Span-America Medical Systems' (SPAN) CEO Jim Ferguson on Q3 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Span - (SPAN)

Span-America Medical Systems, Inc. (NASDAQ:SPAN)

Q3 2014 Earnings Conference Call

August 5, 2014 10:00 AM ET

Executives

Jim Ferguson - President and CEO

Richard Coggins - CFO, Treasurer and Secretary

Analysts

Doug Weiss - DSW Investments

Brian Rafn - Morgan Dempsey Capital Management

Sam Rebotsky - SER Asset Management

Operator

Good morning and welcome to Span-America Medical Systems’ Third Quarter Conference Call. This call is being recorded.

Before we begin today's call, let me remind listeners that this conference call contains statements that are forward-looking as defined within the Private Securities Litigation Reform Act of 1995. We wish to caution the listener that these statements are only predictions, actual events or results may differ materially as a result of risks and uncertainties facing the Company including the inability to achieve anticipated sales growth in the medical and custom product segments, the possibility of disruptions in our consumer products business related to the transfer of our exclusive distribution agreement from Louisville Bedding Company to Hollander Home Fashions in May 2013 as a result of the sale of Louisville Bedding’s utility, bedding, retail businesses to Hollander, the possibility of a loss of a key customer or a distributor from our products, risks related to international operations and foreign exchange associated with our Canadian subsidiary, the possibility of having material uncollectible receivables from one or more of our customers or distributors, the potential for volatile pricing conditions in the market for polyurethane foam, raw material cost increases, the possibility that some or all of our medical products could be determined to be subject to a 2.3% medical device excise tax imposed by the Affordable Care Act, the potential for lost sales due to competition from low-cost foreign imports, changes in relationships with large customers or key suppliers, the impact of competitive products and pricing, government reimbursement changes in the medical market, FDA and Health Canada regulation of medical device manufacturing and other risks referenced from time-to-time in our Securities and Exchange Commission filings. Span-America is not responsible for updating information contained in this conference call beyond today or for changes made to this call by the Conference Call Company or Internet services.

I would now like to turn the call over to Mr. Jim Ferguson, President and CEO of Span-America Medical Systems. Go ahead sir.

Jim Ferguson

Thank you, Jamie and good morning to everyone and thanks for being on the call with us today. And as usual I have Richard Coggins, our CFO with me. He will give you some more financial details in just a few minutes. First, I’d like to give you -- make a few comments about our third quarter performance.

Our third quarter was well below what we had anticipated. And seeing the things really came to a halt with respect to sales in April and May, fortunately June began to improve. The fourth quarter at this point is beginning to shape up as much better. In the third quarter our sales were down 29% which gave us operating earnings that were down 69%. The earnings per share number was $0.13 per share versus $0.41 per share in the third quarter of 2013. This was also a decline of 69%.

We knew that things were going to be tough for our M.C. Healthcare and then our consumer business much as it had been during the first two quarters. But the tough part was a sudden decrease in our normal medical business. This included our support surfaces, positioners, and wheelchair cushions. A lot of decline came from the large corporate order that we had in 2013 but did not repeat in 2014. However, this coupled with continued softness in the bed frame market and made things much more difficult. Many companies saw things soften in the second quarter particularly in the medical segment but we saw this turning over into April and May of the third quarter. As I said June shows improvement and looks very promising.

In the custom products business, we knew that this was going to be stronger with our highly documented walls of a large retail customer. However, we had a number of new projects coming on stream which should had given us a shot in the arm. The unfortunate part was that most of these got pushed back from late April shipped days to late May shipped days and most of this product actually shipped out during the month of June and over into July. This late start was not enough to salvage the quarter for us. The one bright spot was our industrial segment. They have continued to maintain a good pace with sales up 18% in the quarter. The sales manager have been telling me that he was on the verge of some good things happening and he was right we expect this segment to finish strong throughout the end of 2014.

The good part of the quarter was our gross margin. You would have expected it to be down significantly as with the sales, but it was only down six tenths of a percent. As a matter of fact on a year-to-date basis, we’re up 1.7%. This was a sign that we did a pretty good job of taking cost out of the business particularly when we lost our large consumer customer. And it’s also a sign that our pricing in the medical business continues to hold up even though our sales have not matched their expectations.

Overall, it was a tough quarter for us now we would be concerned about the medical business if we were losing business to others, but this is not the case. I believe that we have gone through a very rough patch in the economy which will work its way to the positive side pretty quickly. Both hospitals and nursing homes are still trying to figure out this Affordable Care Act and its made things much tougher than we expected. I would also like to note that last week we also announced our 99th straight dividend and we also not only announced the payment of that dividend but we also increased our dividend from $0.14 a share to $0.15 a share for the quarter.

And with that I’d like to turn it over to Richard and he can give you a lot of the details. Richard?

Richard Coggins

Thank you Jim and thank you to our listeners’ we appreciate you joining us for today’s call. I’ll follow our usual format. First I’ll go over our financial results from the third quarter of this fiscal year and looking at our sales and earnings results. Then I’ll discuss our balance sheet and cash flow for the quarter and then I’ll turn the call back over to Jim to get his comments on the business and our outlook for the future.

As Jim mentioned, our sales and earnings for the third quarter of fiscal 2014 were down significantly from the third quarter last year. There were three main events that affected our third quarter performance and these are in order of largest to smallest impact that they had on our sales volume. The first was a decline in our consumer bedding sales that was caused by the awful large customer that we’ve discussed several times during last few quarters. The second event was a decline in sales of our therapeutic support surfaces which was caused by a large order in the third quarter last year that was not repeated in the third quarter this year. And the third large event was a decline our M.C. Healthcare sales that was mostly due to fluctuations and the timing of capital equipment orders, and I’ll talk more about that in just a minute.

But those three developments gave us a 29% or a $5.4 million decline in sales volume compared with the third quarter last year and almost all of our sales and earnings decline for the third quarter was related to those three events. I’ll give you more details on those items in just a few minutes when we talk about our medical and custom products business units.

So first let’s talk about the medial segment which is our largest and most profitable unit and our total medical sales were down 23% for the quarter to $10.3 million that was a sales decline of 3.1 million compared with total medical sales of 13.4 million in the third quarter last year. Almost all of that medical sales decline came from the two main areas that I just mentioned. First, sales of our therapeutic support surfaces were off by 2.1 million which was a 28% decline in that product line. And this was the first time in 12 quarters or three years that we’ve had a quarter-over-quarter decline in sales of our therapeutic support surfaces and that’s our largest medical product line.

As we said before, it was caused almost entirely by a larger order from a long-term care customer that we had in the third quarter last year that was not repeated in the third quarter of this year. And so excluding the large order from last year’s third quarter our sales of therapeutic support surfaces would have been roughly level in the third quarters of last year and this year. So that event alone made up about two-thirds of our medical sales decline. Most of the remaining one-third of the decrease in medical sales came from our M.C. Healthcare products which were down 27% so that was an $880,000 decrease to 2.4 million in sales for the quarter. And volume of 2.4 million at M.C. Healthcare is about an average quarter for us, but we were comparing that to a particularly strong quarter in the third quarter last year when we had M.C. Healthcare sales of 3.3 million. But if we look forward one quarter, our M.C. Healthcare volume was below average in the fourth quarter of last fiscal year at $1.6 million. So we’re seeing some quarter-to-quarter volatility in this capital equipment business.

And we have strong quarter in the third quarter last year followed by a weak quarter in the first quarter and we will likely see the opposite pattern this year with an average quarter in the third quarter that we just completed followed by a strong quarter in the current quarter or Q4 of this year. In fact our combination of shift in booked orders for M.C. Healthcare so far this quarter that we’re currently in are already greater than our total M.C. Healthcare shipments and for the full fourth quarter last year. So even though we have from quarter-to-quarter swings in sales volume, we expect our M.C. Healthcare sales for the last half of this fiscal year to be higher than they were in the last half of last fiscal year mainly because of healthy sales growth in the fourth quarter this year.

That covers our two largest medical product lines which are therapeutic support surfaces and beds. Now looking at our other medical product lines as a group combined sales of those products were down 7% during the quarter, generally because of lower demand in the third quarter this year compared with last year. The only exception to this occurred in our line of seating products were sales grew by 5% during the quarter.

Now let’s take a look at our Custom Products segment which is made up of consumer bedding and specialty industrial products. And the custom products sales were down 43% in the third quarter to $3 million compared with 5.2 million in the third quarter last year and all of the custom products sales decline came from our consumer bedding products. Consumer sales in the third quarter were down 2.4 million or 54% to $2 million for the quarter, and 100% of the consumer sales decline was the result of the loss of the large retail customer that we’ve talked about several times. Excluding that lost account, our sales in the third quarter were -- our consumers sales in the third quarter were flat compared with third quarter last year.

And as Jim mentioned in his introduction, we had several new pieces of consumer business that were originally scheduled to start early in the third quarter and instead several of them were delayed until later in the third quarter, so the new volume wasn’t significant for our third fiscal quarter this year. In the other part of the custom products segment, our industrial sales had another excellent quarter. Our industrial business often doesn’t get much press because it’s the smaller part of our custom products segment, but we’re happy to give them some recognition now because they are one of the few bright spots in our third quarter performance.

The industrial sales grew nicely in the third quarter at rough 18% to $933,000. The growth was broad-based coming from customers in all major segments of our industrial market. And business conditions are good for most of our industrial customers which is stealing solid demand in this part of our business and it’s a good sign for the health of our regional manufacturing economy. That covers the main points about our sales performance. Now I would like to give you some information about our third quarter earnings results.

Our operating income as Jim mentioned was 69% during the quarter to $563,000 and likewise our net income was also down 69% to $378,000 or $0.13 a share. The main driver in our earnings performance as you would probably expect was our $5.4 million sales decline for the quarter. We expected the sales decline in the consumer bedding business and we reduced our cost in anticipation of the decline, and as a result of that, our consumer bedding business made up 44% of our total sales decline for the quarter to only about 13% of our decline in operating profit.

We did not expect to see the weakness in demand for our medical products around particularly for our therapeutic support surfaces and as a result most of our earnings decline for the quarter occurred within the medical segment. Our gross profit level was down by 30% during the quarter. That was very similar to our 29% sales decline, which means that we reduced our manufacturing cost at almost the same rate as our sales decline. But in spite this cost reductions, our gross margin for the third quarter was down slightly to 32.8% from 33.4% in the third quarter of last year. That slight decrease in margin was caused mainly by that decline in sales volume and to a lesser extent the fixed portion of our manufacturing cost that can’t be changed quickly.

Out total selling, marketing R&D, and administrative expenses all below the gross margin line were down by $630,000 or 13% for the quarter. Most of that reduction was related to our sales decline. I would note however that our R&D expenses were down by 18% during the quarter but that was caused by the completion of product development projects during the last several quarters rather than as a result of our sales decline. And we plan to continue to invest in new product development as we had in the past. That covers the main points about our sales and earnings performance. Now let me change subjects and make a few comments about our balance sheet and cash flow for the first nine months of fiscal 2014.

Our balance sheet at the end of the June 2014 remained in excellent shape. There are just a few noteworthy items. First, our cash balance at the end of the third quarter was $6.9 million that was up by 27% or $1.5 million from our cash level at the end of the last fiscal year. Our accounts receivable balance was down significantly by $1.9 million compared with fiscal during last year and that was a 25% decline, which as you might expect was related to our sales decline in the third quarter.

Our inventory was up slightly which was mostly related to new products in both our medical and consumer product lines. We ended the quarter with no bank debt and a solid capital base of almost $31 million, so our strong balance sheet really gives us an excellent foundation for future growth. Our cash flow from operations for the first nine months of fiscal 2014 was down by 44% to $3.1 million coming up unusually high $5.4 million in cash flow in the first nine months of fiscal 2013.

And there are two reasons for that decline; the first and largest is related to the Black Friday promotion that we did in the first nine months of last fiscal year and because of that promotion a year ago we had a $2.7 million decline in inventory in the first nine months of last fiscal year and the decline in inventory usually creates an increase in cash flow, so 2.7 million or about half of our 5.4 million in cash flow for the year-to-date period last year was entirely related to that reduction in inventory as we shift products for the promotion. And as you probably know since we did not have that he promotion in first nine months in this fiscal year we did not have the corresponding large inventory reduction and the related increase in cash flow like we did a year ago.

So that event alone explains most of the reduction in our year-to-date cash flow. But our cash flow for the year-to-date this year was also held back by our lower earnings during the first nine months of this year compared with the same period last year. In spite of the large decline from unusually high cash flow in the first nine months last year our cash flow was $3.1 million so far this year has allowed us to fund capital expenditures of $516,000 and pay dividends of $1.2 million which were our two largest uses of cash during the first nine months of this fiscal year. Overall, our financial condition is excellent and we look forward to continuing that trend in future quarters.

Now as Jim mentioned we hope you saw our announcement last week that as a result of our solid operating cash flow and strong balance sheet the Board increased our regular quarterly dividend by 7%, the upcoming dividend payment in September will be our 99th consecutive quarterly dividend. We’ve increased our quarterly dividend 10 times in the last 10 years and in addition to the increase in quarterly dividends we’ve also paid for special dividends during that same period. So we believe our dividend policy is an important part of our efforts to create long-term value for our shareholders.

That wraps up my comments on our financial results. I’ll now turn the call back over to Jim for his view on the business.

Jim Ferguson

Thank you, Richard. As we look toward the fourth quarter, we believe that obviously it should be better than what we saw in the third quarter possibly not quite as good as we did in the fourth quarter year ago but obviously much better than what you saw in the third. As I have said previously we had begun to strengthen as we moved into June and even looking forward into the fourth quarter.

In the medical business, bed frame sales have -- is already good almost twice of what we did in the fourth quarter a year ago. Our new Encore Bed is starting to show what we expected it to do when we introduced it. We had projected that we would sell a 1,000 units of that new bed this year and we’re on-track to complete that goal. The regular medical business was improving and sales of our support services are beginning to come back to normal levels. We do not expect any large one-time orders any time in the fourth quarter but we should get back on a more normal pattern of sales for these products. Even though there won’t be any large pops here at the end of the year.

One other thing to mention is there is some continued consolidation in the medical business. We haven’t talked a lot about this but it is something that does impact us and has been a little bit over the last couple of quarters our largest customer McKesson bought our second largest customer Gulf South that put them in quite a bit of a turmoil but they’re finally getting people in the right places to begin moving that business forward. You know how it is when two large companies that claims to be other like that and you get a salesforce that’s kind of the bearing the headlight and then part of the week trying to figure out who is going to stay and who is going to go while they finally has got all that straightened out. And it looks like that they will start to stabilize even though they told us when we were at their meeting in May that it could be as late as February of next year before they get all of the pieces in place but they feel like they’re about 70% to 80% there at this point in time.

The other thing that has also happened and this is on the bed rental front and we’ve talked about that on a number of occasions. We were doing business with a small rental company called Global Medical. They were bought out by the RecoverCare and then RecoverCare was bought out by Joerns, Joerns Medical is one of our largest competitors and we were doing a little bit of business with Global and also a little bit with RecoverCare. And because Joerns is a competitor of ours we will see that business move away it’s not a huge factor but it was something that we had figured that we could grow with both of those companies moving forward. We probably lost a couple of hundred thousand dollars a year, and we’re going to have to try to replace that somewhere else.

But we’re also actively working with another company, a much larger company than these two, and we’re trying to put together a program there. It is somebody that we’d already been working with for a while in the acute care market and hopefully we can move some product in with them and maybe get them a little bit more toward long-term care, so now that’s something that has been rather difficult on us as frames have really started to consolidate on the medical side of our business with a number of our customers.

We still have a number of new products out there that we’re working hard on. We’ve got our bed expanders that are out there. We’ve got a new warehouse product, which is called Protocol. Both of those, we introduced in the third quarter. We’ve not seen a great deal of movement on those yet, but we still believe that they’re going to be very good products for us we think that they are something that we can build on moving forward.

Newest products, which I have talked about, the last time that we had hoped would be ready by the late third, or early fourth quarter, it’s going to be pushed back a little bit further probably sometime into the first quarter of 2015. This is again going to be another surface product. It’s not a serious slowdown, but it was just something kind of a normal issue that we’ve got to deal with from an R&D standpoint to work the way we want to little bit of a designed change, and that came from one of the manufacturers of the pump that we’re working on there. So, again, we’ve got that ready teed up and ready to go we’ve just got to make a few minor modifications.

As those group and the medical business is still up beat even though things have been relatively slow. They think that they are still quite a few opportunities available to them. This does not come quite as fast as they or we would have want. We believe however that we’re going to start seeing that business begin to improve.

In the custom products business we’re now beginning to see things fall into place, new programs are starting to ship as I have said we had hoped that they were going to be ready by the end of April and it really got pushed out into the end of May and the bulk of it moving in June and July. So we really have a lot of opportunities starting to move there. And if you saw in our release I would also like to say that we have a new piece of business that should be coming on stream probably beginning to ship sometime in September and again this is with a major retailer that we’ve done a lot of business with over the years. There will be a program that we’ll start out as to what we’ve been told will annualized at about $4 million. If the projections are correct and we will also have an opportunity to grow that number.

We think there is some things there we can do to make that a little better. This looks very promising, and again we’re looking forward to September in brining that product back to the fold. We will have to hire probably somewhere like an additional 20 people in order to get those projects started and often running. So, we’re looking forward to that.

The other thing that I’ve talked about in the past is that we are -- how we are and have been working very diligently on a Web site that we will begin selling a direct to customer retail mattress product. That Web site is being tested right now and we should be up and live and ready to go by the end of August. That will look so again very promising for us. That was also something that we had counted on pretty heavily to help us out this year and obviously it has been pushed back a number of times. But we’re ready and should be ready to go. Will not impact us a great deal this year but we believe it has the opportunity to do well as we move forward.

We also are looking at our industrial segment as I have said in my comments and as Richard talked about they have done extremely well not only as they’ve been driven by the automotive market but we picked up a number of packaging programs, and we expect them to finish up the year very solidly. For the year through the end of the third quarter they were up 16% on their sales for the year. So they have done extremely well. As far as our foam pricing is concerned it has remained very stable even with the increase that we have seen with all prices over the last two to three months there had been a number of our suppliers that have come out and talked about potential increases at one-time or another, but that has not come to pass.

We have worked very closely with our foam partners and also here in many occasions they have worked with us to give us better pricing in order for us to be more competitive in the marketplace when need be. So, they have worked with us very well. And we’ve got three to four different ones that we work with and we’ve got very strong relationships there. Overall it was a extremely tough quarter, but we believe that we can see light at the end of the tunnel. Our fourth quarter should be better than the third, but may not be right to the level that we saw in the fourth quarter a year ago. We think there was a lot of promise out there as we wind up the year, but we have to be a little bit broad depending upon as we saw in the third quarter in what can happen to us. But we feel like we’ve got a great deal of opportunity and we have set ourselves up for some success in the future.

And with that I’ll ask Jamie to come back and we’ll take questions. Jamie?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll take our first question from Doug Weiss with DSW Investments.

Doug Weiss - DSW Investments

Hey, good morning.

Jim Ferguson

Good morning Doug.

Doug Weiss - DSW Investments

So I have a bunch of questions, I guess on just starting with the gross margin, you described that you’re pleased with the margin, but my sense is that, you had, I think we have talked in prior quarters that you would be getting, there is a time delay on passing through the higher foam prices and see to some extent it sounds like you will begin realizing that this quarter or next quarter on the longer cycle pricing?

Jim Ferguson

Correct. And that’s why we’re saying that, and the reason that we were pleased with it is the fact that with as much sales reduction as we had from a year ago it is often hard to overcome or keep that gross margin intact or up where it needs to be in order for things to keep moving forward. So even though we had a significant decrease in our sales number we were able to keep our gross margin in shouting distance of what we did a year ago. Again we think that’s a kind of feather in a cap although we are -- both our sales people for keeping our pricing up in the medical side of the business primarily and also run our operations people who work to try to take cost out of the business knowing that our sales were going to be down.

Doug Weiss - DSW Investments

Yes, I mean I guess just looking at the second quarter, you were at least on my model you were 35.4 on the gross margin, which was a really good number, now timing was getting you back to those levels of 2011, is that a number you think on a somewhat higher sales days you can get back to and maintain?

Jim Ferguson

Yes, that’s where we’re headed to, once we get our sales stabilized and get those claims moving in the right direction we’ve got a number of programs we’re working on right now and it takes all that and we will number of products and we think those levels are reasonable goal for us.

Richard Coggins

Hey Doug, margin there are really two of the largest drivers of our margin are volume and mix and so what we’ve got going on in the third quarter and year-to-date this year is our volume is down significantly particularly in the third quarter and that’s working against us from a gross margin standpoint. But our mix is working for us in a gross margin standpoint. So when you saw the reduction in margin in the third quarter that was mainly because our volume decline was so large that it offsets the benefit that we got from a more profitable mix. The more profitable mix is coming from our medical business as a larger percentage because of the lost consumer account our medical business has the larger percentage of our sales than it was last year. You can wash out a little bit of the effect in the third quarter by looking at the year-to-date margin which was actually up and that was up inspire the large volume decline because the mix is better.

Jim Ferguson

Yes so…

Doug Weiss - DSW Investments

One thing I would request would be, because I know you disclosed in your Q the segment margin, it would be helpful if you included that in the press release just so it would give us a little, it means a little more sense than other investors of how those are margins are coming in on a segment basis?

Jim Ferguson

Yes, okay. We can take a look at that. You’re right I will put that in the Q actually we have put the operating margin in the Q by segment, so the only thing I would caution you regarding the segment operating margin is that it does quire us to allocate overhead, and in the case of gross margin, it requires us to allocate manufacturing overhead. And we do that consistently and I think we do a good job of it. But it’s not a precise calculation, so it involves some best case estimates on our part so.

Doug Weiss - DSW Investments

Okay that will be great. And then on M.C. Health, it sounds like you’re starting to see a little more traction there and how lumpy do you expect that business to be going forward. Do you think that I sounded like next quarter will be a good one, do you think it’s going to be…?

Jim Ferguson

To tell there will always a way to categorize it. There always will be somewhat lumpy. Any capital goods equipment or capital goods business is going to somewhat lumpy. We are fortunate in our business here that we do have a few things that are somewhat disposable with our Span Aids and which of course are going and in a few of those things are considered more disposable products. But when you start getting in the capital goods, thing change a little bit because there you’re dealing with a different part of money when you’re talking about customers. You’re not talking about in many cases operating dollars you’re talking about capital dollars. So it’s a little harder to get them to try to lose all those capital dollars at some point in time then there are others, so anytime you are dealing with capital goods is going to be a little more rocky growth.

Doug Weiss - DSW Investments

I guess maybe what, and the only way to ask this, do you think that the sort of -- are you getting more traction so that you sort of annualized results there and do you see those coming in high or say 150 year-over-year, what do you think?

Jim Ferguson

We think that things have been real wacky this year. The one big sign that has impacted us there is not getting a big order out of Canada at the end of their fiscal year that was the kind of determining factor. If you look at actually our unit, units sold out of Canada, so even into June a year ago two or three quarters, we had quarters for 4,700 units net worth and this year is like 4,200 units, and the difference being that one big order that was approximately 600 units that we got in Canada a year ago when that was essentially the different. Our units are basically what they were ago is just coming a little bit different, different way. So we are pretty comfortable that we’re moving in the right direction, but again we’re going to have some of those lumps in the road along the way as we move forward.

Doug Weiss - DSW Investments

And then the Veterans Health bill that was recently perhaps I know that you do some business to VA, is that -- are you seeing any benefit from that and this is probably pretty early but?

Jim Ferguson

Not yet, but that was one thing I did want to mention that I did not mention in my comments and that is our VA business continues to do pretty well. For third quarter this year we’re up 7.5%. We did about I guess below the $4.4 million in sales through the three quarters. And we did write out, a little above 4 million year ago, so it’s been 7.5% increase. We still see that business doing extremely well. And one other thing is actually we’re working with them right now, put together some best selling products, actually bed foam combination, bed foam mattress kit can be sold through the VA. So we think there is a lot of room to continue to improve there.

We do believe there will be some money coming there over the course of the next several months, but I think it’s a little bit early. I know one of the comments currently made from our director of corporate counsel hasn’t been is that a lot of the stuffs that they have sent out request for close have been along the lines of computer systems. They kept complaining that they didn’t have up-to-date computer systems and that kind of things, showed a lot of money being spent out right now is on computer systems.

Doug Weiss - DSW Investments

Do you know roughly what percent of your medical mix now is in the acute space?

Jim Ferguson

I would -- off the top of my head, I have not looked at that number here recently but I would say we’re somewhere in the 30% to 35% range. And again, you got to remember it’s not just surfaces we’ve got a number of positioners there. We are still some positioners in there and we still sell wheelchair cushions a lot of the products we fill in that in acute care so it’s not just the surfaces segment of it.

Doug Weiss - DSW Investments

And, how much is on health at this point?

Jim Ferguson

More like about 10%, we were probably close to 20% at one time 15% to 20% that has backed down significantly. And that was caused primarily by a reduction in Medicare reimbursements for homecare. They have really two things, one is reduction in that and then the other thing was competitive bedding. They’ve been decimated over the last couple of years because of Medicare reimbursement and competitive bedding.

Doug Weiss - DSW Investments

Okay. I have a couple of more questions, but I’ll get back in the queue and in case have to pick one out.

Operator

We’ll take our next question from Brian Rafn with Morgan Dempsey Capital Management.

Brian Rafn - Morgan Dempsey Capital Management

Give me a sense Jim maybe from a 50,000 foot view on kind of how you see you’re talking about the sales force being upbeat, how do you see sales; one, in the acute care hospital chain; and two, into more of the sub-acute long term care nursing home chain. How do you see those tow markets going forward for you guys?

Jim Ferguson

I think that those going to be a little bit questionable in the short-term and a lot of it has to do with again I keep wanting it all but to Affordable Care Act. A lot of things going on out there right now and people just not sure although we have a lady on our Board who is in-charge of the nursing program of that bill and she made the comment in our board meeting that they had to get rid of about $250 million out of their budget because of the loss of reimbursement by Medicare or insurance payments coupled with Medicare payments because primarily the Affordable Care Act that’s going on all over the place and people are still kind of working their way around trying to figure how they’re going to deal with the loss of these funds.

It is one thing to say that we’re saving money but it’s another in saying that we’re taking money out of the entire system. And this was one of the things happening concerned about and because everybody talk to me early on and say okay they’ll aren’t you happy because of the Affordable Care Act and all the increased volume that you’re going to get and I said well we’ll see how that volume works out but at the end of the day not only is volume questionable but also what’s the margin going to be on the volume that you do get. And I still think a lot of that’s in play at this point in time with this thing really just going into effect really was it in March is when the thing happened. I think people are still kind of moving around trying to figure out how much money they’re going to have to deal with.

Brian Rafn - Morgan Dempsey Capital Management

Yes is your sense if you could structurally pull off these funding in there is less reimbursements and we’re seeing it all over, it’s not just the healthcare you are seeing it and highway programs and infrastructure and everyone is not being able to rely on the government even though they run off 7 trillion over the Obama administration. Is your sense that you’re going to see maybe hospitals or nursing homes long-term care have to get by what maybe a more durable product or products again at the labs longer or the lifecycle is going to have to be longer versus maybe in the past?

Jim Ferguson

I think it will be combination of the lifecycle being long and the cost being lower. We’ve been seeing at the years in long-term care. You see a lot of product cheaper products coming out of the Far East that had really taken hold in long-term care and the reason being is not because they are good quality products but because they made a budget need that they have. And fortunately you may see more of that in the acute care market. So I think it will be a combination of both of those things.

Brian Rafn - Morgan Dempsey Capital Management

Yes okay. You made a good comment Jim as just and I know you probably don’t have any exact calculations, if you look at your total business at Span-America how much of that business Jim you think is leveraged to capital expenditure budget committees and how much if it overall might be just operating budget in disposable repurchase, replenishment?

Jim Ferguson

On the medical side I would say probably about I don’t know 50% to 60% of it, would be leveraged towards capital equipment and the rest of it would be sort of because even though on the mattress side if it is a nursing home or a hospital zone unless hospitals don’t normally do this but if they do buy three to five surfaces or something like that they can slide under that capital requirement. So, that wouldn’t be considered capital dollars so there is a certain amount of surfaces and so forth that would not, it wouldn’t all be considered capital equipment. But I will say somewhere in that 50% to 60% neighborhood as what capital dollars would be spend on in terms of their products.

Brian Rafn - Morgan Dempsey Capital Management

Is your thought given the constraints you’ve mentioned in the affordable healthcare I thought you were pretty gentle on your commentary. Is your thought that maybe the capital budget committees are stretching out decisions maybe being a little more careful, putting things off, delaying, deferring that type of things, is that you’re seeing that type of activity?

Jim Ferguson

Absolutely and there is a long-term care teams have been doing it requires some time. As we said, we have become accustomed to getting one or two pretty large deals every year and even more than, but the last couple of years or this year, we basically had none. Year ago, we had one. And we got a number of customers that historically have done it prior to that and we haven’t seen anything out of them for two to three years. So you can see that a lot of these customers a lot of these particular long-term care teams, they’re putting a lot of these capital goods acquisitions off. They just don’t want to spend the money because they really don’t know what their situation is moving forward.

Brian Rafn - Morgan Dempsey Capital Management

Okay and maybe a question for Rich. What notes of your K you refer to one customer combined over the last I think two or three years, they would have been something like 11% to 18% of gross sales, was that the McKesson and Gulf South?

Rich Coggins

Yes, it was.

Brian Rafn - Morgan Dempsey Capital Management

Okay, Rich, 28 to 34 was that the lost retail customer?

Rich Coggins

I don’t understand the question, 28 to 34.

Brian Rafn - Morgan Dempsey Capital Management

There was a second major customer under footnote 18 that said one major customer was like 28% to 34% of sales or 32?

Rich Coggins

Yes, I believe that was. I mean looking at fourth year.

Brian Rafn - Morgan Dempsey Capital Management

That’s one of the separate really the McKesson one from the other retail. Jimmy next in the Web site, the mattress product direct, is that a different product that you would be selling with the new retail customers, the $4 million customer?

Jim Ferguson

Yes. The new program is going to be an overlay. It will not be a mattress. The product that were going to sell on our Web site on the new Web site will actually be a full-blown consumer mattress much like you would find on like Tempur-Pedic Web site or anybody of that nature.

Brian Rafn - Morgan Dempsey Capital Management

Okay, thank you.

Rich Coggins

I look it up while you’re talking to Jim, and yes, that’s exactly right, the customer that went from 28% in ’11 to 33% in ’13, what is the consumer customer that we lost earlier, this year, so those numbers for this years for ’14 are going to be significantly down.

Brian Rafn - Morgan Dempsey Capital Management

Yes, okay, okay. In the new customers, the new retailers that you picked up, is it different merchandize than you lost from the old late customer or is it similar merchandize?

Rich Coggins

Pretty similar, not exactly the same, but very similar in Asia.

Brian Rafn - Morgan Dempsey Capital Management

Okay and then just on final one, Jim you’ve talked about kind of foam prices, if you were to look back over the last 10 to 15 years, where you would be in that commodity field like that raw material, would they be up you had a range tile over the last decade or so, where are they today versus that range?

Jim Ferguson

They were versus what we were 10 to 15 years ago, we always the same.

Brian Rafn - Morgan Dempsey Capital Management

Just getting a sense of the volatility over a long period of time, where would your foam prices be today versus where they were high or low over from a favorable market-to-market where the prices were really fairly high?

Jim Ferguson

Not only 15 years ago one of that were main stay foams, if you will, we were paying somewhere in the neighborhood as well. And I just pick one at random year which was kind of the again main stay for us. Probably, about a $0.125 is what we’re paying about 15 years ago and that same foam today is probably somewhere in the $0.17 to $0.18 range per board foot. So you’re up $0.04 to $0.05 that you up what 40%, 45%.

Operator

We will take our next question from Sam Rebotsky with SER Asset Management.

Sam Rebotsky - SER Asset Management

I guess this is just a disappointing quarter and I guess it’s been different call for your ability to sort of project the future based on the changes that are going on?

Jim Ferguson

Yes, it’s been rather difficult. It’s hard enough trying project a capital goods business, but with everything going on externally here in terms of the economy and the changes because of the Affordable Care Act. It makes it that much more difficult and so.

Rich Coggins

One thing I would add is we’ve really got two major things going on here. One of which unfortunately very easy to project the lost consumer business that we talked about for a while, we’ve been pretty accurate on what we expected there and what we didn’t expect, as we mentioned earlier was a weakness in our core medical business and we found that very hard to predict not only because there is a capital equipment business, but also because there seems to be quite a bit of hesitancy among our customers to make purchase commitments. And we hear a lot about the strength in other areas of the economy and it would be reasonable to expect that that would translate into the medical business, but the truth is we haven’t seen it certainly this year in our part of the medical unit. We’ve seen it characterized by hesitancy and just not quite ready to pull the trigger on larger orders.

Sam Rebotsky - SER Asset Management

Okay now one of the things I’m just wondering based on your size and the acquisition of McKesson has made of your two major customer and the acquisition that you made of M.C. and the inability, does it appear that if you were part of a bigger entity that you would have a better ability to use your skills in a more productive and more fruitful way or does it appear that you, if you had more acquisitions that were appropriate assuming you feel that the M.C. was appropriate and you were able to be a bigger organization. So sort of maybe what your thoughts are on when you talk about what you should look like in a couple of years down the road, why don’t you sort of let some light on that?

Jim Ferguson

I think it’s always better for us in terms of heavy size we’ve got to have a certain amount of core size in order to maintain your business particularly as it relates to R&D, relates to sales and marketing expenses, all those things that go along with trying improve your business and grow your business. We have a lot of times people will look at smaller companies and there might be a fund convertor similar to us and they may have no salesforce but somehow they got one or two a nice piece of business and somehow they were seeing as better than us and more profitable than us, at that level that’s true however they’re very limited than their ability to grow.

And I think which are seeing with us is we have had a slight step back here because with lots of volume as I would call critical mass and that has happened to us a couple times, there is no question we’re not hiding from anything but that’s happened a couple of times and we still on onetime we’re doing business depend significantly. This time we lost a big piece of consumer business. Anytime we release a large chunk of business we put a cramp in the dollars that we spent in order to try to grow our business.

So and to answer to your question what do we want to look like in a year or two, obviously we think we can get this thing back on the road to increasing sales and earnings. We think given the economy strengthening a little bit and moving in the right direction and we will do that, get back on a road to having more consistent and what we’re doing than what we’ve shown here in this last year. Also in that timeframe we’ll be introducing morning products. We are actively pursuing more acquisitions at this point. So I would anticipate our business to be larger than what you see right now and obviously more profitable than what you see around now.

I don’t know if that answers your question, but we are not going to sit here and cry albeit so to speak we are setting ourselves up to continue to move this thing forward. We make no excuses, we are what we are, we’ve always been very upfront with everyone trying to let you know what’s happening sometime to the detrimental of is and individuals and to the business as a whole but we are a very upfront company and I think that stems from the top one down leading ourselves and Richard we’re very upfront we’re very honest with people we are going to let them know what’s happening in the business and unfortunately we’ve had two to three tough quarters. If we don’t get out, or would not get out of this thing and we’re going to move this business.

Sam Rebotsky - SER Asset Management

The question always to make a decision, do you try to sell yourself or you try to make more acquisitions. At this point you want to just grow what you have versus what you have to be the acquired?

Jim Ferguson

We won’t look to be acquired at this point in time, that doesn’t say that somebody came in and we wouldn’t entertain the offer, we always do. We have people that us and ask from time-to-time and our Board deals with them. And we will later thank these offers we will do our soon to make sure that the shareholders are taking care of and that in that and I want to make sure you understand what our processes is too because that’s not something that’s done by Richard and I if someone has an interest in doing something with Span-America in terms of making an acquisition that’s done with the other Board members it should we provide the financial information we provide all the information that’s needed for those people to look at the business but the ultimate decision is made by the independent directors not by Richard and I. And I think that’s a good thing from a good corporate governance of situation because then you know how Richard and I trying to negotiate our own ticket out of here and whereas the company would be sold or whatever happens you’ve got the Board actually negotiating with the potential person and I think that is of the of most it would be so doing that.

Sam Rebotsky - SER Asset Management

Well, that’s commendable and frankly we’ll have to see where things go and I guess as an inventor. I think you and the Board have to make a decision whether you should be bigger if there is a good acquisition fit because there is no doubt that you’ve lost some opportunities to other people and hopefully you could win them back and as you are doing and at the right time you could be acquired if that made sense. But good luck and it’s been tough.

Operator

Our next question comes from Doug Weiss with DSW Investments.

Doug Weiss - DSW Investments

So I actually wanted to follow-up a little bit on the prior question on M&A, because you now have 7 million in cash roughly plus the credit line which I believe it is about 10 million. So it seems like you could pretty comfortably finance $20 million acquisition which -- so I guess I think in the recent calls you described the M&A environment has gained somewhat better. Is that still your sense?

Jim Ferguson

I think that it is starting to loosen up a little bit. The biggest thing that we have or the biggest thing we have to overcome really is finding the fit from a size standpoint most of our competitors are much larger than we are. So obviously it puts a lot of those guys out of reach. So we’ve got to find the right fit from a size standpoint in order to bring a company in and we were very fortunate that didn’t see healthcare very I mean else right now many street in terms of size in terms of what we were looking for and it took us a while to get there. So obviously that’s been difficult but we’ve got eyes on a couple of things and we’ll see how they turn out here in the near future.

Doug Weiss - DSW Investments

Okay. And then I guess just a little more on the consumer Internet sales side, it seems to me that the challenge there is that you don’t have a retail space where people could test the product. So what’s your thinking on that?

Jim Ferguson

Well, there are numerous sites out there where people selling these products over the Internet that have no that’s why they have no brick and mortar we’ve got one company that we know of that isn’t somewhat of the same position that we are and I have been talking to the owner about two or three years ago he was selling $10 million over the Internet. So, there are a lot of opportunities out there to sell these types of products over the Internet we don’t necessarily need to have a price where people can try and then so forth.

So we feel pretty comfortable that this is a good place for us to go because we get started with these mattresses in a number of other items we can put pillows out there, we can put pads out there. There are a lot of other we’re providing that we can put out there that's our thinking it’s kind of a cheap way to get into direct retail sell.

Doug Weiss - DSW Investments

And as you recall you actually had a retail product at one point years back, is that accurate?

Jim Ferguson

Mattress product?

Doug Weiss - DSW Investments

Yes, I think at one point…

Jim Ferguson

We had a home care product that we were selling to home care dealers that was kind of retail version of our pressure guard product but we’ve never actually sold well I think that back we sold a complete home mattress that will grow up in a box to lost over a couple of years ago but that was kind about a onetime plan. And that was more of a sticking on the floor type thing or kind of a twin-size application, these are going to be which you would consider something that you would put on your bed at home, so they would be a nice mattress. They are going to sell $800 or $1000 a piece. These are not going to be $200 foam-core mattress.

Doug Weiss - DSW Investments

So is it going to be foam mattress or pump?

Jim Ferguson

It will be a foam matters to begin with. And this home price mattress similar to the Tempur-Pedic style mattresses.

Doug Weiss - DSW Investments

Okay that will be interesting. I supposed it will open up a home market if it goes well.

Jim Ferguson

We believe so. And that doesn’t mean it’s going to take off and we’re going to sell a million and dollar, but we think it has a great opportunity for us and opens up a whole new place that we’ve never gone before. We’re not selling anything over our own Internet spec. We chose not to do that on the medical side of the business then we did the in competition with a lot of our customers and we don’t want to that. And this stage, we’re not really competing with our customers per se. So we feel pretty confident. We can get out there and go against the Tempur-Pedic people like that.

Doug Weiss - DSW Investments

So, I guess one of the issues with this quarter was the weak medical sell, you hadn’t really anticipated them, how do you anticipate more weakness there? Are things that you can do on the SG&A line to improve the margin in a relatively short timeframe?

Jim Ferguson

I would say generally no, at least not in a one-quarter period of time. I think the reductions that you saw on the SG&A side were most related to the decline in volume with exceptional R&D that I mentioned. R&D was just down coincidently because we finished some projects was related to sales volume. Our philosophies in terms of taken expense out when we have a quarter like as we believe that the medical sale decline that we saw in third quarter and to some extent year-to-date is temporary.

And so we don’t want reduce, we don’t want to take cost of our business that could contribute to future sales for us going forward. Now obviously, if you trend last longer than we think then we have to start looking harder at cost and that something we can do. At moment we’ve chosen not do that. We don’t want to exceed our ability to sell in the medical business and once you start taking out marketing people once you start taking out sales people then you empty that ability for us to hit the numbers that we need to hit. But again go back to what Richard said is, if you get to a point where it’s going to be more of the norm as opposed to what it has been in the past then you got start thinking long and harder about okay what I am going to do here. Well, we haven’t got to that point yet. We still think this is a temporary situation.

Richard Coggins

Yes, we think we’re in terms of particularly on medical business -- we think we’re in a great long-term market are. We think we’ve got the right products in terms of beds and support surfaces and related products that we think are going to grow over next steadily over a long period of time. And at the moment, we are at the point of dramatically cutting cost because that can -- as you know that can become sort of vicious cycle then that you create the exact situation that you’re trying to avoid. All we know the things that particularly mind too particularly on the sale side of the business, actually sales people will pay primarily commission and that’s not the sale of 100% commission, but it’s probably 60% to 70% commission. Their basic salaries are fairly low on purpose. They get paid based on what they sell as opposed to being paid some large salary at first. So they want to sell they’re not getting paid so that’s something I think is very important.

Doug Weiss - DSW Investments

Okay and my last question. The large chain custom once a year Christmas promotions, is that happening again, and if yes, when does that go bed?

Jim Ferguson

It has been bedded out. We obviously did that get back and I’ll be honestly they had not obviously got it. I am assuming it will be -- they got it last year which was Chinese manufacturer.

Doug Weiss - DSW Investments

Okay.

Jim Ferguson

But I don’t know that the two.

Operator

And at this time, there are no further questions over the phone.

Jim Ferguson

Okay, we again thank everybody for being with us today and look forward to sharing our results with you at the end of the fourth quarter. Thank you, Jamie.

Operator

Thank you for your participation. This does conclude today’s call.

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