Electronic Systems Technology (ELST.OB) is the maker of the ESTeem line of wireless modems.

It has been a public company since 1984, and filed several patents (since expired) around wireless modem technology.

The company has built a nice cash pile on the balance sheet, and continues to trade at a discount to book value and only slightly above net cash despite being profitable in 8 out of the last 10 years.

Financial Overview

ELST reported results for the 2010 fourth quarter and full year. Annual revenues were up 18%, to $2.24m from $1.89m in 2009.

Sales dropped sharply during the 2008/2009 recession – they are still down 26% from the 2007 high water mark – but are showing signs of improvement across all product lines and geographic regions.

The domestic business increased 20% to $1.68m, and continues to make up roughly 3/4 of total sales.

Foreign revenues increased 17% at a much higher operating margin (42% margins vs. 16.5% for the domestic side).

Mobile data computer terminals (MDC) applications are marketed to public safety agencies such as police stations and now make up only 5% of total sales. The company is shifting its product mix towards more industrial automation projects, both domestic and internationally.

ELST’s strategy is to maintain low levels of inventory to provide maximum cash liquidity, as the company’s products do not require much lead time. The latest inventory balance of $421k is the lowest in the last ten years – hopefully this shows that management is prudently monitoring the available inventory.

Operating expenses increased slightly to $1.18m from $1.09m due to higher bad debt expense, professional services, and salaries. The company expects to cautiously lift wage reductions put in place in 2008/2009 due to improved revenues and profitability.

Operating profits came in at $174k, up from a slight loss last year.

Net income was $129k, up 437% from 2009, albeit from a very low comparable. EPS was $0.03.

Business Ratios

ROE was 4.18%, a number that is depressed due to the large cash balance sitting on the company’s balance sheet.

There are many different methods for calculating excess cash, but I use this formula:

Excess Cash = Total Cash – MAX (0, Current Liabilities-Current Assets)

While most companies need to keep cash on the balance sheet for day-to-day operations, it is probably a nominal amount for ELST – capex requirements are very low and the company does not keep a large amount of inventory on-hand.

Since the company has so much excess cash, ROIC and CROIC provide a better picture, coming in at 25.84% and 31.10% in 2010 respectively.

5-year average ROIC and CROIC are 17.16% and 33.41%.

ELST’s business is definitely in a niche market with capped upside, but it appears that the company remains a solid choice within this niche.

Excess Cash

Unfortunately, the large cash balance is earning very low returns due to the current interest rate environment.

The company paid a small dividend from 2003-2008, so that is the most likely course of action – the current cash balance is the highest in the last ten years.

Paying a small dividend would at least serve to return some of this excess cash to shareholders.

Valuation

On an asset basis, there is no doubt that the company remains cheap. Market cap is currently $2.8m, meaning the company is selling at a discount to its working capital.

NCAV is $0.57 per share, while NNWC is $0.54. At these prices, you are basically picking up a profitable business for free.

With the stock price at $0.55, current EV/EBIT is 1.3x and EV/FCF is 1.5x, or 1.85x and 1.65x using the 5-year average EBIT and FCF numbers.

Conclusion

While still cheap, the stock has appreciated since my original entry point. The biggest risks are product obsolescence or increased competition, as the world of technology can change very rapidly.

The company is certainly not in hyper-growth mode, as 2010 sales numbers were roughly even with 2004.

If the business is in a steady decline (meaning management cannot open up new markets), then the most important consideration is what will happen to the cash balance.

Unless management can find ways to re-invest the capital into the business at acceptable rates of returns – which does not appear to be the case – then excess cash should be returned to shareholders.

More likely, another way to unlock value would be at the hands of an acquirer. The company’s president, T.L. Kirchner, founded the company in 1984 and is now in his early 60’s.

The cash balance would be very attractive in any deal, but the question remains is the ELST’s niche worth pursuing by a larger company? Or is Kirchner thinking about parting with his legacy?

Not sure, but I think I’ll hold to see what happens.

Disclosure

Long ELST

After reviewing the rationale behind closing my investment in SYK, this is the second part of my series on recent stock sales.

iParty (IPT)

While the investment in SYK turned out well, iParty (IPT) is an example of how several errors can compound to change the attractiveness of a position.

Through the first two quarters of this past year, IPT had turned in better than expected results.

In the initial writeup on IPT, I thought that the company was poised for a big year. Same-store comps were up 1.3% and 1.4% on a quarterly basis, putting the company on a strong path going into its busiest time of year – the Halloween season and fourth quarter.

Third quarter results showed a boost in the number of temporary Halloween stores – from 4 to 11 – that caused a  $1.9m loss in the 3rd quarter compared to $1.4m in the same quarter in the prior year, setting back the company’s progress.

Then, fourth quarter results did not show the expected jump. While the balance sheet improved, the company reported full year earnings of only $254k compared to $1.1m in 2009.

I try to avoid putting too much attention on quarterly results, but do keep a close eye on investments and evaluate them when appropriate.

Investment Review

With IPT, I made a mistake in this analysis on two fronts:

1) In the DCF valuation, I placed a much heavier weight on 2009 results – a high water mark for the company – vs. using the long-term averages. My upper estimates were predicated on a growth rate that was not supported by the historically lumpy results (as opposed to a company like SYK, where the trend line has continued upwards more or less in a straight line)

2) I did not include the significant number of preferred shares in my original EV calculations. Not my finest moment, but one of the consequences of learning on the job.

With this new calculation using the preferred shares, total EV comes out to $27.5m. This translates into an EV/EBIT multiple of 30x (!) using 5 year averages.

EV/FCF is slightly better due to the large depreciation expenses, but still high at 21x.

While the company has the backing of top tier investors, continues to expand its retail footprint and clean up its balance sheet, it probably doesn’t qualify as a value investment at these levels.

Conclusion

Warren Buffett said,

“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

Retailing is a tough business, and IPT is in an especially tough part of the retail market. 5 year average ROE of 4.06%, CROIC of 9.25%, and ROIC of 2.54% reflect this challenge.

My investment methodology has gotten more conservative, with a heavier focus on long-term averages, which therefore changes the viewpoint of IPT as a viable value investment.

With this in mind, I closed out my position at $0.30 per share on Feb 24 – I’ll take the gain and move on.

Final Thoughts

To be clear, my preference for long-term investments hasn’t changed (despite the whirlwind of sales in recent months).

It is important to grow as an investor, and I feel like my approach has changed significantly from some of the early analysis on this blog. As my philosophy matures, I’ll continue to make adjustments to the portfolio.

Learning from mistakes is a big part of that process.

Disclosure

I still own a small remaining position in IPT (1%) in my personal account.

I’ve written quite a bit about Techprecision (TPCS.OB) over the past few months (see posts here and here). The company has announced a number of large sales orders in the recent months, and remains poised to capture strong tailwinds across a broad range of industries.

Recent Sales Announcements

• $1.2 Million Purchase Order from New Solar Customer
• $1.19 Million Defense Contract Order
• $900,000 Order from CleanTech Customer
• Continues Accelerated Booking Trend with $1.25 Million in New Orders

For some perspective, the company had revenues of $28m last year – within the last month, they have announced $4.5m in new orders.

Even better, the orders are broadly diversified across a range of industries including Solar, Defense, Medical, and Industrials.

One of the biggest risks with TPCS has been a major reliance on solar (namely their largest customer, GT Solar), so this diversification is a welcome sign.

The $1.2m solar order is also exciting, as it’s the first order out of the new Chinese subsidiary. According to the press release,

“As this customer ramps, the projected volume in two to three years has the potential to exceed the revenue of TechPrecision’s largest current customer.”

A year ago, GT Solar accounted for approx. 30%, or $7m of the company’s backlog, a glimpse at how much this new customer could be worth as it ramps up.

New Investor Presentation

Techprecision also offers a new investor presentation on its website, updated as of March 2011:

[scribd id=50906001 key=key-1fto0cii7h00mq6loxlq mode=slideshow]

Stock Volatility

The stock has been very volatile over the past week, which could have something to do with the earthquake in Japan and subsequent nuclear scare.

While nuclear is a targeted segment for TPCS, less than 1% of 2011 YTD sales occur in this segment (6.28% in 2010).

The stock price has also been hampered as the two insiders (Youtt and Levy) continue to sell shares. While I’d much prefer insider buying, both directors have been selling all year, regardless of the market price.

This short-term volatility does not affect the long-term prospects for the business.

Conclusion

Techprecision possesses a solid advantage with its history of advanced manufacturing to benefit from some heavy tailwinds in its major industry targets.

I remain long (despite the volatility).

Disclosure

Long TPCS