|
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 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 the Company’s Quarterly Report on Form 10-Q for the period ended March 28,
2020 as filed with the SEC 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 initially close
its facilities due to health and safety concerns, it was able to reopen with the majority of employees returning to working onsite
in June 2020. The Company has been able to maintain its operations via remote working and now with its fully active facility, 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 June 27, 2020 compared to Three Months
ended June 29, 2019
Net Revenue
Total net revenue for the quarter ended June 27, 2020 was $599,000,
compared to $1,235,000 for the quarter ended June 29, 2019, a decrease of 52%. Revenue for the third quarter of fiscal 2020 consisted
of $513,000, or 86%, from domestic sources and $86,000, or 14%, from international customers, compared to the same period in fiscal
2019, during which revenue consisted of $1,232,000, or 99%, from domestic sources and $2,000, or 1%, from international customers.
Foreign sales consisted of shipments to one country during each
of the quarters ended June 27, 2020 and June 29, 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 third quarters of fiscal 2020 and 2019:
|
|
|
2020
|
|
2019
|
|
|
|
|
|
|
|
Saudi Arabia
|
|
$
|
86,000
|
|
|
$
|
–
|
|
|
Other
|
|
|
–
|
|
|
|
2,000
|
|
|
|
|
$
|
86,000
|
|
|
$
|
2,000
|
|
For the three months ended June 27, 2020, revenue was derived primarily
from sales of our narrowband radio encryptors and various accessories to a domestic customer for deployment into a Middle Eastern
country amounting to $316,000. We also shipped our narrowband radio encryptors to a domestic customer for deployment into a North
African country amounting to $149,000 and shipped our internet protocol data encryptors to a customer in a Middle Eastern country
amounting to $86,000.
For the three months ended June 29, 2019, revenue was derived primarily
from sales of our engineering services amounting to $953,000 and shipments of our narrowband radio encryptors to a domestic customer
for deployment into a Middle Eastern country amounting to $280,000.
Gross Profit
Gross profit for the third quarter of fiscal 2020 was $355,000,
compared to gross profit of $445,000 for the same period of fiscal 2019, a decrease of 20%. Gross profit expressed as a percentage
of total net revenue was 59% for the third quarter of fiscal 2020 compared to 36% 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 third quarter
of fiscal 2020 were $505,000, compared to $732,000 for the same quarter in fiscal 2019. This decrease of $226,000, or 31%, was
attributable to decreases in general and administrative expenses of $249,000, which were partially offset by increases in selling
and marketing expenses of $23,000 during the three months ended June 27, 2020.
The decrease in general and administrative
expenses for the three months ended June 27, 2020 was primarily attributable to decreases in audit and legal fees of $252,000,
which were unusually high in fiscal 2019 as a result of the restatement of financial statements during such year.
The increase in selling and marketing expenses for the three months
ended June 27, 2020 was primarily attributable to increases in commission expenses of $31,000 and bid and proposal costs of $22,000.
These increases were offset by decreases in product evaluation costs of $10,000, product demonstration costs of $7,000 and consulting
expenses of $3,000 for the period.
Product Development Costs
Product development costs for the quarter ended June 27, 2020 were
$332,000, compared to $43,000 for the quarter ended June 29, 2019. This increase of $289,000, or 671%, was attributable to a decrease
in billable engineering services contracts during the third quarter of fiscal 2020 that resulted in increased product development
costs of $561,000. These increased costs were partially offset by decreases in consulting costs of $170,000 and payroll and payroll-related
expenses of $93,000 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 $47,000 of billable engineering services revenue generated during
the third quarter of fiscal 2020 and $953,000 in the third 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 $482,000 for the third quarter
of fiscal 2020, compared to a net loss of $326,000 for the same period of fiscal 2019. This increase in net loss is primarily attributable
to a 20% decrease in gross profit and an increase in operating expenses of 8% during the third quarter of fiscal 2020.
Nine Months ended June 27, 2020 compared to Nine Months ended
June 29, 2019
Net Revenue
Total net revenue for the nine months ended June 27, 2020 was $1,987,000,
compared to $4,275,000 for the nine months ended June 29, 2019, a decrease of 54%. Revenue for the first nine months of fiscal
2020 consisted of $1,501,000, or 76%, from domestic sources and $487,000, or 24%, from international customers as compared to the
same period in fiscal 2019, during which revenue consisted of $4,076,000, or 95%, from domestic sources and $199,000, or 5%, from
international customers.
Foreign sales consisted of shipments to two countries during the
nine months ended June 27, 2020 and four countries during the nine months ended June 29, 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 nine months of fiscal 2020 and 2019:
|
|
|
2020
|
|
2019
|
|
Saudi Arabia
|
|
$
|
484,000
|
|
|
$
|
112,000
|
|
|
Egypt
|
|
|
–
|
|
|
|
73,000
|
|
|
Philippines
|
|
|
–
|
|
|
|
11,000
|
|
|
Other
|
|
|
3,000
|
|
|
|
3,000
|
|
|
|
|
$
|
487,000
|
|
|
$
|
199,000
|
|
For the nine months ended June 27, 2020, revenue was derived primarily
from sales of our engineering services amounting to $913,000 and shipments of our internet protocol data encryptors to four customers
in a Middle Eastern country amounting to $488,000. We also shipped our narrowband radio encryptors and various accessories to two
domestic customers for deployment into a Middle Eastern country amounting to $434,000 and for deployment into a North African country
amounting to $149,000.
For the nine months ended June 29, 2019, revenue was derived primarily
from sales of our engineering services amounting to $2,820,000, shipments of our narrowband radio encryptors to a domestic customer
for deployment into a North African country amounting to $936,000, and shipments of our narrowband radio encryptors to a domestic
customer for deployment into a Middle Eastern country amounting to $280,000.
Gross Profit
Gross profit for the first nine months of fiscal 2020 was $973,000,
compared to gross profit of $1,644,000 for the same period of fiscal 2019, a decrease of 41%. Gross profit expressed as a percentage
of total net revenue was 49% for the first nine months of fiscal 2020 compared to 38% 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 nine
months of fiscal 2020 were $1,603,000, compared to $1,872,000 for the same period in fiscal 2019. This decrease of $269,000, or
14%, was attributable to decreases in general and administrative expenses of $336,000, offset by increases in selling and marketing
expenses of $67,000 during the nine months ended June 27, 2020.
The decrease in general and administrative
expenses for the nine months ended June 27, 2020 was primarily attributable to a decrease in audit and legal fees of $352,000,
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 $18,000.
The increase in selling and marketing expenses for the nine months
ended June 27, 2020 was primarily attributable to increases in payroll and payroll-related expenses of $48,000, sales commissions
of $54,000 and product demonstration costs of $46,000. These increases were offset by decreases in outside sales and marketing
agreements of $16,000, outside consulting costs of $26,000 and product evaluation costs of $30,000 for the period.
Product Development Costs
Product development costs for the nine months ended June 27, 2020
were $695,000, compared to $187,000 for the nine months ended June 29, 2019. This increase of $508,000, or 272%, was attributable
to a decrease in billable engineering services contracts during the first nine months of fiscal 2020 that resulted in increased
product development costs of $1,333,000, which was partially offset by decreases in engineering project costs of $547,000 and payroll
and payroll-related expenses of $266,000 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 $913,000 of billable engineering services revenue generated during
the first nine months of fiscal 2020 and $2,820,000 in the first nine 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 $1,324,000 for the first nine
months of fiscal 2020, compared to a net loss of $401,000 for the same period of fiscal 2019. This increase in net loss is primarily
attributable to a 41% decrease in gross profit and an increase in operating expenses of 12% during the first nine months of fiscal
2020.
Liquidity and Capital Resources
Our cash and cash equivalents at June 27,
2020 totaled $961,000. 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 the entire loan to be forgiven; in the event that any amount is
not forgiven, that amount 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 $3,479,000 at June 27, 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. While TCC closed its facility due to health and safety concerns, it reopened in June 2020 with a majority
of employees returning to work onsite. 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 cannot provide assurances we will be able to do so on acceptable
terms or at all, 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.
Sources and Uses of Cash
The following table presents our abbreviated
cash flows for the nine month periods ended (unaudited):
|
|
|
June 27,
2020
|
|
June 29,
2019
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,324,000
|
)
|
|
$
|
(401,000
|
)
|
|
Changes not affecting cash
|
|
|
59,000
|
|
|
|
65,000
|
|
|
Changes in assets and liabilities
|
|
|
159,000
|
|
|
|
(867,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash used in operating activities
|
|
|
(1,106,000
|
)
|
|
|
(1,202,000
|
)
|
|
Cash used in investing activities
|
|
|
|
|
|
|
(16,000
|
|
|
Cash provided by financing activities
|
|
|
474,000
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents
|
|
|
(632,000
|
)
|
|
|
(1,218,000
|
)
|
|
Cash and cash equivalents - beginning of period
|
|
|
1,593,000
|
|
|
|
1,982,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents - end of period
|
|
$
|
961,000
|
|
|
$
|
764,000
|
|
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 nine month periods ended June
27, 2020 and June 29, 2019 was $128,000.
Backlog
Backlog at June 27, 2020 and September 28, 2019 amounted to $2,514,000
and $1,154,000, respectively. The orders in backlog at June 27, 2020 are expected to ship and/or services are expected to be performed
over the 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 June 27, 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 nine month periods ended June 27, 2020 and June 29, 2019,
the Company spent $695,000 and $187,000, respectively, on internal product development. The Company also spent $563,000 and $1,994,000,
respectively, on billable development efforts during the first nine months of fiscal 2020 and 2019, respectively. The Company’s
total product development costs during the first nine months of fiscal 2020 were 42% 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
nine 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.
