Manager Quarterly Commentary as of June 30, 2010

Vice Fund (VICEX)
What is most intriguing is that Vice Fund has a solid well-defined mission that seeks to beat the S&P 500Index over the long-run.  
-Jeff Middleswart, Portfolio Manager, USA Mutuals Vice Fund

In the period, we saw the S&P 500 Index decline as sluggish job growth, worries over debt problems in Europe, flagging US home sales, and concerns with Chinese economic growth took their tolls.  The S&P declined by 11.43% for the3 month period ending 06/30/2010  The Vice Fund paid a  dividend in June and outperformed the S&P 500 for the same 3 month period ending 06/30/2010 (click here for most recent performance) Our performance was helped primarily by tobacco holdings where three of our four holdings handily beat the index and the fourth was essentially even with the S&P.  Chinese gaming stocks also beat the index and helped returns. 

During the quarter, we closed out four positions and took profits on each:

Pinnacle Entertainment (PNK) a small regional gaming firm was bought early in the year as largely a cheap asset play.  It was sold in second quarter for a profit as we believed its discount from fair value had been largely erased. 

Spirit Aerosystems Holdings (SPR)is a subcontractor for Boeing.  We sold our remaining position for a profit in 2Q.  It did not pay a dividend which has become a key part of our strategy and we believed we could reallocate those funds into dividend paying positions at lower valuations.

Precision Castparts (PCP) is similar to Spirit.  We sold our position there for a profit, again to focus on defense stocks with cheaper PE ratios and dividends that can top PCP’s 0.1% yield.

United Technologies Corp  (UTX)is in our mind too much of a conglomerate that is too heavily exposed to commercial real estate construction in addition to its aerospace exposure.  A history of write-offs also did not make us comfortable with the earnings quality.  This was a small position that was eliminated at a small profit. 

During the quarter, our three best performing stocks were:

Galaxy Entertainment)– The company operates one casino in Macau and is building a new one in Cotai that is expected to open in 1Q 2011.  During this quarter, the company secured financing to complete the construction, removing the bulk of the negative issues surrounding the stock.  At this point, we believe Galaxy Entertainment is a growth company.  Casinos have historically been good cash flow generators.  While we do not expect a dividend in the near future, the opening of the new resort should allow Galaxy to pay down debt in 2011-2013 and see equity appreciation as the balance sheet improves.

Wynn Macau Ltd–Wynn Macau also owns casinos in China and has been reporting stronger traffic and margins than many other operators.  Even with a higher valuation, this company has been seeing good growth and we are continuing to hold it.

Molson-Coors Brewing Co. (TAP) –This has been one of the cheapest stocks in the alcohol industry and we bought it for its record of successfully cutting huge costs which has fueled debt repayment and higher dividends.  We expect continued improvement although cost cutting benefits will likely be less material.  The dividend was raised again recently.

During the quarter our three worst performing stocks were:

General Dynamics (GD)– down largely due to fears about cutbacks in military spending that may push out some naval ship modernization programs and fears about more delays in Gulfstream shipments if the economy has a double-dip recession.  We still like this stock as we feel it is undervalued and currently offers nearly 3% dividend.  We believe Gulfstream will always be a cyclical company, but it has endured more than two-years of recession, and thus this valuation should be the trough.  Moreover, while General Dynamics could see some programs pushed-out, in many instances it is the only supplier and would likely still get the business eventually.  It is typically viewed as having top-flight assets and a shareholder friendly management.

Melco Crown Entertainment (MPEL) -Initially, there were concerns over liquidity and whether MPEL would violate debt covenants by the end of the year.  In May, MPEL reduced this problem by refinancing debt.  It continues to add new features to properties such as night clubs.  Also weighing on sentiment was higher promotional spending to attract more mass-market patrons.  Along with Galaxy, Melco Crown remains inexpensive on an EBITDA basis but earnings have not materialized yet. 

Bally Technologies (BYI)–down this quarter as concerns linger over the speed at which casinos will start to install new equipment.  Much of this concern surrounds debt-laden customers such as MGM Resorts and Harrah’s.  This company has a clean balance sheet and we believe is undervalued.  We continue to view this as a less risky way to play the expansion of casino gaming into new states and countries without having to pick winners within each market.  Moreover, the replacement cycle for gaming equipment must materialize eventually in our opinion.  Too many new casinos and other competitors that do add new equipment could cannibalize operations at the existing places that are deferring orders and place them at a disadvantage.  BYI has a balance sheet that should enable it to wait out the down-cycle.

Overview of the Portfolio:
We continue to work to reduce the percentage of the portfolio that does not pay dividends.  In the quarter, the group of non-dividend paying stocks was down to 9.9% of the assets despite the appreciation seen in Galaxy Entertainment and Wynn Macau.  We continue to believe that dividends represent a great way to create a more defensive portfolio that should outperform in down markets.  We expect dividends should provide solid returns in up-markets too, which add extra return to capital appreciation. 
By emphasizing companies with strong cash flows, we expect that many VICEX companies could boost dividends as well as repurchase stock to drive EPS for our investors.  Fifteen of the companies owned in the Vice Fund raised their dividend within the last year. 
The tobacco companies this quarter demonstrated the power of solid cash flow to help shield investors from potential problems.  In this last quarter, the tobacco companies faced higher excise taxes in many states and countries looking to boost government revenues.  They faced potential litigation – since denied by the Supreme Court and potential regulation on menthol, a risk that has also been largely played down at this point.  The relatively cheap valuations and attractive dividend yields around 5% and higher, allowed these stocks to rally during the quarter.  The strong dollar could pressure Philip Morris relative to foreign competitors, and both PM and BTI faced issues in Japan over distribution.  With the exception of PM, every tobacco stock we own beat the S&P 500 by a wide-margin.  Every tobacco company in our portfolio raised its dividend, three repurchased shares, and the fourth paid down debt, all of which directly benefitted shareholders with more income and higher earnings per share.
Defense is where we see some of the cheapest stocks in our universe.  16.3% of the portfolio is invested in our core positions of General Dynamics Corp (GD), Lockheed Martin Corp (LMT), Northrop Grumman Corp (NOC) and Raytheon  Company (RTN. We believe, these stocks offer compelling valuations.  Add to that, the dividend yield is over 3% for each of those companies, and all boosted their dividends recently.  We are finding several ancillary positions that compliment these core positions that also have cheap valuations and good long-term potential as acquisition targets and/or growing outlook for demand for their products.  Total defense exposure was 22.7% of the portfolio at the end of the quarter. 
Alcohol is still digesting its merger wave of the 2005-08 period.  We have highlighted Anheuser Busch InBev in our newsletter as a focus stock to demonstrate this trend.  The companies primarily focused on spirits have enjoyed steady growth as emerging markets have industrialized.  Beer companies have seen enormous gains in the emerging economies, and have focused heavily on cost cutting in domestic markets.  The stronger dollar is hurting companies with heavy US production facilities, but we feel this is not a permanent situation, which led us to purchase even more BUD in the period.  We finished the quarter with 23% of the portfolio in this sector.