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 impact of the COVID-19 pandemic (including its duration and severity) and governmental actions in response thereto; the effect of domestic and foreign political unrest; domestic and foreign government policies and economic conditions; 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 2019 Annual Report and Item 1A in Part II of this Quarterly Report on Form 10-Q for a supplemental risk factor relating to COVID-19.

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.

Impact of COVID-19 Coronavirus

As a result of the current economic slowdown due to the COVID-19 pandemic, there has been a noticeable delay in the receipt of customer orders. While we remain in contact with our customers and their requirements have not changed, the operations of certain of our customers have been slowed or shut down entirely. Our suppliers thus far have been able to timely deliver components and parts necessary for the manufacture and production of the Company’s products to fulfill orders, although we cannot be sure this trend will continue. To date, while the Company did close its facilities due to health and safety concerns, it has been able to maintain its operations via remote working and believes it will be in a strong position to respond to our customers’ needs as restrictions ease and operations return to normal. Nonetheless, it is uncertain how long our and our customers’ operations will be impacted, and those of our suppliers, and our ability to respond to customer requirements and supplier issues will become more challenging during a period of sustained disruption. Any period of sustained disruption would have a material adverse effect on the Company’s financial condition and results of operations.

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 28, 2019 and we have not adopted any accounting policies that have had or will have a material impact on our consolidated financial statements. For further discussion of our accounting policies see Note 2, 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 2019 Annual Report as filed with the SEC.

Results of Operations

Three Months ended March 28, 2020 compared to Three Months ended March 30, 2019

Net Revenue

Total net revenue for the quarter ended March 28, 2020 was $723,000, compared to $1,928,000 for the quarter ended March 30, 2019, a decrease of 63%. Revenue for the second quarter of fiscal 2020 consisted of $496,000, or 69%, from domestic sources and $227,000, or 31%, from international customers as compared to the same period in fiscal 2019, during which revenue consisted of $1,822,000, or 94%, from domestic sources and $106,000, or 6%, from international customers.

Foreign sales consisted of shipments to two countries during each of the quarters ended March 28, 2020 and March 30, 2019. 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 quarters of fiscal 2020 and 2019:

For the three months ended March 28, 2020, revenue was derived primarily from sales of our engineering services amounting to $458,000 and shipments of our internet protocol data encryptors to two customers in a Middle Eastern country amounting to $224,000.

For the three months ended March 30, 2019, revenue was derived primarily from sales of our engineering services amounting to $877,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a North African country amounting to $936,000.

Gross Profit

Gross profit for the second quarter of fiscal 2020 was $309,000, compared to gross profit of $799,000 for the same period of fiscal 2019, a decrease of 61%. Gross profit expressed as a percentage of total net revenue was 43% for the second quarter of fiscal 2020 compared to 41% for the same period in fiscal 2019. This increase in gross profit expressed as a percentage of total net revenue was primarily due to the higher sales volume of higher margin equipment sales in fiscal 2020.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the second quarter of fiscal 2020 were $513,000, compared to $595,000 for the same quarter in fiscal 2019. This decrease of $82,000, or 14%, was attributable to decreases in general and administrative expenses of $117,000, which were partially offset by increases in selling and marketing expenses of $35,000 during the three months ended March 28, 2020.

The decrease in general and administrative expenses for the three months ended March 28, 2020 was primarily attributable to decreases in audit and legal fees of $129,000, which were unusually high in fiscal 2019 as a result of the restatement of financial statements during such year, partially offset by an increase in insurance costs of $9,000.

The increase in selling and marketing expenses for the three months ended March 28, 2020 was primarily attributable to increases in payroll and payroll-related expenses of $25,000 and product demonstration costs of $35,000. These increases were offset by decreases in bid and proposal costs of $11,000, outside consulting costs of $9,000 and product evaluation costs of $13,000 for the period.

Product Development Costs

Product development costs for the quarter ended March 28, 2020 were $157,000, compared to $36,000 for the quarter ended March 30, 2019. This increase of $121,000, or 332%, was attributable to a decrease in billable engineering services contracts during the second quarter of fiscal 2020 that resulted in increased product development costs of $389,000. These increased costs were partially offset by decreases in engineering project costs of $166,000 and payroll and payroll-related expenses of $100,000 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. 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 $458,000 of billable engineering services revenue generated during the second quarter of fiscal 2020 and $877,000 in the second quarter of fiscal 2019.

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.

Net Loss

The Company generated a net loss of $361,000 for the second quarter of fiscal 2020, compared to net income of $173,000 for the same period of fiscal 2019. This net loss is primarily attributable to a 61% decrease in gross profit and an increase in operating expenses of 6% during the second quarter of fiscal 2020.

Six Months ended March 28, 2020 compared to Six Months ended March 30, 2019

Net Revenue

Total net revenue for the six months ended March 28, 2020 was $1,389,000, compared to $3,041,000 for the six months ended March 30, 2019, a decrease of 54%. Revenue for the first six months of fiscal 2020 consisted of $988,000, or 71%, from domestic sources and $401,000, or 29%, from international customers as compared to the same period in fiscal 2019, during which revenue consisted of $2,845,000, or 94%, from domestic sources and $196,000, or 6%, from international customers.

Foreign sales consisted of shipments to two countries during the six months ended March 28, 2020 and three countries during the six months ended March 30, 2019. 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 2020 and 2019:

For the six months ended March 28, 2020, revenue was derived primarily from sales of our engineering services amounting to $867,000, shipments of our internet protocol data encryptors to three customers in a Middle Eastern country amounting to $398,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a North African country amounting to $117,000.

For the six months ended March 30, 2019, revenue was derived primarily from sales of our engineering services amounting to $1,867,000 and shipments of our narrowband radio encryptors to a domestic customer for deployment into a North African country amounting to $936,000.

Gross Profit

Gross profit for the first six months of fiscal 2020 was $618,000, compared to gross profit of $1,199,000 for the same period of fiscal 2019, a decrease of 48%. Gross profit expressed as a percentage of total net revenue was 44% for the first six months of fiscal 2020 compared to 39% for the same period in fiscal 2019. This increase in gross profit expressed as a percentage of total net revenue was primarily due to the higher sales volume of higher margin equipment sales in fiscal 2020.

Operating Costs and Expenses

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the first six months of fiscal 2020 were $1,097,000, compared to $1,140,000 for the same period in fiscal 2019. This decrease of $43,000, or 4%, was attributable to decreases in general and administrative expenses of $87,000, offset by increases in selling and marketing expenses of $44,000 during the six months ended March 28, 2020.

The decrease in general and administrative expenses for the six months ended March 28, 2020 was primarily attributable to a decrease in audit and legal fees of $112,000, which were unusually high during fiscal year 2019 as a result of the restatement of financial statements during such year, partially offset by an increase in director fees of $11,000 and an increase in insurance costs of $19,000.

The increase in selling and marketing expenses for the six months ended March 28, 2020 was primarily attributable to increases in payroll and payroll-related expenses of $61,000 and product demonstration costs of $53,000. These increases were offset by decreases in bid and proposal costs of $24,000, outside consulting costs of $23,000 and product evaluation costs of $20,000 for the period.

Product Development Costs

Product development costs for the six months ended March 28, 2020 were $362,000, compared to $144,000 for the six months ended March 30, 2019. This increase of $219,000, or 152%, was attributable to a decrease in billable engineering services contracts during the first six months of fiscal 2020 that resulted in increased product development costs of $772,000, which was partially offset by decreases in engineering project costs of $370,000 and payroll and payroll-related expenses of $173,000 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. 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 $867,000 of billable engineering services revenue generated during the first six months of fiscal 2020 and $1,867,000 in the first six months of fiscal 2019.

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.

Net Loss

The Company generated a net loss of $842,000 for the first six months of fiscal 2020, compared to a net loss of $75,000 for the same period of fiscal 2019. This increase in net loss is primarily attributable to a 48% decrease in gross profit and an increase in operating expenses of 14% during the first six months of fiscal 2020.

Liquidity and Capital Resources

Our cash and cash equivalents at March 28, 2020 totaled $607,000 and we had no debt at such date. In April 2020, we received $474,400 from the U.S. Small Business Administration under the Paycheck Protection Program as authorized under the CARES Act. The Company expects a portion of the loan to be forgiven; any amount not forgiven will be paid back over two years at an interest rate of 1% beginning six months from the date of the loan.

Liquidity and Ability to Continue as a Going Concern

The Company has suffered recurring losses from operations and had an accumulated deficit of $2,997,000 at March 28, 2020. 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. The unaudited 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 December 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/or reduce expenses, including payroll and payroll-related expenses.

In order to have sufficient capital resources to fund operations beyond the temporary relief provided by the CARES Act loan, the Company has been working diligently to secure several large orders with new and existing customers. The receipt of orders is difficult to predict due to the impact of the COVID-19 pandemic on our customers, as many have had to delay orders as a result of their operations being reduced or shut down. TCC closed its facility due to health and safety concerns but has been able to maintain operations with employees working remotely. Nonetheless, any sustained period of disruption in either our customers’ operations or those of the Company would have a material adverse impact on sales activity and revenue.

We are also pursuing raising debt or equity capital. 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, especially in light of the tightening of the credit markets and volatility of the capital markets as a result of the coronavirus.

Should we be unsuccessful in these efforts, we would be forced to implement headcount reductions, employee furloughs and/or reduced hours for certain employees or cease operations completely.

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 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. In September 2018, the Company exercised its option to extend the term of the lease through September 2021. The lease expense for each of the six month periods ended March 28, 2020 and March 30, 2019 was $85,000.

Backlog

Backlog at March 28, 2020 and September 28, 2019 amounted to $471,000 and $1,154,000, respectively. The orders in backlog at March 28, 2020 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 28, 2020 and September 28, 2019, the Company had no outstanding letters of credit.

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 month periods ended March 28, 2020 and March 30, 2019, the Company spent $362,000 and $144,000, respectively, on internal product development. The Company also spent $532,000 and $1,332,000, respectively, on billable development efforts during the first six months of fiscal 2020 and 2019, respectively. The Company’s total product development costs during the first six months of fiscal 2020 were 39% lower than the same period in fiscal 2019 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 total product development expenses will remain lower until we secure a new billable research and development contract.

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, 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 particularly in light of the impact of the COVID-19 pandemic on business and the economy in general.

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 2020.

New Accounting Pronouncements

ASU No. 2016-02, Leases

In February 2016, the FASB issued guidance under ASU No. 2016-02, Leases, with respect to leases. This ASU requires an entity 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. The new guidance was effective for the Company beginning September 29, 2019. The adoption of this standard required the Company to recognize a right-of-use asset and a corresponding lease liability associated with the operating lease on its facilities at 100 Domino Drive, Concord, MA in the amount of $767,712 at September 29, 2019.

Other recent accounting pronouncements were issued by the FASB (including its Emerging Issues Task Force) and the SEC during the first six months of the Company’s 2020 fiscal year but such pronouncements are not believed by management to have a material impact on the Company’s present or future financial statements.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements.