Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Forward-Looking Statements
Certain statements contained herein or as may otherwise be incorporated
by reference herein that are not purely historical constitute “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements include but are not limited to statements regarding
anticipated operating results, future earnings, and the Company’s ability to achieve growth and profitability. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors, including but not limited to 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 its Annual Report
on Form 10-K for the fiscal year ended September 30, 2017.
Overview
The Company 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 also sell these products to commercial entities and U.S. government
agencies. We generate additional 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
There have been no material changes in the Company’s critical
accounting policies or critical accounting estimates since September 30, 2017, nor have we adopted any accounting policy
that has or will have a material impact on our consolidated financial statements. For further discussion of our accounting
policies see Note 1,
Summary of Significant Accounting Policies and Significant Judgments and Estimates
in the Notes to
Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q and the Notes to Consolidated Financial Statements
in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017 as filed with the SEC.
Results of Operations
Three Months ended March 31, 2018 compared to Three Months ended
April 1, 2017
Net Sales
Net sales for the quarter ended March 31, 2018 were $930,000, compared
to $1,385,000 for the quarter ended April 1, 2017, a decrease of 33%. Sales for the second quarter of fiscal 2018 were all from
domestic sources as compared to the same period in fiscal 2017, during which sales consisted of $1,252,000, or 90%, from domestic
sources and $133,000, or 10%, from international customers.
Foreign sales consisted of shipments to three countries during the
quarter ended April 1, 2017; there were no sales into foreign countries by the Company during the quarter ended March 31, 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 sales by country during the second quarter of fiscal 2018 and 2017:
|
|
2018
|
|
2017
|
|
|
|
|
|
Saudi Arabia
|
|
$
|
-
|
|
|
$
|
95,000
|
|
Jordan
|
|
|
-
|
|
|
|
28,000
|
|
Philippines
|
|
|
-
|
|
|
|
10,000
|
|
|
|
$
|
-
|
|
|
$
|
133,000
|
|
For the three months ended March 31, 2018, revenue was derived primarily
from sales of our engineering services amounting to $900,000.
For the three months ended April 1, 2017, product sales revenue
was derived primarily from shipments of our narrowband radio encryptors to a domestic customer for deployment into Afghanistan
amounting to $1,250,000. We sold our internet protocol encryptor to a customer in Saudi Arabia amounting to $95,000 and also made
shipments of our secure telephone and fax encryptor to an international customer in Jordan amounting to $28,000 during the quarter.
Gross Profit
Gross profit for the second quarter of fiscal 2018 was $351,000,
compared to gross profit of $1,147,000 for the same period of fiscal 2017, a decrease of 69%. Gross profit expressed as a percentage
of sales was 38% for the second quarter of fiscal 2018 compared to 83% for the same period in fiscal 2017, which decrease was due
to the lower margin engineering services sales in fiscal 2018.
Operating Costs and Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the second quarter
of fiscal 2018 were $531,000, compared to $545,000 for the same quarter in fiscal 2017. This decrease of $14,000, or 3%, was attributable
to a decrease in selling and marketing expenses of $87,000, which was offset by an increase in general and administrative expenses
of $73,000 during the three months ended March 31, 2018.
The decrease in selling and marketing expenses
for the three months ended March 31, 2018 was attributable to decreases in product evaluation costs of $42,000, bid and proposal
costs of $30,000, outside sales commissions of $19,000 and product demonstration costs of $11,000. These decreases were partially
offset by an increase in personnel-related costs of $14,000.
The increase in general and administrative expenses for the three
months ended March 31, 2018 was primarily attributable to increases in audit fees and other public company costs of $71,000.
Product Development Costs
Product development costs for the quarter ended March 31, 2018 were
$135,000, compared to $477,000 for the quarter ended April 1, 2017. This decrease of $341,000, or 72%, was attributable to an increase
in billable engineering services contracts during the second quarter of fiscal 2018 that resulted in decreased product development
costs of $381,000 and reduced personnel related costs of $40,000. These decreased costs were partially offset by an increase in
engineering project costs of $81,000 during the period.
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 sales; 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.
The Company actively sells its engineering services in support of
funded research and development. The receipt of these orders is sporadic, although such programs can span over several months.
In addition to these programs, the Company also invests in research and development to enhance its existing products or to develop
new products, as it deems appropriate. There was approximately $900,000 of billable engineering services revenue generated during
the second quarter of fiscal 2018 and none in the second quarter of fiscal 2017.
Net Loss
The Company incurred a net loss of $313,000 for the second quarter
of fiscal 2018, compared to net income of $128,000 for the same period of fiscal 2017. This net loss is primarily attributable
to a 69% decrease in gross profit, which was partially offset by a decrease in operating expenses of 35% during the second quarter
of fiscal 2018.
Six Months ended March 31, 2018 compared to Six Months ended
April 1, 2017
Net Sales
Net sales for the six months ended March 31, 2018 were $2,046,000,
compared to $2,017,000 for the six months ended April 1, 2017, an increase of 1%. Sales for the first six months of fiscal 2018
consisted of $1,917,000, or 94%, from domestic sources and $129,000, or 6%, from international customers as compared to the same
period in fiscal 2017, during which sales consisted of $1,784,000, or 88%, from domestic sources and $233,000, or 12%, from international
customers.
Foreign sales consisted of shipments to four countries during each
of the six month periods ended March 31, 2018 and April 1, 2017. 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 during the first six months of
fiscal 2018 and 2017:
|
|
2018
|
|
2017
|
|
|
|
|
|
Philippines
|
|
$
|
70,000
|
|
|
$
|
10,000
|
|
Saudi Arabia
|
|
|
34,000
|
|
|
|
101,000
|
|
Jordan
|
|
|
13,000
|
|
|
|
106,000
|
|
Egypt
|
|
|
12,000
|
|
|
|
16,000
|
|
|
|
$
|
129,000
|
|
|
$
|
233,000
|
|
For the six months ended March 31, 2018, revenue was derived primarily
from sales of our engineering services amounting to $1,800,000 and shipments of our narrowband radio encryptors to a customer in
the Far East amounting to $70,000 and to a domestic customer for deployment into Afghanistan amounting to $57,000.
For the six months ended April 1, 2017, product sales revenue was
derived primarily from shipments of our narrowband radio encryptors to a domestic customer for deployment into Afghanistan amounting
to $1,781,000. The Company made shipments of our secure telephone and fax encryptor to an international customer in Jordan amounting
to $106,000 during the period. We also sold our internet protocol encryptor to a customer in Saudi Arabia amounting to $95,000.
Gross Profit
Gross profit for the first six months of fiscal 2018 was $923,000,
compared to gross profit of $1,590,000 for the same period of fiscal 2017, a decrease of 42%. Gross profit expressed as a percentage
of sales was 45% for the first six months of fiscal 2018 compared to 79% for the same period in fiscal 2017, which decrease was
due to the lower margin engineering services sales in fiscal 2018.
Operating Costs and Expenses
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the first six months
of fiscal 2018 were $991,000, compared to $1,191,000 for the same period in fiscal 2017. This decrease of $200,000, or 17%, was
attributable to a decrease in selling and marketing expenses of $239,000, which was partially offset by an increase in general
and administrative expenses of $39,000, during the six months ended March 31, 2018.
The decrease in selling and marketing expenses for the six months
ended March 31, 2018 was attributable to decreases in product evaluation costs of $60,000, bid and proposal costs of $43,000 and
product demonstration costs of $135,000. These decreases were partially offset by an increase in personnel-related costs of $21,000.
The increase in general and administrative
expenses for the six months ended March 31, 2018 was primarily attributable to increases in audit fees and other public company
costs of $75,000. These increases were partially offset by a decrease in personnel-related costs of $30,000 during the period.
Product Development Costs
Product development costs for the six months ended March 31, 2018
were $301,000, compared to $971,000 for the six months ended April 1, 2017. This decrease of $670,000, or 69%, was attributable
to an increase in billable engineering services contracts during the first six months of fiscal 2018 that resulted in decreased
product development costs of $673,000 and reduced personnel related costs of $85,000. These decreased costs were partially offset
by an increase in engineering project costs of $94,000 during the period.
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 sales; 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.
The Company actively sells its engineering services in support of
funded research and development. The receipt of these orders is sporadic, although such programs can span over several months.
In addition to these programs, the Company also invests in research and development to enhance its existing products or to develop
new products, as it deems appropriate. There was approximately $1,800,000 of billable engineering services revenue generated during
the first six months of fiscal 2018 and none in the first six months of fiscal 2017.
Net Loss
The Company incurred a net loss of $365,000 for the first six months
of fiscal 2018, compared to a net loss of $567,000 for the same period of fiscal 2017. This decrease in net loss is primarily attributable
to a 40% decrease in operating expenses and partially offset by a 42% decrease in gross profit during the first six months of fiscal
2018.
The effects of inflation and changing costs have not had a significant
impact on sales or earnings in recent years. As of March 31, 2018, 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, cash equivalents and marketable
securities (excluding restricted cash) at March 31, 2018 totaled $1,531,000 and we continue to have no debt.
Liquidity and
Ability to Continue as a Going Concern
The Company has suffered
recurring losses from operations and had an accumulated deficit of $1,188,000 at March 31, 2018. These factors raise substantial
doubt about the Company's ability to continue as a going concern within one year from the issuance date of the unaudited consolidated
financial statements included in this Quarterly Report on Form 10-Q. The unaudited consolidated financial statements included herein
do not include any adjustments to reflect the uncertainty 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 through March 31, 2019. In order
to have sufficient cash to fund our operations beyond March 31, 2019, 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, we are pursuing raising capital through equity or debt arrangements. Although
we believe our ability to secure such new business and raise new capital is likely, we cannot provide assurances we will be able
to do so.
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.
Sources and Uses of Cash
The following table presents our abbreviated
cash flows for the six month periods ended (unaudited):
|
|
March 31,
|
|
April 1,
|
|
|
2018
|
|
2017
|
|
|
|
|
|
Net loss
|
|
$
|
(365,000
|
)
|
|
$
|
(567,000
|
)
|
Changes not affecting cash
|
|
|
13
,000
|
|
|
|
86,000
|
|
Changes
in assets and liabilities
|
|
|
284,000
|
|
|
|
(1,167,000
|
)
|
|
|
|
|
|
|
|
|
|
Cash used in operating activities
|
|
|
(68,000
|
)
|
|
|
(1,648,000
|
)
|
Cash
provided by investing activities
|
|
|
213,000
|
|
|
|
187,000
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash
equivalents
|
|
|
145,000
|
|
|
|
(1,461,000
|
)
|
Cash
and cash equivalents - beginning of period
|
|
|
1,284,000
|
|
|
|
2,589,000
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents - end of period
|
|
$
|
1,429,000
|
|
|
$
|
1,128,000
|
|
Operating Activities
The Company used approximately $1,580,000 less cash for operating
activities in the first six months of fiscal 2018 compared to the same period in fiscal 2017. This decrease was primarily attributable
to a decrease in accounts receivable during the six month period ended March 31, 2018.
Investing Activities
Cash provided by investing activities during the first six months
of fiscal 2018 increased by approximately $26,000 compared to the same period in fiscal 2017. This change is primarily attributable
to the maturity of short-term investments in marketable securities of $150,000 and partially offset by a decrease in proceeds from
the sale of cost method investment of $76,000 and an increase in additions equipment and leasehold improvements of $35,000, during
the first six months of 2018.
Company Facilities
On April 1, 2014, the Company entered into
a 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 initial term of the lease is 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 six month
periods ended March 31, 2018 and April 1, 2017 was $85,000.
Backlog
Backlog at March 31, 2018 and September 30, 2017 amounted to $2,157,000
and $1,975,000, respectively. The orders in backlog at March 31, 2018 are expected to ship and/or services are expected to be performed
over the next six months depending on customer requirements and product availability.
Performance guaranties
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 March 31, 2018, the Company had one outstanding letter of credit in the amount of $12,000 and at September 30, 2017 the Company
had two outstanding letters of credit in the amounts of $12,000 and $1,000. These collateralized bank accounts represent cash which
has restrictions on its use.
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 six months ended March 31, 2018 and April 1, 2017, the
Company spent $301,000 and $971,000, respectively, on internal product development. The Company also spent $869,000 on billable
development efforts during the first six months of fiscal 2018. There were no billable development efforts during the first six
months of fiscal 2017. The Company’s total product development costs during the first six months of fiscal 2018 were 20%
higher than the same period in fiscal 2017 but in line with its planned commitment to research and development, and reflected the
costs of custom development, product capability enhancements and production readiness. It is expected that development expenses
for fiscal 2018 will be consistent with fiscal 2017 levels.
It is anticipated that cash from operations
will fund our near-term research and development and marketing activities through at least the end of calendar year 2018. 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;
however, we can provide no guarantees that we will be successful in securing such additional financing.
Other than those stated above, there are no
plans for significant internal product development or material commitments for capital expenditures during the remainder of fiscal
2018.
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. Early adoption is not permitted. The Company is currently evaluating
the impact of this guidance and is still considering whether it will have a material effect on the Company’s consolidated
financial statements. This guidance will become effective for TCC as of the beginning of our 2019 fiscal year.