Item 1. Business
Forward-Looking Statements
This annual report on Form 10-K includes forward-looking statements that describe anticipated results for Span-America Medical Systems, Inc. (the “Company,” “Span-America” or “we”). These statements are estimates or forecasts about Span-America and its markets based on our beliefs, assumptions and expectations. These forward-looking statements therefore involve numerous risks and uncertainties. We wish to caution the reader that these forward-looking statements, such as, but not limited to, our expectations for future sales or future expenses, are only predictions. These forward-looking statements may be generally identified by the use of forward-looking words and phrases, such as “will,” “intends,” “would,” “estimates,” “continues,” “may,” “believes,” “anticipates,” “should,” “optimistic” and “expects,” and are based on the Company’s current expectations or beliefs concerning future events that involve risks and uncertainties. Actual events or results may differ materially as a result of risks and uncertainties in our business. Such risks include, but are not limited to, the “Risk Factors” described in Item 1A. below, other risks referenced from time to time in our other Securities and Exchange Commission (“SEC”) filings, or other unanticipated risks. We disclaim any obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.
Background
Span-America was incorporated under the laws of the state of South Carolina on September 21, 1970. We manufacture therapeutic support surfaces, medical bed frames, patient positioners, mattress overlays and wheelchair cushions for the medical market. We sell but do not manufacture skin care products, fall protection products and in-room furniture used mainly in the long-term care portion of the medical market. We also manufacture foam mattress pads and pillows for the consumer bedding market as well as a variety of custom designed foam products for the industrial market.
We began operations in 1975 as a manufacturer of polyurethane foam patient positioners and later expanded our product lines to include foam mattress overlays for the wound care market primarily in acute care hospitals. Wound care products aid in the treatment or prevention of pressure ulcers. In the late 1970s, we also began producing foam products for industrial applications. In 1985, we introduced the patented Geo-Matt® therapeutic mattress overlay in the health care market, which became one of our leading products. During the same time period, we began selling convoluted foam mattress overlay products to consumer bedding retailers throughout the United States.
We entered the replacement mattress segment of the medical market in 1992 by acquiring certain assets of Healthflex, Inc., including its PressureGuard® II therapeutic support surface. We have since significantly expanded the PressureGuard product line and have added the Geo-Mattress® product line to provide a broad line of therapeutic support surfaces that we sell direct and through distributors primarily to long-term care facilities and, to a lesser extent, acute care hospitals and home health care dealers throughout the United States and Canada.
In December 2011, a newly-formed, wholly-owned subsidiary of the Company, Span Medical Products Canada Inc., a British Columbia corporation (“Span-Canada”), acquired substantially all of the assets of M.C. Healthcare Products Inc., an Ontario corporation with its principal place of business in Beamsville, Ontario. Span-America operates Span-Canada under the registered business name M.C. Healthcare Products (“M.C. Healthcare” or “MCHP”), a division of Span Medical Products Canada Inc. M.C. Healthcare manufactures and markets medical bed frames and related products for the long-term care market and sells them throughout Canada and the United States. We report Span-Canada’s operations as part of our medical segment.
Our primary long-term strategy is to become a leading health care manufacturer and marketer specializing in medical beds, therapeutic support surfaces and other related products used in the prevention and treatment of pressure ulcers. We are actively seeking to develop or acquire new products in this market segment. We also seek to further develop consumer and industrial applications of our medical products.
Our products are distributed primarily in the United States and Canada and, to a lesser degree, in several countries outside North America. Total net sales during fiscal year 2016 were approximately $67.6 million. Total net sales outside the United States during fiscal 2016 were approximately $6.8 million, or 10% of our total net sales. The majority of our sales outside the United States occurred in Canada.
However, during fiscal year 2016, we began selling certain of our medical products in Australia through an independent Australian distributor. Our sales in Australia during fiscal year 2016 were approximately $710,000.
See Note 18 – Operations and Industry Segments and Geographic Areas in the Notes to Consolidated Financial Statements included in Item 8 of this report.
For risks related to our foreign operations, see the risk factors set forth below in Item 1A of this report, which risk factors are incorporated herein by reference.
We maintain a website at
http://www.spanamerica.com
. Our reports and other filings made with the SEC are available free of charge on our website, which includes a link to the Company’s filings in the SEC’s Electronic Data Gathering Analysis and Retrieval (EDGAR) filing database. For more information about M.C. Healthcare and its products, see
http://
www.mchealthcare.com
.
Industry Segment Data
Please See Note 18 – Operations and Industry Segments and Geographic Areas in the Notes to Consolidated Financial Statements included in Item 8 of this report for additional information on industry segment data and revenues from foreign sales. The table below sets forth sales of each of our product lines and segments as a percentage of our total sales for fiscal years 2016, 2015 and 2014.
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Percentage of Total Sales
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Medical Segment
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|
2016
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2015
|
|
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2014
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Therapeutic support surfaces
|
|
|
39
|
%
|
|
|
39
|
%
|
|
|
40
|
%
|
Medical bed frames
|
|
|
14
|
%
|
|
|
17
|
%
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|
|
15
|
%
|
Patient positioners (Span-Aids)
|
|
|
4
|
%
|
|
|
5
|
%
|
|
|
6
|
%
|
Mattress overlays
|
|
|
4
|
%
|
|
|
4
|
%
|
|
|
5
|
%
|
Seating products
|
|
|
3
|
%
|
|
|
3
|
%
|
|
|
4
|
%
|
Skin care products
|
|
|
2
|
%
|
|
|
2
|
%
|
|
|
2
|
%
|
In-room furnishings
|
|
|
1
|
%
|
|
|
2
|
%
|
|
|
1
|
%
|
Fall protection products
|
|
|
1
|
%
|
|
|
1
|
%
|
|
|
2
|
%
|
Other medical products
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|
|
1
|
%
|
|
|
1
|
%
|
|
|
1
|
%
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Medical total
|
|
|
69
|
%
|
|
|
74
|
%
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|
|
76
|
%
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|
|
|
|
|
|
|
|
|
|
|
|
|
Custom Products Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer bedding
|
|
|
25
|
%
|
|
|
20
|
%
|
|
|
18
|
%
|
Industrial products
|
|
|
6
|
%
|
|
|
6
|
%
|
|
|
6
|
%
|
Custom Products total
|
|
|
31
|
%
|
|
|
26
|
%
|
|
|
24
|
%
|
Medical Segment
Span-America’s principal medical products consist of therapeutic support surfaces (which consist of non-powered and powered therapeutic support surfaces), medical bed frames, patient positioners, polyurethane foam mattress overlays, seating products, Selan® skin care and fall protection products. We also sell tables and related in-room furnishings for use in long-term care facilities. We sell these products primarily in North America to customers in the major segments of the health care market, including long-term care facilities, acute care hospitals and home health care providers.
We rely on our own sales force to sell and market our medical products in North America. Our sales force consists of approximately 30 employees and five independent representatives located in key market areas throughout the U.S. and Canada. They call primarily on end-user customers and medical products distributors within our markets to promote the use of Span-America’s products to meet the needs of patients and customers.
Therapeutic Support Surfaces
. For classification purposes, we divide our lines of therapeutic support surfaces into two groups, non-powered and powered, and we have various sub-categories within those two groups. Our non-powered therapeutic support surfaces fall into two main sub-categories: the Geo-Mattress® all-foam products and the non-powered portion of the PressureGuard® product line. Geo-Mattress® products are single-density or multi-layered foam therapeutic support surfaces topped with the same patented Geo-Matt surface used in our overlays.
Non-powered Therapeutic Support Surfaces
. In 1997, we introduced the Geo-Mattress Max, Plus, and Pro models of foam therapeutic support surfaces. In early 1999, we extended the product line with the release of the Geo-Mattress with Wings®, which has been a contributor to overall Geo-Mattress sales. The Wings support surfaces feature raised bolsters on each side designed to reduce the chances of patients rolling out of bed or becoming entrapped between the edge of the therapeutic support surface and the bed’s side rails. We added a second line extension, the Geo-Mattress Atlas®, in December 2000 to address the needs of heavier patients. In 2010, the Company launched the Geo-Mattress® UltraMax™, our most highly engineered Geo-Mattress model to date. Developed primarily for the acute care market, the UltraMax incorporates several proprietary design features, including three-dimensional zoning, an ultra-resilient torso section, and a shear-reducing, bi-directional stretch cover. Together, these premium features allow the UltraMax to deliver a level of support, comfort, and effectiveness that meets the rigorous challenges of the acute care environment.
Span-America’s more complex non-powered support surfaces consist of products from the PressureGuard® series. We acquired the PressureGuard design through the acquisition of Healthflex, Inc. in February 1992. The original design combined a polyurethane foam shell and static air cylinders to form a support surface that incorporated the comfort and pressure relieving features of both mattress overlays and more sophisticated therapeutic support surfaces. This original design, which we later used as the basis for powered versions, was further refined and enhanced multiple times as described below.
In addition to the non-powered, static PressureGuard Renew®, we offer the PressureGuard CFT®. This model incorporates a patented design featuring the principles of constant force technology. The PressureGuard CFT is most appreciated for its dynamic, self-adjusting support surface feature that rivals more expensive powered surfaces, yet it requires no power source.
Long-term care facilities are the end users for most of our non-powered therapeutic support surfaces, which we primarily sell to our medical distributors for resale to the end user. To a lesser extent, we also sell these products to medical distributors for resale to acute care hospitals and to home health care equipment dealers.
Powered Therapeutic Support Surfaces
. Span-America’s powered therapeutic support surfaces constitute the remaining models in the PressureGuard Series. In November 1993, we received Food and Drug Administration (“FDA”) 510(k) marketing approval for the PressureGuard IV therapeutic support surface. Building on the comfort and support of the original PressureGuard design, PressureGuard IV was designed as a sophisticated, powered system for providing pressure reduction and patient comfort, with the added ability to turn the patient. The system was designed to automatically sense the patient’s weight and position and to continually adjust the pressures appropriately while slowly and quietly repositioning the patient at angles up to 30 degrees in cycles of up to two hours. The upgraded version, renamed the PressureGuard Turn Select®, incorporates all of these capabilities, as well as several additional features. Of particular note is a pendant-operated, microprocessor-controlled motion system, which is built into the support surface rather than being suspended from the bed frame as a separate unit.
Another powered system in the PressureGuard line is the PressureGuard APM®, a simpler but effective alternating pressure therapeutic support surface. The APM is targeted primarily at the long-term care and home care markets. In 2000, we added a more feature-rich version of this product called the PressureGuard APM
2
. In 2003, we further upgraded the APM
2
products with new features such as the addition of the Deluxe control unit. The APM
2
gives caregivers the flexibility to offer either alternating pressure or a basic lateral rotation modality by activating a toggle switch on the control panel.
In late 2001, Span-America introduced the PressureGuard Easy Air®, our first offering in the category of low-air-loss therapeutic support surfaces. The Easy Air incorporates several patented design innovations, which we believe allow it to overcome common performance compromises inherent in competitive low-air-loss products. Additionally, the Easy Air is very effective at controlling excess skin moisture, a key performance advantage in the competitive support surfaces marketplace.
In late 2010, we introduced the PressureGuard® Custom Care® series, which consists of three distinct product offerings aimed in large part at the acute care marketplace. Two of the models, Custom Care and Custom Care Convertible, incorporate the Company’s proprietary new Shear Transfer Zone® cover design. This patented design helps eliminate the damaging effects of micro shearing, macro shearing, and rotational shearing on vulnerable skin and tissue caused when bony prominences “dig” into a support surface. Like the PressureGuard CFT, the Custom Care model provides air therapy without the need for a powered control unit. It is designed to provide superior comfort and skin protection while requiring minimal maintenance for five years.
The PressureGuard Custom Care Convertible and Custom Care Convertible low-air-loss models represent our first product offerings in the “convertible” category, a class of support surfaces that has become a popular option in today’s acute care market. In their non-powered mode, Custom Care Convertible models operate as effective tissue load management surfaces for both prevention and treatment of pressure ulcers. Both allow the addition of a powered control unit where more aggressive, dynamic therapy is desired. When the add-on, ruggedized Custom Care Convertible control unit is clicked into position on the support surface, the caregiver is provided the option of either alternating pressure or lateral rotation. On the low-air-loss model, the caregiver can select either of these options while also providing a third treatment modality: microclimate management. This proprietary, patented air delivery design, which has demonstrated long-standing clinical success on the Company’s PressureGuard Easy Air low-air-loss surface, controls excess moisture and heat at the interface between the patient’s skin and the support surface. Both models also incorporate another Span-America feature, the Star Chamber™ air cylinder design. The Star Chamber cylinders maximize the amount of air available within the therapeutic support surface for pressure management, patient support and effective therapy.
In 2014, we introduced the PressureGuard Protocol® therapeutic support surface, which provides customers with an attractive combination of microclimate management, pressure redistribution, ease of use and patient/caregiver safety. Protocol’s proprietary air delivery cover design supplies a gentle flow of air directly to the underside of its highly vapor permeable coverlet, carrying away excess moisture vapor to help protect vulnerable skin. In addition, the Protocol’s efficient control unit generates substantially less heat and noise than traditional, high-output low-air-loss blowers while consuming less power. Caregivers can also select subtle alternating pressure or powered flotation treatment modes.
We introduced The Topper MicroEnvironment Manager® in 2015 as the company’s first completely reusable powered air coverlet for management of excess heat and moisture within the microenvironment surrounding the patient. The Topper is powered by the same, patented Air Diffusion Matrix technology first pioneered in our microclimate management support surfaces, including the PressureGuard Easy Air, Custom Care and Protocol products. The system provides a gentle flow of air directly to the underside of its highly vapor permeable top layer, carrying away excess moisture vapor to help protect vulnerable skin. The Topper is fluid resistant, anti-fungal and bacteriostatically treated. It is designed to be easily wiped clean and disinfected in place using standard hospital-grade solutions. Alternatively, the top layer can be unzipped and machine washed, and the inner air delivery layer can be accessed for wipe-down cleaning and disinfecting if desired.
We sell most of the powered products in the PressureGuard product line to long-term care facilities, usually through our distributors, and to home health care equipment dealers for daily rental in the home care market. We also sell the PressureGuard products in the acute care market, but in smaller quantities than in the long-term care and home care markets.
Bed
Frames
and Furniture
. Through our M.C. Healthcare subsidiary, we manufacture and market the Advantage and Rexx series medical bed frames and related products. These medical beds, collectively branded as the “Q Series,” are designed primarily for the long-term care market and incorporate various industry-leading features, options and accessories that can be configured to meet individual customer needs. In addition, we serve as a distributor of bedside furniture, chairs, tables and over-bed tables for use in long-term care facilities. Approximately 75% of M.C. Healthcare sales for fiscal year 2016 were exported to the U.S., and the remaining 25% were sold in Canada and Australia.
During the latter part of 2013, we introduced a new, premium bed for long-term and sub-acute care settings called the Encore® resident care bed. The Encore is outfitted with a variety of advanced performance features for enhanced patient and caregiver safety and ergonomics. Chief among these is GlideAlign® retractable deck technology, which helps maintain users’ relative positioning to bedside furniture when the head of the bed is elevated. Encore also includes ReadyWide® integrated expansion, which allows tool-less, pin-less expandability to 42” wide, a platform that is in demand among care providers. Encore also features Smart Stop® low position auto pause, which is designed to help reduce the risk of patient falls and other hazards.
Patient Positioners.
We sell our specialty line of patient positioners primarily under the trademark Span-Aids. This is our original product line and consists of over 300 different foam items that aid in relieving the basic patient positioning problems of elevation, immobilization, muscle contracture, foot drop, and foot or leg rotation. Span-Aids patient positioners hold a patient’s body in prescribed positions, provide greater patient comfort, and generally are used to aid long-term comatose patients or those in a weakened or immobilized condition. The positioners also help in the prevention of pressure ulcers by promoting more effective dispersion of pressure, heat and moisture. Span-Aids are intended for single-patient use throughout a patient’s entire treatment program. Among the Span-Aids products that we presently market are abduction pillows, body aligners, head supports, limb elevators and various foot and wrist positioners. We sell patient positioners primarily to acute care hospitals and long-term care facilities through several national medical products distributors.
Mattress Overlays.
Span-America produces a variety of foam mattress overlays, including convoluted foam pads and its patented Geo-Matt® overlay. Span-America’s overlay products are mattress pads rather than complete mattresses and are marketed as less expensive alternatives to more complex therapeutic support surfaces. Our mattress overlays disperse body heat, increase air circulation beneath the patient and reduce moisture accumulation to aid in the prevention and treatment of pressure ulcers. Their convoluted or geometrically contoured construction also reduces shear forces and more evenly distributes the patient’s body weight, thereby reducing the localized pressure that can cause pressure ulcers. The Geo-Matt design includes numerous individual foam cells that are cut to exacting tolerances on computer-controlled equipment to create a clinically effective mattress surface. These products are designed to provide patients with greater comfort and to assist in treating patients who have developed or are susceptible to developing pressure ulcers. The mattress overlays are designed for single patient use. The primary markets for our mattress overlays are long-term care and acute care facilities in North America.
Seating Products.
Another product category in our medical segment consists of seat cushions and related seating products for wheelchairs, geri-chairs (typically used in long-term care facilities) and other health care seating needs. Our offerings in this category can be subdivided into three main groups:
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patient positioning and general pressure management products, and
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pressure management products without patient positioning features.
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Seating products made specifically as an aid to wound healing include the Isch-Dish® and Sacral Dish® pressure relief cushions. Seating products made for patient positioning and general pressure management include the Isch-Dish Thin, the Geo-Matt® Contour® cushion, the Equalizer®, and the EZ-Dish®. The Equalizer contoured positioning cushion has a multi-component design that includes a viscoelastic foam top, proprietary soft polymer inserts, and a contoured base. This makes it an attractive option for durable medical equipment suppliers and rehab seating specialists. The EZ-Dish pressure relief cushion, which uses some of the features of the original Isch-Dish design, offers a simpler, more affordable solution to the seating problems of nursing home patients. The Geo-Wave® Cushion assists with positioning and pressure reduction for patients using specialty recliners and geri-chairs. The Short-Wave® seat and back cushion reduces shear and assists with patient positioning in standard wheelchairs.
Seating products designed to address pressure management without additional positioning benefits include the Gel-T® cushion and the Geo-Matt and Geo-Matt PRT® wheelchair cushions. The Gel-T is a gel/foam combination cushion that is especially popular with elderly patients. The Geo-Matt and Geo-Matt PRT cushions incorporate our proprietary Geo-Matt anti-shearing surface.
Skin Care Products.
We also market the Selan® line of skin care creams and lotions under a license agreement with Trividia Manufacturing Solutions, Inc. formerly Nipro Consumer Healthcare, Inc., DBA P.J. Noyes Company. The products, which are manufactured by P.J. Noyes, are used for cleaning, moisturizing and protecting patients’ skin and are sold primarily in long-term care and acute care settings. The term of our license agreement with Trividia Manufacturing Solutions has been extended through December 31, 2020.
Fall Protection Products.
In December 2008, we began marketing the Risk Manager® bedside safety mat, which was a new product category for Span-America. The Risk Manager is manufactured outside the United States, using an elastomeric gel compound and is designed to cushion the force of impact and reduce the chance of injury to a patient who falls at the bedside. The Risk Manager is sold primarily in the long-term care market.
Availability of our Medical Products from Durable Medical Equipment Distributors.
Although our medical products are most commonly used in long-term care facilities and, to a lesser extent, in acute care facilities, all of our medical products described above are also available for sale to retail customers through durable medical equipment distributors specializing in the sale of medical products to the general public at retail for individual use.
Distributor Relationships.
We sell our medical products to many customers of varying sizes. We also sell our branded medical products to several medical products distributors which resell our products to acute care hospitals and long-term care facilities throughout North America and, to a lesser extent, in Australia. We believe our relationships with these distributors are good. However, the loss of one or more of these distributors could have a material adverse effect on our business. Sales to our largest medical distributor, McKesson, made up approximately 24% of net sales in the medical segment during fiscal 2016. See Item 1A. “Risk Factors” below for more information regarding our relationships with large customers.
Custom Products Segment
Span-America’s custom products segment includes two major product lines: consumer bedding products and various engineered industrial products. Our consumer product line consists primarily of convoluted and contour-cut mattress overlays and specially designed pillows for the consumer bedding market. We have a distribution agreement for consumer products with Hollander Home Fashions (“Hollander”) which expires in December 2018. The agreement automatically renews for successive three-year terms unless either party provides notice of its intent not to renew at least 60 days prior to the expiration date.
Our industrial product line consists of custom engineered foam products used in a variety of markets, including the automotive, packaging, durable goods, electronics and water sports equipment industries. Our largest industrial customers manufacture automobiles and specialty packaging products. Most of our industrial products are made to order according to customer specifications and are sold primarily in the southeastern United States.
In fiscal 2016, approximately 57% of our total custom products sales were distributed through Hollander. Also in fiscal 2016, approximately 19% of our total custom products sales were distributed through another consumer distributor, Sinomax USA Inc. (“Sinomax”), but that distributor relationship ended in May 2016. The loss of the Hollander relationship could have a material adverse effect on our business. See Item 1A. “Risk Factors” below for more information regarding our relationships with large customers.
Research and Development
Span-America’s expenditures for research and development were $1,135,000, $1,137,000 and $1,072,000 for fiscal years 2016, 2015 and 2014, respectively. We incur almost all of our research and development expenses in the medical segment for the development of new products, new features of existing products and product design improvements.
Please see information under the heading “Results of Operations Fiscal 2016 vs. 2015,” “Selling, Research & Development and Administrative Expenses” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information on research and development expenses.
Competition
Medical
. In the medical market segment, we face significant competition for sales of the three main categories of therapeutic support surfaces. These are powered air therapy support surfaces, non-powered air therapy support surfaces and therapeutic foam support surfaces.
Competition in the therapeutic support surface market is based on a variety of factors including product performance, ease of use, patient safety features, price and durability. Customers often select a product based on these criteria after conducting a formal clinical evaluation.
Chief competitors include Joerns Healthcare, Inc., Medline Industries, Inc., Drive DeVilbiss Healthcare, Inc., Invacare Corporation, GF Health Products, Inc. (Graham-Field), Hill-Rom Holdings, Inc. (Hill-Rom), Sizewise Worldwide and Stryker. These competitors use combinations of their own sales representatives and manufacturer’s representatives to sell nationwide directly to hospitals, distributors, long-term care facilities and original equipment manufacturers.
These competitors are larger and have greater resources than Span-America. We believe our competitive advantages in the medical segment include innovative and patented product designs, product quality, manufacturing capabilities, distribution relationships, rapid delivery capabilities and responsiveness to customer requirements. Many smaller national and regional competitors also participate in this segment, with varying marketing strategies and resources.
S
pan Medical Produ
cts Canada.
Created through the December 2011 acquisition of M.C. Healthcare Products in Beamsville, Ontario, Canada, this division faces competition for sales in the long-term care market both from manufacturers and national distributors of long-term care beds and related furniture. Price as well as product features and performance, quality, delivery and brand recognition all play a part in selection of a particular product. Additionally, the ability to offer packages that include a variety of products as well as financing can also influence the buying decision. The purchase decision may also be based on a mixture of the preceding factors.
Several of the primary competitors in the long-term care market for medical beds and related in-room furniture are the same as those in the support surfaces segment. These include Joerns Healthcare, Inc., Medline Industries, Inc., Drive DeVilbiss Healthcare, Inc., Invacare Corporation and GF Health Products, Inc. (Graham-Field). These competitors are larger than Span Medical Products Canada and use their own sales forces, manufacturer's representatives, distributors, durable medical equipment dealers or a combination thereof to sell their products to acute care facilities, long-term care facilities or to the general public at retail for individual use. While our medical bed and in-room furniture business has historically been smaller than its major competitors, we believe the product line has a reputation for high quality, innovative features and excellent customer service.
Custom Products.
In the custom products segment, we routinely encounter significant competition for our mattress pad and pillow products. The competition for traditional polyurethane foam products is principally based on price, which is largely determined by foam density and thickness. However, competition also exists due to variations in product design and packaging. There are presently a number of companies with the manufacturing capability to produce similar bedding products. Our primary competitors in this market are Sleep Innovations, Inc., E.R. Carpenter Company and Sinomax, all of which are larger and have greater resources than Span-America.
We also have a number of competitors in the market for our industrial products, including Hibco Plastics, CelloFoam North America, Inc. and Foam-Tech. These competitors are larger and have greater resources than Span-America, including large, nationwide sales forces. The competition for industrial foam products is largely based on price. In many instances, however, design, product quality and delivery capabilities are also important.
We believe that our competitive advantages in the custom products segment include our distribution relationship with Hollander, innovative product designs, manufacturing and foam fabrication capabilities, low cost manufacturing processes and responsiveness to customer requirements.
During recent years, we have encountered increasing competition in the consumer bedding market from visco foam products manufactured both in the United States and China. Visco foam, also known as visco-elastic foam or memory foam, has greater density and different properties than traditional polyurethane foam products. It responds to body temperature, conforms to the shape of the body, and generally has slower recovery time compared with traditional polyurethane foam. Memory foam is also significantly more expensive than traditional foam and is more difficult to handle and fabricate. Because memory foam is more difficult to cut and shape than traditional foam, the memory foam mattress pads currently on the market, including our own, tend to be somewhat undifferentiated without unique surface designs. Consequently, it is more difficult for us to differentiate our memory foam products from those of our competitors. In addition, since memory foam is more expensive and more dense than traditional foam, it is more cost effective for overseas competitors (from China for example) to ship the products into the U.S. market. This is generally because retail prices of memory foam products are significantly higher than comparable traditional foam products, which generates much higher revenue per square foot of retail shelf space and lowers shipping costs as a percent of sales value.
Major Customers
Sales to McKesson Corporation, one of our medical distributors, during fiscal 2016 made up approximately 17% of our total net sales and approximately 24% of sales in the medical products segment. Sales to the United States Department of Veterans Affairs made up approximately 8% of our total net sales and approximately 11% of net sales in the medical products segment during fiscal 2016.
During fiscal 2016, we had significant relationships with two distributors for our consumer foam products. Sales to Hollander during fiscal 2016 made up approximately 18% of our total net sales and approximately 57% of sales in the custom products segment. Sales to Sinomax during fiscal 2016 made up approximately 6% of our total net sales and approximately 19% of sales in the custom products segment, but that distributor relationship ended in May 2016.
See “Industry Segment Data – Medical Segment – Distributor Relationships” above and Note 17 – Major Customers and Note 18 – Operations and Industry Segments and Geographic Areas in the Notes to Consolidated Financial Statements below for more information on major customers. The loss of any of these major customers could have a material adverse effect on our business.
Seasonal Trends
Seasonal trends within our medical segment are generally not material to our operations. However, we periodically have significant seasonal fluctuations within our custom products segment. The custom products segment consists of our consumer and industrial product lines. We occasionally experience significant fluctuations within our consumer bedding products due to seasonal promotions with our retail customers. Historically, these consumer promotions have commonly occurred during our first and fourth fiscal quarters, ending in December and September, respectively. The consumer products promotions are arranged on a case-by-case basis with our retail customers and our marketing partner, Hollander. Consequently, it is possible to have multiple promotions within a fiscal year or none at all, depending on market and competitive conditions. We have not experienced significant seasonal fluctuations in our industrial product line.
Patents and Trademarks
Span-America holds 18 United States patents and four foreign patents relating to various components of our beds, therapeutic support surfaces and seating products for the medical segment. We also have filed eight additional patent applications, which are currently pending. We believe that these patents are important to our business. However, while we have a number of products covered by patents, there are competitive alternatives available, sales of which are not restricted by our patents. Therefore, we do not rely solely on our patents to maintain our competitive position in our various markets.
Our principal patents include those on our PressureGuard and seating products. The PressureGuard patents have remaining lives ranging from one to 12 years with additional patents pending. The seating patents have remaining lives ranging from one to two years. We believe the expiration of these principal patents would not have a material adverse effect on our business.
We hold 39 federally registered trademarks and 19 foreign trademark registrations primarily within our medical segment, including
Span-A
merica, Span-Aids, Geo-Matt, Geo-Mattress, PressureGuard, Custom Care
and
Encore
. We also have 11 trademark registration applications presently pending. We believe that these trademarks are readily identifiable in their respective markets and add value to our product lines.
Raw Materials and
Backlog
Approximately 85% of our raw materials consist of polyurethane foam, nylon/vinyl mattress covers and tubes, motors, pneumatic pumps, blowers, bed actuators, steel and metal stampings. In addition, we use corrugated shipping containers, polyethylene plastic packaging material and hook and loop fasteners. We believe that our basic raw materials are in adequate supply and are available from many suppliers at competitive prices.
See Item 1A. “Risk Factors” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information on price increases for polyurethane foam.
As of October 1, 2016, we had unshipped (or open) orders of approximately $4.1 million, which represented a 43% decrease compared with our open orders of $7.2 million at fiscal year-end 2015. Our open orders were much higher at fiscal year-end 2015 because of a large seasonal promotion for consumer products that was completed in November 2015. We expect to fill all orders open as of October 1, 2016 in the 2017 fiscal year.
Employees
We had 238 full-time employees as of October 1, 2016 (170 in the United States and 68 in Canada). Of these employees, 150 were manufacturing personnel. Span-America is not a party to any collective bargaining agreement in the United States and has never experienced an interruption or curtailment of operations due to labor controversy.
The manufacturing employees of M.C. Healthcare, located in Beamsville, Ontario (42 employees at October 1, 2016) are members of the Sheet Metal Workers’ International Association, Local Union #540 (the “Union”), whose employment is governed by a Collective Agreement with the Union that was assumed by operation of Canadian labor law by our Canadian subsidiary in connection with the asset acquisition. This Collective Agreement will expire by its terms on October 31, 2018. We believe that our relations with our employees are good in both the United States and Canada.
Supervision and Regulation
The Federal Food, Drug and Cosmetic Act, and regulations issued or proposed thereunder, provide for regulation by the FDA of the marketing, manufacture, labeling, packaging and distribution of medical devices, including some of our medical products. These regulations require, among other things, that medical device manufacturers register with the FDA, list devices manufactured by them, and file various reports. In addition, our manufacturing facilities are subject to periodic inspections by regulatory authorities and must comply with “good manufacturing practices” as required by the FDA and state regulatory authorities. We believe that we are in substantial compliance with applicable regulations and do not anticipate having to make any material expenditures as a result of FDA or other regulatory requirements.
We are certified as an ISO 9001 and ISO 13485 supplier for our PressureGuard therapeutic support surface products from our Greenville, South Carolina plant. ISO (the International Organization for Standardization) is a worldwide federation of national standards bodies dealing with quality-system requirements that can be used by a supplier to demonstrate its capability and for the assessment of the capability of a supplier by external parties. Compliance with ISO standard 13485 is required by Health Canada for all Class II medical devices sold there. All of our powered therapeutic support surfaces for the health care market are considered Class II medical devices. The certification is subject to reassessment at six-month intervals. We have maintained our certification based on the results of ISO audits conducted during fiscal year 2016.
The Canadian Food and Drugs Act, and the Medical Devices Regulations issued thereunder, provide for regulation by Health Canada of the manufacture, labeling, packaging, distribution, sale and advertisement of medical devices, including non-powered and powered therapeutic support surfaces and bed frames made through Span Medical Products Canada Inc., Span-America's wholly-owned subsidiary, which are considered Class I medical devices in Canada. The Medical Devices Regulations require, among other things, that Class I and II medical device manufacturers selling medical devices hold a medical device establishment license and file various reports. In addition, manufacturing facilities are subject to periodic inspections by regulatory authorities and must comply with device safety and effectiveness requirements as required by the Medical Devices Regulations and Health Canada. We believe that we are in substantial compliance with applicable regulations and do not anticipate having to make any material expenditures as a result of Health Canada or other currently applicable regulatory requirements.
The Therapeutic Goods Administration (TGA) is part of the Australian Government Department of Health, and is responsible for regulating therapeutic goods. The Therapeutic Goods Act 1989 (the Act) outlines a risk based regulatory framework for therapeutic goods, with the level of regulation reflecting the assessed risk of the product. Therapeutic goods on the market in Australia are required to be manufactured to an appropriate quality, and while no therapeutic good can be considered risk free, when used as intended the benefits of any product should outweigh the risks associated with its use. Our beds, as well as foam and powered mattresses, are considered Class I (low risk) under this regulation and are all registered using Emergo Group as our Australian Sponsor. We believe that we are in substantial compliance with applicable regulations and do not anticipate having to make any material expenditures as a result of TGA or other currently applicable regulatory requirements.
Environmental Matters
Our manufacturing operations in the U.S. and Canada are subject to various government regulations pertaining to the discharge of materials into the environment. We believe that we are in substantial compliance with currently applicable regulations. We do not anticipate that continued compliance will have a material effect on our capital expenditures, earnings or competitive position.
Item 1A. Risk Factors
The loss of a key distributor or customer in the Company’s medical or custom products segments could cause a rapid and significant sales decline, which would likely result in a material decline in earnings.
Many of our medical products are sold through large national distributors in the United States and Canada. We do not maintain long-term distribution agreements with most of these distributors. Instead, we supply them based on purchase orders that are issued by the customers on a daily or weekly basis. With minimal notice, either party can generally end these supplier-customer relationships. It is also possible that a non-participating distributor may acquire one or more distributors with whom we have a relationship, at which time the survivor distributor may decide to terminate the relationship. If a large customer or distributor decided to discontinue purchasing our products, our sales and earnings could quickly decline. Our largest customer in the medical segment is McKesson Corporation, which represented approximately 17% of our total net sales and 24% of our sales in the medical segment during fiscal 2016.
Historically, our consumer bedding products have been sold through our distributor, Hollander, under a marketing and distribution agreement that originally would have expired in December 2015. The agreement automatically renews for successive three-year terms unless either party provides notice of its intent not to renew at least 60 days prior to the expiration date. Neither party provided the other with the requisite notice of intent not to renew the marketing and distribution agreement in 2015. The next renewal anniversary is December 2018. Sales to Hollander accounted for approximately 18% of our total net sales during fiscal 2016 and 57% of our sales in the custom products segment. The loss of the Hollander relationship could have a material adverse effect on our business.
Through May 2016, we shipped consumer products to a major consumer retailer through a different distributor, Sinomax. Hollander verbally consented to the separate distribution channel for this retailer. Sales to Sinomax accounted for approximately 6% of our total net sales during fiscal 2016 and 19% of our sales in the custom products segment, but that distributor relationship ended in May 2016.
For more information on major customers and information on our business segments, see the discussions under Item 1. “Business – Industry Segment Data – Medical Segment – Distributor Relationships,” Item 1. “Business – Industry Segment Data – Custom Products Segment,” Item 1. “Business – Major Customers,” Note 17 – Major Customers and Note 18 – Operations and Industry Segments and Geographic Areas in the Notes to Consolidated Financial Statements.
Our sales and earnings performance can be volatile when compared from quarter
-
to
-
quarter or year
-
to
-
year because of the effect of
(1) large, infrequently recurring orders of therapeutic support surfaces or medical beds in our medical segment and (2)
limited
-
time
or seasonal
promotions that occur
on an irregular basis
in our custom products segment.
Within our medical segment, our two largest volume product lines are therapeutic support surfaces and medical beds, which are sold primarily in the long-term care market. Since these products are sometimes purchased as part of capital improvement projects, the purchases can occur in large-volume quantities at irregular intervals. These large orders can cause volatility in our quarter-to-quarter and year-to-year sales and earnings comparisons.
Within our custom products segment, we have from time to time participated in several limited time, seasonal promotions of our consumer products. These promotions had the effect of temporarily increasing our sales and earnings during the periods the promotions took place. The promotions are conducted primarily at the sole discretion of our retail customers and therefore may or may not recur in future periods. While we benefit from these promotions when they take place, if similar promotions do not recur in future comparative periods, or if the quantities ordered or prices accepted are less than the comparable prior-year period, it creates an unfavorable sales and earnings comparison with prior-year periods. This situation might obscure or overshadow more gradual favorable changes, or less dramatic unfavorable changes, in our ordinary course of business, which we believe more accurately reflect the long-term financial health of our business.
Possible downturns
in the U.S. economy combined with uncertainties about health care reform and tax policy could cause our sales to decline, which in turn could have a material negative effect on our earnings.
The largest volume product lines within our medical segment are our lines of therapeutic support surfaces, which consist of our PressureGuard and Geo-Mattress products as well as our private-label support surfaces, and our lines of medical beds for the long-term care market. These products are generally considered by us and our customers to be capital purchase items instead of consumable supplies. We believe that purchases of these capital goods are more easily postponed during business downturns than purchases of consumables. Consequently, sales of our support surfaces and medical beds are likely to be more sensitive to general economic weakness than other medical product lines in our business. Also, uncertainties about federal and state tax policy, interest rate projections and the implementation or repeal of health care reform could cause our customers to delay, reduce or cancel capital expenditure plans, which could slow sales particularly within our support surface and medical bed product lines. Therapeutic support surface sales made up 39% of total Company sales during fiscal 2016 and increased 3% during the year compared with fiscal 2015. Sales of medical beds made up 14% of total Company sales during fiscal 2016. Sales of therapeutic support surfaces and medical beds could decline if economic conditions worsen or if health care reform and changes in tax policy result in reduced demand from our customers.
In addition, our industrial products are sold primarily to the automotive, packaging and water sports industries, as well as various other manufacturers. Our industrial business has historically been more affected by general economic trends than other Span-America product lines. Therefore an economic downturn is likely to have a greater effect on sales of industrial products than on other product lines in our business. Sales of industrial products could decline if economic conditions worsen.
Since many of our operating costs are fixed within a normal monthly range of sales and production activity, sales declines could result in proportionally greater declines in earnings performance. We would attempt to reduce expenses in response to lower sales levels, but we cannot give assurance that we would be able to fully offset the effect of a decline in sales volume. As a result, our business could be materially adversely affected by an economic downturn or weakness in the economy.
Downturns in the U.S. and global economies could also have a material adverse effect on the business or financial condition of one or more of our key customers or distributors or on several customers and distributors that, in the aggregate, account for a material portion of our sales. Such an adverse effect on our customers or distributors could, in turn, have a material adverse effect on our own business and/or financial condition as a result of a loss or material reduction in our sales to such customers or distributors and also, potentially, our inability to collect a material amount of accounts receivable (which accounts receivable are unsecured) owed to us by such customers or distributors if they become unable to pay their debts.
Since our therapeutic support surfaces and medical bed products are considered to be capital purchases by our customers, some customers may have to borrow all or a portion of the funds necessary to purchase our products. In this event, the current and projected levels of interest rates may, if such rates are increasing or are projected to increase, have a material adverse effect on the customers’ order quantities and our resulting sales to those customers.
If some or all of our medical products were determined to be subject to the medical device excise tax imposed by the Affordable Care Act, there could be a material adverse effect on our net income.
Beginning January 1, 2013, the Affordable Care Act imposed a 2.3% excise tax on sales of products defined as “medical devices” by the regulations of the U.S. Food & Drug Administration (the “FDA”) unless the products fit within certain exemptions enumerated in the Affordable Care Act. Subsequently, the Consolidated Appropriations Act of 2016 imposed a two-year moratorium on the medical device excise tax on medical device sales from January 1, 2016 through December 31, 2017. We believe that all of our medical products except for Selan® skin care products are “medical devices” within the meaning of the FDA regulations. We also believe that our medical products are exempt from the excise tax because our interpretation is that they meet the definition that is commonly referred to as the “Retail Exemption.” The Retail Exemption provision allows an exemption for medical devices of a type that can be purchased by the general public at retail for individual use if (1) the device is regularly available for purchase and use by individual consumers who are not medical professionals, and (2) the device’s design demonstrates that it is not primarily intended for use in a medical institution or office or by medical professionals. While we believe all of our medical products are exempt, the Retail Exemption is based on a facts-and-circumstances inquiry into numerous factors listed in the Affordable Care Act rather than a “bright line” standard. If some or all of our medical products were found to be medical devices subject to the excise tax, we could incur material tax expenses on our sales of medical devices which could have a material adverse effect on our sales, earnings and financial condition. Our medical sales excluding Selan totaled $11.1 million from October 2015 through December 2015 (when the moratorium took effect), $46.6 million in fiscal 2015, $41.1 million in fiscal year 2014 and $35.6 million in the nine-month period from January 2013 (when the tax became effective) through our fiscal year ended in September 2013. If the excise tax were found to apply to all of our medical products (other than Selan products), our additional tax expense (excluding interest and penalties) would be approximately $255,000 for fiscal 2016, $1,071,000 for fiscal year 2015, $945,000 for fiscal year 2014 and approximately $819,000 for the nine-month period from January 2013 through September 2013. Of course, actual future sales levels and the amount of any applicable excise tax would vary.
Our acquisition of M
.
C
.
Healthcare in December
2011 has introduced different
risks for the Company, including
those related to
international operations,
foreign exchange, a unionized workforce and impairment of goodwill or other intangible assets.
M.C. Healthcare’s manufacturing facility is located in Beamsville, Ontario, Canada. We are leasing the current facility under a five-year lease agreement as described elsewhere in this report. As a result, we have been operating in a foreign country under different laws, regulations and customs, all of which have added potential new risks and costs to the Company.
Prior to the acquisition, Span-America had no material foreign exchange risk. As a result of the acquisition, we now manufacture and sell products in both the U.S. and Canada. Revenues and costs are incurred in both U.S. and Canadian dollars. We are therefore subject to realized and unrealized gains or losses on foreign currency translation activities related to our operations. These foreign exchange gains or losses could have a material effect on our results of operations. See Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations – Foreign Currency Exchange” and Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” for more information on foreign exchange risk.
Span-America had no material experience in managing a unionized workforce prior to the M.C. Healthcare acquisition. Most of the manufacturing employees at our Beamsville, Ontario plant are members of a union. We are therefore subject to risks related to the management of union employees such as work slowdowns or stoppages, compliance with the terms of the union agreement and periodic contract negotiations. However, we believe that our relations with our employees are good.
The M.C. Healthcare acquisition resulted in additional goodwill of approximately $2.5 million. We evaluate this goodwill at least annually for possible impairment. If the goodwill became impaired and not recoverable, it could result in a material non-cash charge to earnings, which could have a material adverse effect on our financial condition. See Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Impairment of Goodwill” and Note 5 – Goodwill in the Notes to Consolidated Financial Statements for more information on goodwill impairment.
Our medical business could lose sales volume or could have a lower sales growth rate as a result of government reimbursement changes in the medical market.
Most of our end-user customers in the long term care and acute care markets are eligible for reimbursement by the Centers for Medicare and Medicaid Services (“CMS”) for patient care and treatment. The reimbursement in these markets is done generally on a per diem basis, depending on the condition and needs of each patient. We receive no direct reimbursements from CMS, but our end-user customers often submit reimbursement requests to CMS. For example, we sell therapeutic support surfaces to long-term care facilities, which, in many cases, receive per-diem-based reimbursements from CMS for the care and treatment of the patients in these facilities. If the CMS reimbursement rates are reduced, the demand for our medical products could decrease, because a reduction in CMS reimbursement rates reduces the revenue of the affected facilities. The potential decrease in demand for our medical products would depend on the size of the CMS rate reduction. A significant rate reduction could have a material adverse impact on our sales and earnings.
Our earnings could be negatively affected by raw material cost increases that we are unable to recover through sales price increases.
The cost of polyurethane foam represented approximately 36% of our total cost of goods sold in fiscal 2016. An increase in foam raw material costs that we are not able to pass through to our customers by increasing prices could have a significant negative effect on our profitability. Besides polyurethane foam, our other major raw material categories include therapeutic support surface covers made of various water-proof fabrics, vinyl bags, vinyl air cylinders, electronic components for medical beds and support surfaces, motors, pneumatic pumps, blowers, corrugated boxes, bed positioning actuators, steel and metal stampings. Raw materials are our single largest cost category, representing approximately 73% of our total cost of goods sold in fiscal 2016. Cost increases in these raw materials could have a significant adverse effect on earnings if we are unable to recover the higher costs through sales price increases or operating expense reductions.
Changes in applicable laws or increased government regulations to limit carbon dioxide and other greenhouse gas emissions, as a result of concern over climate change, may result in increased raw material costs or other costs, which would negatively affect our profitability.
Our sales volume could decline as a result of competition from low-cost foreign imports.
During the last several 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 and bed products has increased, 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. Also, our customers in the consumer market, which are usually national retailers, are generally more likely to change suppliers to buy lower-cost products than our customers in the medical market. Therefore, we could lose significant sales volume in our consumer bedding business and some portion of our medical sales volume if we are unable to compete effectively with low-cost imports.
Substantially all of our medical products are classified as medical devices and are regulated by the FDA and Health Canada.
These regulations require, among other things, that medical device manufacturers register with the FDA and Health Canada, list devices manufactured by them, and file various reports. In addition, our manufacturing facilities are subject to periodic inspections by regulatory authorities and must comply with “good manufacturing practices” as required by the FDA, state and Canadian regulatory authorities. Although we believe that we are in substantial compliance with currently applicable regulations, the existence of the regulations creates the risk of a product recall and related expenses as well as the risk of additional expenses required to meet new regulatory requirements.
Loss of key personnel, and/or our inability to attract qualified personnel including qualified hourly production personnel, may limit our ability to grow and reduce our ability to compete.
We are committed to the idea that the people engaged in working for the Company are our strongest and best resource. Most recently, it has been difficult to find and retain qualified production personnel in Greenville. If we are unable to attract and retain production personnel, then production of our products could be compromised. We believe that our relationship with our employees is good, but in the event of a significant work slowdown or work stoppage, our sales and profitability would be materially adversely affected.
Our sales volume could decline in the event other devices or pharmaceuticals are determined to be more effective than
our
products for the prevention and treatment of pressure ulcers.
Our therapeutic support surfaces are designed and indicated for the prevention and treatment of pressure ulcers. In the event that other devices or pharmaceuticals are demonstrated to be superior to our therapeutic support surfaces in the prevention and treatment of pressure ulcers, and if we are unable to respond to the challenge with our own new products of a superior type, then we could experience a material sales and profitability decline.
Our ability to compete effectively in the medical market is dependent on a continuous stream of innovation in the form of new, more medically effective and more cost effective new products.
Our product development results are very important in maintaining and expanding our competitive position in the medical marketplace. If for whatever reason, including loss of key personnel, regulatory setbacks or delays, lack of adequate financial resources, the inability to access needed technologies due to such technologies being subject to intellectual property ownership by others, a key product development not meeting performance requirements, premature product obsolescence and other factors, we are unable to keep up the rate of new product design and development, our competitive position in the marketplace could be compromised resulting in a decrease in sales and earnings.
One of the key strengths of our Company is its sales organization, including field sales representatives and specialists, and such strength is dependent on the continuity of our sales organization.
Loss of a significant portion of our sales organization, be it to our direct competition, other medical device companies, our inability to provide competitive compensation, illnesses, retirement or other factors, could have a material adverse effect on our sales level or our rate of sales increase.
We are dependent on our suppliers, particularly our foam suppliers, to have the ability to meet our needs on a timely basis for raw materials used in our products.
In the event our suppliers, particularly our foam suppliers, cannot respond on time to our orders for raw materials, or in the event one or more key suppliers go out of the business, we may incur backorders and in turn may not be able to produce our products in time to fill orders from our customers. If this situation occurred, our customers may cancel their orders with us and seek substitute products from our competition, in which case we could lose market share and experience a decrease in sales, or a decrease in the rate of sales growth.
A shortage of one or more chemicals used in the production of foam could result in a reduction in the supply of foam and an increase in the price.
As noted above, various types of foam represent the most prevalent raw material in many of our products. In turn, foam is comprised of various chemicals purchased by our foam suppliers for the production of their foam products. In the event of a shortage of any of the key chemicals, the foam suppliers may not be able to produce the foam we order and/or the price could be higher to reflect the chemical shortage, in which case we may not be able to produce our products at planned costs, we may not be able to increase the price sufficiently to cover the cost, we may incur backorders and we may suffer reduced profitability.
Adverse product liability settlements could have a material impact on our reputation, sales
and
profitability.
While we believe our products are safe, efficacious and reliable, and we believe our products meet all known regulatory requirements in the markets in which they are sold, customers and/or patients may take a different position. The Company maintains insurance coverage that would mitigate costs related to products liability claims. However, a material adverse products liability settlement or judgment could damage our reputation, require the payment of costs, fines and legal expenses, result in the loss of one or more customers and potentially risk a reduction in sales or the rate of sales increase.
Larger, well-established competitors dominate the markets in which we compete.
Virtually all of our competitors for our therapeutic surfaces, medical beds and custom products range from somewhat larger to substantially larger than the Company. While we believe we are holding or gaining market share in our largest product lines, depending on the particular market, larger, well-financed competitors present a formidable challenge. If we are unable to compete effectively with these larger competitors, we could lose market share, and sales could decrease.
Our
growth has been fueled by a combination of organic growth from product development interspersed with occasional acquisitions.
Product development risks are discussed above. In the event suitable acquisitions are not available, are too expensive, are too complex, or if available, are unreasonable in price, are not straightforward, are a distraction to management, are difficult to integrate, or result in distributor dislocations, among other problems, our growth component related to acquisitions could be hindered, resulting in a reduction in the rate of sales increase at best, and Company management and customer distraction could result at worst, and ultimately, the acquisition could fail to be additive to the Company. In addition, if capital to fund acquisitions is not available or too expensive, then our ability to grow through acquisitions could be limited to those that could be funded internally.
While
we are
not solely dependent on
our
intellectual property and trade secrets to protect
our
products, to a certain extent these protections provide a deterrent to the competition.
If for whatever reason we are unable to protect our intellectual property in the form of patent claims, trade secrets including know-how, and trademarks, then new or more aggressive competition would be anticipated with the result that our sales and profitability could be materially adversely affected.
A successful cyber-attack on
our
computer system and network could seriously disrupt
our
operations and compromis
e
Company and customer information.
While we have purchased and installed software designed to ward off hostile cyber-attacks, we are not immune from a focused cyber-attack. A successful cyber-attack could make it impossible to enter orders from customers, place orders with suppliers, conduct supply chain operations, invoice customers, meet payroll and conduct other day to day operational tasks using our computer system. Such an event could lead to our inability to supply customers on time, large and lengthy backorders, a sharp decline in customer service levels, and as a result, a decrease in sales and profitability.
Storms,
f
ires,
f
loods, and the like could interrupt
our
operations and prevent a rapid return to operating status, which could compromise
our
ability to supply
our
customers and result in a loss of sales and a reduction in profitability.
With the exception of a few “purchased” products for resale, we manufacture all of our products in one of only two locations. Medical beds are produced in our Beamsville, Ontario, Canada location but not in our Greenville location, and our therapeutic support surfaces are primarily produced in Greenville but not in Beamsville. In the event of a damaging hurricane, tornado, fire or flood in Greenville, or a damaging blizzard, fire or flood in Beamsville, the ability to produce certain products could be seriously compromised for a lengthy period of time. To the extent products may not be available to satisfy customer orders, our sales and profitability could be materially adversely affected.
Span-America
is a microcap public company with a limited outstanding common stock float, limited analyst coverage, and relatively light daily trading volume, all of which may constrain buy and sell transactions to small quantities over an extended period of time.
Existing and prospective shareholders may find it difficult to buy or sell the desired quantities of our common stock without impacting the stock price either negatively or positively depending on the desired transaction. As such, it may be necessary to achieve the desired total transaction in several smaller quantity steps, with the result that transaction costs to the shareholder could be more than transaction costs for a single transaction. While we believe our repurchase of common stock in October 2015 was in the best interest of the shareholders, the common stock repurchased by the Company was retired, resulting in a further reduction in the float.
If, for any of the reasons noted above, or other factors within or beyond
our
control,
our
free cash flow is materially constrained in any quarterly period or for any longer period of time,
we
may not be able to continue to pay all or a portion of
our
current dividend to shareholders.
While our management and Board are proud of the Company’s record in creating value for shareholders and in returning a portion of such value to shareholders periodically in the form of regular quarterly dividends and special dividends, management and the Board acknowledge that the future payment of such dividends is dependent upon many factors including the avoidance of the material negative impact of any of the risk factors noted above, or any other risk factors not so noted above that are beyond reasonable expectations at this time.
During fiscal year 2016, we began distributing certain of our medical products through a local distributor in Australia. As we expand the distribution of our products beyond North America, the company will be subject to increased risk
s
related to various anti-corruption laws in the countries where we do business.
The laws of most countries make the payment or offer of payment or receipt of a bribe, kickback or other corrupt payment a crime, subjecting both the company and individual employees to criminal and civil penalties, including fines and prison sentences. These anti-corruption laws include, but are not limited to, the U.S. Foreign Corrupt Practices Act (the “FCPA”). If our employees or representatives fail to comply with these anti-corruption laws, including the FCPA, the company could be subject to penalties and fines, which could disrupt our business and have negative financial and legal consequences.