Iteris Inc (ITI) reported fiscal second quarter results last week, building upon a solid first quarter.

The Sensor business remains on the upswing after an extremely difficult prior year, while Transportation Systems remains depressed due to uncertainty around governmental budgets.

Sales Highlights

Net sales and contract revenue for the fiscal second quarter was $14.1m, a 5.2% decrease compared to the year-ago quarter. Revenues within the Transportation Systems segment declined 18.5%, a slight moderation from the 19.3% decline in the previous quarter.

The Transportation Systems segment is contract-based through local, state, and federal governments. It therefore is highly dependent on government funding and can be highly volatile.

The future outlook for this segment is dependent on the passage of a new long-term Federal Highway Bill, which elapsed in 2009 and hasn’t been re-authorized. However, according to the company’s CEO, Abbas Mohaddes:

“While the second quarter’s Transportation Systems revenue decreased, we expect this segment to contribute to our growth over the coming periods. This market is showing signs of increasing traction, as evidenced by new allocated federal and local funds for transportation projects resulting in expanded requests for proposals”

Overall, total revenues were basically flat compared to the prior year, but the company has improved its product mix towards higher margin products, leading to a significant increase on the bottom line.

Segment Breakdown

Overall, gross margins were 44.7% compared to 44.2% in the prior year quarter. Iteris managed to control expenses, reducing them slightly to $5.3m, a 1.9% decrease.

Balance Sheet

The company continues to generate significant free cash flow, evidenced by the increase in the cash balance to $12.3m as of September 30, 2010, compared to $10.4m on September 30, 2009, an 18% increase.

In the same period, long-term debt decreased by 30.8% to $2.05m, and the company has a $12m unused credit line.

However, the company does have a significant amount of intangibles and goodwill on the balance sheet, a possible yellow flag. The latest goodwill impairment test showed the Transportation Systems segment was assessed at only 10% above its carrying value.

Further declines in this segment could force Iteris to write down its investment, a scenario that needs to be monitored closely.

Outlook

During the quarter, the company announced a 5-year extension with DAF Trucks, N.V to continue offering Iteris’s LDW system as a factory installed option on its heavy trucks.

In addition, Valeo, ITI’s marketing partner, announced a new contract with an OEM car company to offer Iteris’s lane departure warning (LDW) system as an option on two additional vehicles.

The LDW systems are currently only available on four Infiniti models, so this is a positive step towards returning to profitability in the Vehicle Sensors segment.

Final Thoughts

Joel Slutzky, one of Iteris’s directors, had entered into a 10b5-1 trading plan starting in July to sell 8000 shares per month for the next year, a total of 96,000 shares.

There are many reasons why an insider would sell stock (negative outlook on the business, cash flow, taxes, etc), but I generally view disclosed trading plans over a set period of time as primarily diversification plays.

(i.e. if an insider had a negative short-term outlook, he or she would sell a lump of shares right away rather than spread them out over an entire year)

In this latest release, Iteris disclosed that Mr. Slutzky had canceled his share sales entirely after only four months, or 1/3 of the original plan.

Could this be a positive sign for the upcoming quarters? It remains to be seen…

Disclosure

Long ITI

China Agri-Business Inc. (CHBU) has been holding in my Value Uncovered model portfolio since June, when the company was selling at a discount to its NNWC.

The company reported outstanding second quarter earnings 10 days ago, with the stock jumping over 20% on the news, before falling back over the last week.

CHBU remains in solid financial shape and is growing like crazy, and yet is trading for less than NNWC.

Financial Highlights

CHBU reported a huge increase in sales for the first half of the year on strength of the company’s “New Agriculture-Generator” initiative. Net revenues jumped an outstanding 325% to $4.99M compared to revenues of $1.17M in the prior year period.

For the second quarter, net income increased 206%, increasing quarterly earnings per share to $0.06.

Gross margin has dropped significantly compared to last year, from 73% to 35%, as the company undergoes a transformation to the new direct store sales model.

Despite the change in gross margin, both operating and net margin levels remain extremely high at 23% and 21.8% respectively (the company pays no taxes).

The company’s balance sheet is extremely solid, with a current ratio of 13.9 – with most of these assets being liquid.

Despite significant investments in equipment this year, CHBU continues to throw off cash, generating 757k in FCF for the year so far, more than doubling the amount from a year ago.

New Sales Model

Based on these results, the company is moving to an entirely new sales model going forward. Direct store sales now make up over 80% of the CHBU’s total revenues, as the traditional sales network becomes less of a focus.

Growth was largely driven by an expansion in the number of total stores, increasing from 250 to 346 in a single quarter. The company expects 500 stores by October 2010, several months earlier than previously forecasted.

Although the new model has much lower margins than the traditional network, the rapid growth like this is hard to ignore. Despite the impressive steps China has taken as a country overall, there remains a huge rural population that could benefit from the company’s products.

According to the press release,

“At the Company’s direct sales stores, farmers can purchase fertilizer products, including organic fertilizers made by China Agri, have access to the Company’s sales staff who are knowledgeable about the products offered, and receive services that include technical support. This will help farmers to increase their crop yields and productivity and, in turn, should encourage them to be loyal long-term customers for China Agri.”

Valuation

My original investment thesis was based on the fact that the stock was a Net/Net trading at less than net cash. Here are updated numbers for the past few quarters:

Based on the most recent closing price, the stock is currently selling at a 22% discount to NNWC.

Conclusion

It is not often that the market provides a growing, cash flow positive stock with a market cap less than the cash on the balance sheet. CHBU is a capital-light business with little debt and obvious growth potential.

As with many Chinese stocks, management and disclosure is always a concern. The company has limited experience running a retail operation and will assuredly run into growing pains as the torrid expansion eventually slows.

The company is also in line to purchase a large parcel of land to expand capacity, a transaction that will cut into the margin of safety on a NNWC basis.

However, if CHBU continues to report operating results like this quarter, the stock might be worth holding on to as an earnings/growth play, rather than just a value investment based on assets.

Disclosure

Long CHBU

Servotronics Inc. (SVT) recently reported 2010 second quarter earnings and the market reacted favorably as the company turned in another solid quarter. The stock price jumped to $10, after trading around $9 for the prior month or two.

Second Quarter Results

Revenues for the 2nd quarter were $8.2M compared to $9.1M in the same period last year, a drop of approx. 10%.

The Consumer Products Group was the source of the decline, with sales dropping 23%, partially offset by a slight increase in revenues for the Advanced Technology Group.

Despite the top-line drop, quarterly net income was up significantly, increasing 10% to $778k compared to $710k in the prior year quarter. For the 6 month period ending June 30, 2010, net income was 68% higher, as the company continues to benefit from an outstanding first quarter.

FCF is $1.6M so far this year, more than doubling the cash flow generated in the same period last year.

Segment Analysis

The ATG division continues to chug along, as operating profit increased for the second consecutive quarter.

The company has also worked to improve the CPG’s product line, allowing margins to increase slightly despite the drop in sales.

Conclusion

With conservative estimates, the business is on track to generate over $3M in owner earnings for the year, close to the record set in 2008.

Management has performed well through the economic downturn – after a small hiccup at the end of 2009 – and the stock should benefit as the aerospace markets turn around (see my post on SIFCO as well).

I’m revising my conservative valuation downward slightly, to $12.50-$13.50, with an upward estimate closer to $15.

Disclosure

Long SVT