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 27, 2008
or





 ̈           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  ̈.  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  ̈.  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
 ̈.





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.   ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.  (Check one):


Large
      Accelerated Filer  ̈
              
              Accelerated
      Filer  ̈Non-Accelerated Filerx
              
              Smaller
      Reporting Company  ̈





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).  Yes  ̈.  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 $27,928,972.





The
number of shares of the registrant’s common stock, no par value, outstanding as
of December 17, 2008 was 2,734,500.





Documents
Incorporated By Reference





Portions
of the Company’s Definitive Proxy Statement for the annual shareholders’ meeting
to be held February 12, 2009 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” described in Item 1A below and other risks referenced from time
to time in our other Securities and Exchange Commission (“SEC”)
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 and
other foam products for the medical, consumer and industrial
markets.





We began operations in 1975 as a
manufacturer of polyurethane foam patient positioners and later expanded our
product lines to include foam mattress overlays for the wound care market
primarily in acute care hospitals.  Wound care products aid in the
treatment or prevention of pressure ulcers 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-Mattâ therapeutic
mattress overlay in the health care market, which became one of our 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 therapeutic support
surface.  We have since significantly expanded the PressureGuard
product line and have added the Geo-Mattress® product line to provide a broad
line of therapeutic support surfaces that we sell 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, and we completed the development of the product and
initially launched Secure I.V. in 2004.  However, we were unable to
generate sufficient sales volume in the safety catheter segment to make it a
viable business.  Consequently, in October 2007, we decided to exit
the safety catheter business and try to sell the related assets.  As
of September 29, 2007, we recorded an impairment charge to eliminate the book
value of our safety catheter assets.  We are currently engaged in
efforts to sell this part of our business.  However, our efforts to
date have been unsuccessful.




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.  We are actively seeking to develop or acquire new products in
this market segment.  We also seek to further develop consumer and
industrial applications of our medical products.





Our products are distributed in the
United States and to a lesser degree in several foreign
countries.  Total export sales during fiscal 2008 were approximately
$3.3 million or 5.6% of total net sales.  The majority of our export
sales occurred in Canada.  See Note 17 – Operations and Industry
Segments 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 SEC 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 – Operations and
Industry Segments in the Notes to Financial Statements included in Item 8 of
this report for additional information on industry segment data and revenues
from foreign sales.





Medical





Span-America’s
principal medical products consist of polyurethane foam mattress overlays,
therapeutic support surfaces (which consist of non-powered and powered
therapeutic support surfaces), patient positioners, seating products and Selan®
skin care 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 72% of total net sales in fiscal 2008, 71% of total net
sales in fiscal 2007 and 71% of total net sales in fiscal 2006.





Mattress
Overlays.  Span-America produces a variety of foam mattress
overlays, including convoluted foam pads and its patented Geo-Matt®
overlay.  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
localized pressure that causes ulcers.  The Geo-Matt design includes
numerous individual foam cells that are cut to exacting tolerances on
computer-controlled equipment to create a clinically effective mattress surface.
Mattress overlays comprised approximately 6% of total net sales in fiscal
2008.  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 therapeutic support surfaces.  The
mattress overlays are designed for single patient use.




2




Therapeutic Support
Surfaces.  Span-America’s non-powered therapeutic support
surfaces fall into two main product categories: the Geo-Mattress® all-foam
products and the non-powered portion of the PressureGuard® product
line.  Geo-Mattress® products are single-density or multi-layered foam
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
support surfaces.  In early 1999, we extended the product line with
the release of the Geo-Mattress with Wings®, which has been a significant
contributor to overall Geo-Mattress sales.  The Wings support surfaces
feature raised perimeter bolsters designed to reduce the chances of patients
rolling out of bed or becoming entrapped.  A second line extension,
the Geo-Mattress Atlas®, was added in December 2000 to address the needs of
patients with obesity.





Span-America’s
more complex non-powered support surfaces consist of products from the
PressureGuard® series.  We acquired the PressureGuard design through
the acquisition of Healthflex, Inc. in February 1992.  The original
design combined a polyurethane foam shell and static air cylinders to form a
support surface that incorporated the comfort and pressure relieving features of
both mattress overlays and more sophisticated 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
addition to the non-powered, static PressureGuard Renew®, 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.  The CFTrepresented
our second largest medical product in terms of 2008 sales.





Span-America’s
powered therapeutic support surfaces constitute the remaining models in the
PressureGuard Series.  In November 1993, we received Food and Drug
Administration (“FDA”) 510(k) marketing approval for the PressureGuard IV
therapeutic support surface.  Building on the comfort and support of
the original PressureGuard design, PressureGuard IV was designed as a
sophisticated, powered system for providing pressure reduction and patient
comfort, with the added ability to turn the patient.  The system was
designed to automatically sense the patient’s weight and position, and to
continually adjust the pressures appropriately while slowly and quietly
repositioning the patient at angles up to 30 degrees in cycles of up to two
hours.  The upgraded version, renamed the PressureGuard Turn Select®,
incorporates all of these capabilities, as well as several additional
features.  Of particular note is a pendant-operated,
microprocessor-controlled motion system, which is built into the support surface
rather than being suspended from the bed frame as a separate unit.




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
APM2.  The
APM2products were further upgraded with new features in 2003, such as the
addition of the Deluxe control unit.  The APM2 gives
caregivers the flexibility to offer either alternating pressure or a basic
lateral rotation modality by activating a toggle switch on the control
panel.  In fiscal 2008, the APM2 was our
largest medical product line as measured by sales.





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 we believe 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.





We sell
all of the powered products in the PressureGuard Series to long-term care
facilities, usually through our distributors, and to home health care equipment
dealers for daily rental in the home care market.  We also sell the
PressureGuard products in the acute care market, although the volume there is
much less than in the long-term care and home care markets.





In fiscal
2004, we began working with Hill-Rom Company, Inc. (now Hill-Rom Holdings, Inc.
(NYSE:HRC)) 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, formerly 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 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
support surfaces became our fastest growing product line in fiscal years 2006
and 2007.  Our original supply agreement with Hill-Rom expired in May
2008.  We signed a new agreement in July 2008, which contains no
minimum purchase quantities or exclusivity provisions.  The new
agreement will expire in July 2009 but is automatically renewed unless either
party provides 60 days cancellation notice.  Since the expiration of
the original agreement, Hill-Rom has added several products to compete with our
CFT mattress.  As a result, we expect sales to Hill-Rom in fiscal 2009
to be lower than they were in fiscal 2008.  See “Major Customers” on
page 9.  We also manufacture private-label mattresses for other
customers, depending on market conditions and customer interest.





Therapeutic
support surfaces and related products made up approximately 54% of total Company
net sales in fiscal 2008, 54% in fiscal 2007, and 52% in fiscal
2006.




4


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 2008.  This is our
original product line and consists of over 300 different foam items that aid in
relieving the basic patient positioning problems of elevation, immobilization,
muscle contracture, foot drop, and foot or leg rotation.  Span-Aids
patient positioners hold a patient's body in prescribed positions, provide
greater patient comfort, and generally are used to aid long-term comatose
patients or those in a weakened or immobilized condition.  The
positioners also help in the prevention of pressure ulcers by promoting more
effective dispersion of pressure, heat and moisture.  Span-Aids are
intended for single-patient use throughout a patient's entire treatment
program.  Among the Span-Aids products that we presently market are
abduction pillows, body aligners, head supports, limb elevators and various foot
and wrist positioners.  We sell patient positioners primarily to
hospitals and long-term care facilities through several national medical
products distributors.





Seating Products.Another
product category in our medical segment consists of seat cushions and related
seating products for wheelchairs, Geri-chairs (typically used in long-term care
facilities) and other health care seating needs.  Our offerings in
this category can be subdivided into three main groups:





·
            wound
      healing aids,


·
            patient
      positioning and general pressure management products,
  and


·
            pressure
      management products without patient positioning
  features.





Seating
products made specifically as an aid to wound healing include the Isch-Dish® and
Sacral Dish® pressure relief cushions.  Seating products made for
patient positioning and general pressure management include the Isch-Dish Thin,
the Geo-Matt® Contour® cushion, the Equalizer®, and the EZ-Dish®.  The
Equalizer contoured positioning cushion has a multi-component design that
includes a viscoelastic foam top, proprietary soft polymer inserts, and a
contoured base.  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.  The Geo-Wave® Cushion assists with
positioning and pressure reduction for patients using specialty recliners and
Geri-chairs.  The Short-Wave® seat and back cushion reduces shear and
assists with patient positioning in standard wheelchairs.





Seating
products designed to address pressure management without additional positioning
benefits include the Gel-T® cushion and the Geo-Matt and Geo-Matt PRT®
wheelchair cushions.  The Gel-T is a gel/foam combination cushion that
is especially popular with elderly patients.  The Geo-Matt and
Geo-Matt PRT cushions incorporate our proprietary Geo-Matt anti-shearing
surface.





Seating products accounted for
approximately 4% of total net sales in fiscal 2008.





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 2008.




5




Distributor and Private-Label
Manufacturing Relationships. We sell our medical products to many
customers of varying sizes.  Our largest medical customer in fiscal
2008 was Hill-Rom Company, for whom we manufacture therapeutic support surfaces
that incorporate Span-America’s patented features and are sold under the
Hill-Rom name.  Sales to Hill-Rom during fiscal 2008 made up
approximately 17% of net sales in the medical segment.  We also sell
our branded medical products to several medical products distributors who resell
our products to acute care hospitals and long-term care facilities throughout
North America.  Sales to our four largest medical distributors made up
approximately 52% of net sales in the medical segment during fiscal
2008.  We believe our relationships with these distributors are
good.  However, the loss of any one of these customers could have a
material adverse effect on our business.  See Item 1A. “Risk Factors”
below for more information on our relationships with large
customers.





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
2009.  The agreement automatically renews for successive three-year
terms unless either party provides notice of its intent not to renew at least 60
days prior to the expiration date.





Our industrial product line consists of
specially designed foam products used in a variety of markets, including the
water sports equipment, automotive, photographic film, durable goods and
electronics industries.  Our largest industrial customers manufacture
kayaks, cars and specialty packaging products.  The majority of our
industrial products are made to order according to customer
specifications.  We currently have one full-time sales representative
and several manufacturers’ representatives selling our industrial foam
fabrication capabilities primarily in the southeastern United
States.





Custom products represented
approximately 28% of our total net sales in fiscal 2008, compared with 29% in
fiscal 2007 and 29% in fiscal 2006.  In fiscal 2008, approximately 71%
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.  Sales of consumer bedding products within the
custom products segment represented 22% of total Company net sales in fiscal
2008, 23% in fiscal 2007 and 22% in fiscal 2006.




6




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.  However, we were unable to generate sufficient sales
volume in the safety catheter segment to make it a viable
business.  Consequently, in October 2007, we decided to exit the
safety catheter business and try to sell the related assets.  As of
September 29, 2007, we recorded an impairment charge to eliminate the book value
of our safety catheter assets.  We are currently engaged in efforts to
sell this part of our business.  The losses, net of income taxes, for
the discontinued safety catheter segment were $50,000 in 2008, $2.6 million in
2007 (including an impairment charge of $1.9 million, after tax) and $724,000 in
2006.





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 Expense2008
                  
                  
                  2007
                  
                  
                  2006Medical
                  
                  $
                  657,000
                  
                  
                  $
                  724,000
                  
                  
                  $
                  520,000Custom
      products
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,000Total
      R& D - Operating
                  
                  
                  657,000
                  
                  
                  
                  724,000
                  
                  
                  
                  522,000Discontinued  Operations
      - Safety catheters
                  
                  
                  -
                  
                  
                  
                  83,000
                  
                  
                  
                  112,000Total
      R&D expense
                  
                  $
                  657,000
                  
                  
                  $
                  807,000
                  
                  
                  $
                  634,000




We expect
research and development costs in fiscal 2009 to be higher than those of fiscal
2008 as a result of 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 full-function
therapeutic support surfaces designed and manufactured either by us or our
competitors.  Sales of overlays have generally declined since the
1990s as customers began to replace single-patient-use overlays with full
function mattresses that incorporated the pressure relieving features of
overlays.  Competition with respect to our Span-Aids 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 one of
the largest nationwide suppliers of therapeutic mattress overlays and patient
positioners to the U.S. health care market.  Our primary competitors
in the overlay and positioner markets are Sunrise Medical, Inc. and Covidien
(formerly Tyco Healthcare).





Competition in the therapeutic support
surface 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 support surfaces.





The market for therapeutic support
surfaces developed principally during the 1990s.  Competitors include
The Encompass Group, Gaymar Industries, Inc., Hill-Rom Holdings, 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
Span-America.  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. (currently operating under Chapter 11), E.R. Carpenter Company
and Zinus, Inc., 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 many instances, however,
design, product quality 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.




8




Within the last few 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, it is more difficult for us to differentiate our products from
those of our competitors.  Consequently, the visco mattress pads
currently on the market tend to be somewhat undifferentiated without unique
surface designs.  In addition, since visco foam is significantly more
expensive and more dense than traditional foam, it is more cost effective for
overseas competitors (from China for example) to ship the products into the U.S.
market.  This is generally because retail prices of visco foam
products are significantly higher than comparable traditional foam products,
which generates much higher revenue per square foot of retail shelf space and
lowers shipping costs as a percent of sales value.





Major
Customers





We have an agreement with Louisville
Bedding Company to distribute our consumer foam products.  Sales to
Louisville Bedding during fiscal 2008 made up approximately 20% of our total net
sales and approximately 71% 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 exceeded 10% of our total net sales.  Sales to
Hill-Rom, for whom we manufacture private label therapeutic support surfaces,
made up approximately 12% of total net sales and approximately 17% of net sales
in the medical segment during fiscal 2008.  Sales to one of our
distributors, McKesson Medical Surgical, during fiscal 2008 made up
approximately 11% of total net sales and approximately 15% of net sales in the
medical products segment.





Our exclusive agreement to supply
Hill-Rom Holdings, Inc. with private label support surfaces expired on May 4,
2008.  In July 2008, we signed a new agreement with Hill-Rom to
continue providing it with our patented therapeutic support surfaces on a
private label basis.  The new agreement establishes pricing through
December 31, 2008 and provides Span-America with inventory protection for
products supplied to Hill-Rom.    The inventory protection
terms require Hill-Rom to reimburse Span-America for up to $300,000 of
customer-specific inventory under certain conditions.  The initial
term of the agreement is one year, expiring July 10, 2009.  However,
it automatically renews for successive one-year periods unless cancelled
pursuant to the agreement.  Either party may cancel the agreement for
any reason with 60 days written notice.  The agreement contains no
minimum sales volume commitments and no exclusivity provisions for either
party.  We expect to continue to supply therapeutic support surfaces
to Hill-Rom, but since the new agreement contains no volume requirements, we
cannot accurately forecast our future sales to Hill-Rom.  Our
expectation for fiscal 2009 is that Hill-Rom sales will decline from fiscal 2008
levels.





See “Industry Segment Data – Medical –
Distributor and Private-Label Manufacturing Relationships” above and Note 16 –
Major Customers and Note 17 – Operations and Industry Segments 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 34 United States patents and 8
foreign patents relating to various components of our patient positioners,
mattress overlays, and therapeutic support surfaces for the medical
segment.  We have also filed additional patent
applications.  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 5 years with additional patents pending.  The
PressureGuard patents have remaining lives ranging from 6 to 10 years with
additional patents pending.  The Span-Aids patents have remaining
lives ranging from less than a year to 7 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 4 to 13 years.  The mark “Secure I.V.” is also Span-America’s
registered trademark.  We have also filed additional patent
applications.  If we are successful in our efforts to sell the Secure
I.V. business, we expect that the purchaser will acquire the related patents and
trademarks.





We hold 37 federally registered
trademarks and 18 foreign trademark registrations, including Span-America, Span-Aids, Geo-Matt,
Geo-Mattress, PressureGuard,andIsch Dishin 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 containers,
polyethylene plastic packaging material and hook-and-loop
fasteners.  We believe that our basic raw materials are in adequate
supply and are available from many suppliers at competitive prices.




10




See Item 1A. “Risk Factors” and Item 7.
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” for more information on price increases for polyurethane
foam.





As of September 27, 2008, we had
unshipped orders of approximately $1.2 million, which represents a 4% decrease
compared to our backlog of $1.3 million at fiscal year end 2007.  We
expect to fill all orders in the current backlog in the 2009 fiscal
year.





Employees





We had 253 full-time employees as of
September 27, 2008.  Of these employees, six were officers, 18 were
management personnel, 23 were administrative and clerical personnel, 27 were
sales personnel, and 179 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 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.  All of our powered medical therapeutic support surfaces are
considered Class II medical devices.  The certification is subject to
reassessment at six-month intervals.  We have maintained our
certification based on the results of ISO audits conducted during fiscal year
2008.





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 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
Hill-Rom and McKesson Medical Surgical.  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 2009.  The agreement automatically renews for successive
three-year terms unless either party provides notice of its intent not to renew
at least 60 days prior to the expiration date.





Our exclusive agreement to supply
Hill-Rom with private label therapeutic support surfaces expired in May
2008.  Hill-Rom was our largest customer in the medical segment in
fiscal 2008 with sales of approximately $7.0 million.  We expect to
continue to supply products to Hill-Rom under the terms of a new, one-year
agreement signed in July 2008.  The new agreement automatically renews
for successive one-year periods unless it is cancelled by either party with 60
days written notice.  The new agreement contains no minimum sales
volume commitments and no exclusivity provisions for either party.  At
this time due to lack of information from Hill-Rom regarding its expected demand
for our products, we are unable to accurately forecast future sales to
Hill-Rom.  However, we estimate that our sales to Hill-Rom in fiscal
2009 will be lower than they were in fiscal 2008.  In addition, we
expect that growth in sales of our branded medical products could at least
partially offset possible declines in sales to Hill-Rom.  However, we
can give no assurance to that effect.





For more information on major customers
and information on our business segments, see the discussions under “Major
Customers,” Note 16 – Major Customers and Note 17 – Operations and Industry
Segments in the Notes to Financial Statements, Item 1. “Business – Industry
Segment Data – Medical – Distributor and Private-Label Manufacturing
Relationships” and Item 1. “Business – Industry Segment Data – Custom
Products.”





The current weakness in the U.S.
economy and associated problems in the credit markets could cause our sales to
decline, which in turn could have a negative effect on our
earnings.  Our fastest growing products during the last five
years have been our lines of therapeutic support surfaces, which consist of our
PressureGuard and Geo-Mattress products as well as our private-label support
surfaces.  Sales of these support surfaces represented 54% of our
total net sales in fiscal 2008.  These products are generally
considered by us and our customers to be capital purchase items instead of
consumable supplies.  We believe that purchases of these capital goods
are more easily postponed during business downturns than purchases of
consumables.  Consequently, sales of our support surfaces are likely
to be more sensitive to general economic weakness than other medical product
lines in our business.  Also, tight conditions in credit markets could
make it more difficult for our customers to obtain financing for capital
expenditures, which could slow sales particularly within our support surface
product lines.




12


In addition, our industrial products
are sold primarily to the water sports, automotive and packaging industries, as
well as various other manufacturers.  Our industrial business has
historically been more affected by general economic trends than other
Span-America product lines.  Therefore an economic downturn would
likely have a greater effect on sales of industrial products than on other
product lines in our business.





Since many of our operating costs are
fixed within a reasonable range of sales and production activity, sales declines
could result in proportionally greater declines in earnings
performance.  We would attempt to reduce expenses in response to lower
sales levels, but we cannot give assurance that we would be able to fully offset
the effect of a rapid decline in sales volume.





Our medical business could lose sales
volume or could have a lower sales growth rate as a result of government
reimbursement changes in the medical market.  A number of our
medical products are eligible for reimbursement by Medicare.  We
receive no direct reimbursements from Medicare, but our customers often submit
reimbursement requests to Medicare.  For example, we sell therapeutic
support surfaces to home health care dealers who in turn rent these products to
patients.  Medicare reimburses the dealers 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, depending on the size of the rate reduction.  Medicare has
announced a reimbursement rate cut beginning in January 2009 that will affect
certain products and services offered by durable medical equipment (DME)
dealers.  Although our products will not be directly affected by these
rate cuts, the reimbursement reductions will likely put downward pressure on DME
dealer profitability, which could indirectly affect demand for our
products.





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 42% of our total cost of goods sold
in fiscal 2008.  An increase in foam raw material costs that we are
not able to offset through sales price increases or expense reductions 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 boxes.  Raw materials are our single largest
cost category in the business, representing approximately 74% of our total cost
of goods sold in fiscal 2008.  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 expense
reductions.




13




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 believe that we have potentially greater
exposure to low-cost imports in our consumer bedding product lines because those
products have more commodity-like characteristics than our medical
products.  Also, our customers, who are generally national retailers,
are more likely to change suppliers to buy lower-cost
products.  Therefore, we could lose significant sales volume in our
consumer bedding business and smaller parts of our medical sales volume if we
are unable to compete effectively with low-cost imports.





Certain of our medical 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 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 that 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.  In fiscal 2006, we completed a 58,000 square foot addition to
our plant in Greenville, which is included in the square footage total
above.  We believe our current manufacturing and storage space is
adequate to support our operations during the next several years, depending on
sales growth rates.





We also lease 15,000 square feet of
warehouse space in Salt Lake City, Utah for use as a distribution center for our
medical products.  We lease this facility on a month-by-month basis at
a rate of $6,750 per month.





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.




14




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 2008 fiscal year.





PART
II





Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds





ISSUER
PURCHASES OF EQUITY SECURITIES




Period
              
              (a)
      Total Number
                of
      Shares
                Purchased
              
              
              (b)
      Average
                Price
      Paid per
                Share
              
              
              (c)
      Total Number
                of
      Shares
                Purchased
      as
                Part
      of Publicly
                Announced
                Plans
      or
                Programs
              
              
              (d)
      Maximum
                Number
      of
                Shares
      that May
                Yet
      Be
                Purchased
      Under
                the
      PlansJune
      29, 2008-Aug.
      2, 2008
              
              
              7,050
              
              
              
              11.63
              
              
              
              7,050
              
              
              
              76,711Aug.
      3, 2008 – Aug. 30, 2008
              
              
              400
              
              
              
              12.88
              
              
              
              400
              
              
              
              76,311Aug.
      31, 2008 – Sept.  27, 2008
              
              
              1,800
              
              
              
              12.37
              
              
              
              1,800
              
              
              
              74,511Total
              
              
              9,250
              
              
              
              11.82
              
              
              
              9,250
              
              
              
              74,511





The
Company announced on November 28, 2007 that the Board of Directors authorized
the Company to repurchase up to 138,772 shares of its common
stock.  The program may be suspended or discontinued at any
time.





Our
credit facility restricts dividends and stock repurchases.  See the
description of these restrictions under Part II – Item 7 – Management’s
Discussion and Analysis of Financial Condition and Results of Operations –
Liquidity and Capital Resources, which description is incorporated herein by
reference.





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 27, 2008, there were 2,759,077 common shares
outstanding.  As of December 17, 2008, there were 194 shareholders of
record and approximately 1,400 beneficial shareholders.  The closing
price of Span-America's stock on December 17, 2008 was $10.09 per
share.




15




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





Quarterly
      Stock Price DataFirst
                    
                    
                    Second
                    
                    
                    Third
                    
                    
                    Fourth
                    
                    
                    YearFor
      Fiscal 2008High
                    
                    $
                    18.75
                    
                    
                    $
                    13.39
                    
                    
                    $
                    13.52
                    
                    
                    $
                    13.50
                    
                    
                    $
                    18.75Low
                    
                    
                    9.88
                    
                    
                    
                    10.17
                    
                    
                    
                    10.17
                    
                    
                    
                    10.60
                    
                    
                    
                    9.88For
      Fiscal 2007High
                    
                    $
                    14.79
                    
                    
                    $
                    16.99
                    
                    
                    $
                    29.04
                    
                    
                    $
                    30.95
                    
                    
                    $
                    30.95Low
                    
                    
                    12.90
                    
                    
                    
                    14.19
                    
                    
                    
                    15.51
                    
                    
                    
                    14.03
                    
                    
                    
                    12.90





The Company has paid a regular
quarterly cash dividend since January 1990.  In July 2006, the Board
increased the quarterly dividend to $0.06 per share from $0.045 per
share.  In February 2007, the Board increased the quarterly dividend
to $0.08 per share from $0.06 per share.  In April 2007, the Board
declared a special cash dividend of $5.00 per share payable on June 6, 2007 to
all shareholders of record on May 23, 2007.  In April 2008, the Board
increased the quarterly dividend to $0.09 per share from $0.08 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.  See the discussion of our revolving
bank credit facility in Note 8 Borrowings in the Notes to Financial Statements
for a description of restrictions on our ability to pay dividends, which
description is incorporated herein by reference.





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





16




PERFORMANCE
GRAPH





Notwithstanding
any statement in any of the Company’s previous or future filings under the
Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as
amended, incorporating future or past filings, including this Annual Report on
Form 10-K, in whole or in part, the following Performance Graph shall not be
incorporated by reference into any such filing unless the incorporation
specifically lists the following Performance Graph.





The following graph sets forth the
performance of the Company’s Common Stock for the five-year period from
September 27, 2003, through September 27, 2008, compared to the Russell MicroCap
Index and a peer group index.  The peer group index was prepared by an
unaffiliated third party and is comprised of all exchange-listed companies that
had the standard industry classification code 3842 (which relates to medical
products and supplies) as of September 27, 2008.  The companies
included in the peer group index are shown below.  All stock prices
reflect the reinvestment of cash dividends.





COMPARISON
OF CUMULATIVE TOTAL RETURN AMONG


SPAN-AMERICA
MEDICAL SYSTEMS, INC.,


THE
RUSSELL MICROCAP INDEX


AND
A PEER GROUP









Assumes
$100 invested on September 27, 2003.


Assumes
dividends reinvested.  Fiscal year ending September 27,
2008.




17




COMPANIES
INCLUDED IN PEER GROUP INDEX





Standard
Industry Classification Code 3842


at
September 27, 2008




Antares
      Pharma, Inc.
                ATS
      Medical, Inc.
                Biocoral,
      Inc.Chad
      Therapeutics, Inc.
                Cytori
      Therapeutics, Inc.
                Emergency
      Filtration Products, Inc.Exactech,
      Inc.
                Hansen
      Medical, Inc.
                Hill-Rom
      Holdings, Inc.Integra
      Lifesciences Holdings
                Invacare
      Corp.
                Lakeland
      Industries, Inc.Langer,
      Inc.
                Medical
      Action Industries
                Medical
      Solutions Management, Inc.Mine
      Safety Appliances Co.
                Miracor
      Diagnostics, Inc.
                Orthologic
      Corp.Point
      Blank Solutions, Inc.
                Quantum
      MRI, Inc.
                RTI
      Biologics, Inc.Sharps
      Compliance Corp.
                Sonic
      Innovations, Inc.
                Stryker
      Corp.Symmetry
      Medical, Inc.
                Synovis
      Life Technologies
                Theragenics
      Corp.Wright
      Medical Group, Inc.
                Zimmer
      Holdings, Inc.




18




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)





2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005
                      
                      
                      2004For
      the year:
                      
                      
                      
                      
                      
                      (1)
                      
                      
                      
                      (1)
                      
                      
                      
                      (1)
                      
                      
                      
                      (1)Net
      sales
                      
                      $
                      59,265
                      
                      
                      $
                      60,544
                      
                      
                      $
                      51,436
                      
                      
                      $
                      48,433
                      
                      
                      $
                      49,870Gross
      profit
                      
                      
                      20,395
                      
                      
                      
                      20,951
                      
                      
                      
                      16,438
                      
                      
                      
                      15,304
                      
                      
                      
                      12,833Operating
      income
                      
                      
                      7,518
                      
                      
                      
                      8,128
                      
                      
                      
                      5,093
                      
                      
                      
                      4,633
                      
                      
                      
                      2,993Income
      from continuing operations
                      
                      
                      4,919
                      
                      
                      
                      5,505
                      
                      
                      
                      3,779
                      
                      
                      
                      3,408
                      
                      
                      
                      2,446Net
      income
                      
                      
                      4,869
                      
                      
                      
                      2,874
                      
                      
                      
                      3,055
                      
                      
                      
                      2,439
                      
                      
                      
                      1,985Cash
      flow from operations
                      
                      
                      5,250
                      
                      
                      
                      6,294
                      
                      
                      
                      2,497
                      
                      
                      
                      2,589
                      
                      
                      
                      2,812Capital
      expenditures for continuingoperations
                      
                      
                      692
                      
                      
                      
                      1,009
                      
                      
                      
                      1,071
                      
                      
                      
                      2,375
                      
                      
                      
                      388Per
      share:Income
      from continuing operations:Basic
                      
                      $
                      1.77
                      
                      
                      $
                      2.02
                      
                      
                      $
                      1.43
                      
                      
                      $
                      1.31
                      
                      
                      $
                      0.95Diluted
                      
                      
                      1.71
                      
                      
                      
                      1.92
                      
                      
                      
                      1.36
                      
                      
                      
                      1.24
                      
                      
                      
                      0.90Net
      income:Basic
                      
                      $
                      1.76
                      
                      
                      $
                      1.06
                      
                      
                      $
                      1.15
                      
                      
                      $
                      0.94
                      
                      
                      $
                      0.77Diluted
                      
                      
                      1.70
                      
                      
                      
                      1.00
                      
                      
                      
                      1.10
                      
                      
                      
                      0.89
                      
                      
                      
                      0.73Cash
      dividends declared
                      
                      
                      0.34
                      
                      
                      
                      5.30
                      
                      
                      
                      0.195
                      
                      
                      
                      0.565
                      
                      
                      
                      0.145




(1)
              As
      restated to show the safety catheter segment as a discontinued
      operation.  See Note 11 in Notes to Financial
      Statements.




19




Five-Year
Financial Summary


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





2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004(1)
                    
                    
                    (1)
                    
                    
                    (1)
                    
                    
                    (1)At
      end of year:Working
      capital
                    
                    
                    8,048
                    
                    
                    
                    7,447
                    
                    
                    
                    13,338
                    
                    
                    
                    10,638
                    
                    
                    
                    11,623Property
      and equipment - net
                    
                    
                    6,569
                    
                    
                    
                    6,537
                    
                    
                    
                    6,137
                    
                    
                    
                    5,812
                    
                    
                    
                    3,656Total
      assets
                    
                    
                    24,113
                    
                    
                    
                    23,838
                    
                    
                    
                    31,012
                    
                    
                    
                    28,666
                    
                    
                    
                    27,098Long
      term debt
                    
                    
                    700
                    
                    
                    
                    3,700Shareholders'
      equity
                    
                    
                    17,332
                    
                    
                    
                    13,788
                    
                    
                    
                    24,517
                    
                    
                    
                    21,561
                    
                    
                    
                    20,419Book
      value per share
                    
                    
                    6.28
                    
                    
                    
                    4.97
                    
                    
                    
                    9.22
                    
                    
                    
                    8.26
                    
                    
                    
                    7.88Number
      of employees from continuingoperations
                    
                    
                    253
                    
                    
                    
                    317
                    
                    
                    
                    287
                    
                    
                    
                    291
                    
                    
                    
                    301Key
      ratios:Return
      on net sales (2)
                    
                    
                    8.2
                    %
                    
                    
                    4.7
                    %
                    
                    
                    5.9
                    %
                    
                    
                    5.0
                    %
                    
                    
                    4.0
                    %Return
      on average shareholders' equity (2)
                    
                    
                    31.3
                    %
                    
                    
                    15.0
                    %
                    
                    
                    13.3
                    %
                    
                    
                    11.6
                    %
                    
                    
                    10.2
                    %Return
      on average total assets (2)
                    
                    
                    20.3
                    %
                    
                    
                    10.5
                    %
                    
                    
                    10.2
                    %
                    
                    
                    8.7
                    %
                    
                    
                    7.7
                    %Current
      ratio
                    
                    
                    2.5
                    
                    
                    
                    2.3
                    
                    
                    
                    3.8
                    
                    
                    
                    3.0
                    
                    
                    
                    3.3




(1)
            As
      restated to show the safety catheter segment as a discontinued
      operation.  See Note 11 in Notes to Financial
      Statements.


(2)
            These
      "Return" ratios are calculated using net income as shown above, which
      includes losses from discontinued
operations.





20




Item
7.  Management's Discussion and Analysis of Financial Condition and
Results of Operations





OVERVIEW


Span-America’s operations are divided
into two primary business units or segments: medical and custom
products.  Our revenues, profits and cash flows are derived from the
development, manufacture and sale of products for these two market
segments.  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.  We sell the industrial product line directly to our
customers.  Prior to fiscal year 2008, we had a third business unit
involving the development, manufacture and sale of safety
catheters.  In October 2007, we decided to exit the safety catheter
business because we had not been able to generate sufficient sales volume to
make the segment a viable business.  Consequently, we recorded a $2.9
million impairment charge in fiscal 2007 to eliminate the book value of the
safety catheter assets.  Revenues and expenses related to the safety
catheter business in fiscal year 2008 are shown in our financial statements as a
discontinued operation.





Results
of operations for fiscal years 2007 and 2006 have been restated to show the
safety catheter segment as a discontinued operation.





RESULTS
OF OPERATIONS FISCAL 2008 VS. 2007





Summary


Total sales in fiscal 2008 declined 2%
to $59.3 million compared with $60.5 million in fiscal 2007 because of lower
sales volume in both our medical and custom products
segments.  Medical sales were down 2% to $42.5 million due mainly to a
decline in sales of private label therapeutic support
surfaces.  Custom products sales for fiscal 2008 decreased 3% to $16.8
million due to lower sales of consumer bedding products compared with fiscal
year 2007.





Income from continuing operations
declined 11% in fiscal 2008 to $4.9 million, or $1.71 per diluted share, because
of lower sales levels, higher raw material costs in the medical segment, a
slight increase in selling expenses and a decline in non-operating
income.





Net income, which includes results from
the discontinued safety catheter segment, was up 69% in fiscal 2008 to $4.9
million, or $1.70 per diluted share.  The increase in fiscal 2008 net
income was caused by our exit from the safety catheter segment in early fiscal
2008 and the resulting decrease in losses from the now discontinued
operation.


21




Sales


Total sales in our core medical
business declined 2% to $42.5 million in fiscal 2008 compared with $43.2 million
in fiscal 2007.  The decline in medical sales was caused mostly by
lower volume of private-label therapeutic support surfaces manufactured for
Hill-Rom.  Sales to Hill-Rom declined by $2.7 million in fiscal
2008.  See below for further discussion of our Hill-Rom
relationship.  Sales of therapeutic support surfaces, including
private label and branded products, declined by 2% during fiscal
2008.  Therapeutic support surfaces, or mattresses, are our largest
medical product line, making up 75% of our medical segment sales in both fiscal
2008 and fiscal 2007.  We sell these specialty mattresses to
hospitals, long-term care facilities and home care dealers throughout the United
States and Canada.  Excluding sales to Hill-Rom, sales of our
therapeutic support surfaces were up 8% in fiscal 2008, reflecting solid growth
in our branded mattress products.  Growth leaders among our branded
support surfaces included the PressureGuard APM2
alternating pressure mattress and the Geo-Mattress line of all-foam support
surfaces.  We had mixed results in sales of our other medical product
lines during fiscal 2008.  Sales of our Span-Aids patient positioners
declined by 4% due mostly to lower export business.  Sales of mattress
overlays increased 3%, Selan skin care sales rose 4% and sales of seating
products declined 1% during fiscal 2008.  Medical sales accounted for
72% of total net sales in fiscal year 2008 compared with 71% in fiscal
2007.





We expect medical sales for fiscal 2009
to be affected by the expiration in May 2008 of our previous manufacturing
agreement with Hill-Rom.  Hill-Rom was our largest medical customer in
fiscal 2008, representing sales of approximately $7.0 million, which made up 17%
of medical sales and 12% of total Company sales.  We signed a new
agreement with Hill-Rom in July 2008 to continue providing it with therapeutic
support surfaces on a private label basis.  The new agreement
establishes pricing through December 31, 2008, and provides us with protection
against inventory obsolescence for products supplied to Hill-Rom.  The
initial term of the agreement is one year, expiring July 10, 2009, but it will
automatically renew for successive one-year periods.  Either party may
cancel the agreement for any reason with 60 days written notice.  The
agreement contains no minimum sales volume commitments and no exclusivity
provisions for either party.  Hill-Rom has expanded the number of
competing products it offers in this category.  Consequently, we
expect our sales to Hill-Rom in fiscal 2009 to be lower than they were in fiscal
2008.  However, since we do not receive sales forecasts from Hill-Rom,
we cannot accurately predict future sales to Hill-Rom.





We remain
optimistic about the growth prospects for the branded products in our medical
business in fiscal 2009 and beyond.  We expect steady growth in our
branded medical business during fiscal 2009, which should at least partially
offset anticipated declines in sales to Hill-Rom; however, there can be no
assurance to this effect.  We plan to expand our sales and marketing
efforts to distribute our therapeutic support surfaces in the acute care market
in fiscal 2009.  In addition, we plan to continue our new-product
development efforts, which have contributed significantly to our past sales
growth.





Our custom products segment consists of
consumer bedding products and specialty foam products for the industrial
market.  Sales in the custom products segment declined 3% during
fiscal 2008 to $16.8 million from $17.3 million in fiscal 2007.  The
entire decline occurred in the consumer part of the custom products segment,
where sales were down 5% to $13.0 million compared with $13.7 million in fiscal
2007.  The consumer sales decrease was caused mostly by the loss of
one customer due to bankruptcy and loss of another due to an acquisition by a
competitor.  This lost business was partially offset by an increase in
sales of consumer mattress overlays and pillows to Wal-Mart, our largest
customer in the custom products segment.  All of our consumer products
are sold through our marketing and distribution partner, Louisville Bedding
Company.  We expect consumer sales in fiscal 2009 to be higher than
they were in fiscal 2008.


22





In the other part of the custom
products segment, industrial sales increased 5% in fiscal 2008 to $3.8 million
compared with $3.6 million in fiscal 2007.  The growth in industrial
sales came from a combination of new and existing customers primarily in the
automotive and water sports markets.  We believe industrial sales in
fiscal 2009 will be slightly lower than those of fiscal 2008 due to the current
weakness in the U. S. economy.





Gross
Profit


Our gross profit decreased by 3% during
fiscal 2008 to $20.4 million compared with $21.0 million in fiscal
2007.  Gross margin declined slightly to 34.4% for fiscal 2008 from
34.6% in fiscal 2007.  The decreases in gross profit and gross margin
were caused by lower sales volume in the medical and custom products segments
and higher raw material costs in the medical segment.  The increase in
medical material cost was affected by higher foam costs and an increase in
warranty expense related to performance problems with two electronic components
within our therapeutic support surface product lines.  The problems
were resolved in the fourth quarter of fiscal 2008.  See Note 7 in the
Notes to Financial Statements for more information on warranty
expense.





We implemented several lean
manufacturing techniques during fiscal 2008, which improved our labor usage and
efficiency, particularly in the custom products segment.  As a result,
our number of employees declined and labor costs declined both in absolute
dollars and as a percentage of sales.  The decline in labor costs
partially offset higher raw material costs during the
year.  Manufacturing overhead expenses remained level in fiscal years
2008 and 2007.  We expect our gross margin during fiscal 2009 to be
similar to that of fiscal 2008.  However, our 2009 gross profit and
margin performance will depend heavily on sales volume, product mix and raw
material costs.





Selling,
Research & Development and Administrative Expenses


Selling and marketing expenses
increased 1% to $9.0 million and 15.2% of net sales in fiscal 2008 compared with
$8.9 million and 14.7% of net sales in fiscal 2007.  The increase
occurred in the medical segment and was mostly in the categories of sales
commissions, evaluation samples and shipping costs.  Those expenses
increased even though sales declined because we mostly replaced declining
private-label sales, which have no commission and shipping costs, with
increasing branded product sales, which carry standard commission and shipping
costs.  We will likely see this trend continue in fiscal
2009.  Consequently, we believe that total selling and marketing
expenses for fiscal 2009 will increase over 2008 levels.





Total research and development expenses
declined 9% to $657,000 in fiscal 2008 compared with $724,000 in fiscal
2007.  Almost all of our research and development expenses are
incurred in the medical segment and are related to the development of new
products, new features of existing products and design
improvements.  The expense decline in fiscal 2008 was caused by the
completion of product development projects in fiscal 2008 that were ongoing in
fiscal 2007 and by lower incentive compensation expense.  R&D
expenses will likely fluctuate from quarter to quarter and from year to year,
depending on the nature of the development projects being pursued.  We
expect total R&D expenses in fiscal 2009 to be higher than those of fiscal
2008.


23





Administrative expenses increased 1% to
$3.23 million in fiscal 2008 from $3.21 million in fiscal 2007.  The
expense increase was caused mainly by a decline in the cash value of
corporate-owned life insurance.  A decrease in the cash value of life
insurance is shown as an administrative expense, while an increase is shown as a
reduction in administrative expenses.  Please see “Item 7A.
Quantitative and Qualitative Disclosures about Market Risk” below and Notes 5
and 9 in the Notes to Financial Statements for additional information on the
cash value of life insurance.  The increase in administrative expenses
also reflected higher cost for property and casualty insurance.  These
expense increases were mostly offset by a decline in incentive compensation
expense in fiscal 2008.  We expect administrative expenses for fiscal
2009 to be slightly higher than they were in fiscal 2008.





Operating
Income


In the
medical segment, operating income for fiscal 2008 declined by 17% to $7.6
million compared with $9.1 million in fiscal 2007.  The decrease was
caused by lower medical sales volume, higher raw material costs and higher
medical selling expenses in fiscal 2008 compared with last fiscal
year.





The
custom products segment showed a significant improvement in operating income,
which rose to $801,000 in fiscal 2008 compared with an operating loss of
$267,000 in fiscal 2007.  The increase in custom products operating
income was caused by across-the-board expense reductions in that segment as well
as an increase in industrial sales volume.  Within the custom products
segment, we achieved cost reductions during the year in the categories of raw
materials, labor and manufacturing overhead as a result of ongoing efforts to
improve material usage and yields and to increase manufacturing
efficiencies.  We also adopted lean manufacturing techniques to reduce
the number of employees required to meet production requirements.





Operating income for the total Company
declined 7% in fiscal 2008 to $7.5 million compared with $8.1 million in fiscal
2007.  As discussed above, the decline in medical operating income was
greater than the improvement in custom products operating income.





Non-Operating
Income


Investment income declined by 82% to
$51,000 in fiscal 2008 compared with $277,000 in fiscal
2007.   The decrease was caused by a significant reduction in the
level of short-term investments, which in turn was related to our $5.00 per
share special dividend paid in June 2007.  The $13.9 million special
dividend was funded by liquidation of our short-term investments and the
addition of $5.7 million in long-term debt during fiscal 2007.  We
expect investment income for fiscal 2009 to be similar to the fiscal 2008
level.


24




Interest
Expense


Interest expense in fiscal 2008
increased 5% to $108,000 compared with $103,000 in fiscal 2007.  The
increase was caused by a higher average balance of long-term debt in fiscal 2008
compared with 2007.  Since the addition of long-term debt took place
in June 2007 as described above, the debt was outstanding for only four months
during fiscal year 2007.  Although we steadily reduced the debt level
during fiscal 2008, the average balance was higher in fiscal 2008 than in
2007.  See “Liquidity and Capital Resources” below for further
discussion about our revolving credit facility.





Income
from Continuing Operations, Net Income and Dividends


Income from continuing operations in
fiscal 2008 declined 11% to $4.9 million, or $1.71 per diluted share, compared
with $5.5 million, or $1.92 per diluted share, in fiscal 2007.  The
decrease was caused by lower medical and custom products sales volume, higher
raw material costs in the medical segment, higher medical selling expenses and
lower investment income in fiscal 2008 compared with fiscal 2007.





Net income, which includes results from
the discontinued safety catheter segment, increased 69% in fiscal 2008 to $4.9
million, or $1.70 per diluted share, compared with $2.9 million, or $1.00 per
diluted share, in fiscal 2007.  The increase in net income was the
result of discontinuing the safety catheter segment, which reduced our after-tax
loss from discontinued operations to $50,000 in fiscal 2008 from $2.6 million in
fiscal 2007.





During fiscal 2008, we paid dividends
of $943,000, or 19% of net income for the year.  This amount consisted
of two quarterly dividends of $0.08 per share and two quarterly dividends of
$0.09 per share.  In April 2008, the board of directors increased our
quarterly dividend by 12.5%, from $0.08 to $0.09 per share.





RESULTS
OF OPERATIONS FISCAL 2007 VS. 2006





Summary


Results of operations for fiscal years
2007 and 2006 have been restated to show revenues and expenses of the safety
catheter segment as a discontinued operation.





Net sales in fiscal 2007 increased 18%
to $60.5 million compared with $51.4 million in fiscal 2006.  The
sales increase was the result of higher sales volumes in both the medical and
custom products segments.  Medical sales increased 18% to $43.2
million.  Sales in the custom products segment rose by 17% to $17.3
million.





Income from continuing operations in
fiscal 2007 increased 46% to $5.5 million, or $1.92 per diluted share, compared
with $3.8 million, or $1.36 per diluted share, in fiscal 2006.  The
increase was due mostly to higher sales volume.  However, improved
manufacturing efficiencies, a more profitable product mix and slower rates of
growth in operating expenses also contributed to the increase in earnings from
continuing operations.





Net
income, which includes results from the discontinued safety catheter segment,
declined 6% in fiscal 2007 to $2.9 million, or $1.00 per diluted share, compared
with $3.1 million, or $1.10 per diluted share, in fiscal 2006.  The
decrease in net income was caused by a larger loss from discontinued operations
in fiscal year 2007 compared with 2006.  The 2007 loss from
discontinued operations includes a non-cash, after-tax impairment charge of $1.9
million, or $0.67 per share, related to the exit and proposed sale of our safety
catheter business.


25





Sales


Total sales in the medical business
grew 18% to $43.2 million in fiscal 2007 compared with $36.7 million in fiscal
2006.  Sales of therapeutic support surfaces (our largest medical
product line) rose 21% in fiscal 2007 to $32.6 million and represented 75% of
total medical sales.  We sell these specialty mattresses to hospitals,
long-term care facilities and home care dealers throughout the United States and
Canada.  Medical sales accounted for 71% of total net sales in each of
fiscal years 2007 and 2006.  Product line growth leaders within the
therapeutic support surface group were the PressureGuard CFT, which includes
private label products manufactured for Hill-Rom, the Geo-Mattress line of
all-foam support surfaces and the PressureGuard Easy Air low-air-loss support
surfaces.  In other medical product lines, sales of wheelchair seating
products increased by 23%, patient positioners were up by 7% and overlays and
Selan skin care products each rose by 2%.





Our custom products segment consists of
consumer bedding products and specialty foam products for the industrial
market.  Sales in the custom products segment increased 17% during
fiscal 2007 to $17.3 million from $14.8 million in fiscal 2006.  All
of the sales growth was attributable to consumer bedding products, which were up
23% to $13.7 million compared with $11.2 million last year.  This
increase was the result of sales of the new fusion mattress overlays to Wal-Mart
and other retailers through our marketing partner, Louisville Bedding
Company.  The fusion overlays combine the performance of traditional
foam with the feel and features of visco foam to give customers a unique bedding
choice.





In the other part of the custom
products segment, industrial sales were flat at $3.6 million as sales growth
from existing and new customers was offset by lost business from a key customer
related to price competition.





Gross
Profit


Our gross profit increased by 27%
during fiscal 2007 to $21.0 million compared with $16.4 million in fiscal
2006.  Gross margin rose to 34.6% for fiscal 2007 from 32.0% in fiscal
2006.  The increase in gross profit level was due to higher sales
volumes and lower manufacturing costs as a percent of sales.  The
reduction in manufacturing costs as a percent of sales was due to improved
production efficiencies, cost savings from various process improvement projects,
and from closing our California manufacturing plant and replacing it with a
distribution center in Utah.  We also benefitted from the relative
stability of raw material costs during fiscal 2007.





Selling,
Research & Development and Administrative Expenses


Selling and marketing expenses
increased 10% to $8.9 million, but declined to 14.7% of net sales in fiscal 2007
compared with $8.1 million and 15.7% of net sales million in fiscal
2006.  Most of the dollar increase occurred in the medical segment and
was due to costs related to our new distribution center in Utah and higher
commissions and shipping expenses related to higher medical sales
volumes.


26





Total research and development expenses
increased 39% to $724,000 in fiscal 2007 compared with $522,000 in fiscal
2006.  A large majority of our R&D expenses from continuing
operations are incurred by the medical segment.  The expense increase
in fiscal 2007 compared with 2006 is related to an increase in new product
development efforts in the medical segment during fiscal 2007.





Administrative expenses increased 17%
to $3.2 million in fiscal 2007 from $2.8 million in fiscal 2006.  The
increase was mainly the result of higher incentive compensation, professional
fees and bad debt expense during fiscal 2007.





Operating
Income


Operating
income in the medical segment rose 33% in fiscal 2007 to $9.1 million compared
with $6.8 million in fiscal 2006.  The increase was caused by higher
medical sales volume, improved manufacturing efficiencies, a more profitable
sales mix within the medical segment and comparatively slower growth rates in
medical segment operating expenses.





The
custom products segment showed an operating loss in fiscal
2007.  However, the loss decreased 75% to $267,000 ($0.06 per diluted
share after taxes) compared with $1.1 million ($0.26 per diluted share after
taxes) in fiscal 2006.  The decrease in the custom products operating
loss was primarily caused by the increase in sales volume of consumer bedding
products and improved manufacturing efficiencies.  The custom products
segment is allocated a portion 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 our earnings because it absorbs overhead and
administrative expenses that would otherwise be reallocated to the medical
segment if we exited the custom products business.  If that occurred
and nothing else changed, the medical segment and the total Company would be
less profitable.





Operating income for the total Company
rose 60% to $8.1 million compared with $5.1 million in fiscal 2006 for the
reasons described above.





Non-Operating
Income


Investment and other income declined by
10% in fiscal 2007 to $277,000 compared with $308,000 in fiscal
2006.  The decline was caused by a lower gain on the sale of assets in
fiscal 2007 compared with fiscal 2006.  The gain on the sale of assets
in fiscal 2007 was $9,000, down 91% from $99,000 in fiscal 2006.





Investment income in fiscal 2007
increased 28% to $261,000 compared with $204,000 in fiscal 2006.  The
increase was due to higher interest rates and slightly higher average balances
of marketable securities during fiscal 2007 compared with fiscal
2006.





We received no royalty income in fiscal
2007 as a result of the expiration in December 2005 of our license agreement for
the Safety-Lok® shielded syringe product formerly 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 and recorded $247,000 of royalty income in fiscal
2006.


27





Interest
Expense


Fiscal 2007 results included $103,000
in interest expense incurred from the addition of $5.7 million in debt to
partially fund the $5.00 per share special dividend paid on June 6,
2007.  No comparable interest expense was incurred in fiscal
2006.  See “Liquidity and Capital Resources” below for further
discussion about our revolving credit facility.





Income
from Continuing Operations, Net Income and Dividends


Income from continuing operations rose
46% in fiscal 2007 to $5.5 million, or $1.92 per diluted share, compared with
$3.8 million, or $1.36 per diluted share, in fiscal 2006.  The
increase in earnings was due to higher sales volume, improved manufacturing
efficiencies, a more profitable product mix and slower rates of growth in
operating expenses.





Net
income declined 6% in fiscal 2007 to $2.9 million, or $1.00 per diluted share,
compared with $3.1 million, or $1.10 per diluted share, in fiscal
2006.  The decrease in net income was caused by an increase in the
loss from discontinued operations in fiscal year 2007 compared with
2006.  The loss from the discontinued safety catheter segment
increased 263% from $724,000 in fiscal 2006 to $2.6 million in fiscal
2007.  The 2007 loss from discontinued operations of $2.6 million
includes a non-cash, after-tax impairment charge of $1.9 million, or $0.67 per
share, related to the exit and proposed sale of our safety catheter
business.





During fiscal 2007, we paid dividends
of approximately $14.7 million, or 511% of net income, for the
year.  This amount consisted of a special dividend of $5.00 per share,
one quarterly dividend of $0.06 per share and three quarterly dividends of $0.08
per share.





LIQUIDITY
AND CAPITAL RESOURCES


We generated cash from operations of
$5.3 million during fiscal 2008, which was down 17% compared with record cash
flow of $6.3 million in fiscal 2007.  The major positive factors
affecting cash flow from operations in fiscal 2008 were decreases in our
deferred tax asset and inventory levels compared with increases in those two
line items in fiscal 2007.  The main factors causing a reduction in
operating cash flow during fiscal 2008 were a decrease in accounts payable and
accrued expenses, a decrease in earnings as adjusted for the non-cash impairment
charge in fiscal 2007 and an increase in accounts receivable during the
year.  The balance sheet components of these changes are described
below.





The main uses of cash provided by
operations in fiscal 2008 were repayment of $3.0 million of long-term debt,
payment of dividends of $943,000, stock repurchases of $748,000 and equipment
purchases of $692,000.





Working capital increased by $602,000,
or 8%, to $8.0 million during fiscal 2008.  The increase in working
capital was primarily caused by a higher balance in accounts receivable and a
decrease in accrued and sundry liabilities.  In addition, our current
ratio increased to 2.5 at fiscal year-end 2008 from 2.3 at fiscal year-end
2007.


28





Accounts receivable, net of allowances,
increased 10% to $7.8 million at the end of fiscal 2008 compared with $7.1
million at the end of fiscal 2007.  The increase was the result of a
slower average collection time for accounts receivable during fiscal 2008
compared with fiscal 2007.  The days sales outstanding (or average
collection time), calculated using a 12-month average for accounts receivable
balances, increased to 46 days in 2008 compared with 43 days in
2007.  The longer collection time is due to normal month-to-month
fluctuations in the timing of payments received and a slight shift in the mix of
medical sales toward slower paying customers due to a decline in sales of
private-label medical products.  All of our accounts receivable are
unsecured.





Inventory, net of reserves, decreased
by $7,000 to $4.0 million at fiscal year-end 2008 compared with fiscal year-end
2007.  The slight change was the result of normal fluctuations in
inventory levels.  The most significant changes, which were largely
offsetting, were a decrease in medical finished goods inventory and increases in
consumer and industrial raw materials inventory.  Inventory turns from
continuing operations decreased slightly to 9.7 times in fiscal 2008 compared
with 10.6 times in fiscal 2007.  We expect inventory levels in fiscal
2009 to be similar to 2008 fiscal year-end levels.





Our deferred income tax asset decreased
31% during fiscal 2008 to $683,000 from $997,000 due mostly to a decrease in
accrued incentive compensation and, to a lesser extent, a decrease in the
non-deductible inventory reserve.  The decline in accrued incentive
compensation was caused by a decrease in management bonuses in fiscal 2008
compared with fiscal 2007.





Prepaid expenses decreased 47% to
$52,000 during fiscal 2008 from $97,000 at the end of fiscal
2007.  The decrease was the result of normal monthly fluctuations in
prepaid accounts.





Net property and equipment increased by
$32,000, less than 1%, during fiscal 2008.  The change resulted from
the combination of $656,000 in depreciation expense offset by capital
expenditures of $692,000.  We expect capital expenditures in fiscal
2009 to be lower than those of fiscal 2008.





Other assets decreased by 5% to $2.3
million during fiscal 2008 compared with $2.4 million at fiscal year end 2007
due to decreases in cash value of life insurance and deposits placed with
suppliers.  The decrease in cash value of life insurance was related
to stock market declines during fiscal 2008.  See “Item 7A.
Quantitative and Qualitative Disclosures about Market Risk” below for more
information about the cash value of life insurance.





Our trade accounts payable increased by
18% in fiscal 2008 to $2.5 million due mostly to an increase in raw material
purchases in September 2008.  Accrued and sundry liabilities declined
by 18% during the year to $2.8 million compared with $3.4 million last
year.  The decrease was caused by declines in accruals for incentive
compensation, income taxes and payroll taxes.


29


During
fiscal 2007, we entered into a $10 million revolving credit agreement with a
bank to partially fund the $5.00 per share special dividend paid on June 6, 2007
and other corporate needs.  We initially borrowed $5.7 million to fund
the dividend.  We repaid $2.0 million during fiscal 2007 and another
$3.0 million during fiscal 2008, leaving a balance of $700,000 outstanding at
fiscal year-end 2008.  The maximum principal amount we can borrow at
any one time under the agreement is $10 million.  The maturity date is
June 5, 2012.  The agreement is unsecured and accrues interest at a
variable rate equal to 30-day LIBOR plus a margin ranging from 85 to 165 basis
points depending on our leverage ratio (as defined in the
agreement).  The margin in effect during fiscal 2008 was 85 basis
points.  The interest rate, including the margin, at September 27,
2008 was 3.34%.  Interest-only payments are required
monthly.  The agreement includes financial covenants relating to
tangible net worth and leverage ratios.  The agreement restricts
dividends, stock repurchases, mergers and acquisitions, asset sales,
indebtedness, liens, and capital expenditures (see below).  Violation
of loan covenants could result in acceleration of the term of the
agreement.  We have pledged to grant the bank a security interest in
our accounts, instruments, and chattel paper upon its request in the event of a
default as defined in the agreement.  We believe that we were in
compliance with the loan covenants as of September 27, 2008.





The
credit facility restricts dividends and stock repurchases during any fiscal year
to an aggregate amount of no more than 50% of the sum of (i) our income from
continuing operations for that fiscal year plus (ii) the absolute value of any
aggregate after-tax, non-cash and extraordinary losses for that fiscal
year.  As an exception to the restriction above, we may pay a regular
quarterly dividend in an amount no greater than the previous quarter’s regular
dividend so long as we remain in compliance with the financial covenants after
giving effect to the payment of the dividend.





We believe that funds on hand, funds
generated from operations and funds available under our revolving credit
facility are adequate to finance our operations and expected capital
requirements during fiscal 2009 and for the foreseeable future.





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 27,
2008 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 YearsRevolving
      credit agreement
                    
                    $
                    700
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    700Purchase
      obligations - Note 19
                    
                    
                    1,250
                    
                    
                    $
                    625
                    
                    
                    $
                    625Deferred
      compensation - Note 9
                    
                    
                    866
                    
                    
                    
                    114
                    
                    
                    
                    227
                    
                    
                    
                    227
                    
                    
                    $
                    298Total
      contractual obligations
                    
                    $
                    2,816
                    
                    
                    $
                    739
                    
                    
                    $
                    852
                    
                    
                    $
                    927
                    
                    
                    $
                    298


30





IMPACT
OF INFLATION AND COST OF RAW MATERIALS


Based on current conditions in the
markets for our primary raw materials, we do not expect inflation to be a
significant factor for our operations in fiscal 2009.  We experienced
increases in most of our raw material and other operating costs during fiscal
year 2008.  We were able to partially offset these higher costs
through sales price increases in fiscal 2008, efficiency improvements and other
expense reduction efforts.  However, we can give no assurance that we
will be able to offset future cost increases, which could negatively affect our
profitability.





The cost of polyurethane foam, our
primary raw material, is indirectly influenced by oil
prices.  However, other market factors also affect foam prices,
including supply availability of component chemicals, demand for related
products from domestic and international manufacturers, competition among
domestic suppliers, our purchase volumes and regulatory
requirements.  Recent declines in oil prices and a weakening economy
have created expectations for potential decreases in raw material costs, but we
have not seen any decreases to date.  It is difficult to predict the
impact that possible future raw material cost decreases might have on our
profitability.  The effect of deflation in raw material costs would
depend on the extent to which we had to lower selling prices of our products to
respond to sales price competition in the market.  Consequently, it is
difficult for us to accurately predict the impact that inflation or deflation
might have on our operations.  We currently expect that neither
inflation nor deflation will have a significant impact on our operations in
fiscal 2009.





CRITICAL
ACCOUNTING POLICIES


This discussion and analysis of
financial condition and results of operations is based on our financial
statements that 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.


31




Allowance for Doubtful
Accounts


Credit evaluations are undertaken to
set credit limits for all customers.  We regularly evaluate past due
items in our accounts receivable listing and provide what we estimate to be
adequate reserves for doubtful accounts.  Customer financial
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 27, 2008, our provision for doubtful
accounts represented approximately 2.9% of total accounts receivable, or
$235,000.  This compares with $189,000, or 2.6% of total accounts
receivable at fiscal year-end 2007.





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 27, 2008, our provision for excess and
obsolete inventory represented approximately 5.2% of total inventories, or
$221,000.  This compares with $199,000, or 4.7% of total inventories
at fiscal year-end 2007.





Warranty
Obligations


We warrant certain of our products for
specific periods 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
$438,000 in fiscal 2008, $222,000 in fiscal 2007 and $185,000 in fiscal
2006.  See Notes 6 and 7 in the Notes to Financial Statements for more
information on product warranties.





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 2008, 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 27, 2008, the carrying value of goodwill was
$1.9 million.


32




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.  Accordingly, we recorded an impairment charge of $2.9
million in September of 2007 which eliminated 100% of the book value of the
safety catheter assets.  We have attempted to sell the assets related
to the safety catheter business, but our efforts so far have been
unsuccessful.  Proceeds from a future sale of these assets, if any,
will be recorded as a gain on the disposition of assets from discontinued
operations.  (See Notes 11 and 17 in the Notes to Financial
Statements.)





Present
Value of Deferred Compensation


We are obligated under the terms of a
retirement agreement to make fixed payments for the remaining lives of
Span-America’s founder and his ex-wife as discussed in Note 9 “Deferred
Compensation” in the Notes to Financial Statements.  This obligation
can be funded from internally generated cash or from the cash value of
Company-owned life insurance policies, which had a value of $1.8 million at
September 27, 2008.  See Item 7A below and Notes 5 and 9 in the Notes
to Financial Statements for more information on deferred compensation and the
cash value of life insurance.  We have fully accrued the present value
of the expected payments due over the combined estimated life expectancy of our
founder and his ex-wife.  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 27, 2008, we had recorded a
deferred compensation liability of approximately $866,000, including current and
long-term portions.  If we reduced the discount rate by 1%, the
deferred compensation liability would be increased by approximately $45,000 and
pre-tax income would be reduced by the same amount.





Item 7A. Quantitative and
Qualitative Disclosures About Market Risk





We are exposed to financial market risk
because our other assets at September 27, 2008 included $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 that are being used as the funding vehicle for a
retirement program for Span-America’s founder and former
chairman.  See “Present Value of Deferred Compensation”
above.  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 27, 2008, cash value
of life insurance decreased by 4%, creating after-tax expense of approximately
$92,000.


33


Our credit facility accrues interest at
a variable rate equal to 30-day LIBOR plus a margin ranging from 85 to 165 basis
points depending on our then-applicable leverage ratio (as defined in the credit
facility).  The current margin is 85 basis points.  Interest
is payable monthly.  An increase in interest rates would have a
negative impact on our financial condition and earnings to the extent that we
had outstanding borrowings under the facility.  The degree of impact
would vary depending on the level of the borrowings.  Using our level
of long-term debt at September 27, 2008 of $700,000, and assuming a constant
level of debt for the entire year, a 100 basis point increase in the interest
rate on the outstanding loan balance would increase our interest expense by
approximately $7,000 per year.





Item 8.  Financial
Statements and Supplementary Data




Span-America
Medical Systems, Inc.


Financial
Statements





September
27, 2008





Contents





Report of Independent Registered Public Accounting
      Firm
                          
                          
                          35Financial
      StatementsStatements
      of Income
                          
                          
                          36Balance
      Sheets
                          
                          
                          37Statements
      of Changes in Shareholders’Equity
      and Comprehensive Income
                          
                          
                          38Statements of Cash Flows
                          
                          
                          39Notes
      to Financial Statements
                          
                          
                          40


34





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 27, 2008 and September 29, 2007 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 27,
2008.  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 27, 2008 and September 29, 2007 and the results of its
operations and its cash flows for each of the years in the three year period
ended September 27, 2008 in conformity with accounting principles generally
accepted in the United States of America.





We were
not engaged to examine management’s assertion about the effectiveness of
Span-America Medical Systems, Inc.’s internal control over financial reporting
as of September 27, 2008 and, accordingly, we do not express an opinion
thereon.





/s/  ELLIOTT DAVIS,
LLC





Greenville,
South Carolina


December
18, 2008


35




Statements of
Income





Years EndedSeptember 27,
                              
                              
                              September 29,
                              
                              
                              September 30,2008
                              
                              
                              2007
                              
                              
                              2006(Restated)
                              
                              
                              (Restated)Net
      sales
                              
                              $
                              59,265,265
                              
                              
                              $
                              60,543,829
                              
                              
                              $
                              51,436,160Cost
      of goods sold
                              
                              
                              38,869,911
                              
                              
                              
                              39,592,675
                              
                              
                              
                              34,998,074Gross
      profit
                              
                              
                              20,395,354
                              
                              
                              
                              20,951,154
                              
                              
                              
                              16,438,086Selling
      and marketing expenses
                              
                              
                              8,988,657
                              
                              
                              
                              8,893,608
                              
                              
                              
                              8,073,547Research
      and development expenses
                              
                              
                              657,369
                              
                              
                              
                              724,331
                              
                              
                              
                              521,794General
      and administrative expenses
                              
                              
                              3,230,854
                              
                              
                              
                              3,205,273
                              
                              
                              
                              2,750,15212,876,880
                              
                              
                              
                              12,823,212
                              
                              
                              
                              11,345,493Operating
      income
                              
                              
                              7,518,474
                              
                              
                              
                              8,127,942
                              
                              
                              
                              5,092,593Non-operating
      income and expense:Investment
      income and other
                              
                              
                              50,755
                              
                              
                              
                              276,852
                              
                              
                              
                              307,706Royalty
      income
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              246,627Interest
      expense
                              
                              
                              108,465
                              
                              
                              
                              103,152Net
      non-operating (expense) income
                              
                              
                              (57,710
                              )
                              
                              
                              173,700
                              
                              
                              
                              554,333Income
      from continuing operations before income taxes
                              
                              
                              7,460,764
                              
                              
                              
                              8,301,642
                              
                              
                              
                              5,646,926Income
      taxes on continuing operations - Note 12
                              
                              
                              2,542,000
                              
                              
                              
                              2,797,000
                              
                              
                              
                              1,868,000Income
      from continuing operations
                              
                              
                              4,918,764
                              
                              
                              
                              5,504,642
                              
                              
                              
                              3,778,926(Loss)
      from discontinued operations, net of income tax benefit of$25,000
      (2008), $1,337,000 (2007) and $358,000 (2006)
                              
                              
                              (49,915
                              )
                              
                              
                              (2,630,703
                              )
                              
                              
                              (724,115
                              )Net
      income
                              
                              $
                              4,868,849
                              
                              
                              $
                              2,873,939
                              
                              
                              $
                              3,054,811Earnings
      per share of common stock - Note 13Income
      from continuing operations:Basic
                              
                              $
                              1.77
                              
                              
                              $
                              2.02
                              
                              
                              $
                              1.43Diluted
                              
                              $
                              1.71
                              
                              
                              $
                              1.92
                              
                              
                              $
                              1.36(Loss)
      from discontinued operations:Basic
                              
                              $
                              (0.02
                              )
                              
                              $
                              (0.97
                              )
                              
                              $
                              (0.27
                              )Diluted
                              
                              
                              n/a
                              
                              
                              
                              n/a
                              
                              
                              
                              n/aNet
      income:Basic
                              
                              $
                              1.76
                              
                              
                              $
                              1.06
                              
                              
                              $
                              1.15Diluted
                              
                              $
                              1.70
                              
                              
                              $
                              1.00
                              
                              
                              $
                              1.10Dividends
      per share of common stock
                              
                              $
                              0.340
                              
                              
                              $
                              5.300
                              
                              
                              $
                              0.195Weighted
      average shares outstanding:Basic
                              
                              
                              2,771,754
                              
                              
                              
                              2,723,942
                              
                              
                              
                              2,648,635Diluted
                              
                              
                              2,868,494
                              
                              
                              
                              2,864,820
                              
                              
                              
                              2,771,924





The
accompanying notes are an integral part of these financial
statements.




36





Balance
Sheets





September 27,
                      
                      
                      September 29,2008
                      
                      
                      2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      833,714
                      
                      
                      $
                      808,864Accounts
      receivable, net of allowances of $235,000 (2008) and $189,000
      (2007)
                      
                      
                      7,771,366
                      
                      
                      
                      7,064,438Inventories
      - Note 2
                      
                      
                      3,990,999
                      
                      
                      
                      3,997,585Deferred
      income taxes - Note 12
                      
                      
                      683,000
                      
                      
                      
                      997,000Prepaid
      expenses
                      
                      
                      51,964
                      
                      
                      
                      97,395Total
      current assets
                      
                      
                      13,331,043
                      
                      
                      
                      12,965,282Property
      and equipment, net - Note 3
                      
                      
                      6,569,091
                      
                      
                      
                      6,536,842Goodwill
      - Note 4
                      
                      
                      1,924,131
                      
                      
                      
                      1,924,131Other
      assets - Note 5
                      
                      
                      2,288,589
                      
                      
                      
                      2,411,803$
                      24,112,854
                      
                      
                      $
                      23,838,058LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                      
                      $
                      2,528,934
                      
                      
                      $
                      2,146,138Accrued
      and sundry liabilities - Note 6
                      
                      
                      2,753,771
                      
                      
                      
                      3,372,586Total
      current liabilities
                      
                      
                      5,282,705
                      
                      
                      
                      5,518,724Long-term
      debt - Note 8
                      
                      
                      700,000
                      
                      
                      
                      3,700,000Deferred
      income taxes - Note 12
                      
                      
                      45,000
                      
                      
                      
                      38,000Deferred
      compensation - Note 9
                      
                      
                      752,684
                      
                      
                      
                      793,667Total
      long-term liabilities
                      
                      
                      1,497,684
                      
                      
                      
                      4,531,667Total
      liabilities
                      
                      
                      6,780,389
                      
                      
                      
                      10,050,391Commitments
      and contingencies - Notes 18 and 19Shareholders'
      equity - Notes 10 and 13 Common stock, no par value, 20,000,000 shares
      authorized; issued and outstanding shares 2,759,077 (2008) and 2,775,444
      (2007)
                      
                      
                      1,308,847
                      
                      
                      
                      1,724,225Additional
      paid-in capital
                      
                      
                      563,304
                      
                      
                      
                      528,945Retained
      earnings
                      
                      
                      15,460,314
                      
                      
                      
                      11,534,497Total
      shareholders' equity
                      
                      
                      17,332,465
                      
                      
                      
                      13,787,667$
                      24,112,854
                      
                      
                      $
                      23,838,058





The
accompanying notes are an integral part of these financial
statements.




37





Statements of Changes in Shareholders'
Equity and Comprehensive Income





AccumulatedAdditional
                                
                                
                                
                                
                                
                                OtherCommon Stock
                                
                                
                                Paid-in
                                
                                
                                Retained
                                
                                
                                ComprehensiveShares
                                
                                
                                Amount
                                
                                
                                Capital
                                
                                
                                Earnings
                                
                                
                                Loss
                                
                                
                                TotalBalance
      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 securities available 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
                                )
                                
                                
                                24,517,458Net
      income for the 2007 fiscal year
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                2,873,939
                                
                                
                                
                                
                                
                                
                                
                                2,873,939Reclassification
      adjustment from sale of securities
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3,495
                                
                                
                                
                                3,495Comprehensive
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                2,877,434Common
      stock issued to Directors
                                
                                
                                8,500
                                
                                
                                
                                132,090
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                132,090Common
      stock issued on exercise of stock options
                                
                                
                                109,109
                                
                                
                                
                                595,917
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                595,917Tax
      benefits for stock options exercised
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                314,371
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                314,371Stock
      repurchase
                                
                                
                                (2,510
                                )
                                
                                
                                (35,900
                                )
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (35,900
                                )Stock
      option compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                77,960
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                77,960Cash
      dividends paid or declared  ($5.30  per
      share)
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (14,691,663
                                )
                                
                                
                                
                                
                                
                                
                                (14,691,663
                                )Balance
      at September 29, 2007
                                
                                
                                2,775,444
                                
                                
                                
                                1,724,225
                                
                                
                                
                                528,945
                                
                                
                                
                                11,534,497
                                
                                
                                
                                -
                                
                                
                                
                                13,787,667Net
      income for the 2008 fiscal year
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                4,868,849
                                
                                
                                
                                
                                
                                
                                
                                4,868,849Common
      stock issued to Directors
                                
                                
                                8,500
                                
                                
                                
                                111,265
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                111,265Common
      stock issued on exercise of stock options
                                
                                
                                39,394
                                
                                
                                
                                220,901
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                220,901Stock
      repurchase
                                
                                
                                (64,261
                                )
                                
                                
                                (747,544
                                )
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (747,544
                                )Stock
      option compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                34,359
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                34,359Cash
      dividends paid or declared  ($0.34  per
      share)
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (943,032
                                )
                                
                                
                                
                                
                                
                                
                                (943,032
                                )Balance
      at September 27, 2008
                                
                                
                                2,759,077
                                
                                
                                $
                                1,308,847
                                
                                
                                $
                                563,304
                                
                                
                                $
                                15,460,314
                                
                                
                                $
                                -
                                
                                
                                $
                                17,332,465





The
accompanying notes are an integral part of these financial
statements.




38





Statements of Cash
Flows





Years EndedSeptember 27,
                              
                              
                              September 29,
                              
                              
                              September 30,2008
                              
                              
                              2007
                              
                              
                              2006OPERATING
      ACTIVITIES:Net
      income
                              
                              $
                              4,868,849
                              
                              
                              $
                              2,873,939
                              
                              
                              $
                              3,054,811Adjustments
      to reconcile net income to net cash provided by operating
      activities:Impairment
      charge
                              
                              
                              
                              
                              
                              
                              2,878,803Depreciation
                              
                              
                              656,075
                              
                              
                              
                              891,872
                              
                              
                              
                              814,210Amortization
                              
                              
                              73,282
                              
                              
                              
                              137,841
                              
                              
                              
                              128,971Provision
      for losses on accounts receivable
                              
                              
                              75,500
                              
                              
                              
                              99,841
                              
                              
                              
                              47,762Provision
      for deferred income taxes
                              
                              
                              321,000
                              
                              
                              
                              (962,629
                              )
                              
                              
                              (39,128
                              )Realized
      loss on securities available for sale
                              
                              
                              
                              
                              
                              
                              3,595Gain
      on sale and disposal of property and equipment
                              
                              
                              (13,781
                              )
                              
                              
                              (8,644
                              )
                              
                              
                              (99,378
                              )Decrease
      (Increase) in cash value of life insurance
                              
                              
                              82,987
                              
                              
                              
                              (138,199
                              )
                              
                              
                              (102,955
                              )Deferred
      compensation
                              
                              
                              (40,983
                              )
                              
                              
                              (37,947
                              )
                              
                              
                              (35,136
                              )Stock
      compensation expense
                              
                              
                              34,359
                              
                              
                              
                              77,960
                              
                              
                              
                              46,860Changes
      in operating assets and liabilities:Accounts
      receivable
                              
                              
                              (782,428
                              )
                              
                              
                              (267,767
                              )
                              
                              
                              176,341Inventories
                              
                              
                              6,586
                              
                              
                              
                              (435,896
                              )
                              
                              
                              (1,136,996
                              )Prepaid
      expenses and other assets
                              
                              
                              197,243
                              
                              
                              
                              345,596
                              
                              
                              
                              (65,976
                              )Accounts
      payable and accrued expenses
                              
                              
                              (228,205
                              )
                              
                              
                              835,530
                              
                              
                              
                              (291,907
                              )Net
      cash provided by operating activities
                              
                              
                              5,250,484
                              
                              
                              
                              6,293,895
                              
                              
                              
                              2,497,479INVESTING
      ACTIVITIES:Purchases
      of marketable securities
                              
                              
                              
                              
                              
                              
                              (5,095,000
                              )
                              
                              
                              (4,618,714
                              )Proceeds
      from sales of marketable securities
                              
                              
                              
                              
                              
                              
                              10,187,175
                              
                              
                              
                              3,610,000Purchases
      of property and equipment
                              
                              
                              (692,043
                              )
                              
                              
                              (1,009,175
                              )
                              
                              
                              (1,073,696
                              )Proceeds
      from sale of property and equipment
                              
                              
                              17,500
                              
                              
                              
                              9,137
                              
                              
                              
                              101,305Payments
      for other assets
                              
                              
                              (73,602
                              )
                              
                              
                              (86,685
                              )
                              
                              
                              (116,434
                              )Net
      cash (used for) provided by investing activities
                              
                              
                              (748,145
                              )
                              
                              
                              4,005,452
                              
                              
                              
                              (2,097,539
                              )FINANCING
      ACTIVITIES:Dividends
      paid
                              
                              
                              (943,032
                              )
                              
                              
                              (14,691,663
                              )
                              
                              
                              (516,781
                              )Proceeds
      of long-term debt
                              
                              
                              
                              
                              
                              
                              5,700,000Repayment
      of long-term debt
                              
                              
                              (3,000,000
                              )
                              
                              
                              (2,000,000
                              )Purchase
      and retirement of common stock
                              
                              
                              (747,544
                              )
                              
                              
                              (35,900
                              )Proceeds
      from exercise of options for common stock
                              
                              
                              213,087
                              
                              
                              
                              561,555
                              
                              
                              
                              197,980Net
      cash used for financing activities
                              
                              
                              (4,477,489
                              )
                              
                              
                              (10,466,008
                              )
                              
                              
                              (318,801
                              )Increase
      (Decrease) in cash and cash equivalents
                              
                              
                              24,850
                              
                              
                              
                              (166,661
                              )
                              
                              
                              81,139Cash
      and cash equivalents at beginning of year
                              
                              
                              808,864
                              
                              
                              
                              975,525
                              
                              
                              
                              894,386Cash
      and cash equivalents at end of year
                              
                              $
                              833,714
                              
                              
                              $
                              808,864
                              
                              
                              $
                              975,525





The
accompanying notes are an integral part of these financial
statements.




39




NOTES
TO FINANCIAL STATEMENTS


September
27, 2008





1.   SIGNIFICANT
ACCOUNTING POLICIES





Description
of Business


We
manufacture and distribute 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.





Cash
and Cash Equivalents


We
consider all cash equivalents to be highly liquid investments with a maturity
when purchased of three months or less.  Depending on market
conditions, we may maintain a centralized cash management program whereby our
excess cash balances are invested in commercial paper and are considered cash
equivalents.  Cash balances in our accounts usually exceed federally
insured limits.





Accounts
Receivable


We
provide credit in the normal course of business and perform ongoing credit
evaluations on certain of our customers, but generally we do not require
collateral to support these receivables.  We also establish 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 the potential for recovery is
considered remote.





Inventories


Our
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 September 29, 2007, the balance in
construction in progress represented costs incurred relating to the installation
of a purchased software system not ready for use at that time.


40





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, or 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 4.  Accumulated
amortization of intangible assets at September 27, 2008 and September 29, 2007
was approximately $2,463,000 and $2,400,000, respectively.  We
annually review 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.”  We
also review 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.  See Note 11 – Impairment of Safety
Catheter Assets.





Revenue
Recognition


We
recognize revenue 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.





We have
applied the accounting and disclosure requirements of Securities and Exchange
Commission Staff Accounting Bulletin (SAB) No. 104.





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 $1,837,000 in 2008, $1,801,000 in
2007, and $1,697,000 in 2006.





Fair
Value of Financial Instruments


The
carrying amounts reported in our balance sheets for cash and cash equivalents,
accounts receivable, cash value of life insurance, accounts payable, and debt
approximate their fair values.  The fair values of our 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 – Earnings per Share of Common
Stock.





Stock-Based
Compensation


We
account for stock based payments in accordance with the Financial Accounting
Standards Board’s (FASB) SFAS No. 123R “Share-Based Payment,” which requires us
to measure and recognize compensation expense for all stock-based payments at
fair value.  Stock-based payments include stock option
grants.  We grant options to purchase common stock to some of our
employees under various plans at prices equal to the market value of the stock
on the dates the options were granted.


41





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: risk-free interest rate of 4.58%; dividend
yield of 1.5%; volatility factor of the expected market price of our common
stock of 35.7%; and a weighted average expected life of the option of 8.2
years.  No options were granted during fiscal years 2008 or
2007.





Fiscal
Year


Our
fiscal year ends on the Saturday nearest to September 30.  Fiscal
years 2008, 2007 and 2006 were 52-week years.  Fiscal year 2009 will
be a 53-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 are projected to 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 us to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes and the disclosure of contingent assets and
liabilities.  Although these estimates are based on our knowledge of
current events and actions planned for the future, the estimates may ultimately
differ from actual results.





Recently
Issued Accounting Standards


In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities.”  SFAS No. 159
provides companies with an option to report selected financial assets and
liabilities at fair value. SFAS No. 159 also establishes presentation and
disclosure requirements designed to (a) facilitate comparisons between companies
that choose different measurement attributes for similar types of assets and
liabilities and (b) to provide additional information that will make it easier
for investors and other financial statement users to understand the effect on
earnings of the company’s choice to use fair value.  Additionally,
SFAS No. 159 requires entities to display on the face of the balance sheet the
fair value of those assets and liabilities for which the company has chosen to
use fair value.  SFAS No. 159 is effective for Span-America
beginning in fiscal year 2009.  We are currently assessing the
potential impact of SFAS No. 159 on our financial statements, but we do not
expect it to have a material effect on our financial position or results of
operations.





In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements.”  Among other requirements, SFAS No. 157 defines fair
value and establishes a framework for measuring fair value and also expands
disclosure about the use of fair value to measure assets and liabilities. SFAS
No. 157 is effective for Span-America beginning in fiscal year 2009. We are
currently evaluating the potential impact of SFAS No. 157 on our financial
statements, but we do not expect it to have a material effect on our financial
position or results of operations.


42





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 our financial statements upon
adoption.





Reclassifications


Results
of operations for fiscal years 2007 and 2006 have been restated to show the
safety catheter segment as a discontinued operation.  See Note 11 –
Impairment of Safety Catheter Assets.





Certain
prior year amounts have been reclassified to conform to the current year
presentation in the accompanying financial statements.  These
reclassifications had no material effect on previously reported results of
operations or retained earnings.





2.  INVENTORIES





2008
                  
                  
                  2007Raw
      materials
                  
                  $
                  2,825,817
                  
                  
                  $
                  2,680,520Finished
      goods
                  
                  
                  1,165,182
                  
                  
                  
                  1,317,065$
                  3,990,999
                  
                  
                  $
                  3,997,585





3.  PROPERTY
AND EQUIPMENT





2008
                      
                      
                      2007Land
                      
                      $
                      469,718
                      
                      
                      $
                      469,718Land
      improvements
                      
                      
                      486,698
                      
                      
                      
                      486,698Buildings
                      
                      
                      6,783,714
                      
                      
                      
                      6,776,068Construction
      in progress
                      
                      
                      
                      
                      
                      
                      344,975Machinery
      and equipment
                      
                      
                      6,613,918
                      
                      
                      
                      5,611,931Furniture
      and fixtures
                      
                      
                      487,775
                      
                      
                      
                      474,037Automobiles
                      
                      
                      9,520
                      
                      
                      
                      9,52014,851,343
                      
                      
                      
                      14,172,947Less
      accumulated depreciation
                      
                      
                      8,282,252
                      
                      
                      
                      7,636,105$
                      6,569,091
                      
                      
                      $
                      6,536,842





4.  GOODWILL
AND OTHER INTANGIBLES





As of
September 27, 2008 and September 29, 2007, we had goodwill of
$1,924,131.  In addition, we had patents and trademarks (net of
accumulated amortization) of $316,435 as of September 27, 2008 and $306,116 as
of September 29, 2007.  The goodwill is associated with the medical
segment, and the patents and trademarks are associated with the
medical and custom products segments.  Goodwill has been determined to
have an indefinite useful life in accordance with SFAS No. 142.  The
useful lives of individual patents and trademarks have been reviewed, and no
material changes were required.


43




Amortization
expense for patents and trademarks from continuing operations during fiscal
years 2008, 2007, and 2006 was $63,282, $59,165 and $61,650,
respectively.  Estimated amortization expense for the next five fiscal
years based on existing patents and trademarks is as follows:





EstimatedAmortizationFiscal
      years
                    
                    Expense2009
                    
                    
                    60,8312010
                    
                    
                    37,3042011
                    
                    
                    33,9152012
                    
                    
                    29,7482013
                    
                    
                    26,671





5.  OTHER
ASSETS





2008
                      
                      
                      2007Patents
      and trademarks, net of accumulated amortization of $1,435,091 (2008) and
      $1,371,809 (2007)
                      
                      $
                      316,435
                      
                      
                      $
                      306,116Cash
      value of life insurance policies
                      
                      
                      1,837,869
                      
                      
                      
                      1,920,856Other
                      
                      
                      134,285
                      
                      
                      
                      184,831$
                      2,288,589
                      
                      
                      $
                      2,411,803





6.  ACCRUED
AND SUNDRY LIABILITIES





2008
                      
                      
                      2007Salaries
      and other compensation
                      
                      $
                      1,271,859
                      
                      
                      $
                      1,984,920Federal
      and state income taxes and sales taxes
                      
                      
                      101,359
                      
                      
                      
                      176,697Payroll
      taxes accrued and withheld
                      
                      
                      129,992
                      
                      
                      
                      173,478Property
      taxes
                      
                      
                      181,800
                      
                      
                      
                      164,625Medical
      insurance
                      
                      
                      276,071
                      
                      
                      
                      214,260Warranty
      reserve
                      
                      
                      365,721
                      
                      
                      
                      332,881Vendor
      rebates
                      
                      
                      410,990
                      
                      
                      
                      311,285Other
                      
                      
                      15,979
                      
                      
                      
                      14,440$
                      2,753,771
                      
                      
                      $
                      3,372,586




44





7.  PRODUCT
WARRANTIES





We offer
warranties of various lengths to our customers depending on the specific product
sold.  Our warranties require us 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, we record a liability for
estimated costs that may be incurred under our 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 our expectations, there can be no assurance that future warranty costs
will not exceed historical amounts.  We regularly assess the adequacy
of our recorded liability and adjust the balance as necessary.





Changes
in our product warranty liability for the years ended September 27, 2008 and
September 29, 2007 are as follows:




2008
                    
                    
                    2007Accrued
      liability at beginning of year
                    
                    $
                    332,881
                    
                    
                    $
                    282,887Increases
      in reserve
                    
                    
                    470,440
                    
                    
                    
                    271,594Expenses
                    
                    
                    (437,600
                    )
                    
                    
                    (221,600
                    )Accrued
      liability at end of year
                    
                    $
                    365,721
                    
                    
                    $
                    332,881




8.  BORROWINGS





Long-term
debt consists of a revolving credit facility from a bank.  The maximum
principal amount we can borrow at any one time under the agreement is $10
million.  The maturity date is June 5, 2012.  The agreement
is unsecured and accrues interest at a variable rate equal to 30-day LIBOR plus
a margin ranging from 85 to 165 basis points depending on our leverage ratio (as
defined in the agreement).  The margin in effect for fiscal 2008 was
85 basis points.  The interest rate at September 27, 2008 was
3.34%.  Interest-only payments are required monthly.  The
agreement includes financial covenants relating to tangible net worth and
leverage ratios.  The agreement restricts dividends, stock
repurchases, mergers and acquisitions, asset sales, indebtedness, liens, and
capital expenditures.  Violation of loan covenants could result in
acceleration of the term of the agreement.  We have pledged to grant
the bank a security interest in our accounts, instruments, and chattel paper
upon its request in the event of a default as defined in the
agreement.





The
credit facility restricts dividends and stock repurchases during any fiscal year
to an aggregate amount of no more than 50% of the sum of (i) our income from
continuing operations for that fiscal year plus (ii) the absolute value of our
aggregate after-tax, non-cash and extraordinary losses for that fiscal year, if
any.  As an exception to the restriction noted above, we may pay a
regular quarterly dividend in an amount no greater than the previous quarter’s
regular dividend so long as we remain in compliance with the financial covenants
after giving effect to the payment of the dividend.





We paid
interest expense of approximately $108,000 in 2008 and $103,000 in 2007 and paid
no interest during fiscal year 2006.


45





9.  DEFERRED
COMPENSATION





We are
obligated to make fixed payments of approximately $114,000 per year to our
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.  We have fully accrued the present value of the expected payments
due over the combined life expectancy of the executive and his
ex-wife.  We recognized expenses of approximately $73,000 in 2008,
$76,000 in 2007, and $78,000 in 2006 related to this agreement.  An 8%
discount rate was used in measuring the present value of our deferred
compensation obligation.





10.  SHAREHOLDERS’
EQUITY





In
January 2007, the Board adopted the 2007 Equity Incentive Plan (“2007 Plan”),
which was approved by shareholders in February 2007.  The 2007 Plan
authorized the Board to grant stock-based compensation awards to our officers,
directors and key employees for up to 250,000 shares of Company common
stock.  Awards may be in the form of restricted stock, non-restricted
stock, restricted stock units, options or stock appreciation rights
(SARs).  Total awards under the 2007 Plan may not exceed 250,000
shares, of which no more than 75,000 shares may be in the form of restricted
stock, non-restricted stock or restricted stock units.  The per share
exercise prices of options or SARs granted under the 2007 Plan must be no less
than the fair market value of a share on the grant date.  The terms
and conditions of each award may be set by the Board or a committee of the
Board.  The 2007 Plan will expire on December 31, 2016 unless
terminated earlier in accordance with the plan.  As of September 27,
2008, no awards had been granted under the 2007 Plan.





In March
1997, the Board adopted the 1997 Stock Option Plan (“1997 Plan”).  The
1997 Plan authorized the Board to grant options to our key officers and
employees for up to 200,000 shares of our 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 vest at the
greater of 1,000 shares per year or 20% of the grant.  Options expire
10 years from the date of grant for continuing employees, or three months after
termination of employment for employees who leave the Company.  The
1997 Plan was terminated on October 20, 2007.  The termination does
not affect options outstanding under the plan, but no further options can be
granted under the 1997 Plan.





In
November 1991, the Board adopted the 1991 Stock Option Plan (“1991
Plan”).  The 1991 Plan authorized the Board to grant options for up to
200,000 shares of Company common stock to our 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.


46


Shown
below is a summary of activity under the Company’s four stock option
plans.





Outstanding
                            
                            
                            ExercisableWeighted
                            
                            
                            
                            
                            
                            WeightedAverage
                            
                            
                            
                            
                            
                            AverageShares
                            
                            
                            Number
      of
                            
                            
                            Ex.
      Price
                            
                            
                            Number
      of
                            
                            
                            Ex.
      PriceAvailable
                            
                            
                            Shares
                            
                            
                            Per Share
                            
                            
                            Shares
                            
                            
                            Per ShareBalance
      at 10/1/05
                            
                            
                            51,495
                            
                            
                            
                            350,807
                            
                            
                            $
                            5.64
                            
                            
                            
                            332,876
                            
                            
                            $
                            5.51Fiscal
      Year 2006Granted
                            
                            
                            (29,045
                            )
                            
                            
                            29,045
                            
                            
                            
                            9.67Exercised
                            
                            
                            
                            
                            
                            
                            (38,750
                            )
                            
                            
                            5.11Forfeited
                            
                            
                            750
                            
                            
                            
                            (750
                            )
                            
                            
                            12.43Balance
      at 9/30/06
                            
                            
                            23,200
                            
                            
                            
                            340,352
                            
                            
                            
                            6.03
                            
                            
                            
                            307,432
                            
                            
                            
                            5.66Fiscal
      Year 2007GrantedExercised
                            
                            
                            
                            
                            
                            
                            (108,089
                            )
                            
                            
                            5.20Forfeited
                            
                            
                            2,750
                            
                            
                            
                            (2,750
                            )
                            
                            
                            9.64New
      option plan
                            
                            
                            250,000Balance
      at 9/29/07
                            
                            
                            275,950
                            
                            
                            
                            229,513
                            
                            
                            
                            6.39
                            
                            
                            
                            218,860
                            
                            
                            
                            6.23Fiscal
      Year 2008GrantedExercised
                            
                            
                            
                            
                            
                            
                            (38,743
                            )
                            
                            
                            5.50Forfeited1997
      Plan expired
                            
                            
                            (25,950
                            )Balance
      at 9/27/08
                            
                            
                            250,000
                            
                            
                            
                            190,770
                            
                            
                            $
                            6.57
                            
                            
                            
                            189,802
                            
                            
                            $
                            6.55





Shown
below is a summary of stock options outstanding and exercisable at fiscal
year-end 2008.





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$
      2.75 - $ 4.30
                
                
                86,843
                
                
                $
                3.87
                
                
                
                2.5
                
                
                
                86,843
                
                
                $
                3.876.18
      -    6.18
                
                
                27,767
                
                
                
                6.18
                
                
                
                4.4
                
                
                
                27,767
                
                
                
                6.189.18
      -  10.52
                
                
                76,160
                
                
                
                9.78
                
                
                
                6.6
                
                
                
                75,192
                
                
                
                9.79$
      2.75 - $10.52
                
                
                190,770
                
                
                $
                6.57
                
                
                
                4.4
                
                
                
                189,802
                
                
                $
                6.55





The Board
of Directors adopted a stock purchase incentive plan in February
2000.  The 2000 Restricted Stock Plan was created to encourage our
management employees to purchase and hold Span-America common
stock.  Plan benefits are paid in shares of Company common
stock.  Benefits earned and accrued under the plan were $7,254 in
2008, $7,814 in 2007 and $11,212 in 2006.  We issued stock valued at
$7,814 in 2008, leaving a vested balance of $7,254 at September 27,
2008.


47




11.  IMPAIRMENT
OF SAFETY CATHETER ASSETS





In
October 2007, we decided to exit the safety catheter business and sell the
related assets because we had been unable to generate sufficient sales volume to
make it a viable business.  As of September 29, 2007, we recorded an
impairment charge of approximately $2,879,000 to eliminate the book value of our
safety catheter assets and we are currently engaged in efforts to sell this
segment.  As a result of the degree of uncertainty associated with any
potential sale of these assets, we concluded that we could not reasonably
estimate a net realizable value for the assets.  This charge included an
impairment charge for equipment of approximately $1,712,000, impairment of
patents and trademarks of approximately $373,000 and reduction in net realizable
value of inventories of approximately $794,000.  No impairments were
considered necessary during fiscal year 2006.  Revenues and expenses
related to the safety catheter business in fiscal year 2008 are shown as a
discontinued operation.





Results
of operations for fiscal years 2007 and 2006 have been restated to show the
safety catheter segment as a discontinued operation.





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
our deferred tax liabilities and assets as of September 27, 2008 and September
29, 2007 are as follows:





2008
                    
                    
                    2007Deferred
      tax liabilities:Depreciation
                    
                    $
                    (417,000
                    )
                    
                    $
                    (442,000
                    )Deferred
      tax assets:Deferred
      compensation
                    
                    
                    316,000
                    
                    
                    
                    600,000Accrued
      expenses
                    
                    
                    271,000
                    
                    
                    
                    286,000Inventory
                    
                    
                    357,000
                    
                    
                    
                    387,000Amortization
                    
                    
                    101,000
                    
                    
                    
                    118,000Other
                    
                    
                    10,000
                    
                    
                    
                    10,000Total
      deferred tax assets
                    
                    
                    1,055,000
                    
                    
                    
                    1,401,000Net
      deferred tax assets
                    
                    $
                    638,000
                    
                    
                    $
                    959,000




We made
cash income tax payments, net of refunds, of approximately $2,302,000,
$2,114,000, and $1,960,000 in fiscal years 2008, 2007, and 2006,
respectively.


48


Federal
and state income tax provisions consist of the following:





2008
                  
                  
                  2007
                  
                  
                  2006Current:Federal
                  
                  $
                  2,048,000
                  
                  
                  $
                  2,502,000
                  
                  
                  $
                  1,471,000State
                  
                  
                  160,000
                  
                  
                  
                  222,000
                  
                  
                  
                  126,0002,208,000
                  
                  
                  
                  2,724,000
                  
                  
                  
                  1,597,000Deferred:Federal
                  
                  
                  288,000
                  
                  
                  
                  (1,165,000
                  )
                  
                  
                  (91,000
                  )State
                  
                  
                  21,000
                  
                  
                  
                  (99,000
                  )
                  
                  
                  4,000309,000
                  
                  
                  
                  (1,264,000
                  )
                  
                  
                  (87,000
                  )Income
      tax expense
                  
                  $
                  2,517,000
                  
                  
                  $
                  1,460,000
                  
                  
                  $
                  1,510,000





Income
tax expense differs from the amounts computed by applying the federal tax rate
to income before income taxes as follows:





2008
                
                
                2007
                
                
                2006Computed
      tax at the statutory rate
                
                $
                2,511,189
                
                
                $
                1,474,000
                
                
                $
                1,552,000Increases
      (decreases):State
      income taxes, net of federal tax benefit
                
                
                120,000
                
                
                
                81,000
                
                
                
                86,000Tax-exempt
      investment income
                
                
                
                
                
                
                (51,000
                )
                
                
                (53,000
                )Extraterritorial
      income exclusion
                
                
                
                
                
                
                
                
                
                
                (12,600
                )Officer's
      life insurance
                
                
                31,000
                
                
                
                (44,000
                )
                
                
                (32,000
                )Domestic
      production deduction
                
                
                (133,345
                )
                
                
                (77,000
                )
                
                
                (44,000
                )Other,
      net
                
                
                (11,844
                )
                
                
                77,000
                
                
                
                13,600Income
      tax expense
                
                $
                2,517,000
                
                
                $
                1,460,000
                
                
                $
                1,510,000




49


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.





2008
                  
                  
                  2007
                  
                  
                  2006Numerator for basic and
      diluted earnings per
      share:Income
      from continuing operations
                  
                  $
                  4,918,764
                  
                  
                  $
                  5,504,642
                  
                  
                  $
                  3,778,926(Loss) from discontinued
      operations, net of
      income taxes
                  
                  
                  (49,915
                  )
                  
                  
                  (2,630,703
                  )
                  
                  
                  (724,115
                  )Net
      income
                  
                  $
                  4,868,849
                  
                  
                  $
                  2,873,939
                  
                  
                  $
                  3,054,811Denominator:Denominator
      for basic earnings per share:Weighted
      average shares
                  
                  
                  2,771,754
                  
                  
                  
                  2,723,942
                  
                  
                  
                  2,648,635Effect
      of dilutive securities:Employee
      and board stock options
                  
                  
                  96,740
                  
                  
                  
                  140,878
                  
                  
                  
                  123,289Denominator
      for diluted earnings per share:Adjusted weighted average
      shares and assumed
      conversions
                  
                  
                  2,868,494
                  
                  
                  
                  2,864,820
                  
                  
                  
                  2,771,924Income
      from continuing operations per share:Basic
                  
                  $
                  1.77
                  
                  
                  $
                  2.02
                  
                  
                  $
                  1.43Diluted
                  
                  $
                  1.71
                  
                  
                  $
                  1.92
                  
                  
                  $
                  1.36(Loss)
      from discontinued operations per share:Basic
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.97
                  )
                  
                  $
                  (0.27
                  )Diluted
                  
                  
                  n/a
                  
                  
                  
                  n/a
                  
                  
                  
                  n/aNet
      income per share:Basic
                  
                  $
                  1.76
                  
                  
                  $
                  1.06
                  
                  
                  $
                  1.15Diluted
                  
                  $
                  1.70
                  
                  
                  $
                  1.00
                  
                  
                  $
                  1.10




14.  EMPLOYEE
BENEFITS AND INCENTIVE PLANS





We have a
401(k) plan available to employees meeting eligibility
requirements.  We match a percentage of employee contributions, with
certain limitations.  Our 401(k) matching contributions amounted to
approximately $212,000, $183,000, and $190,000 for the 2008, 2007 and 2006
fiscal years, respectively.




15.  RELATED-PARTY
TRANSACTIONS





We had no
related-party transactions.


50




16.  MAJOR
CUSTOMERS





We have a
business relationship with a customer to manufacture and supply private label
mattresses.  Sales to this customer made up approximately 12% of net
sales in 2008, 17% in 2007 and 16% in 2006.  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 2008, 2007 and 2006.





We have a
business relationship with another customer to distribute certain of our
consumer products.  Sales to this customer amounted to 20% of net
sales in 2008, 21% of net sales in 2007, and 20% of net sales in
2006.





See Note
17 for further information about sales to major customers.





17.  OPERATIONS
AND INDUSTRY SEGMENTS





For
management and reporting purposes, we divide our business into two
segments:  medical and custom products.  This industry
segment information corresponds to the markets in the United States and Canada
for which we manufacture and distribute our various products and therefore
complies with the requirements of SFAS No. 131, “Disclosures about Segments of
an Enterprise and Related Information.”  See also Note 11 – Impairment
of the Safety Catheter Segment.





The
following table summarizes certain information on industry
segments:





2008
                    
                    
                    2007
                    
                    
                    2006Net
      sales:Medical
                    
                    $
                    42,456,763
                    
                    
                    $
                    43,248,331
                    
                    
                    $
                    36,675,830Custom
      products
                    
                    
                    16,808,502
                    
                    
                    
                    17,295,498
                    
                    
                    
                    14,760,330Total
                    
                    $
                    59,265,265
                    
                    
                    $
                    60,543,829
                    
                    
                    $
                    51,436,160Operating
      profit (loss):Medical
                    
                    $
                    7,615,385
                    
                    
                    $
                    9,129,693
                    
                    
                    $
                    6,839,256Custom
      products
                    
                    
                    800,849
                    
                    
                    
                    (266,994
                    )
                    
                    
                    (1,063,636
                    )Total
                    
                    
                    8,416,234
                    
                    
                    
                    8,862,699
                    
                    
                    
                    5,775,620Corporate
      expense
                    
                    
                    (897,760
                    )
                    
                    
                    (734,757
                    )
                    
                    
                    (683,027
                    )Other
      expense (income)
                    
                    
                    (57,710
                    )
                    
                    
                    173,700
                    
                    
                    
                    554,333Income
      from continuing operations before income taxes
                    
                    $
                    7,460,764
                    
                    
                    $
                    8,301,642
                    
                    
                    $
                    5,646,926




51





2008
                    
                    
                    2007
                    
                    
                    2006Identifiable
      assets:Medical
                    
                    $
                    15,852,599
                    
                    
                    $
                    15,869,258
                    
                    
                    $
                    13,513,665Custom
      products
                    
                    
                    5,583,170
                    
                    
                    
                    5,234,675
                    
                    
                    
                    6,096,464Corporate
                    
                    
                    2,677,085
                    
                    
                    
                    2,734,125
                    
                    
                    
                    8,054,930Discontinued
      operations
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,347,419$
                    24,112,854
                    
                    
                    $
                    23,838,058
                    
                    
                    $
                    31,012,478Depreciation
      and amortization expenses:Operating:Medical
                    
                    $
                    512,415
                    
                    
                    $
                    444,751
                    
                    
                    $
                    380,944Custom
      products
                    
                    
                    216,440
                    
                    
                    
                    232,522
                    
                    
                    
                    207,992Corporate
                    
                    
                    502
                    
                    
                    
                    429
                    
                    
                    
                    632729,357
                    
                    
                    
                    677,702
                    
                    
                    
                    589,568Other
      - discontinued operations
                    
                    
                    
                    
                    
                    
                    352,011
                    
                    
                    
                    353,613$
                    729,357
                    
                    
                    $
                    1,029,713
                    
                    
                    $
                    943,181Capital
      expenditures:Medical
                    
                    $
                    492,088
                    
                    
                    $
                    884,655
                    
                    
                    $
                    735,962Custom
      products
                    
                    
                    199,955
                    
                    
                    
                    124,520
                    
                    
                    
                    335,111692,043
                    
                    
                    
                    1,009,175
                    
                    
                    
                    1,071,073Other
      - discontinued operations
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,623$
                    692,043
                    
                    
                    $
                    1,009,175
                    
                    
                    $
                    1,073,696





Total
sales by industry segment include sales from unaffiliated customers as reported
in our 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.





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.





We have
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 52% of net medical sales in 2008, 57% in 2007,
and 58% in 2006.  In the custom products segment, sales to one
customer accounted for 71% of net custom products sales in 2008, 72% in 2007,
and 69% in 2006.





Export
sales (net), primarily to Canada, were approximately $3,287,000 in 2008,
$3,569,000 in 2007, and $3,004,000 in 2006.  We have no physical
assets in Canada or any foreign country.


52





18.  OPERATING
LEASES





We lease
truck equipment in South Carolina.  In addition, we lease a 15,000
square foot distribution facility in Utah for $6,750 a month.  The
Utah facility lease is cancellable by either party with 60 days
notice.  Both leases require us to pay certain insurance and
maintenance costs.





Rental
expense for all operating leases was $104,000 in 2008, $107,000 in 2007, and
$212,000 in 2006.





19.  COMMITMENTS
AND CONTINGENCIES





We are
committed to minimum purchases of $625,000 of Selan® skin care products per
calendar year through 2010.  For the fiscal years ended 2008, 2007 and
2006, purchases under this commitment were $748,000, $782,000, and
$757,000.





From time
to time we are defendants in legal actions involving claims arising in the
normal course of business.  We believe that, as a result of legal
defenses and insurance arrangements, none of these actions should have a
material adverse effect on our operations or financial condition.





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
                                                            
                                                            
                                                            YearFor
      Fiscal 2008Net
      sales
                                                            
                                                            $
                                                            13,664
                                                            
                                                            
                                                            $
                                                            15,770
                                                            
                                                            
                                                            $
                                                            14,852
                                                            
                                                            
                                                            $
                                                            14,979
                                                            
                                                            
                                                            $
                                                            59,265Gross
      profit
                                                            
                                                            
                                                            4,647
                                                            
                                                            
                                                            
                                                            5,544
                                                            
                                                            
                                                            
                                                            4,955
                                                            
                                                            
                                                            
                                                            5,249
                                                            
                                                            
                                                            
                                                            20,395Operating
      income
                                                            
                                                            
                                                            1,638
                                                            
                                                            
                                                            
                                                            2,134
                                                            
                                                            
                                                            
                                                            1,771
                                                            
                                                            
                                                            
                                                            1,975
                                                            
                                                            
                                                            
                                                            7,518Income
      from continuing operations
                                                            
                                                            
                                                            1,062
                                                            
                                                            
                                                            
                                                            1,404
                                                            
                                                            
                                                            
                                                            1,162
                                                            
                                                            
                                                            
                                                            1,291
                                                            
                                                            
                                                            
                                                            4,919Loss
      from discontinued operations  net of income taxes
                                                            
                                                            
                                                            (17
                                                            )
                                                            
                                                            
                                                            (27
                                                            )
                                                            
                                                            
                                                            (4
                                                            )
                                                            
                                                            
                                                            (2
                                                            )
                                                            
                                                            
                                                            (50
                                                            )Net
      income
                                                            
                                                            
                                                            1,045
                                                            
                                                            
                                                            
                                                            1,377
                                                            
                                                            
                                                            
                                                            1,158
                                                            
                                                            
                                                            
                                                            1,289
                                                            
                                                            
                                                            
                                                            4,869Earnings
      per shareBasic
                                                            
                                                            
                                                            0.38
                                                            
                                                            
                                                            
                                                            0.50
                                                            
                                                            
                                                            
                                                            0.42
                                                            
                                                            
                                                            
                                                            0.47
                                                            
                                                            
                                                            
                                                            1.76Diluted
                                                            
                                                            
                                                            0.36
                                                            
                                                            
                                                            
                                                            0.48
                                                            
                                                            
                                                            
                                                            0.41
                                                            
                                                            
                                                            
                                                            0.45
                                                            
                                                            
                                                            
                                                            1.70




53





Quarterly
      Financial Data (Unaudited)(Amounts
      in thousands, except per share data)First
                              
                              
                              Second
                              
                              
                              Third
                              
                              
                              Fourth
                              
                              
                              YearFor
      Fiscal 2007 *Net
      sales
                              
                              $
                              13,432
                              
                              
                              $
                              16,421
                              
                              
                              $
                              15,204
                              
                              
                              $
                              15,486
                              
                              
                              $
                              60,544Gross
      profit
                              
                              
                              4,778
                              
                              
                              
                              5,188
                              
                              
                              
                              5,481
                              
                              
                              
                              5,504
                              
                              
                              
                              20,951Operating
      income
                              
                              
                              1,787
                              
                              
                              
                              1,967
                              
                              
                              
                              2,087
                              
                              
                              
                              2,286
                              
                              
                              
                              8,128Income
      from continuing operations
                              
                              
                              1,219
                              
                              
                              
                              1,336
                              
                              
                              
                              1,447
                              
                              
                              
                              1,503
                              
                              
                              
                              5,505Loss
      from discontinued operations net of income taxes
                              
                              
                              (199
                              )
                              
                              
                              (155
                              )
                              
                              
                              (192
                              )
                              
                              
                              (2,084
                              )
                              
                              
                              (2,631
                              )Net
      income
                              
                              
                              1,021
                              
                              
                              
                              1,181
                              
                              
                              
                              1,255
                              
                              
                              
                              (582
                              )
                              
                              
                              2,874Earnings
      per shareBasic
                              
                              
                              0.38
                              
                              
                              
                              0.44
                              
                              
                              
                              0.46
                              
                              
                              
                              (0.21
                              )
                              
                              
                              1.06Diluted
                              
                              
                              0.36
                              
                              
                              
                              0.42
                              
                              
                              
                              0.43
                              
                              
                              
                              n/a
                              
                              
                              
                              1.00





* As
restated to show the safety catheter segment as a discontinued operation. See
Note 11.





Item 9. Changes in and
Disagreements With Accountants on Accounting and Financial
Disclosure





None





Item 9A.  Controls
and Procedures





Evaluation
of Disclosure Controls and Procedures


Our management has evaluated, with the
participation of our Chief Executive Officer and Chief Financial Officer,
the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this annual report (the “Evaluation Date”), and, based on this
evaluation, our 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 our internal controls over financial
reporting during the last quarter of fiscal 2008 that have materially affected
or are reasonably likely to materially affect our internal control over
financial reporting.





Disclosure controls and procedures
are  controls and other procedures that are designed to ensure that
information required to be disclosed by us in the reports that we file or submit
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 management in the reports that it files or submits under the
Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate to allow for timely decisions regarding required
disclosure.


54






Management’s
Report on Internal Control over Financial Reporting


The
management of Span-America Medical Systems, Inc. is responsible for establishing
and maintaining adequate internal control over financial reporting, as such term
is defined in Exchange Act Rules 13a-15(f) and 15d-15(f).  Span-America’s
internal control system was designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles and includes those policies and procedures
that:


1.
            pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect the transactions and dispositions of the assets of
      Span-America;


2.
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of Span-America
      are being made only in accordance with authorizations of management and
      directors of Span-America; and


3.
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of Span-America’s assets that
      could have a material effect on the financial
  statements.





All
internal control systems, no matter how well designed, have inherent
limitations.  Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation





We have
assessed the effectiveness of our internal control over financial reporting as
of September 27, 2008.  In making this assessment, we used the framework
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal Control--Integrated Framework.  Based on that
assessment, we believe that as of September 27, 2008, our internal control over
financial reporting is effective.





This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting.  Our report on internal control was not subject to
attestation by our registered public accounting firm pursuant to temporary rules
of the Securities and Exchange Commission that permit us to provide only
management’s report in this annual report.





Other
Matters


We are in
the process of finalizing the implementation of a new Enterprise Resource
Planning (ERP) system.  An ERP system is a fully-integrated set of programs
and databases that incorporate order processing, production planning and
scheduling, purchasing, accounts receivable and inventory management and
accounting.   In connection with this ERP system implementation, we
have updated and will continue to update our internal controls over financial
reporting, as necessary, to accommodate modifications to our business processes
and accounting procedures.  We do not believe that this ERP system
implementation will have an adverse effect on our internal control over
financial reporting.




55


Item 9B.  Other
Information





None





PART
III





Item
10.  Directors, Executive Officers and Corporate
Governance





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 our 2008 fiscal year under the headings
“Proposals to be Voted Upon – Election of Directors,” “Corporate Governance,”
“Executive Officers” and “Section 16(a) Beneficial Ownership Reporting
Compliance.”





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 our 2008 fiscal year under the headings
“Compensation of Executive Officers,” “Corporate Governance – Director
Compensation” and “Corporate Governance – Compensation Committee Interlocks and
Insider Participation.”





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
our definitive Proxy Statement filed or to be filed with the Securities and
Exchange Commission on or prior to 120 days following the end of our 2008 fiscal
year is incorporated herein by reference.


56




The
following table summarizes information regarding our equity compensation plans
as of September 27, 2008:





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
            
            190,770
            
            $
            6.57
            
            250,000Equity
      compensation plans not approved by security holders
            
            0
            
            
            0
            
            0(1)Total
            
            190,770
            
            $
            6.57
            
            250,000  (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.  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.  We
      do 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.





For additional information on our stock
option plans, see Note 10 in the Notes to Financial Statements for the year
ended September 27, 2008.




Item 13.  Certain
Relationships and Related Transactions, and Director
Independence





The information required under Item 13
of Part III is incorporated herein by reference to portions of our definitive
Proxy Statement filed or to be filed with the Securities and Exchange Commission
on or prior to 120 days following the end of our 2008 fiscal year under the
headings “Certain Relationships and Related Transactions” and “Corporate
Governance – Director Independence.”


57





Item
14.  Principal Accountant Fees and Services
 
 The information required under Item 14
of Part III is incorporated herein by reference to portions of our definitive
Proxy Statement filed or to be filed with the Securities and Exchange Commission
on or prior to 120 days following the end of our 2008 fiscal year under the
heading “Principal Accountant Fees and Services.”
  PART IV
 
 Item 15.  Exhibits
and 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.
 
 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.
  58
  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
              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.
 
 4.2.1
              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.
 
 4.3
              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*
              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.
 
 10.3*
              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.
 
 10.4*
              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.
 
 10.4.1*
              Amendment
      No. 1 to the 1991 Stock Option Plan: Incorporated by reference to Exhibit
      10.4.2 to the 1998 10-K.
 
 10.5*
              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.
  59
  10.5.1*
              Amendment
      No. 1 to the 1997 Stock Option Plan: Incorporated by reference to Exhibit
      10.14.2 to the 1998 10-K.
 
 10.6*
              1997
      Long Term Incentive Stock Option Plan: Incorporated by reference to
      Exhibit 10.15 to the 1997 10-K.
 
 10.7*
              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.
 
 10.8*
              Span-America
      Medical Systems, Inc. 2007 Equity Incentive Plan: Incorporated by
      reference to Appendix A to the Company’s Definitive Proxy Statement for
      its 2007 Annual Meeting of Shareholders filed with the Commission on
      January 8, 2007.
 
 10.9*
              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.
 
 10.10*
              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.
 
 10.11*
              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.
 
 10.12*
              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.
 
 10.13*
              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.
 
 10.14*
              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.
 
 10.15*
              Severance
      Protection Agreement between the Company and Erick C. Herlong dated
      December 1, 2008.
 
 10.16*
              Severance
      Protection Agreement between the Company and Marie Sitter dated December
      1, 2008.
 
 10.17
              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.
  60
  10.17.1
              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.
 
 10.18
              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.
 
 10.19
              Loan
      Agreement dated June 5, 2007 by and between Carolina First Bank, as
      lender, and the Company, as borrower:  Incorporated by reference
      to the Company’s Current Report on Form 8-K dated June 5, 2007 and filed
      with the commission on June 11,
2007.
 
 10.19.1
              Revolving
      Note dated June 5, 2007 by the Company to Carolina First
      Bank:  Incorporated by reference to the Company’s Current Report
      on Form 8-K dated Jun 5, 2007 and filed with the commission on June 11,
      2007.
 
 10.19.2
              Negative
      Pledge Agreement dated June 5, 2007 by the Company to Carolina First
      Bank:  Incorporated by reference to the Company’s Current Report
      on Form 8-K dated June 5, 2007 and filed with the commission on June 11,
      2007.
 
 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
 
 (c)
              Financial Statement
      Schedules


61





Schedule
      VIII Valuation and Qualifying AccountsCOL.
      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 27, 2008Deducted
      from asset accounts:Reserve
      for uncollectible accounts
                                    
                                    $
                                    189,000
                                    
                                    
                                    $
                                    75,500
                                    
                                    
                                    $
                                    29,500
                                    
                                    (a)
                                    
                                    $
                                    235,000Year
      Ended September 29, 2007Deducted
      from asset accounts:Reserve
      for uncollectible accounts
                                    
                                    $
                                    117,000
                                    
                                    
                                    $
                                    99,841
                                    
                                    
                                    $
                                    27,841
                                    
                                    (a)
                                    
                                    $
                                    189,000Year
      Ended September 30, 2006Deducted
      from asset accounts:Reserve
      for uncollectible accounts
                                    
                                    $
                                    116,000
                                    
                                    
                                    $
                                    47,762
                                    
                                    
                                    $
                                    46,762
                                    
                                    (a)
                                    
                                    $
                                    117,000





(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.


62





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
      19, 2008Thomas
      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 Officer and
      DirectorJames
      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/
      Dan R. Lee
                                
                                DirectorDan
      R. Lee/s/
      Linda D. Norman
                                
                                DirectorLinda
      D. Norman


December 19, 2008


63