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TCCO: A Follow Up

|Includes: Technical Communications Corp. (TCCO)
The week ago article on TCCO touched on a few good points, here are some more:
Strong Consistent Profits Given Geopolitical Environment:
TCCO manufactures encrypted communications devices primarily for the military. The company earned $0.55 in F2007, $0.63 in F2008 and is on track to earn at least $0.50 in F2009. The primary reason for this strength stems from orders in Afghanistan. TCCO’s Encryption technology is being imbedded into existing military radios of the local Afghan forces. This has led to strong consistent earnings over the past three years and a robust backlog, which has remained elevated for the past several quarters (discussed below).
Possible Expansion Into Iraq:
The market for TCCO’s products is the best it has been in a long time. In the 2007 annual report TCCO’s CEO said:
 “We believe that TCC encryption products will play a key role in the future of Afghanistan as the country moves to expand control of its security through the establishment of a countrywide secure radio network. Similar results are possible in Iraq, where TCC products are being evaluated.”
Nothing has happened in Iraq yet and I suspect it’s because the war has taken a lot longer than expected however there is nothing to suggest that what the CEO said above is no longer the case.
Backlog as of 3Q:09 stood at $6.7 million, equal to all of F2008 revenue (a good margin of safety). In F2007 when the company earned $0.55 in EPS, backlog averaged $2.6 million and F2008 when the company earned $0.63, the backlog averaged $6.9 million. For the first nine months of F2009 the backlog averaged $7.4 million and the company is on track to do, in my opinion, at least $0.50. The reason it is below the last two years is explained below but bottom line; revenue drivers are there (given geopolitical environment) and elevated backlog provides good visibility into future earnings.
Strong Financial Profile:
TCCO’s gross margin has been above 60% for the past several years, suggesting the company does not have much competition and is able to leverage its operating expenses very well. Operating expenses have been historically low and consistent as have product development costs up until this year (mentioned above). Product development costs are on track to double from last year, a negative for this year but a potential benefit in years to come if the company is upgrading and developing new products. We forecast roughly $0.50 in EPS for F2009 however, had the company kept product development (or R&D) costs equal to that of F2008, EPS this year would be over $0.90. I am hopeful that management wouldn’t have given up that much in earnings to build new products or upgrades unless they were pretty sure it would generate future revenue.
The Balance Sheet:
Like the previous article on TCCO mentioned, the balance sheet is strong with $2.73 in cash (per basics shares) $2.45 on a diluted share basis. What the article didn’t mention is that there is extra cash tied up in higher working capital. If you reduce working capital down to where it ended F2008, cash would increase back up close to the $3 on a dilute share count and almost $3.40 on basic shares out standing. Then if you look a year out and say TCCO converts its backlog into earning and therefore cash flow, the company could have close to $4 per share in cash. TCCO currently has a $4 tangible book value.
The Option:
TCCO also has a great “call option”. The company also provides encryption technology for regular cell phones and smart phones. In the 10Q TCCO says:
“It is also expected that CipherTalk Secure Voice encryption and CipherSMS Secure Text Messaging will be applied to additional mobile platforms and that customer-specific features will be developed”
On the company’s website offerings for consumer products are shown. Should a well known smart phone company ever decide to make this an option on say an I-phone or Blackberry, the royalty income could be huge.
Possible Catalysts:
An activist investor to push for a $2 special dividend and get management to hire a team to go after the smart phone market!!
In Summary TCCO Has:
1) Good future revenue growth environment (Afghanistan and maybe Iraq).
2) A good strong backlog of future orders (good visibility).
3) New products (from increased R&D) and a reduction in costs when the new product development phase is over.
4) TCCO is trading at 7x F2008 and about 9x artificially depressed expected F2009 estimates of $0.50.
5) In a year from now as TCCO converts its backlog to cash it could have close to $4 per share in cash.

Disclosure: Long TCCO.OB