RETRACTABLE TECHNOLOGIES INC - Quarter Report: 2005 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2005

or

For the transition period from                      to                     

Commission file number 000-30885

Retractable Technologies, Inc.

(Exact name of registrant as specified in its charter)

(972) 294-1010

(Registrant’s telephone number, including area code)

(Former name, former address, and former fiscal year, if changed since last report)

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨  No ¨

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 23,491,884 shares of Common Stock, no par value, issued and outstanding on November 9, 2005.

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PART I-FINANCIAL INFORMATION

RETRACTABLE TECHNOLOGIES, INC.

CONDENSED BALANCE SHEETS

See accompanying notes to condensed financial statements

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RETRACTABLE TECHNOLOGIES, INC.

CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

See accompanying notes to condensed financial statements

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RETRACTABLE TECHNOLOGIES, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

See accompanying notes to condensed financial statements

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RETRACTABLE TECHNOLOGIES, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)

Business of the Company

Retractable Technologies, Inc. (the “Company”) was incorporated in Texas on May 9, 1994, to design, develop, manufacture, and market safety syringes and other safety medical products for the healthcare profession. The Company began to develop its manufacturing operations in 1995. The Company’s manufacturing and administrative facilities are located in Little Elm, Texas. The Company’s primary products are the VanishPoint^® syringe in the 1cc, 3cc, 5cc, and 10cc sizes and blood collection tube holders. The Company has conducted preliminary clinical evaluations and worked with national distributors to encourage healthcare facilities to transition from the use of standard needle products to the VanishPoint^® products.

Basis of presentation

The accompanying condensed financial statements are unaudited and, in the opinion of management, reflect all adjustments that are necessary for a fair presentation of the financial position and results of operations for the periods presented. All of such adjustments are of a normal and recurring nature. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the entire year. The condensed financial statements should be read in conjunction with the financial statement disclosures contained in the Company’s audited financial statements for the year ended December 31, 2004.

Accounting estimates

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.

Cash and cash equivalents

For purposes of reporting cash flows, cash and cash equivalents include unrestricted cash and investments with original maturities of three months or less.

Accounts receivable

The Company records trade receivables when revenue is recognized. No product has been consigned to customers. The Company’s allowance for doubtful accounts is primarily determined by review of specific trade receivables. Those accounts that are doubtful of collection are included in the allowance. An additional allowance has been established based on a percentage of receivables outstanding. These provisions are reviewed to determine the adequacy of the allowance for doubtful accounts. Trade receivables are charged off when there is certainty as to their being uncollectible. Trade receivables are considered delinquent when payment has not been made within contract terms.

Inventories

Inventories are valued at the lower of cost or market, with cost being determined using a standard cost method, which approximates average cost. Provision is made for any excess or obsolete inventories.

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Property, plant, and equipment

Property, plant, and equipment are stated at cost. Expenditures for maintenance and repairs are charged to operations as incurred. Cost includes major expenditures for improvements and replacements which extend useful lives or increase capacity and interest cost associated with significant capital additions. Gains or losses from property disposals are included in income.

Depreciation and amortization are calculated using the straight-line method over the following useful lives:

Long-lived assets

The Company assesses the recoverability of long-lived assets using an assessment of the estimated undiscounted future cash flows related to such assets. In the event that assets are found to be carried at amounts which are in excess of estimated gross future cash flows, the assets will be adjusted for impairment to a level commensurate with a discounted cash flow analysis of the underlying assets.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current period’s presentation.

Intangible assets

Intangible assets are stated at cost and consist primarily of patents, a license agreement granting exclusive rights to use patented technology, and trademarks which are amortized using the straight-line method over 17 years.

Financial instruments

The fair value of financial instruments is determined by reference to various market data and other valuation techniques as appropriate. The Company believes that the fair value of financial instruments approximates their recorded values.

Concentrations of credit risk

The Company’s financial instruments exposed to concentrations of credit risk consist primarily of cash, cash equivalents, and accounts receivable. Cash balances, some of which exceed the federally insured limits, are maintained in financial institutions; however, management believes the institutions are of high credit quality. The majority of accounts receivable are due from companies which are well-established entities. As a consequence, management considers any exposure from concentrations of credit risks to be limited.

Revenue recognition

Revenue is recognized for sales to distributors when title and risk of ownership passes to the distributor, generally upon shipment. Revenue is recorded on the basis of sales price to distributors, less contractual

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pricing allowances. Contractual pricing allowances consist of (i) rebates granted to distributors who provide tracking reports which show, among other things, the facility that purchased the products, and (ii) a provision for estimated contractual pricing allowances for products that the Company has not received tracking reports. Rebates are recorded when issued and are applied against the customer’s receivable balance. The provision for contractual pricing allowances is reviewed at the end of each quarter and adjusted for changes in levels of products for which there is no tracking report. Additionally, if it becomes clear that tracking reports will not be provided by individual distributors, the provision is further adjusted. The estimated contractual allowance is netted against individual distributors’ accounts receivable balances for financial reporting purposes. The resulting net balance is reflected in accounts receivable or accounts payable, as appropriate. The terms and conditions of contractual pricing allowances are governed by contracts between the Company and its distributors. Revenue for shipments directly to end-users is recognized when title and risk of ownership passes from the Company. Any product shipped or distributed for evaluation purposes is expensed.

Reimbursed discounts

The Company receives reimbursed discounts from one of the settlement agreements reached in its federal antitrust lawsuit, Retractable Technologies, Inc. v. Becton Dickinson & Co. et al. Payments under the discount reimbursement program are recognized upon delivery of the product, provided collection is reasonably assured. Such amounts are presented in the Condensed Statements of Operations as a separate component of revenues.

Income taxes

The Company provides for deferred income taxes in accordance with Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes (“SFAS 109”). SFAS 109 requires an asset and liability approach for financial accounting and reporting for income taxes based on the tax effects of differences between the financial statement and tax bases of assets and liabilities, based on enacted rates expected to be in effect when such basis differences reverse in future periods. Deferred tax assets are periodically reviewed for realizability. Valuation allowances are recorded when realizability of deferred tax assets is not likely.

Earnings per share

The Company has adopted Statement of Financial Accounting Standards No. 128, “Earnings Per Share,” which establishes standards for computing and presenting earnings per share. Basic earnings per share are computed by dividing net earnings for the period (adjusted for any cumulative preferred dividends for the period) by the weighted average number of common shares outstanding during the period. The Company has potentially dilutive Common Stock equivalents consisting of convertible preferred stock, stock options, and convertible debt. The potential dilution, if any, is shown on the following schedule.

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Research and development costs

Research and development costs are expensed as incurred.

Stock-based compensation

The Company has three stock-based director, officer, and employee compensation plans. The Company uses the fair value recognition provisions of SFAS No. 123 “Accounting for Stock Issued to Employees,” and related Interpretations. Effective January 1, 2002, the Company adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” for all director, officer, and employee awards granted, modified, or settled after December 31, 2001.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share Based Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. SFAS No. 123(R) must be adopted by the Company by the first quarter of 2006. Currently, the Company uses the Black-Scholes model to estimate the value of stock options granted to employees and is evaluating option valuation models, including the Black-Scholes model, to determine which model the Company will utilize upon adoption of SFAS No. 123(R). The Company plans to adopt SFAS No. 123(R) using the modified-prospective method. Management does not anticipate that adoption of SFAS No. 123(R) will have a material impact on the Company’s stock-based compensation expense.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, Inventory Pricing, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage), should be expensed as incurred and not included in overhead. In addition, this Statement requires the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions in SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is currently assessing the impact of SFAS No. 151 on its financial statements.

Inventories consist of the following:

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The provision (benefit) for income taxes for the three and nine month periods ended September 30, 2005 differs from the expected amounts using statutory rates primarily due to stock option activity, 2004 income tax estimate changes, and changes in the valuation allowance on certain deferred tax assets. The provision for income taxes for the three and nine month periods ended September 30, 2004 consists of state income taxes, net of the benefit of net operating losses carried forward. Federal income taxes for the three and nine month periods ended September 30, 2004 were partially offset by net operating losses carried forward from prior periods. The primary reconciling item between income taxes based on amounts using statutory rates and the provision for income taxes for the three and nine month periods ended September 30, 2004 was the decrease in the valuation allowance of the net operating losses carried forward.

On September 30, 2005 the Company established the Retractable Technologies, Inc. 401(k) Plan (the “Plan”), which qualifies under Section 401(k) of the Internal Revenue Code. The Plan will begin operations in November 2005, and will be available to all U.S. employees who have completed 3 months of employment. Under the Plan, employees will be able to contribute a portion of their pre-tax compensation. The Company will be able to make discretionary matching contributions to the Plan.

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FORWARD-LOOKING STATEMENT WARNING

Certain statements included by reference in this filing containing the words “could,” “may,” “believes,” “anticipates,” “intends,” “expects,” and similar such words constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Any forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the impact of dramatic increases in demand, our ability to quickly increase capacity in the event of a dramatic increase in demand, our ability to access the market, our ability to decrease production costs, our ability to continue to finance research and development as well as operations and expansion of production, and the increased interest of larger market players, specifically Becton Dickinson & Co. (“BD”), in providing safety needle devices. Given these uncertainties, undue reliance should not be placed on forward-looking statements.

The following discussion contains trend information and other forward-looking statements that involve a number of risks and uncertainties. Our actual future results could differ materially from our historical results of operations and those discussed in the forward-looking statements. Variances have been rounded for ease of reading. All period references are to the periods ended September 30, 2005 or 2004.

OVERVIEW

We have been manufacturing and marketing our retractable syringe products into the marketplace since 1997. Our products have been and continue to be distributed nationally through numerous distributors. However, we have been blocked from access to the market by exclusive marketing practices engaged in by BD who dominates the market. We continue to attempt to gain access to the market through our sales efforts and innovative technology.

We are focusing on methods of upgrading our manufacturing capability and efficiency in order to enable us to offer our technology at a reduced price. Our agreement with Double Dove, a Chinese manufacturer, has enabled us to increase manufacturing capacity with little or no capital outlay and provided a competitive manufactured cost. We believe our current capitalization provides the resources necessary to implement these changes and greatly improve our manufacturing capacity and efficiency, thereby reducing our unit cost. We are also marketing more products internationally.

Historically, unit sales have increased in the latter part of the year due, in part, to the demand for syringes during the flu season.

The Company was the sole U.S. syringe manufacturer to receive a contract under the President’s Emergency Plan. We will ship 11.7 million syringes to seven African countries. The countries are Botswana, Coite d’Ivoire, Ethiopia, Kenya, Nigeria, Tanzania, and Uganda.

The Company received 501k approval to market the VanishPoint^® automated retraction intravenous (IV) catheter. The device is expected to be available in a variety of sizes in the first quarter of 2006.

Comparison of Three Months Ended

September 30, 2005, and September 30, 2004

Domestic sales accounted for 96.5 percent and 89.3 percent of the revenues for the three months ended September 30, 2005 and 2004, respectively. International sales accounted for the remaining revenues. Domestic revenues increased 6.0 percent and international revenues decreased 68.0 percent. Unit sales decreased 4.9 percent. Domestic unit sales increased 9.5 percent and international sales decreased 65.9 percent. Domestic unit sales were 93.2 percent of total unit sales. The international sales declined due to the existence of a large order in the third quarter of 2004 pursuant to the President’s Emergency Plan.

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Gross profit increased primarily due to lower cost product coming out of inventory and a more profitable mix of products between domestic and international sales. Units in inventory at September 30, 2005 are recorded at a lower cost than units in inventory at June 30, 2005. Profit margins can fluctuate depending upon, among other things, the cost of product manufactured and the capitalized cost of product recorded in inventory, as well as product mix. The lower unit cost in ending inventory at September 30, 2005 should have a positive effect on profit margins for the fourth quarter.

Operating expenses consisted of increases in compensation expense of $132,000 in Sales and marketing mitigated by a decrease of consulting expense of $90,000. The increase in Research and development costs were due principally to the development of the catheter. General and administrative costs increased due to increases in compensation, shareholder expense, education expense, travel and entertainment, and legal expenses.

Loss from operations decreased due principally to improved profit margins.

Interest income increased due to higher invested cash balances.

The lower loss from operations and the net interest income resulted in net income.

The provision (benefit) for income taxes for the three month period ended September 30, 2005 differs from the expected amounts using statutory rates primarily due to stock option activity, 2004 income tax estimate changes, and changes in the valuation allowance on certain deferred tax assets. The provision for income taxes for the three month period ended September 30, 2004 consists of state income taxes, net of the benefit of net operating losses carried forward. Federal income taxes for the three month period ended September 30, 2004 were partially offset by net operating losses carried forward from prior periods. The primary reconciling item between income taxes based on amounts using statutory rates and the provision for income taxes for the three month period ended September 30, 2004 was the decrease in the valuation allowance of the net operating losses carried forward.

Preferred dividend requirements decreased 22.0 percent due to conversions of Preferred Stock into Common Stock.

Weighted average common shares outstanding increased due to the conversions and exercise of options.

The Company’s balance sheet remains strong with cash making up 67.8 percent of total assets. Working capital was $56,133,530 at September 30, 2005, a decrease of $1,059,201 from December 31, 2004. The current ratio improved from 8.3 at December 31, 2004 to 9.0 at September 30, 2005. The quick ratio also improved from 7.4 to 7.8 from December 31, 2004 to September 30, 2005. These all indicate a strong financial position.

Approximately $2.0 million in cash flows used by operating activities were used for working capital items. Investing activities were primarily for the completion of the new building. Financing activities consisted of the final draw down of the construction loan from 1^st International Bank (“1^st International”). The Company began principal and interest payments on this loan in the first quarter of 2005.

Comparison of Nine Months Ended

September 30, 2005, and September 30, 2004

Domestic sales accounted for 94.0 percent and 93.4 percent of the revenues for the nine months ended September 30, 2005 and 2004, respectively. International sales accounted for the remaining revenues. Unit sales increased 8.2 percent. Domestic unit sales were 89.0 percent of total unit sales for the nine months ended September 30, 2005.

Gross profit increased due primarily to improved sales and lower unit cost of product being sold. Profit margins can fluctuate depending upon, among other things, the cost of product manufactured and the capitalized cost of product recorded in inventory, as well as product mix. The lower unit cost in ending inventory at September 30, 2005 should have a positive effect on profit margins for the fourth quarter.

Operating expenses declined due principally to the reduction in legal fees attributable to the Company’s litigation with BD and NMT in 2004. Legal costs declined $2,420,000. Sales and marketing costs increased due to

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hiring additional personnel in sales resulting in an increase in wages of $333,000 and additional travel and entertainment costs of $109,000. These increases in Sales and marketing expense were mitigated by a reduction in consulting fees of $198,000. Research and development costs increased principally due to development work on the catheter. General and administrative costs were affected by additional accounting fees, increased travel and entertainment, education costs, dues expense and lower stock option expense, as well as legal expense noted previously.

Loss from operations decreased $2,790,749, or 48.3 percent due principally to the decreased litigation costs and improved profit margins.

Interest income increased due to higher invested cash balances.

The provision (benefit) for income taxes for the nine month period ended September 30, 2005 differs from the expected amounts using statutory rates primarily due to stock option activity, 2004 income tax estimate changes, and changes in the valuation allowance on certain deferred tax assets. The provision for income taxes for the nine month period ended September 30, 2004 consists of state income taxes, net of the benefit of net operating losses carried forward. Federal income taxes for the nine month period ended September 30, 2004 were partially offset by net operating losses carried forward from prior periods. The primary reconciling item between income taxes based on amounts using statutory rates and the provision for income taxes for the nine month period ended September 30, 2004 was the decrease in the valuation allowance of the net operating losses carried forward.

Preferred dividend requirements decreased 29.7 percent due to conversions of Preferred Stock into Common Stock.

Weighted average common shares outstanding increased due to conversions and exercise of options.

LIQUIDITY AND FUTURE CAPITAL REQUIREMENTS

Historical Sources of Liquidity

We have historically funded operations primarily from proceeds from private placements, loans, and litigation efforts. We were capitalized with approximately $52,600,000 raised from six separate private placement offerings. We also funded operations through bank loans aggregating $12,910,000. We have received cash payments of $88,514,873 from litigation settlements through September 30, 2005. Additionally, through September 30, 2005, we have received $1,031,266 in discount reimbursements in cash from a litigation settlement.

Internal Sources of Liquidity

Margins and Market Access

In early 2004 we began to receive shipment of product under our agreement with Double Dove. We believe as we receive greater quantities our profit margins could increase provided we have market access. Margins tend to improve with additional sales and higher production levels. To achieve profits from operations we would need minimal access to hospital markets which has been difficult to obtain due to the monopolistic marketplace which was the subject of our lawsuit against BD. We will continue to attempt to gain access to the market through our sales efforts and innovative technology. We are focusing on methods of upgrading our manufacturing capability and efficiency in order to enable us to offer our technology at a reduced price. We believe our current capitalization provides the resources necessary to implement these changes and greatly improve our manufacturing capacity and efficiency, thereby reducing our unit cost.

The mix of domestic and international sales affects the average sales price of our products. The higher the ratio of domestic sales to international sales, the higher the average sales price will be. Typically international sales are shipped directly from China. Purchases of product manufactured in China will usually decrease the average cost of manufacture for all units as domestic costs, such as indirect labor and overhead, remain relatively constant. The number of units produced by the Company and manufactured in China can have a significant effect on the carrying costs of inventory as well as cost of sales. The average unit cost in the third quarter of 2005 is lower than the average unit cost in inventory at June 30, 2005. This is due to more units, in the aggregate, purchased and produced in the third quarter of 2005. Inventory was higher at September 30, 2005, compared to December 31, 2004, due to more units on hand mitigated by lower average cost per unit. The Company will continue to evaluate the appropriate

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mix of products manufactured domestically and those manufactured in China to achieve economic benefits as well as maintaining our domestic manufacturing capability.

We had a reduction in staff of 18 employees effective August 11, 2005. In connection with the reduction in staff, terminated employees were eligible to receive severance benefits in the form of a one-time lump sum payment. The total amount of the severance benefits was $63,000. Annual savings attributable to this staff reduction will be approximately $380,000.

Seasonality

Historically, unit sales have increased in the latter part of the year due, in part, to the demand for syringes during the flu season.

Licensing Agreement

We entered into a License Agreement with Baiyin Tonsun Medical Device Co., Ltd. (“BTMD”) as of May 13, 2005, which was approved by the People’s Republic of China (the “PRC”) on August 1, 2005. We have granted to BTMD a limited exclusive license to manufacture and a limited exclusive right to sell syringes in the PRC having retractable needles that incorporate our technology for a term of three years. This License Agreement is subject to the Technology License Agreement dated June 23, 1995 between Mr. Thomas J. Shaw, our founder and CEO, as licensor and the Company, as licensee. Accordingly, Mr. Shaw will receive 5% of the licensing proceeds we receive. BTMD has agreed to manufacture and sell these products in the PRC and to pay us a quarterly royalty of two and one-half cents per unit on 1/2 cc, 3 cc, and 5 cc syringes and a royalty of three and one-half cents per unit on 1 cc and 10 cc syringes. We anticipate the receipt of royalties beginning no later than the first contract year. The obligation to pay the royalties continues even if any and all of our patent rights in the PRC are found to be invalid or unenforceable for any reason. We have the right, but not the obligation, to terminate the agreement if we have not received royalty payments for at least 25,000,000 units during 2006, 50,000,000 units in 2007, and 100,000,000 units per year for each year thereafter.

Cash Requirements

Due to prior litigation settlements, we have sufficient cash reserves and intend to rely on operations, cash reserves, and debt financing as the primary ongoing sources of cash. In the event we continue to have only limited market access and cash generated from operations becomes insufficient to support operations, we would take cost cutting measures to reduce cash requirements. Such measures could result in reduction of units being produced, reduction of workforce, reduction of salaries of officers and other nonhourly employees, and deferral of royalty payments to Thomas Shaw.

External Sources of Liquidity

We obtained a loan from 1^st International for $2,500,000 for financing of the warehouse. Principal and interest payments began in the first part of 2005. We have obtained several loans over the past six years, which have, together with the proceeds from sales of equities, enabled us to pursue development and production of our products. Currently we believe we could obtain additional funds through loans if needed. Furthermore, the shareholders previously authorized an additional 5,000,000 shares of a Class C Preferred Stock that could, if necessary, be designated and used to raise funds through the sale of equity.

We previously filed our periodic reports as a small business issuer through the period ended December 31, 2004. The information required by Item 305 of Regulation S-K was not required under the disclosure requirements for small business issuers. Pursuant to Item 305 of Regulation S-K, disclosure of quantitative and qualitative information about market risk is required in the first annual report. Information relating to interim financial statements is not required until after the first fiscal year end in which Item 305 is applicable. Accordingly, we

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anticipate providing a quantitative and qualitative analysis regarding market risk in our Form 10-K for the year ending December 31, 2005.

Pursuant to paragraph (b) of Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934 (the “Exchange Act”) and on November 10, 2005, our President, Chairman, and Chief Executive Officer, Thomas J. Shaw (the “CEO”), and our Vice President and Chief Financial Officer, Douglas W. Cowan (the “CFO”), acting in their capacities as our principal executive and financial officers, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act, and concluded that, as of September 30, 2005, and based on the evaluation of these controls and procedures as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Exchange Act, there were no significant deficiencies in these procedures. The CEO and CFO concluded that our disclosure controls and procedures are effective.

There have been no material changes in our internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the last fiscal quarter or in any other factor that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

PART II-OTHER INFORMATION

We disclosed our recent filing of a lawsuit against Abbott Laboratories Inc. in our Form 10-Q filed on August 15, 2005.

Sale of Equity Securities and Use of Proceeds

Katie Petroleum, Inc. purchased 136,436 shares of Common Stock through the exercise of options at a price of $1 per share for total consideration of $136,436.

Working Capital Restrictions and Limitations on the Payment of Dividends

We maintain cash for use as collateral for letters of credit we provide from time to time to enable, among other things, the purchase of product from China. As of September 30, 2005, we had no funds held as restricted cash for such purposes. The Board of Directors has authorized management to borrow and incur indebtedness in the form of letters of credit in an aggregate amount, at any one time, of $3,000,000.

The certificates of designation for each of the outstanding series of Class B Convertible Preferred Stock each provide that, if a dividend upon any shares of Preferred Stock is in arrears, no dividends may be paid or declared or any other distribution made upon any stock ranking junior to such stock and generally no such junior stock may be redeemed.

Series I Class B Convertible Preferred Stock

For the nine months ended September 30, 2005, the amount in arrears is $69,802 and the total arrearage as of September 30, 2005 is $120,015.

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Series II Class B Convertible Preferred Stock

For the nine months ended September 30, 2005, the amount in arrears is $210,397 and the total arrearage as of September 30, 2005 is $377,380.

Series III Class B Convertible Preferred Stock

For the nine months ended September 30, 2005, the amount in arrears is $102,189 and the total arrearage as of September 30, 2005 is $2,683,843.

Series IV Class B Convertible Preferred Stock

For the nine months ended September 30, 2005, the amount in arrears is $417,000 and the total arrearage as of September 30, 2005 is $5,229,471.

Series V Class B Convertible Preferred Stock

For the nine months ended September 30, 2005, the amount in arrears is $332,932 and the total arrearage as of September 30, 2005 is $1,930,298.

The 2005 Annual Meeting of Stockholders (the “Annual Meeting”) of the Company was held on September 16, 2005, at 10:00 a.m., CST. The purpose of the meeting was to elect four Class 1 Directors.

Of the 23,342,198 shares of Common Stock of the Company entitled to vote, 18,560,305 shares were represented in person or by proxy at the Annual Meeting, which is more than the 11,671,099 required to constitute a quorum. Accordingly, the election of four Class 1 Directors was put to a vote and the results were as follows:

Accordingly, Russell Kuhlman, Patti King, Marco Laterza, and Jimmie Shiu were elected as Class 1 Directors to serve until the Company’s 2007 Annual Meeting. As of the adjournment of the Annual Meeting, the Board of Directors consisted of the following members:

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None

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SIGNATURES

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.

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