Span-America Corporation (SPAN)
Founded in 1970 and headquartered in Greenville, South Carolina, Span-America Corporation (SPAN) began operations in 1975 as a manufacturer of polyurethane foam patient positions and later expanded line to include foam mattress overlays for the wound care market in acute care hospitals. SPAN essentially has two main businesses: 1) Medical and 2) Custom.
MEDICAL SEGMENT (70%+ of sales and usually 80-90% of profits)
In this segment, the company is primarily a manufacturer of foam and air mattresses ("therapeutic support surfaces") for medical providers (nursing homes, hospitals, and home care). The company has a sales force of 30 and 5 independent representatives who sell directly to end-users and to medical product distributors. SPAN’s mattresses are patented and designed to reduce the chances of patients rolling out of bed or becoming entrapped.
A big target market for SPAN is the bed sores market. Pressure ulcers are a large area of focus for hospitals as they can directly impact pay for performance from Medicare and other payors. The company’s mattresses have been clinically shown to reduce pressure ulcers (bed-sores). These mattresses automatically sense the patient’s weight and position to continually adjust the pressures while slowly and quietly repositioning the patient at angles up to 30 degrees in cycles of up to two hours. Products include the PressureGuard mattress system, GeoMattress, and Geo-Matt. Largest customers are McKesson Medical-Surgical (17% of medical) and the U.S. Veterans Affairs (11% of medical). Importantly, bed sore mattresses are designed for single patient use.
The company’s primary competitors are Hill-Rom, Kinetic Concepts, Invacare, Joerns Healthcare, and Medline Industries. The company acquired Healthflex in 1992 which enabled launch of PressureGuard therapeutic product and later acquired M.C. Healthcare for $10mm in December 2011 to enter medical bed frame market.
SPAN began expanding more aggressively into the acute care hospital area in 2009, having historically sold its proprietary brands to nursing homes and home health providers, and having accessed the hospital market through a private label contract with Hill-Rom which ended in 2008. At the time Hill-Rom decided to source a lower cost, lower technology product from one of Span's competitors. The loss of that contract, which had precluded SPAN selling proprietary mattresses to hospitals, reduced sales for a period while Span worked its way into the hospital market directly.
The hospital market is considerably larger than SPAN's other markets and better capitalized. In addition, the barriers to entry in hospitals are higher, given lengthy product review cycles, so those relationships tend to be more lasting and sticky once they are established. SPAN currently sells into the hospital space through a distribution agreement with Cardinal Health, which took several years to establish, and according to recent earnings calls, is just beginning to bear fruit. Since 2009, SPAN has grown hospital sales to 35%-45% of its total medical sales base from zero.
CUSTOM SEGMENT (30% of sales and usually 10-20% of profits)
This segment, which essentially is the “consumer channel” manufactures mattress pads and foam based accessories for big box retailers (Walmart, Target) and department stores primarily through distributors under their own brand. A small portion of this segment manufactures foam based product for automotive manufacturers, largely BMW. These businesses are marginal to earnings and partly serve to better distribute fixed costs. The company primarily sells products through distributors and mattress rental providers. Beautyrest is SPAN’s most well-known and highly regarded consumer mattress. Hollander, a distributor, represents 60% of Custom segment sales.
Management is compensated very reasonably (salaries are fairly low) and is incented with restricted stock over time, which may explain the dividend policy over time (as RSU holders, they get the dividend, whereas if they owned options, they would not). They have also been responsible stewards from a balance sheet and capital allocation perspective. They have wanted to make a medium sized acquisition which would fit into its existing distribution network, but thus far has been unable to find the right fit at the right price. Failing that it has distributed excess cash as dividends while continuing to maintain a strong and conservative balance sheet.
Raw materials are SPAN’s largest cost, representing 75% of COGS. Within that bucket, foam is the biggest line item, representing about 45% of COGS, and 30% of revenue. Foam prices closely track oil prices, and can increase COGS by several million dollars in period where oil prices rise more than 10%. The company typically passes those costs through immediately on products for the retail channel, but often has a contractual delay on product for the medical market of several quarters. As a result, SPAN’s margins tend to improve several quarters after a foam price increase, as price increases get picked up in total sales. Note that foam is gradually declining as a percent of COGS reflecting a gradual mix shift to higher tech, air mattresses. That shift should continue as the company’s hospital offering skews toward these lower foam content mattresses.
Patents are also a risk. SPAN holds 17 U.S. patents and 11 foreign patents relating to its various mattress products in the medical segment. The patent lives range in length from 2 years to 9 years.
In the custom segment, low cost imports are the primary threat (and this threat is increasing). But Custom only represents 10-20% of profits.
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Span-America operates in a niche business that is poised to capture the growth of an expanding health care industry.
The U.S. Census Bureau reports the domestic population aged 65 and older will nearly double from 43.1 million to 84 million by 2050. SPAN is well positioned to benefit from the “aging of America” as it specializes in medical mattresses and bed frames for hospitals and long-term care facilities (e.g., mattresses for air flow and bed sores). SPAN’s core product (a mattress for bed sores) generates a recurring revenue stream as the mattress must be changed for every patient. The company’s products are necessary for long term care so nurses do not have to spend significant amounts of time continually move patients; risking injury.
While these secular tailwinds continue to build, SPAN plods along generating mid-teens or better ROEs, paying attractive ordinary and special dividends and running a debt free balance sheet. Excluding only special dividends, BVPS has grown at a 10% CAGR for the past decade while maintaining a 3% dividend yield. SPAN has paid dividends for 100+ consecutive quarters. SPAN can be purchased for only 11.5x FCF, 7x EBITDA and 12x EPS.
Customer stickiness and expanding relationships should allow SPAN to participate in a growing medical industry while capturing a mid to high single digit FCF yield. This will allow them to continue to grow book value and return cash to shareholders through their 3% common dividend yield and special dividends. The last special dividend was issued in 2014 for the amount of $1 per share. A special dividend may be in the offing after the life insurance policy on former CEO Donald Spann pays out this year, adding $3.3 M of cash to the balance sheet.