Span-America Medical Systems 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the Quarterly Period Ended January 1, 2011
___ 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)
70 Commerce Center
Greenville, South Carolina 29615>
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (864) 288-8877
(Former name, former address and former fiscal year, if changed since last report.)
APPLICABLE ONLY TO CORPORATE ISSUERS
SPAN-AMERICA MEDICAL SYSTEMS, INC.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Note: The Balance Sheet at October 2, 2010 has been derived from the audited financial statements at that date.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The statements contained in this Quarterly Report that are not historical facts are forward-looking statements that involve risks and uncertainties. We wish to caution the reader that these forward-looking statements, such as our expectations for future sales results or expense changes compared with previous periods, are only predictions. Actual events or results may differ materially as a result of risks and uncertainties facing our Company as described in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 2, 2010 and other risks referenced in our Securities and Exchange Commission filings. We disclaim any obligation to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise.
RESULTS OF OPERATIONS
Sales for the first quarter of fiscal 2011 declined by 4% to $11.7 million compared with $12.2 million in the first quarter of last year primarily as a result of weak demand for our premium PressureGuard® support surfaces in the long-term care and home care markets. Although we had higher sales of Geo-Mattress® all-foam support surfaces, other medical product lines and our consumer and industrial products, the increases were not enough to offset lower volume within our PressureGuard product group. Net income for the quarter declined to $717,000, or $0.25 per diluted share, compared with $1.1 million, or $0.40 per diluted share, in the first quarter of 2010. The decrease in net income compared with last year was primarily the result of a less profitable sales mix in the custom products segment, lower sales and a less profitable sales mix in the medical segment and higher material costs in the consumer part of the custom products segment.
The sales decrease for the first quarter of 2011 compared with the first quarter of 2010 was due primarily to the 8% decline in sales in the medical segment to $8.0 million from $8.7 million in the first quarter of 2010. Sales of therapeutic support surfaces, our largest overall medical product line, declined 13% to $4.7 million in the first quarter of fiscal 2011 from $5.5 million in the first quarter of last year mainly because of lower volume within our PressureGuard product lines. The decline in PressureGuard sales was partly offset by an increase in sales of our Geo-Mattress support surfaces. Geo-Mattress products are generally less expensive than PressureGuard products and tend to be more popular in a weak economy. We are still experiencing weak demand for equipment purchases in the long-term care and home care markets where customer spending and capital availability remain constrained by a reported lack of confidence in the economy and concern about Medicare and Medicaid funding.
Sales results for other medical products were largely positive in the first quarter of 2011. Patient positioner sales rose 2% in the first quarter of fiscal 2011 compared with the first quarter of fiscal 2010 due to increased demand from our customers in the acute care market. Sales of the Risk Manager® bedside safety mat grew by 27%, and sales of seating products increased by 6%. Mattress overlays declined 9%, and Selan sales were down by 1% compared with the same period in the last fiscal year.
We expect sales in the medical segment to slowly improve in the remaining quarters of fiscal 2011 compared with first quarter fiscal 2011 performance. We recently introduced the Custom Care® and Ultramax® therapeutic support surfaces that are targeted at the acute care market, and we expect these new products to contribute to our expected growth during the remainder of the year. In addition, we believe sales will continue to benefit from growth in our Geo-Mattress product line.
Within the custom products segment, sales rose 4% to $3.7 million in the first quarter of fiscal 2011 compared with the same quarter last year as a result of increased demand and higher sales volume in both parts of the custom products business: consumer and industrial product lines. Sales of consumer bedding products increased 3% to $3.0 million compared with the first quarter of last year. The growth in consumer sales came mostly from two new consumer product lines launched in the fourth quarter of fiscal 2010. Sales growth from the new product lines was partly offset by a decline in sales to another consumer customer. We believe the decline in sales to that customer was caused by the customer’s increase in the retail price of our products, which reduced demand compared with the first quarter of fiscal 2010.
Sales of industrial products increased 8% in the first quarter of fiscal 2011 to $679,000 compared with $627,000 in the first quarter of last year. The sales growth in our industrial product lines came from customers in the automotive and packaging markets, which was partly offset by a decline in industrial sales to the water sports market.
We expect custom products sales for the remaining quarters of fiscal 2011 to be greater than those of the first quarter of fiscal 2011.
Gross profit for the first quarter of fiscal 2011 declined 15% to $4.0 million compared with $4.7 million in the first quarter of last fiscal year. Gross margin declined to 34.2% of net sales in the first quarter of fiscal 2011 compared with 38.3% of net sales in the first quarter of fiscal 2010. Most of the declines in gross profit and margin compared with the first quarter of fiscal 2010 occurred in the consumer part of our custom products segment and were caused by a combination of a less profitable sales mix and higher material costs. Our consumer sales mix was less profitable in the first quarter of fiscal 2011 because one of the two new consumer product lines shipped in the first quarter was an opening price point product, which generally has a lower gross margin than our other consumer products. In addition, lower medical sales volume and a less profitable medical sales mix contributed to a lower gross margin in the medical segment in the first quarter of fiscal 2011. We expect our overall gross profit and margin for the remainder of fiscal 2011 to improve slightly over first quarter levels. However, we believe gross margins in the consumer business will remain under pressure in the near term due to competitive pricing situations.
Selling, Research & Development and Administrative Expenses
Selling and marketing expenses declined 1% to $2.1 million during the first quarter of fiscal 2011 compared with the first quarter of fiscal 2010 because of lower commissions and incentive compensation in the medical segment. We believe that total selling and marketing expenses for the remaining quarters of fiscal 2011 will be slightly higher than first quarter levels.
Medical benefits cost, which is spread across several expense line items, increased by $125,000 in the first quarter of fiscal 2011 due to higher-than-usual claims cost. This reduced earnings by $0.03 per diluted share after taxes compared with the first quarter of fiscal 2010.
Research and development expenses decreased 26% to $164,000 for the first quarter of fiscal 2011 compared with $223,000 in the first quarter of fiscal 2010 because we completed several medical product development projects during fiscal 2010. We are continuing to pursue several attractive product development projects. Consequently, we expect total research and development expenses for the remaining quarters of fiscal 2011 to be similar to first quarter levels.
General and administrative expenses declined by 1% to $683,000 in the first quarter of fiscal 2011 compared with $693,000 in the first quarter of last year. The decrease was primarily due to lower incentive compensation and property/casualty insurance expense in the first quarter of fiscal 2011 compared with the first quarter of fiscal 2010. We expect that administrative expenses for the remaining quarters of fiscal 2011 will be similar to first quarter levels.
Operating income for the first quarter of fiscal 2011 was down 36% to $1.1 million compared with $1.7 million in the first quarter of last year. The decline in operating income for the first quarter of fiscal 2011 was the result of lower medical sales volume, a less profitable mix of sales in both the medical and custom products segments and higher material costs primarily within our consumer product lines.
Investment and other non-operating income fell to $5,000 in the first quarter of fiscal 2011 from $14,000 in the first quarter of fiscal 2010 because of lower average levels of short-term investments and lower interest rates earned in the first quarter this year compared with last year. We expect net non-operating income for the remaining quarters of fiscal 2011 to be similar to first quarter levels.
Net Income and Dividends
Net income declined 37% to $717,000, or $0.25 per diluted share, compared with $1.1 million, or $0.40 per diluted share, in the first quarter last year. The decline in net income was caused mainly by the factors described above. We expect net income in the remaining quarters of fiscal 2011 to be slightly higher than first quarter levels.
During the first quarter of fiscal 2011, we paid dividends of $276,000, or 38% of net income. This payment represented one quarterly dividend of $0.10 per share. During the first quarter of last year, we paid dividends of $272,000, or 24% of net income, which also represented one quarterly dividend of $0.10 per share.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operations during the first quarter of fiscal 2011 decreased 78% to $348,000 compared with $1.5 million in the first quarter of fiscal 2010. The decrease in operating cash flow during the first quarter was caused mainly by a decrease in accounts payable, an increase in inventory levels and lower net income compared with the first quarter of fiscal 2010. Major uses of cash provided by operations during the first quarter were payment of dividends of $276,000 and the purchase of property and equipment of $74,000.
Working capital increased by $486,000, or 4%, to $12.4 million at the end of the first quarter of fiscal 2011 compared with fiscal year end 2010. The increase was caused primarily by lower balances of accounts payable and higher inventory levels as discussed below. The current ratio at quarter end was up to 4.0 from 3.4 at fiscal year-end 2010.
Accounts receivable, net of allowances, decreased by 8% to $6.6 million at the end of the first quarter of fiscal 2011 compared with $7.1 million at the end of fiscal 2010 reflecting our lower sales levels in the first quarter. Days sales outstanding (or average collection time), calculated using a monthly average for our trade accounts receivable, was 45 days in the first quarter of fiscal 2011 compared with 42 days in the first quarter of fiscal year 2010. The longer collection time resulted from extended payment terms offered to a medical customer group as part of a sales promotion program in the fourth quarter of last year. All of our accounts receivable are unsecured.
Inventories increased by $379,000, or 9%, to $4.5 million at the end of the first quarter of fiscal 2011 compared with $4.1 million at fiscal year-end 2010. The inventory increase occurred mainly in the categories of medical and consumer raw materials related to our new Custom Care product line in the medical segment and two new product lines in the consumer segment. We expect total inventory levels during fiscal 2011 to be similar to first quarter levels.
Prepaid expenses decreased by 54% to $198,000 on January 1, 2011, compared with $431,000 at the end of fiscal 2010 because income tax payments refundable at the end of fiscal 2010 were offset by income tax accruals during the first quarter of fiscal 2011.
Net property and equipment decreased by $104,000, or 2%, to $5.6 million at the end of the first quarter of fiscal 2011 as the result of normal depreciation expense of $178,000, partially offset by capital expenditures of $74,000. We expect capital expenditures during fiscal 2011 to be similar to those of fiscal 2010.
Other assets increased $58,000, or 2%, to $2.8 million on January 1, 2011, compared with fiscal year-end 2010 mainly because of an increase in the cash value of corporate-owned life insurance policies.
Our accounts payable decreased by $797,000, or 34%, to $1.5 million on January 1, 2011, compared with $2.3 million at fiscal year-end 2010. The decline was the result of lower levels of foam purchased in December 2010 compared with September 2010, which was related to the decline in sales volume in the first quarter of fiscal 2011. Accrued and sundry liabilities decreased by $110,000, or 4%, to $2.5 million compared with fiscal year-end 2010 due to the payment of previously accrued incentive compensation.
We currently have no borrowings outstanding on our revolving line of credit. The maximum principal amount we can borrow at any one time under the agreement is $10 million. The maturity date is June 5, 2012. We believe that we were in compliance with all covenants relating to this agreement as of January 1, 2011.
Our 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 in the loan agreement. Violation of loan covenants could result in the acceleration of certain provisions of the agreement.
In November 2007, we announced a program to repurchase up to 138,772 shares of our outstanding common stock. On February 11, 2009, the Board expanded the repurchase program by 100,000 shares, bringing the total number of authorized shares to 238,772. Pursuant to this program, we repurchased 600 shares of our outstanding common stock during the first quarter of fiscal 2011 at a total cost of approximately $8,000. We intend to continue to repurchase our stock from time to time in the open market or in private transactions, depending on market and Company conditions. Considering prior purchases, we are still authorized to repurchase 95,903 shares under the program. The stock repurchase program, however, may be suspended or discontinued at any time.
We believe that funds on hand, funds generated from operations and funds available under our revolving credit facility are adequate to finance normal operations and planned capital expenditures during fiscal 2011 and for the foreseeable future.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
IMPACT OF INFLATION
Based on current conditions in the markets for our primary raw materials, we expect inflation to be a small to moderate factor for our operations in fiscal 2011. We experienced modest price increases in several of our raw materials during the first quarter of fiscal 2011. We could experience upward pressure on raw material costs if demand for our commonly-used raw materials increases as a result of a strengthening U.S. economy or if oil prices increase materially. We have generally been successful at offsetting the effect of previous raw material cost increases through a combination of sales price increases, 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 the available supply of component chemicals, demand for related products from domestic and international manufacturers, competition among domestic suppliers, our purchase volumes and regulatory requirements. Consequently, it is difficult for us to accurately predict the impact that future inflation and other factors might have on the cost of polyurethane foam, our largest-volume raw material.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to financial market risk in three areas: our short-term investments, cash value of life insurance, and our credit facility. As of January 1, 2011, we had short-term investments of $3.7 million, which were classified as available for sale. These short-term investments are high quality, highly liquid corporate commercial paper and bonds known as “variable rate demand notes” or “low floaters.” The bonds are issued by municipalities or companies and are backed by letters of credit from federally insured banks. The bonds carry the credit rating of the underlying bank. The interest rate on each bond is a floating rate, which is reset weekly or monthly, depending on the issue, by the re-marketing agent based on market rates for comparable securities or through an auction process. We can liquidate the bonds at any time with a settlement date of seven days after the trade date. Using the level of securities available for sale at January 1, 2011, a 100 basis point increase or decrease in interest rates for one year would increase or decrease pre-tax earnings by approximately $37,000. The effect of a 100 basis point increase or decrease in interest rates will vary from period to period with the dollar amount invested in our low floater portfolio.
As of January 1, 2011, our other assets included $2.0 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. 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, company and interest rate risks 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 quarter ended January 1, 2011, cash value of life insurance increased by 3%, creating non-cash income of approximately $83,000.
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 degree of impact would vary depending on the level of the borrowings. Interest is payable monthly. There is no unused commitment fee associated with the line of credit. An increase in interest rates would have a negative impact on our financial condition and earnings to the extent that we have outstanding borrowings under the facility. Unless we borrow again under the facility or otherwise incur significant debt with a variable interest rate, a change in interest rates would have no material effect on our interest expense.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of January 1, 2011, and, based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures were effective as of January 1, 2011. There were no changes in the Company’s internal control over financial reporting during our fiscal quarter ended January 1, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Disclosure controls and procedures are the Company’s controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
We announced on November 28, 2007 that the Board of Directors authorized the Company to repurchase up to 138,772 shares of its common stock. On February 11, 2009, the Board expanded the repurchase program by 100,000 shares, bringing the total number of authorized shares to 238,772. 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 I – Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources, which description is incorporated herein by reference.
ITEM 6. EXHIBITS
Pursuant to the requirements 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.
/s/ Richard C. Coggins
Richard C. Coggins
Chief Financial Officer
/s/ James D. Ferguson
James D. Ferguson
President and Chief Executive Officer
Date: February 14, 2011