It’s a busy time of year from an earnings perspective, and the real world has gotten in the way of my normal posting schedule.

However, I’m pretty happy with the earnings results so far, as most of my current positions have performed well – some more so than others.

While one quarter’s (or even a year or longer in many cases) performance doesn’t make or break the merits of a selection, I continue to monitor my investment thesis closely for any signs of deterioration, whether from competition, changing market conditions, or other catalysts.

To be more efficient, I’m going to combine several earnings reports into a series of summary posts.

AMCON Distributing Co. (DIT)

Despite a challenging distributing environment and significantly higher energy costs, AMCON turned in a solid quarter.

Second quarter revenues came in at $206m, down 6% from $230m during the same quarter in 2010. The majority of this decrease was a lower volume of cigarette sales (down $18.7m) that was not offset by a corresponding increase in cigarette prices (up $5.9m).

Net income was $1.5m, down 12%, translating to quarterly EPS of $2.56.

While the income statement showed some pressure, management continues to strengthen the balance sheet.

Due to the nature of the DIT’s business model (i.e. extremely low margins, decent operating leverage), it was good to see the company pay off $5.8m in debt during the quarter.

More importantly, the company renewed its credit agreement with Bank of America – an absolutely vital lifeline for the distributing side of the business – for another 3 years on significantly better terms:

Management continues to take a long-term perspective, not only in expansion but in potential acquisition targets as well:

“We are delighted to have an enhanced credit facility that we believe will give us additional flexibility to take advantage of potential acquisitions and merchant opportunities …We are taking a long range view as we continue to make investments in foodservice, technology and related value added propositions designed to increase our customers’ bottom line… We are carefully evaluating new store locations in both of the regions we operate in. Our recent store opening in Tulsa, Oklahoma has met our expectations. Our niche in the retail market is well defined and we believe there is room to prudently expand…”

Sparton Corp (SPA)

After reporting tough second quarter results back in February, Sparton’s stock sold off sharply over the next few days, dropping almost 20%, despite reasonable explanations for the mixed results and several positive developments.

The confidence was vindicated with the third quarter results this week, as quarterly revenues shot up more than 30% to $50.3m, compared to $38.6m in the third quarter last year.

The new acquisition of Byers Peak is providing immediate gains – with further margin improvements possible due to the planned plant consolidation – and the EMS segment finally showed a big jump in margins as management focuses on profitable contracts.

This margin improvement led to the largest quarterly gross profit in over five years, with quarterly net income more than tripling to $2.5m, or $0.25 per share.

The turnaround is continuing nicely, setting up SPA for its stated (and very bold) goal of reaching $500m in sales by 2015.

Advant-E Corp (ADVC)

The company continues to chug along with steadily improving results. First quarter revenue was up 5% to $2.3m, compared to $2.2m in the same period the previous year.

Edict Systems, the amazingly-consistent SaaS growth machine, turned out another 2% revenue increase, but the big surprise was the Merkur Group with a 22% jump in sales.

Merkur was hit hard during the recession – even posting small losses – but the acquisition is looking better as the economy recovers.

Net income was up to $385k, equal to $0.006 per share, up 45% over the first quarter last year.

More importantly, the company announced another special dividend of $0.02 per share, payable in two installments during the remainder of 2011. The last special dividend was a big part of the original investment thesis.

By the end of 2012, the company will have returned $0.05 per share in dividends in less than two years – almost 20% of the current market cap – once again showing a commitment to rewarding “shareholders, many of whom are long-term investors in the Company.”

Gaming Partners International (GPIC)

I was very late in posting my viewpoint on GPIC’s 2010 financial results, as the company quickly followed up my post by announcing stellar first quarter earnings.

According to the press release,

“For the first quarter of 2011, the Company posted revenues of $17.8 million and net income of $1.7 million, or $0.21 per basic and diluted share. These results compare to revenues of $10.9 million and net income of $37,000, or $0.00 per basic and diluted share, for the first quarter of 2010.”

And backing up my thesis:

“The primary reason for the significant increase in first quarter 2011 net income was comparably higher sales of chips to casinos in Macau.”

As far as the company’s prospects for the rest of 2011, consider this:

GPIC’s first quarter EPS of $0.21 is roughly 40% of the company’s earnings for all of 2010, the 2nd best year in the company’s history, AND the first quarter is usually the slowest of the year.

While the company warned that the rest of the year will unlikely match these results, I think it bodes well for the annual outlook (and hopefully the stock price!).

Concluding Thoughts

I continue to look for ways to raise additional cash in the portfolio, as I remain skeptical on the overall market.

However, there are quite a few stocks, including a few international ones, that I am tracking closely. I’ve had 6-7 bids outstanding for many weeks, as I continue to remain patient about picking up shares in some of these illiquid issues.

I hope to showcase some fresh analysis over the coming months.

Make sure to stay tuned for Part II as more holdings report their results.

Disclosure

Long DIT, SPA, ADVC, & GPIC

Sparton Corp. (SPA) reported fiscal 2nd quarter results two weeks ago. The stock dropped sharply on the news, but has since rebounded. A great deal has occurred since my original post on the company.

SPA’s management continues to focus on improving margins and eliminating unprofitable contracts, so the fall in top-line results is probably expected – and sets the company up for a much better future.

Financial Results

Sparton reported results for the fiscal 2nd quarter of 2011, with sales falling from $47.2m to $46.3m, or 1.9%. The company showed top-line weakness across most of the major product divisions including foreign sonobuoy sales in the DSS segment and increased program losses within the EMS segment.

However, the Delphi acquisition has proved profitable, contributing $11.4m in sales on a net income rate of $1.2m, a major boost to the quarter’s final tally.

Operating profits were up 3% to $1.58m compared to $1.48m in the prior year quarter. The 2010 second quarter was negatively impacted by a $1m restructuring charge, but helped by a $1.9m income tax benefit, making bottom line comparisons difficult.

Overall, the company reported net income of $1.4m, or $0.14 per share.

Through the first six months of the year, sales are off 3% with significant declines in the EMS business offset by revenue increases in the Medical segment.

Operating income is much improved, even discounting for a $2.4m gain due to the recent acquisition, up to $5.6m.

The balance sheet remains strong, with $30m in cash offset by only $1.8m in debt (and the company has an unused $20m credit line available).

Business Segment Overview

Since taking over, management has been extremely focused on improving margins in the company’s core businesses. Some of the legacy contracts in the EMS division were unprofitable, and the company has made the difficult decision to cut loose or restructure contracts with those customers, causing the sales decrease.

Long-term, this is a sound strategy, as the remaining customer relationships will translate into higher margins, a key portion of the original investment thesis.

In addition, the legacy Medical business segment has shown declines over the past few quarters, due to softening in several core customers. According to Cary Wood, Sparton’s CEO:

“there have been three major customer issues that have primarily impacted the overall softening, with one customer that suspended production to make product enhancement modifications, a second customer who moved their production back into their own manufacturing footprint, and a third customer who right-sized their inventories due to market softening and a primary working capital initiative.”

Despite the reduction in volume in the Strongsville facility – where the legacy Medical business is performed – the company has maintained a 14% gross margin due to strong cost containment measures, well within their targets.

Finally, SPA’s DSS segment continues to perform due to the long-term nature of Navy contracts. Most of the margin impact is due to variability in international orders.

Major Events

Two weeks ago, the company announced an agreement to sell its New Mexico facility for $4.2m. The sale is expected to close by the end of February, and removes the last idle facility on the company’s books from the recent restructuring, in addition to boosting Sparton’s cash balance.

On Feb 22, the company announced a new acquisition within the Medical Segment, picking up certain assets and liabilities of Byers Peak, Inc.

According to the press release, Byers Peak

“primarily manufactures medical devices for OEM and emerging technology companies in the Therapeutic Device market, including products for surgical navigation, RF energy generation, non-invasive pain relief, arterial disease, and kidney dialysis.”

The company expects to pick up $10m in annual revenue, with the acquisition accretive to earnings no later than the second quarter of fiscal 2012. It also serves to diversify the customer base and will leverage Byers existing customer relationships and field presence.

Conference Call Notes

• Expenses up ~$500k due to legal claims and payments in a lost arbitration class. Frustrating experience but one-time non-recurring expense (almost $0.05/shr)
• Medical: Major customer reduced units by 30% but expected to ramp back up to 100 units per year
• EMS: Vietnam business has doubled in each of past two years. Overall, “won’t populate (segment) with low margin business even if it’s high volume”
• Backlog in latest quarter was $120m, up in each of past five quarters. Highest in history was $124m in fiscal 2009 (but unprofitable backlog at that point in time)

Valuation

Sparton has already generated $5.6m in operating income (or $3.2m w/o the acquisition gain).

Assuming Q2 run-rate is sustainable – probably conservative considering the potential for margin improvement, new acquisition boosts, and sales increases – puts the company on track for roughly $8.6m in annual EBIT run-rate.

With an enterprise value of ~$50m, this translates into a 5.8x multiple, with tons of growth potential.

Conclusion

I’m very impressed with Cary Wood, Sparton’s new CEO, and his outlook and thought process on this turnaround.

He remains committed to improving margins and hasn’t let go of the company’s goal to be a $500m company by 2014.

The business continues to generate cash, and is now sitting on a nice cash pile for future acquisitions. While I normally like to see management return this cash to shareholders, so far it has proven to invest in reasonable, accretive, and smart acquisitions.

As long as that trend continues, I’m on board.

Disclosure

Long SPA

After 3 years and over $35m in losses, Sparton Corp (SPA) took a giant leap forward in 2010, evidence of a strong turnaround by the new management team.

SPA struggled through several bad years due to a variety of causes: underutilized and unused manufacturing facilities, lax management, inflexible long-term contracts and overall recessionary pressure.

Despite these difficulties, the underlying business had potential, and based on latest results, the stock remains undervalued with strong potential for future growth.

Background

Sparton operated at only 25% of operating capacity for period of time after management decided to move business to an inefficient facility in Jackson, MI (where the company HQ’s and management were located), instead of keeping it at a modern facility in New Mexico.

In addition, quality concerns led to substantial losses within the DSS segment as Sparton was forced to eat the losses on fixed price contracts.

Finally, in mid-2008, the company’s largest shareholder, Lawndale Capital Management, initiated a proxy fight citing concerns regarding Sparton’s corporate governance and board composition – new directors were nominated, along with a recommendation for hiring an experienced turnaround management team to shakeup the long-entrenched and underperforming management group.

Soon after, a rockstar turnaround team was put into place, starting with the hiring of a new CEO, Cary Wood, in November 2008.

The new team instituted a number of initiatives for controlling costs during a tough business climate and setting the strategic vision for the company’s future, including:

• Cutting staff by 6% during the course of 2009
• Freezing pension plan accruals and 401(k) matching contributions
• Closing several plant facilities and consolidating others
• Initiating lean manufacturing principles throughout the company’s locations
• Eliminating unprofitable long-term contracts
• Setting long-term growth strategy, including identifying core business segments

These changes were necessary and significant step in the right direction.

Business Segments

Management also consolidated and organized the business into three segments:

Medical Device Operations – contract design and development for complex electromechanical devices for medical device customers

Electronic Manufacturing Services (EMS) – contract manufacturing and prototyping for industrial customers seeking quality-assured products such as flight control systems, security systems, lighting, and defense

Defense & Security Systems (DSS) – design and production of defense programs, focused on sonobuoys, an anti-submarine warfare (“ASW”) device used by the U.S. Navy and foreign governments. Note: Sonobuoys are consumable devices with a life of less than 8 hours and the Navy requires a constant supply – Sparton is one out of only two companies capable of manufacturing these products.

Financials

For fiscal 2010, total sales were down 22% to $173.98m, as the company walked away from unprofitable contracts with several major customers, primarily within the EMS segment.

Despite the sales decrease, the company blew out its income targets, turning in four straight profitable quarters after reporting pre-tax losses for the previous twelve. Overall, net income jumped to $7.44m compared to a loss of $15.75m in 2009.

These results were more than double management’s incentive goals, as the business returned to profitability significantly ahead of schedule.

Further, these results were accomplished despite continued restructuring expenses in 2010 ($4.1m compared to $7m in 2009). The good news is that all restructuring activities appear to have been completed as of June 2010.

Gross margins averaged 15.9% in 2010 with encouraging improvements in all three business segments. Operating margins are tight (3.3%) but should continue to rise.

In fact, the company’s EMS segment reported an operating loss in 2010, with a terrible fourth quarter. However, management raised its margin guidance for this segment going into 2011, a positive sign for the segment’s prospects.

CROIC (14.8%) and ROE (11.6%) are both solid and should increase as well.

As part of the turnaround plan, Sparton aggressively paid down debt, reducing it from $22.96m in June 2009 to only $1.92m a year later.

In addition to producing solid free cash flow ($7.9m), the company also has an unused $20m credit facility, and over $30m in cash on the balance sheet (with another $3.2m in restricted cash about to be released).

Once the restricted cash is released, the company will be have almost $33m in net cash, giving the stock an EV of under $40m.

Catalysts

Uninhibited Growth

Even with the stellar results, the company still has room for improvement – an easy change will be the reporting of clean operating results going forward in 2011.

Restructuring/impairment charges and other operating expenses (related to carrying costs for facilities – now sold) added up to $5.78m, offset by $3.12m in gains from the disposition of these assets.

Removing these expenses will add almost $0.27 per share to 2011 results.

In addition, SPA announced the resumption in marketing programs, an area neglected for several years:

“in the near term, a new marketing initiative will center around identifying our brand and brand position, developing new selling collateral materials, enhancing our trade show image and presence, and modernizing Sparton’s website architecture and technology – all done with a level of professionalism that will fully support and improve the selling effort.”

Finally, Sparton is also recommitting itself to R&D activities around creating proprietary product lines within the DSS segment, a potential (and high margin) boost to future profits.

Smart Acquisitions

In August, Sparton announced the acquisition of the contract manufacturing business of Delphi Medical Systems for $8m.

The acquisition is expected to add $32m in additional revenue. Delphi has two manufacturing facilities that could eventually be consolidated, and management believes that margins could be improved a similar range to corporate (13-15%).

Since the purchase also covers Delphi’s inventory, the acquisition is a steal, and will allow SPA to broaden its reach into the Western U.S.

Investor Roadshow

Despite the turnaround, many investors are still unaware of this micro-cap stock.

Management appears to be attacking this situation by going on the road – with investor presentations scheduled in Minneapolis (Oct), Dallas (Nov), Connecticut & Baltimore (Dec), along with stops in California, New York, and Philadelphia.

Sparton’s corporate presentation presents a compelling story, and the market should react favorably to the stock’s potential.

2011 Estimates

Using the average of these two estimates, and my forecasted EPS for 2011 comes in at $1.27/shr.

Valuation

The current EV/EBIT ratio is 6.5 – very cheap for a profitable and growing company.

SPA’s current P/E ratio is 9.18. While it is hard to find a close competitor, SPA’s industry has an average P/E ratio of 16.

Applying this P/E multiple to the current share price and EPS numbers yields a target value of $12.

Using this same multiple but a 2011 estimated EPS of $1.27 would imply a per share price of $20.

Conclusion

Cary Wood and the rest of the management team have done an incredible job of focusing the company and recovering from a string of bad years – it is a true turnaround story with plenty of opportunity going forward.

The Delphi acquisition should be immediately accretive, and Sparton will continue to drive profitability by improving margins across the business units.

Conservatively, the stock should return 50%+ over the next year or two.

Building on 111 years of history, Sparton Corp has big plans:

“Sparton will become a $500 million enterprise by fiscal 2015 by attaining key market positions in our primary lines of business and through complementary and compatible acquisitions; and will consistently rank in the top half of our peer group in return on shareholder equity and return on assets.”

It’s an audacious goal, but one that will richly reward shareholders who are along for the ride.

I’m adding SPA to the Value Uncovered portfolio at today’s closing price of $6.85.

Disclosure

Long SPA