify emerging technological trends, enhance capabilities, and develop and manufacture new technologies and products quickly, in a cost-effective manner, and at competitive prices. The development of new and enhanced products is a complex and costly process. We may need to make substantial capital expenditures and incur significant research and development costs to develop and introduce such new products and enhancements. Our choices for developing technologies may prove incorrect if customers do not adopt the products we develop or if the technologies ultimately prove to be technically or commercially unviable. Development schedules also may be adversely affected as the result of the discovery of performance problems. If we fail to timely develop and introduce competitive new technologies, our business, financial condition and results of operations would be adversely affected.
Existing or new competitors may develop competing or superior technologies.
The industry in which the Company competes is highly competitive, and the Company has several domestic and foreign competitors. Many of these competitors have substantially greater financial, technical, sales and 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, can survive sustained price reductions in order to gain market share, and can devote greater resources to support existing products and develop new competing products. Any period of sustained price reductions for 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. It is also possible that competing products will emerge that may be superior in quality and performance and/or less expensive than those of the Company, or that similar technologies may render TCC’s products obsolete or uncompetitive and prevent the Company from achieving or sustaining profitable operations.
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The operating performance of our products is critical to our business and reputation.
The sale and use of our products entail a risk of product failure, product liability or other claims. Occasionally, some of our products have quality issues resulting from the design or manufacture of the product or the software used in the product. Often these issues are discovered prior to shipment and may result in shipping delays or even cancellation of orders by customers. Other times problems are discovered after the products have shipped, requiring us to resolve issues in a manner that is timely and least disruptive to our customers. Such pre-shipment and post-shipment problems have ramifications for TCC, including cancellation of orders, product returns, increased costs associated with product repair or replacement, and a negative impact on our goodwill and reputation.
Once our products are in use, any product failure, including software or hardware failure, which causes a breach of security with respect to our customer’s confidential communications could have a material adverse effect on TCC. There is no guarantee of product performance or that our products are adequate to protect against all security breaches. While we attempt to mitigate such risks by maintaining insurance and including warranty disclaimers and liability limitation clauses in our arrangements with customers, such mitigation measures may not protect us against liability in all instances. If our products failed for any reason, our clients could experience data loss, financial loss, personal and property losses, harm to reputation, and significant business interruption. Such events may expose us to substantial liability, increased regulation and/or penalties, as well as loss of customer business and a diminished reputation. Any product liability claims and related litigation would likely be time-consuming and expensive, may not be adequately covered by insurance, and may delay or terminate research and development efforts, regulatory approvals and commercialization activities.
If our products and services do not interoperate with our end-users’ products, orders could be delayed or cancelled, which could significantly reduce our revenues.
Our products are designed to interface with our end-users’ existing products, each of which has different specifications and utilizes multiple protocol standards. Many of our end-users’ systems contain multiple generations of products that have been added over time as these systems have grown and evolved. Our products and services must interoperate with all of these products and services as well as with future products and services that might be added to meet our end-users’ requirements. If our products do not interface with those within our end-users’ products and systems, orders for our products could be delayed or cancelled, which could significantly reduce our revenues.
Government regulation and legal uncertainties could harm our business.
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 or participating in future contracts. Moreover, payments to the Company for work performed on contracts with agencies of the U.S. government are subject to audit and adjustment. The Company could be required to return any payments received from U.S. government agencies if it is found to have violated federal regulations. There have been no government audits in recent years and the Company believes the result of such audits, should they occur, would not have a material adverse effect on its financial position or results of operations, though we can give no assurances.
The Company’s security products are subject to export restrictions administered by the U.S. Department of Commerce and U.S. 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 and some end-users. 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. Delays in obtaining necessary approvals could be costly in terms of lost sales opportunities and compliance costs. Should export restrictions increase or regulations become more restrictive, or should new laws be enacted, it could have a negative impact on the Company’s international business, which impact could be material.
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Contracts with the U.S. government may not be fully funded at inception and are subject to termination.
A portion of our revenues has historically been generated under agreements with the U.S. government. Any changes or delays in the budget of the U.S. government, and in particular defense spending, could affect our business, and funding levels are difficult to predict with any certainty. Moreover, certain multi-year contracts are conditioned on the continuing availability of appropriations. However, funds are typically appropriated on a fiscal-year basis, even though contract performance may extend over many years, making future sales and revenues under multi-year contracts uncertain. Changes in appropriations and budgets as well as economic conditions generally in subsequent years may impact the funding for these contracts. In addition, changes in funding and other factors may lead to the termination of such contracts. In addition, U.S. government contracts may be canceled at any time by the government with limited or no notice or penalty. Adverse changes in funding and the termination of government contracts could have a material adverse impact on the Company’s financial condition and results of operations.
If the protection of our intellectual property is inadequate, our competitors may gain access to our technologies.
The Company’s technological expertise and experience, including certain proprietary rights that it has developed and maintains as trade secrets, are crucial to the conduct of the Company’s business and its ability to compete in the marketplace. Such technological expertise and experience are important as they enable an efficient design and development process. Loss of this experience and expertise would have an adverse impact on the Company. To protect our proprietary information, we rely primarily on a combination of internal procedures, contractual provisions, and copyright, trademark and trade secret laws. Such internal procedures and contractual provisions may not prove sufficient to maintain the confidentiality and proprietary nature of such information and may not provide meaningful protection in the event of any unauthorized use or disclosure. Trade secret and copyright laws afford only limited protection. Current and potential trademarks and patents may not provide us with any competitive advantage and patents and trademarks must be enforced and maintained in order to provide protection, which may prove costly and time-consuming.
Despite our efforts to safeguard and maintain our proprietary rights, we may not be successful in doing so or the steps taken by us may be inadequate to deter unauthorized parties from misappropriating our technologies or prevent them from obtaining and using our proprietary information, products and technologies. Moreover, our competitors may independently develop similar technologies or design around patents issued to us.
Other parties may have patent rights relating to the same subject matter covered by our products or technologies, enabling them to prevent us from operating without obtaining a license and paying royalties. Third parties also may challenge our proprietary rights or claim we are infringing on their rights. Any claims of infringement or misappropriation, with or without merit, would likely be time-consuming, result in costly litigation and diversion of resources, and cause delays in the development and commercialization of our products. We may be required to expend significant resources to develop non-infringing intellectual property, pay royalties, or obtain licenses to the intellectual property that is the subject of such litigation. Royalties may be costly and licenses, if required, may not be available on terms acceptable to us, the absence of which could seriously harm our business.
In addition, the laws and enforcement mechanisms of some foreign countries with respect to intellectual property may not offer the same level of protection as do the laws of the United States. Legal protections of our rights may be ineffective in such countries, and technologies developed in such countries may not be protected in jurisdictions where protection is ordinarily available. Our inability to protect our intellectual property both in the United States and abroad would have a material adverse effect on our financial condition and results of operations.
The Company relies on a small number of customers for a large percentage of its revenues.
We will be successful only if a significant number of customers adopt our secure communications products. Historically the Company has had a small number of customers representing a large percentage of its total revenue. Although the Company endeavors to expand its customer base, we expect that sales to a limited number of customers will continue to account for a high percentage of our revenues in any given period for the foreseeable future. This reliance makes us particularly susceptible to factors affecting those customers. If such customers’ business declines and as a result our sales to such customers decline without corresponding sales orders from other customers, our financial condition and results of operations would be adversely affected. It is difficult to predict the rate at which customers will use our products, even in the case of repeat customers, and we do not typically have long-term contractual arrangements.
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We may not be able to maintain effective product distribution channels.
We rely on an in-house sales force as well as domestic and international representatives, consultants and distributors for the sale and distribution of our products. Our sales and marketing organization may be unable to successfully compete against more extensive and well-funded operations of certain of our competitors. In addition, we must manage sales and marketing personnel in numerous countries around the world with the concomitant difficulties in maintaining effective communications due to distance, language and cultural barriers. Further, certain of our distributors may carry competing products lines, which may negatively impact our net revenues.
We rely on single or limited sources for the manufacture and supply of certain product components.
For a small percentage of parts, we rely upon a single or limited number of manufacturers and suppliers. Moreover, because we depend on third party manufacturers and suppliers, we do not directly control product delivery schedules or component quality. In addition, we may not be able to maintain satisfactory contractual relations with our manufacturers and suppliers. A significant delay in delivering products to our customers, whether from unforeseen events such as natural disasters or otherwise, or unforeseen quality issues could have a material adverse effect on our results of operations and financial condition. If we lose any of the manufacturers or suppliers of certain product components, we expect that it would take from three to six months for a new manufacturer or supplier to begin full-scale production of one of our products. The delay and expense associated with qualifying a new manufacturer or supplier and commencing production could result in a material loss of revenue and reduced operating margins and harm our relationships with customers. While we have not experienced any significant supply problems or problems with the quality of the manufacturing process of our suppliers and there have been no materially late deliveries of components or parts to date, it is possible that in the future we may encounter problems in the manufacturing process or shortages in parts, components or other elements vital to the manufacture, production and sale of our products.
The loss of existing key management and technical personnel and the inability to attract new hires could have a detrimental effect on the Company.
Our success depends on identifying, hiring, training, and retaining qualified professionals. Competition for qualified employees in our industry is intense and made more difficult due to the tight labor market in Massachusetts. We expect these conditions to remain so for the foreseeable future. If we were unable to attract and hire a sufficient number of employees, or if a significant number of our current employees or any of our senior managers resign, we may be unable to complete or maintain existing projects or bid for new projects of similar scope and revenue. The Company’s success is particularly dependent on the retention of existing management and technical personnel, including Carl H. Guild, Jr., the Company’s President and Chief Executive Officer. Although the Company has entered into an employment agreement with Mr. Guild, the loss or unavailability of his services could impede our ability to effectively manage our operations.
We may need to expand our operations and we may not effectively manage any future growth.
As of December 13, 2019, we employed 22 full-time and two part-time employees as well as several consultants. In the event our products and services obtain greater market acceptance, we may be required to expand our management team and hire and train additional technical and skilled personnel. We may need to scale up our operations in order to service our customers, which may strain our resources, and we may be unable to manage our growth effectively. If our systems, procedures, and controls are inadequate to support our operations, growth could be delayed or halted, and we could lose our opportunity to gain significant market share. In order to achieve and manage growth effectively, we must continue to improve and expand our operational and financial management capabilities. Any inability to manage growth effectively could have a material adverse effect on our business, results of operations, and financial condition.
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Security breaches and other disruptions could interfere with the Company’s operations and could compromise the Company’s and its customer’s information, exposing the Company to liability that would cause the Company’s business and reputation to suffer.
In the ordinary course of business, the Company relies upon information technology networks and systems, some of which are managed by third parties, to process, transmit and store electronic information, and to manage or support a variety of business processes and activities, including collection of payments from purchasers of our products. The Company also uses information technology systems to record, process and summarize financial information and results of operations for internal reporting purposes, and to comply with regulatory financial reporting, legal, and tax requirements. Additionally, the Company collects and stores sensitive data, including personally identifiable information of the Company’s employees, in data centers and on information technology networks. The secure operation of these information technology networks and the processing and maintenance of this information is material to the Company’s business operations and strategy. Despite security measures, the Company’s information technology networks and infrastructure may be vulnerable to damage, disruptions, or shutdowns due to attacks by cyber criminals or breaches due to employee error or malfeasance or other disruptions, power outages, computer viruses, telecommunication or utility failures, terrorist acts, natural disasters or other catastrophic events. The occurrence of any of these events could compromise the Company’s networks, and the information stored there could be accessed, publicly disclosed, lost, or stolen. Any such access, disclosure, or other loss of information could result in legal claims, liability, and regulatory proceedings and penalties under laws protecting the privacy of personal information, disrupt operations, and damage the Company’s reputation, which could adversely affect the Company’s business, results of operations and financial condition. In addition, as security threats continue to evolve and increase in frequency and sophistication, the Company may need to invest additional resources to protect the security of its systems.
| Item 1B. | UNRESOLVED STAFF COMMENTS |
Not applicable.
| Item 2. | PROPERTIES |
On March 27, 2014, the Company entered into a lease for its current facilities commencing April 1, 2014. This lease is located at 100 Domino Drive, Concord, MA. The Company has been a tenant in this space since 1983. This is the Company’s only facility and houses all manufacturing, research and development, and corporate operations. The initial term of the lease was for five years through March 31, 2019 at an annual rate of $171,000. In addition, the lease contains options to extend the lease for two and one half years through September 30, 2021 and another two and one half years through March 31, 2024 at an annual rate of $171,000. Rent expense for each of the years ended September 28, 2019 and September 29, 2018 was $171,000. On September 25, 2018, the Company exercised its option to renew the lease through September 30, 2021.
| Item 3. | LEGAL PROCEEDINGS |
There are no current legal proceedings as to which TCC or its subsidiary is a party or as to which any of their property is subject.
| Item 4. | MINE SAFETY DISCLOSURES |
Not applicable.
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| Item 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Market Information
The Company’s common stock, $0.10 par value, trades on the NASDAQ Capital Market under the symbol “TCCO.”
Holders
As of December 13, 2019, there were 58 record holders of our Common Stock. We believe there are approximately 2,200 beneficial holders of our stock based on information reported to TCC by the Company’s transfer agent.
Dividends
It is not the Company’s intention to pay dividends unless future profits warrant such actions.
Equity Compensation Plan Information
The following table presents information about the Technical Communications Corporation 2010 Equity Incentive Plan and the Technical Communications Corporation 2005 Non-Statutory Stock Option Plan as of the fiscal year ended September 28, 2019. For more information on these plans, see the discussion of the Company’s stock option plans and stock-based compensation plans included in Note 2 to the Company’s financial statements as of and for the year ended September 28, 2019, included herewith.
| Plan category | Number of securities to be issued upon exercise of outstanding options | Weighted average exercise price of outstanding options | Number of securities remaining available for future issuance | |||||||||
| Equity compensation plans approved by security holders | 196,337 | (1) | $ | 8.02 | 193,863 | |||||||
| Equity compensation plans not approved by security holders | 35,000 | (2) | $ | 7.86 | - | |||||||
| Total | 231,337 | $ | 8.00 | 193,863 | ||||||||
(1) Of the 196,337 options outstanding as of September 28, 2019, 136,937 were exercisable as of such date at an average exercise price of $9.78 per share.
(2) Of the 35,000 options outstanding as of September 28, 2019, all were exercisable as of such date at an average exercise price of $7.86 per share.
Sales of Unregistered Securities and Purchases by the Issuer and Affiliated Purchasers
There were no sales by the Company of unregistered shares of the Company’s common stock during the 2019 fiscal year and no purchases of TCC stock by or on behalf of the Company or any affiliated purchaser during the fourth fiscal quarter of our 2019 fiscal year.
| Item 6. | SELECTED FINANCIAL DATA |
Not applicable.
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| Item 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion of the Company’s financial condition and 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 may contain statements that are not purely historical. Such 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. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, including but not limited to the effect of foreign political unrest; domestic and foreign government policies and economic conditions; future changes in export laws or regulations; changes in technology; the ability to hire, retain and motivate technical, management and sales personnel; the risks associated with the technical feasibility and market acceptance of new products; changes in telecommunications protocols; the effects of changing costs, exchange rates and interest rates; and the Company's ability to secure adequate capital resources. Such risks, uncertainties and other factors could cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. For a more detailed discussion of the risks facing the Company, see the Company’s filings with the SEC, including this Form 10-K for the fiscal year ended September 28, 2019 and the “Risk Factors” section included herein.
Overview
TCC designs, manufactures, markets and sells communications security equipment that utilizes various methods of encryption to protect the information being transmitted. Encryption is a technique for rendering information unintelligible, which information can then be reconstituted if the recipient possesses the right decryption “key”. The Company manufactures several standard secure communications products and also provides custom-designed, special-purpose secure communications products for both domestic and international customers. The Company’s products consist primarily of voice, data and facsimile encryptors. Revenue is generated principally from the sale of these products, which have traditionally been to foreign governments either through direct sale, pursuant to a U.S. government contract, or made as a sub-contractor to domestic corporations under contract with the U.S. government. We have also sold these products to commercial entities and U.S. government agencies. In addition to product revenue, we generate revenue from contract engineering services performed for certain government agencies, both domestic and foreign, and commercial entities.
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 amounts of revenues and expenses during the reporting periods.
On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, inventory reserves, receivable reserves, impairment of long-lived assets, income taxes, fair value and stock-based compensation. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. By their nature estimates are subject to an inherent degree of uncertainty. Actual results may differ from these estimates under different assumptions or conditions and such differences may be material.
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The accounting policies that management believes are most critical to aid in fully understanding and evaluating our reported financial results include those listed below. For a more detailed discussion, see Note 2 in the Notes to Consolidated Financial Statements included herewith.
Revenue Recognition
We perform funded research and development and technology development for commercial companies and government agencies primarily under fixed-price contracts. On fixed-price contracts that are expected to exceed one year in duration, revenue is recognized pursuant to the proportional performance method based upon the proportion of actual costs incurred to the total estimated costs for the contract. We typically receive periodic progress payments on these types of contracts, and we 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, the U.S. Government Accountability Office and other agencies. Adjustments are recognized in the period made. There have been no government audits in recent years and the Company believes the result of such audits, should they occur, would not have a material adverse effect on its financial position or results of operations. When the current estimates of total contract revenue and contract costs for a product development contract 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.
Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product and passage of title 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 freight on board shipping point, except for certain foreign shipments for which title passes upon entry of the product into the first port in the buyer’s country. If the product requires installation to be performed by TCC, or other acceptance criteria exist, all revenue related to the product is deferred and recognized upon completion of the installation or satisfaction of the customer acceptance criteria. We provide for a warranty reserve at the time the product revenue is recognized.
Costs incurred in connection with funded research and development are included in cost of revenue. Product development costs are charged to billable engineering services, bid and proposal efforts or business development activities, as appropriate. Product development costs charged to billable projects are recorded as cost of revenue; engineering costs charged to bid and proposal efforts are recorded as selling expenses; and product development costs charged to business development activities are recorded as marketing expenses. Product development costs consist primarily of costs associated with personnel, outside contractor and engineering services, supplies and materials. Cost of product revenue includes material, labor and overhead.
Inventory
The Company values its inventory at the lower of actual cost (based on the first-in, first-out method) to purchase and/or manufacture and the current estimated net realizable value (based on estimated selling prices, less the cost to sell) 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 are less than the associated carrying values, inventory carrying values are written down. In addition, the Company makes judgments as to future demand requirements and compares those with the current or committed inventory levels. Reserves are established for inventory levels that exceed future demand. It is possible that additional reserves above those already established may be required in the future if market conditions for our products should deteriorate.
Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that management believes 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 an impairment of their ability to make payments, additional allowances may be required, which would reduce net income. In addition, if the Company becomes aware of a customer’s inability to meet its financial obligations to TCC, a specific write-off is recorded in that amount.
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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 subject the Company 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 inventory obsolescence and stock-based compensation, 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 approximately $3.9 million as of September 28, 2019 due to uncertainties related to our ability to realize 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.
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 and it is not anticipated that we will be subject to foreign taxes in the near future.
Stock-Based Compensation
We measure compensation expense for all stock-based payments based on the grant date fair value. We expense stock-based compensation over the employee’s requisite service period, generally the vesting period of the award.
The choice of a valuation technique to determine fair value, and the approach utilized to develop the underlying assumptions for that technique, involve significant judgments. These judgments reflect management’s assessment of the most accurate method of valuing the stock options we issue, based on our historical experience, knowledge of current conditions, and beliefs of what could occur in the future given available information. Our judgments could change over time as additional information becomes available to us, or the facts underlying our assumptions change. Any change in our judgments could have a material effect on our financial statements. We believe that our estimates incorporate all relevant information available at the time made and represent a reasonable approximation in light of the difficulties involved in valuing non-traded stock options.
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Results of Operations
Year ended September 28, 2019 compared to year ended September 29, 2018
Net Revenue
Net revenues for the years ended September 28, 2019 and September 29, 2018 were $7,024,000 and $3,685,000, respectively, an increase of $3,339,000 or 91%. Revenue for fiscal 2019 consisted of $6,757,000, or 96%, from domestic sources and $267,000, or 4%, from international customers as compared to fiscal 2018, in which revenue consisted of $3,423,000, or 93%, from domestic sources and $262,000, or 7%, from international customers.
Foreign revenue consisted of shipments to five countries during the year ended September 28, 2019 and four countries during the year ended September 29, 2018. A sale is attributed to a foreign country based on the location of the contracting party. Domestic revenue may include the sale of products shipped through domestic resellers or manufacturers to international destinations. The table below summarizes our principal foreign revenue by country:
| 2019 | 2018 | |||||||
| Saudi Arabia | $ | 112,000 | $ | 121,000 | ||||
| Philippines | 78,000 | 89,000 | ||||||
| Egypt | 74,000 | 39,000 | ||||||
| Jordan | - | 13,000 | ||||||
| Other | 3,000 | - | ||||||
| $ | 267,000 | $ | 262,000 | |||||
For the year ended September 28, 2019, revenue was derived primarily from sales of our engineering services amounting to $3,239,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a Middle Eastern country amounting to $2,499,000 and to a domestic customer for deployment into a North African country amounting to $936,000.
For the year ended September 29, 2018, revenue was derived primarily from sales of our engineering services amounting to $3,236,000 and shipments of our narrowband radio encryptors to a customer in the Far East amounting to $90,000 and to a domestic customer for deployment into Afghanistan amounting to $57,000. We also sold our internet protocol encryptor to customers in Saudi Arabia amounting to $121,000 during the period.
Gross Profit
Gross profit for fiscal 2019 was $3,357,000, compared to gross profit of $972,000 for fiscal 2018, an increase of 245%. Gross profit expressed as a percentage of revenue was 48% for fiscal 2019 compared to 26% for fiscal 2018, which lower gross profit percentage for 2018 was due to the lower margin engineering services revenue during such year. During fiscal 2019, there was a higher concentration of revenue related to product sales, which historically will yield higher margins.
Operating Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for fiscal 2019 were $2,407,000, compared to $1,941,000 for fiscal 2018. This increase of $466,000, or 24%, was attributable to an increase in general and administrative expenses of $396,000 and an increase in selling and marketing expenses of $70,000 during the 2019 fiscal year.
The increase in general and administrative expenses for the year ended September 28, 2019 was primarily attributable to increases in audit and legal fees of $403,000.
| 21 |
The increase in selling and marketing expenses for the year ended September 28, 2019 was attributable to increases in payroll and payroll-related expenses of $69,000, sales commissions of $92,000, product evaluation costs of $23,000 and product demonstration costs of $22,000 during the period. These increases were partially offset by decreases in outside sales and marketing agreements of $74,000, outside consulting costs of $54,000, and travel expenses of $17,000 during the year.
Product Development Costs
Product development costs for fiscal years 2019 and 2018 were $333,000 and $521,000, respectively. This decrease of $188,000, or 36%, was attributable to an increase in billable engineering services contracts during fiscal 2019 that resulted in decreased product development costs of $270,000, a decrease in payroll and payroll related expenses of $48,000 and a decrease in service contracts amounting to $25,000. These decreased costs were partially offset by an increase in engineering project costs of $162,000 during the period.
The Company actively sells its engineering services in support of funded research and development. The receipt of these orders is sporadic, although such programs can span over several months to several years. In addition to these programs, the Company invests in research and development to enhance its existing products or to develop new products, as it deems appropriate. There was $3,239,000 of billable engineering services revenue generated during fiscal 2019 and $3,236,000 of billable engineering services revenue generated during fiscal 2018.
Net Income (Loss)
The Company generated net income of $631,000 for fiscal 2019, compared to a net loss of $1,480,000 for fiscal 2018. This increase in net income is primarily attributable to a 245% increase in gross profit during fiscal 2019 and an 11% decrease in operating expenses.
The effects of inflation and changing costs have not had a significant impact on revenue or earnings in recent years. As of September 28, 2019, none of the Company’s monetary assets or liabilities was subject to foreign exchange risks. The Company usually includes an inflation factor in its pricing when negotiating multi-year contracts with customers.
Liquidity and Capital Resources
Our cash and cash equivalents at September 28, 2019 totaled $1,593,000 and we continue to have no debt.
Liquidity and Ability to Continue as a Going Concern
For the fiscal year ended September 28, 2019 the Company generated $631,000 of net income. For the prior seven year period from fiscal 2012 to fiscal 2018, the Company suffered recurring losses from operations and had an accumulated deficit of $2,155,000 at September 28, 2019. Despite the current year net income, these factors continue to raise substantial doubt about the Company's ability to continue as a going concern within one year from the issuance date of the consolidated financial statements included in this Annual Report on Form 10-K. Such consolidated financial statements do not include any adjustments to reflect the substantial doubt about the Company’s ability to continue as a going concern.
We anticipate that our principal sources of liquidity will only be sufficient to fund our activities to September 26, 2020. In order to have sufficient cash to fund our operations beyond that point, we will need to secure new customer contracts, raise additional equity or debt capital, and reduce expenses, including payroll and payroll-related expenses.
In order to have sufficient capital resources to fund operations, the Company has been working diligently to secure several large orders with new and existing customers. In addition, the Company is considering raising capital through equity or debt arrangements. Although we believe our ability to secure such new business or raise new capital is likely, we cannot provide assurances we will be able to do so.
| 22 |
Should we be unsuccessful in these efforts, we would then be forced to implement headcount reductions, employee furloughs and/or reduced hours for certain employees or cease operations completely.
Sources and Uses of Cash
The following table presents our abbreviated cash flows for the years ended September 28, 2019 and September 29, 2018:
| 2019 | 2018 | |||||||
| Net income (loss) | $ | 631,000 | $ | (1,480,000 | ) | |||
| Changes not affecting cash | 83,000 | 239,000 | ||||||
| Changes in current assets and current liabilities | (1,087,000 | ) | 1,620,000 | |||||
| Cash (used in) provided by operating activities | (373,000 | ) | 379,000 | |||||
| Cash (used in) provided by investing activities | (16,000 | ) | 306,000 | |||||
| Net (decrease) increase in cash and cash equivalents | (389,000 | ) | 685,000 | |||||
| Cash and cash equivalents - beginning of year | 1,982,000 | 1,297,000 | ||||||
| Cash and cash equivalents - end of year | $ | 1,593,000 | $ | 1,982,000 | ||||
Operating Activities
The Company used approximately $752,000 more cash from operating activities in fiscal 2019 compared to fiscal 2018. This increase was primarily attributable to a $3,729,000 decrease in deferred revenue in fiscal 2019 compared to fiscal 2018. This increase in use of cash was partially offset by an increase in net income of $2,111,000 and a decrease in accounts payable and inventory of $743,000 at September 28, 2019.
Investing Activities
Cash provided by investing activities during fiscal 2019 decreased by approximately $322,000. This change is primarily attributable to the maturity of short-term investments in marketable securities of $350,000 and a decrease in additions to equipment and leasehold improvements of $27,000.
Financing Activities
There were no financing activities during either fiscal 2019 or 2018.
Debt Instruments
The Company currently maintains no debt instruments. The Company did borrow $300,000 from its Chief Executive Officer, President and Chairman of the Board, Carl H. Guild, Jr., on August 29, 2019 for working capital purposes, which loan was repaid in full on September 23, 2019.
Backlog
Backlog at September 28, 2019 and September 29, 2018 amounted to $1,154,000 and $2,118,000, respectively. The orders in backlog at September 28, 2019 are expected to ship and/or services are expected to be performed over the next 12 months depending on customer requirements and product availability.
Performance guarantees
Certain foreign customers require the Company to guarantee bid bonds and performance of products sold. These guaranties typically take the form of standby letters of credit. Guarantees are generally required in amounts of 5% to 10% of the purchase price and last in duration from three months to one year. At September 28, 2019 and September 29, 2018, the Company had no outstanding letters of credit.
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Research and Development
Research and development efforts are undertaken by the Company primarily on its own initiative. In order to compete successfully, the Company must improve existing products and develop new products as well as attract and retain qualified personnel. No assurances can be given that the Company will be able to hire and train such technical, management and sales personnel or successfully improve and develop its products.
During the fiscal years ended September 28, 2019 and September 29, 2018, the Company spent $333,000 and $521,000, respectively, on internal product development. The Company also spent $2,218,000 and $2,028,000 on billable development efforts during fiscal 2019 and 2018, respectively. In fiscal 2019, the Company’s total product development costs were consistent with fiscal 2018 levels and reflected the costs of custom development, product capability enhancements and production readiness. It is expected that product development expenses in fiscal 2020 will again be consistent with fiscal 2019 levels.
Technical work continued to focus on three principal areas: development of solutions that meet the needs of OEMs; product enhancements that include expanded features, planned capability and applications growth; and custom solutions that tailor our products and services to meet the unique needs of our customers. Going forward, the Company expects to continue focusing technical efforts in these areas while also increasing our systems design and integration capabilities and services offering portfolio. The following are highlights of our product development efforts in fiscal 2019:
| • | Continuation of the development of the next generation IP encryptors, the Cipher X 7220 and 7210; |
| • | Completion of the development of the aircraft-compatible HSE 6000 radio encryption product variants; and |
| • | Provision of custom engineering services. |
It is anticipated that working capital will fund our near-term research and development and marketing activities to September 26, 2020. We also believe that, in the long term, based on current billable activities, cash from operations will be sufficient to meet the development goals of the Company, although we can give no assurances. Any increase in development activities - either billable or new product related - will require additional resources, which we may not be able to fund through cash from operations. In circumstances where resources will be insufficient, the Company will look to other sources of financing, including debt and/or equity investments.
Capital Expenditures
Other than those stated above, there are no plans for material commitments for capital expenditures in fiscal 2020.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
New Accounting Pronouncements
ASU 2014-09, Revenue from Contracts with Customers, amended by ASU 2015-14 (Topic 606), ASU 2016-10, ASU 2016-11 and ASU 2016-12
The Company elected to adopt ASC 606 using the modified retrospective method approach as of September 30, 2018, which approach was applied to all contracts not completed as of such date. The adoption of this standard did not have a material impact on the financial statements included herewith.
Equipment Sales Revenue The deliverables under the previous guidance are consistent with performance obligations identified under ASC 606. Under ASC 606, we continued to allocate the transaction price between the elements and performance obligations within the contract. Revenue recognition for the performance obligations accounted for under ASC 606 was consistent with current guidance given the transfer of control of the promised goods or services follows the same pattern. As such, the adoption of ASC 606 did not result in a material impact on revenue recognition.
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Engineering Services Revenue The deliverables under the previous guidance are consistent with performance obligations identified under ASC 606. The adoption of ASC 606 did not result in a change to the timing of revenue recognition for this type of revenue, as the standard requires revenues to be estimated and recognized upon transfer of the promised goods and services. As such, the adoption of ASC 606 did not result in a material impact on revenue recognition.
ASU No. 2016-02, Leases
In February 2016, the FASB issued guidance with respect to leases. This ASU requires entities to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. This guidance offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We are currently evaluating the potential impact this standard will have on our financial statements and related disclosure and believe that the most notable impact to our financial statements upon adoption will be the recognition of a right-of-use asset and a lease liability for our leased facility in Concord, MA. The Company expects to adopt this standard during its fiscal year 2020.
Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force) and the SEC during our 2019 fiscal year but such pronouncements are not believed by management to have a material impact on the Company’s present or future financial statements.
| Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Not applicable.
| Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
The financial statements and notes thereto listed in the accompanying index to financial statements (Item 15) are filed as part of this Annual Report on Form 10-K and are incorporated herein by reference.
| Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
Not applicable.
| Item 9A. | CONTROLS AND PROCEDURES |
Evaluation of disclosure controls and procedures. The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Based on that review and evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of September 28, 2019 as a result of the material weaknesses in our internal control over financial reporting discussed below.
Management’s annual report on internal control over financial reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of September 28, 2019. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework (2013). Based on such an assessment, management concluded that the Company’s internal control over financial reporting was not effective as of September 28, 2019 due to the material weaknesses discussed below.
| 25 |
Our internal control over financial reporting is a process designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluations of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
A goal of the assessment was to determine whether any material weaknesses existed with respect to the Company’s internal control over financial reporting. A “material weakness” is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis by the Company’s internal controls.
As previously reported in our Form 10-K for the fiscal year ended September 29, 2018, as well as prior fiscal years, management had concluded that the Company did not maintain effective internal control over financial reporting due to material weaknesses in such internal control related to the misapplication of generally accepted accounting principles associated with revenue recognition, inventory reserves, accruals and the preparation of the consolidated financial statements, as well as the classification and disclosure of financial information, all caused by a lack of adequate skills and experience within the accounting department. In addition, management also previously identified a material weakness due to a lack of sufficient staff to segregate accounting duties. During fiscal year 2018, the Company also identified a lack of an adequately trained accounting department and an independent review of financial reporting, as well as a material weakness in internal control over significant non-routine transactions, all as disclosed in the relevant quarterly reports filed during our 2018 fiscal year.
Nonetheless, management believes that our consolidated financial statements included in this Annual Report on Form 10-K have been prepared in accordance with generally accepted accounting principles. Our Chief Executive Officer and Chief Financial Officer have certified that, based on such officer’s knowledge, the financial statements and other financial information included in this Annual Report on Form 10-K fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report. In addition, we initiated a remediation plan for the material weaknesses, described below.
Our management, with oversight from the Audit Committee, is actively engaged in remediating the identified material weaknesses. As part of these remediation efforts management has undertaken education and training for TCC’s accounting staff and management to address certain core competencies that resulted in the lack of operational effectiveness. Management will continue to assess the design of controls to determine if enhancements are needed to increase effectiveness of our internal control over financial reporting. Management has retained a subject matter expert in the area of income tax accounting and is assessing the need to retain additional subject matter experts to ensure compliance with generally accepted accounting principles and SEC rules and regulations. Both management and the Audit Committee have increased their oversight of non-routine transactions. This includes oversight of large revenue contracts as well as judgement areas, including inventory reserves and accruals. This oversight will contribute to the assessment of the need to retain additional subject matter experts.
| 26 |
The Company made significant progress in improving its internal control over financial reporting during the latter part of fiscal 2019 but these remediation efforts are ongoing; the Company’s goal is to have all material weaknesses remediated by the end of fiscal 2020.
Changes in internal control over financial reporting. The changes in the aforementioned internal control over financial reporting and the remediation efforts undertaken as of year-end and expected to be undertaken in fiscal 2020 have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. No other changes in the Company’s internal control over financial reporting occurred during the fourth quarter of its 2019 fiscal year.
| Item 9B. | OTHER INFORMATION |
Not applicable.
| 27 |
| Item 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
The information required by this Item 10 is incorporated herein by reference to our Definitive Proxy Statement, under the captions “Members of the Board of Directors, Nominees and Executive Officers,” “Certain Relationships and Related Person Transactions; Legal Proceedings,” “Corporate Governance,” and “Section 16(a) Beneficial Ownership Reporting Compliance,” with respect to our 2020 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 2019 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/investors.aspx.
| Item 11. | EXECUTIVE COMPENSATION |
The information required by this Item 11 is incorporated herein by reference to our Definitive Proxy Statement, under the captions “Compensation” and “Compensation Discussion and Analysis” with respect to our 2020 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 2019 fiscal year.
| Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required by this Item 12 is incorporated herein by reference to Part II, Item 5 herein under the caption “Equity Compensation Plan Information” and by reference to our Definitive Proxy Statement, under the caption “Security Ownership of Certain Beneficial Owners and Management,” with respect to our 2020 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 2019 fiscal year.
| Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
The information required by this Item 13 is incorporated herein by reference to our Definitive Proxy Statement, under the captions “Certain Relationships and Related Person Transactions; Legal Proceedings” and “Corporate Governance” with respect to our 2020 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 2019 fiscal year.
| 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 III – Ratification of Selection of Independent Registered Public Accounting Firm with respect to our 2020 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 2019 fiscal year.
| 28 |
| Item 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
| (1) | Financial Statements The following Consolidated Financial Statements and Notes thereto are filed as part of Part II, Item 8 of this report: |
| (2) | List of Exhibits |
| 29 |
| 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 | |
| 101.INS | XBRL Report Instance Document | |
| 101.SCH | XBRL Taxonomy Extension Schema Document | |
| 101.CAL | XBRL Taxonomy Calculation Linkbase Document | |
| 101.LAB | XBRL Taxonomy Label Linkbase Document | |
| 101.PRE | XBRL Presentation Linkbase Document | |
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |
Footnotes:
* Attached to this filing
+ Denotes a management contract or compensatory plan or arrangement
| Item 16. | FORM 10-K SUMMARY |
Not applicable.
| 30 |
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| TECHNICAL COMMUNICATIONS CORPORATION | ||||
| By: | /s/ Carl H. Guild, Jr. | |||
| Carl H. Guild, Jr. | ||||
| Chief Executive Officer and President | ||||
| Chairman of the Board, Director | ||||
| Date: | December 13, 2019 | |||
Pursuant to the requirements of the Securities Exchange Act of 1934, 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 13, 2019 | |
| Carl H. Guild, Jr. | Chairman of the Board, Director | ||
| (Principal Executive Officer) | |||
| /s/ Michael P. Malone | Treasurer and Chief Financial Officer | December 13, 2019 | |
| Michael P. Malone | (Principal Financial | ||
| and Accounting Officer) | |||
| /s/ Thomas E. Peoples | Director | December 13, 2019 | |
| Thomas E. Peoples | |||
| /s/ Francisco F. Blanco | Director | December 13, 2019 | |
| Francisco F. Blanco | |||
| /s/ Ralph M. Norwood | Director | December 13, 2019 | |
| Ralph M. Norwood |
| 31 |
Technical Communications Corporation and Subsidiary
September 28, 2019 and September 29, 2018
| ASSETS | 2019 | 2018 | ||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 1,593,395 | $ | 1,982,434 | ||||
| Accounts receivable - trade | 125,923 | 559,493 | ||||||
| Inventories, net | 1,042,212 | 1,368,696 | ||||||
| Other current assets | 118,250 | 142,279 | ||||||
| Total current assets | 2,879,780 | 4,052,902 | ||||||
| Equipment and leasehold improvements | 4,591,756 | 4,578,501 | ||||||
| Less accumulated depreciation and amortization | (4,554,275 | ) | (4,529,298 | ) | ||||
| Equipment and leasehold improvements, net | 37,481 | 49,203 | ||||||
| Total assets | $ | 2,917,261 | $ | 4,102,105 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 355,158 | $ | 187,958 | ||||
| Customer deposits | 2,046 | 35,628 | ||||||
| Deferred revenue | - | 2,106,514 | ||||||
| Accrued liabilities: | ||||||||
| Compensation and related expenses | 238,171 | 220,544 | ||||||
| Commissions | 84,804 | - | ||||||
| Other current liabilities | 17,533 | 18,405 | ||||||
| Total current liabilities | 697,712 | 2,569,049 | ||||||
| Commitments and contingencies (Note 12) | ||||||||
| Stockholders' equity | ||||||||
| Common stock - par value $0.10 per share; 7,000,000 shares authorized, 1,850,403 issued and outstanding at September 28, 2019 and September 29, 2018 | 185,041 | 185,041 | ||||||
| Additional paid-in capital | 4,189,439 | 4,134,371 | ||||||
| Accumulated deficit | (2,154,931 | ) | (2,786,356 | ) | ||||
| Total stockholders' equity | 2,219,549 | 1,533,056 | ||||||
| Total liabilities and stockholders’ equity | $ | 2,917,261 | $ | 4,102,105 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
| 32 |
Technical Communications Corporation and Subsidiary
Consolidated Statements of Operations
Years ended September 28, 2019 and September 29, 2018
| 2019 | 2018 | |||||||
| Net revenue | ||||||||
| Engineering services | $ | 3,239,179 | $ | 3,236,135 | ||||
| Equipment sales | 3,784,944 | 448,804 | ||||||
| Total net revenue | 7,024,123 | 3,684,939 | ||||||
| Cost of revenue | ||||||||
| Engineering services | 2,217,997 | 2,070,327 | ||||||
| Equipment sales | 1,448,463 | 642,399 | ||||||
| Total cost of revenue | 3,666,460 | 2,712,726 | ||||||
| Gross profit | 3,357,663 | 972,213 | ||||||
| Operating expenses: | ||||||||
| Selling, general and administrative | 2,407,214 | 1,941,175 | ||||||
| Product development | 332,704 | 520,663 | ||||||
| Total operating expenses | 2,739,918 | 2,461,838 | ||||||
| Operating income (loss) | 617,745 | (1,489,625 | ) | |||||
| Other income | ||||||||
| Investment income | 13,680 | 10,026 | ||||||
| Total other income | 13,680 | 10,026 | ||||||
| Net income (loss) | $ | 631,425 | $ | (1,479,599 | ) | |||
| Net income (loss) per common share | ||||||||
| Basic | $ | 0.34 | $ | (0.80 | ) | |||
| Diluted | $ | 0.34 | $ | (0.80 | ) | |||
| Weighted average shares | ||||||||
| Basic | 1,850,403 | 1,846,536 | ||||||
| Diluted | 1,850,555 | 1,846,536 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
| 33 |
Technical Communications Corporation and Subsidiary
Consolidated Statements of Cash Flows
Years ended September 28, 2019 and September 29, 2018
| 2019 | 2018 | |||||||
| Operating activities: | ||||||||
| Net income (loss) | $ | 631,425 | $ | (1,479,599 | ) | |||
| Adjustments to reconcile net income (loss) to cash (used in) provided by operating activities: | ||||||||
| Depreciation and amortization | 27,942 | 48,213 | ||||||
| Stock-based compensation | 55,068 | 30,292 | ||||||
| Adjustments to reduce inventory to net realizable value | - | 184,064 | ||||||
| Amortization of premium on held to maturity securities | - | 10,253 | ||||||
| Payment of tax on exercise of stock options | - | (33,870 | ) | |||||
| Changes in current assets and current liabilities: | ||||||||
| Accounts receivable | 433,570 | 170,684 | ||||||
| Inventories | 326,484 | (194,416 | ) | |||||
| Other current assets | 24,029 | (6,586 | ) | |||||
| Deferred revenue | (2,106,514 | ) | 1,622,393 | |||||
| Customer deposits | (33,582 | ) | (18,258 | ) | ||||
| Accounts payable and accrued liabilities | 268,759 | 46,323 | ||||||
| Cash (used in) provided by operating activities | (372,819 | ) | 379,493 | |||||
| Investing activities: | ||||||||
| Additions to equipment and leasehold improvements | (16,220 | ) | (43,662 | ) | ||||
| Proceeds from maturities of marketable securities | - | 350,000 | ||||||
| Cash (used in) provided by investing activities | (16,220 | ) | 306,338 | |||||
| Net (decrease) increase in cash, cash equivalents and restricted cash | (389,039 | ) | 685,831 | |||||
| Cash and cash equivalents at beginning of year | 1,982,434 | 1,296,603 | ||||||
| Cash and cash equivalents at end of year | $ | 1,593,395 | $ | 1,982,434 | ||||
| Supplemental disclosures: | ||||||||
| Income taxes paid | $ | 912 | $ | - | ||||
The accompanying notes are an integral part of these consolidated financial statements.
| 34 |
Technical Communications Corporation and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Years ended September 28, 2019 and September 29, 2018
| 2019 | 2018 | |||||||
| Stockholders' Equity | ||||||||
| Shares of common stock: | ||||||||
| Beginning balance | 1,850,403 | 1,839,877 | ||||||
| Cashless exercise of stock options | - | 10,526 | ||||||
| Ending balance | 1,850,403 | 1,850,403 | ||||||
| Common stock at par value: | ||||||||
| Beginning balance | $ | 185,041 | $ | 183,988 | ||||
| Cashless exercise of stock options | - | 1,053 | ||||||
| Ending balance | 185,041 | 185,041 | ||||||
| Additional paid-in capital: | ||||||||
| Beginning balance | 4,134,371 | 4,139,002 | ||||||
| Cashless exercise of stock options | - | (1,053 | ) | |||||
| Cashless exercise of stock options to pay taxes | - | (33,870 | ) | |||||
| Stock-based compensation | 55,068 | 30,292 | ||||||
| Ending balance | 4,189,439 | 4,134,371 | ||||||
| Accumulated deficit: | ||||||||
| Beginning balance | (2,786,356 | ) | (1,306,757 | ) | ||||
| Net income (loss) | 631,425 | (1,479,599 | ) | |||||
| Ending balance | (2,154,931 | ) | (2,786,356 | ) | ||||
| Total stockholders’ equity | $ | 2,219,549 | $ | 1,533,056 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
| 35 |
Notes to Consolidated Financial Statements
(1) Company Operations
Technical Communications Corporation (“TCC”) was incorporated in Massachusetts in 1961; its wholly-owned subsidiary, TCC Investment Corp., was organized in that jurisdiction in 1982. Technical Communications Corporation and TCC Investment Corp. are collectively referred to herein as the “Company”. The Company’s business consists of only one industry segment, which is the design, development, manufacture, distribution, marketing and sale of communications security devices, systems and services. The secure communications solutions provided by TCC protect vital information transmitted over a wide range of data, video, fax and voice networks. TCC’s products have been sold into over 115 countries and are in service with governments, military agencies, telecommunications carriers, financial institutions and multinational corporations.
Liquidity and Ability to Continue as a Going Concern
For the fiscal year ended September 28, 2019, the Company generated $631,000 of net income. For the prior seven year period from fiscal 2012 to fiscal 2018, the Company suffered recurring losses from operations and had an accumulated deficit of $2,155,000 at September 28, 2019. Despite the current year net income, these factors continue to raise substantial doubt about the Company's ability to continue as a going concern within one year from the issuance date of the consolidated financial statements included in this Annual Report on Form 10-K. Such consolidated financial statements do not include any adjustments to reflect the substantial doubt about the Company’s ability to continue as a going concern.
The Company anticipates that its principal sources of liquidity will only be sufficient to fund activities to September 26, 2020. In order to have sufficient cash to fund operations beyond that point, the Company will need to secure new customer contracts, raise additional capital and reduce expenses, including payroll and payroll-related expenses.
In order to have sufficient capital resources to fund operations, the Company has been working diligently to secure several large orders with new and existing customers. In addition, the Company is considering raising capital through equity or debt arrangements. Although it believes its ability to secure such new business and raise new capital is likely, it cannot provide assurances it will be able to do so.
Should the Company be unsuccessful in these efforts, it would then be forced to implement headcount reductions, employee furloughs and/or reduced hours for certain employees or cease operations completely.
(2) Summary of Significant Accounting Policies
The Company follows accounting standards set by the Financial Accounting Standards Board, commonly referred to as the FASB. The FASB sets generally accepted accounting principles (“GAAP”) that the Company follows to ensure it consistently reports its financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards CodificationTM, sometimes referred to as the Codification or ASC.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of TCC 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 GAAP in the United States 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 periods. Significant judgments and estimates include those related to revenue recognition, receivable reserves, inventory reserves, impairment of long-lived assets, income taxes, fair value and stock-based compensation. Actual results could differ from those estimates.
| 36 |
Notes to Consolidated Financial Statements (continued)
Cash and Cash Equivalents
Cash and cash equivalents include demand deposits at banks and other investments (including mutual funds) readily convertible into cash. The Company maintains its cash and cash equivalents in bank deposit accounts and money market mutual funds that, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on its cash, cash equivalents or marketable securities.
Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that management believes 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. When the financial condition of the Company’s customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances are recorded. In addition, if the Company becomes aware of a customer’s inability to meet its financial obligations to TCC, a specific write-off is recorded in that amount. There was no allowance for doubtful accounts at September 28, 2019 or September 29, 2018.
Inventories
The Company values its inventory at the lower of actual cost (based on the first-in, first-out method) to purchase and/or manufacture and net realizable value (based on estimated selling prices, less the cost to sell) 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 are less than the associated carrying values, inventory carrying values are written down. In addition, the Company makes judgments as to future demand requirements and compares those with the current or committed inventory levels. Reserves are established for inventory levels that exceed the Company’s judgment of future demand. It is possible that additional reserves above those already established may be required in the future if market conditions for the Company’s products should deteriorate.
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the lesser of the estimated useful life of the asset or the applicable lease term. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation and amortization are removed from the accounts, and any resulting gain or loss is recognized in operations for the period. The costs of maintenance and repairs are charged to operations as incurred; significant renewals and betterments are capitalized.
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. These events include a significant decrease in the market price of a long-lived asset, a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition, a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset, including an adverse action or assessment by a regulator, an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset, a current-period operating or cash flow loss combined with a history of operating or cash flow losses, or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset, among other items. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows expected to be generated by such asset. If the carrying amount of the asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized in the amount by which the carrying amount exceeds the fair value of the asset. There were no events or changes in circumstances that required the Company to review long-lived assets for impairment during fiscal years 2019 and 2018.
| 37 |
Notes to Consolidated Financial Statements (continued)
Revenue Recognition
The Company’s engineering services revenue is derived from performing funded research and development and technology development for commercial companies and government agencies primarily under fixed-price contracts. On fixed-price contracts that are expected to exceed one year in duration, revenue is recognized pursuant to the proportional performance method based upon the proportion of actual costs incurred to the total estimated costs for the contract. The Company receives periodic progress payments and it retains the rights to the intellectual property developed in government contracts.
The Company recognizes equipment sales revenue when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product and passage of title to the customer has occurred and the Company has determined that collection of the fee is probable. Title to the product generally passes upon shipment of the product, as the products are shipped freight on board shipping point, except for certain foreign shipments for which title passes upon entry of the product into the first port in the buyer’s country. If the product requires installation to be performed by TCC or other acceptance criteria exist, all revenue related to the product is deferred and recognized upon completion of the installation or satisfaction of the customer acceptance criteria. The Company provides for a warranty reserve at the time the product revenue is recognized.
As of September 29, 2018, billings in excess of revenues were recorded as deferred revenue in relation to contracts based on proportional performance of $2,107,000. Deferred revenue represents the cumulative difference between the amounts billed and revenue recognized for services performed. There was no deferred revenue at September 28, 2019.
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, the U.S. Government Accountability Office and other agencies. Adjustments are recognized in the period made. There have been no audits in recent years and the Company believes the result of such audits, should they occur, would not have a material adverse effect on its financial position or results of operations. If the current estimates of total contract revenue and contract costs for a product development contract 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.
Costs incurred in connection with funded research and development are included in cost of revenue. Product development costs are charged to billable engineering services, bid and proposal efforts or business development activities, as appropriate. Product development costs charged to billable projects are recorded as cost of revenue; engineering costs charged to bid and proposal efforts are recorded as selling expenses; and product development costs charged to business development activities are recorded as marketing expenses. Product development costs consist primarily of costs associated with personnel, outside contractor and engineering services, supplies and materials. Cost of product revenue includes material, labor and overhead.
Revenue for the fiscal year ended September 28, 2019 consists of $3,239,000 from engineering services and $3,785,000 from equipment sales compared to $3,236,000 from engineering services and $449,000 from equipment sales for the year ended September 29, 2018.
| 38 |
Notes to Consolidated Financial Statements (continued)
Stock-Based Compensation
Stock-based compensation expense is measured at the grant date based on the calculated fair value of the award. The expense is recognized over the employee’s requisite service period, generally the vesting period of the award. The related excess tax benefit received upon the exercise of stock options, if any, is reflected in the Company’s statement of cash flows as an operating activity. There were no excess tax benefits for the fiscal years ended September 28, 2019 and September 29, 2018.
The Company uses the Black-Scholes option pricing model as the method for determining the estimated fair value of its stock awards. The Black-Scholes method of valuation requires several assumptions: (1) the expected term of the stock award, (2) the expected future stock price volatility over the expected term, (3) a risk-free interest rate and (4) the expected dividend rate. The expected term represents the expected period of time the Company believes the options will be outstanding based on historical information. Estimates of expected future stock price volatility are based on the historic volatility of the Company’s common stock and the risk free interest rate is based on the U.S. Treasury Note rate. The Company utilizes a forfeiture rate based on an analysis of its actual experience. The forfeiture rate is not material to the calculation of stock-based compensation.
The fair value of options at date of grant was estimated with the following assumptions:
| September 28, 2019 | September 29, 2018 | |||||||
| Assumptions: | ||||||||
| Option life (years) | 6.5 | 6.5 | ||||||
| Risk-free interest rate | 2.1 | % | 2.8 | % | ||||
| Stock volatility | 86 | % | 85 | % | ||||
| Dividend yield | 0 | % | 0 | % | ||||
There were 40,500 and 20,500 options granted during the fiscal years ended September 28, 2019 and September 29, 2018, respectively. The weighted average grant date fair value of options granted during the years ended September 28, 2019 and September 29, 2018 was $2.67 and $4.55, respectively. The following table summarizes stock-based compensation costs included in the Company’s consolidated statements of operations for the years ended September 28, 2019 and September 29, 2018:
| 2019 | 2018 | |||||||
| Selling, general and administrative | $ | 50,706 | $ | 24,939 | ||||
| Product development | 4,362 | 5,353 | ||||||
| Total stock-based compensation expense before taxes | $ | 55,068 | $ | 30,292 | ||||
As of September 28, 2019 there was $148,200 of unrecognized compensation expense related to options outstanding. The unrecognized compensation expense will be recognized over the remaining requisite service period. As of September 28, 2019 the weighted average period over which the compensation expense is expected to be recognized is 3.48 years.
The Technical Communications Corporation 2005 Non-Statutory Stock Option Plan and 2010 Equity Incentive Plan were outstanding at September 28, 2019. There are an aggregate of 600,000 shares authorized for issuance under these plans, of which options to purchase 231,337 shares were outstanding at September 28, 2019. Vesting periods are at the discretion of the Board of Directors and typically range between zero and five years. Options under these plans are granted with an exercise price equal to fair value at time of grant and have a term of ten years from the date of grant.
| 39 |
Notes to Consolidated Financial Statements (continued)
As of September 28, 2019, there were 193,863 shares available for grant under the 2010 Equity Incentive Plan. The 2005 Non-Statutory Stock Option Plan has expired and options are no longer available for grant under such plan.
The following tables summarize stock option activity during fiscal years 2018 and 2019:
| Options Outstanding | ||||||||||||||||||||
| Number of Shares | Weighted Average | Weighted Average Contractual Life | ||||||||||||||||||
| Unvested | Vested | Total | Exercise Price | (years) | ||||||||||||||||
| Outstanding, September 30, 2017 | 34,200 | 212,081 | 246,281 | $ | 8.36 | 3.95 | ||||||||||||||
| Grants | 20,500 | - | 20,500 | 6.22 | ||||||||||||||||
| Vested | (10,000 | ) | 10,000 | - | 3.25 | |||||||||||||||
| Exercises | - | (31,800 | ) | (31,800 | ) | 5.60 | ||||||||||||||
| Cancellations/forfeitures | - | (7,844 | ) | (7,844 | ) | 9.68 | ||||||||||||||
| Outstanding, September 29, 2018 | 44,700 | 182,437 | 227,137 | $ | 8.50 | 3.76 | ||||||||||||||
| Grants | 34,500 | 6,000 | 40,500 | 3.58 | ||||||||||||||||
| Vested | (16,000 | ) | 16,000 | - | 3.96 | |||||||||||||||
| Exercises | - | - | - | - | ||||||||||||||||
| Cancellations/forfeitures | (3,800 | ) | (32,500 | ) | (36,300 | ) | 6.24 | |||||||||||||
| Outstanding, September 28, 2019 | 59,400 | 171,937 | 231,337 | $ | 8.00 | 3.99 | ||||||||||||||
Information related to the stock options vested or expected to vest as of September 28, 2019 is as follows:
| Range of Exercise Prices |
Number of Shares |
Weighted- Average Remaining Contractual Life (years) |
Weighted- Average Exercise Price |
Exercisable Number of Shares |
Exercisable Weighted- Average Exercise Price |
|||||||||||||||||
| $2.01 | - | $3.00 | 20,300 | 6.89 | $ | 2.69 | 9,800 | $ | 2.73 | |||||||||||||
| $3.01 | - | $4.00 | 46,500 | 9.53 | 3.61 | 8,400 | 3.64 | |||||||||||||||
| $4.01 | - | $5.00 | 16,600 | 4.74 | 4.34 | 14,200 | 4.37 | |||||||||||||||
| $5.01 | - | $10.00 | 37,000 | 4.20 | 7.75 | 28,600 | 7.90 | |||||||||||||||
| $10.01 | - | $15.00 | 110,937 | 0.96 | 11.44 | 110,937 | 11.44 | |||||||||||||||
| 231,337 | 3.99 | $ | 8.00 | 171,937 | $ | 9.39 | ||||||||||||||||
The aggregate intrinsic value of the Company’s “in-the-money” outstanding and exercisable options was $0 as of September 28, 2019 and $13,625 as of September 29, 2018. There were 31,800 stock options exercised during the year ended September 29, 2018 with a total intrinsic value of $140,350 and none during the year ended September 28, 2019. Nonvested common stock options are subject to the risk of forfeiture until the fulfillment of specified conditions.
Income Taxes
The Company accounts for income taxes using the asset/liability method. 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. The Company provides a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value.
| 40 |
Notes to Consolidated Financial Statements (continued)
The Company follows the appropriate guidance relative to uncertain tax positions. This standard provides detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in the financial statements. Uncertain tax positions must meet a recognition threshold of more-likely-than-not in order for those tax positions to be recognized in the financial statements. There were no uncertain tax positions as of September 28, 2019 and September 29, 2018.
Warranty Costs
The Company provides for estimated warranty costs at the time product revenue is recognized based upon historical experience.
Fair Value of Financial Measurements
In determining fair value measurements, the Company follows the provisions of FASB ASC 820, Fair Value Measurements and Disclosures. FASB ASC 820 defines fair value, establishes a framework for measuring fair value under GAAP, and enhances disclosures about fair value measurements. The topic provides a consistent definition of fair value that focuses on an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The topic also prioritizes, within the measurement of fair value, the use of market-based information over entity-specific information and establishes a three-level hierarchy for fair value measurements based on the nature of inputs used in the valuation of an asset or liability as of the measurement date. The three level hierarchy is as follows:
| Level 1 - | Pricing inputs are quoted prices available in active markets for identical assets or liabilities as of the measurement date. |
| Level 2 - | Pricing inputs are quoted prices for similar assets and liabilities, or inputs that are observable, either directly or indirectly, for substantially the full term through corroboration with observable market data. |
| Level 3 - | Pricing inputs are unobservable for the assets and liabilities, that is, inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability. |
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The Company’s available for sale securities consist of money market mutual funds held in a brokerage account, which are classified as cash equivalents and measured at fair value.
The Company assesses the levels of the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer in accordance with the Company’s accounting policy regarding the recognition of transfers between levels of the fair value hierarchy. During the fiscal years ended September 28, 2019 and September 29, 2018, there were no transfers between levels.
As of September 28, 2019, the Company did not hold any assets classified as Level 1, Level 2 or Level 3 and as of September 29, 2018, the Company did not hold any assets classified as Level 2 or Level 3.
| 41 |
Notes to Consolidated Financial Statements (continued)
The following table sets forth by level, within the fair value hierarchy, the assets measured at fair value on a recurring basis as of September 29, 2018, in accordance with the fair value hierarchy as defined above:
| September 29, 2018 | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | ||||||
| Mutual funds: | ||||||||
| Money market funds | $ | 1,020,039 | $ | 1,020,039 | ||||
| Total mutual funds | 1,020,039 | 1,020,039 | ||||||
| Total assets | $ | 1,020,039 | $ | 1,020,039 | ||||
There were no assets or liabilities measured at fair value on a nonrecurring basis at September 28, 2019 or September 29, 2018.
Earnings (Loss) per Share (EPS)
The Company presents both a “basic” and a “diluted” EPS. Basic EPS is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. In computing diluted EPS, stock options that are dilutive (i.e., those that reduce earnings per share) are included in the calculation of EPS using the treasury stock method. The exercise of outstanding stock options is not included 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.
Research and Development
Research and development costs are included in product development expenses in the consolidated statements of operations. Expenditures for Company-sponsored research and development projects are expensed as incurred and were $332,704 and $520,663 in fiscal 2019 and 2018, respectively. Customer-sponsored research and development projects performed under contracts are accounted for as contract costs as the work is performed and included in cost of revenue; such amounts were $2,217,997 and $2,027,944 in fiscal years 2019 and 2018, respectively.
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 2019 fiscal year ended on September 28, 2019 and included 52 weeks. The 2018 fiscal year ended on September 29, 2018 and included 52 weeks.
Reclassifications
Certain footnote reclassifications have been made to prior year amounts to conform to this year’s presentation for income taxes in Note 10.
New Accounting Pronouncements
ASU 2014-09, Revenue from Contracts with Customers, amended by ASU 2015-14 (Topic 606), ASU 2016-10, ASU 2016-11 and ASU 2016-12
In May 2014, the FASB and the International Accounting Standards Board issued guidance on the principles for recognizing revenue and developing a common revenue standard for U.S. GAAP and International Financial Reporting Standards that would: (1) remove inconsistencies and weaknesses in revenue requirements, (2) provide a more robust framework for addressing revenue issues, (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, (4) provide more useful information to users of financial statements through improved disclosure requirements, and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. This guidance is effective prospectively for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The new guidance was effective for the Company beginning September 30, 2018. The Company has elected to adopt ASC 606 using the modified retrospective method approach as of September 30, 2018, which approach was applied to all contracts not completed as of such date. The adoption of this standard did not have a material impact on the financial statements included herewith.
| 42 |
Notes to Consolidated Financial Statements (continued)
Equipment Sales Revenue The deliverables under the previous guidance are consistent with performance obligations identified under ASC 606. Under ASC 606, the Company continued to allocate the transaction price between the elements and performance obligations within the contract. Revenue recognition for the performance obligations accounted for under ASC 606 was consistent with current guidance given the transfer of control of the promised goods or services follows the same pattern. As such, the adoption of ASC 606 will not result in a material impact on revenue recognition.
Engineering Services Revenue The deliverables under the previous guidance are consistent with performance obligations identified under ASC 606. The adoption of ASC 606 did not result in a change to the timing of revenue recognition for this type of contract as the standard requires revenues to be estimated and recognized upon transfer of the promised goods and services. As such, the adoption of ASC 606 will not result in a material impact on revenue recognition.
ASU No. 2016-02, Leases
In February 2016, the FASB issued guidance with respect to leases. This ASU requires entities to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. This guidance offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. The Company is currently evaluating the potential impact this standard will have on the financial statements and related disclosure and believe that the most notable impact to the financial statements upon adoption will be the recognition of a right-of-use asset and a lease liability for the leased facility in Concord, MA. The Company expects to adopt this standard during its 2020 fiscal year.
Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force) and the SEC during fiscal 2019 but such pronouncements are not believed by management to have a material impact on the Company’s present or future financial statements.
(4) Net Income (Loss) Per Share
Outstanding potentially dilutive stock options, which were not included in the net income (loss) per share amounts as their effect would have been anti-dilutive, were 220,837 and 227,137 shares in fiscal years 2019 and 2018, respectively.
(5) Cash Equivalents and Marketable Securities
The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents. Substantially all cash equivalents are invested in money market mutual funds. Money market mutual funds held in a brokerage account are considered available for sale. The Company accounts for marketable securities in accordance with FASB ASC 320, Investments—Debt and Equity Securities. All marketable securities must be classified as one of the following: held to maturity, available for sale, or trading. The Company classifies its marketable securities as either available for sale or held to maturity.
| 43 |
Notes to Consolidated Financial Statements (continued)
Available for sale securities are carried at fair value, with unrealized holding gains and losses reported in stockholders’ equity as a separate component of accumulated other comprehensive income (loss). Held to maturity securities are carried at amortized cost. The cost of securities sold is determined based on the specific identification method. Realized gains and losses, and declines in value judged to be other than temporary, are included in investment income.
As of September 29, 2018, cash equivalents consisted of the following:
| Accrued | Gross Unrealized | Estimated | ||||||||||||||||||
| Cost | Interest | Gains | Losses | Fair Value | ||||||||||||||||
| Money market mutual funds | $ | 1,020,039 | $ | - | $ | - | $ | - | $ | 1,020,039 | ||||||||||
(6) Inventories
Inventories consist of the following:
| September 28, 2019 | September 29, 2018 | |||||||
| Finished goods | $ | 120,726 | $ | - | ||||
| Work in process | 182,863 | 356,278 | ||||||
| Raw materials and supplies | 738,623 | 1,012,418 | ||||||
| Total inventories | $ | 1,042,212 | $ | 1,368,696 | ||||
As a result of changes in the market for certain Company products and the resulting excess quantities, carrying amounts for those inventories were reduced by approximately $184,000 during the fiscal year ended September 29, 2018. This inventory write-down was reflected in cost of goods sold in the statements of operations. Management believes that this reduction properly reflected inventory at lower of cost or net realizable value, and no additional losses will be incurred upon disposition of the excess quantities. While it is at least reasonably possible that the estimate will change materially in the near term, no estimate can be made of the range of additional loss that is at least possible.
(7) Equipment and Leasehold Improvements
Equipment and leasehold improvements consist of the following:
| September
28, 2019 |
September
29, 2018 |
Estimated Useful Life (years) | ||||||||||
| Engineering and manufacturing equipment | $ | 2,181,649 | $ | 2,168,148 | 3 | - | 8 | |||||
| Demonstration equipment | 845,541 | 845,541 | 3 | |||||||||
| Furniture and fixtures | 1,020,616 | 1,020,862 | 3 | - | 8 | |||||||
| Automobile | 49,441 | 49,441 | 5 | |||||||||
| Leasehold improvements | 494,509 | 494,509 | Lesser of useful life or term of lease | |||||||||
| Total equipment and leasehold improvements | 4,591,756 | 4,578,501 | ||||||||||
| Less accumulated depreciation and amortization | (4,554,275 | ) | (4,529,298 | ) | ||||||||
| Equipment and leasehold improvements, net | $ | 37,481 | $ | 49,203 | ||||||||
| 44 |
Notes to Consolidated Financial Statements (continued)
Depreciation expense was $27,942 and $48,213 for the fiscal years ended September 28, 2019 and September 29, 2018, respectively.
(8) Leases
On March 27, 2014, the Company entered into a lease for its current facilities commencing April 1, 2014. This lease is located at 100 Domino Drive, Concord, MA. The Company has been a tenant in this space since 1983. This is the Company’s only facility and houses all manufacturing, research and development, and corporate operations. The initial term of the lease was for five years through March 31, 2019 at an annual rate of $171,000. In addition, the lease contains options to extend the lease for two and one half years through September 30, 2021 and another two and one half years through March 31, 2024 at an annual rate of $171,000. Rent expense for each of the years ended September 28, 2019 and September 29, 2018 was $171,000. On September 25, 2018, the Company exercised its option to renew the lease through September 30, 2021. Future minimum lease payments under the remainder of this lease total $342,000 at September 28, 2019 (payable at $171,000 in 2020 and $171,000 in 2021).
(9) Warranty
The Company's products generally carry a standard 15 month warranty. The Company records 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 warranty reserve is included in other current liabilities on the balance sheet.
The following table reflects changes in the Company's accrued warranty account:
| September 28, 2019 | September 29, 2018 | |||||||
| Beginning balance | $ | 3,312 | $ | 15,911 | ||||
| Plus: accruals related to new sales | 18,703 | 2,204 | ||||||
| Less: payments and adjustments to prior period accruals | (2,714 | ) | (14,803 | ) | ||||
| Ending balance | $ | 19,301 | $ | 3,312 | ||||
(10) Income Taxes
The income tax expense (benefit) is different from what would be obtained by applying the statutory federal income tax rate to income (loss) before income taxes due to the following:
| September 28, 2019 | September 29, 2018 | |||||||||||||||
| Amount | Percent | Amount | Percent | |||||||||||||
| Tax expense (benefit) at U.S. statutory rate | $ | 132,599 | 21.0 | % | $ | (362,946 | ) | (24.5 | %) | |||||||
| State income tax provision, net of federal benefit | (6,883 | ) | (1.1 | %) | (70,523 | ) | (4.8 | %) | ||||||||
| Federal research credits | (96,075 | ) | (15.2 | %) | (69,439 | ) | (4.7 | %) | ||||||||
| Change in state income tax rate | - | - | (41,961 | ) | (2.8 | %) | ||||||||||
| Change in federal income tax rate | - | - | 1,443,180 | 97.5 | % | |||||||||||
| Other | 23,116 | 3.7 | % | 19,977 | 1.4 | % | ||||||||||
| Valuation allowance | (52,757 | ) | (8.4 | %) | (918,288 | ) | (62.1 | %) | ||||||||
| Total income tax expense (benefit) | $ | - | - | $ | - | - | ||||||||||
| 45 |
Notes to Consolidated Financial Statements (continued)
Deferred income taxes consist of the following:
| September 28, 2019 | September 29, 2018 | |||||||
| Inventory differences | $ | 1,209,239 | $ | 1,206,040 | ||||
| Net operating losses | 1,945,238 | 1,554,615 | ||||||
| Deferred revenue | - | 568,917 | ||||||
| Stock based compensation | 123,658 | 116,149 | ||||||
| Tax credits | 520,176 | 374,239 | ||||||
| Other | 142,021 | 173,128 | ||||||
| Total | 3,940,332 | 3,993,088 | ||||||
| Less: valuation allowance | (3,940,332 | ) | (3,993,088 | ) | ||||
| Total | $ | - | $ | - | ||||
On December 22, 2017, the Tax Cuts and Jobs Act (the “TCJA”) was signed into law in the United States. The TCJA reduced the U.S. corporate tax rate from the 34% to 21% for tax years beginning after December 31, 2017. As a result of the newly enacted law, the Company was required to revalue all deferred tax assets and liabilities existing as of December 31, 2017 to reflect the reduction in the federal tax rate. This revaluation resulted in a reduction to the Company’s deferred tax asset of $1.4 million, with a corresponding reduction to the Company’s valuation allowance. Consequently, there was no impact on the accompanying consolidated financial statements that resulted from the reduction in the federal tax rate. Other relevant provisions of the TCJA did not have a material impact on the accompanying consolidated financial statements.
During fiscal year 2014, the Company established a valuation allowance against deferred tax assets. The valuation allowance is related to uncertainty with respect to the Company’s ability to realize its deferred tax assets. Deferred tax assets consist of net operating loss carryforwards, tax credits, inventory differences and other temporary differences. During fiscal year 2019, the change in the valuation allowance was $52,756 and related primarily to the TCJA. During fiscal year 2018, the change in the valuation allowance was $918,288 and related primarily to the TCJA.
Due to the nature of the Company’s 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 the Company will be subject to foreign taxes in the near future.
The Company files income tax returns in the U.S. federal jurisdiction and in the states of Massachusetts and New Hampshire. For U.S. federal purposes, the tax years 2015 through 2018 and for state purposes 2015 through 2018 remain open to examination. In addition, the amount of the Company’s federal and state net operating loss carryforwards utilized in prior periods may be subject to examination and adjustment. The Company has federal research credits of $352,279 available through fiscal year 2039 and net operating loss carryforwards of $7,423,299 available through fiscal year 2038 and the net operating loss carryforward generated in fiscal year 2019 will carryforward indefinitely. In addition, the Company has Massachusetts research credits of $212,529 available through fiscal year 2034 and net operating loss carryforwards of $6,431,410 available through fiscal year 2039.
(11) 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 2019 or 2018. The Company's matching contributions were $67,082 and $67,750 in fiscal years 2019 and 2018, respectively.
| 46 |
Notes to Consolidated Financial Statements (continued)
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. Under the plan, there were no bonuses earned, accrued or paid to eligible employees at September 28, 2019 or September 29, 2018.
(12) Major Customers and Export Revenue
In fiscal year 2019, the Company had three customers representing 96% (47%, 36% and 13%) of total net revenue and at September 28, 2019 had one customer representing 98% of accounts receivable. In fiscal year 2018, the Company had one customer representing 87% of total net revenue and at September 29, 2018 had one customer representing 95% of accounts receivable.
A breakdown of net revenue is as follows:
| September 28, 2019 | September 29, 2018 | |||||||
| Domestic | $ | 6,757,118 | $ | 3,422,545 | ||||
| Foreign | 267,005 | 262,394 | ||||||
| Total Revenue | $ | 7,024,123 | $ | 3,684,939 | ||||
A summary of foreign sales, as a percentage of total foreign revenue, by geographic area, is as follows:
| September 28, 2019 | September 29, 2018 | |||||||
| Mid-East and Africa | 70.5 | % | 65.8 | % | ||||
| Far East | 29.2 | % | 34.2 | % | ||||
| Europe | 0.3 | % | - | |||||
The Company sold products to customers located in five countries during the year ended September 28, 2019 and to customers located in four countries during the year ended September 29, 2018. A sale is attributed to a foreign country based on the location of the contracting party. Domestic revenue may include the sale of products shipped through domestic resellers or manufacturers to international destinations. The table below summarizes our foreign revenues by country as a percentage of total foreign revenue.
| September 28, 2019 | September 29, 2018 | |||||||
| Saudi Arabia | 42.0 | % | 46.0 | % | ||||
| Philippines | 29.2 | % | 34.2 | % | ||||
| Egypt | 27.5 | % | 14.8 | % | ||||
| Jordan | - | 5.0 | % | |||||
| Other | 1.3 | % | - | |||||
(13) Related Party Transactions
On August 29, 2019 the Company issued a Demand Promissory Note in favor of Carl H. Guild, Jr. in the principal amount of $300,000. Mr. Guild, the Company’s Chief Executive Officer, President and Chairman of the Board, loaned the money to the Company to provide working capital. This note was repaid with interest in the amount of $411 on September 23, 2019.
| 47 |
Notes to Consolidated Financial Statements (continued)
(14) Shareholder Rights Plan
On August 7, 2014, the Board of Directors of the Company adopted a Stockholder Rights Plan to replace the Company's former plan, which had expired on August 5, 2014. The new plan is substantially similar to the former plan, and was not adopted in response to any specific takeover threat. In adopting the plan, the Board 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 18, 2014. Until the rights become exercisable, which occurs with certain exceptions when a person or affiliated group acquires 15% or more of TCC's common stock, they will trade automatically with the common stock and separate rights certificates will not be issued. Each right, once exercisable, will entitle the holder (other than rights owned by the acquiring person or group) to buy one share of the common stock at a price of $25 per share, subject to certain adjustments. The rights can generally be redeemed by the Company 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 acquisition of beneficial ownership by any person or group of 15% or more of the Company’s outstanding common stock, subject to certain exceptions. The rights will expire on August 6, 2024 unless earlier redeemed.
| 48 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and
Stockholders of Technical Communications Corporation:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Technical Communications Corporation and Subsidiary (the Company) as of September 28, 2019, and the related consolidated statements of operations, cash flows and changes in stockholders’ equity for the year then ended, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 28, 2019, and the results of its operations and its cash flows for the year ended September 28, 2019, in conformity with accounting principles generally accepted in the United States of America.
Substantial Doubt About the Company’s Ability to Continue as a Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, for the fiscal year ended September 28, 2019 the Company generated $631,000 of net income, however for the prior seven year period from fiscal 2012 to fiscal 2018, the Company suffered recurring losses from operations and has an accumulated deficit of $2,155,000 at September 28, 2019. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding those matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Stowe & Degon LLC
Westborough, Massachusetts
December 5, 2019
We have served as the Company’s auditors since 2019.
| 49 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and
Stockholders of Technical Communications Corporation:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Technical Communications Corporation and Subsidiary (the Company) as of September 29, 2018, and the related consolidated statements of operations, cash flows and changes in stockholders’ equity for the year then ended, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 29, 2018, and the results of its operations and its cash flows for the year ended September 29, 2018, in conformity with accounting principles generally accepted in the United States of America.
Substantial Doubt About the Company’s Ability to Continue as a Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations and has an accumulated deficit of $2,786,356 at September 29, 2018. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding those matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ CohnReznick LLP
We have served as the Company’s auditor since 2018.
Boston, Massachusetts
June 21, 2019
50
Exhibit 10.7
DEMAND PROMISSORY NOTE
| $300,000.00 | August 29, 2019 |
FOR VALUE RECEIVED, the undersigned, Technical Communications Corporation, a Massachusetts corporation with its principal place of business at 100 Domino Drive, Concord, Massachusetts 01742 (the “Maker”) hereby promises to pay to Carl H. Guild, Jr., an individual residing at 14 Algonquin Avenue, Andover, Massachusetts 01810 (the “Holder”), the principal sum of Two Hundred and fifty Thousand Dollars ($300,000.00), in lawful money of the United States of America, ON DEMAND, with interest from the date hereof on the whole amount of such principal sum remaining from time to time unpaid at the rate per annum of two percent (2.0%).
Maker may prepay this Note, in whole or in part, at any time without premium or penalty. Any partial prepayment shall be applied first against all accrued interest through the date of the prepayment and second against the principal amount outstanding. Interest shall be computed on the basis of a three hundred and sixty five (365) day year and shall be paid for the actual number of days on which principal is outstanding.
All payments of principal and interest on this Note shall be payable to the Holder at the above address, or at such other place in the United States of America as the Holder may from time to time designate in writing at least ten (10) days before such payment is due.
The entire unpaid principal balance of, and all accrued unpaid interest on, this Note shall, at the option of the Holder, become forthwith due and payable without notice or demand upon the happening of any of the following events of default: (a) default in payment as required hereunder and such default continues for ten (10) days after such payment is due; or (b) appointment of a receiver of any property, common law assignment or trust mortgage for the benefit of creditors, the commencement of any kind of insolvency proceedings, or the filing of any proceedings under any bankruptcy or other law relating to the relief of debtors (and, if such action or proceeding is involuntary on the part of such Maker, such action or proceeding is not dismissed within ninety (90) days), of, by or against either Maker.
No delay or omission by the Holder in exercising or enforcing any of his powers, rights, privileges, remedies or discretions hereunder shall operate as a waiver thereof on that or any other occasion, and no single or partial exercise of any right hereunder shall preclude other or future exercise thereof. No waiver of any right or remedy hereunder on any occasion shall be construed as a bar or waiver of any such right or remedy on any future occasion, nor as a continuing waiver. Maker agrees that no variance, extension or renewal of this Note shall affect the absolute and unconditional liability of Maker hereunder.
Maker hereby waives presentment, demand, notice of protest, suretyship defenses, and all other demands and notices in connection with the delivery, acceptance, performance, default and/or enforcement of this Note or of any rights hereunder. Maker will pay to the Holder on demand all costs and expenses, including reasonable attorneys’ fees, relating to the collection and/or enforcement of this Note or of any rights hereunder.
This Note shall be governed by and construed and enforced in accordance with the laws of the Commonwealth of Massachusetts. If any provision of this Note is held to be invalid or unenforceable by a court of competent jurisdiction, the other provisions of this Note shall remain in full force and effect.
IN WITNESS WHEREOF, Maker has caused this Note to be executed as a sealed instrument, all as of the day, month, and year first written above.
| Technical Communications Corporation | |||
| /s/ W. Neal Grinnell | By: | /s/ Michael P. Malone | |
| Witness | Name: | Michael P. Malone | |
| Title: | Chief Financial Officer | ||
Exhibit 21
List of Subsidiaries
TCC Investment Corp., a Massachusetts corporation
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statement (No. 333-174247) on Form S-3 and the Registration Statements (Nos. 333-76102; 333-127447, 333-139737; 333-161259; 333-174250) on Forms S-8 of Technical Communications Corporation of our report, which includes an explanatory paragraph relating to the Company’s ability to continue as a going concern dated December 13, 2019, on our audit of the consolidated financial statements of Technical Communications Corporation and Subsidiary as of September 28, 2019 and for the year then ended, included in this Annual Report on Form 10-K of Technical Communications Corporation for the year ended September 28, 2019.
/s/ Stowe & Degon LLC
Westborough, Massachusetts
December 5, 2019
Exhibit 23.2
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statement (No. 333-174247) on Form S-3 and the Registration Statements (Nos. 333-76102; 333-127447, 333-139737; 333-161259; 333-174250) on Forms S-8 of Technical Communications Corporation of our report, which includes an explanatory paragraph relating to the Company’s ability to continue as a going concern dated June 21, 2019, on our audit of the consolidated financial statements of Technical Communications Corporation and Subsidiary as of September 29, 2018 and for the year then ended, included in this Annual Report on Form 10-K of Technical Communications Corporation for the year ended September 28, 2019.
/s/ CohnReznick LLP
Boston, Massachusetts
December 13, 2019
Exhibit 31.1
CERTIFICATION
I, Carl H. Guild, Jr., certify that:
| (1) | I have reviewed this annual report on Form 10-K of Technical Communications Corporation; |
| (2) | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| (3) | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| (4) | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| a. | designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| b. | designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| c. | evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| d. | disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| (5) | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| a. | all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| b. | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| /s/ Carl H. Guild, Jr. |
Carl H. Guild, Jr.
President and Chief Executive Officer
Dated: December 13, 2019
Exhibit 31.2
CERTIFICATION
I, Michael P. Malone, certify that:
| (1) | I have reviewed this annual report on Form 10-K of Technical Communications Corporation; |
| (2) | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| (3) | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| (4) | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| a. | designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| b. | designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| c. | evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| d. | disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| a. | all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| b. | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| /s/ Michael P. Malone |
Michael P. Malone
Treasurer and Chief Financial Officer
Dated: December 13, 2019
Exhibit 32
CERTIFICATION PURSUANT TO
18 U.S.C. § 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, each of the undersigned President and Chief Executive Officer and Treasurer and Chief Financial Officer of Technical Communications Corporation (the “Company”) certifies that, to his knowledge:
1) the Company’s Annual Report on Form 10-K for the fiscal year ended September 28, 2019 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
2) the information contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 28, 2019 fairly presents, in all material respects, the financial condition and results of operations of the Company.
| /s/ Carl H. Guild, Jr. | /s/ Michael P. Malone | |
| Carl H. Guild, Jr. | Michael P. Malone | |
| President and Chief Executive Officer | Treasurer and Chief Financial Officer | |
| Date: December 13, 2019 | Date: December 13, 2019 |
Note 9 - Warranty - Schedule of Product Warranty Liability (Details) - USD ($) |
12 Months Ended | |
|---|---|---|
Sep. 28, 2019 |
Sep. 29, 2018 |
|
| Beginning balance | $ 3,312 | $ 15,911 |
| Plus: accruals related to new sales | 18,703 | 2,204 |
| Less: payments and adjustments to prior period accruals | (2,714) | (14,803) |
| Ending balance | $ 19,301 | $ 3,312 |
Note 11 - Employee Benefit Plans (Details Textual) - USD ($) |
12 Months Ended | |
|---|---|---|
Sep. 28, 2019 |
Sep. 29, 2018 |
|
| Defined Contribution Plan, Employer Discretionary Contribution Amount | $ 67,082 | $ 67,750 |
| Accrued Bonuses | $ 0 | $ 0 |