Span-America Holding (SPAN) has been part of the ValueUncovered portfolio for over a year, my longest holding.

Despite lots of volatility throughout the year (touching almost $20/shr), the stock’s is only slightly up, primarily helped by consistent dividend payouts (including a large special dividend earlier this year).

I am catching up on past SEC filings, and SPAN’s 2010 report came out a few weeks ago.

Financial Review

Total revenues in 2010 declined 6% to $52.4m compared to the prior fiscal year, with declines reported in both operating segments.

SPAN’s therapeutic support surfaces (the largest part of the medical product segment at 62% of sales), are considered a capital expenditure. Although the outlook has improved, the product line continues to face weakness in the company’s main markets.

The acute care market continues to be the bright spot, with several new product lines experiencing double digit YoY growth. Overall, medical sales were down 6% to $35.6m compared to $37.8m in 2009.

In the custom products segment, sales decreased 7% to $16.8m compared to $18.1m last year.

Last year’s numbers were helped by a one-time test program which was not repeated in 2010.

This is the 3rd year in a row of annual revenue decreases.

More worrisome, the company has slowly shifted its product mix towards consumer products and away from therapeutic support surfaces, which command much higher margins – support surfaces are down from 54% of total sales in 2007 to 43% in this latest fiscal year.

Despite the lower top-line, the company remains solidly profitable and continues to throw off generous amounts of free cash flow.

Net income was $4.5m – down slightly from the year before – but the company still managed to produce $5.3m in FCF. Using these figures and the current market cap of 41m equals a solid FCF yield of 13%.

The company paid out $3.9m in dividends, or 86% of net income, a solid way to return cash to shareholders.

The balance sheet remains strong, with a current ratio of 3.39, no debt, and cash and marketable securities of $4.4m

Industry Outlook

While the company continues to be solidly profitable, it is facing headwinds on a number of different fronts:

Increased Foreign Competition – There is no doubt that the company will face increased pressure from foreign competitors in the future, especially China.

This shift will put even greater pressure on margins, and slowly erode the high returns on capital that the company has experienced. Some product segments, such as consumer bedding, have little differentiation aside from price:

“During the last two years, we have experienced increased competition in our medical and custom products segments from low-cost foreign imports. In the medical segment, the number of low-cost, imported mattress products has increased in the last two years, but it has not yet had a significant impact on our medical business. We believe that we have potentially greater exposure to low-cost imports in our consumer bedding product lines because those products have more commodity-like characteristics than our medical products.”

Uncertainty around Medicare – As a medical company, a number of SPAN’s products are eligible for reimbursement from Medicare. There has been a ton of proposed regulation and controversy over the recent healthcare laws.

While the fallout is still undetermined, it will create additional fear and hesitation on the part of consumers when purchasing new medical products, potentially cutting into SPAN’s sales.

Continued Economic Weakness – While the stock market has enjoyed a record run, the economy and job market are definitely not back to full speed. SPAN has benefited tremendously over the past five years by an increase in its therapeutic support surfaces – in 2010, they made up 42% of total sales.

The sale of these products significantly boosted SPAN’s FCF rate, up to the current levels of $5-$6m per year. It is unclear whether the company can continue aggressive growth in this area.

Conclusion

I recently came across another post regarding the author’s equity investing philosophy. In addition to laying out a solid set of ground rules, it also included this quote from Warren Buffett’s 1977 annual letter:

“One of the lessons your management has learned – and, unfortunately, sometimes re-learned – is the importance of being in businesses where tailwinds prevail rather than headwinds.”

I think that this valuable lesson applies to SPAN.

While the balance sheet remains strong and the company continues to throw off lots of cash, the overall trend is headed in the wrong direction.

While there still appears to be a gap between the stock’s intrinsic value and the current market price, I’m afraid that the value may fall to meet the price instead of the other way around.

The stock is releasing earnings in the next few weeks. As a general rule, I try to avoid holding stocks through an earnings release unless I plan to hold for long-term.

In addition, I’ve been growingly increasingly nervous of the broader market and therefore actively trimming my positions in order to raise more cash.

With that in mind, I’m closing out my position in SPAN at today’s closing price of $15.55, a gain of 10.06% vs 16.74% for the S&P.

Disclosure

No positions.

A great year for the overall market, the S&P finished up 14.6% on the year after a sustained rally after the July lows.

2010 also concluded the first calendar year-end for Value Uncovered. Just having launched the site back in May, I’m pleased with the first half-year performance.

Stock Positions

Check out the Holdings page for a list of my current stock holdings, with 16 positions overall. 15 out of 16 ended the year with positive returns since my original analysis/writeup.

Lowlights

NOOF was the only laggard, still down 15.76% since my entry point of $2.03. Since my original writeup, the balance sheet has continued to remain strong but earnings improvements have been slow to materialize – the stock remains extremely cheap.

I think NOOF’s new lease agreement will provide substantial cost savings going forward.

The stock continues to be held by a large number of institutional investors and insiders were buying back shares near the yearly low. I remain bullish on the name going forward.

While the rest of my positions showed positive gains, 5 trailed the S&P: SPAN, SVT, ACU, APNC, and IPT.

It is interesting to note that the first three stocks (SPAN, SVT, ACU) were some of my original picks and have shown the least results. I believe I have made strong improvements in my valuation analysis and overall investment philosophy.

The one item of note from these stocks was that SPAN paid a nice special dividend of $1.00 per share, adding almost 6% to the position’s total return.

I find that closing out positions is often the hardest part of my decision-making process. Several of these stocks (ACU, SVT, ELST), neared the low-end of my intrinsic value estimates during the course of the year.

When this occurs, it is a great time to sell and recycle money into more attractive opportunities. From now on, I will be keeping a close eye on these positions as they near the bottom of my intrinsic value estimates.

Highlights

I closed out a position in CHBU for a gain of 80%, my largest return to date. I originally entered the position when the company is selling at a large discount to their net cash. Despite the positive overall result, I managed to exit the CHBU position one week too early, missing out on ~100-150% in gains.

Other large winners included TPCS, ADVC, and DIT, all returning more than 30% since my original analysis.

ADVC benefited from paying out the announced special cash dividends, providing the 10% yield I talked a in my original writeup.

DIT continued its march upwards on the back of the new management team, posting over $1B in sales for the first time in company history.

TPCS was the best performer, and management seemed extremely bullish on the latest conference call. The new investor presentation does a great job of laying out the potential for the company going forward.

APNC announced that they were pursuing a broad range of strategic alternatives to unlock shareholder value, so I’ll be keeping a close eye on any news.

Special Situations

2010 was also the first year that I started investing in special situations or workouts.

I completed several investments, including my first merger arbitrage play with the UBET/CHDN merger, a successful going private transaction with AHOM, and easy money with tender offers for FIS and VR.

I remain on the lookout for other special situations but have found relatively few opportunities with the proper risk/reward characteristics.

Biggest Mistake

Despite the successes in my event-driven investments, my biggest mistake also occurred there – EMMS – my largest loser at -25.76%.

It was a great lesson around the dangers of getting hooked on a particular situation even when the dynamics of the situation radically changed.

The goal of these workouts is to supplement other opportunities with small absolute gains on a short time horizon, leading to a nice annualized figure with little risk.

With EMMS, I learned that chasing the last 5% is not worth the risk, especially when the downside is 50% or more.

Lesson learned.

Future Strategy

Ideally, I’m planning on holding somewhere between 10-20 positions at one time. Today, I’m near the high end of my target portfolio makeup, and have several positions that I’ll be cutting back when the opportunity presents itself.

In the broader market, I’m not finding very much that I like – most solid names seem fairly valued and there are very few that currently offer enough margin of safety.

For this reason, I have started doing more research into the PinkSheets market. It is a wild world, but amidst the development companies, scams, and terrible businesses, there are a gems with absolutely incredible potential.

However, many of these stocks are extremely illiquid so it will be very hard for me to write about them effectively.

Although I have no illusions about my ability to move the markets, picking up positions in some of these .PK names often takes week or even months, a dynamic that doesn’t lend itself to public tracking.

Conclusion

2010 was a great year and I’m looking forward to improving upon my results in 2011. I also enjoy hearing from my readers, so please use the Contact Form or follow me on twitter to share your ideas or questions.

I’d also welcome suggestions or feedback on improving the site, whether its article suggestions, layout/feel, or additional tools that you might find helpful.

Good luck in 2011!

Disclosure

See Holdings page for current positions.

Techprecision’s (TPCS.OB) stock has been on a tear over the past several months on the news of increased backlog and a new Chinese subsidiary. The new investor presentation outlines the incredible growth opportunities the company has in nuclear, alternative energy, and high-tech medical device manufacturing.

The press release announces the purchase and expansion of the company’s manufacturing facility. From the press release:

“On December 30, 2010, Ranor received $6.2 million in tax exempt bond financing through the Massachusetts Development Finance Authority to purchase the property and complete an 18,000 sq. ft. facility expansion in calendar year 2011.  Additionally, the bond funding will also be used to finance one of the largest CNC (Computer Numeric Control) horizontal gantry mills in North America, which Ranor requires for production of new orders and to more aggressively participate in its Nuclear, Defense and Medical businesses.”

The terms of the bond offering seem very attractive for Techprecision with an average interest rate fixed at 4% for the next 7-10 years.

The original lease agreement was under a related entity controlled by one of the company’s directors, Alex Levy, at a higher interest rate (6.85%).

As an outside investor, related entity transactions make me nervous so this new deal should much simplify the reporting and capital structure for Techprecision.

According to the company’s CEO, the new gantry mill will allow Techprecision to process projects 35% faster than existing toolsets. It will also save approximately $200k per year in cash flow, a significant contribution based on the company’s current run rate.

Full details of the agreement are due in the company’s next earnings release.

Since the company’s main competitive advantage is its high-tech manufacturing capabilities, this looks like another positive development for TPCS.

Disclosure

Long TPCS