Check out my last post on SPAN’s 2nd Quarter Earnings.

After announcing a sizable special dividend last quarter (and an overall bullish report), Span-America Systems, Inc (SPAN) followed by reporting fiscal 3rd quarter results last week.

After an initial glance at the financials, it was a tough quarter and the price took a corresponding dive. Despite the quarterly volatility, the stock remains significantly undervalued.

Q3 Results

Quarterly revenue and earnings dropped 8% and 17% respectively, as the company reported lower sales volume across each business segment.

The majority of the decline occurred in the consumer sales division (down 19% and part of the custom product segment), due to a market test program last year that was halted for 2010.

Without the effects of the test program, the division would have actually reported a sales increase.

Quarterly Cost Fluctuations

Although the company has done a great job of streamlining its manufacturing process to control and trim costs, quarterly earnings can still be affected by unavoidable changes in administrative expenses.

Example:

As of April 3, SPAN owned a $1.9m life insurance policy for its founder and former chairman. This policy is invested in mutual funds and fixed income contracts, and therefore exposed to fluctuations in equity markets and interest rates.

According to the company,

“The cash value decreased by $71,000 in the third quarter this year compared with a $68,000 increase in the third quarter last year. The $139,000 swing in cash value was the primary factor in administrative expenses rising 16% compared with the prior year’s third quarter.

Excluding the effect of the changes in cash value for both quarters, administrative expenses would have declined by 2% in the third quarter”

As with all stock investments, these short-term fluctuations can impact the stock price on a given day or quarter, but longer-term (where value investors focus), the business fundamentals and intrinsic value should win out.

YTD Financials

Despite the rough quarter, net income for the year was up 8% to $3.3m as the company continues to focus on controlling costs.

Going into the fourth quarter (usually the company’s strongest) SPAN is still on-track to produce its best FCF and earnings year in history.

Capital Goods vs. Consumables

The company’s product mix includes a mixture of capital goods (such as therapeutic support surfaces) and consumables.

As in most recessions, the recent economic downturn has forced many businesses to delay investments in capital equipment.

These delays have affected SPAN’s quarterly numbers, but longer-term, this scenario should lead to pent-up demand as the economy turns around.

“We believe this is due to economic pressures facing our customers over the short-term and should result in higher future demand as customers eventually replace and upgrade therapeutic support surfaces in their facilities.”

Investing in the Future

The company continues to invest in expanding its product line, with several new products rolling out in the fourth quarter.

I’m particularly interested in SPAN’s new high-end therapeutic support surface for the acute care industry, as this market reported significant growth across a number of product lines in the third quarter.

Outlook

Management has managed to control costs nicely, and seems to have positioned the company for a strong end to the year.

According to Jim Ferguson, SPAN’s CEO:

“We expect to report improved operating results in the fourth quarter compared with the third quarter. Our fourth quarter usually outperforms the first three quarters based on seasonal sales trends. We believe our consumer sales will grow due to a new program with a large retailer, and our industrial business should benefit from the expanding manufacturing activity in our region.

Q4 should be a big quarter for SPAN.  Mid to long-term investors should be rewarded as SPAN’s stock price rises to meet its intrinsic value.

Disclosure

Long SPAN