RETRACTABLE TECHNOLOGIES INC - Quarter Report: 2006 June (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 June 30, 2006

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  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 Sections 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: 23,612,164 shares of Common Stock, no par value, issued and outstanding on August 1, 2006.

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PART I-FINANCIAL INFORMATION

Item 1. Financial Statements.

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 includes the 1cc syringe in an allergy tray. The Company introduced the IV safety catheter in the market in the first quarter of 2006. The Company has conducted preliminary clinical evaluations and worked with national distributors to encourage healthcare facilities to transition from the use of standard syringes to the VanishPoint^® syringe.

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 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 filed in the Form 10-K on March 31, 2006, for the year ended December 31, 2005.

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. A reserve is established for any excess or obsolete inventories.

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The Company implemented Statement of Financial Accounting Standards No. 151, Inventory Costs (“SFAS No. 151”), in the first quarter of 2006. Implementation of SFAS No. 151 did not have a material effect on the Company’s financial position or results of operations as of and for the period ended June 30, 2006.

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.

Concentration of certain risks

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.

The Company manufactures syringes in Little Elm, Texas as well as utilizing a manufacturer in China. During the first six months of 2006, approximately 70% of the units were produced in China.

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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 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.

Marketing fees

The Company paid Abbott Laboratories, Inc. (“Abbott”) marketing fees for services they provided. The contracted services were to include participation in promotional activities, development of educational and promotional materials, representation at trade shows, clinical demonstrations, inservicing and training, and tracking reports detailing the placement of the Company’s products to end-users. Marketing fees were accrued at the time of the sale of product to Abbott. These fees were paid after Abbott provided the Company a tracking report of product sales to end-users. These costs were included in Sales and Marketing expense in the Condensed Statements of Operations. No marketing fees have been accrued since October 15, 2003, the date the National Marketing and Distribution Agreement with Abbott was terminated. On August 15, 2005, the Company filed a lawsuit against Abbott concerning this agreement.

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 invoicing of amounts due under the agreement provided collection is reasonably assured. Such amounts are presented in the Condensed Statements of Operations as a separate component of revenues.

As part of the litigation settlement agreements reached in the second quarter of 2003, a discount reimbursement program of $8,000,000, which is net of legal fees, was established whereby the Company is being provided quarterly reimbursements for certain discounts given to participating facilities. The Company offers certain discounts to participating facilities and is being reimbursed for such discounts. Unit sales to participating facilities comprised 32 percent of total domestic unit sales for the six months ended June 30, 2006. Payments are recognized upon delivery of products provided collection is reasonably assured. Cumulative reimbursements of $7,240,000 were recorded through June 30, 2006.

Management estimates that cumulative reimbursed discounts will reach $8,000,000 during the third quarter of 2006; however, the Company is currently committed to continue offering such discounts to participating facilities through the end of that year. Discounts to participating facilities in excess of the cumulative $8,000,000 discount reimbursement will have a negative impact on gross profit which will begin in the third quarter of 2006.

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

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effect when such basis differences reverse in future periods. Deferred tax assets are periodically reviewed for realizability. The Company has sufficient taxable income from prior carryback years to realize all of its current deductible temporary differences that are reasonably expected to reverse in the upcoming year. The Company has established a valuation allowance for the remaining net asset as future taxable income cannot be reasonably assured at this time.

The Company adopted the provisions of EITF 05-8, Income Tax Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature, in the first quarter of 2006. EITF 05-8 concludes that the difference in book basis and tax basis of a convertible debt instrument is a temporary difference. Furthermore, recognition of deferred tax for a beneficial conversion feature should be recorded as an adjustment (reduction) to additional paid-in capital and an increase to deferred tax liabilities. As a result of implementing EITF 05-8, additional paid-in capital was reduced by $141,233; the current deferred tax asset was reduced by $38,699; and the long-term deferred tax liability was increased by $102,524.

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 is computed by dividing net earnings for the period (adjusted for any cumulative dividends for the period) by the weighted average number of common shares outstanding during the period. The Company’s potentially dilutive Common Stock equivalents consist of options, convertible debt and convertible Preferred Stock and are all antidilutive for the three and six months ended June 30, 2006 and 2005. Accordingly, basic loss per share is equal to diluted earnings per share.

Research and development costs

Research and development costs are expensed as incurred.

Share-based compensation

The Company has issued options under three stock-based director, officer and employee compensation plans as well as several individual option agreements. The two 1996 plans have terminated; however, the options continue until their expected maturity dates. Prior to 2002, the Company accounted for those plans under the recognition and measurement provisions (intrinsic value method) of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Effective January 1, 2002, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, prospectively to all awards granted, modified, or settled after December 31, 2001. Awards generally vest over periods up to three years.

The Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (Revised 2004) (“SFAS No. 123 R”), Share-Based Payment, effective January 1, 2006. It did not have a material impact to the financial statements of the Company. In accordance with the disclosure requirements of SFAS No. 123 R, the Company incurred the following share-based compensation costs:

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During the quarter ended June 30, 2006, six employees exercised options for the issuance of 21,780 shares at an option price of $1 per share for aggregate consideration of $21,780. Two independent Directors exercised options for the issuance of 25,000 shares at an option price of $1 per share for aggregate consideration of $25,000. In addition, two consultants exercised options for the issuance of 22,500 shares at an option price of $1 per share for aggregate consideration of $22,500. All options were non-qualified stock options. The employees’ options were issued under the 1996 Incentive Stock Option Plan and the remainder of the options were issued under the 1996 Stock Option Plan for Directors and Other Individuals.

Inventories consist of the following:

The Company’s effective tax rates (a benefit in both periods) on the net loss before income taxes were 49.7% and 31.2% for the three months ended June 30, 2006 and 2005, respectively. The effective tax rates (a benefit in both periods) on the net loss before income taxes were 37.9% and 32.7% for the six months ended June 30, 2006 and 2005, respectively. The effective tax rate for the three and six month periods ended June 30, 2006 was higher primarily due to a reduction of a valuation allowance for a deferred tax asset attributable to stock options.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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, the recently increased interest of larger market players, specifically Becton Dickinson & Co. (“BD”), in providing safety needle devices, and other factors. 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 June 30, 2006 or 2005.

OVERVIEW

We have been manufacturing and marketing our 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 believe that its monopolistic business practices continue despite its paying $100 million to settle a lawsuit with the Company for anticompetitive practices, business disparagement, and tortious interference. Although we made limited progress in some areas, such as the alternate care and international markets, our volumes are not as high as they should be given the nature and quality of our product, the federal and state legislation requiring use of safe needle devices, and the Senate Subcommittee hearings on Group Purchasing Organizations (“GPOs”). We continue

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to pursue various strategies to have better access to the hospital market, as well as other markets, including attempting to gain access to the market through our sales efforts and innovative technology. In the event we continue to have only limited market access and the cash provided by the litigation settlements and generated from operations becomes insufficient, the Company 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.

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. We are also marketing more product internationally. In 2004 and 2005, we were awarded a federal contract to supply syringes to various African countries. The first award from PATH was for 1,530,000 units. The 2005 award was for 11,700,000 units. Both awards were filled over multiple quarters due principally to logistical requirements for the orders. We are hopeful that these awards will continue to increase under this program.

Product purchases from Double Dove, a Chinese manufacturer, have enabled us to increase manufacturing capacity with little capital outlay and provided a competitive manufactured cost. These purchases have enabled improved profit margins in spite of limited revenues. The cost of production per unit has generally declined as volumes increased.

We also have a license agreement with Baiyin Tonsun Medical Device Co., Ltd. (“BTMD”), a Chinese company. We previously anticipated receiving royalties from the licensing agreement with BTMD before the end of the first contract year ending August 2006. We have recently visited the facility. There has been substantial progress, but we now anticipate the initial receipt of royalties by the end of 2006 or the first quarter of 2007. During the first contract year, BTMD is required to sell at least 25,000,000 units. Based on the lowest possible royalty rate, this would result in a payment of $625,000.

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

Comparison of Three Months Ended

June 30, 2006, and June 30, 2005

Domestic sales accounted for 83.6 percent and 96.9 percent of the revenues for the three months ended June 30, 2006 and 2005, respectively. International sales accounted for the remaining revenues. Domestic revenues increased 27.4 percent and international revenues increased 691.3 percent. Overall, unit sales increased 73.9 percent. Domestic unit sales increased 17.4 percent and international sales increased over 1,100 percent. Domestic unit sales were 64.2 percent of total unit sales for the three months ended June 30, 2006.

International sales increased due to much higher shipments to PATH in the second quarter compared to the same period last year. The timing of the PATH shipments will vary from quarter to quarter.

Gross profit increased primarily due to higher revenues due to increased volumes mitigated by lower average sales prices. Additionally, the average cost of goods sold per unit decreased by 33.2 percent. 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 sales mix. The lower cost in ending inventory at June 30, 2006, should have a continuing positive effect on profit margins for the third quarter.

The Company offers certain discounts to participating facilities and is being reimbursed up to a cumulative amount of $8,000,000 under a litigation settlement agreement. Unit sales to participating facilities comprised 33.2 percent of total domestic unit sales for the three months ended June 30, 2006. Payments are recognized upon delivery of products provided collection is reasonably assured. Cumulative reimbursements of $7.2 million were recorded through June 30, 2006.

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Management estimates that cumulative reimbursed discounts will reach $8,000,000 before the end of the third quarter of 2006; however, the Company is currently committed to continue offering such discounts to participating facilities through the end of that year. Discounts to participating facilities in excess of the cumulative $8,000,000 discount reimbursement will have a negative impact on gross profit which will begin in the third quarter of 2006. The discount program ends December 31, 2006.

Operating expenses increased 23.5 percent. The increase in expense for Sales and Marketing was attributable primarily to additional sales personnel, trade shows, travel and entertainment expense, advertising, and consulting costs. The decrease in Research and Development costs was due principally to costs related to the catheter. General and administrative costs increased due to higher legal expenses and state franchise tax.

Loss from operations decreased due principally to higher revenues and improved profit margins mitigated by higher operating expenses.

Interest income and expense increased due to higher rates.

The Company’s effective tax rates (a benefit in both periods) on the net loss before income taxes were 49.7% and 31.2% for the three months ended June 30, 2006 and 2005, respectively. The effective tax rate for the three months ended June 30, 2006 was higher primarily due to a reduction of a valuation allowance for a deferred tax asset attributable to stock options.

Comparison of Six Months Ended

June 30, 2006, and June 30, 2005

Domestic sales accounted for 86.6 percent and 92.0 percent of the revenues for the six months ended June 30, 2006 and 2005, respectively. International sales accounted for the remaining revenues. Domestic revenues increased 31.6 percent and international revenues increased 136.0 percent. Overall, unit sales increased 45.5 percent. Domestic unit sales increased 20.2 percent and international sales increased 199.5 percent. Domestic unit sales were 70.9 percent of total unit sales for the six months ended June 30, 2006.

International sales increased due to substantially higher shipments to PATH for the six months ended June 30, 2006 compared to the same period last year. The timing of the PATH shipments will vary from quarter to quarter.

Gross profit increased primarily due to higher revenues due to increased volumes mitigated by lower average sales prices due to higher international sales. Additionally, the average cost of goods sold per unit decreased by 15.2 percent. 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 sales mix. The lower unit cost in ending inventory at June 30, 2006, should have a continuing positive effect on profit margins for the third quarter.

The Company offers certain discounts to participating facilities and is being reimbursed up to a cumulative amount of $8,000,000 under a litigation settlement agreement. Unit sales to participating facilities comprised 32.1 percent of total domestic unit sales for the six months ended June 30, 2006. Payments are recognized upon delivery of products provided collection is reasonably assured. Cumulative reimbursements of $7.2 million were recorded through June 30, 2006.

Management estimates that cumulative reimbursed discounts will reach $8,000,000 before the end of the third quarter of 2006; however, the Company is currently committed to continue offering such discounts to participating facilities through the end of that year. Discounts to participating facilities in excess of the cumulative $8,000,000 discount reimbursement will have a negative impact on gross profit which will begin in the third quarter of 2006. The discount program ends December 31, 2006.

Operating expenses increased 24.3 percent. The increase in expense for Sales and Marketing was attributable primarily to additional sales personnel, travel expense, trade shows, and advertising. The increase in Research and Development costs was due principally to costs related to the catheter, consulting costs, and higher compensation costs. General and administrative costs were higher due to legal expenses, state franchise tax, consulting costs, and compensation. Accounting fees were lower for the six month period.

Loss from operations decreased due principally to higher revenues and improved profit margins mitigated by higher operating expenses.

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Interest income and expense increased due to higher rates.

The Company’s effective tax rates (a benefit in both periods) on the net loss before income taxes were 37.9% and 32.7% for the six months ended June 30, 2006 and 2005, respectively. The effective tax rate for the six months ended June 30, 2006 was higher primarily due to a reduction of a valuation allowance for a deferred tax asset attributable to stock options.

The Company’s balance sheet remains strong with cash making up 69.7 percent of total assets. Working capital was $55.3 million at June 30, 2006, a decrease of $690,000 from December 31, 2005. The current ratio improved from 11.3 at December 31, 2005, to 11.4 at June 30, 2006. The quick ratio increased from 10.7 at December 31, 2005 to 10.9 at June 30, 2006. These indicators continue to demonstrate a strong financial position.

Approximately $600,000 in cash flow was used by operating activities. The remaining uses of cash were for capital costs incurred for equipment for the manufacture of the catheter and repayment of long-term debt.

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 loans aggregating over $15,000,000. We received cash payments of $88,514,873 from litigation settlements through September 30, 2005. Cumulative discount reimbursements of $7,240,000 were recorded through June 30, 2006. Discount reimbursements will end after we receive an aggregate of $8,000,000 under the settlement.

Internal Sources of Liquidity

Margins and Market Access

In early 2004 we began to receive shipment of product from Double Dove. We believe as we receive and produce greater quantities our unit cost of goods sold could decrease. If we have market access, we believe our long-term profit margins could increase as margins tend to improve with additional sales and higher production levels. To be profitable 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. Generally, the higher the ratio of domestic sales to international sales, the higher the average sales price will be. However, for the remainder of 2006, we will continue to offer discounts under the discount reimbursement program (the bulk of which will no longer be reimbursed) which will negatively affect our profit margins until the end of the year. 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 second quarter of 2006 is lower than the average unit cost in inventory at December 31, 2005. This is due to more units, in the aggregate, purchased and produced in the first quarter of 2006. Inventory was 5.4 percent lower at June 30, 2006, compared to December 31, 2005, primarily due to a decrease in finished goods mitigated by an increase in raw materials. The Company will continue to evaluate the appropriate mix of products manufactured domestically and those manufactured in China to achieve economic benefits as well as to maintain our domestic manufacturing capability. Currently, approximately 30% of our syringes are produced domestically.

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.

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Licensing Agreement

We entered into a License Agreement with 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 previously anticipated receiving royalties before the end of the first contract year ending August 2006. We have recently visited the facility. There has been substantial progress, but we now anticipate the initial receipt of royalties by the end of 2006 or the first quarter of 2007. 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 have obtained several loans from the inception of the Company, 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

None

Item 4. Controls and Procedures.

Pursuant to paragraph (b) of Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934 (the “Exchange Act”) and on August 10, 2006, 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 June 30, 2006, 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.

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PART II-OTHER INFORMATION

Item 1. Legal Proceedings.

We have previously reported in our Form 10-Q filed on August 15, 2005, that we filed a lawsuit against Abbott Laboratories, Inc.

Item 1A. Risk Factors.

There were no material changes in Risk Factors applicable to the Company as set forth in our Form 10-K annual report which was filed on March 31, 2006, and which is available on EDGAR other than those set forth below.

Management estimates that cumulative reimbursed discounts will reach $8,000,000 before the end of the third quarter of 2006; however, the Company is currently committed to continue offering such discounts to participating facilities through the end of that year. Discounts to participating facilities in excess of the cumulative $8,000,000 discount reimbursement will have a negative impact on gross profit which will begin in the third quarter of 2006. The discount program ends December 31, 2006.

In the event we continue to have only limited market access and the cash provided by the litigation settlements and generated from operations becomes insufficient, the Company 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.

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

Sale of Equity Securities and Use of Proceeds

Six employees exercised options for the issuance of 21,780 shares at an option price of $1 per share for aggregate consideration of $21,780. Two independent Directors exercised options for the issuance of 25,000 shares at an option price of $1 per share for aggregate consideration of $25,000. In addition, two consultants exercised options for the issuance of 22,500 shares at an option price of $1 per share for aggregate consideration of $22,500. All options were non-qualified stock options. The employees’ options were issued under the 1996 Incentive Stock Option Plan and the remainder of the options were issued under the 1996 Stock Option Plan for Directors and Other Individuals.

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 June 30, 2006, 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.

Item 3. Defaults Upon Senior Securities.

Series I Class B Convertible Preferred Stock

As of the six months ended June 30, 2006, the amount in arrears is $43,000 and the total arrearage is $184,000.

Series II Class B Convertible Preferred Stock

As of the six months ended June 30, 2006, the amount in arrears is $122,000 and the total arrearage is $565,000.

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Series III Class B Convertible Preferred Stock

As of the six months ended June 30, 2006, the amount in arrears is $67,000 and the total arrearage is $2,785,000.

Series IV Class B Convertible Preferred Stock

As of the six months ended June 30, 2006, the amount in arrears is $278,000 and the total arrearage is $5,646,000.

Series V Class B Convertible Preferred Stock

As of the six months ended June 30, 2006, the amount in arrears is $221,000 and the total arrearage is $2,262,000.

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

None

Item 5. Other Information.

We will hold our annual meeting on September 22, 2006, at the Little Elm City Hall located at 100 W. El Dorado Parkway, Little Elm, Texas 75068.

The independent Directors recently recommended to the Board the membership of the various outstanding committees. The Board of Directors unanimously approved such recommendation. Accordingly, the committees are comprised of the following members:

Audit Committee

The Audit Committee consists of Messrs. Clarence Zierhut, Marwan Saker, and Marco Laterza. The Chairman is Mr. Laterza.

Compensation and Benefits Committee

The Compensation and Benefits Committee consists of Messrs. Clarence Zierhut and Marco Laterza and Jimmie Shiu, M.D. The Chairman is Mr. Zierhut.

Nominating Committee

The Nominating Committee consists of Messrs. Marco Laterza and Marwan Saker, and Jimmie Shiu, M.D. The Chairman is Mr. Saker.

Item 6. Exhibits.

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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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