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TCCO > SEC Filings for TCCO > Form 10-K on 22-Dec-2011All Recent SEC Filings

Show all filings for TECHNICAL COMMUNICATIONS CORP

Form 10-K for TECHNICAL COMMUNICATIONS CORP


22-Dec-2011

Annual Report


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 future changes in export laws or regulations; changes in technology; the effect of foreign political unrest; the ability to hire, retain and motivate technical, management and sales personnel; the risks associated with the technical feasibility and market acceptance of new products; changes in telecommunications protocols; the effects of changing costs, exchange rates and interest rates; and the Company's ability to secure adequate capital resources. Such risks, uncertainties and other factors could cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. For a more detailed discussion of the risks facing the Company, see the Company's filings with the Securities and Exchange Commission, including this Form 10-K for the fiscal year ended September 24, 2011 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. However, we have also sold these products to commercial entities and U.S. government agencies. We also generate revenues from contract engineering services performed for certain government agencies, both domestic and foreign, 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, income taxes 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. 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.


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Revenue Recognition
Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has occurred and we have determined that collection of the fee is probable. Title to the product generally passes upon shipment of the product, as the products are shipped FOB shipping point, except for certain foreign shipments where 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, all revenue related to the product is deferred and recognized upon completion of the installation. We provide for a warranty reserve at the time the product revenue is recognized.
We perform 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. Revenue from reimbursement contracts is recognized as services are performed. 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. In each type of contract, we receive periodic progress payments or payments upon reaching interim milestones, 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. Adjustments are recognized in the period made. 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.
Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development are included in cost of sales. Inventory
We value our inventory at the lower of actual cost, based on first-in, first-out basis (FIFO) to purchase and/or manufacture or the current estimated market value (based on the estimated selling prices, less the cost to sell) of the inventory. We periodically review inventory quantities on hand and record a provision for excess and/or obsolete inventory based primarily on our estimated forecast of product demand, as well as historical usage. Due to the custom and specific nature of certain of our products, demand and usage for products and materials can fluctuate significantly. A significant decrease in demand for our products could result in a short-term increase in the cost of inventory purchases and an increase in excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence, any of which could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant negative impact on the value of our inventory and would reduce our reported operating results. Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is based primarily on a specific analysis of accounts in the receivable portfolio and historical write-off experience. While management believes the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required, which would reduce net income. 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 deferred revenue, for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. We must then record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.


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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 valuation allowance against our deferred tax assets of $1.1 million as of September 24, 2011 due to uncertainties related to our ability to utilize these assets. The valuation allowance is based on our estimates of taxable income by jurisdiction and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could materially impact our financial position and results of operation. Due to the nature of our current operations in foreign countries (selling products into these countries with the assistance of local representatives), the Company has not been subject to any foreign taxes in recent years. Also, it is not anticipated that we will be subject to foreign taxes in the near future. Stock Based Compensation
We record the compensation expense for all share-based payments based on the grant date fair value. We expense share-based compensation over the employee's requisite service period, generally the vesting period of the award. The choice of a valuation technique, 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. Results of Operations
Year ended September 24, 2011 as compared to year ended September 25, 2010 Net Sales
Net sales for the years ended September 24, 2011 and September 25, 2010 were $12,102,000 and $21,551,000, respectively, a decrease of $9,449,000 or 44%. Sales for fiscal 2011 consisted of $11,808,000, or 98%, from domestic sources and $294,000, or 2%, from international customers as compared to fiscal 2010, in which sales consisted of $20,771,000, or 96%, from domestic sources and $780,000, or 4%, from international customers.
Foreign sales consisted of shipments to six different countries during the year ended September 24, 2011 and five different countries during the year ended September 25, 2010. 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 sales by country:

                                         2011          2010
                        Thailand       $  90,000     $ 648,000
                        Bahrain           88,000             -
                        Saudi Arabia      60,000        28,000
                        France            48,000             -
                        Slovakia           4,000        87,000
                        Other              4,000        17,000

                                       $ 294,000     $ 780,000

Revenue for fiscal 2011 was derived from the sale of the Company's narrowband radio encryptors to a U.S. radio manufacturer amounting to $8,160,000 and to an additional domestic customer amounting to $262,000. Billings under programs for engineering services work amounting to $241,000 also were recognized during the period. In addition, we made the final shipment under a contract with CECOM amounting to $610,000 during fiscal 2011. We also sold our secure data link encryptors to a domestic customer amounting to $630,000 and we shipped our high speed bulk encryptors amounting to $1,710,000 under a contract with a domestic customer.


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Revenue for fiscal 2010 was derived from the sale of the Company's narrowband radio encryptors to a U.S. radio manufacturer amounting to $12,863,000 and to an additional domestic customer amounting to $474,000. Billings under programs for engineering services work amounting to $2,562,000 also were recognized during the period. In addition, we continued shipping products under the contract with CECOM amounting to $3,591,000 during fiscal 2010. We also sold our secure telephone, fax, and data encryptors to a foreign customer amounting to $592,000 and we began shipping our high speed bulk encryptors amounting to $1,196,000 under a contract with a domestic customer Gross Profit
Gross profit for fiscal year 2011 was $9,810,000, a decrease of $6,334,000 or 39%, compared to gross profit of $16,144,000 for fiscal year 2010. Gross profit expressed as a percentage of sales was 81% in fiscal year 2011 compared to 75% in the prior year. The increase in gross profit as a percentage of sales was primarily associated with higher margin products being sold in fiscal 2011. Operating Costs and Expenses
Selling, General and Administrative
Selling, general and administrative expenses for fiscal 2011 were $2,813,000, compared to $2,808,000 for fiscal 2010. This increase of $5,000 was attributable to an increase in selling and marketing expenses of $87,000 offset by a decrease in general and administrative expenses of $82,000 during the 2011 fiscal year. The increase in selling and marketing costs during fiscal 2011 was attributable to an increase in product evaluation expenses of $203,000 and travel and outside consulting expenses of $38,000 and $33,000, respectively, and by an increase in personnel-related costs of $35,000. These increases were partially offset by decreases in third party sales and marketing agreements of $43,000, outside sales commissions of $76,000, customer support expenses of $34,000 and bid and proposal activities of $67,000.
The decrease in general and administrative costs during fiscal 2011 was primarily attributable to a decrease in professional fees of $12,000 and a decrease in bad debt expense of $100,000, which were partially offset by an increase in charitable contributions of $15,000. Product Development
Product development costs for fiscal 2011 were $3,530,000, compared to $2,608,000 for fiscal 2010, an increase of $922,000 or 35%. This increase was primarily attributable to an increase in personnel-related costs of $179,000 and a decrease in billable engineering services work performed, which increased product development costs by approximately $1,336,000. These increases were offset by decreases in engineering support expenses of $363,000, outside consulting fees of $110,000, costs for materials and supplies of $79,000 and recruiting costs of $50,000.
The Company actively sells its engineering services in support of funded research and development. The receipt of these orders is sporadic, although such programs can span over several months. In addition to these programs, the Company invests in research and development to enhance its existing products or to develop new products, as it deems appropriate. There was $241,000 of billable engineering services revenue generated during fiscal 2011 and $2,562,000 generated during fiscal 2010.
It is anticipated that cash from operations will fund our near-term research and development and marketing activities. We also believe that, in the long term, based on current billable activities and the improvement in business prospects, cash from operations will be sufficient to meet the development goals of the Company, although we can give no assurances. Any increase in activities - either billable or new product related - will require additional resources, which we may not be able to fund through cash from operations. In circumstances where resources will be insufficient, the Company will look to other sources of financing, including debt and/or equity investments.


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Net Income
The Company generated net income of $2,269,000 for fiscal year 2011 as compared to net income of $7,868,000 for fiscal year 2010, a $5,599,000 decrease. This 71% decrease in net income is primarily attributable to a substantial decrease in gross profit on revenue from orders of our radio encryptors for deployment into Afghanistan.
The effects of inflation and changing costs have not had a significant impact on sales or earnings in recent years. As of September 24, 2011, none of the Company's monetary assets or liabilities was subject to foreign exchange risks. The Company usually includes an inflation factor in its pricing when negotiating multi-year contracts with customers.
Liquidity and Capital Resources
Cash and cash equivalents decreased by $1,802,000, or 16%, to $9,232,000 as of September 24, 2011, from a balance of $11,034,000 at September 25, 2010. This decrease was primarily attributable to cash used in operations of $810,000, which included a decrease in accrued income taxes payable of $1,635,000, the payout of dividends of $731,000 and fixed asset additions of $266,000 during the period.
During fiscal 2011, the Company paid special cash dividends totaling $731,000. The payment of these dividends was based on the profits generated by the Company during that timeframe. In addition, in November 2011 the Company's Board of Directors declared a dividend of $0.10 per share of common stock outstanding. The dividend is payable in cash on December 15, 2011 to all shareholders of record on December 1, 2011. It is not the Company's intention to pay dividends on a regular basis unless future profits warrant such actions. During fiscal 2011, we received orders for our radio encryptors for use in Afghanistan amounting to $12.4 million, $7.8 million of which was shipped in fiscal 2011, and we continued shipments of our high speed encryptors to support a Patriot Missile upgrade program in Taiwan from Raytheon Company amounting to $1.7 million. In addition, during the first fiscal quarter of 2012 we received orders for additional radio encryptors for use in Afghanistan amounting to $857,000 and a new order from Raytheon to continue its upgrade program of Patriot Missile systems in Taiwan amounting to $1.2 million.
It is anticipated that cash from operations will fund our near-term research and development and marketing activities. We also believe that, in the long term, based on current billable activities and the improvement in business prospects, cash from operations will be sufficient to meet the development goals of the Company, although we can give no assurances. Any increase in activities - either billable or new product related - will require additional resources, which we may not be able to fund through cash from operations. In circumstances where resources will be insufficient, the Company will look to other sources of financing, including debt and/or equity investments.
The Company paid $1,745,000 during the fiscal year ended September 24, 2011 for income taxes related to fiscal year 2010 and $1,470,000 on current tax estimates of its income tax liability for fiscal year 2011. The Company has recorded refundable income taxes of $350,000 as of September 24, 2011.
The Company's backlog as of September 24, 2011 is approximately $5.2 million. The orders in backlog are expected to ship during fiscal 2012 depending on customer requirements and product availability.
The Company has a line of credit agreement with Bank of America (the "Bank") for a line of credit not to exceed the principal amount of $600,000. The line is supported by a financing promissory note. The loan is a demand loan with interest payable at the Bank's prime rate plus 1% on all outstanding balances. The loan is secured by all assets of the Company (excluding consumer goods) and requires the Company to maintain its deposit accounts with the Bank, as well as comply with certain other covenants. The Company believes this line of credit agreement provides it with an important external source of liquidity, if necessary. There were no cash borrowings against the line during fiscal years 2011 and 2010.
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. Guaranties 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 24, 2011 and September 25, 2010 there were no outstanding standby letters of credit. The Company secures its outstanding standby letters of credit with the line of credit facility with the Bank.


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In April 2007, the Company entered into a new lease for its current facilities. This lease is for 22,800 square feet 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 term of the lease is for five years through March 31, 2012 at an annual rate of $159,000. In addition the lease contains options to extend the lease for two and one half years through September 30, 2014 and another two and one half years through March 31, 2017, at an annual rate of $171,000. Rent expense for each of the years ended September 24, 2011 and September 25, 2010 was $159,000. On September 30, 2011 the Company exercised its option to renew the lease for the period April 1, 2012 through September 30, 2014.
In fiscal 2012, the Company expects to increase its investment in internal product development by approximately 35%. Our plan is to continue evaluating several technical options for enhancing the DSP 9000 radio encryption product line, which may include cryptography modifications, hardware and software changes and partnering with radio manufacturers to incorporate imbedded solutions.
In 2011, TCC completed systems testing of a high speed, SONET/SDH optical encryptor called the 72B, which provides full-rate encryption capability at 155mbs and 622mbs speeds. This encryptor is designed to be compliant with FIPS level 140-2 and is expected to be offered in three configurations covering applications for commercial telecommunications providers through highly ruggedized military and government requirements. TCC expects that the 72B encryptor family will provide fully interoperable operations between office and harsh field environments. In 2012, the Company expects to field test the 72B and demonstrate the product to several potential customers.
On-going research and development in support of product improvements and application variants also is expected to continue. In 2011 TCC began development of an advanced, 100mbs through 1gbs family of IP encryptors which will service private network markets for government, military and satellite users. This initiative is planned to have an initial product introduction in 2012. Should the Company choose to embark on a major development program in addition to its traditional research and development activities, engineering staff will have to be added. The Company has sufficient physical resources to support the added staff and believes that adequate technical resources exist in the Boston area to meet potential needs; however we may need financial resources, in addition to cash from operations, to fund a major new development program. Other than those stated above, there are no plans for significant internal product development in fiscal 2012 and the Company does not anticipate any significant capital expenditures during the year. Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.

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