The allure of a thinly-traded, nano-cap like Technical Communications (NASDAQ:TCCO) stock is that investors can find a hidden gem. The risk is that many such stocks face significant challenges; some are even shady fly-by-night operators that rely on questionable promotions to drive investor interest.
TCCO stock, at least of late, has been a prime example of the potential returns investors can garner in small, undercovered names. Shares jumped a stunning 308% on Dec. 10 after the company posted a huge fiscal fourth quarter profit.
The optimism has dimmed somewhat: TCCO was up as much as 435% intraday following earnings, and has receded by 34% from that day’s close. Still, shares have gained 170% since the Q4 release, thanks to a steady recovery in recent trading.
Meanwhile, the risks here seem manageable, at least by the standards of a stock with a $10 million market capitalization. Technical Communications is not a company with a questionable background or unproven technology. It’s a real company with a real history and, at least in fiscal 2019, real profits and cash flow.
That said, there is one key risk here. And it’s probably a big enough risk to suggest at least that the easy money has been made.
The Case for TCCO Stock
Again, TCCO stock is not a standard nano-cap stock. The company was founded in 1961, and pivoted to manufacturing secure communications devices in the late 1960s. Governments worldwide are the primary customers; according to its 10-K filing, Technical Communications has delivered products into over 115 countries during its history.
Meanwhile, the company’s incentives seem reasonably aligned with its shareholders, for one key reason. Chief executive officer Carl Guild owns 18% of outstanding shares, according to the proxy statement filed this month.
In the context of those structural factors, the gains after the fourth quarter release do make some sense. TCCO stock trades just above $5; it generated 56 cents per share in earnings in Q4 alone, and 34 cents for the year. Revenue in fiscal 2019 nearly doubled and Technical Communications swung from a loss to a profit — yet shares trade at just 15.6x last year’s earnings.
Fundamentally, Technical Communications stock looks like a steal, even after quadrupling in a single session. But the one key risk is that the numbers don’t tell the whole story here.
The core problem with Technical Communications is that its business is lumpy. Revenues are inconsistent, in large part because the company relies on just a few big orders for much of its revenue.
In fiscal 2018, for instance, a single customer drove 87% of total revenue, according to this year’s 10-K. Even in the stronger FY19, just three customers accounted for 96% of sales. Technical Communications offers both products and custom solutions (what the company calls engineering revenue), but product revenues vary greatly from year to year and even quarter to quarter. Q4 and even FY19 performance doesn’t necessarily signal a return to immediate growth or even profitability.
That looks like a potential problem heading into fiscal 2020. TCCO closed fiscal 2018 with a backlog over $2 million. Backlog at the end of this year was zero. That doesn’t mean revenue necessarily declines, but given what the company itself notes are long product cycles, it does suggest that first quarter revenue, at least, will be soft. And soft revenue for Technical Communications usually leads to operating losses.
The profit for the full year was Technical Communications’ first since fiscal 2011. Since then, the business has gone in the wrong direction, posting steady operating losses to the point that the most recent 10-K still contained a so-called “going concern” warning.
That warning doesn’t mean the company is headed into bankruptcy in the next twelve months (investors might recall a similar warning from Chesapeake Energy (NYSE:CHK), which was followed by a debt refinancing). But Technical Communications still closed fiscal 2019 with just $1.6 million in cash and averaged an annual operating loss of nearly $2 million in the four prior fiscal years. As Ian Bezek noted this month, the company in August had to borrow $300,000 from CEO Guild for working capital.
And it’s possible Technical Communications reverts to losses. Revenue in fiscal 2019 was still one-third what the company posted in fiscal 2010. As with drone manufacturer AeroVironment (NASDAQ:AVAV), it appears that fewer U.S. “boots on the ground” in the Middle East (and Afghanistan in particular) has been a key factor. That issue is unlikely to change.
Again, Technical Communications isn’t necessarily destined for bankruptcy. But there is a very real risk that fiscal 2019 results, and particularly the Q4 numbers, are an outlier. The simple fundamental case — a company growing at a rapid clip, whose stock is still “cheap” on an earnings basis — doesn’t tell the whole story.
There is one interesting question to ask about Technical Communications: why, exactly, is this company public? In its first profitable year since fiscal 2011, the company generated $631,000 in net income. Surely, the costs of being a public company depress that figure, and are likely a few percentage points of revenue on their own.
That leads to another interesting question: for how long will Technical Communications be public? Guild is 76 years old. Chief Financial Officer Michael Malone is 60, and the three other directors on the company’s board all are over 70. It does seem like the leaders of the company could be in a position to cash out, particularly given Guild’s aforementioned ownership of a large block of stock.
And a sale would seem to be possible. Again, its technology has been refined for five decades now, and the 10-K cites “next generation” encryptors, the Cipher X 7220 and 7210. Technical Communications is too small for a defense giant like Lockheed Martin (NYSE:LMT). But what about fellow micro-cap CSP Inc. (NASDAQ:CSPI), or French competitor Thales SA (OTCMKTS:THLLY)?
The response to this speculation — and to be clear, it’s purely speculation — is that a case has held for most of this decade. This is a company whose market capitalization was under $4 million just a few weeks ago. The technology should have had similar value in 2011, or 2014. But perhaps GAAP profits, and the potential for cost savings, could make Technical Communications attractive as a tuck-in acquisition.
The word there, however, is “perhaps.” This still is a stock with substantial risk, looking at the revenue and profit trends over the past decade. If the company can run a profitable business and if management decides it’s time to exit, TCCO shares may have more upside ahead. Investors need to remember that those are both big “ifs.”
As of this writing, Vince Martin has no positions in any securities mentioned.