**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**Form
      10-K**





x
            Annual
                report pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934


For
      the
      fiscal year ended **September
      30, 2006** or





o
            Transition
                report pursuant to section 13 or 15(d) of the Securities Exchange
                Act of
                1934


For
      the
      transition period from _______ to _______.





Commission
      file number 0-11392





**SPAN-AMERICA
                MEDICAL SYSTEMS, INC.**(Exact
                name of registrant as specified in its
                charter)





**South
                Carolina**
            **57-0525804**(State
                or other jurisdiction of incorporation or organization)
            (I.R.S.
                Employer Identification No.)**70
                Commerce Center, Greenville, South Carolina**
            **29615**(Address
                of principal executive offices)
            (Zip
                Code)





Registrant’s
                telephone number, including area code
            **(864)
                288-8877**





Securities
      Registered pursuant to section 12(b) of the Act:





Title
                of each class
            Name
                of each exchange on which registeredNone
            None





Securities
      Registered pursuant to section 12(g) of the Act:





Common
                stock, no par value(Title
                of class)





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes o No x





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes o No
      x





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes x No o








Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of the registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. o





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
      the
      Act). (Check one):


Large
      Accelerated Filer o     Accelerated
      Filer o    
Non-Accelerated Filer x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act). Yes o No x





The
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates computed by reference to the price at which the common equity
      was
      last sold as of the last business day of the registrant’s most recently
      completed second fiscal quarter was $31,276,224.





The
      number of shares of the registrant’s common stock, no par value, outstanding as
      of December 15, 2006 was 2,673,165.





Documents
      Incorporated By Reference





Portions
      of the Company’s Definitive Proxy Statement for the annual shareholders’ meeting
      to be held February 8, 2007 are incorporated by reference into Part
      III.











**PART
      I**





**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” or
“Span-America”). 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. 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” listed in Item 1A below and other risks referenced from
      time to time in our other Securities and Exchange Commission filings. We
      disclaim any obligation to update any forward-looking statement whether as
      a
      result of new information, future events or otherwise.





**Background**





Span-America
      Medical Systems, Inc. was incorporated under the laws of the state of South
      Carolina on September 21, 1970. We manufacture and distribute a variety of
      polyurethane foam products for the medical and custom products
      markets.





We
      began
      operations in 1975 as a manufacturer of polyurethane foam patient positioners
      and expanded our product lines to produce 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 and diabetic ulcers, commonly known
      as bedsores. In the late 1970s we also began producing foam products for
      industrial applications. In 1985, we introduced the patented
      Geo-Matt â mattress
      overlay in the health care market, which became one of the Company’s leading
      products. About the same time, 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 through
      the acquisition of Healthflex, Inc., which included the PressureGuard® II
      replacement mattress. We have since significantly expanded the PressureGuard
      mattress line and have added the Geo-Mattress® product line to provide a broad
      line of therapeutic support surfaces that are sold directly and through
      distributors to hospitals, long-term care facilities, and home health care
      dealers throughout the Unites States and Canada.





In
      July
      2002, we acquired certain assets of Vadus, Inc. which included patents and
      equipment related to the design and production of the Secure I.V.® line of short
      peripheral intravenous catheters. The product line was in the development stage
      at the time of the acquisition. We have completed the initial development of
      the
      product line and are manufacturing and marketing it to select health care
      providers in the United States. The safety catheter segment is a separate
      segment for financial reporting purposes.





1


Our
      primary long-term strategy is to become a leading health care manufacturer
      and
      marketer specializing in wound management products used in the prevention and
      treatment of pressure ulcers. Most of the products in our medical segment are
      currently directed toward pressure management applications. We are actively
      seeking to develop or acquire new products in this market segment. We also
      seek
      to further develop and manufacture consumer and industrial applications of
      our
      medical products. In addition, we intend to provide a line of intravenous
      catheters with unique features to fill a niche in the safety catheter market
      segment.





Our
      products are distributed in the United States and to a lesser degree in several
      foreign countries. Total export sales during fiscal 2006 were approximately
      $3.2
      million or 6.1% of total net sales. The majority of our export sales occurred
      in
      Canada and Great Britain. See Note 17 in the Notes to Financial Statements
      included in Item 8 of this report.





We
      maintain a website at *http://www.spanamerica.com* .
      Our
      reports and other filings made with the Securities and Exchange Commission
      are
      available free of charge on the website, which includes a link to the Company’s
      filings in the SEC’s EDGAR filing database.





**Industry
      Segment Data**





Please
      see Note 17 in the Notes to Financial Statements included in Item 8 of this
      report for additional information on industry segment data.





**Medical**





Span-America’s
      principal medical products consist of polyurethane foam mattress overlays,
      therapeutic support surfaces (which consist of non-powered and powered
      mattresses), patient positioners, and seating products. We market these products
      to all health care settings, including acute care hospitals, long-term care
      facilities, and home health care providers, primarily in North America. Sales
      of
      medical products represented 71% of total net sales in fiscal 2006, 63% of
      total
      net sales in fiscal 2005, and 47% of total net sales in fiscal
      2004.





*Mattress
      Overlays.* Span-America produces a variety of foam mattress overlays, including convoluted
      foam pads and its patented Geo-Matt® overlay. 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.
      Mattress overlays comprised approximately 6% of total net sales in fiscal 2006.
      These products are designed to provide patients with greater comfort and to
      assist in treating patients who have or are susceptible to developing pressure
      ulcers. Span-America's overlay products are mattress pads rather than complete
      mattresses and are marketed as less expensive alternatives to more complex
      replacement mattresses. The mattress overlays are designed for single patient
      use.





Our
      mattress overlays disperse body heat, increase air circulation beneath the
      patient, and reduce moisture build-up in order to prevent the development of
      pressure ulcers and promote healing. Their convoluted or geometrically contoured
      construction also reduces shear forces and more evenly distributes the patient's
      body weight, thereby reducing the pressure that causes ulcers.





2


*Therapeutic
      Mattresses* .
      Span-America’s non-powered therapeutic replacement mattresses (as distinguished
      from overlays) are of two types. Geo-Mattress® products are single-density or
      multi-layered foam mattresses topped with the same patented Geo-Matt surface
      used in our overlays. These mattresses are sold as alternatives to standard
      innerspring and all-foam mattresses often found in acute and long-term care
      settings.





In
      1997,
      we introduced the Geo-Mattress Max, Plus, and Pro models of foam therapeutic
      replacement mattresses. In early 1999, we extended the product line with the
      release of the Geo-Mattress with Wings®. This product, which features raised
      perimeter bolsters for added patient safety, has been a significant contributor
      to overall Geo-Mattress sales. A second line extension, the Geo-Mattress Atlas®,
      was added in December 2000 to address the needs of bariatric
      patients.





Span-America’s
      more complex non-powered replacement mattresses consist of products from the
      PressureGuard® series. The PressureGuard design was acquired through the
      acquisition of Healthflex, Inc. in February 1992. The original design combines
      a
      polyurethane foam shell and static air cylinders to form a replacement mattress
      that incorporates the comfort and pressure relieving features of both mattress
      overlays and more sophisticated dynamic mattresses. This original design, which
      we later used as the basis for powered versions (see below), was further refined
      through a complete technical upgrade of all PressureGuard components in November
      1997. In conjunction with this upgrade, some models were renamed to better
      reflect their functions.





In
      addition to the non-powered, static PressureGuard Renew® (formerly PressureGuard
      II), we also offer the PressureGuard CFT®. This model incorporates patented
      design principles of constant force technology. The PressureGuard CFT is unique
      in that it is a dynamic support surface that rivals very expensive powered
      surfaces in effectiveness, yet it requires no power source of any kind. In
      fiscal 2006, the CFT became our largest medical product line as measured by
      sales.





Span-America’s
      powered therapeutic replacement mattresses constitute the remaining models
      in
      the PressureGuard Series. In November 1993, we received FDA 510(k) marketing
      approval for the PressureGuard IV mattress system. 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 mattress rather than being hung on the bed frame as a separate
      unit.





3


Another
      powered system in the PressureGuard line is the PressureGuard APM®, a simpler
      but effective alternating pressure mattress. 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 mattress called the PressureGuard APM 2 .
      The
      APM 2 products
      were further upgraded with new features in 2003, such as the addition of the
      Deluxe control unit. The APM 2 gives
      the caregiver the flexibility to offer either alternating pressure or a basic
      lateral rotation modality by activating a toggle switch on the control panel.
      The APM 2 represents
      our second largest medical product in terms of revenues.





In
      late
      2001, Span-America introduced the PressureGuard Easy Air®, our first offering in
      the category of low-air-loss mattresses. The Easy Air incorporates several
      patented design innovations, which the company believes allow it to overcome
      common performance compromises inherent in competitive low-air-loss products.
      Additionally, the Easy Air was independently documented (see *Ostomy/Wound
      Management* ,
      January
      2003, Volume 49, Issue 1, pp. 32-42) to outperform all leading competitors
      at
      that time in controlling excess skin moisture, a key performance advantage
      in
      the competitive support surfaces marketplace.





All
      of
      the powered products in the PressureGuard Series are sold primarily through
      home
      health care equipment dealers for daily rental in home care, long-term care
      and,
      less commonly, in acute care settings. Following the government’s 1998
      implementation of the Prospective Payment System of reimbursement, however,
      long-term care facilities increasingly have elected to purchase these products
      outright through our distributors rather than continuing to rent
      them.





In
      fiscal
      2004, we began working with Hill-Rom Company, Inc. to develop a private-label
      version of our PressureGuard CFT mattress to be sold under the Hill-Rom name
      primarily to acute care hospitals. Hill-Rom, a division of Hillenbrand
      Industries, is a major supplier of hospital beds and various other types of
      patient care equipment. Since the initial work in 2004, we have expanded the
      private label CFT line to include several other therapeutic mattresses with
      additional features designed to meet Hill-Rom’s needs. The PressureGuard CFT
      product line was our fastest growing group of mattresses in fiscal 2006. We
      also
      manufacture private-label mattresses for other customers on a case-by-case
      basis, depending on market conditions and customer interest.





During
      fiscal 2006, replacement mattresses and related products made up approximately
      52% of total net sales.





*Patient
      Positioners.* Our
      specialty line of patient positioners is sold primarily under the trademark
      Span-Aids®. Span-Aids accounted for approximately 7% of our total net sales in
      fiscal 2006. 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 presently marketed are abduction pillows, body aligners,
      head
      supports, limb elevators and various foot and wrist positioners. Our patient
      positioners are sold primarily to hospitals and long-term care facilities by
      several national medical products distributors.





4


*Seating
      Products.* Another
      product category in our medical segment consists of seating cushions and related
      seating products. Our offerings in this category can be subdivided into three
      main groups:





·
            wound
                healing aids,


·
            patient
                positioning and general pressure management products,
                and


·
            pressure
                management products without patient positioning
                elements.





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® ContourTM cushion, the EqualizerTM, and the EZ-DishTM. The Equalizer
      contoured positioning cushion has a multi-component design that includes a
      viscoelastic foam top, proprietary soft polymer inserts, and a contoured base.
      Like the Isch-Dish, the Equalizer is included among seating products covered
      for
      reimbursement by the Medicare system. 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.





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.





Seating
      products accounted for approximately 3% of total net sales in fiscal
      2006.





*Skin
      Care Products.* We also
      market the Selan® line of skin care creams and lotions under a license agreement
      with PJ Noyes Company. The products, which are manufactured by PJ Noyes, are
      used for cleaning, moisturizing and protecting patients’ skin and are primarily
      sold in long-term care and acute care settings. The license agreement with
      PJ
      Noyes will expire in 2011. Sales of skin care products accounted for
      approximately 2% of our total net sales in fiscal 2006.





*Distributor
      Relationships.* We sell
      our medical products to customers of varying sizes. The largest of these
      customers are medical products distributors who resell our products to acute
      care hospitals and long-term care facilities throughout North America. During
      2006, sales to the largest distributor of our medical products made up
      approximately 16% of net sales and sales to our four largest medical
      distributors made up approximately 58% of net sales in the medical segment.
      The
      loss of any one of these customers could have a material adverse effect on
      our
      business.





5


**Custom
      Products**





Span-America's
      custom products segment includes two major product lines: consumer bedding
      products and industrial foam products. Our consumer product line consists
      primarily of convoluted and contour-cut mattress overlays and specially designed
      pillows for the consumer bedding market. The consumer products are marketed
      to
      retailers through Louisville Bedding Company, a leading manufacturer and
      distributor of bedding products in North America. Louisville Bedding is the
      exclusive distributor of our consumer foam products pursuant to a distribution
      agreement between the companies, which expires in December 2006. The agreement
      automatically renews for successive three-year terms unless either party
      provides notice of their intent not to renew at least 60 days prior to the
      expiration date. Neither party has given notice of non-renewal. Both parties
      are
      currently negotiating non-material amendments to the agreement, which have
      not
      been finalized.





Our
      industrial product line consists primarily of foam packaging and cushioning
      materials. We also produce foam products that are used for flotation, sound
      insulation and gasketing purposes. The majority of these products are made
      to
      order according to customer specifications. To date, most of our industrial
      sales have been in the flotation, specialty packaging and automotive segments
      of
      the custom products market. We currently have one full-time sales representative
      and several manufacturer’s representatives selling our industrial foam
      fabrication capabilities primarily in the southeastern United States. Our
      customers represent a wide variety of markets, including the sports equipment,
      automotive, photographic film, durable goods and electronics
      industries.





Custom
      products represented approximately 29% of our total net sales in fiscal 2006,
      compared with 37% in fiscal 2005 and 53% in fiscal 2004. In fiscal 2006,
      approximately 69% of our total custom products sales were distributed through
      Louisville Bedding Company. The loss of this relationship would have a material
      adverse effect on our business.





**Safety
      Catheters**





In
      July
      2002, we acquired assets related to the Secure I.V.® protected short peripheral
      intravenous catheter from Vadus, Inc., a privately owned designer and
      manufacturer of catheters. The acquired assets consisted primarily of patents
      and equipment related to the design, production and sale of the Secure I.V.
      catheter. The Secure I.V. has FDA 510(k) approval and is protected by 20
      patents. The product line is currently being manufactured for Span-America
      by an
      unaffiliated contract manufacturing company. Net sales of Secure I.V. were
      less
      than 1% of total net sales in fiscal 2006. We operate this portion of our
      business as a separate business segment.





Since
      acquiring the assets of Secure I.V., we have completed the design and
      development of the product and have scaled up from prototype manufacturing
      to
      semi-automated production. Market test shipments of Secure I.V. began in late
      fiscal 2004. Based on initial feedback from the market test customers, we
      decided in December 2004 to delay the full release of Secure I.V. in order
      to
      make three design enhancements to improve the product’s performance. By the
      fourth quarter of fiscal 2005, we had completed the design changes, testing
      and
      re-validation and re-introduced the product to the market. The product line
      is
      being marketed by a network of distributors who specialize in specialty medical
      products, including intravenous catheters. We have a number of product
      evaluations currently ongoing at various locations throughout the United States.
      Sales of Secure I.V. in fiscal 2006 were $75,000. The safety catheter segment
      is
      a new business unit for Span-America with limited sales and production history.
      Consequently, there can be no assurance that these products will be successful
      in the market or that the segment will become profitable.





6


In
      March
      2006, we entered into a one-year distribution agreement with Command Medical
      Products, Inc. to sell the HuberProTM safety Huber needle infusion set to
      customers in the alternate site market - primarily oncology clinics. The
      HuberPro is being sold by our existing Secure I.V. distributors. We believe
      that
      the addition of HuberPro will allow us to leverage our sales efforts by adding
      a
      second product line that can be sold to many of the same customers who are
      interested in the Secure I.V. product line. We believe the current distribution
      agreement, which expires in March 2007, will be renewed with no material
      changes.





**Research
      and Development**





Span-America’s
      expenditures for research and development for the last three fiscal years are
      set forth in the following table:





Research
                and Development Expense2006
            
            2005
            
            2004Medical
            
            $
            520,000
            
            $
            407,000
            
            $
            311,000Custom
                products
            
            
            2,000
            
            
            1,000
            
            
            11,000Safety
                catheters
            
            
            112,000
            
            
            733,000
            
            
            364,000Total
                R&D expense
            
            $
            634,000
            
            $
            1,141,000
            
            $
            686,000





We
      expect
      research and development costs in fiscal 2007 to be slightly higher than those
      of fiscal 2006 due mainly to a planned increase in new product development
      efforts in the medical segment.





**Competition**





*Medical* .
      In the
      medical market segment, we face significant competition for sales of our foam
      mattress overlays. Competition within the overlay market is primarily based
      on
      price and delivery for convoluted foam overlays. For therapeutic overlays,
      including Geo-Matt, competition is based on price, product performance, quality
      and delivery. However, the largest single source of competition for our mattress
      overlay products is from therapeutic support surfaces (or mattresses). Prior
      to
      fiscal 2006, sales of overlays had declined for several years as many customers
      eliminated the need for mattress overlays by purchasing therapeutic replacement
      mattresses. Competition with respect to our Span-Aid patient positioners is
      primarily based on price. However, a secondary source of competition for patient
      positioners results from alternative methods, such as the use of pillows and
      other devices to position patients.





7


We
      believe that Span-America is among the top three nationwide suppliers of foam
      mattress overlays and patient positioners to the U.S. health care market. Our
      primary competitors in the overlay and positioner markets are the BioClinic
      division of Sunrise Medical, Inc., Kendall (a division of Tyco International)
      and Ehob, Inc.




The
      competition in the therapeutic replacement mattress market is based on product
      performance, price and durability. Potential customers typically select a
      product based on these criteria after conducting a formal clinical evaluation
      of
      sample mattresses for periods of one to six months. A secondary source of
      competition results from alternative products such as mattress overlays, which
      are significantly less expensive than replacement mattresses.





The
      market for therapeutic replacement mattresses was developed principally during
      the 1990s. Competitors include The Encompass Group, Gaymar Industries, Inc.,
      Hill-Rom (a division of Hillenbrand Industries, Inc.), Kinetic Concepts, Inc.,
      Invacare Corporation, Sunrise Medical, Inc., Direct Supply, Inc. and Medline
      Industries, Inc. These competitors use combinations of their own sales
      representatives and manufacturer’s representatives to sell directly to
      hospitals, distributors, and long-term care facilities nationwide.





Many
      of
      our competitors in the health care segment are larger and have greater resources
      than our Company. We believe our competitive advantages in the medical segment
      include innovative and patented product designs, product quality, manufacturing
      capabilities, distribution relationships, and customer
      responsiveness.





*Custom
      Products.* In the
      custom products segment, we have encountered significant competition for our
      mattress pad and pillow products. The competition 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., Leggett and Platt, Inc., and E.R. Carpenter Company, all
      of
      which are larger and have greater resources than we do. We also have a number
      of
      competitors in the market for our industrial products, including SCA Packaging
      North America (formerly Tuscarora, Inc.) and UFP Technologies, Inc. These
      competitors are larger and have greater resources than we do. The competition
      for industrial foam products is largely based on price. In some instances,
      however, design and delivery capabilities are also important. We believe our
      competitive advantages in the custom products segment include our distribution
      relationship with Louisville Bedding Company, innovative product designs, foam
      manufacturing and fabrication capabilities, low cost manufacturing processes,
      and customer responsiveness.





Within
      the last two 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. Visco foam is also significantly more expensive than traditional foam
      and
      is more difficult to handle and fabricate. Because visco foam is more difficult
      to cut and shape than traditional foam, the visco mattress pads currently on
      the
      market tend to be somewhat undifferentiated without unique surface designs.
      Although we currently fabricate and sell visco foam products, it is more
      difficult for us to differentiate our products from our competitors’ because of
      the current commodity-like nature of visco foam mattress pads. In addition,
      since visco foam is significantly more expensive and heavier than traditional
      foam, it is more cost effective for overseas competitors (from China for
      example) to ship the products to the U.S. market.





8


*Safety
      Catheters* .
      Our
      Secure I.V. products compete in the protected short peripheral intravenous
      catheter marketplace. Approximately 85% of the market is supplied by three
      major
      companies: Smiths Group plc, Becton Dickinson and Company, and B. Braun Medical,
      Inc. All of these companies have established national sales organizations and
      worldwide distribution networks. Their resources are greater than ours. We
      currently have distribution agreements with distributors in three distinct
      markets: acute care, alternate care and emergency medical services. Our
      emergency medical services distributor is a national distributor. The other
      distributors are regional but in combination offer national coverage.





We
      believe that Secure I.V.’s design offers a competitive advantage in that it
      allows for intravenous catheter insertions without the need for vein occlusion,
      which helps passively protect health care workers from exposure to blood-borne
      pathogens. However, potential customers may choose competing products over
      Secure I.V. because the competitors offer a wider range of custom variations
      for
      their safety catheters than we do for Secure I.V. In addition, the competitors
      are able to supply a wider variety of other medical devices to their customers.
      Because of design differences and economies of scale, competing devices are
      less
      costly to make.





**Major
      Customers**





We
      have a
      business relationship with Louisville Bedding Company to distribute our consumer
      foam products. Sales to Louisville Bedding during fiscal 2006 made up
      approximately 20% of our total net sales and approximately 69% of sales in
      the
      custom products segment.





In
      the
      medical segment, sales to two additional customers with whom we have business
      relationships to re-sell certain of our medical products exceed 10% of our
      total
      net sales. Sales to Hill-Rom, for whom we manufacture private label mattresses,
      during fiscal 2006 made up approximately 16% of total net sales and
      approximately 22% of sales in the medical products segment. Sales to one of
      our
      distributors, PSS World Medical, Inc. (“PSS”), during fiscal 2006 made up
      approximately 11% of total net sales and approximately 16% of sales in the
      medical products segment.





See
      “Distributor Relationships” above and Notes 16 and 17 in the Notes to Financial
      Statements below for more information on major customers. The loss of any of
      these major customers would have a material adverse effect on our
      business.





9


**Seasonal
      Trends**





Some
      seasonality can be identified in certain of our medical and consumer foam
      products. However, the fluctuations have minimal effect on our operations
      because of offsetting trends among these product lines. We have not experienced
      significant seasonal fluctuations in our industrial product line.





**Patents
      and Trademarks**




We
      hold
      37 United States patents and 10 foreign patents relating to various components
      of our patient positioners, mattress overlays, and therapeutic support surfaces
      for the medical segment. Additional patent applications have been filed. 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, which are not covered by these patents. Therefore, we do not rely
      solely on our patents to maintain our competitive position in our various
      markets.





Our
      principal patents include the patents on Geo-Matt, Geo-Mattress, PressureGuard,
      and Span-Aids products. The Geo-Matt and Geo-Mattress patents have remaining
      lives ranging from 1 to 7 years with additional patents pending. The
      PressureGuard patents have remaining lives ranging from 8 to 12 years with
      additional patents pending. The Span-Aids patents have remaining lives ranging
      from less than a year to 8 years.





As
      previously noted, in July 2002, we acquired assets related to the Secure I.V.®
catheter product line of Vadus, Inc., a privately owned designer and
      manufacturer of peripheral intravenous catheters. The Secure I.V. has FDA 510(k)
      approval and is protected by 11 U. S. patents and 9 foreign patents, all of
      which are owned by Span-America. The Secure I.V. patents have remaining terms
      ranging from 6 to 15 years. The mark “Secure I.V.” is also Span-America’s
      registered trademark. We have also filed additional patent
      applications.





We
      hold
      38 federally registered trademarks and 18 foreign trademark registrations,
      including *Span-America,
      Span-Aids, Geo-Matt, Geo-Mattress, PressureGuard,* and *Isch
      Dish* in
      the
      medical and consumer segments *.* Other
      federal registration applications are 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**





Polyurethane
      foam and nylon/vinyl mattress covers and tubes account for approximately 80%
      of
      our raw materials. In addition, we use corrugated shipping cartons, 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 the price
      increases for polyurethane foam in fiscal 2006.





10


As
      of
      September 30, 2006, we had unshipped orders of approximately $1.3 million,
      which
      represents a 31% decrease compared to our backlog of $1.8 million at fiscal
      year
      end 2005. Most of the decrease occurred in our medical products segment and
      was
      due to a large order for powered mattresses and one for seating products at
      fiscal year end 2005. Our order backlog fluctuates significantly from month
      to
      month. Consequently, the 31% decrease in backlog at fiscal year end 2006 is
      not
      necessarily indicative of sales trends for the coming fiscal year. All orders
      in
      the current backlog are expected to be filled in the 2007 fiscal
      year.




**Employees**





We
      had
      289 full-time employees as of September 30, 2006. Of these employees, six were
      officers, 19 were management personnel, 24 were administrative and clerical
      personnel, 25 were sales personnel, and 215 were manufacturing employees. We
      are
      not a party to any collective bargaining agreement and have never experienced
      an
      interruption or curtailment of operations due to labor controversy. We believe
      that our relations with our employees are good.





**Supervision
      and Regulation**





The
      Federal Food, Drug and Cosmetic Act, and regulations issued or proposed
      thereunder, provide for regulation by the Food and Drug Administration (the
      “FDA”) of the marketing, manufacture, labeling, packaging and distribution of
      medical devices, including our products. These regulations require, among other
      things, that medical device manufacturers register with the FDA, list devices
      manufactured by them, and file various types of 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 mattress
      products from the Greenville, South Carolina plant. These standards are prepared
      by the American Society for Quality Control Standards Committee to correspond
      to
      the International Standard ISO 9001:2000. 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. 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
      2006.





**Environmental
      Matters**





Our
      manufacturing operations are subject to various government regulations
      pertaining to the discharge of materials into the environment. We believe that
      we are in substantial compliance with applicable regulations. We do not
      anticipate that continued compliance will have a material effect on our capital
      expenditures, earnings or competitive position.


11


**Item
      1A. Risk Factors**





**The
      Secure I.V. product line has limited sales history and market exposure and
      therefore involves greater risks and uncertainties than our more established
      product lines.** We
      completed design and development of the Secure I.V. safety catheter in late
      fiscal 2005 and immediately began sales and marketing efforts for this new
      product line. The product line has been available to the market through select
      distributors for approximately one year with limited success. At this early
      stage in the product’s life cycle, we cannot accurately predict the degree of
      future success that Secure I.V. might achieve in the marketplace. Although
      our
      product has a unique design that to our knowledge is not available elsewhere
      in
      the market, we are competing against larger companies with more experience
      in
      the safety catheter market, well-established distribution channels and greater
      resources than Span-America. Consequently, it could take a significant amount
      of
      time and additional investment for Secure I.V. sales and earnings to have a
      meaningful impact on our operating results. We cannot offer assurance that
      Secure I.V. sales will become meaningful or that the safety catheter segment
      will become profitable. If the safety catheter segment does not become
      profitable, the assets related to this segment could become impaired. See
“Impairment of Long-Lived Assets” in Item 7. “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations” and Note 17 in the
      Notes to Financial Statements for more information on the safety catheter
      segment.





**We
      currently have a sole source contract manufacturer for the Secure I.V. product
      line.** The
      Secure I.V. product line is presently being manufactured for Span-America by
      a
      single unaffiliated company that specializes in contract manufacturing
      operations. Having a sole-source manufacturer for the Secure I.V. product line
      creates additional risks for the safety catheter segment that we do not have
      in
      our other segments. Since the products are manufactured by an unaffiliated
      company, we have somewhat less control over product costs, manufacturing
      efficiency and quality than we do for products manufactured directly by us.
      These risks are mitigated by the terms of our agreement with our supplier and
      by
      procedures put in place to ensure that the products meet necessary quality
      standards. Our agreement with the contract manufacturer expires in September
      2007 but may be terminated by either party with 90 days notice under certain
      conditions as specified in the agreement. Our source of supply is also subject
      to risks related to the contract manufacturer, including management or strategic
      changes and property and casualty risks for an off-site location. If we were
      required to move our production equipment to another location, it could cause
      a
      delay in supplying our products to the market and additional expenses for
      moving, set-up and re-validation of the production line.





**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 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. These
      supplier-customer relationships can generally be ended by either party with
      minimal notice. Consequently, if a large customer or distributor decided to
      discontinue purchasing our products, our sales and earnings could quickly
      decline. Our largest customers in the medical segment are PSS World Medical
      and
      Hill-Rom. In addition, all of our consumer foam products are sold through our
      exclusive distributor, Louisville Bedding Company, under a marketing and
      distribution agreement that expires in December 2006. The agreement
      automatically renews for successive three-year terms unless either party
      provides notice of their intent not to renew at least 60 days prior to the
      expiration date. Neither party has given notice of non-renewal. Both parties
      are
      currently negotiating non-material amendments to the agreement, which have
      not
      been finalized. For more information on major customers and information on
      our
      business segments, see the discussion under “Major Customers” on page 9 and
      Notes 16 and 17 in the Notes to Financial Statements, Item 1. “Business -
      Industry Segment Data - Medical - Distributor Relationships” and Item 1.
“Business - Industry Segment Data - Custom Products.”





12


**Our
      earnings could be negatively affected by raw material cost increases that we
      are
      unable to recover through sales price increases or expense reductions.** The
      cost
      of polyurethane foam represented approximately 40% of our total cost of goods
      sold in fiscal 2006. An increase in foam raw material costs that we are not
      able
      to offset could have a significant negative effect on our profitability. Besides
      polyurethane foam, our other major raw material categories include nylon
      mattress covers, vinyl bags, vinyl air cylinders, electronic components for
      mattresses and corrugated cartons. Raw materials are our single largest cost
      category in the business, representing approximately 72% of our total cost
      of
      goods sold in fiscal 2006. 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 other means.





**Our
      sales volume could decline as a result of competition from low-cost foreign
      imports.** Within
      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
      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 and our customers, who are generally national
      retailers, are more likely to change suppliers to buy lower-cost products.
      Therefore, we could lose significant parts of our consumer bedding business
      and
      certain parts of our medical business if we are unable to compete effectively
      with low-cost imports.





**Our
      business is subject to the loss of existing sales or slower growth rates due
      to
      the impact of competitive products and pricing** .
      All
      three of our business segments operate in highly competitive market
      environments. For each of our product lines, there are a number of alternative
      products in the market with similar features and benefits offered by several
      competitors, some of whom have greater resources than Span-America.





**Our
      medical business could lose sales volume or could have lower sales growth rates
      as a result of government reimbursement changes in the medical
      market.** A number
      of our medical products are eligible for reimbursement by Medicare. We have
      no
      direct dealings with Medicare reimbursement, but our customers often submit
      reimbursement requests to Medicare. For example, we might sell therapeutic
      mattresses to a home health care dealer who in turn rents our mattresses to
      patients. Medicare reimburses the dealer for some or all of the patient’s rental
      cost. If Medicare reimbursement rates are reduced, the demand for our medical
      products that are covered by Medicare could also be reduced.





13


**Certain
      of our medical products and all of our Secure I.V. products are classified
      as
      medical devices and are regulated by the FDA.** These
      regulations require, among other things, that medical device manufacturers
      register with the FDA, list devices manufactured by them, and file various
      types
      of reports. In addition, our manufacturing facilities and those of our contract
      manufacturer for the Secure I.V. products are subject to periodic inspections
      by
      regulatory authorities and must comply with “good manufacturing practices” as
      required by the FDA and state regulatory authorities. Although we believe we
      are
      in substantial compliance with 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 the regulatory
      requirements.





**Item
      1B. Unresolved Staff Comments**





None





**Item
      2. Properties**





We
      own
      our principal office and manufacturing facility which is located in Greenville,
      South Carolina. This facility contains approximately 188,000 square feet used
      by
      the medical and custom products segments and is located on a 13-acre site.
      This
      includes a 58,000 square foot plant expansion completed in fiscal 2006. The
      addition is being used for manufacturing and warehousing purposes.





We
      lease
      15,000 square feet of warehouse space in Salt Lake City, Utah for use as a
      distribution center for our medical products. The lease rate for the facility
      is
      $6,750 per month. The lease expires in August 2008 unless renewed by mutual
      agreement. Until October 31, 2006 we leased a manufacturing facility in Norwalk,
      California. The lease expired on October 31, 2006.





We
      consider the South Carolina and Utah facilities to be suitable and adequate
      for
      their intended purposes.





**Item
      3. Legal Proceedings**





From
      time
      to time we are a party to various legal actions arising in the normal course
      of
      business. We believe that as a result of legal defenses and insurance
      arrangements with parties believed to be financially capable, there are no
      proceedings threatened or pending against us that, if determined adversely,
      would have a material adverse effect on our financial position or results of
      operations.





**Item
      4. Submission of Matters to a Vote of Security Holders**





No
      matters were submitted to a vote of security holders during the fourth quarter
      of our 2006 fiscal year.


14


**PART
      II**





**Item
      5. Market for the Registrant's Common Equity, Related Stockholder Matters and
      Issuer Repurchases of Equity Securities**





The
      common stock of Span-America Medical Systems, Inc. trades on The NASDAQ Global
      Market® under the symbol SPAN. As of September 30, 2006, there were 2,660,345
      common shares outstanding. As of December 15, 2006, there were 215 shareholders
      of record and approximately 1,000 beneficial shareholders. The closing price
      of
      Span-America's stock on December 15, 2006 was $14.13 per share.





Selected
      quarterly stock price data is shown on the following table.





**Quarterly
                Stock Price Data****First**
            
            **Second**
            
            **Third**
            
            **Fourth**
            
            **Year****For
                Fiscal 2006**High
            
            $
            11.15
            
            $
            14.90
            
            $
            14.00
            
            $
            13.74
            
            $
            14.90Low
            
            
            8.65
            
            
            10.05
            
            
            10.27
            
            
            10.83
            
            
            8.65**For
                Fiscal 2005**High
            
            $
            12.50
            
            $
            13.70
            
            $
            11.19
            
            $
            12.95
            
            $
            13.70Low
            
            
            10.42
            
            
            10.00
            
            
            8.62
            
            
            8.81
            
            
            8.62





The
      Company has paid a regular quarterly cash dividend since January 1990. In July
      2004, the Board increased the quarterly dividend to $0.04 per share from $0.035
      per share. In December 2004, the Board declared a special cash dividend of
      $0.40
      per share payable on January 12, 2005 to all shareholders of record on December
      22, 2004. In July 2005, the Board increased the quarterly dividend to $0.045
      per
      share from $0.04 per share. In July 2006, the Board increased the quarterly
      dividend to $0.06 per share from $.045 per share. The Company expects to
      continue to pay quarterly dividends for the foreseeable future, though the
      Board
      may discontinue paying dividends at any time. Future dividend payments will
      depend upon the Company’s earnings and liquidity position.





Each
      non-employee Director of the Company receives 1,000 shares of Company common
      stock per year in lieu of annual cash compensation. As compensation for
      additional duties, the Chairman of the Board receives an additional 1,000
      shares, and the Chairman of the Audit Committee receives an additional 500
      shares of Company common stock per year. The following table sets forth
      information about unregistered shares of common stock issued in fiscal year
      2006
      to our non-employee Directors for their service as Directors.





#
                Shares of Common
            
            Fair
                Market Value on
            
            AggregateIssue
                Date
            
            Stock
                Issued
            
            Issue
                Date ($ Per Share)
            
            Value03/03/06
            
            
            8,500
            
            
            $13.38
            
            
            $113,730





15





We
      did
      not register the shares issued to non-employee Directors in reliance on the
      exemption provided by Section 4(2) of the Securities Act of 1933, as amended,
      which exempts stock issued outside of a public offering from registration
      requirements.





The
      information regarding equity compensation plans set forth under Item 12 below
      is
      incorporated herein by reference.





**Item
      6. Selected Financial Data**





Selected
      Financial Data for the Company’s last five fiscal years is shown in the table
      below.




**Five-Year
        Financial Summary**


(Amounts
        in thousands, except per share and employee data)


**2006**
            
            2005
            
            2004
            
            2003
            
            2002For
                the year:Net
                sales
            
            **$**
            **51,557**
            
            $
            48,439
            
            $
            49,929
            
            $
            41,575
            
            $
            33,536Gross
                profit
            
            
            **15,699**
            
            
            14,713
            
            
            12,691
            
            
            11,134
            
            
            10,175Operating
                income
            
            
            **4,010**
            
            
            3,133
            
            
            2,308
            
            
            1,440
            
            
            1,717Net
                income
            
            
            **3,055**
            
            
            2,439
            
            
            1,985
            
            
            1,399
            
            
            1,658Cash
                flow from operations
            
            
            **2,497**
            
            
            2,589
            
            
            2,812
            
            
            1,147
            
            
            1,486Capital
                expenditures
            
            
            **1,074**
            
            
            2,405
            
            
            1,997
            
            
            1,647
            
            
            559Per
                share:Net
                income:Basic
            
            **$**
            **1.15**
            
            $
            0.94
            
            $
            0.77
            
            $
            0.55
            
            $
            0.66Diluted
            
            
            **1.10**
            
            
            0.89
            
            
            0.73
            
            
            0.53
            
            
            0.64Cash
                dividends declared
            
            
            **0.195**
            
            
            0.565
            
            
            0.145
            
            
            0.14
            
            
            0.12At
                end of year:Working
                capital
            
            
            **13,338**
            
            
            10,638
            
            
            11,623
            
            
            10,814
            
            
            11,058Property
                and equipment - net
            
            
            **8,132**
            
            
            8,090
            
            
            6,185
            
            
            4,817
            
            
            3,632Total
                assets
            
            
            **31,012**
            
            
            28,666
            
            
            27,098
            
            
            24,156
            
            
            22,076Shareholders'
                equity
            
            
            **24,517**
            
            
            21,561
            
            
            20,419
            
            
            18,525
            
            
            17,394Book
                value per share
            
            
            **9.22**
            
            
            8.26
            
            
            7.88
            
            
            7.26
            
            
            6.85Number
                of employees
            
            
            **289**
            
            
            293
            
            
            303
            
            
            299
            
            
            254Key
                ratios:Return
                on net sales
            
            
            **5.9**
            **%**
            
            5.0
            %
            
            4.0
            %
            
            3.4
            %
            
            4.9
            %Return
                on average shareholders' equity
            
            
            **13.3**
            **%**
            
            11.6
            %
            
            10.2
            %
            
            7.8
            %
            
            9.9
            %Return
                on average total assets
            
            
            **10.2**
            **%**
            
            8.7
            %
            
            7.7
            %
            
            6.1
            %
            
            7.8
            %Current
                ratio
            
            
            **3.8**
            
            
            3.0
            
            
            3.3
            
            
            3.5
            
            
            4.2




16
 
 **Item
          7. Management's Discussion and Analysis of Financial Condition and Results
          of
          Operations**
 
 **OVERVIEW**
  Span-America’s
          business is divided into three market segments: medical, custom products
          and
          safety catheters. In the medical segment, we manufacture and market a
          comprehensive selection of pressure management products, including Geo-Matt®,
          PressureGuard®, Geo-Mattress®, Span-Aids®, Isch-Dish®, and Selan® products. In
          the custom products segment, we manufacture consumer mattress pads and
          pillows
          for the retail bedding market and various engineered foam products for
          the
          industrial market. Our consumer mattress pads and pillows are marketed
          by our
          exclusive distributor, Louisville Bedding Company. The industrial product
          line
          is sold directly by Span-America. The safety catheter segment consists
          of two
          product lines: the Secure I.V.® short peripheral intravenous catheter and the
          HuberPro® safety Huber needle infusion set. Secure I.V. is manufactured for
          Span-America by an unaffiliated contract manufacturer according to our
          specifications. The HuberPro product line is manufactured by Command Medical
          Products, Inc. and sold by Span-America under a license agreement. Our
          revenues,
          profits and cash flows are derived from the development, manufacture and
          sale of
          these products.
 
 **RESULTS
          OF OPERATIONS FISCAL 2006 VS. 2005**
 
 **Summary**
  Net
          sales
          in fiscal 2006 increased 6% to $51.6 million compared with $48.4 million
          in
          fiscal 2005. The sales increase was the result of higher volumes in the
          medical
          segment where sales increased 21% to $36.7 million. Sales in the custom
          products
          segment fell by 18% to $14.8 million.
 
 Net
          income rose 25% in fiscal 2006 to a record $3.1 million, or $1.10 per diluted
          share, compared with $2.4 million, or $0.89 per diluted share, in fiscal
          2005.
          The increase in earnings resulted mainly from higher unit sales in our
          PressureGuard® line of therapeutic surfaces for the medical segment and a
          decline in research and development expenses in the safety catheter segment
          compared with fiscal 2005.
 
 **Sales**
  Sales
          in
          our medical segment rose 21% to $36.7 million in fiscal 2006 compared with
          $30.3
          million the previous year. The medical sales growth was led by our proprietary
          therapeutic support surfaces (or mattresses), sales of which increased
          by 28%
          over 2005 levels. We sell these specialty mattresses to hospitals, long-term
          care facilities and home care dealers throughout the United States and
          Canada.
          Our PressureGuard CFT® support surfaces, which are sold primarily in the acute
          care market, made up about two-thirds of the total growth in the medical
          segment. Other top performing mattress products included the PressureGuard
          APM 2 ®
          alternating pressure mattresses, the PressureGuard Easy Air® low-air-loss
          mattress and our private label therapeutic surfaces manufactured for Hill-Rom.
          The APM 2 and Easy
          Air products are sold primarily in the long-term care and home care sections
          of
          the medical market. In other medical product lines, Selan® skin care products
          rose by 11%. Mattress overlay sales were up by 6%. Sales of seating products
          increased 2%, and sales of patient positioners climbed by 1%. The majority
          of
          the sales increases in our positioners, seating and overlay product lines
          were
          due to sales price increases that were passed along to customers in response
          to
          raw material cost increases we received in the first quarter of fiscal
          2006.
 
 17
 Our
          medical business achieved solid growth in fiscal 2006 primarily because
          of
          increased customer demand for our therapeutic support surfaces, particularly
          in
          the long-term care market, and the success of our private label support
          surfaces
          in the acute care market. Therapeutic support surfaces made up approximately
          73%
          of our total medical sales in fiscal 2006, and are our fastest growing
          medical
          product lines. The growth in medical mattress sales could make our total
          medical
          sales more volatile from quarter to quarter because mattresses are capital
          purchase items with longer selling cycles, whereas our other medical products
          are generally consumable items where repeat orders are common. We expect
          total
          medical sales to increase during fiscal 2007, but the rate of growth will
          likely
          be slower than that achieved in fiscal 2006.
 
 Our
          custom products segment consists of consumer bedding products and specialty
          foam
          products for the industrial market. Sales in the custom products segment
          declined 18% during fiscal 2006 to $14.8 million from $18.1 million in
          fiscal
          2005. The entire decline occurred in the consumer portion of the custom
          products
          segment, where sales of consumer bedding products were down 29% to $11.2
          million. The consumer sales decline was caused primarily by the phase out
          of our
          previous line of Geo-Comfort foam overlays sold to Wal-Mart, increased
          competition from imported and domestic visco foam products and lost business
          to
          one customer that was acquired by a larger company. The weakness in consumer
          sales was the main factor causing the operating loss in the custom products
          segment during fiscal 2006. To help reverse this trend, we developed a
          new
          FusionTM mattress overlay during the year, which began shipping late in our
          fourth fiscal quarter. The Fusion pad replaces the Geo-Comfort line and
          is being
          sold under Wal-Mart’s HomeTrends brand. We are also selling the Fusion products
          to other retailers. As a result of the new product introduction and other
          new
          programs with our marketing partner Louisville Bedding Company, we expect
          consumer sales to grow modestly in fiscal 2007.
 
 In
          the
          other part of the custom products segment, industrial sales increased by
          46% to
          $3.6 million. The industrial sales increase was primarily attributable
          to higher
          demand from existing customers. We believe industrial sales in fiscal 2007
          will
          be slightly higher than those of fiscal 2006.
 
 Sales
          in
          the safety catheter segment were $120,000 in fiscal 2006 and consisted
          of
          $75,000 in sales of Secure I.V. catheters and $45,000 in sales of the HuberPro
          infusion sets. Sales of Secure I.V. were $6,000 in fiscal 2005. There were
          no
          comparable HuberPro sales in the year-earlier period. Results in the safety
          catheter business continued to be below our expectations. However, we made
          progress in the segment and were encouraged by three positive events during
          fiscal 2006. First, we signed a license agreement in the second quarter
          that
          added the HuberProTM product line to the safety catheter business unit. Our
          investment in the HuberPro product line is limited to the purchase of inventory,
          which we will stock and then resell through our distributors. The HuberPro
          is a
          safety Huber needle infusion set sold in the alternate site market, mainly
          to
          oncology clinics. The addition of the HuberPro line allows us to leverage
          our
          distribution and sales efforts that were previously focused only on Secure
          I.V.
          Second, in the third quarter we signed an agreement to offer Secure I.V.
          to
          Novation, the industry’s leading health care contracting services company. The
          agreement does not require a purchase commitment, but it should significantly
          increase the visibility of Secure I.V. within Novation’s network of 2,500 VHA
          and UHC members. And finally, during the fourth fiscal quarter, we finalized
          arrangements to sell Secure I.V. through Bound Tree Medical, which serves
          as our
          exclusive distributor for Secure I.V. in the emergency medical
          market.
 
 18
 We
          expect
          sales of Secure I.V. and HuberPro to increase in fiscal 2007, but we do
          not yet
          have enough market feedback to accurately project growth. We plan to expand
          our
          sales and distribution efforts within the safety catheter segment in the
          coming
          year, but we do not expect the segment to be profitable in fiscal 2007.
          We
          believe, however, that the operating loss for the segment in fiscal 2007
          will be
          less than that of fiscal 2006. Our main focus for this segment in fiscal
          2007
          will be to increase sales volume and market exposure for these two product
          lines
          and gain enough customer feedback to evaluate the potential for future
          success
          in the safety catheter business.
 
 **Gross
          Profit**
  Our
          gross
          profit level increased by 7% during fiscal 2006 to $15.7 million compared
          with
          $14.7 million in fiscal 2005. The gross profit margin percentage remained
          level
          at 30.4%. The increase in gross profit level was due to higher sales volumes
          in
          the medical segment. The medical segment typically has a higher gross margin
          than the custom products segment because many of our medical products are
          patented and proprietary. In addition, higher material costs were also
          partly
          offset by lower labor costs due to improved manufacturing efficiencies
          and lower
          overtime requirements related to higher inventory levels. We expect the
          gross
          margin percentage during fiscal 2007 to be slightly lower than that of
          fiscal
          2006 because of an expected shift in sales mix toward the lower margin
          custom
          products segment.
 
 **Selling,
          Research & Development and Administrative Expenses**
  Selling
          and marketing expenses increased 7% to $8.2 million, or 15.9% of net sales,
          in
          fiscal 2006 compared with $7.7 million, or 15.8% of sales, in fiscal 2005.
          Most
          of the increase occurred in the medical segment and was due to higher expenses
          for commissions and shipping costs related to higher sales volumes. We
          believe
          that total selling and marketing expenses for fiscal 2007 will increase
          over
          2006 levels due to planned programs and expected future growth in the medical
          and safety catheter segments.
 
 Total
          research and development expenses decreased 44% to $634,000 in fiscal 2006
          compared with $1.1 million in fiscal 2005. The entire decrease occurred
          in the
          safety catheter segment where R&D expenses dropped by $621,000, or 85%, to
          $112,000 compared with $733,000 in the prior year. R&D expenses were high in
          the safety catheter segment during the first three quarters of fiscal 2005
          because of design changes being made to Secure I.V. The design changes
          were
          completed in the fourth quarter of fiscal 2005, which significantly lowered
          R&D expenses related to Secure I.V. in fiscal 2006. We expect research and
          development expenses for the safety catheter segment during fiscal 2007
          to be
          similar to those of fiscal 2006. We consider safety catheters to be a separate
          reportable segment based on product type and distribution channels. See
          Note 17
          in the Notes to Financial Statements for additional information on the
          safety
          catheter segment.
 
 19
 In
          the
          medical segment, R&D expenses increased 27% in fiscal 2006 to $520,000
          compared with $407,000 in 2005, offsetting part of the expense decline
          in the
          safety catheter segment. The expense increase in the medical segment was
          related
          to new product development efforts. We expect total R&D expenses in fiscal
          2007 to be slightly higher than those of fiscal 2006.
 
 General
          and administrative expenses remained level at $2.8 million in fiscal 2006.
          Increases in incentive compensation and bad debt expense were offset by
          a
          decline in insurance expense. We expect general and administrative expenses
          for
          2007 to be slightly higher than 2006 levels.
 
 The
          operating loss in the safety catheter segment for fiscal 2006 declined
          by 28% to
          $1.1 million ($0.26 per diluted share after taxes) compared with $1.5 million
          ($0.35 per diluted share after taxes) in fiscal 2005. The decline in operating
          loss was primarily due to a reduction in R&D expenses. We believe that the
          operating loss in the safety catheter segment for fiscal 2007 will be less
          than
          that of fiscal 2006.
 
 The
          custom products segment also showed an operating loss in fiscal 2006. The
          custom
          products operating loss for fiscal 2006 increased to $1.1 million ($0.26
          per
          diluted share after taxes) compared with a loss of $226,000 ($0.05 per
          diluted
          share after taxes) in fiscal 2005. The increase in the operating loss was
          primarily caused by the decline in sales volume of consumer bedding products
          as
          described above. The custom products segment receives an allocated share
          of our
          total manufacturing overhead and administrative expenses. Since these allocated
          expenses are largely fixed within a reasonable range of sales volume, a
          sales
          decline within the segment can result in a proportionally larger decline
          in
          segment operating income. However, we believe that the custom products
          segment
          makes a positive contribution to the Company’s earnings because the segment
          absorbs overhead and administrative expenses that would be reallocated
          to the
          medical segment if we exited the custom products business. If that occurred,
          the
          medical segment and the total company would likely be less
          profitable.
 
 Total
          operating profit increased 28% to $4.0 million compared to $3.1 million
          in
          fiscal 2005. The increase was primarily the result of higher sales volume
          in the
          medical segment and lower R&D expenses in the safety catheter
          segment.
 
 **Non-Operating
          Income**
  Investment
          income increased by 80% to $204,000 in fiscal 2006 compared with $113,000
          in
          fiscal 2005. The increase in investment income was the result of higher
          interest
          rates and slightly higher average balances of marketable securities in
          fiscal
          2006.
 
 Royalty
          income fell 50% in fiscal 2006 to $247,000 compared with $498,000 in fiscal
          2005
          as a result of the expiration in December 2005 of our license agreement
          for the
          Safety-Lok® shielded syringe product licensed to Becton Dickinson and Company
          (BD). The license agreement ended due to the expiration of the related
          patents.
          We received the final royalty payment from BD in February 2006.
 
 20
 Other
          non-operating income for 2006 included a $99,000 gain on the sale of
          manufacturing equipment. We expect total non-operating income for fiscal
          2007 to
          be significantly lower than 2006 levels because of lower royalty income
          as
          described above and the lack of additional gains on asset sales.
 
 **Net
          Income and Dividends**
  Net
          income for fiscal 2006 increased 25% to $3.1 million, or $1.10 per diluted
          share, compared with $2.4 million, or $0.89 per diluted share, in fiscal
          2005.
          The increase was due primarily to higher sales volume in the medical segment,
          lower R&D expenses in the safety catheter segment and lower labor costs due
          to improved manufacturing efficiencies.
 
 During
          fiscal 2006, we paid dividends of approximately $517,000, or 17% of net
          income,
          for the year. This amount represented three quarterly dividends of $0.045
          per
          share and one quarterly dividend of $0.06 per share.
 
 **RESULTS
          OF OPERATIONS FISCAL 2005 VS. 2004**
 
 **Summary**
  Net
          sales
          in fiscal 2005 decreased 3% to $48.4 million compared with $49.9 million
          in
          fiscal 2004. The decrease was the result of sales declines in the custom
          products segment that were not fully offset by strong sales growth in the
          medical segment. Sales in the custom products segment declined 32% to $18.1
          million while sales in the medical segment rose by 30% to $30.3
          million.
 
 Net
          income rose 23% in fiscal 2005 to $2.4 million, or $0.89 per diluted share,
          compared with $2.0 million, or $0.73 per diluted share, in fiscal 2004.
          The
          increase in earnings resulted primarily from higher unit sales of PressureGuard®
and Geo-Mattress® therapeutic surfaces for the medical market and a more
          profitable product mix, as sales rose in the higher margin medical segment
          and
          fell in the lower margin custom products segment.
 
 **Sales**
  Sales
          in
          our medical segment rose 30% to $30.3 million in fiscal 2005 compared with
          $23.3
          million the previous year. The medical sales growth was led by our therapeutic
          support surfaces which increased by 58% over 2004 levels. We sell these
          specialty mattresses to hospitals, long-term care facilities and home care
          dealers throughout the United States and Canada. Increased sales of the
          PressureGuard CFT® mattresses, sold mostly in the acute care market, made up
          about half of the total growth in the medical segment. The PressureGuard
          APM®
and Easy Air® powered therapeutic surfaces and the Geo-Mattress foam mattresses
          also made up a significant portion of our medical sales growth during the
          year.
          The APM, Easy Air and Geo-Mattress products are sold primarily in the long-term
          care and home care sections of the medical market. In other medical product
          lines, sales of seating products increased 10%, Selan® skin care products rose
          by 9%, and patient positioners decreased by 9% due to lower export sales.
          Sales
          of overlays were down by 14%, continuing a long-term trend of customers
          switching to replacement mattresses from mattress overlays. Our medical
          business
          achieved solid growth in fiscal 2005 primarily because of increased customer
          acceptance of our therapeutic mattresses, particularly in the long-term
          care
          market, and the initial success of our private label mattresses in the
          acute
          care market.
 
 21
 Our
          custom products segment consists of consumer bedding products and specialty
          foam
          products for the industrial market. Sales in the custom products segment
          declined 32% during fiscal 2005 to $18.1 million from $26.5 million in
          fiscal
          2004. Most of the custom products 2005 sales decrease was due to lower
          unit
          volumes of pillows and Geo-Systems® mattress pads sold to major retailers
          through Louisville Bedding Company. Sales of consumer bedding products
          decreased
          34% in 2005 to $15.6 million. The decline in consumer bedding sales resulted
          from increased competition in the mattress pad business, particularly from
          visco
          foam products, and in pillow products where a portion of our business was
          lost
          to a competing visco foam pillow manufactured in China. In addition, we
          lost a
          smaller part of our mattress pad business due to a customer switching from
          our
          branded products to a lower cost private-label version.
 
 In
          the
          other part of the custom products segment, industrial sales declined by
          14% to
          $2.5 million. The industrial sales decline was caused by the loss of business
          with several existing customers due to a temporary acquisition-related
          purchase
          slowdown by a large customer, a customer’s manufacturing operation being moved
          outside the United States, and pricing competition.
 
 In
          the
          safety catheter segment, sales were $6,000 as we recorded the first shipments
          of
          the redesigned Secure I.V. product line in the fourth quarter of fiscal
          2005.
          The Secure I.V. safety catheter was not offered for sale in the first three
          quarters of fiscal 2005 pending the completion of design enhancements.
          We began
          shipping market test samples of the product in the latter part of fiscal
          2004.
          However, in December 2004 we decided to delay the full release of the Secure
          I.V. as a result of initial customer feedback that revealed the potential
          benefits of making three design improvements to the product. The design
          improvements were completed in the fourth quarter of fiscal 2005, and we
          began
          limited shipments of the new products.
 
 **Gross
          Profit**
  Our
          gross
          profit level increased by 16% to $14.7 million during fiscal 2005 from
          $12.7
          million in fiscal 2004. The gross profit margin percentage rose to 30.4%
          for
          fiscal 2005 compared with 25.4% for fiscal 2004. The increases in gross
          profit
          level and margin were due to higher sales volumes in the medical segment.
 
 **Selling,
          Research & Development and Administrative Expenses**
  Selling
          and marketing expenses increased 11% to $7.7 million, or 15.8% of sales,
          in
          fiscal 2005 compared with $6.9 million, or 13.9% of sales, in fiscal 2004.
          Most
          of the increase occurred in the medical segment and was due to higher expenses
          for commissions, salespersons’ salaries and shipping costs. Selling and
          marketing expenses increased as a percent of sales primarily because of
          the
          decline in custom products sales during the year.
 
 Total
          R&D expenses increased 66% to $1.1 million in fiscal 2005 compared with
          $686,000 in fiscal 2004. The majority of the increase occurred in the safety
          catheter segment and was related to new product development efforts for
          the
          Secure I.V. product line. R&D expense for the safety catheter segment in
          fiscal 2005 increased 102% to $733,000 compared with $364,000 in the prior
          year.
          The increased costs were primarily due to higher expenses for labor, scrapped
          material, engineering and product development related to design changes
          and
          production test runs.
 
 22
 General
          and administrative expenses remained level at $2.8 million in fiscal 2005.
          Lower
          professional fees, incentive compensation and bad debt expenses were offset
          by
          higher costs for property and casualty insurance and administrative
          salaries.
 
 Operating
          profit increased 36% to $3.1 million compared to $2.3 million in fiscal
          2004.
          The increase was primarily caused by higher medical sales volume and a
          more
          profitable product mix.
 
 **Non-Operating
          Income**
  Investment
          income increased by 11% to $113,000 in fiscal 2005 compared with $102,000
          in
          fiscal 2004. The increase in investment income was the result of higher
          interest
          rates and slightly higher average balances of marketable securities in
          fiscal
          2005.
 
 Royalty
          income decreased 9% to $498,000 in fiscal 2005 compared with $545,000 in
          fiscal
          2004 as a result of lower sales volume of the Safety-Lok® shielded syringe
          product licensed to Becton Dickinson and Company (BD).
 
 Other
          non-operating income for 2005 included a $26,000 gain on the sale of
          manufacturing equipment.
 
 **Net
          Income and Dividends**
  Net
          income for fiscal 2005 increased 23% to $2.4 million, or $0.89 per diluted
          share, compared with $2.0 million, or $0.73 per diluted share, in fiscal
          2004.
          The increase was due primarily to higher sales volume in the medical segment
          and
          a more profitable sales mix.
 
 During
          fiscal 2005, we paid dividends of approximately $1.5 million, or 60% of
          net
          income, for the year. This amount represented three quarterly dividends
          of $0.04
          per share, one quarterly dividend of $0.045 per share and one special dividend
          of $0.40 per share.
  **LIQUIDITY
          AND CAPITAL RESOURCES**
  We
          generated cash from operations of $2.5 million during fiscal 2006, which
          was a
          4% decline compared with $2.6 million in fiscal 2005. The major factors
          contributing to the change in cash flow during the year were increased
          inventory
          and decreased accounts payable and accrued expenses. These reductions in
          operating cash flow were largely offset by increases in net income and
          a
          decrease in accounts receivable.
 
 Working
          capital increased by $2.7 million, or 25%, to $13.3 million during fiscal
          2006.
          The increase was caused by higher year-end balances of cash and marketable
          securities related to improved sales. Our working capital level was also
          affected by an increase in inventory levels as discussed below and a decrease
          in
          accounts payable and accrued liabilities. Our current ratio increased to
          3.8 at
          September 30, 2006 from 3.0 at fiscal year end 2005.
  23
 Accounts
          receivable, net of allowances, decreased 3% to $7.0 million at the end
          of fiscal
          2006 compared with $7.2 million at the end of fiscal 2005. The decrease
          resulted
          from higher sales in the medical segment in the fourth quarter of 2005
          which
          were collected in the first quarter of fiscal 2006. The days sales outstanding
          (or average collection time), calculated using a 12-month average for accounts
          receivable balances, increased to 47 days in 2006 compared with 44 days
          in 2005.
          The increase resulted from a higher percentage of medical sales in fiscal
          2006.
          Medical sales typically have longer collection times than custom products
          sales.
          All of our accounts receivable are unsecured.
 
 Inventory,
          net of reserves, increased by $1.1 million (35%) to $4.4 million at September
          30, 2006 compared with $3.2 million at October 1, 2005. The increases occurred
          in the medical segment and in the newly acquired HuberPro line, which is
          part of
          the safety catheter segment. The increase in the medical product line was
          intended to support higher medical sales levels and reduce order fill times
          particularly for medical mattress products. The increase in medical inventory
          was also affected by the release of an updated version of our patented
          low-air-loss mattress. Inventory turns for fiscal 2006 decreased to 9.5
          times
          from 11.4 times in fiscal 2005 primarily because of higher inventory levels
          in the medical and safety catheter segments. We expect inventory levels
          in
          fiscal 2007 to be slightly higher than those of fiscal 2006.
 
 Prepaid
          expenses increased 32% to $736,000 during fiscal 2006 from $557,000 at
          the end
          of fiscal 2005. The increase was primarily the result of an increase in
          income
          taxes receivable at year end fiscal 2006.
 
 Net
          property and equipment increased by less than 1% during fiscal 2006. The
          change
          resulted from the combination of building and equipment purchases of $1.1
          million partially offset by regular depreciation expense. Approximately
          $628,000
          of the capital expenditures for fiscal 2006 was related to the 58,000 square
          foot expansion to our South Carolina manufacturing plant, which was completed
          in
          November 2005. We expect capital expenditures in fiscal 2007 to be less
          than
          fiscal 2006 primarily because no building expansion is planned in 2007
          and
          capital expenditures will be limited mainly to investments in new
          equipment.
 
 From
          time
          to time, we purchase forward contracts for foreign currency to lock in
          exchange
          rates for future payments on manufacturing equipment that we order. The
          foreign
          exchange contracts are used to eliminate foreign currency fluctuations
          during
          the six to nine month period between the date the order is placed and the
          date
          of final payment. Realized gains and losses, if any, are included in the
          cost of
          the related equipment. Unrealized gains and losses on open contracts are
          not
          material to our results of operations or financial condition. We held no
          forward
          contracts as of September 30, 2006. We have not engaged in foreign currency
          transactions since fiscal year 2003; however, it is possible that we will
          do so
          again in fiscal 2007 due to anticipated purchases of equipment manufactured
          in
          Germany.
 
 Other
          assets increased by 5% to $2.8 million during fiscal 2006 compared with
          $2.6
          million at fiscal year end 2005 mainly due to an increase in the cash surrender
          value of life insurance policies and expenditures for patents and
          trademarks.
 
 24
 Our
          trade
          accounts payable decreased 12% in fiscal 2006 to $2.4 million. The decrease
          in
          payables was primarily the result of higher sales levels and associated
          purchases during the last two months of fiscal 2005 related to unusually
          high
          sales volume in the fourth quarter of fiscal 2005, which was not repeated
          in the
          fourth quarter of fiscal 2006. Accrued and sundry liabilities decreased
          by 7%
          during the year to $2.5 million compared with $2.7 million last year. The
          decrease was mostly due to lower accruals for income taxes.
 
 We
          believe that funds on hand and funds generated from operations are adequate
          to
          finance our operations and expected capital requirements during fiscal
          2007 and
          for the foreseeable future. The terms of our supply agreement with the
          contract
          manufacturer for our Secure I.V. product line require us to pay approximately
          $9,100 per week in labor and overhead charges for production of the Secure
          I.V.
          catheter in lieu of a per unit charge. This weekly charge is expected to
          remain
          in effect for the next six to 12 months, depending on actual production
          volume,
          and can be changed by the mutual agreement of both parties.
 
 **OFF-BALANCE-SHEET
          ARRANGEMENTS**
  We
          have
          no off-balance-sheet arrangements.
 
 **CONTRACTUAL
          OBLIGATIONS**
  The
          following table summarizes our significant contractual obligations and
          commercial commitments at September 30, 2006 and the future periods in
          which
          such obligations are expected to be settled in cash. For additional information
          regarding these obligations, see the referenced footnotes in the Notes
          to
          Financial Statements under Item 8 below.
 
 Payments
                      Due by PeriodContractual
                    Obligations
                
                
                
                Less
                    Than
                
                
                
                
                
                More
                    Than(dollars
                    in thousands)
                
                Total
                
                1
                    Year
                
                1-3
                    Years
                
                3-5
                    Years
                
                5
                    YearsPurchase
                    obligations - Note 19
                
                $
                2,500
                
                $
                625
                
                $
                1,250
                
                $
                625Deferred
                    compensation - Note 10
                
                
                945
                
                
                114
                
                
                227
                
                
                227
                
                $
                377Total
                    contractual obligations
                
                $
                3,445
                
                $
                739
                
                $
                1,477
                
                $
                852
                
                $
                377
  **IMPACT
          OF INFLATION AND COST OF RAW MATERIALS**
  Inflation
          was a moderate factor for our operations in fiscal 2006. We received price
          increases on certain of our polyurethane foam and other raw materials in
          our
          first fiscal quarter. We recovered the majority of the cost of these increases
          by selectively raising sales prices, improving manufacturing efficiencies
          and
          reducing other costs. Our raw material pricing largely stabilized in the
          second
          fiscal quarter, and further increases during the remainder of the fiscal
          year
          were not material. Based on current conditions in the markets for our primary
          raw materials, we do not expect inflation to be a significant factor in
          our
          operations in fiscal 2007. However, volatile oil prices, additional increases
          in
          the cost of polyurethane foam or other raw materials could negatively affect
          our
          profitability if we are unable to recover the higher costs through sales
          price
          increases or other cost reduction efforts.
  25
 **CRITICAL
          ACCOUNTING POLICIES**
  This
          discussion and analysis of financial condition and results of operations
          is
          based on our financial statements which we prepare in conformity with accounting
          principles generally accepted in the United States of America. The preparation
          of our financial statements requires us to make estimates and assumptions
          that
          affect the reported amounts of assets, liabilities, revenues and expenses.
          These
          estimates and assumptions are based on historical experience and on various
          other factors that we believe are reasonable under the circumstances, the
          results of which form the basis for making judgments about the carrying
          values
          of assets and liabilities that are not readily apparent from other sources.
          These estimates and assumptions also require the application of certain
          accounting policies, many of which require us to make estimates and assumptions
          about future events and their impact on amounts reported in our financial
          statements and related notes. We periodically review our accounting policies
          and
          estimates and make adjustments when facts and circumstances
          dictate.
 
 Actual
          results may differ from these estimates under different assumptions or
          conditions. Any differences may have a material impact on our financial
          condition and results of operations.
 
 In
          addition to the accounting policies which are more fully described in the
          Notes
          to Financial Statements included in this report, we have identified the
          following critical accounting policies used in the preparation of our financial
          statements.
 
 **Allowance
          for Doubtful Accounts**
  Credit
          evaluations are undertaken to set credit limits for all customers. On a
          quarterly basis, we evaluate past due items in the accounts receivable
          listing
          and provide what we estimate to be adequate reserves for doubtful accounts.
          Customer economic conditions may change and increase the risk of
          non-collectibility and may require additional provisions which would negatively
          impact our operating results. As of September 30, 2006, our provision for
          doubtful accounts represented approximately 1.7% of total accounts receivable,
          or $117,000.
 
 **Inventories**
  We
          regularly review inventory quantities on hand and adjust for excess and
          obsolete
          inventory based primarily on historical usage rates and our estimated forecast
          of product demand and production. Actual demand may differ from our estimate,
          in
          which case we may have understated or overstated the provision required
          for
          obsolete and excess inventory, which would have an impact on our operating
          results. As of September 30, 2006, our provision for excess and obsolete
          inventory represented approximately 10.2% of total inventories, or
          $446,000.
 
 We
          began
          to carry Secure I.V. inventory in fiscal 2005 and HuberPro inventory in
          fiscal
          2006. Since we have limited sales and production history for these new
          product
          lines, our future estimates for safety catheter inventory reserves could
          be more
          volatile than those in our medical and custom products segments.
 
 **Warranty
          Obligations**
  We
          warrant certain of our products for a specific period of time against
          manufacturing or performance defects. We provide for the estimated future
          cost
          of warranty obligations in cost of goods sold when the related revenue
          is
          recognized. The accrued warranty cost represents our best estimate at the
          time
          of sale of the total cost that we will incur to repair or replace covered
          products or parts. The amount of accrued estimated warranty cost is primarily
          based on historical experience as well as current information on repair
          costs.
          Actual warranty cost could differ from the estimated amounts. On a quarterly
          basis, we review the accrued balances and update the historical warranty
          cost
          trends. If we were required to accrue additional warranty cost in the future,
          it
          would negatively affect operating results. Our actual warranty expense
          was
          approximately $185,000 in fiscal 2006 and $174,000 in fiscal 2005. See
          Notes 7
          and 8 in the Notes to Financial Statements for more information on product
          warranties.
 
 26
 **Impairment
          of Goodwill**
  As
          required by SFAS No. 142, “Goodwill and Other Intangible Assets”, we evaluate
          goodwill in our medical business unit for impairment at least annually
          or more
          frequently if events occur or circumstances change that could reduce the
          fair
          value of our medical business unit. For fiscal year end 2006, we determined
          that
          the fair value of the medical business unit exceeded its carrying value
          and thus
          no impairment charge was required. In assessing the value of goodwill,
          we must
          make assumptions regarding estimated future cash flows and other factors
          to
          determine the fair value of the medical business unit. If these estimates
          or
          their related assumptions change in the future, we may be required to record
          impairment charges which would negatively impact operating results. As
          of
          September 30, 2006, the carrying value of goodwill was $1.9
          million.
 
 **Impairment
          of Long-Lived Assets**
  “Impairment”
          is the condition that exists when the carrying amount of a long-lived asset
          or
          asset group is greater than its fair value. As required by SFAS No. 144,
          we
          evaluate long-lived assets for potential impairment whenever events occur
          or
          circumstances indicate that the carrying amount of the assets may not be
          recoverable. The carrying amount of a long-lived asset is not recoverable
          if it
          exceeds the sum of the undiscounted cash flows expected to result from
          the use
          and eventual disposition of the asset. If the carrying amount of a long-lived
          asset is not recoverable and is greater than its fair value, the asset
          is
          impaired and an impairment loss must be recognized. To date, we have had
          no
          indicators of impairment for long-lived assets. However, our investment
          in the
          safety catheter business unit raises the possibility of a future impairment
          loss. Since the Secure I.V. product line has limited sales history and
          is in the
          process of emerging from development stage, it involves greater risks and
          uncertainties than our more established product lines. We completed the
          initial
          design and development of Secure I.V. during the third quarter of fiscal
          2005.
          We have been marketing the product line through select distributors since
          approximately September 2005. During fiscal year 2006, sales of Secure
          I.V. were
          $75,000. The continued passage of time without an improvement in sales
          increases
          the possibility of a future impairment charge in the safety catheter segment.
          If
          Secure I.V. sales do not show a meaningful increase in the near future,
          it is
          possible that the assets associated with Secure I.V. could become impaired,
          resulting in a material impairment charge against our earnings and a material
          reduction in our assets. If the assets associated with the safety catheter
          segment became impaired, the impairment loss could be as much as the total
          assets of the safety catheter segment. (See Note 17 in the Notes to Financial
          Statements.) If such an event had occurred as of September 30, 2006, our
          assets
          and operating income would have been reduced by up to $3.3 million, and
          net
          income after taxes would have been reduced by up to $2.2 million, or $0.81
          per
          diluted share, using the weighted average diluted shares outstanding at
          fiscal
          year end 2006. The actual amount of any future impairment loss could be
          more or
          less, depending on the level of assets and the degree of impairment at
          the time
          we determine an impairment charge is necessary.
 
 27
 **Present
          Value of Deferred Compensation**
  We
          are
          obligated to make fixed payments under a retirement agreement over the
          remaining
          life of Span-America’s founder as discussed in Note 10 “Deferred Compensation”
in the Notes to Financial Statements. We have fully accrued the present
          value of
          the expected payments due over the executive’s estimated life expectancy. In
          calculating this present value we estimated an effective long-term interest
          rate
          of 8%. If actual long-term interest rates declined significantly and we
          were
          required to accrue additional deferred compensation costs in the future,
          it
          would negatively affect operating results. As of September 30, 2006, we
          had
          recorded a deferred compensation liability of approximately $945,000, including
          current and long-term portions. If we reduced the discount rate by 1%,
          the
          deferred compensation liability would be increased by approximately $58,000
          and
          pre-tax income would be reduced by the same amount.
 
 **Item
          7A. Qualitative and Quantitative Disclosures About Market
          Risk**
 
 We
          are
          exposed to financial market risk in two areas: short-term investments and
          cash
          value of life insurance. As of September 30, 2006, we had short-term investments
          of $5.1 million which were classified as available for sale. Included in
          these
          short-term investments are approximately $4.8 million of high quality and
          highly
          liquid corporate commercial paper and bonds known as “variable rate demand
          notes” or “low floaters.” The bonds are issued by municipalities or companies
          and are backed by letters of credit from federally insured banks. The bonds
          carry the credit rating of the underlying bank and are therefore highly
          rated.
          The interest rate on the bonds is a floating rate which is reset weekly
          or
          monthly, depending on the issue, by the re-marketing agent based on market
          rates
          for comparable securities or through an auction process. We can liquidate
          the
          bonds at any time with a settlement date of seven to 35 days after the
          trade
          date. Using the level of securities available for sale at fiscal year end
          2006,
          a 100 basis point increase or decrease in interest rates for one year would
          increase or decrease after-tax earnings by approximately $48,000. The effect
          of
          a 100 basis point increase or decrease in interest rates will vary from
          period
          to period with the dollar amount invested in our low floater
          portfolio.
 
 Our
          $5.1
          million in short-term investments at fiscal year end also included approximately
          $365,000 in a portfolio of investment grade preferred stocks. The preferred
          shares are generally callable within three to five years and have after-tax
          dividend yields currently higher than the variable rate demand notes described
          above. Dividends from the preferred stocks are generally paid quarterly
          and
          qualify for the 70% dividends received deduction available to corporate
          holders
          of the preferred shares. These shares are traded on the New York Stock
          Exchange
          and per share prices are subject to interest rate risks similar to
          intermediate-term bonds as well as specific company risk factors. We believe
          that substantial fluctuations in long-term interest rates or prices of
          the
          preferred stocks would not have a material effect on our financial
          position.
 
 28
 In
          addition, our other assets at September 30, 2006 include $1.8 million in
          cash
          value of life insurance, which is subject to market risk related to equity
          pricing and interest rate changes. The cash value is generated from life
          insurance policies which are being used as the funding vehicle for a retirement
          program for Span-America’s founder and former chairman. The cash value is
          invested in a combination of fixed income life insurance contracts and
          a
          portfolio of mutual funds managed by an insurance company. The fixed income
          contracts are similar to fixed income bond funds and are therefore subject
          to
          interest rate and company risk. The mutual fund portfolios invest in common
          stocks and bonds in accordance with their individual investment objectives.
          These portfolios are exposed to stock market and interest rate risk similar
          to
          comparable mutual funds. We believe that substantial fluctuations in equity
          markets and interest rates and the resulting changes in cash value of life
          insurance would not have a material adverse effect on our financial position.
          During the fiscal year ended September 30, 2006, cash value of life insurance
          increased by 6%, creating after-tax income of approximately
          $94,000.
  29
 
 **Item
            8. Financial Statements and Supplementary Data**
 
 **Span-America
            Medical Systems, Inc.**
 **Financial
            Statements**
 
 **September
            30, 2006**
 
 Contents
 
 Report
                      of Independent Registered Public Accounting Firm
                  31Financial
                      StatementsStatements
                      of Income
                  32Balance
                      Sheets
                  33Statements
                      of Changes in Shareholders’Equity
                      and Comprehensive Income
                  34Statements
                      of Cash Flows
                  35Notes
                      to Financial Statements
                  36
 
 30
 
 **Report
            of Independent Registered Public Accounting Firm**
 
 Shareholders
            and Board of Directors
 Span-America
            Medical Systems, Inc.
 Greenville,
            South Carolina
 
 We
            have
            audited the accompanying balance sheets of Span-America Medical Systems,
            Inc. as
            of September 30, 2006 and October 1, 2005 and the related statements
            of income,
            changes in shareholders’ equity and comprehensive income, and cash flows for
            each of the years in the three year period ended September 30, 2006.
            These
            financial statements are the responsibility of the Company’s management. Our
            responsibility is to express an opinion on these financial statements
            based on
            our audits.
 
 We
            conducted our audits in accordance with the Standards of the Public Company
            Accounting Oversight Board (United States). Those standards require that
            we plan
            and perform the audits to obtain reasonable assurance about whether the
            financial statements are free of material misstatement. An audit includes
            examining, on a test basis, evidence supporting the amounts and disclosures
            in
            the financial statements. An audit also includes assessing the accounting
            principles used and significant estimates made by management, as well
            as
            evaluating the overall financial statement presentation. We believe that
            our
            audits provide a reasonable basis for our opinion.
 
 In
            our
            opinion, the financial statements referred to above present fairly, in
            all
            material respects, the financial position of Span-America Medical Systems,
            Inc.,
            as of September 30, 2006 and October 1, 2005 and the results of its operations
            and its cash flows for each of the years in the three year period ended
            September 30, 2006 in conformity with accounting principles generally
            accepted
            in the United States of America.
 
  /s/
                      ELLIOTT DAVIS, LLC
  
 Greenville,
            South Carolina
 November
            1, 2006
  31
  **Statements
              of Income**
 Years
                      Ended**September
                      30,**
                  
                  October
                      1,
                  
                  October
                      2,**2006**
                  
                  2005
                  
                  2004Net
                      sales
                  
                  **$**
                  **51,556,548**
                  
                  $
                  48,439,310
                  
                  $
                  49,929,129Cost
                      of goods sold
                  
                  
                  **35,857,885**
                  
                  
                  33,725,836
                  
                  
                  37,238,586Gross
                      profit
                  
                  
                  **15,698,663**
                  
                  
                  14,713,474
                  
                  
                  12,690,543Selling
                      and marketing expenses
                  
                  
                  **8,208,043**
                  
                  
                  7,656,876
                  
                  
                  6,924,720Research
                      and development expenses
                  
                  
                  **633,608**
                  
                  
                  1,141,198
                  
                  
                  686,413General
                      and administrative expenses
                  
                  
                  **2,846,534**
                  
                  
                  2,781,951
                  
                  
                  2,771,205**11,688,185**
                  
                  
                  11,580,025
                  
                  
                  10,382,338Operating
                      income
                  
                  
                  **4,010,478**
                  
                  
                  3,133,449
                  
                  
                  2,308,205Non-operating
                      income (expense):Investment
                      income
                  
                  
                  **204,042**
                  
                  
                  113,342
                  
                  
                  101,958Royalty
                      income
                  
                  
                  **246,627**
                  
                  
                  497,516
                  
                  
                  545,072Other
                  
                  
                  **103,664**
                  
                  
                  29,600
                  
                  
                  (8,326
                  )**554,333**
                  
                  
                  640,458
                  
                  
                  638,704Income
                      before income taxes
                  
                  
                  **4,564,811**
                  
                  
                  3,773,907
                  
                  
                  2,946,909Provision
                      for income taxes (Note 12)
                  
                  
                  **1,510,000**
                  
                  
                  1,335,000
                  
                  
                  962,000Net
                      income
                  
                  **$**
                  **3,054,811**
                  
                  $
                  2,438,907
                  
                  $
                  1,984,909Earnings
                      per share of common stock (Note 13)Net
                      income:Basic
                  
                  **$**
                  **1.15**
                  
                  $
                  0.94
                  
                  $
                  0.77Diluted
                  
                  **$**
                  **1.10**
                  
                  $
                  0.89
                  
                  $
                  0.73Dividends
                      per share of common stock
                  
                  **$**
                  **0.195**
                  
                  $
                  0.565
                  
                  $
                  0.145Weighted
                      average shares outstanding:Basic
                  
                  
                  **2,648,635**
                  
                  
                  2,603,932
                  
                  
                  2,579,451Diluted
                  
                  
                  **2,771,924**
                  
                  
                  2,739,149
                  
                  
                  2,731,873
  The
            accompanying notes are an integral part of these financial
            statements.
 32
 **Balance
              Sheets**
 **September
                      30,**
                  
                  October
                      1,**2006**
                  
                  2005**ASSETS**Current
                      assets:Cash
                      and cash equivalents
                  
                  **$**
                  **975,525**
                  
                  $
                  894,386Securities
                      available for sale (Note 2)
                  
                  
                  **5,134,882**
                  
                  
                  4,106,326Accounts
                      receivable, net of allowances of $117,000(2006)
                      and $116,000 (2005)
                  
                  
                  **6,986,794**
                  
                  
                  7,232,522Inventories
                      (Note 3)
                  
                  
                  **4,353,479**
                  
                  
                  3,216,483Prepaid
                      expenses and deferred income taxes
                  
                  
                  **735,684**
                  
                  
                  557,172Total
                      current assets
                  
                  
                  **18,186,364**
                  
                  
                  16,006,889Property
                      and equipment, net (Note 4)
                  
                  
                  **8,132,057**
                  
                  
                  8,089,511Goodwill
                      (Note 5)
                  
                  
                  **1,924,131**
                  
                  
                  1,924,131Other
                      assets (Notes 5 and 6)
                  
                  
                  **2,769,926**
                  
                  
                  2,645,314**$**
                  **31,012,478**
                  
                  $
                  28,665,845**LIABILITIES
                      AND SHAREHOLDERS' EQUITY**Current
                      liabilities:Accounts
                      payable
                  
                  **$**
                  **2,374,357**
                  
                  $
                  2,704,100Accrued
                      and sundry liabilities (Note 7)
                  
                  
                  **2,474,049**
                  
                  
                  2,664,618Total
                      current liabilities
                  
                  
                  **4,848,406**
                  
                  
                  5,368,718Deferred
                      income taxes (Note 12)
                  
                  
                  **815,000**
                  
                  
                  869,000Deferred
                      compensation (Note 10)
                  
                  
                  **831,614**
                  
                  
                  866,750Total
                      liabilities
                  
                  
                  **6,495,020**
                  
                  
                  7,104,468Commitments
                      and contingencies (Notes 18 and 19)Shareholders'
                      equity (Notes 11 and 13)Common
                      stock, no par value, 20,000,000 sharesauthorized;
                      issued and outstanding shares2,660,345
                      (2006) and 2,611,768 (2005)
                  
                  
                  **1,032,118**
                  
                  
                  707,016Additional
                      paid-in capital
                  
                  
                  **136,614**
                  
                  
                  41,882Retained
                      earnings
                  
                  
                  **23,352,221**
                  
                  
                  20,814,191Accumulated
                      other comprehensive loss
                  
                  
                  **(3,495**
                  **)**
                  
                  (1,712
                  )Total
                      shareholders' equity
                  
                  
                  **24,517,458**
                  
                  
                  21,561,377**$**
                  **31,012,478**
                  
                  $
                  28,665,845
  The
            accompanying notes are an integral part of these financial statements.
  33
 
  **Statements
            of Changes in Shareholders' Equity and Comprehensive
            Income**
 AccumulatedAdditional
                  
                  
                  
                  OtherCommon
                      Stock
                  
                  Paid-in
                  
                  Retained
                  
                  ComprehensiveShares
                  
                  Amount
                  
                  Capital
                  
                  Earnings
                  
                  Loss
                  
                  TotalBalance
                      at September 27, 2003
                  
                  
                  2,552,154
                  
                  $
                  283,981
                  
                  $
                  10,035
                  
                  $
                  18,231,325
                  
                  $
                  -
                  
                  $
                  18,525,341Net
                      income for the 2004 fiscal year
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,984,909
                  
                  
                  
                  
                  
                  1,984,909Common
                      stock issued to Directors
                  
                  
                  8,500
                  
                  
                  114,750
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  114,750Common
                      stock issued onexercise
                      of stock options
                  
                  
                  31,564
                  
                  
                  159,125
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  159,125Tax
                      benefits for stock options exercised
                  
                  
                  
                  
                  
                  
                  
                  
                  9,262
                  
                  
                  
                  
                  
                  
                  
                  
                  9,262Cash
                      dividends paid or declared($0.145
                      per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (373,995
                  )
                  
                  
                  
                  
                  (373,995
                  )Balance
                      at October 2, 2004
                  
                  
                  2,592,218
                  
                  
                  557,856
                  
                  
                  19,297
                  
                  
                  19,842,239
                  
                  
                  -
                  
                  
                  20,419,392Net
                      income for the 2005 fiscal year
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,438,907
                  
                  
                  
                  
                  
                  2,438,907Unrealized
                      loss on securitiesavailable
                      for sale
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,712
                  )
                  
                  (1,712
                  )Comprehensive
                      income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,437,195Common
                      stock issued to Directors
                  
                  
                  9,000
                  
                  
                  92,970
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  92,970Common
                      stock issued onexercise
                      of stock options
                  
                  
                  10,550
                  
                  
                  56,190
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  56,190Tax
                      benefits for stock options exercised
                  
                  
                  
                  
                  
                  
                  
                  
                  11,566
                  
                  
                  
                  
                  
                  
                  
                  
                  11,566Stock
                      option compensation expense
                  
                  
                  
                  
                  
                  
                  
                  
                  11,019
                  
                  
                  
                  
                  
                  
                  
                  
                  11,019Cash
                      dividends paid or declared($0.565
                      per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,466,955
                  )
                  
                  
                  
                  
                  (1,466,955
                  )Balance
                      at October 1, 2005
                  
                  
                  2,611,768
                  
                  
                  707,016
                  
                  
                  41,882
                  
                  
                  20,814,191
                  
                  
                  (1,712
                  )
                  
                  21,561,377Net
                      income for the 2006 fiscal year
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,054,811
                  
                  
                  
                  
                  
                  3,054,811Unrealized
                      loss on securitiesavailable
                      for sale
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,783
                  )
                  
                  (1,783
                  )Comprehensive
                      income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,053,028Common
                      stock issued to Directors
                  
                  
                  8,500
                  
                  
                  113,730
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  113,730Common
                      stock issued onexercise
                      of stock options
                  
                  
                  40,077
                  
                  
                  211,372
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  211,372Tax
                      benefits for stock options exercised
                  
                  
                  
                  
                  
                  
                  
                  
                  47,872
                  
                  
                  
                  
                  
                  
                  
                  
                  47,872Stock
                      option compensation expense
                  
                  
                  
                  
                  
                  
                  
                  
                  46,860
                  
                  
                  
                  
                  
                  
                  
                  
                  46,860Cash
                      dividends paid or declared($0.195
                      per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (516,781
                  )
                  
                  
                  
                  
                  (516,781
                  )**Balance
                      at September 30, 2006**
                  
                  
                  **2,660,345**
                  
                  **$**
                  **1,032,118**
                  
                  **$**
                  **136,614**
                  
                  **$**
                  **23,352,221**
                  
                  **$**
                  **(3,495**
                  **)**
                  **$**
                  **24,517,458**
  The
            accompanying notes are an integral part of these financial
            statements.
  34
  **Statements
          of Cash Flows**
 Years
                      Ended**September
                      30,**
                  
                  October
                      1,
                  
                  October
                      2,**2006**
                  
                  2005
                  
                  2004**OPERATING
                      ACTIVITIES:**Net
                      income
                  
                  **$**
                  **3,054,811**
                  
                  $
                  2,438,907
                  
                  $
                  1,984,909Adjustments
                      to reconcile net income to netcash
                      provided by operating activities:Depreciation
                  
                  
                  **814,210**
                  
                  
                  715,706
                  
                  
                  618,559Amortization
                  
                  
                  **128,971**
                  
                  
                  128,769
                  
                  
                  98,449Provision
                      (recovery) for losses on accounts receivable
                  
                  
                  **47,762**
                  
                  
                  34,263
                  
                  
                  (6,830
                  )Provision
                      for deferred income taxes
                  
                  
                  **(39,128**
                  **)**
                  
                  (122,434
                  )
                  
                  385,262(Gain)
                      loss on sale and disposal of property and equipment
                  
                  
                  **(99,378**
                  **)**
                  
                  (26,246
                  )
                  
                  11,596Increase
                      in cash value of life insurance
                  
                  
                  **(102,955**
                  **)**
                  
                  (101,233
                  )
                  
                  (121,464
                  )Deferred
                      compensation
                  
                  
                  **(35,136**
                  **)**
                  
                  (32,533
                  )
                  
                  (30,124
                  )Stock
                      compensation expense
                  
                  
                  **46,860**
                  
                  
                  11,019Changes
                      in operating assets and liabilities:Accounts
                      receivable
                  
                  
                  **176,341**
                  
                  
                  (671,343
                  )
                  
                  (669,888
                  )Inventory
                  
                  
                  **(1,136,996**
                  **)**
                  
                  (498,910
                  )
                  
                  (178,248
                  )Prepaid
                      expenses and other assets
                  
                  
                  **(65,976**
                  **)**
                  
                  457,496
                  
                  
                  (80,334
                  )Accounts
                      payable and accrued expenses
                  
                  
                  **(291,907**
                  **)**
                  
                  255,402
                  
                  
                  799,651Net
                      cash provided by operating activities
                  
                  
                  **2,497,479**
                  
                  
                  2,588,863
                  
                  
                  2,811,538**INVESTING
                      ACTIVITIES:**Purchases
                      of marketable securities
                  
                  
                  **(4,618,714**
                  **)**
                  
                  (3,719,866
                  )
                  
                  (1,800,000
                  )Proceeds
                      from sales of marketable securities
                  
                  
                  **3,610,000**
                  
                  
                  4,305,000
                  
                  
                  1,273,636Purchases
                      of property and equipment
                  
                  
                  **(1,073,696**
                  **)**
                  
                  (2,405,418
                  )
                  
                  (1,997,491
                  )Proceeds
                      from sale of property and equipment
                  
                  
                  **101,305**
                  
                  
                  26,246Payments
                      for other assets
                  
                  
                  **(116,434**
                  **)**
                  
                  (185,295
                  )
                  
                  (165,237
                  )Net
                      cash used for investing activities
                  
                  
                  **(2,097,539**
                  **)**
                  
                  (1,979,333
                  )
                  
                  (2,689,092
                  )**FINANCING
                      ACTIVITIES:**Dividends
                      paid
                  
                  
                  **(516,781**
                  **)**
                  
                  (1,466,955
                  )
                  
                  (373,995
                  )Common
                      stock issued upon exercise of options
                  
                  
                  **197,980**
                  
                  
                  44,213
                  
                  
                  147,815Net
                      cash used for financing activities
                  
                  
                  **(318,801**
                  **)**
                  
                  (1,422,742
                  )
                  
                  (226,180
                  )Increase/(decrease)
                      in cash and cash equivalents
                  
                  
                  **81,139**
                  
                  
                  (813,212
                  )
                  
                  (103,734
                  )Cash
                      and cash equivalents at beginning of year
                  
                  
                  **894,386**
                  
                  
                  1,707,598
                  
                  
                  1,811,332Cash
                      and cash equivalents at end of year
                  
                  **$**
                  **975,525**
                  
                  $
                  894,386
                  
                  $
                  1,707,598
  The
            accompanying notes are an integral part of these financial
            statements.
  35
 **NOTES
            TO FINANCIAL STATEMENTS**
 **September
            30, 2006**
 
 **1.
            SIGNIFICANT ACCOUNTING POLICIES**
 
 **Description
            of Business**
  The
            Company manufactures and distributes replacement mattresses, mattress
            overlays,
            patient positioners, seating cushions, and skin care products for the
            medical
            market and pillows, mattress pads and various foam products for the custom
            products market throughout the United States and Canada. In addition,
            the
            Company has recently begun manufacturing and marketing the Secure I.V.
            line of
            intravenous catheters to the health care market in North America. The
            catheter
            product line was acquired in early development stage in 2002. The Company
            began
            selling the HuberPro needle infusion set in April 2006 primarily to oncology
            clinics.
 
 **Cash
            and Cash Equivalents**
  The
            Company considers all cash equivalents to be highly liquid investments
            with a
            maturity when purchased of three months or less. Depending on market
            conditions,
            the Company may maintain a centralized cash management program whereby
            its
            excess cash balances are invested in commercial paper and are considered
            cash
            equivalents. Cash balances in the Company’s accounts usually exceed federally
            insured limits.
 
 **Accounts
            Receivable**
  The
            Company provides credit in the normal course of business and performs
            ongoing
            credit evaluations on certain of its customers, but generally does not
            require
            collateral to support such receivables. The Company also establishes
            an
            allowance for doubtful accounts based upon factors surrounding the credit
            risk
            of specific customers, historical trends and other information. Account
            balances
            are charged against the allowance after all collection efforts have been
            exhausted and potential for recovery is considered remote.
 
 **Inventories**
  Inventories
            are valued at the lower of cost (first-in, first-out method) or
            market.
 
 **Property
            and Equipment**
  Property
            and equipment is stated at cost. Maintenance, repairs, and minor replacements
            that do not improve or extend the useful lives of assets are expensed
            when
            incurred. Depreciation is computed using the straight-line method. Estimated
            useful lives for buildings and land improvements range from 15 to 35
            years. The
            estimated useful lives of all other property and equipment range from
            3 years to
            15 years. For income tax purposes, substantially all depreciation is
            computed
            using accelerated methods.
 
 Construction
            in progress is stated at cost, which includes the cost of construction
            and other
            direct costs attributable to the construction. No provision for depreciation
            is
            made on construction in progress until the relevant assets are completed
            and put
            into use. As of October 1, 2005, the balance in construction in progress
            represented costs incurred relating to a 58,000 square foot expansion
            of the
            Greenville, SC plant. The total cost of the expansion was $2.9 million.
            The
            building was occupied in November 2005. (See Note 4.)
 
 36
 
 **Intangibles**
  Intangible
            assets are amortized using the straight-line method. Costs of patents
            are
            amortized over periods ranging from 10 to 17 years, and trademarks are
            amortized
            over periods of 5 or 10 years. Goodwill, costs in excess of the fair
            value of
            net assets, acquired from two separate acquisitions, is accounted for
            under
            Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other
            Intangible Assets.” See Note 5. Accumulated amortization of intangible assets at
            September 30, 2006 and October 1, 2005 was approximately $2,546,000 and
            $2,419,000, respectively. The Company reviews annually the recoverability
            of the
            carrying value of these assets in accordance with SFAS No. 142 and SFAS
            No. 144
“Accounting for the Impairment of Long-Lived Assets and for Long-Lived
            Assets to
            be Disposed Of.” The Company also reviews long-lived assets and the related
            intangible assets for impairment whenever events or changes in circumstances
            indicate the carrying amount of such assets may not be recoverable.
 
 **Revenue
            Recognition**
  Revenue
            is recognized by the Company when goods are shipped and title passes
            to the
            customer. There are no customer acceptance provisions, and the right
            to return
            exists only in cases of damaged product, non-compliance with customer
            specifications or warranty claims.
  The
            Company has applied the accounting and disclosure requirements of Securities
            and
            Exchange Commission Staff Accounting Bulletin (SAB) No. 101.
 
 **Advertising
            Costs**
  Advertising
            costs are expensed as incurred.
 
 **Shipping
            and Handling Costs**
  Shipping
            and handling costs that are not reimbursed by customers are charged to
            selling
            and marketing expenses and were approximately $1,697,000 in 2006, $1,516,000
            in
            2005, and $1,445,000 in 2004.
 
 **Fair
            Value of Financial Instruments**
  The
            carrying amounts reported in the balance sheet for cash and cash equivalents,
            securities available for sale, accounts receivable, cash value of life
            insurance, accounts payable, and debt approximate their fair values.
            The fair
            values of the Company’s securities available for sale are based on quoted market
            prices when available, or quoted market prices of financial instruments
            with
            similar characteristics.
 
 **Earnings
            Per Share of Common Stock**
  Earnings
            per share of common stock are computed based on the weighted average
            number of
            shares outstanding during each period in accordance with SFAS No. 128,
“Earnings
            Per Share.” (See Note 13).
  37
 
 **Stock-Based
            Compensation**
  During
            December 2004, the Financial Accounting Standards Board (FASB) issued
            SFAS No.
            123R “Share-Based Payment,” which requires the Company to measure and recognize
            compensation expense for all stock-based payments at fair value. This
            statement
            eliminated the ability to account for share-based compensation transactions
            using Accounting Principles Board Opinion 25, “Accounting for Stock Issued to
            Employees” (“APB No. 25”). Stock-based payments include stock option grants. The
            Company grants options to purchase common stock to some of its employees
            under
            various plans at prices equal to the market value of the stock on the
            dates the
            options were granted. The Company adopted SFAS No. 123R in the fourth
            quarter of
            fiscal 2005 using the modified prospective method.
 
 Prior
            to
            adopting SFAS No. 123R, the Company accounted for stock options under
            APB No.
            25. Accordingly, no compensation expense was charged to operations in
            previous
            fiscal years. If compensation expense for the plans had been determined
            based on
            the fair value at the grant dates for awards under the plans consistent
            with the
            accounting method available under SFAS No. 123 “Accounting for Stock Based
            Compensation,” the Company's net income and net income per common share would
            have been reduced to the proforma amounts indicated below:
 **2006**
                      
                      2005
                      
                      2004Net
                          incomeAs
                          reported
                      
                      **$**
                      **3,054,811**
                      
                      $
                      2,438,907
                      
                      $
                      1,984,909Add
                          stock-based employee compensationexpense
                          included in reported net income,net
                          of taxes
                      
                      
                      **46,860**
                      
                      
                      11,019Deduct
                          stock-based employeecompensation
                          expense determined underfair-value-based
                          method for all awards,net
                          of taxes - after adoption of SFAS 123R
                      
                      
                      (46,860
                      )
                      
                      (11,019
                      )Deduct
                          stock-based employeecompensation
                          expense determined underfair-value-based
                          method for all awards,net
                          of taxes - prior to adoption of SFAS 123R
                      
                      
                      
                      
                      
                      (140,166
                      )
                      
                      (156,594
                      )Pro
                          forma
                      
                      **$**
                      **3,054,811**
                      
                      $
                      2,298,741
                      
                      $
                      1,828,315Basic
                          net income per common shareAs
                          reported
                      
                      **$**
                      **1.15**
                      
                      $
                      0.94
                      
                      $
                      0.77Stock
                          option expense, net of taxes
                      
                      
                      **-**
                      
                      
                      (0.05
                      )
                      
                      (0.06
                      )Pro
                          forma
                      
                      **$**
                      **1.15**
                      
                      $
                      0.88
                      
                      $
                      0.71Diluted
                          net income per common shareAs
                          reported
                      
                      **$**
                      **1.10**
                      
                      $
                      0.89
                      
                      $
                      0.73Stock
                          option expense, net of taxes
                      
                      
                      **-**
                      
                      
                      (0.05
                      )
                      
                      (0.06
                      )Pro
                          forma
                      
                      **$**
                      **1.10**
                      
                      $
                      0.84
                      
                      $
                      0.67
  The
            fair
            value of each option grant is estimated on the date of grant using the
            Black-Scholes option pricing model with the following weighted average
            assumptions for grants made in 2006, 2005 and 2004, respectively: risk-free
            interest rates of 4.58%, 4.08% and 4.14%; dividend yields of 1.5%, 1.5%
            and
            1.1%; volatility factors of the expected market price of the Company's
            common
            stock of 35.7%, 32.3% and 38.9%; and a weighted average expected life
            of the
            option of 8.2 years for fiscal year 2006 and 8.0 years for fiscal years
            2005 and
            2004.
 
 38
 **Fiscal
            Year**
  The
            Company’s fiscal year ends on the Saturday nearest to September 30. Fiscal years
            2006 and 2005 were 52-week years. Fiscal year 2004 was a 53-week year.
            Fiscal
            year 2007 will be a 52 -week year.
 
 **Income
            Taxes**
  In
            accordance with SFAS No. 109, “Accounting for Income Taxes,” the liability
            method is used in accounting for income taxes. Under this method, deferred
            tax
            assets and liabilities are determined based on differences between financial
            reporting and tax bases of assets and liabilities and are measured using
            the
            enacted tax rates and laws that will be in effect when the differences
            are
            expected to reverse.
 
 **Use
            of Estimates**
  The
            preparation of financial statements in conformity with accounting principles
            generally accepted in the United States of America requires management
            to make
            estimates and assumptions that affect the amounts reported in the financial
            statements and accompanying notes. Although these estimates are based
            on
            management’s knowledge of current events and actions planned for the future, the
            estimates may ultimately differ from actual results.
 
 **Recently
            Issued Accounting Standards**
  In
            September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS
            No. 157 defines fair value, establishes a framework for measuring fair
            value and
            expands disclosures about fair value measurements. It also established
            a fair
            value hierarchy that prioritizes information used in developing assumptions
            when
            pricing an asset or liability. SFAS 157 will be effective for us beginning
            in
            fiscal 2008. We are evaluating the statement to determine the effect
            on our
            financial statements and related disclosures.
 
 In
            September 2006, the Securities and Exchange Commission (SEC) issued SAB
            No. 108,
“Financial Statements - Considering the Effects of Prior Year Misstatements
            when
            Quantifying Misstatements in Current Year Financial Statements.” SAB 108
            requires companies to quantify the impact of all correcting misstatements,
            including both the carryover and reversing effects of prior year misstatements,
            on the current year financial statements. This pronouncement is effective
            for us
            in fiscal 2008. We do not believe SAB 108 will have a material effect
            on our
            financial statements and related disclosures.
 
 In
            June
            2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
            Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes
            recognized in an enterprise’s financial statements in accordance with SFAS No.
            109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold
            and measurement attribute for the financial statement recognition and
            measurement of a tax position taken or expected to be taken in a tax
            return. FIN
            48 also provides guidance on derecognition, classification, interest
            and
            penalties, accounting in interim periods, disclosure and transition.
            FIN 48 will
            be effective for us beginning in fiscal 2007. We are evaluating the
            interpretation to determine the effect on our financial statements and
            related
            disclosures.
 
 39
 Other
            accounting standards that have been issued or proposed by FASB or other
            standards-setting bodies that do not require adoption until a future
            date are
            not expected to have a material impact on the Company's financial statements
            upon adoption.
 
 **2.
            SECURITIES AVAILABLE FOR SALE**
 
 The
            variable rate demand notes included in securities available for sale
            are carried
            at aggregate cost which approximates market. Preferred stocks are carried
            at
            market value. Unrealized holding losses were $3,495 and $1,712 during
            fiscal
            years 2006 and 2005. The Company had no unrealized holding gains or losses
            during fiscal year 2004.
  **2006**
                  
                  2005Variable
                      rate demand notes
                  
                  **$**
                  **4,769,797**
                  
                  $
                  3,938,171Preferred
                      stocks
                  
                  
                  **365,085**
                  
                  
                  168,155**$**
                  **5,134,882**
                  
                  $
                  4,106,326
 
 **3.
              INVENTORIES**
 **2006**
                  
                  2005Raw
                      materials
                  
                  **$**
                  **2,829,048**
                  
                  $
                  2,412,803Finished
                      goods
                  
                  
                  **1,524,431**
                  
                  
                  803,680**$**
                  **4,353,479**
                  
                  $
                  3,216,483
 
 **4.
              PROPERTY AND EQUIPMENT**
 **2006**
                  
                  2005Land
                  
                  **$**
                  **469,718**
                  
                  $
                  317,343Land
                      improvements
                  
                  
                  **486,698**
                  
                  
                  246,172Buildings
                  
                  
                  **6,774,418**
                  
                  
                  4,317,011Construction
                      in progress
                  
                  
                  
                  
                  
                  2,233,042Machinery
                      and equipment
                  
                  
                  **7,817,829**
                  
                  
                  8,624,238Furniture
                      and fixtures
                  
                  
                  **447,412**
                  
                  
                  427,175Automobiles
                  
                  
                  **9,520**
                  
                  
                  9,520Leasehold
                      improvements
                  
                  
                  **12,330**
                  
                  
                  12,330**16,017,925**
                  
                  
                  16,186,831Less
                      accumulated depreciation
                  
                  
                  **7,885,868**
                  
                  
                  8,097,320**$**
                  **8,132,057**
                  
                  $
                  8,089,511
 
 40
 **5.
            GOODWILL AND OTHER INTANGIBLES**
 
 As
            of
            September 30, 2006 and October 1, 2005 the Company had goodwill (net
            of
            accumulated amortization) of $1,924,131 and patents and trademarks (net
            of
            accumulated amortization) of $720,221 as of September 30, 2006 and $762,757
            as
            of October 1, 2005. All goodwill is part of the medical segment. Patents
            and
            trademarks are part of the medical and safety catheter segments. The
            Company has
            re-assessed the useful lives of goodwill and patents and trademarks.
            Goodwill
            was determined to have an indefinite useful life. Amortization of goodwill
            ceased on September 29, 2001 as a result of the Company’s adoption of SFAS No.
            142 at the beginning of fiscal year 2002. The useful lives of individual
            patents
            and trademarks were reviewed and no material changes were required. No
            impairment losses were recorded on the Company’s intangible assets as a result
            of the adoption of SFAS No. 142 based on the annual goodwill impairment
            test.
 
 Amortization
            expense for patents and trademarks during fiscal years 2006, 2005, and
            2004 was
            $128,971, $128,769, and $98,449, respectively. Estimated amortization
            expense
            for the next five fiscal years is as follows:
  **Estimated****Amortization**Fiscal
                      years
                  
                  **Expense**2007
                  
                  **$**
                  **101,782**2008
                  
                  
                  **80,814**2009
                  
                  
                  **78,784**2010
                  
                  
                  **76,617**2011
                  
                  
                  **73,293**
 
 **6.
            OTHER ASSETS**
 
 **2006**
                  
                  2005Patents
                      and trademarks, net of accumulated amortizationof
                      $1,518,281 (2006) and $1,391,551 (2005)
                  
                  **$**
                  **720,221**
                  
                  $
                  762,757Cash
                      value of life insurance policies
                  
                  
                  **1,782,658**
                  
                  
                  1,679,703Other
                  
                  
                  **267,047**
                  
                  
                  202,854**$**
                  **2,769,926**
                  
                  $
                  2,645,314
 
 41
  **7.
            ACCRUED AND SUNDRY LIABILITIES**
 
 **2006**
                  
                  2005Salaries
                      and other compensation
                  
                  **$**
                  **1,384,772**
                  
                  $
                  1,347,808Federal
                      and state income taxes
                  
                  
                  **13,435**
                  
                  
                  333,889Payroll
                      taxes accrued and withheld
                  
                  
                  **126,450**
                  
                  
                  111,638Property
                      taxes
                  
                  
                  **144,800**
                  
                  
                  144,800Medical
                      insurance
                  
                  
                  **164,204**
                  
                  
                  77,850Warranty
                      reserve
                  
                  
                  **282,887**
                  
                  
                  243,477Vendor
                      rebates
                  
                  
                  **268,198**
                  
                  
                  221,030Customer
                      deposits
                  
                  
                  **74,520**
                  
                  
                  141,016Other
                  
                  
                  **14,783**
                  
                  
                  43,110**$**
                  **2,474,049**
                  
                  $
                  2,664,618
 
 **8.
            PRODUCT WARRANTIES**
 
 The
            Company offers warranties of various lengths to its customers depending
            on the
            specific product sold. The Company’s warranties require it to repair or replace
            non-performing products during the warranty period at no cost to the
            customer.
            At the time revenue is recognized for covered products, the Company records
            a
            liability for estimated costs that may be incurred under its warranties.
            The
            costs are estimated based on historical experience and any recent warranty
            trends that have been identified. (Although historical warranty costs
            have been
            within expectations, there can be no assurance that future warranty costs
            will
            not exceed historical amounts.) The Company periodically assesses the
            adequacy
            of its recorded liability and adjusts the balance as necessary.
 
 Changes
            in the Company’s product warranty liability for the years ended September 30,
            2006 and
            October 1, 2005 are as follows:
  **2006**
                  
                  2005Accrued
                      liability at beginning of year
                  
                  **$**
                  **243,477**
                  
                  $
                  212,564Increases
                      in reserve
                  
                  
                  **224,510**
                  
                  
                  204,613Expenses
                  
                  
                  **(185,100**
                  **)**
                  
                  (173,700
                  )Accrued
                      liability at end of year
                  
                  **$**
                  **282,887**
                  
                  $
                  243,477
 
 **9.
            BORROWINGS**
 
 The
            Company paid no interest expense during fiscal years 2006, 2005, or
            2004.
 
 **10.
            DEFERRED COMPENSATION**
 
 The
            Company is obligated to make fixed payments of approximately $114,000
            per year
            to its founder and former chief executive officer pursuant to a retirement
            agreement. The payments will be made for the longer of the executive’s remaining
            life or his ex-wife's remaining life, if she survives him. The Company
            has fully
            accrued the present value of the expected payments due over the combined
            life
            expectancy of the executive and his ex-wife. The Company recognized expenses
            of
            approximately $78,000 in 2006, $81,000 in 2005, and $83,000 in 2004 related
            to
            this agreement. An 8% discount rate was used in measuring the present
            value of
            the Company's deferred compensation obligation.
 
 42
 **11.
            SHAREHOLDERS’ EQUITY**
 
 In
            March
            1997, the Board adopted the 1997 Stock Option Plan (“1997 Plan”). The 1997 Plan
            authorized the Board to grant options to key officers and employees of
            the
            Company for up to 200,000 shares of the Company's common stock. Options
            granted
            under the 1997 Plan are generally granted at the fair market value on
            the date
            of grant. These options become exercisable and vested at the greater
            of 1,000
            shares per year or 20% of the grant. Vested options expire 10 years from
            the
            date of grant for continuing employees, or three months after termination
            for
            employees who leave the Company.
 
 In
            November 1991, the Board adopted the 1991 Stock Option Plan (“1991 Plan”). The
            1991 Plan authorized the Board to grant options of up to 200,000 shares
            of the
            Company's common stock to officers and key employees and 50,000 shares
            to
            directors who are neither officers nor employees of the Company. All
            other terms
            and conditions of the 1991 Plan are similar to the 1997 Plan. The 1991
            Plan was
            terminated on November 7, 2001. The termination does not affect options
            outstanding under the plan, but no further options can be granted under
            the 1991
            Plan.
 
 In
            March
            1987, the Board of Directors adopted the 1987 Stock Option Plan (“1987 Plan”).
            The 1987 Plan authorized the Board to grant options of up to 200,000
            shares of
            the Company's common stock to officers and key employees of the Company.
            All
            other terms and conditions of the 1987 Plan are similar to the 1997 Plan.
            The
            1987 Plan was terminated on March 31, 1997. The termination does not
            affect
            options outstanding under the plan, but no further options can be granted
            under
            the 1987 Plan.
 43
 
 A
            summary
            of activity under the Company’s three stock option plans is as
            follows.
 
 Outstanding
                  
                  ExercisableWeighted
                  
                  
                  
                  WeightedAverage
                  
                  
                  
                  AverageShares
                  
                  Number
                      of
                  
                  Ex.
                      Price
                  
                  Number
                      of
                  
                  Ex.
                      PriceAvailable
                  
                  Shares
                  
                  Per
                      Share
                  
                  Shares
                  
                  Per
                      ShareBalance
                      at 9/27/03
                  
                  
                  93,700
                  
                  
                  295,250
                  
                  $
                  5.26
                  
                  
                  263,850
                  
                  $
                  5.13Fiscal
                      Year 2004Granted
                  
                  
                  (23,750
                  )
                  
                  23,750
                  
                  
                  13.58Exercised
                  
                  
                  
                  
                  
                  (29,500
                  )
                  
                  5.01ForfeitedForfeitures
                      terminatedBalance
                      at 10/2/04
                  
                  
                  69,950
                  
                  
                  289,500
                  
                  
                  5.97
                  
                  
                  267,800
                  
                  
                  5.70Fiscal
                      Year 2005Granted
                  
                  
                  (25,000
                  )
                  
                  25,000
                  
                  
                  11.85Exercised
                  
                  
                  
                  
                  
                  (9,200
                  )
                  
                  4.79ForfeitedForfeitures
                        terminatedBalance
                      at 10/1/05
                  
                  
                  44,950
                  
                  
                  305,300
                  
                  
                  6.48
                  
                  
                  291,300
                  
                  
                  6.29**Fiscal
                      Year 2006****Granted**
                  
                  
                  **(22,500**
                  **)**
                  
                  **22,500**
                  
                  
                  **12.48****Exercised**
                  
                  
                  
                  
                  
                  **(38,750**
                  **)**
                  
                  **5.11****Forfeited**
                  
                  
                  **750**
                  
                  
                  **(750**
                  **)**
                  
                  **12.43****Forfeitures
                      terminated****Balance
                      at 9/30/06**
                  
                  
                  **23,200**
                  
                  
                  **288,300**
                  
                  **$**
                  **7.12**
                  
                  
                  **262,800**
                  
                  **$**
                  **6.62**
 
 A
            summary
            of stock options outstanding and exercisable at fiscal year end 2006
            is shown
            below.
 
 Outstanding
                  
                  ExercisableWeightedWeighted
                  
                  Average
                  
                  
                  
                  WeightedAverage
                  
                  Remaining
                  
                  
                  
                  AverageRanges
                      of Exercise
                  
                  Number
                      of
                  
                  Ex.
                      Price
                  
                  Contract
                  
                  Number
                      of
                  
                  Ex.
                      PricePrices
                  
                  Shares
                  
                  Per
                      Share
                  
                  Life
                      (yrs)
                  
                  Shares
                  
                  Per
                      Share$
                      3.55 - $ 4.91
                  
                  
                  104,300
                  
                  $
                  4.10
                  
                  
                  1.5
                  
                  
                  104,300
                  
                  $
                  4.105.41 - 7.97
                  
                  
                  113,500
                  
                  
                  6.47
                  
                  
                  4.2
                  
                  
                  112,500
                  
                  
                  6.4611.85 - 13.58
                  
                  
                  70,500
                  
                  
                  12.63
                  
                  
                  8.5
                  
                  
                  46,000
                  
                  
                  12.72$3.55
                      - $13.58
                  
                  
                  288,300
                  
                  $
                  7.12
                  
                  
                  4.3
                  
                  
                  262,800
                  
                  $
                  6.62
 
 44
  The
            Board
            of Directors adopted a stock purchase incentive plan in February 2000.
            The 2000
            Restricted Stock Plan was created to encourage management employees of
            the
            Company to purchase and hold the Company's common stock. Plan benefits
            are paid
            in shares of the Company’s common stock. Benefits earned and accrued under the
            plan were $11,212 in 2006, $13,392 in 2005, and $11,977 in 2004. The
            Company
            issued stock valued at $13,392 in 2006, leaving a vested balance of $11,212
            at
            September 30, 2006.
 
 In
            March
            1997 the Board of Directors approved the 1997 Long-Term Incentive Stock
            Option
            Plan for certain executives of the Company based on achievement of specified
            financial goals by fiscal year end 1999. As of September 30, 2006, the
            Company
            has accrued compensation expense of $23,150 related to this plan.
 
 **12.
            INCOME TAXES**
 
 Deferred
            income taxes reflect the net tax effects of temporary differences between
            the
            carrying amounts of assets and liabilities for financial reporting purposes
            and
            the amounts used for income tax purposes. Significant components of the
            Company’s deferred tax liabilities and assets as of September 30, 2006 and
            October 1, 2005 are as follows:
 
 **2006**
                  
                  2005Deferred
                      tax liabilities:Depreciation
                  
                  **$**
                  **1,115,000**
                  
                  $
                  1,171,000Other
                  
                  
                  
                  
                  
                  10,000Total
                      deferred tax liabilities
                  
                  
                  **1,115,000**
                  
                  
                  1,181,000Deferred
                      tax assets:Deferred
                      compensation
                  
                  
                  **300,000**
                  
                  
                  312,000Accrued
                      expenses
                  
                  
                  **388,000**
                  
                  
                  320,000Inventory
                  
                  
                  **95,000**
                  
                  
                  106,000Other
                  
                  
                  **14,000**
                  
                  
                  38,000Total
                      deferred tax assets
                  
                  
                  **797,000**
                  
                  
                  776,000Net
                      deferred tax liabilities
                  
                  **$**
                  **318,000**
                  
                  $
                  405,000
 
 The
            Company made cash income tax payments, net of refunds, of approximately
            $1,960,000, $974,000, and $617,000 in fiscal years 2006, 2005, and 2004,
            respectively.
 
 45
 
 Federal
            and state income tax provisions consist of the following:
 
 **2006**
                  
                  2005
                  
                  2004Current:Federal
                  
                  **$**
                  **1,471,000**
                  
                  $
                  1,357,000
                  
                  $
                  443,000State
                  
                  
                  **126,000**
                  
                  
                  112,000
                  
                  
                  90,000**1,597,000**
                  
                  
                  1,469,000
                  
                  
                  533,000Deferred:Federal
                  
                  
                  **(91,000**
                  **)**
                  
                  (133,000
                  )
                  
                  425,000State
                  
                  
                  **4,000**
                  
                  
                  (1,000
                  )
                  
                  4,000**(87,000**
                  **)**
                  
                  (134,000
                  )
                  
                  429,000Income
                      tax expense
                  
                  **$**
                  **1,510,000**
                  
                  $
                  1,335,000
                  
                  $
                  962,000
 
 Income
            tax expense differs from the amounts computed by applying the federal
            tax rate
            to income before income taxes as follows:
 
 **2006**
                  
                  2005
                  
                  2004Computed
                      tax at the statutory rate
                  
                  **$**
                  **1,552,000**
                  
                  $
                  1,283,000
                  
                  $
                  1,002,000Increases
                      (decreases):State
                      income taxes, net of federal tax benefit
                  
                  
                  **86,000**
                  
                  
                  74,000
                  
                  
                  62,000Tax-exempt
                      investment income
                  
                  
                  **(53,000**
                  **)**
                  
                  (36,000
                  )
                  
                  (18,000
                  )Extraterritorial
                      income exclusion
                  
                  
                  **(12,600**
                  **)**
                  
                  (18,000
                  )
                  
                  (24,000
                  )Officer's
                      life insurance
                  
                  
                  **(32,000**
                  **)**
                  
                  (31,000
                  )
                  
                  (38,000
                  )Domestic
                      production deduction
                  
                  
                  **(44,000**
                  **)**Other,
                      net
                  
                  
                  **13,600**
                  
                  
                  63,000
                  
                  
                  (22,000
                  )Income
                      tax expense
                  
                  **$**
                  **1,510,000**
                  
                  $
                  1,335,000
                  
                  $
                  962,000
 
 46
  **13.
            EARNINGS PER SHARE OF COMMON STOCK**
 
 The
            following table sets forth the computation of basic and diluted earnings
            per
            share of common stock in accordance with SFAS No. 128.
 
 **2006**
                  
                  2005
                  
                  2004Numerator
                      for basic and dilutedearnings
                      per share:Net
                      income
                  
                  **$**
                  **3,054,811**
                  
                  $
                  2,438,907
                  
                  $
                  1,984,909Denominator:Denominator
                      for basic earnings per share:Weighted
                      average shares
                  
                  
                  **2,648,635**
                  
                  
                  2,603,932
                  
                  
                  2,579,451Effect
                      of dilutive securities:Employee
                      and board stock options
                  
                  
                  **123,289**
                  
                  
                  135,217
                  
                  
                  152,422Denominator
                      for diluted earnings per share:Adjusted
                      weighted average sharesand
                      assumed conversions
                  
                  
                  **2,771,924**
                  
                  
                  2,739,149
                  
                  
                  2,731,873Net
                      income per share:Basic
                  
                  **$**
                  **1.15**
                  
                  $
                  0.94
                  
                  $
                  0.77Diluted
                  
                  **$**
                  **1.10**
                  
                  $
                  0.89
                  
                  $
                  0.73
 
 **14.
            EMPLOYEE BENEFITS AND INCENTIVE PLANS**
 
 The
            Company has an employee savings and investment plan (401(k) plan) available
            to
            employees meeting eligibility requirements. The Company matches a percentage
            of
            the employee contributions, with certain limitations. Contributions by
            the
            Company amounted to approximately $190,000, $164,000, and $158,000 for
            the 2006,
            2005, and 2004 fiscal years, respectively.
 
 **15.
            RELATED-PARTY TRANSACTIONS**
 
 The
            Company paid approximately $138,000 in 2004 in legal fees to a firm having
            a
            member who was also a director of the Company until July 2004.
 
 **16.
            MAJOR CUSTOMERS**
 
 The
            Company has a business relationship with a customer to manufacture private
            label
            mattresses. Sales to this customer made up approximately 16% of net sales
            in
            2006, 8% in 2005 and 1% in 2004. The largest of our medical customers
            are
            distributors who sell our products to acute care hospitals and other
            treatment
            facilities throughout the United States. Sales generated by the largest
            of these
            distributors amounted to approximately 11% of net sales in 2006, 13%
            in 2005,
            and 8% in 2004.
 
 47
 The
            Company has a business relationship with another customer to distribute
            certain
            of its consumer products. Sales to this customer amounted to 20% of net
            sales in
            2006, 33% in 2005, and 47% in 2004.
 
 See
            Note
            17 for further information about sales to major customers.
 
 **17.
            OPERATIONS AND INDUSTRY SEGMENTS**
 
 The
            Company reports on three segments of business: medical, custom products,
            and
            safety catheters. This industry segment information corresponds to the
            markets
            in the United States and Canada for which the Company manufactures and
            distributes its polyurethane foam, packaging and other products and therefore
            complies with the requirements of SFAS No. 131, “Disclosures about Segments of
            an Enterprise and Related Information.”
 
 48
  The
            following table summarizes certain information on industry
            segments:
 
 **2006**
                  
                  2005
                  
                  2004Net
                      sales:Medical
                  
                  **$**
                  **36,675,830**
                  
                  $
                  30,338,548
                  
                  $
                  23,339,157Custom
                      products
                  
                  
                  **14,760,330**
                  
                  
                  18,094,490
                  
                  
                  26,530,908Safety
                      catheters
                  
                  
                  **120,388**
                  
                  
                  6,272
                  
                  
                  59,064Total
                  
                  **$**
                  **51,556,548**
                  
                  $
                  48,439,310
                  
                  $
                  49,929,129Operating
                      profit (loss):Medical
                  
                  **$**
                  **6,839,256**
                  
                  $
                  5,519,942
                  
                  $
                  3,053,548Custom
                      products
                  
                  
                  **(1,063,636**
                  **)**
                  
                  (225,966
                  )
                  
                  637,578Safety
                      catheters
                  
                  
                  **(1,082,115**
                  **)**
                  
                  (1,499,697
                  )
                  
                  (684,421
                  )Total
                  
                  
                  **4,693,505**
                  
                  
                  3,794,279
                  
                  
                  3,006,705Corporate
                      expense
                  
                  
                  **(683,027**
                  **)**
                  
                  (660,830
                  )
                  
                  (698,500
                  )Other
                      income
                  
                  
                  **554,333**
                  
                  
                  640,458
                  
                  
                  638,704Income
                      before income taxes
                  
                  **$**
                  **4,564,811**
                  
                  $
                  3,773,907
                  
                  $
                  2,946,909Identifiable
                      assets:Medical
                  
                  **$**
                  **13,513,665**
                  
                  $
                  13,094,814
                  
                  $
                  9,045,678Custom
                      products
                  
                  
                  **6,096,464**
                  
                  
                  5,838,000
                  
                  
                  6,808,154Safety
                      catheters
                  
                  
                  **3,347,419**
                  
                  
                  3,035,118
                  
                  
                  2,996,127Corporate
                  
                  
                  **8,054,930**
                  
                  
                  6,697,913
                  
                  
                  8,247,966**$**
                  **31,012,478**
                  
                  $
                  28,665,845
                  
                  $
                  27,097,925Depreciation
                      and amortization expenses:Medical
                  
                  **$**
                  **380,944**
                  
                  $
                  288,629
                  
                  $
                  230,407Custom
                      products
                  
                  
                  **207,992**
                  
                  
                  214,368
                  
                  
                  283,019Safety
                      catheters
                  
                  
                  **353,613**
                  
                  
                  340,606
                  
                  
                  202,682Corporate
                  
                  
                  **632**
                  
                  
                  872
                  
                  
                  900**$**
                  **943,181**
                  
                  $
                  844,475
                  
                  $
                  717,008Capital
                      expenditures:Medical
                  
                  **$**
                  **735,962**
                  
                  $
                  1,540,520
                  
                  $
                  189,303Custom
                      products
                  
                  
                  **335,111**
                  
                  
                  834,680
                  
                  
                  198,290Safety
                      catheters
                  
                  
                  **2,623**
                  
                  
                  30,218
                  
                  
                  1,609,898**$**
                  **1,073,696**
                  
                  $
                  2,405,418
                  
                  $
                  1,997,491
 
 Total
            sales by industry segment include sales from unaffiliated customers as
            reported
            in the Company’s statements of income. In calculating operating profit,
            non-allocable general corporate expenses, interest expense, other income,
            and
            income taxes are not included, but certain corporate operating expenses
            incurred
            for the benefit of all segments are included on an allocated basis.
 
 49
 Identifiable
            assets are those assets that are used in the operations of each segment
            on an
            allocated basis. Amounts shown for corporate assets consist primarily
            of cash,
            marketable securities, and cash surrender value of life insurance.
 
 The
            Company has several customers whose sales represent significant portions
            of
            sales in their respective business segments. In the medical segment,
            sales to
            the top four distributors represented 58% of net medical sales in 2006,
            59% in
            2005, and 52% in 2004. In the custom products segment, sales to one customer
            accounted for 69% of net custom products sales in 2006, 87% in 2005 and
            89% in
            2004.
 
 Export
            sales, primarily to Canada and Great Britain, were approximately, $3,162,000
            in
            2006, $2,127,000 in 2005 and $2,988,000 in 2004.
 
 **18.
            OPERATING LEASES**
 
 The
            Company leases truck equipment in South Carolina. Until October 31, 2006,
            the
            Company leased manufacturing space in California. The lease was terminated
            on
            that date. In October 2006, the company began to lease a 15,000 square
            foot
            distribution facility in Utah for $6,750 per month. The lease is cancellable
            by
            either party with 60 days notice. All of the leases require the Company
            to pay
            certain insurance and maintenance costs.
 
 Rental
            expense for all operating leases was $212,000 in 2006, $321,000 in 2005
            and
            $339,000 in 2004.
 
 **19.
            COMMITMENTS AND CONTINGENCIES**
 
 The
            Company is committed to minimum purchases of $625,000 of Selan® skin care
            products per calendar year through 2010. Previously, the Company was
            committed
            to purchases of $500,000 per calendar year through 2005. For the fiscal
            years
            ended 2006, 2005 and 2004, purchases under this commitment were $757,000,
            $763,000 and $635,000, respectively.
 
 The
            Company’s supply terms with the contract manufacturer for its Secure I.V.
            product line require payment of approximately $9,100 per week in labor
            and
            overhead charges for production of the Secure I.V. catheter in lieu of
            a per
            unit charge. This weekly charge is expected to remain in effect for the
            next six
            to 12 months, depending on actual production volume, and can be changed
            by the
            mutual agreement of both parties.
 
 From
            time
            to time the Company is a defendant in legal actions involving claims
            arising in
            the normal course of business. The Company believes that, as a result
            of legal
            defenses and insurance arrangements, none of these actions should have
            a
            material adverse effect on its operations or financial condition.
 50
  **20.
            QUARTERLY FINANCIAL DATA (Unaudited)**
 
 Selected
            quarterly financial data are shown in the following table.
  **Quarterly
              Financial Data (Unaudited)**
 (Amounts
              in thousands, except per share data)
 **First**
                  
                  **Second**
                  
                  **Third**
                  
                  **Fourth**
                  
                  **Year****For
                      Fiscal 2006**Net
                      sales
                  
                  $
                  13,282
                  
                  $
                  12,234
                  
                  $
                  12,548
                  
                  $
                  13,493
                  
                  $
                  51,557Gross
                      profit
                  
                  
                  3,882
                  
                  
                  3,574
                  
                  
                  4,009
                  
                  
                  4,234
                  
                  
                  15,699Operating
                      income
                  
                  
                  1,057
                  
                  
                  774
                  
                  
                  1,017
                  
                  
                  1,162
                  
                  
                  4,010Net
                      income
                  
                  
                  789
                  
                  
                  638
                  
                  
                  728
                  
                  
                  900
                  
                  
                  3,055Earnings
                      per shareBasic
                  
                  
                  0.30
                  
                  
                  0.24
                  
                  
                  0.27
                  
                  
                  0.34
                  
                  
                  1.15Diluted
                  
                  
                  0.29
                  
                  
                  0.23
                  
                  
                  0.26
                  
                  
                  0.32
                  
                  
                  1.10**For
                      Fiscal 2005**Net
                      sales
                  
                  $
                  10,778
                  
                  $
                  12,955
                  
                  $
                  10,626
                  
                  $
                  14,080
                  
                  $
                  48,439Gross
                      profit
                  
                  
                  3,259
                  
                  
                  3,846
                  
                  
                  3,118
                  
                  
                  4,490
                  
                  
                  14,713Operating
                      income
                  
                  
                  612
                  
                  
                  762
                  
                  
                  439
                  
                  
                  1,320
                  
                  
                  3,133Net
                      income
                  
                  
                  499
                  
                  
                  600
                  
                  
                  418
                  
                  
                  922
                  
                  
                  2,439Earnings
                      per shareBasic
                  
                  
                  0.19
                  
                  
                  0.23
                  
                  
                  0.16
                  
                  
                  0.35
                  
                  
                  0.94Diluted
                  
                  
                  0.18
                  
                  
                  0.22
                  
                  
                  0.15
                  
                  
                  0.34
                  
                  
                  0.89
 
 51
  **Item
            9. Changes in and Disagreements with Accountants on Accounting and Financial
            Disclosure**
 
 None
 
 **Item
            9A. Controls and Procedures**
 
 The
            Company has evaluated, with the participation of the Chief Executive
            Officer and
            Chief Financial Officer, the effectiveness of the Company’s disclosure controls
            and procedures as of the end of the period covered by this annual report
            (the
“Evaluation Date”), and, based on this evaluation, the Company’s Chief Executive
            Officer and Chief Financial Officer have concluded that these controls
            and
            procedures were effective at the Evaluation Date. There were no changes
            in the
            Company’s internal controls over financial reporting during the last quarter
            of
            fiscal 2006 that have materially affected or are reasonably likely to
            materially
            affect its internal control over financial reporting.
 
 Disclosure
            controls and procedures are the Company’s controls and other procedures that are
            designed to ensure that information required to be disclosed by the Company
            in
            the reports that it files or submits under the Exchange Act is recorded,
            processed, summarized and reported, within the time periods specified
            in the
            Securities and Exchange Commission’s rules and forms. Disclosure controls and
            procedures include, without limitation, controls and procedures designed
            to
            ensure that information required to be disclosed by the Company in the
            reports
            that it files or submits under the Exchange Act is accumulated and communicated
            to the Company’s management, including its Chief Executive Officer and Chief
            Financial Officer, as appropriate to allow for timely decisions regarding
            required disclosure.
 
 **Item
            9B. Other Information**
 
 None
 
 **PART
            III**
 
 **Item
            10. Directors and Executive Officers of the Registrant**
 
 Information
            required under Item 10 of Part III is incorporated herein by reference
            to
            portions of the definitive Proxy Statement filed or to be filed with
            the
            Securities and Exchange Commission on or prior to 120 days following
            the end of
            the Company's 2006 fiscal year under the headings “Election of Directors,”
“Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance”
and “Election of Directors - Code of Ethics.”
 
 **Item
            11. Executive Compensation**
 
 Information
            required under Item 11 of Part III is incorporated herein by reference
            to
            portions of the definitive Proxy Statement filed or to be filed with
            the
            Securities and Exchange Commission on or prior to 120 days following
            the end of
            the Company's 2006 fiscal year under the heading “Compensation of Directors and
            Executive Officers.”
 
 52
 **Item
            12. Security Ownership of Certain Beneficial Owners and Management and
            Related
            Stockholder Matters**
 
 The
            information under the heading “Security Ownership of Certain Beneficial Owners
            and Management” set forth in the Company’s definitive Proxy Statement filed or
            to be filed with the Securities and Exchange Commission on or prior to
            120 days
            following the end of the Company’s 2006 fiscal year is incorporated herein by
            reference.
 
 The
            following table summarizes information regarding the Company’s equity
            compensation plans as of September 30, 2006:
 
 Plan
                      category
                  Number
                      of securities to be issued upon exercise of outstanding options,
                      warrants
                      and rights
                  Weighted-average
                      exercise price of outstanding options, warrants and rights
                  Number
                      of securities remaining available for future issuance under
                      equity
                      compensation plans (excluding securities reflected in column
                      (a))(a)
                  (b)
                  (c)Equity
                      compensation plans approved by security holders
                  288,300
                  $7.12
                  112,091Equity
                      compensation plans not approved by security holders
                  0
                  0
                  0(1)Total
                  288,300
                  $7.12
                  112,091(1)
                      Under the Company’s director compensation arrangements, there is no set
                      amount of equity securities authorized for issuance, but the
                      Company
                      currently anticipates issuing approximately 8,500 shares annually.
 
 For
            additional information on the Company’s stock option plans, see Note 11 in the
            Notes to Financial Statements for the year ended September 30,
            2006.
 
 See
            Item
            5 of Part II for more information on shares of the Company’s common stock issued
            to Directors in lieu of their annual cash compensation.
 
 **Item
            13. Certain Relationships and Related Transactions**
 
 The
            information required under Item 13 of Part III is incorporated herein
            by
            reference to portions of the definitive Proxy Statement filed or to be
            filed
            with the Securities and Exchange Commission on or prior to 120 days following
            the end of the Company's 2006 fiscal year under the heading “Certain
            Relationships and Related Transactions.”
 53
 
 **Item
            14. Principal Accountant Fees and Services**
 
 Additional
            information required under Item 14 of Part III is incorporated herein
            by
            reference to portions of the definitive Proxy Statement filed or to be
            filed
            with the Securities and Exchange Commission on or prior to 120 days following
            the end of the Company's 2006 fiscal year under the heading “Principal
            Accountant Fees and Services.”
 
 **PART
            IV**
 
 **Item
            15. Exhibits, Financial Statement Schedules**
 
 (a)
            (1) Financial
            Statements
 
 The
            response to this portion of Item 15 is submitted under Item 8, Financial
            Statements and Supplementary Data, beginning on page 30.
 
 (2) Financial
            Statement Schedules
 
 The
            response to this portion of Item 15 is submitted below under Item
            15(c).
 
 (3) Listing
            of Exhibits
 
 3.1
                  Restated
                      Articles of Incorporation: Incorporated by reference to Exhibit
                      3(a) to
                      the Company’s Registration Statement on Form S-18, Commission File No.
                      0-11392.
 
 3.1.1
                  Articles
                      of Amendment filed with the South Carolina Secretary of State
                      on February
                      6, 1989: Incorporated by reference to Exhibit 3.1.1 to the
                      Company’s
                      Annual Report on Form 10-K for the fiscal year ended September
                      28,
                      1991.
 
 3.1.2
                  Articles
                      of Amendment filed with the South Carolina Secretary of State
                      on March 5,
                      1992: Incorporated by reference to Exhibit 4.4 to the Company’s
                      Registration Statement on Form S-2 dated May 11, 1992, Commission
                      File No.
                      33-47670.
 
 3.1.3
                  Articles
                      of Amendment filed with the South Carolina Secretary of State
                      on April 22,
                      1993: Incorporated by reference to Exhibit 4.1 to the Company’s Quarterly
                      Report on Form 10-Q for the quarter ended April 3,
                      1993.
 
 3.2
                  Amended
                      and Restated By-Laws dated February 4, 1997: Incorporated by
                      reference to
                      Exhibit 3.0 to the Company’s Quarterly Report on Form 10-Q for the quarter
                      ended March 29, 1997.
 
 54
 3.2.1
                  
                  Amendment
                      to the Company's By-laws dated March 13, 2003: Incorporated
                      by reference
                      to Exhibit 3.2 to the Company's report on Form 8-K dated March
                      13, 2003,
                      Commission File No. 000-11392.
 
 3.2.2
                  
                  Amendment
                      to the Company's By-laws dated November 7, 2003: Incorporated
                      by reference
                      to Exhibit 3.2.2 to the Company’s Annual Report on Form 10-K for the
                      fiscal year ended September 27, 2003 (the “2003 10-K”), Commission File
                      No. 0-11392.
 
 4.1
                  
                  Specimen
                      of Common Stock certificate: Incorporated by reference to Exhibit
                      1 to the
                      Form S-8 filed on January 8, 1990, Commission File No.
                      33-32896.
 
 4.2
                  
                  The
                      Registrant hereby agrees to furnish to the Securities and Exchange
                      Commission upon request a copy of any instrument with respect
                      to long-term
                      debt not being registered in a principal amount less than 10%
                      of the total
                      assets of the Registrant on a consolidated
                      basis.
 
 4.3
                  
                  Amended
                      and Restated Shareholder Rights Agreement dated March 24, 2003,
                      between
                      Span-America Medical Systems, Inc. and American Stock Transfer
& Trust
                      Company as Rights Agent: Incorporated by reference to Exhibit
                      4.1 to the
                      Company's report on Form 8-K dated March 24,
                      2003.
 
 4.3.1
                  
                  Amendment
                      No. 1 to the Amended and Restated Shareholder Rights Agreement
                      dated
                      November 19, 2003: Incorporated by reference to Exhibit 4.1
                      to the
                      Company's report on Form 8-K dated December 2,
                      2003.
 
 4.4
                  Agreement
                      among Span-America Medical Systems, Inc., Jerry Zucker, and
                      Robert B.
                      Johnston, dated December 17, 2003, regarding nomination of
                      Mr. Johnston to
                      the Span-America Board of Directors: Incorporated by reference
                      to Exhibit
                      4.4 to the 2003 10-K.
 
 10.1
                  
                  Patent
                      Assignment and Royalty Agreement between Donald C. Spann and
                      the Company,
                      with letter amendment thereto: Incorporated by reference to
                      Exhibit 10(c)
                      to the Form S-18 filed on June 2, 1983, Commission File No.
                      2-832-74-A.
 
 10.2*
                  1987
                      Stock Option Plan: Incorporated by reference to Exhibit 10
                      to the
                      Company's Annual Report on Form 10-K for the fiscal year ended
                      October 2,
                      1987, Commission File No. 0-11392.
 
 10.2.1*
                  Amendment
                      No. 1 to the 1987 Stock Option Plan: Incorporated by reference
                      to Exhibit
                      10.2.2 to the Company’s Annual Report on Form 10-K for the fiscal year
                      ended October 3, 1998 (the “1998 10-K”), Commission File No.
                      0-11392.
 
 10.3*
                  1991
                      Stock Option Plan: Incorporated by reference to Exhibit 10.6
                      to the
                      Company’s Annual Report on Form 10-K for the fiscal year ended September
                      28, 1991 (the “1991 10-K”), Commission File No.
                      0-11392.
 
 55
 10.3.1*
                  Amendment
                      No. 1 to the 1991 Stock Option Plan: Incorporated by reference
                      to Exhibit
                      10.4.2 to the 1998 10-K.
 
 10.4*
                  
                  Retirement
                      Agreement dated February 6, 1991 between the Company and Donald
                      C. Spann:
                      Incorporated by reference to Exhibit 10.7 to the 1991
                      10-K.
 
 10.5*
                  
                  Voluntary
                      Resignation Agreement dated July 30, 1993 between the Company
                      and Donald
                      C. Spann: Incorporated by reference to Exhibit 10.1 to the
                      Company's
                      Quarterly Report on Form 10-Q for the quarter ended July 3,
                      1993,
                      Commission File No. 0-11392.
 
 10.6*
                  1997
                      Stock Option Plan: Incorporated by reference to Exhibit 10.14
                      to the
                      Company’s Annual Report on Form 10-K for the fiscal year ended September
                      27, 1997 (the “1997 10-K”), Commission File No.
                      0-11392.
 
 10.6.1*
                  Amendment
                      No. 1 to the 1997 Stock Option Plan: Incorporated by reference
                      to Exhibit
                      10.14.2 to the 1998 10-K.
 
 10.7*
                  1997
                      Long Term Incentive Stock Option Plan: Incorporated by reference
                      to
                      Exhibit 10.15 to the 1997 10-K.
 
 10.8
                  Distribution
                      Agreement dated March 1, 1999 between the Company and Louisville
                      Bedding
                      Corporation: Incorporated by reference to Exhibit 10.16 to
                      the Company’s
                      Annual Report on Form 10-K for the fiscal year ended September
                      30, 2000
                      (the “2000 10-K”), Commission File No.
                      000-11392.
 
 10.8.1
                  Addendum
                      to Distribution Agreement between Louisville Bedding Company
                      and
                      Span-America Medical Systems, Inc. dated January 1, 2002: Incorporated
                      by
                      reference to Exhibit 10.17 to the Company’s Quarterly Report on Form 10-Q
                      for the quarter ended March 30,
                      2002.
 
 10.9
                  Asset
                      Purchase Agreement By and Among Span-America Medical Systems,
                      Inc., Vadus,
                      Inc., and Certain Stockholders of Vadus, Inc. dated February
                      1, 2002,
                      including amendments dated May 20, 2002 and July 9, 2002: Incorporated
                      by
                      reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q
                      for the quarter ended June 29,
                      2002.
 
 10.10
                  Production,
                      Marketing and Product Development Support Agreement between
                      Span-America
                      Medical Systems, Inc. and Vadus, Inc. dated February 1, 2002:
                      Incorporated
                      by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form
                      10-Q for the quarter ended June 29,
                      2002.
 
 10.11*
                  Severance
                      Protection Agreement between the Company and James D. Ferguson
                      dated July
                      25, 2002: Incorporated by reference to Exhibit 10.20 of the
                      Company’s
                      Annual Report on Form 10-K for the fiscal year ended September
                      28, 2002
                      (the “2002 10-K”), Commission File No.
                      000-11392.
 
 56
 10.12*
                  Severance
                      Protection Agreement between the Company and Robert E. Ackley
                      dated July
                      25, 2002: Incorporated by reference to Exhibit 10.21 of the
                      2002
                      10-K.
 
 10.13*
                  Severance
                      Protection Agreement between the Company and Richard C. Coggins
                      dated July
                      25, 2002: Incorporated by reference to Exhibit 10.22 of the
                      2002
                      10-K.
 
 10.14*
                  Severance
                      Protection Agreement between the Company and James R. O’Reagan dated July
                      25, 2002: Incorporated by reference to Exhibit 10.23 of the
                      2002
                      10-K.
 
 10.15*
                  Severance
                      Protection Agreement between the Company and Clyde A. Shew
                      dated July 25,
                      2002: Incorporated by reference to Exhibit 10.24 of the 2002
                      10-K.
 
 10.16*
                  Severance
                      Protection Agreement between the Company and Wanda J. Totton
                      dated
                      February 11, 2004: Incorporated by reference to Exhibit 10.1
                      of the
                      Company’s Quarterly Report on Form 10-Q for the quarter ended April
                      3,
                      2004.
 
 10.17*
                  Span-America
                      Medical Systems, Inc. 2000 Restricted Stock Plan: Incorporated
                      by
                      reference to Exhibit B to the Company’s Definitive Proxy Statement filed
                      with the Commission on January 11,
                      2001.
 
 10.18
                  Amended
                      Private Label Product Supply Agreement between the Company
                      and Hill-Rom
                      Company, Inc. dated September 14, 2004. Incorporated by reference
                      to
                      Exhibit 10.18 of the Company’s Annual Report on Form 10-K for the fiscal
                      year ended October 1, 2005 (the “2005 10-K”), Commission File No.
                      000-11392.
 
 23.1
                  Consent
                      of Elliott Davis, LLC.
 
 31.1
                  Officer
                      Certifications Pursuant to Section
                      302.
 
 32.1
                  Officer
                      Certifications Pursuant to Section
                      906.
 
 *
                  Management
                      contract or compensatory plan or
                      arrangement.
 
 (b)
                  Exhibits
  The
                      exhibits required by this section of Item 15 are attached hereto
                      or
                      incorporated by reference
  57
 
 (c)
                  Financial
                      Statement Schedules
 
 **Schedule
              VIII Valuation and Qualifying Accounts**
 COL.
                      A
                  
                  COL.
                      B
                  
                  COL
                      C.
                  
                  COL.
                      D
                  
                  
                  COL.
                      EADDITIONS(1)Balance
                      at
                  
                  Charged
                      to
                  
                  
                  
                  
                  Balance
                      atBeginning
                      of
                  
                  Costs
                      and
                  
                  Deductions-
                  
                  
                  End
                      ofDescription
                  
                  Period
                  
                  Expenses
                  
                  Describe
                  
                  
                  PeriodYear
                      Ended September 30, 2006Deducted
                      from asset accounts:Reserve
                      for uncollectible accounts
                  
                  $
                  116,000
                  
                  $
                  47,762
                  
                  $
                  46,762
                  
                  (a
                  )
                  $
                  117,000Year
                      Ended October 1, 2005Deducted
                      from asset accounts:Reserve
                      for uncollectible accounts
                  
                  $
                  140,000
                  
                  $
                  34,263
                  
                  $
                  58,263
                  
                  (a
                  )
                  $
                  116,000Year
                      Ended October 2, 2004Deducted
                      from asset accounts:Reserve
                      for uncollectible accounts
                  
                  $
                  175,000
                  
                  $
                  (6,830
                  )
                  $
                  28,170
                  
                  (a
                  )
                  $
                  140,000
  (a)
              Uncollectible accounts written off.
 
 All
            other
            schedules for which provision is made in the applicable accounting regulations
            of the Securities and Exchange Commission are not required under the
            related
            instructions or are inapplicable, and therefore have been omitted.
 
 58
  SIGNATURES
 
 Pursuant
            to the requirements of Section 13 or 15(d) of the Securities Exchange
            Act of
            1934, the registrant has duly caused this report to be signed on its
            behalf by
            the undersigned, thereunto duly authorized.
 
 SPAN-AMERICA
            MEDICAL SYSTEMS, INC.
 By:
                        /s/ Thomas D. Henrion
                    
                    December
                        20, 2006Thomas
                        D. HenrionChairman
                        of the Board
 Pursuant
            to the requirements of the Securities Exchange Act of 1934, this report
            has been
            signed below by the following persons on behalf of the registrant and
            in the
            capacities on the date indicated.
 /s/
                          James D. Ferguson
                    
                    President,
                        Chief Executive OfficerJames
                        D. Ferguson
                    
                    (Principal
                        Executive Officer)/s/
                        Richard C. Coggins
                    
                    Chief
                        Financial Officer and DirectorRichard
                        C. Coggins
                    
                    (Principal
                        Financial Officer)/s/
                        Gwendolyn L. Randolph
                    
                    ControllerGwendolyn
                        L. Randolph/s/
                        Robert H. Dick
                    
                    DirectorRobert
                        H. Dick/s/
                        Thomas F. Grady, Jr.
                    
                    DirectorThomas
                        F. Grady, Jr./s/
                        Guy R. Guarch
                    
                    DirectorGuy
                        R. Guarch/s/
                        Thomas D. Henrion
                    
                    DirectorThomas
                        D. Henrion/s/
                        Robert B. Johnston
                    
                    DirectorRobert
                        B. Johnston/s/
                        Linda D. Norman
                    
                    DirectorLinda
                        D. Norman/s/
                        Peter S. Nyberg
                    
                    DirectorPeter
                        S. Nyberg
  December
            20, 2006
  59