**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

 

**WASHINGTON, D.C. 20549**

 

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**FORM 10-KSB**

 

| **ý**                                |   | **ANNUAL REPORT UNDER SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                         |
|-------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                      |   | **For the fiscal year ended June 30, 2003**                                                                                                                                                                                                 |
|                                      |   |                                                                                                                                                                                                                                        |
| **o**                                     |   | **TRANSITION REPORT UNDER SECTION 13  or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                     |
|                                      |   | **For the transition period from                   to                   .** |
|                                      |   |                                                                                                                                                                                                                                        |
| **Commission File Number:  0-22390** |

 

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**SHARPS COMPLIANCE CORP.**

(Name of Small Business Issuer in its Charter)

 

| **Delaware**                                                    |   | **74-2657168**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **9350 Kirby Drive, Houston, Texas**                            |   | **77054**                            |
| (Address of principal executive offices)                        |   | (Zip Code)                           |
|                                                            |   |                                 |
| **(713) 432-0300**                                              |
| Registrant’s  telephone number                             |

 

Check whether the issuer (1)filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90days.    Yes    ý   No    o

 

Check if there is no disclosureof delinquent filers in response to item 405 of Regulation S-B is not containedin this form, and no disclosure will be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-KSB or any amendment to this Form10-KSB.  o

 

Issuer’s revenues for mostrecent fiscal year: $8,419,339

 

Aggregate market value of thevoting stock held by non-affiliates computed by the closing stock price onSeptember 23, 2003**, **$10,009,460.

 

Number of shares outstanding ofthe issuer’s Capital Stock as of September 23, 2003: 9,910,356

 

Check whether the registrant isan accelerated filer (as defined in Exchange Act Rule 12b-2). Yes  o    No  ý

 

Transitional Small BusinessDisclosure Format (check one): Yes  o  No  ý

 

**DOCUMENTS INCORPORATED BY REFERENCE:**

 

Portions of the Registrant’sdefinitive Proxy Statement for the 2003 Annual Meeting of Stockholders to beheld on December 9, 2003****are incorporated by reference in Part III hereof.

 

 

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SHARPS COMPLIANCE CORP.

 

TABLE OF CONTENTS *

ANNUAL REPORT ON FORM 10-KSB

 
| PART I    |
|-----------|
|      |   |
| Item 1    | Description of Business |
| Item 2    | Description of Property |
| Item 3    | Legal Proceedings |
| Item 4    | Submission of Matters to a Vote of Security  Holders |
|      |   |
| PART II   |
|      |   |
| Item 5    | Market for Common Equity and Related  Stockholder Matters |
| Item 6    | Management’s Discussion and Analysis or  Plan of Operations |
| Item 7    | Financial Statements |
| Item 8    | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure |
| Item 8A   | Controls and Procedures |
|      |   |
| PART  III |
|      |   |
| Item 9    | Directors, Executive Officers, Promoters and Control Persons;  Compliance with Section 16(a) of the Exchange Act |
| Item 10   | Executive Compensation |
| Item 11   | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters |
| Item 12   | Certain Relationships and Related  Transactions |
| Item 13   | Exhibits and Reports on Form 8-K |
| Item 14   | Principal Accountant Fees and Services |
|      |   |
|      | Signatures |

 

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*                 This Table of Contents is inserted forconvenience of reference only and is not a part of this Report as filed.

 

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**INFORMATIONREGARDING FORWARD-LOOKING STATEMENTS**

 

*This annual report on Form 10-KSB containscertain forward-looking statements and information relating to the Company andits subsidiaries that are based on the beliefs of the Company’s management aswell as assumptions made by and information currently available to the Company’smanagement. When used in this report, the words “anticipate”, “believe”,“expect”, “estimate”, “project” and “intend” and words or phrases of similarimport, as they relate to the Company or its subsidiaries or Companymanagement, are intended to identify forward-looking statements.  Such statements reflect the current risks,uncertainties and assumptions related to certain factors, including withoutlimitations, competitive factors, general economic conditions, customerrelations, relationships with vendors, governmental regulation and supervision,seasonality, distribution networks, product introductions and acceptance,technological change, changes in industry practices, onetime events and otherfactors described herein.  Based uponchanging conditions, should any one or more of these risks or uncertaintiesmaterialize, or should any underlying assumptions prove incorrect, actualresults may vary materially from those described herein as anticipated,believed, estimated, expected or intended. All such forward-looking statements speak only as of the date of thisForm 10-KSB.  The Company does notintend to update these forward-looking statements.*

 

**PART I**

 

**ITEM1.  DESCRIPTION OF BUSINESS**

 

The information presentedherein is for Sharps Compliance Corp. and its wholly owned subsidiaries, SharpsCompliance, Inc. of Texas dba Sharps Compliance, Inc., Sharps e-Tools.com,Inc., Sharps Environmental Services, Inc. dba Sharps Environmental Services ofTexas, Inc. and Sharps Manufacturing, Inc. (collectively, “Sharps” or the“Company”).  Sharps’ principal office islocated at 9350 Kirby Drive, Houston, Texas 77054.

 

The Company provides access toall of its filings with the Securities and Exchange Commission (“SEC”) throughits website www.sharpsinc.com, as soon as reasonably practicable after thereports are filed with the SEC.  Thesefilings are also available free of charge through the Company’s investorrelations department.

 

**PRODUCTSAND SERVICES**

 

Sharps is a leading developerof cost effective solutions for improving safety and efficiency related to theproper  disposal of medical waste byindustry and consumers.  These solutionsinclude Sharps Disposal by Mail SystemTM, Pitch-ItTM IV Poles, Trip LesSystemTM,Sharps Pump Return Box, Sharps Enteral Pump Return Box, Sharps SureTemp ToteTM,Sharps e-Tools, Sharps Environmental Services and Sharps Consulting.  Some products and services facilitatecompliance with state and federal regulations by tracking, incinerating anddocumenting the disposal of medical waste. Additionally, some products and services facilitate compliance witheducational and training requirements required by federal, state, local andregulatory agencies.

 

The Sharps Disposal by MailSystemTM is a comprehensive solution for the containment, transportation,destruction and tracking of medical waste for commercial (healthcare andnon-healthcare) and retail industries. The Sharps Disposal by Mail SystemTM contains a securely sealed, leak andpuncture resistant sharps container in several sizes; United States PostalService (“USPS”) approved shipping carton with priority mail postage; absorbentmaterial inside the container that can safely hold up to 150 milliliters offluids; a red bag for additional containment and complete documentation andtracking manifest.  Customers who usethe Sharps Disposal by Mail SystemTM are responsible for mailing the system tothe Company’s disposal facility for incineration (i.e. Sharps EnvironmentalServices).  Upon destruction, Sharpssupplies verification of destruction to the customer.

 

The Pitch-ItTM IV Poles aredesigned as a cost effective, portable, lightweight and disposable alternativeto traditional IV poles used for gravity-fed or pump-administeredinfusions.  The innovative pole designprovides opportunities for the home healthcare industry to improve logisticalefficiencies by eliminating the costs and inconvenience of retrieving, cleaning,bagging, tagging and storing of traditional IV poles.  The Pitch-ItTM poles are available in three models: (i) tabletop,(ii) floor and (iii) full-size with wheels.

 

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The Trip LesSystemTM is asolution for the home healthcare (commercial) industry that eliminates costlytrips by healthcare providers to the patient’s home after therapy has beencompleted.  The Trip LesSystemähas combined two complete programs for return and disposal.  All systems contain the Sharps Disposal byMail SystemTM along with either (i) a prepaid pump return box or (ii) aPitch-ItTM IV Pole, depending on the patient’s therapy.

 

Sharps’ asset return boxes(i.e., the Sharps Pump Return Box and Sharps Enteral Pump Return Box) aremarketed to home healthcare providers, primarily for use with home infusionpatients.  These products providedelivery and retrieval of expensive equipment, like infusion and enteral pumps,phototherapy and TENS units, between the healthcare provider and the patient.

 

The Sharps SureTemp ToteTM is adisposable cooler that maintains a safe range for temperature-sensitivematerials.  Sharps primarily markets theproduct to home healthcare providers to protect IV medications used in homeinfusion.  Its disposable naturerelieves the home healthcare provider of tracking, cleaning and maintainingreusable coolers.

 

The Sharps e-Tools onlineservices include Sharps TracerTM, Asset TracerTM and ComplianceTrak.  SharpsTracerTM is a manifest imaging andtracking program for registered customers for the purpose of tracking andcertifying the transportation and disposal of regulated medical waste.  SharpsTracerTM eliminates traditionalpaper-based methods of manifest tracking and is designed to enhance customerefficiencies with an automatic Proof of Destruction, Market Data Collectionabilities and Return to Store Programs capabilities.  AssetTracerTM allows its registered subscribers to manageeffectively all types of capital assets through a single, organizeddatabase.  The program can be used inconjunction with other Company products or independently and includesmanagement reporting for regulatory compliance, preventative maintenance andasset status and/or location. ComplianceTrak offers a broad range of employee centered compliance andeducation programs.  The programs rangefrom policy and procedure development to specialized training and certificationfor all employees required to meet certain Occupational Safety and HealthAdministration (“OSHA”) standards.

 

Sharps Environmental Servicesprovide environmental solutions for customers with a wide variety of wastedisposal needs.  Primary servicesinclude the destruction and disposal of (i) medical sharps waste, (ii)legal/confidential documents, (iii) pharmaceutical products and (iv)non-hazardous industrial waste.  Thisservice allows the Company to oversee directly the proper disposal of itsSharps Disposal by Mail SystemsTM.  Effective July 1, 2000, the Company entered into an agreement withthe City of Carthage, Texas, and Panola County to manage and operate the PanolaCounty Resources Recovery Facility (“PCRRF”), a municipally owned incinerator.  The agreement has been amended to extenduntil June 30, 2012.

 

Sharps Consulting provides abroad range of services including (i) analysis of legal and regulatoryimplications of present waste handling practices, (ii) communicating newlegislation and industry best practices minimizing employee exposure andliability, (iii) serving as intermediary with regulatory agencies and (iv)educating employees on infection control practices and the dangers ofimproperly handled medical waste.

 

**MARKETS**

 

Sharps’ target markets includethe home healthcare industry, assisted living facilities and dental,veterinarian and physician markets (commercial healthcare); hospitality andother industrial markets (commercial non-healthcare); home self-injectors(retail) and other markets where Sharps’ products and services may be bundledor cross-sold to provide solutions to prospective customers.  Sharps is involved in the mission to helpseparate the potentially infectious medical waste from the regular waste.  The repeat order nature of our business andan infrastructure, which is nationwide, has helped drive our growth.  Sharps has remained flexible and responsiveto its customer needs in industries that demand effective cost and logisticalsolutions, quick response and technological innovation.

 

**Home Healthcare Industry**.Healthcare is increasingly provided in the home setting, requiring healthcareprofessionals to dispose of contaminated syringes, surgical supplies and othermaterials outside of medical facilities. The home healthcare industry is a primary market for the Trip LesSystemä,which includes the Sharps Disposal by Mail SystemTM, Pitch-ItTM IV Pole and assetreturn box.  Sharps’ products aredistributed to the home healthcare industry through major national homecareequipment and supply distributors, including Medline, Medical Specialties,Medic ACS and Redline.  The homehealthcare industry is a somewhat fragmented market; however, managementestimates that approximately 20 corporations dominate the home healthcaremarket within the United States and Sharps currently maintains a relationshipwith a majority

 

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of these corporations.

 

The Trip LesSystemäis predominate with many of the top home healthcare corporations under contractand is under serious consideration with several of the remainingcompanies.  Sharps’ current principalcustomers include nationally recognized, leading home healthcare customers suchas Apria Healthcare Inc., Coram Healthcare Inc. and Accredo Health, Inc.  Among the leading national home healthcarecompanies, Sharps has become part of the formulary for dealing with thedisposal of the sharps (syringes, needles, lancets, sutures, catheter needlesor any item that can puncture the skin), primarily because of the TripLesSystemä.  Thesystem is cost effective because it reduces the number of costly trips by thehome healthcare providers to patients’ homes to retrieve medical waste or todeliver or retrieve medical equipment.

 

Sharps sells its products andservices to home health companies directly and through distributors.  Sharps’ strategy is to obtain agreementswith homecare companies to use Sharps’ products and arrange for the homecarecompany’s distributor of choice to sell and deliver the product and servicesdirectly to the homecare company.

 

Management expects aclarification issued by the Department of Transportation (“DOT”) to affectmedical waste delivery among home healthcare providers.  The DOT clarified the exemptions to 49CFRPart 173.134(b) of the Hazardous Materials Regulations (“HMR”), thereby requiringhome healthcare providers to follow HMR requirements for regulated medicalwaste during transport.  Healthcareproviders who are transporting regulated medical waste must use DOT approved,tested and registered containers.  TheSharps Disposal by Mail SystemTM meets all HMR requirements through USPSpermitting procedures.  Sharps hasstarted a marketing and educational program informing home healthcare providersof this clarification and offering the Sharps Disposal by Mail SystemTM fortheir transportation needs.

 

**Assisted Living Facilities**.Sharps believes that assisted living providers are an excellent market for theSharps Disposal by Mail SystemTM because their residents are more likely thanthe general populous to self-inject, thereby generating a stream of medicalwaste requiring proper disposal.  Thevolume produced by each facility is particularly suited for disposal in SharpsDisposal by Mail SystemTM.

 

**Dentists, Veterinarians and Physicians**.Sharps has a presence within these healthcare markets with the Sharps Disposalby Mail SystemTM.  Sharps’ system isideal for these small volume waste generators. Sharps has grouped the dental, physician and veterinarian markettogether due to their similar model and duration usage.

 

Sharps utilizes distributors toreach the dental, veterinarian and physician marketplace.  In all areas, Sharps’ products and servicesare distributed through major distributors within each of the respectivemarkets.  Henry Schein and PattersonDental distribute to dental customers. In the veterinary market, the main distributors are The Butler Companyand MWI Veterinary Supply.  In thephysician market, a variety of methods are used to reach the needs of allphysicians, including sales through Group Purchasing Organizations.

 

**Hospitality and Other Industrial Markets**.Sharps sells both directly and through distributors, such as Ecolab, Inc. andFront Line Sales, Inc., to the hospitality and other industrial markets,including hotels, motels, resorts, schools, colleges, stadiums, daycarecenters, planes, trains, cruise ships, casinos, supermarkets, distributioncenters, business offices, restaurants, bars and clubs.  Management believes that OSHA enhancedregulations will increase this important market for Sharps’ products and services.  Sharps has developed specialized versions ofits Sharps Disposal by Mail SystemTM, which permit an institutionalestablishment to easily introduce the product. Sharps developed custom-designed cones, one used to collect contaminatedsharps when discovered and a second used as a temporary receptacle by transientindividuals who need to dispose of syringes.

 

**Home Self-Injectors**.A growing market is the home self-injector market.  Approximately three percent of the United States population, orindividuals in one out of every twelve households, use sharps in the treatmentof conditions such as diabetes, multiple sclerosis, infertility, migraines,allergies and hemophilia, as well as infectious diseases like hepatitis andHIV.  While medical waste disposal inthe home is largely unregulated, certain states require used sharps from homeself-injectors to be disposed as medical waste and not as regular garbage.

 

Sharps is actively marketing tothe vast number of insulin dependent diabetics and this market is expected togrow as testing for the condition increases and modern dietary habits lead togrowing numbers of diabetics.  In May of2002, Sharps signed

 

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a three-year, renewableagreement with BD Consumer Health Care, a division of Becton, Dickinson andCompany (“BD”), the world’s largest syringe manufacturer.  The agreement names Sharps as the exclusivesupplier of Sharps Disposal by Mail SystemsTM for retail sale nationally.  BD will be marketing the mail-back disposalsystem to Sharps’ target market of home self-injectors in BD’s syringe boxes,diabetic newsletter and “Getting Started” kits for newly diagnoseddiabetics.  Sharps is also marketing tothe retail customer through a joint sales and marketing agreement with WasteManagement, Inc. (“WM”), a leading waste services provider.  WM will market Sharps’ disposal by mailsystems to WM’s 25 million residential customers.

 

**INDUSTRYANALYSIS**

 

The large, fragmented medicalwaste industry has experienced significant growth since its inception.  The regulated medical waste industry arosewith the Medical Waste Tracking Act of 1988, which Congress enacted in responseto media attention after medical waste washed ashore on beaches, particularlyin New York and New Jersey.  Since the1980s, the public and governmental regulators have increasingly restricted thehandling and disposal of medical waste generated by the healthcareindustry.  Regulated medical waste isgenerally described as any medical waste that can cause an infectious disease,including single-use disposable items such as needles, syringes, gloves andother medical supplies, cultures and stocks of infectious agents and blood andblood products.  Today, almost allbusinesses have waste disposal concerns for safety and liability reasons.  Regulated waste such as syringes, razorblades, bloodborne items, bio-hazard waste spills and other sharps waste canoccur in the following situations: treating cuts, abrasions and burns; findingneedles, syringes or blood-soaked items in the workplace; launderingblood-soaked linens or finding needles or razor blades in linens; and cleaningup broken glass with blood stains or bio-hazardous waste.

 

**MARKETSIZE**

 

Management believes manybusinesses that are not outsourcing medical waste services are unaware of OSHArequirements regarding proper training of employees that may handle medicalwaste.  These businesses includerestaurants, casinos, hotels and generally all businesses in which employeesmay come into contact with bloodborne pathogens.  In addition, medical waste generated in the home is currentlyunregulated and may become subject to similar bloodborne pathogen regulationsin the future.

 

**Home Healthcare Industry**

 

Homecare target markets includeSharps’ primary market, home infusion providers, as well as home nursingagencies.  There are approximately 4,500sites in the United States that provide home infusion services including local,national and hospital-based providers generating approximately 4.5 billion dollarsin annual revenue.  A large percentageof the patients in this market are serviced by twenty large chains andaffiliations, the majority of which are Sharps’ customers.  Recent statistics on home nursing agenciesshow 7,152 Medicare Certified Agencies employing 240,136 clinical full timeemployees.  The home nursing market,unlike the infusion market, downsized after the Balanced Budget Amendment of1997.  Sharps’ focus in the home nursingmarket is secondary to infusion due to the potential business per site, but theSharps Disposal by Mail SystemTM could service their total medical wastehandling, disposal and documentation needs. Sharps’ sales force focuses on these accounts.

 

**Dentist, Veterinarians and Physicians**

 

Recent figures supplied by theAmerican Dental Association, the American Medical Association and the AmericanVeterinary Association, indicate that there are approximately 152,000 dentists,598,000 physicians and 59,000 veterinarians in active practice in the UnitedStates.  Management estimates that alarge majority of these offices would benefit from replacing waste haulingservices with the Sharps Disposal by Mail SystemTM.

 

**Hospitality and Other Industrial Markets**

 

The Lodging Industry Profilefor 2002, published by Bureau of Labor Statistics, estimates there areapproximately 41,000 properties consisting of 4.2 million rooms supporting morethan 7.8 million jobs. In 29 states, the tourism industry ranks as the first,second or third largest employer. According to the National Restaurant Association, the restaurantindustry employs approximately 11.7 million people.  Management believes that a comprehensive application of OSHAregulations

 

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would require the majority ofthese employees to be trained in the proper handling of medical wasteencountered in the workplace.

 

**Home Self-Injectors**

 

The American DiabetesAssociation (“ADA”) estimates approximately 17.0 million people in the UnitedStates, or 6.2% of the population, have diabetes.  Of diagnosed cases, the ADA estimates 3.7 million require dailyinsulin injections.

 

Management believes that theoverall demand for Sharps’ solutions will grow, with such growth being fueledby a number of factors, including the following:

 

1.               Thehealthcare industry is under pressure to reduce costs and improveefficiency.  Sharps believes that theCompany’s solutions help healthcare providers reduce costs by reducing theirmedical waste tracking, handling and compliance costs and equipment deliveryand return costs.

 

2.               Federal,state and local regulations for transporting and/or disposing of medical wasteare increasing over time.

 

3.               OSHAhas issued regulations concerning employee exposure to bloodborne pathogens andother potentially infectious materials that require special procedures for thehandling and disposal of medical waste and annual training of all personnel whomay be exposed to blood and other body fluids. Management believes these regulations will expand the market for Sharps’products and services.

 

**RESEARCHAND DEVELOPMENT**

 

Sharps’ research anddevelopment costs have not been material. The Company is seeking newapplications for the Sharps Disposal by Mail SystemTM in many different areas,since small quantity medical waste generators can be found in manyindustries.  Sharps is also consideringthe development of new products to assist companies in complying with OSHAregulations regarding medical waste handling. The Company intends to utilize the services of prospective manufacturersin the development of the new product, which should keep development costs at aminimum.

 

**MARKETRISKS**

 

Although Sharps has experiencedgrowth in revenues over the past few years, there is an inherent concentrationof credit risk associated with accounts receivable arising from sales to itsmajor customers, which are primarily distributors.  For the year ended June 30, 2003, three customers representedapproximately 60% (or $445,000) of total accounts receivable balance at June30, 2003.  For the year ended June 30,2002, four customers represented approximately 56% (or $363,000) of totalaccounts receivable at June 30, 2002. For the year ended June 30, 2003, two customers represented 41% ofrevenues.  For the year ended June 30,2002, four customers represented 56% of revenues.  The Company may be affected by its dependence on a limited numberof high volume customers.  Managementbelieves that the risk is mitigated by (i) the contractual relationships withthe end user of the products and reputation of Sharps’ major customers, (ii) aloss of any distributor does not necessarily mean the loss of the underlyingcustomer base of that distributor for the Company’s products and (iii) thecontinued diversification of the Company’s products and services.

 

Sharps continues to sole-sourcetransportation, which consists of delivering the Sharps Disposal by Mail SystemTMfrom the end user to the Company’s facility. Transportation is currently sole-sourced to the USPS.  Management believes the risk of dependenceis mitigated by the long-standing business relationship.  Although there are no assurances with regardto the continued future business association, management believes thatalternative sources would be available.

 

**INTELLECTUALPROPERTY**

 

Sharps has applied in theUnited States for registration of a number of trademarks and patents, many ofwhich have been registered and granted, but can give no assurance that theCompany will obtain registrations for the other trademarks and patents forwhich it has applied.

 

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**RISKFACTORS**

 

**Operating History; History of Losses**

 

Sharps has incurred cumulativelosses from operations since its inception. The future success of Sharps is dependent upon many factors, includingenvironmental regulation, continuity of its distributorship and customeragreements, successful completion of its product development activities and theidentification and penetration of additional markets for its products andservices.  Management believes that theCompany’s current resources, including its factoring line of credit and the$500,000 proceeds from the September 2003 private placement will be sufficientto fund operations through fiscal year 2004. There can be no assurance that the Company will be able to obtainfinancing, if necessary, on acceptable terms to fund operations beyond thattime frame; however, management believes that it will be successful in raisingsuch financing, if necessary.

 

**Dependence on Certain Management Personnel**

 

Sharps’ growth and developmentto date has been largely dependent on the active participation and leadershipof its Chairman and Chief Executive Officer, Dr. Burton Kunik.  During the period from September 2002through July 2003, the Company has hired and/or replaced its senior managementteam including its Chief Operating Officer, Chief Financial Officer and SeniorVice President of Sales and Marketing. The Company believes that the business is dependent upon the continuedemployment of the Chief Executive Officer as well as the senior management teamand has therefore entered into employment agreements with all the above notedindividuals in order to provide incentive for their continued employment withthe Company.

 

**Competition**

 

There are several competitorswho offer disposal of medical waste services such as a division of Stericycle,Inc.; however, no other company focuses primarily on the disposal of sharpsmedical waste, nationally, through transport by the USPS.  While Sharps currently does not face anysignificant competition in the mail sharps disposal business, the Company mustcompete with larger and better-capitalized companies.

 

**Customer Relationships**

 

Sharps generally has no firmlong-term volume commitments from its customers and enters into individualpurchase orders or contracts.  AlthoughSharps has contractual relationships with the majority of its customers, Sharpshas experienced fluctuations in order levels from period to period and expectsto continue experiencing such fluctuations in the near future.  In addition, customer purchase orders may becanceled and order volume levels can be changed, canceled or delayed withlimited or no penalties.  Sharps cannotassure the replacement of canceled, delayed or reduced purchase orders with newbusiness.  Moreover, Sharps financialcondition and results of operations will depend in significant part upon the Company’sability to obtain orders from new customers, as well as the financial conditionand success of its customers, its customers’ products and services and thegeneral economy.  The factors affectingany of the major customers of Sharps or their customers could have a materialadverse effect on the businesses, financial condition and results of operationsof Sharps.

 

**Incinerator Facilities**

 

The Company’s business uses anincinerator facility for medical waste disposal.  Effective July 29, 2002, the Company extended its multi-yearagreement for such a facility with the City of Carthage, Texas, and PanolaCounty to operate the PCRRF through June 30, 2012.  The Company is responsible for operating and maintaining thefacility in compliance with all federal, state and local laws and/or any otherregulatory agency involving solid waste disposal.  Any disruption in the availability of a disposal facility mayhave an adverse impact on the Company. The Company can make no assurances that no such disruption will occur inthe future.

 

The Company believes thefacility is in material compliance with all applicable federal, state, localand/or regulatory agency requirements, air pollution and TNRCC (“Texas NaturalResources Conservation Commission”) regulations through 2005.  The Company entered into an agreement with asecondary burn facility to provide services in the event the PCRRF isunavailable.

 

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**Governmental Regulation**

 

Sharps is required to operatewithin guidelines established by federal, state, local and/or regulatoryagencies.  Such guidelines have beenestablished to promote occupational safety and health standards and certainstandards have been established in connection with the handling, transportationand disposal of certain types of medical and solid wastes, including mailedsharps.  Sharps believes that it iscurrently in compliance in all material respects with all applicable laws andregulations governing its business. However, in the event additional guidelines are established to morespecifically control the business of Sharps, including the environmentalservices subsidiary, additional expenditures may be required in order forSharps to be in compliance with such changing regulations.  Furthermore, any material relaxation of anyexisting regulatory requirements governing the transportation and disposal ofmedical sharps products could result in a reduced demand for Sharps’ productsand services and could have a material adverse effect on Sharps’ revenues andfinancial condition.  The scope andduration of existing and future regulations affecting the medical and solidwaste disposal industry cannot be anticipated and are subject to change due topolitical and economic pressures.

 

**Postal Work Interruptions**

 

Since Sharps transports itsdisposal products using the USPS, any interruption in day-to-day postalservices could have a material adverse effect on Sharps’ revenues and financialcondition.  Postal delivery interruptionsare rare and unpredictable.  However,since USPS employees are federal employees, such employees may be prohibitedfrom engaging in or continuing a postal work stoppage, although there can be noassurance that such work stoppage can be avoided.

 

**ITEM2. DESCRIPTION OF PROPERTY**

 

Sharps currently leases 10,634square feet of rentable space in Houston, Texas.  The lease period commenced October 1, 2002, and terminatesJanuary 31, 2008.  The initial annual rent(including taxes, insurance and common area expenses) is $116,280, or $10.94per square foot.  Although, the baserent portion of the lease obligation (approximately 78%) is fixed, the portionrelated to taxes, insurance and common area expenses are subject to annualadjustments based on actual costs incurred.

 

The Company leases anincinerator facility located in Carthage, Texas for medical waste disposal. Theamended lease requires rental payments of $2,000 per month for the first year(year ended June 30, 2003) escalating by $6,000 per year (or $500 per month)each year thereafter until termination of the lease on June 30, 2012. TheCompany is required to pay additional rent equal to $0.02 per pound for allmaterials burned, treated, received or transferred at the incinerator facilityexceeding 100,000 pounds per month. The Company did not incur any additionalrent during the year ended June 30, 2003. The Company is responsible for thecost of operating and maintaining the facility. For accounting purposes and asa result of the lease escalation clause, the Company records lease expense forthis facility on a straight-line basis over the life of the lease whichcomputes to $4,250 per month, or $51,000 per year.

 

**ITEM 3. LEGAL PROCEEDINGS**

 

Sharps is involved in certainlegal actions and claims arising in the normal course of business.  While the outcome of these matters cannot bepredicted with certainty, management believes these matters will not have amaterial adverse effect on Sharps’ consolidated financial position, results ofoperations or liquidity.

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

During the three months endedJune 30, 2003, no matter was submitted by the Company to a vote of itsstockholders through the solicitation of proxies or otherwise.

 

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**PARTII**

 

**ITEM 5. MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS**

 

**Market Information**:During the two (2) years ended June 30, 2003, the common stock of the Companyhas been quoted on the over-the-counter (“OTC”) Bulletin Board under the symbol“SCOM”.  The Company’s common stock hashad limited trading volume, averaging approximately 36,000 shares traded permonth on the OTC Bulletin Board. The table below sets forth the high and lowclosing prices on the OTC Bulletin Board for each quarter within the last twofiscal years.

 
|                                       |   | **Common  Stock** |       |
|--------------------------------------------|--------|-------------------|------------|
|                                       |   | **High**          |       | **Low** |   |
| **Fiscal Year Ended June 30, 2002**        |   |              |       |   |   |
| First Quarter                              |   | $                 | 1.80       |   | $ | .62 |   |
| Second Quarter                             |   | $                 | 1.85       |   | $ | 1.15 |   |
| Third Quarter                              |   | $                 | 2.00       |   | $ | 1.52 |   |
| Fourth Quarter                             |   | $                 | 2.55       |   | $ | 1.53 |   |
|                                       |   |              |       |   |   |
| **Fiscal year Ended June 30, 2003**        |   |              | ** ** |   | ** ** |
| First Quarter                              |   | $                 | 1.80       |   | $ | 1.05 |   |
| Second Quarter                             |   | $                 | 1.70       |   | $ | 1.10 |   |
| Third Quarter                              |   | $                 | 1.50       |   | $ | 1.10 |   |
| Fourth Quarter                             |   | $                 | 1.25       |   | $ | 0.72 |   |
|                                       |   |              |       |   |   |
| **Fiscal Year Ending June 30, 2004**       |   |              | ** ** |   | ** ** |
| First Quarter (through September 23, 2003) |   | $                 | 1.10       |   | $ | 0.82 |   |

 

**Stockholders**: AtSeptember 23, 2003, there were 9,910,356 shares of common stock held by 206holders of record.  The last reportedsale of the common stock on September 23, 2003, was $1.01 per share.  The Company completed a private placement of1.1 million shares of common stock on October 12, 2001, at a price of $1.10 pershare.  The Company completed a privateplacement of 625,000 shares of common stock on September 24, 2003, at a priceof $0.80 per share.  Proceeds from bothof the above noted offerings were used to fund operations and for workingcapital purposes.

 

**Dividend Policy**: TheCompany has never declared nor paid any cash dividends on its commonstock.  The Company currently intends toretain all of its earnings for the operation and expansion of its business anddoes not anticipate paying any dividends in the foreseeable future.

 

**ITEM6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS**

 

The discussion and analysispresented below should be read in conjunction with the consolidated financialstatements and related notes appearing elsewhere in this Form-10KSB.  See “Information Regarding Forward LookingStatements.”

 

9

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**RESULTSOF OPERATIONS**

 

The following table sets forth,for the periods indicated, certain items from the Company’s CondensedConsolidated Financial Statements of Operations, expressed as a percentage ofrevenue:

 

|                                |   | **Year Ended  June 30,** |   |
|-------------------------------------|--------|--------------------------|--------|
|                                |   | **2003**                 |   | **2002** |   |
|                                |   |                     |   |   |   |
| Total revenues                      |   | 100                      | %      | 100 | % |
| Costs and expenses:                 |   |                     |   |   |   |
| Cost of revenues                    |   | (69                      | )%     | (67 | )% |
| Selling, general and administrative |   | (44                      | )%     | (44 | )% |
| Depreciation and amortization       |   | (2                       | )%     | (2 | )% |
|                                |   |                     |   |   |   |
| Total operating expenses            |   | (115                     | )%     | (113 | )% |
| Operating loss                      |   | (15                      | )%     | (13 | )% |
| Interest income, net                |   | 0                        | %      | 0 | % |
| Net loss                            |   | (15                      | )%     | (13 | )% |

 

**YEARENDED JUNE 30, 2003 COMPARED TO YEAR ENDED JUNE 30, 2002**

 

Total revenues for the yearended June 30, 2003 of $8,419,339 increased by $1,906,314, or 29%, over thetotal revenues for the year ended June 30, 2002 of $6,513,025. The increase inrevenues is attributable to (i) manufacturing revenues related to the Pro-Tecproduct line of $371,000, (ii) an increase in sales of the Sharps Disposal byMail System products of $350,000, (iii) an increase in sales of Pump Return Boxproducts of $297,000, (iv) a $279,000 change in accounting estimate related tothe revenue deferral on Pump return products and (v) an increase in theSureTemp Totes products of $222,000. The underlying reasons for the increase in revenues for these productlines are, (i) the entry into the retail market for the Sharps Disposal by MailSystems products, (ii) new revenues associated with the Pro-Tec products(acquired in October 2002) and (iii) an overall demand in the home healthcaremarket for the Company’s products.

 

During the fourth quarter offiscal year 2003, the Company recognized increased revenues of approximately$279,000 in conjunction with a change in accounting estimate related to pumpreturn products.  Prior to the change inestimate, the Company deferred 100% of all pump return sales.  Through historical trend analysis, which wasnot available in the past, the Company has subsequently determined that acertain percentage of all containers sold are not returned.  Accordingly, the Company has recognized,during the fourth quarter of 2003, a portion of the deferred revenue that waspreviously deferred.

 

Cost of revenues for the yearended June 30, 2003 of $5,798,150 were 69% of revenues and included thefollowing special items, (i) an inventory write-down of $86,918 and (ii) baddebt write-off of $205,000. When excluding the two special items noted above,the cost of revenues is $5,506,232, or 65% of revenues. Cost of revenues forthe year ended June 30, 2002 of $4,361,072 was 67% of revenues for the correspondingperiod.

 

SG&A expenses for the yearended June 30, 2003 of $3,754,014 increased by $860,809, or 30%, over theSG&A expenses for the year ended June 30, 2002. The increase in theSG&A expenses is primarily a result of an increase in the followingexpenses, (i) professional fees of $348,000, (ii) compensation related of$439,000, (iii) office lease of $41,000, (iv) travel and entertainment of$44,000, and (v) insurance of $35,000. The underlying reasons for the increase in the above noted expenses are,(i) an increase in outside professional fees associated with the entry into theretail and residential markets, (ii) an increase in audit fees associated withthe change in the accounting of the Company’s revenue recognition policy andcorresponding restatement of prior period financials, (iii) an increase inemployees necessary to facilitate the Company’s current and expected growth and(iv) the move of the Company’s operations to a larger office facility.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Cash and cash equivalentsdecreased by $361,469 to $135,884 at June 30, 2003 from $497,353 at June 30,2002. Additionally, short-term investments decreased from $502,287 to zeroduring the same period. The decrease in cash and cash equivalents andshort-term investments is primarily a result of the $1,277,527 net loss for theyear ended June 30, 2003,

 

10

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partially offset by theDecember 31, 2002 repayment of a related party note receivable totaling$358,400 (principal plus interest).

 

Property and equipmentincreased by $327,701 to $597,691 at June 30, 2003 from $269,990 at June 30,2002. This increase is attributable to the purchase of a newoperations/accounting system and the October 2002 Pro-Tec asset acquisition,partially offset by depreciation for 2003.

 

Note receivable fromstockholder was paid in full on December 31, 2002 thereby reducing the June 30,2002 balance of $320,000 to zero.

 

The Company’s various debt andcapital leases (including current portion) increased by $453,096 as of June 30,2003 as compared to the June 30, 2002 balances. This increase is attributableto, (i) the $262,043 working capital line of credit debt and (ii) the remainingobligation incurred in conjunction with the ProTec acquisition of $166,667.

 

The increase in the Company’snet loss and corresponding cash losses is a result of the $861,000 increase inthe SG&A expenses for the year ended June 30, 2003 (discussed above)partially offset by the increase in revenues and gross profit of $469,000.  The Company believes the net loss and cashlosses should decrease as a result of the recently implemented cost reductionplan (discussed below).

 

As a result of the recentoperating losses, the Company has implemented an aggressive cost reduction plandesigned to significantly reduce expenses and improve operating margins. TheCompany began realizing the benefits of the cost reduction plan in March 2003.Additionally, the Company implemented an increase in its product priceseffective April 1, 2003. Management believes the effect of the two items notedabove will have a significant positive impact on the financial results of theCompany and a corresponding decrease in the cash losses generated.

 

Management believes that theCompany’s current cash resources along with its asset-based factoring line ofcredit and the $500,000 proceeds from the September 2003 private placement willbe sufficient to fund operations for the twelve months ended June 30, 2004.

 

**QUARTERLYRESULTS OF OPERATIONS (UNAUDITED)**

 

The following tables set forthselected quarterly information for 2003 and 2002.  We believe that all necessary adjustments have been included inthe amounts below to present fairly the results of such periods.

 
|                                        |   | **Quarter Ended**      |      |
|---------------------------------------------|--------|------------------------|-----------|
|                                        |   | **September 30, 2002** |      | **December 31, 2002** |   | **March 31, 2003** |   | **June 30, 2003** |   |
| Total revenues                              |   | $                      | 2,048,868 |   | $ | 2,339,809 |   | $ | 1,837,796 |   | $ | 2,192,866 |   |
| Cost of revenues                            |   | $                      | 1,381,390 |   | $ | 1,598,551 |   | $ | 1,438,175 |   | $ | 1,380,034 |   |
| Operating loss                              |   | $                      | (195,484  | ) | $ | (263,583 | ) | $ | (705,809 | ) | $ | (118,243 | ) |
| Net loss                                    |   | $                      | (188,202  | ) | $ | (257,020 | ) | $ | (706,386 | ) | $ | (125,919 | ) |
| Net loss per share                          |   | $                      | (0.02     | ) | $ | (0.03 | ) | $ | (0.07 | ) | $ | (0.01 | ) |
| Weighted average shares - basic and diluted |   | 9,822,023              |      | 9,862,784 |   | 9,874,060 |   | 9,897,134 |   |

 
|                                        |   | **Quarter Ended**      |      |
|---------------------------------------------|--------|------------------------|-----------|
|                                        |   | **September 30, 2001** |      | **December 31, 2001** |   | **March 31, 2002** |   | **June 30, 2002** |   |
| Total revenues                              |   | $                      | 1,473,760 |   | $ | 1,490,892 |   | $ | 1,620,794 |   | $ | 1,927,579 |   |
| Cost of revenues                            |   | $                      | 1,046,725 |   | $ | 1,076,405 |   | $ | 1,004,473 |   | $ | 1,233,469 |   |
| Operating loss                              |   | $                      | (233,947  | ) | $ | (407,486 | ) | $ | (59,903 | ) | $ | (157,314 | ) |
| Net loss                                    |   | $                      | (221,493  | ) | $ | (396,619 | ) | $ | (51,866 | ) | $ | (149,060 | ) |
| Net loss per share                          |   | $                      | (0.03     | ) | $ | (0.05 | ) | $ | (0.01 | ) | $ | (0.02 | ) |
| Weighted average shares - basic and diluted |   | 8,705,356              |      | 9,661,878 |   | 9,820,899 |   | 9,822,023 |   |

 

11

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**CRITICALACCOUNTING POLICIES**

 

Inventory:  Inventory consists primarily of finishedgoods and supplies held for sale and are stated at the lower of cost using theaverage cost method or market.

 

Realization ofLong-lived Assets: The Company evaluates the recoverability of property and equipment andintangible or other assets if facts and circumstances indicate that any ofthose assets might be impaired.  If anevaluation is required, the estimated future undiscounted cash flows associatedwith the asset are compared to the asset’s carrying amount to determine if awrite-down to market value or discounted cash flow value is necessary.

 

RevenueRecognition: The Company adopted the Securities and Exchange Commission’s (“SEC”)Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition”, whichprovides guidance related to revenue recognition based on interpretations andpractices followed by the SEC.  UnderSAB No. 101, certain products offered by the Company have revenue producingcomponents that are recognized over multiple delivery points (Sharps Disposalby Mail Systems, referred to as “Mailback” and Sharps Return Boxes, referred toas “Pump Returns”) and can consist of up to three separate elements as follows:(1) the sale of the container system, (2) the transportation of the containersystem and (3) the treatment and disposal (incineration) of the containersystem.  The individual fair value ofthe transportation and incineration services are determined by the sales priceof the service offered by third parties, with the fair value of the containerbeing the residual value.  Revenue forthe sale of the container is recognized upon delivery to the customer, at whichtime the customer takes title and assumes risk of ownership.  Transportation revenue on Mailbacks isrecognized when the customer returns the mailback container system and thecontainer has been received at the Company’s treatment facility.  The Mailback container system is mailed tothe incineration facility using the USPS. Incineration revenue is recognized upon the destruction andcertification of destruction having been prepared on the container.  Since the transportation element and theincineration elements are undelivered services at the point of initial sale ofthe container, the Mailback revenue is deferred until the services areperformed.  The current and long-termportions of deferred revenues are determined through regression analysis andhistorical trends.  Furthermore, throughregression analysis of historical data, the Company has determined that acertain percentage of all container systems sold may not be returned.  Accordingly, a portion of the transportationand incineration elements are recognized at the point of sale.

 

Shipping andHandling Fees and Costs:  The Company records amounts billed to customers for shipping andhandling as revenue.  Costs incurred bythe Company for shipping and handling have been classified as cost of revenue.

 

Income Taxes:  The liability method is used in accountingfor deferred income taxes.  Under thismethod, deferred tax assets and liabilities are determined based on differencesbetween financial reporting and tax bases of assets and liabilities and aremeasured using the enacted tax rates and laws that will be in effect when thedifferences are expected to reverse. The realizability of deferred tax assets is evaluated annually and avaluation allowance is provided if the deferred tax assets, more likely thannot, will not give rise to future benefits in the Company’s tax returns.

 

SegmentReporting: Statement of Financial Accounting Standards (“SFAS”) No. 131,“Disclosures about Segments of an Enterprise and Related Information,” requiresthat a public business enterprise report financial and descriptive informationabout its operating segments. Generally, financial information is required to be reported on the basisused internally for evaluating segment performance and resource allocation.  The Company operates in a single segment,focusing on developing cost effective, logistical and educational solutions forhealthcare and non-healthcare institutional markets.

 

**RECENTLYISSUED ACCOUNTING STANDARDS**

 

In June 2002, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities”, which requires among other items,that liabilities for the costs associated with exit or disposal activities berecognized when the liabilities are incurred, rather than when an entitycommits to an exit plan.  SFAS No. 146is effective for exit or disposal activities initiated after December 31,2002.  The adoption of SFAS No. 146 hadno material impact on the results of operations or financial condition of theCompany.

 

In November 2002, the FASBissued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others”, which requires a guarantor to

 

12

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recognize, at the inception ofa guarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee and expands the disclosures required to be made by aguarantor about its obligations under guarantees that it has issued.  Initial recognition and measurementprovisions of FIN 45 are applicable on a prospective basis to guarantees issuedor modified.  The disclosurerequirements were effective immediately and were adopted beginning with theCompany’s Form 10-QSB for the three months ended December 31, 2002.  This interpretation had no material impacton the results of operations or financial condition of the Company.

 

In November 2002, the EmergingIssues Task Force (“EITF”) reached a consensus on EITF Issue No. 00-21,“Revenue Arrangements with Multiple Deliveries” (“EITF 00-21”).  EITF 00-21 addresses certain aspects inaccounting for arrangements under which a company will perform multiplerevenue-generating activities.  Inapplying EITF 00-21, generally, separate contracts with the same customer thatare entered into at or near the same time are presumed to have been negotiatedas a package and should, therefore, be evaluated as a single contractualarrangement.  It also addresses howcontract consideration should be measured and allocated to the separatedeliverables in the arrangement.  Thispronouncement is applicable to revenue arrangements entered into beginning in2004.  The Company believes that it is incompliance with the requirements of EITF 00-21.

 

In December 2002, the FASB issuedSFAS No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure - an amendment of FASB statement No. 123”, which providesalternative methods of transition for a voluntary change to the fair valuemethod of accounting for stock-based employee compensation and amends thedisclosure requirements of SFAS No. 123 to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  The transition guidance andannual disclosure requirements were effective for fiscal years ending afterDecember 15, 2002.  As the Company willcontinue to apply Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees”, the Company’s policy for accounting for stock-basedemployee compensation will not change as a result of SFAS No. 148.  The Company adopted the annual disclosureprovisions for this Form 10-KSB.  TheCompany adopted the interim disclosure provisions for its Form 10-QSB datedMarch 31, 2003.

 

In January 2003, the FASBissued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities”, which requires that companies that control another entitythrough interests other than voting rights should consolidate the controlledentity.  FIN 46 applies to variableinterest entities created after January 31, 2003, and to variable interestentities in which an enterprise obtains an interest after that date.  The related disclosure requirements wereeffective immediately.  Management doesnot believe the adoption of FIN 46 will have any impact on the Company’sfinancial position or results of operations.

 

In April 2003, the FASB issuedSFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and HedgingActivities”, which amends SFAS No. 133 to provide clarification on thefinancial accounting and reporting of derivative instruments and hedgingactivities and requires that contracts with similar characteristics to be accountedfor on a comparable basis.  Theprovisions of SFAS No. 149 are effective for contracts entered into or modifiedafter June 30, 2003, and for hedging relationships designated after June 30,2003.  The adoption of SFAS No. 149 willnot have a material impact on the Company’s results of operations or financialposition.

 

In May 2003, the FASB issuedSFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity”, which establishes standards onthe classification and measurement of certain financial instruments withcharacteristics of both liabilities and equity.  The provisions of SFAS No. 150 are effective for financialinstruments entered into or modified after May 31, 2003 and to all otherinstruments that exist as of the beginning of the first interim financialreporting period beginning after June 15, 2003.  The adoption of SFAS No. 150 did not have a material impact onthe Company’s results of operations or financial position.

 

**ITEM7. FINANCIAL STATEMENTS**

 

The financial statements of theCompany and the related report of the Company’s independent accountants thereonare included in this report and are referenced as pages F-1 to F-19.

 

13

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**ITEM8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

The information required bythis item is not applicable.

 

**ITEM8A.  CONTROLS AND PROCEDURES**

 

See Report of Management andInternal Controls on F-2.

 

 

**PARTIII**

 

**ITEM 9.  DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE WITH SECTION16(a) OF THE EXCHANGE ACT**

 

The information required bythis item is incorporated herein by reference to the information under thecaption “Management” of the Registrant’s definitive Proxy Statement to be filedpursuant to Regulation 14A with the Securities and Exchange Commission (“SEC”)relating to its Annual Meeting of Stockholders to be held on December 9, 2003.

 

Paragraph 16(a) of theSecurities Exchange Act of 1934, as amended, requires the Company’s executiveofficers and directors, and persons who beneficially own more than 10% of theCompany’s equity securities, to file reports of security ownership and changesin such ownership with the SEC. Officers, directors and greater than 10%beneficial owners also are required by SEC regulations to furnish the Companywith copies of all Section 16(a) forms they file.

 

To the Company’s knowledge,based solely on review of the copies of such reports furnished to the Company,during the fiscal year ended June 30, 2003, all Section 16(a) filingrequirements applicable to its officers, directors and greater than 10%beneficial owners were complied with.

 

**ITEM10. EXECUTIVE COMPENSATION**

 

The information required bythis item is incorporated herein by reference to the information under thecaptions “Management” and “Executive Compensation” of the Registrant’sdefinitive Proxy Statement to be filed pursuant to Regulation 14A with the SECrelating to its Annual Meeting of Stockholders to be held on December 9, 2003.

 

**ITEM 11. SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The information required bythis item is incorporated herein by reference to the information under thecaptions “Security Ownership of Management” and “Certain Beneficial Owners” ofthe Registrant’s definitive Proxy Statement to be filed pursuant to Regulation14A with the SEC relating to its Annual Meeting of Stockholders to be held onDecember 9, 2003.

 

**ITEM 12. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

The information required bythis item is incorporated herein by reference to the information under thecaption “Certain Relationships and Related Transactions” of the Registrant’sdefinitive Proxy Statement to be filed pursuant to Regulation 14A with the SECrelating to its Annual Meeting of Stockholders to be held on December 9, 2003.

 

14

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**ITEM13. EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)  Exhibits

 
| **Exhibit  Number** |   | **Description  of Exhibit** |
|---------------------|--------|-----------------------------|
|                |   |                        |   |
| 2.1                 |   |                        | Agreement and Plan of Reorganization  between U.S. Medical Systems, Inc., Sharps Compliance, Inc. and its  Stockholders, dated February 27, 1998 (incorporated by reference from Exhibit  2.1 to Form 8-K, dated February 27, 1998) |
| 3.1                 |   |                        | Bylaws of Company (incorporated by  reference from Exhibit 3.4 to Form 10-KSB, dated June 30, 1994) |
| 3.2                 |   |                        | Certificate of Elimination of the Series A  10% Voting Convertible Preferred Stock of Sharps Compliance Corp.  (incorporated by reference from Exhibit 3.6 to Form 10-KSB, dated June 30,  1998) |
| 4.1                 |   |                        | Specimen Stock Certificate (incorporated by  reference from Exhibit 4.4 to Form-10KSB, dated June 30, 1998) |
| 10.1                |   |                        | Employment Agreement by and between Sharps  Compliance Corp. and Dr. Burt Kunik effective January 1, 2003 (incorporated  by reference from Exhibit 10.35 to Form10-QSB dated December 30, 2002). |
| 10.2                |   |                        | Employment Agreement by and between Sharps  Compliance Corp. and Ronald E. Pierce, dated July 14, 2003 (filed herewith). |
| 10.3                |   |                        | Employment Agreement by and between Sharps  Compliance Corp. and David P. Tusa, dated July 14, 2003 (filed herewith). |
| 10.4                |   |                        | Employment Agreement by and between Sharps  Compliance Corp. and Michael D. Archer, dated July 14, 2003 (filed herewith). |
| 10.5                |   |                        | Exclusive Distributorship Agreement between  Pro-Tec Containers, Inc. and Sharps Compliance, Inc., dated April 1, 1998  (incorporated by reference from Exhibit 10.31 to Form 10-KSB, dated June 30,  1998) |
| 10.6                |   |                        | Purchase Agreement between Ivy Green  Corporation and Sharps Compliance, Inc., dated June 19, 1998 (incorporated by  reference from Exhibit 10.32 to Form 10-KSB, dated June 30, 1998) |
| 10.7                |   |                        | Lease Agreement between Lakes Technology  Center, Ltd. and Sharps Compliance, Inc., dated August 1, 1998 (incorporated  by reference from Exhibit 10.33 to Form 10-KSB, dated June 30, 1998) |
| 10.8                |   |                        | Severance Agreement between C. Lee Cooke,  Jr. and Sharps Compliance Corp. (formerly known as - U.S. Medical Systems,  Inc.), dated September 2, 1998 (incorporated by reference from Exhibit 10.34  to Form 10-KSB, dated June 30, 1998) |
| 16.1                |   |                        | Letter regarding changes in Certifying  Accountant to Arthur Andersen LLP, dated April 22, 1998 (incorporated by  reference from Exhibit 16.1 to Form 8-K, dated April 22, 1998) |
| 16.2                |   |                        | Letter regarding changes in Certifying  Accountant to Mann Frankfort Stein & Lipp CPAs L.L.P. (incorporated by  reference from Exhibit 16.1 to Form 8-K, dated January 11, 2002) |
| 31.1                |   |                        | Certification of Chief Executive Officer in  accordance with Section 302 of the Sarbanes-Oxley Act. |
| 31.2                |   |                        | Certification of Chief Financial Officer in  accordance with Section 302 of the Sarbanes-Oxley Act. |
| 32.1                |   |                        | Certification of Chief Executive Officer in  accordance with Section 906 of the Sarbanes-Oxley Act. |
| 32.2                |   |                        | Certification of Chief Financial Officer in  accordance with Section 906 of the Sarbanes-Oxley Act. |

 

 

(b)  Reports on Form8-K

 

Form 8-K,dated and filed May 13, 2003, announcing the Company’s results of operationsfor the three and nine months ended March 31, 2003.

 

Form 8-K,dated and filed August 11, 2003, announcing the Company’s results of operationsfor the year ended June 30, 2003.

 

Form 8-K,dated and filed September 24, 2003, announcing the completion of a $500,000private placement of common stock.

 

15

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**ITEM14.  PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

The information required bythis item is incorporated herein by reference to the Registrant’s definitiveProxy Statement to be filed pursuant to Regulation 14A with the SEC relating toits Annual Meeting of Stockholders to be held on December 9, 2003.

 

16

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**SIGNATURES**

 

In accordance with Section 13or 15(d) of the Exchange Act, the registrant caused this report to be signed onits behalf by the undersigned, thereunto duly authorized.

 
|                       | REGISTRANT:              |                                                  |
|----------------------------|--------------------------|-------------------------------------------------------|
|                       | SHARPS  COMPLIANCE CORP. |                                                  |
|                       |                     |                                                  |   |
| Dated:  September 26, 2003 | By:                      | /s/ BURTON  J. KUNIK                                  |   |
|                       |                     | Dr. Burton  J. Kunik                                  |   |
|                       |                     | Chairman of  the Board and  Chief Executive Officer   |   |
|                       |                     |                                                  |   |
|                       | By:                      | /s/ DAVID P.  TUSA                                    |   |
|                       |                     | David P.  Tusa                                        |   |
|                       |                     | Senior Vice  President &  Chief Financial Officer |   |
|                       |                     |                                                  |   |
|                       | By:                      | /s/ C. LEE  COOKE, JR.                                |   |
|                       |                     | C. Lee  Cooke, Jr.                                    |   |
|                       |                     | Director                                              |   |
|                       |                     |                                                  |   |
|                       | By:                      | /s/ RAMSAY  GILLMAN                                   |   |
|                       |                     | Ramsay  Gillman                                       |   |
|                       |                     | Director                                              |   |
|                       |                     |                                                  |   |
|                       | By:                      | /s/ PARRIS  H. HOLMES, JR.                            |   |
|                       |                     | Parris H.  Holmes, Jr.                                |   |
|                       |                     | Director                                              |   |
|                       |                     |                                                  |   |
|                       | By:                      | /s/ F.  GARDNER PARKER                           |   |
|                       |                     | F. Gardner  Parker                                    |   |
|                       |                     | Director                                              |   |
|                       |                     |                                                  |   |
|                       | By:                      | /s/ PHILIP  C. ZERRILLO                               |   |
|                       |                     | Philip C.  Zerrillo                                   |   |
|                       |                     | Director                                              |   |
|                            |                          |                                                       |  |  |

 

 

17

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**SHARPS COMPLIANCE CORP. AND SUBSIDIARIESINDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
| **CONSOLIDATED FINANCIAL STATEMENTS**                                                                      |
|------------------------------------------------------------------------------------------------------------|
|                                                                                                       |
| Report of Management and Internal Controls                                                                 |
|                                                                                                       |
| Report of Independent Public Accountants                                                                   |
|                                                                                                       |
| Consolidated Balance Sheets as of June 30,  2003 and 2002                                                  |
|                                                                                                       |
| Consolidated Statements of Operations for  the Years Ended June 30, 2003 and 2002                          |
|                                                                                                       |
| Consolidated Statements of Stockholders’  Equity (Deficit) for the Years Ended June 30, 2003 and 2002 |
|                                                                                                       |
| Consolidated Statements of Cash Flows for  the Years Ended June 30, 2003 and 2002                          |
|                                                                                                       |
| Notes to Consolidated Financial Statements                                                                 |

 

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**REPORT OF MANAGEMENT AND INTERNAL CONTROLS**

 

The financial statements included herein have beenprepared in conformity with accounting principles generally accepted in theUnited States of America.  Management isresponsible for preparing the consolidated financial statements and maintainingand monitoring the Company’s system of internal accounting controls.  The Company believes that the existingsystem of internal controls provides reasonable assurance that errors orirregularities that could be material to the financial statements are preventedor would be detected in a timely manner. Key elements of the Company’s system of internal controls includecareful selection of management personnel, appropriate segregation ofconflicting responsibilities, periodic evaluations of Company financial andbusiness practices, communication practices that provide assurance thatpolicies and managerial authorities are understood throughout the Company, andperiodic meetings between the Company’s audit committee, senior financialmanagement personnel and independent public accountants.

 

Theconsolidated financial statements were audited by Mann Frankfort Stein &Lipp CPAs, L.L.P., independent public accountants, who have also issued areport on the consolidated financial statements.

 
| /s/DR.  BURTON J. KUNIK                                                   |   |
|---------------------------------------------------------------------------|--------|
|                                                                      |
| Dr. Burton  J. Kunik                                                      |
| *Chairman of the Board and Chief Executive Officer*                       |
|                                                                      |
|                                                                      |
| /s/DAVID P.  TUSA                                                         |   |
|                                                                      |
| David P.  Tusa                                                            |
| *Senior Vice President, Chief Financial Officer  and Corporate Secretary* |
|                                                                           |        |  |

 

F-2

----

 

**REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS**

 

 

To the Board of Directors and Stockholders ofSharps Compliance Corp.

Houston, Texas

 

We have audited theaccompanying consolidated balance sheets of Sharps Compliance Corp. (a Delawarecorporation) and subsidiaries as of June 30, 2003 and 2002, and the relatedconsolidated statements of operations, stockholders’ equity (deficit) and cashflows for the years then ended.  Theseconsolidated financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the UnitedStates.  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall consolidated financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Sharps ComplianceCorp. and subsidiaries as of June 30, 2003 and 2002, and the consolidatedresults of their operations and their cash flows for the years then ended, inconformity with accounting principles generally accepted in the United States.

 

 
| /s/ MANN  FRANKFORT STEIN & LIPP CPAs, L.L.P.                              |   |
|--------------------------------------------------------------------------------|--------|
|                                                                           |
| Houston,  Texas                                                                |
| August 7,  2003, except for Note 13 as to which the date is September 24, 2003 |

 

F-3

----

 

**SHARPS COMPLIANCE CORP. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                         |   | **June 30,** |      |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------|-----------|
|                                                                                                                                         |   | **2003**     |      | **2002** |   |
| ASSETS                                                                                                                                       |   |         |      |   |   |
| CURRENT ASSETS                                                                                                                               |   |         |      |   |   |
| Cash and cash equivalents                                                                                                                    |   | $            | 135,884   |   | $ | 497,353 |   |
| Short-term investments                                                                                                                       |   | —       |      | 502,287 |   |
| Restricted cash                                                                                                                              |   | 152,851      |      | 10,010 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $35,141 and $9,489, respectively                                             |   | 740,760      |      | 784,466 |   |
| Inventory                                                                                                                                    |   | 299,136      |      | 331,463 |   |
| Prepaid and other assets                                                                                                                     |   | 125,808      |      | 219,406 |   |
| TOTAL CURRENT ASSETS                                                                                                                         |   | 1,454,439    |      | 2,344,985 |   |
|                                                                                                                                         |   |         |      |   |   |
| PROPERTY AND EQUIPMENT, net of accumulated  depreciation of $429,502 and $299,454, respectively                                              |   | 597,691      |      | 269,990 |   |
|                                                                                                                                         |   |         |      |   |   |
| INTANGIBLE ASSETS, net of accumulated  amortization of $101,225 and $80,979, respectively                                                    |   | —       |      | 20,246 |   |
|                                                                                                                                         |   |         |      |   |   |
| NOTE RECEIVABLE FROM STOCKHOLDER                                                                                                             |   | —       |      | 320,000 |   |
|                                                                                                                                         |   |         |      |   |   |
| OTHER ASSETS                                                                                                                                 |   | 11,695       |      | 37,294 |   |
|                                                                                                                                         |   |         |      |   |   |
| TOTAL ASSETS                                                                                                                                 |   | $            | 2,063,825 |   | $ | 2,992,515 |   |
|                                                                                                                                         |   |         |      |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY (DEFICIT)                                                                                         |   |         |      |   |   |
|                                                                                                                                         |   |         |      |   |   |
| CURRENT LIABILITIES                                                                                                                          |   |         |      |   |   |
| Accounts payable                                                                                                                             |   | $            | 567,918   |   | $ | 636,124 |   |
| Accrued liabilities                                                                                                                          |   | 226,427      |      | 290,440 |   |
| Deferred revenue - pump return                                                                                                               |   | 205,125      |      | 323,088 |   |
| Current portion of deferred revenue -  incineration                                                                                          |   | 108,547      |      | 114,212 |   |
| Current portion of deferred revenue -  transportation                                                                                        |   | 476,630      |      | 419,370 |   |
| Notes payable and current portion of  long-term debt                                                                                         |   | 407,374      |      | 114,429 |   |
| Current maturities of capital lease  obligations                                                                                             |   | 36,501       |      | — |   |
| TOTAL CURRENT LIABILITIES                                                                                                                    |   | 2,028,522    |      | 1,897,663 |   |
|                                                                                                                                         |   |         |      |   |   |
| LONG-TERM DEFERRED REVENUE - INCINERATION,  net of current portion                                                                           |   | 35,794       |      | 53,745 |   |
|                                                                                                                                         |   |         |      |   |   |
| LONG-TERM DEFERRED REVENUE -  TRANSPORTATION, net of current portion                                                                         |   | 164,142      |      | 197,351 |   |
|                                                                                                                                         |   |         |      |   |   |
| LONG-TERM DEBT, net of current portion                                                                                                       |   | 45,563       |      | 24,227 |   |
|                                                                                                                                         |   |         |      |   |   |
| OBLIGATIONS UNDER CAPITAL LEASES, net of  current maturities                                                                                 |   | 102,314      |      | — |   |
|                                                                                                                                         |   |         |      |   |   |
| OTHER LIABILITIES                                                                                                                            |   | 27,000       |      | — |   |
|                                                                                                                                         |   |         |      |   |   |
| TOTAL LIABILITIES                                                                                                                            |   | 2,403,335    |      | 2,172,986 |   |
|                                                                                                                                         |   |         |      |   |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                                |   | —       |      | — |   |
|                                                                                                                                         |   |         |      |   |   |
| STOCKHOLDERS’ EQUITY (DEFICIT)                                                                                                          |   |         |      |   |   |
| Common stock, $0.01 par value per share;  20,000,000 shares authorized; 9,910,356 and 9,822,023 shares issued and  outstanding, respectively |   | 99,103       |      | 98,220 |   |
| Additional paid-in capital                                                                                                                   |   | 6,963,918    |      | 6,846,313 |   |
| Accumulated deficit                                                                                                                          |   | (7,402,531   | )         | (6,125,004 | ) |
| TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)                                                                                                    |   | (339,510     | )         | 819,529 |   |
|                                                                                                                                         |   |         |      |   |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  (DEFICIT)                                                                                   |   | $            | 2,063,825 |   | $ | 2,992,515 |   |

 

See accompanying notes to consolidatedfinancial statements

 

F-4

----

 

**SHARPSCOMPLIANCE CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**

 
|                                                                                   |   | **Year Ended June 30,** |       |
|----------------------------------------------------------------------------------------|--------|-------------------------|------------|
|                                                                                   |   | **2003**                |       | **2002** |   |
| REVENUES                                                                               |   |                    |       |   |   |
| Distribution, net                                                                      |   | $                       | 7,632,998  |   | $ | 5,963,081 |   |
| Consulting and environmental services                                                  |   | 415,815                 |       | 549,944 |   |
| Manufacturing                                                                          |   | 370,526                 |       | — |   |
| TOTAL REVENUES                                                                         |   | 8,419,339               |       | 6,513,025 |   |
|                                                                                   |   |                    |       |   |   |
| COSTS AND EXPENSES                                                                     |   |                    |       |   |   |
| Cost of revenues                                                                       |   | 5,798,150               |       | 4,361,072 |   |
| Selling, general and administrative                                                    |   | 3,754,014               |       | 2,893,205 |   |
| Depreciation and amortization                                                          |   | 150,294                 |       | 117,398 |   |
| TOTAL COSTS AND EXPENSES                                                               |   | 9,702,458               |       | 7,371,675 |   |
|                                                                                   |   |                    |       |   |   |
| OPERATING LOSS                                                                         |   | (1,283,119              | )          | (858,650 | ) |
|                                                                                   |   |                    |       |   |   |
| OTHER INCOME (EXPENSE)                                                                 |   |                    |       |   |   |
| Interest income                                                                        |   | 16,562                  |       | 41,721 |   |
| Interest expense                                                                       |   | (10,970                 | )          | (2,109 | ) |
| TOTAL OTHER INCOME (EXPENSE)                                                           |   | 5,592                   |       | 39,612 |   |
|                                                                                   |   |                    |       |   |   |
| NET LOSS                                                                               |   | $                       | (1,277,527 | ) | $ | (819,038 | ) |
|                                                                                   |   |                    |       |   |   |
| BASIC AND DILUTED NET LOSS PER COMMON SHARE                                            |   | $                       | (.13       | ) | $ | (.09 | ) |
|                                                                                   |   |                    |       |   |   |
| WEIGHTED AVERAGE SHARES USED IN COMPUTING  BASIC AND DILUTED NET LOSS PER COMMON SHARE |   | 9,863,123               |       | 9,502,888 |   |

 

See accompanying notes to consolidatedfinancial statements

 

F-5

----

 

**SHARPSCOMPLIANCE CORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)**

 
|                                       |   | **Common Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  Deficit** |   | **Total  Stockholders’  (Deficit)  Equity** |   |
|--------------------------------------------|--------|------------------|--------|----------------------------------|--------|--------------------------|--------|--------------------------------------------------|--------|
| **Shares**                                 |   | **Amount**       |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Balances, July 1, 2001                     |   | 8,705,356        |   | $                                | 87,053 |                     | $      | 5,572,598                                        |   | $ | (5,305,966 | ) | $ | 353,685 |   |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Issuance of common stock for cash          |   | 1,116,667        |   | 11,167                           |   | 1,215,500                |   | —                                           |   | 1,226,667 |   |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Issuance of options for services provided  |   | —           |   | —                           |   | 58,215                   |   | —                                           |   | 58,215 |   |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Net loss                                   |   | —           |   | —                           |   | —                   |   | (819,038                                         | )      | (819,038 | ) |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Balances, June 30, 2002                    |   | 9,822,023        |   | 98,220                           |   | 6,846,313                |   | (6,125,004                                       | )      | 819,529 |   |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Issuance of common stock for cash          |   | 88,333           |   | 883                              |   | 56,368                   |   | —                                           |   | 57,251 |   |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Issuance for options for services provided |   | —           |   | —                           |   | 61,237                   |   | —                                           |   | 61,237 |   |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Net loss                                   |   | —           |   | —                           |   | —                   |   | (1,277,527                                       | )      | (1,277,527 | ) |
|                                       |   |             |   |                             |   |                     |   |                                             |   |   |   |
| Balances, June 30, 2003                    |   | 9,910,356        |   | $                                | 99,103 |                     | $      | 6,963,918                                        |   | $ | (7,402,531 | ) | $ | (339,510 | ) |

 

See accompanying notes to consolidated financial statements

 

F-6

----

 

**SHARPS COMPLIANCE CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                         |   | **Year Ended  June 30,** |       |
|------------------------------------------------------------------------------|--------|--------------------------|------------|
|                                                                         |   | **2003**                 |       | **2002** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                         |   |                     |       |   |   |
| Net loss                                                                     |   | $                        | (1,277,527 | ) | $ | (819,038 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                     |       |   |   |
| Depreciation and amortization                                                |   | 150,294                  |       | 117,398 |   |
| Stock based consulting expense                                               |   | 61,237                   |       | 58,215 |   |
| Bad debt expense                                                             |   | 179,955                  |       | 7,000 |   |
| Inventory write-down                                                         |   | 86,918                   |       | — |   |
| Changes in operating assets and  liabilities:                                |   |                     |       |   |   |
| Increase in restricted cash                                                  |   | (142,841                 | )          | — |   |
| Increase in accounts receivable                                              |   | (136,249                 | )          | (82,192 | ) |
| Increase in inventory                                                        |   | (54,591                  | )          | (108,256 | ) |
| Decrease (increase) in prepaid and other  assets                             |   | 119,197                  |       | (95,265 | ) |
| Increase (decrease) in accounts payable and  accrued liabilities             |   | (105,219                 | )          | 228,663 |   |
| Decrease (increase) in deferred revenue                                      |   | (117,528                 | )          | 270,347 |   |
| NET CASH USED IN OPERATING ACTIVITIES                                        |   | (1,236,354               | )          | (423,128 | ) |
|                                                                         |   |                     |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                         |   |                     |       |   |   |
| Purchases of property and equipment                                          |   | (83,685                  | )          | (145,717 | ) |
| Payment on note receivable                                                   |   | 320,000                  |       | — |   |
| Proceeds from sales of short-term  investments                               |   | 502,287                  |       | 748,991 |   |
| Purchases of short-term investments                                          |   | —                   |       | (1,023,347 | ) |
| NET CASH PROVIDED BY (USED IN) INVESTING  ACTIVITIES                         |   | 738,602                  |       | (420,073 | ) |
|                                                                         |   |                     |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                   |   |                     |       |   |   |
| Payments on long-term debt                                                   |   | (197,762                 | )          | (220,770 | ) |
| Borrowings on long-term debt                                                 |   | 28,364                   |       | 227,382 |   |
| Net proceeds from factoring agreement                                        |   | 262,043                  |       | — |   |
| Payments on capital lease obligations                                        |   | (13,613                  | )          | — |   |
| Issuance of common stock                                                     |   | 57,251                   |       | 1,226,667 |   |
| NET CASH PROVIDED BY FINANCING ACTIVITIES                                    |   | 136,283                  |       | 1,233,279 |   |
|                                                                         |   |                     |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                        |   | (361,469                 | )          | 390,078 |   |
|                                                                         |   |                     |       |   |   |
| CASH AND CASH EQUIVALENTS, beginning of  year                                |   | 497,353                  |       | 107,275 |   |
|                                                                         |   |                     |       |   |   |
| CASH AND CASH EQUIVALENTS, end of year                                       |   | $                        | 135,884    |   | $ | 497,353 |   |
|                                                                         |   |                     |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION                            |   |                     |       |   |   |
| Cash paid for interest                                                       |   | $                        | 10,970     |   | $ | 2,109 |   |
|                                                                         |   |                     |       |   |   |
| NONCASH INVESTING AND FINANCING ACTIVITIES:                                  |   |                     |       |   |   |
|                                                                         |   |                     |       |   |   |
| Property and equipment additions financed  through issuance of debt          |   | $                        | 221,636    |   | $ | — |   |
|                                                                         |   |                     |       |   |   |
| Property and equipment additions acquired  under capital lease               |   | $                        | 152,428    |   | $ | — |   |

 

See accompanying notes to consolidated financial statements

 

F-7

----

 

**SHARPS COMPLIANCE CORP. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30, 2003 AND 2002**

 

**NOTE1 - ORGANIZATION AND BACKGROUND**

 

Organization:  The accompanying consolidated financialstatements include the financial transactions and accounts of Sharps ComplianceCorp. and its wholly owned subsidiaries, Sharps Compliance, Inc. of Texas, dbaSharps Compliance, Inc., Sharps e-Tools.com, Inc. (“Sharps e-Tools”), SharpsEnvironmental Services, Inc., dba Sharps Environmental Services of Texas, Inc.and Sharps Manufacturing, Inc. (collectively, “Sharps” or the  “Company”). All significant intercompany accounts and transactions have beeneliminated upon consolidation.

 

BusinessProducts:  TheCompany focuses on developing cost effective, logistical and educationalsolutions for healthcare and non-healthcare institutional markets.  These solutions include Sharps Disposal byMail SystemTM, Pitch-ItTM IV Poles, Sharps SureTemp ToteTM, Trip LesSystemTM,Sharps asset return boxes, Sharps e-Tools, Sharps Environmental Services, andSharps Consulting.  The Company’sproducts and services are provided primarily to create cost and logisticalefficiencies.  These products andservices facilitate compliance with certain state and federal regulations, aswell as compliance with educational and training requirements required byfederal, state, local and regulatory agencies.

 

The Sharps Disposal by MailSystemTM is a comprehensive solution for the containment, transportation,destruction and tracking of medical waste for the commercial, industrial andhome healthcare industries.  The SharpsDisposal by Mail SystemTM contains a securely sealed, leak and puncture resistantsharps container in several sizes; United States Postal Service (“USPS”)approved shipping carton with priority mail postage; absorbent material insidethe container that can hold up to 150 milliliters of waste; a red bag foradditional containment; and complete documentation and tracking manifest.  Customers who use the Sharps Disposal byMail SystemTM are responsible for mailing the systems to the Company’s disposalfacility for incineration (i.e. Sharps Environmental Services).

 

The Pitch-ItTM IV Pole systemsare designed as a cost effective, portable, lightweight and disposablealternative to traditional IV poles used for gravity-fed or pump-administeredinfusions.  The innovative pole designprovides opportunities for the home healthcare industry to improve logisticalefficiencies through elimination of traditional delivery and pickup of IVpoles.  The Pitch-ItTM poles areavailable in three models: (i) tabletop, (ii) floor and (iii) full-size withwheels.

 

The Sharps SureTemp ToteTM is adisposable cooler that maintains a safe range for temperature-sensitivematerials.  Sharps primarily markets theproduct to home healthcare providers to protect IV medications used in homeinfusion.

 

The Trip LesSystemTM is asolution for the home healthcare (commercial) industry that will eliminatemultiple trips to the patient’s home by providers after treatment has beencompleted.  The Trip LesSystemTM hascombined two complete programs for return and disposal.  All systems contain the Sharps Disposal byMail SystemTM along with either (i) a prepaid pump return box or (ii) aPitch-ItTM IV Pole system, depending on the patient’s therapy.

 

Sharps’ asset return boxes(i.e., Sharps Pump Return Box and Sharps Enteral Pump Return Box) are marketedto home healthcare providers, primarily for use with home infusion patients.  These products provide delivery andretrieval of expensive equipment, like infusion and Enteral pumps.

 

The Sharps e-Tools onlineservices include SharpsTracerTM, AssetTracerTM and ComplianceTrak.  SharpsTracerTM is a manifest imaging andtracking program for registered customers with the purpose of tracking andcertifying the transportation and disposal of regulated medical waste.  SharpsTracerTM eliminates traditionalpaper-based methods of manifest tracking and is designed to enhance customerefficiencies with an automatic Proof of Destruction, Market Data Collectionabilities and Return to Store Programs capabilities.  AssetTracerTM allows its registered subscribers to manage alltypes of capital assets through a single, organized database.  The program can be used in conjunction withother Company products or independently and includes management reporting forregulatory compliance, preventative maintenance, and asset status and/orlocation.  ComplianceTrak offers a broadrange of employee centered compliance and education programs.  The programs range from policy and proceduredevelopment to specialized training and certification for all employeesrequired to meet certain Occupational Safety and Health Administration (“OSHA”)standards.

 

F-8

----

 

Sharps Environmental Servicesprovides environmental solutions for customers with a wide variety of wastedisposal needs.  Destruction anddisposals are the primary services which are available to the Company’s affiliates,as well as to its and other customers and includes destruction and disposal of,among other things, (i) medical waste, (ii) legal and confidential documents,(iii) pharmaceutical products and (iv) non-hazardous industrial waste.  This service also allows the Company todirectly oversee the proper disposal of its Sharps Disposal by Mail SystemsTMand allows the Company to provide its proprietary SharpsTracerTM.  Prior to July 1, 2000, the Companyoutsourced these functions to a facility managed and operated by the PanolaCounty Resource Recovery Facility. Effective July 1, 2000, the Company entered into an agreement with theCity of Carthage and Panola County, Texas to manage and operate the PanolaCounty Resources Recovery Facility, a municipally owned incinerator.  The agreement has been amended to extenduntil June 30, 2012.

 

Sharps Consulting provides abroad range of services including (i) analysis of legal and regulatoryimplications of present waste handling practices, (ii) communicating newlegislation and industry best practices for minimizing employee exposure andliability, (iii) serving as intermediary with regulatory agencies and (iv)educating staff on the dangers of improper medical wastes and infection controlpractices.

 

Concentrationsof Customers and Suppliers:  Although Sharps has experienced growth in revenues over the pastfew years, there is an inherent concentration of credit risk associated withaccounts receivable arising from sales to its major customers, which areprimarily distributors.  For the yearended June 30, 2003, three customers represented approximately 60% (or$445,000) of total accounts receivable balance at June 30, 2003.  For the year ended June 30, 2002, fourcustomers represented approximately 56% (or $363,000) of total accountsreceivable at June 30, 2002.  For theyear ended June 30, 2003 two customers represented 41% of revenues.  For the year ended June 30, 2002 fourcustomers represented 56% of revenues. The Company may be affected by its dependence on a limited number ofhigh volume customers.  Managementbelieves that the risk is mitigated by (i) the contractual relationships withthe end user of the products and reputation of Sharps’ major customers, (ii) aloss of any distributor does not necessarily mean the loss of the underlyingcustomer base of that distributor for the Company’s products and (iii) thecontinued diversification of the Company’s products and services.

 

Sharps continues to sole-sourcetransportation, which consists of delivering the Sharps Disposal by MailSystemTM from the end user to the Company’s facility.  Transportation is currently sole-sourced to the USPS.  Management believes the risk of dependenceis mitigated by the long-standing business relationship.  Although there are no assurances with regardto the continued future business association, management believes thatalternative sources would be available.

 

Liquidity:  The Company has incurred cumulative lossessince its inception.  The future successof Sharps is dependent upon many factors, including environmental regulation,continuity of its distributorship agreements, successful completion of itsproduct development activities and the identification and penetration ofadditional markets for its products and services.  Management believes that the Company’s current resources will besufficient to fund operations through fiscal year 2004.  There can be no assurance that the Companywill be able to obtain financing on acceptable terms to fund operations beyondthat time frame; however, management believes that it will be successful inraising such financing, if necessary. Additionally, the Company maintains an agreement with a financialinstitution for a $1.25 million asset-based line of credit (see Note 6).

 

 

**NOTE2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Reclassifications:  Certain items in the 2002 financialstatements have been reclassified to conform to the current year presentation.

 

CashEquivalents and Short-term Investments:  The Company considers all highly liquidinvestments with a maturity of three months or less at the time of purchase tobe cash equivalents. Short-term investments consist of certificates of depositwith original maturities greater than three months but less than one year.  Short-term investments are classified asheld-to-maturity and are classified at amortized cost.

 

Inventory:  Inventory consists primarily of finishedgoods and supplies held for sale and are stated at the lower of cost using theaverage cost method or market.

 

F-9

----

 

Property andEquipment: Property and equipment is stated at cost less accumulated depreciation.Depreciation is computed using the straight-line method based on the estimateduseful lives of the assets.  Additions,improvements and renewals significantly adding to the asset value or extendingthe life of the asset are capitalized. Ordinary maintenance and repairs, which do not extend the physical oreconomic life of the property or equipment, are charged to expense asincurred.  During the years ended June30, 2003 and 2002, the Company recorded depreciation expense of $130,048 and$97,154, respectively.

 

IntangibleAssets: Intangible assets consist of costs related to two patents acquired inJune 1998. The patents are being amortized over their estimated useful lives offive years and were fully amortized during the year ended June 30, 2003.  During the years ended June 30, 2003 and2002, the Company recorded amortization expense of $20,246 and $20,244,respectively.  Accumulated amortizationat June 30, 2003 and 2002 was $101,225 and $80,979, respectively.

 

Realization ofLong-lived Assets: The Company evaluates the recoverability of property and equipment andintangible or other assets if facts and circumstances indicate that any ofthose assets might be impaired.  If anevaluation is required, the estimated future undiscounted cash flows associatedwith the asset are compared to the asset’s carrying amount to determine if awrite-down to market value or discounted cash flow value is necessary.

 

Stock-BasedCompensation: The Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 123, “Accounting for Stock-Based Compensation”, but elected to continue toaccount for its employee stock-based compensation plan under AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees” and its related interpretations in accounting for its stock optionplan (see Note 10).  While the Companycontinues to use APB No. 25, pro forma information regarding net income (loss)and earnings per share is required under SFAS No. 123 and SFAS No. 148,“Accounting for Stock-Based Compensation - Transition and Disclosure - anamendment of SFAS Statement No. 123”, including that the information bedetermined as if the Company had accounted for its stock options under the fairvalue method prescribed by SFAS No. 123.

 

The Company uses theBlack-Scholes option valuation model to value options granted.  Because changes in input assumptions canmaterially affect the fair value estimate, the existing model may notnecessarily provide the only measure of fair value for the employee stockoptions.  The Company used the followingweighted-average assumptions for options granted during the years ended June30, 2003 and 2002, as follows: risk-free interest rates of 3.38% and 4.89%,respectively; expected annual dividend yield of 0%; volatility factors of theexpected market price of the Company’s common stock of approximately 61.81% and96.89%, respectively; and a weighted-average expected life of the options of 7years.

 

Had compensation expense forstock based compensation been determined consistent with the provisions of SFASNo. 123 (and as amended by SFAS No. 148), the Company’s net loss would havebeen increased, as follows:

 

|                                                                                                                                        |   | **Year Ended  June 30,** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|
|                                                                                                                                        |   | **2003**                 |       | **2002** |   |
|                                                                                                                                        |   |                     |       |   |   |
| Net loss, as reported                                                                                                                       |   | $                        | (1,277,527 | ) | $ | (819,038 | ) |
| Less: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | $                        | (255,091   | ) | (160,943 | ) |
|                                                                                                                                        |   |                     |       |   |   |
| Net loss, pro forma                                                                                                                         |   | $                        | (1,532,618 | ) | $ | (979,981 | ) |
|                                                                                                                                        |   |                     |       |   |   |
| Basic and diluted net loss per share, as  reported                                                                                          |   | $                        | (0.13      | ) | $ | (0.09 | ) |
|                                                                                                                                        |   |                     |       |   |   |
| Basic and diluted net loss per share, pro  forma                                                                                            |   | $                        | (0.16      | ) | $ | (0.10 | ) |

 

F-10

----

 

The Company records the fairvalue of options issued to non-employee consultants at the fair value of theoptions issued.  Any expense isrecognized over the service period or at the date of issuance if the options arefully vested and no further performance obligation exists.  During the years ended June 30, 2003 and2002, expense of $61,237 and $58,215 was recorded for option grants tonon-employees that were fully vested at the date of the grant and for which nofurther performance obligation exists. The expense was recorded in selling, general and administrative expensesin the accompanying consolidated financial statements.

 

RevenueRecognition: The Company adopted the Securities and Exchange Commission’s (“SEC”)Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition”, whichprovides guidance related to revenue recognition based on interpretations andpractices followed by the SEC.  UnderSAB No. 101, certain products offered by the Company have revenue producingcomponents that are recognized over multiple delivery points (Sharps Disposalby Mail Systems, referred to as “Mailbacks” and Sharps Return Boxes, referredto as “Pump Returns”) and can consist of up to three separate elements asfollows: (1) the sale of the container system, (2) the transportation of thecontainer system and (3) the treatment and disposal (incineration) of thecontainer system.  The individual fairvalue of the transportation and incineration services are determined by thesales price of the service offer by third parties, with the fair value of thecontainer being the residual value. Revenue for the sale of the container is recognized upon delivery to thecustomer, at which time the customer takes title and assumes risk ofownership.  Transportation revenue onMailbacks is recognized when the customer returns the mailback container systemand the container has been received at the Company’s treatment facility.  The Mailback container system is mailed tothe incineration facility using the USPS. Incineration revenue is recognized upon the destruction andcertification of destruction having been prepared on the container.  Since the transportation element and theincineration elements are undelivered services at the point of initial sale ofthe container, the Mailback revenue is deferred until the services areperformed.  The current and long-termportions of deferred revenues are determined through regression analysis andhistorical trends.  Furthermore, throughregression analysis of historical data, the Company has determined that acertain percentage of all container systems sold may not be returned.  Accordingly, a portion of the transportationand incineration elements is recognized at the point of sale.

 

During the fourth quarter of fiscalyear 2003, the Company recognized increased revenues of approximately $279,000in conjunction with a change in accounting estimate related to pump returnproducts.  Prior to the change inestimate, the Company deferred 100% of all pump return sales.  Through historical trend analysis which wasnot available in the past, the Company has subsequently determined that acertain percentage of all containers sold are not returned.  Accordingly, the Company has recognized,during the fourth quarter of 2003, a portion of the deferred revenue that waspreviously deferred.

 

Shipping andHandling Fees and Costs:  The Company records amounts billed to customers for shipping andhandling as revenue.  Costs incurred bythe Company for shipping and handling have been classified as cost of revenues.

 

Income Taxes:  The liability method is used in accountingfor deferred income taxes.  Under thismethod, deferred tax assets and liabilities are determined based on differencesbetween financial reporting and tax bases of assets and liabilities and aremeasured using the enacted tax rates and laws that will be in effect when thedifferences are expected to reverse. The realizability of deferred tax assets is evaluated annually and a valuationallowance is provided if the deferred tax assets, more likely than not, willnot give rise to future benefits in the Company’s tax returns.

 

Net Loss PerShare: Earnings per share (“EPS”) data for all years presented has beencomputed pursuant to Statement of Financial Accounting Standards (“SFAS”) No.128, “Earnings Per Share”, that requires a presentation of basic and dilutedearnings per share.  Basic EPS excludesdilution and is determined by dividing income or loss available to commonstockholders by the weighted average number of common shares outstanding duringthe period adjusted for preferred stock dividends, if any.  Diluted EPS reflects the potential dilutionthat could occur if securities and other contracts to issue common stock were exercisedor converted into common stock.  Optionsoutstanding during each year have not been included in the calculation ofdiluted EPS, as they would have an anti-dilutive effect on EPS.  There are no differences in basic EPS anddiluted EPS for either year presented.

 

FinancialInstruments:  TheCompany considers the fair value of all financial instruments not to bematerially different from their carrying values at year-end based onmanagement’s estimate of the Company’s ability to borrow funds under terms andconditions similar to those of the Company’s existing debt.

 

F-11

----

 

SegmentReporting: SFAS No. 131, “Disclosures about Segments of an Enterprise and RelatedInformation,” requires that a public business enterprise report financial anddescriptive information about its operating segments. Generally, financialinformation is required to be reported on the basis used internally forevaluating segment performance and resource allocation.  The Company operates in a single segment,focusing on developing cost effective, logistical and educational solutions forhealthcare and non-healthcare institutional markets.

 

Use ofEstimates:  Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets,liabilities and disclosure of contingent liabilities at the date of theconsolidated financial statements and the reported amounts of revenue andexpense during the reporting period. Actual results could differ from these estimates.

 

RecentAccounting Pronouncements:  In June 2002, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards (“SFAS”) No. 146,“Accounting for Costs Associated with Exit or Disposal Activities”, whichrequires among other items, that liabilities for the costs associated with exitor disposal activities be recognized when the liabilities are incurred, ratherthan when an entity commits to an exit plan. SFAS No. 146 is effective for exit or disposal activities initiatedafter December 31, 2002.  The adoptionof SFAS No. 146 had no material impact on the results of operations orfinancial condition of the Company.

 

In November 2002, the FASBissued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others”, which requires a guarantor to recognize, at theinception of a guarantee, a liability for the fair value of the obligationundertaken in issuing the guarantee and expands the disclosures required to bemade by a guarantor about its obligations under guarantees that it hasissued.  Initial recognition andmeasurement provisions of FIN 45 are applicable on a prospective basis toguarantees issued or modified.  Thedisclosure requirements were effective immediately and were adopted beginningwith the Company’s Form 10-QSB for the three months ended December 31,2002.  This interpretation had nomaterial impact on the results of operations or financial condition of theCompany.

 

In November 2002, the EmergingIssues Task Force (“EITF”) reached a consensus on EITF Issue No. 00-21,“Revenue Arrangements with Multiple Deliveries” (“EITF 00-21”).  EITF 00-21 addresses certain aspects inaccounting for arrangements under which a company will perform multiplerevenue-generating activities.  Inapplying EITF 00-21, generally, separate contracts with the same customer thatare entered into at or near the same time are presumed to have been negotiatedas a package and should, therefore, be evaluated as a single contractualarrangement.  It also addresses howcontract consideration should be measured and allocated to the separatedeliverables in the arrangement.  Thispronouncement is applicable to revenue arrangements entered into beginning in2004.  The Company believes that it isin compliance with the requirements of EITF 00-21.

 

In December 2002, the FASBissued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure - an amendment of FASB Statement No. 123”, which providesalternative methods of transition for a voluntary change to the fair valuemethod of accounting for stock-based employee compensation and amends thedisclosure requirements of SFAS No. 123 to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  The transition guidance andannual disclosure requirements were effective for fiscal years ending afterDecember 15, 2002.  As the Company willcontinue to apply Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees”, the Company’s policy for accounting for stock-basedemployee compensation will not change as a result of SFAS No. 148.  The Company adopted the annual disclosureprovisions for this Form 10-KSB.  TheCompany adopted the interim disclosure provisions for its Form 10-QSB datedMarch 31, 2003.

 

F-12

----

 

In January 2003, the FASBissued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities”, which requires that companies that control another entitythrough interests other than voting rights should consolidate the controlledentity.  FIN 46 applies to variableinterest entities created after January 31, 2003, and to variable interestentities in which an enterprise obtains an interest after that date.  The related disclosure requirements wereeffective immediately.  Management doesnot believe the adoption of FIN 46 will have any impact on the Company’sfinancial position or results of operations.

 

In April 2003, the FASB issuedSFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and HedgingActivities”, which amends SFAS No. 133 to provide clarification on thefinancial accounting and reporting of derivative instruments and hedgingactivities and requires that contracts with similar characteristics to beaccounted for on a comparable basis. The provisions of SFAS No. 149 are effective for contracts entered intoor modified after June 30, 2003, and for hedging relationships designated afterJune 30, 2003.  The adoption of SFAS No.149 will not have a material impact on the Company’s results of operations orfinancial position.

 

In May 2003, the FASB issuedSFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity”, which establishes standards onthe classification and measurement of certain financial instruments withcharacteristics of both liabilities and equity.  The provisions of SFAS No. 150 are effective for financialinstruments entered into or modified after May 31, 2003 and to all otherinstruments that exist as of the beginning of the first interim financialreporting period beginning after June 15, 2003.  The adoption of SFAS No. 150 did not have a material impact onthe Company’s results of operations or financial position.

 

 

**NOTE3 - ACCOUNT RECEIVABLE AND INVENTORY WRITE-DOWN**

 

During fiscal year 2003, theCompany recorded bad debt expense of $204,822 (included in cost of revenues)related to one customer in the environmental operations division.  It became apparent that the collection ofthe outstanding receivable was uncertain, therefore the Company engaged anoutside attorney to assist in the collection process.  The $204,822 consists of the adjustment necessary to reflect theestimated net realizable value of the receivable including attorney fees.

 

During fiscal year 2003 and asa result of a physical inventory performed, the Company recorded an inventorywrite-down adjustment totaling $86,918 (included in cost of revenues).  The write-down consisted of obsolete inventoryof $22,649 and shrinkage of $64,269.

 

 

**NOTE4 - PROPERTY AND EQUIPMENT**

 

At June 30, 2003 and 2002,property and equipment consisted of the following:

 

|                                  |   |            |   | **June 30,** |    |
|---------------------------------------|--------|-----------------|--------|--------------|---------|
|                                  |   | **Useful Life** |   | **2003**     |    | **2002** |   |
| Furniture and fixtures                |   | 3 to 5 years    |   | $            | 34,538  |   | $ | 33,578 |   |
| Equipment                             |   | 5 years         |   | 171,718      |    | 120,603 |   |
| Manufacturing                         |   | 15 years        |   | 225,782      |    | — |   |
| Computers and software                |   | 3 to 5 years    |   | 431,654      |    | 263,376 |   |
| Leasehold improvements                |   | 3 years         |   | 131,090      |    | 119,476 |   |
| Automobiles                           |   | 5 years         |   | 32,411       |    | 32,411 |   |
|                                  |   |            |   | 1,027,193    |    | 569,444 |   |
| Less:   accumulated depreciation |   |            |   | (429,502     | )       | (299,454 | ) |
|                                  |   |            |   |         |    |   |   |
| Net property and equipment            |   |            |   | $            | 597,691 |   | $ | 269,990 |   |

 

F-13

----

 

On October 1, 2002, Sharpscompleted a purchase of the Pro-Tec product line assets from Futura MedicalCorporation (“Futura”) for $300,000.  Asconsideration for the asset purchase, the Company made payments of $50,000 atclosing and $83,333 on March 1, 2003. The Company is scheduled to make twelve (12) additional monthly paymentsof $13,889 (beginning September 1, 2003) to Futura as payment for the remainingobligation at June 30, 2003 of $166,667. This asset purchase consists of all inventories, molds, fixtures,supplies, customer list and other fixed assets used in the manufacturing of thePro-Tec product line.  The assetpurchase increased inventory by $78,364 and property and equipment by$221,636.  The Company did not assumeany operations, other liabilities or employees as a part of this assetpurchase. Revenues generated from this product line are $370,526 (since October2002) and are classified in the Company’s Statement of Operations as“Manufacturing”.

 

The Company leases anincinerator facility located in Carthage, Texas for medical waste disposal. Theamended lease requires rental payments of $2,000 per month for the first year(year ended June 30, 2003) escalating by $500 per month each year thereafteruntil termination of the lease on June 30, 2012. The Company is required to payadditional rent equal to $0.02 per pound for all materials burned, treated,received or transferred at the incinerator facility exceeding 100,000 poundsper month. The Company did not incur any additional rent during the year endedJune 30, 2003. The Company is responsible for the cost of operating andmaintaining the facility. For accounting purposes and as a result of the leaseescalation clause, the Company records lease expense for this facility on astraight-line basis over the life of the lease which computes to $4,250 per month,or $51,000 per year.

 

 

**NOTE5 - NOTE RECEIVABLE FROM STOCKHOLDER**

 

At June 30, 2002, the Companyheld a $320,000 personal, full recourse note receivable from the ChiefExecutive Officer of the Company.  Thenote was amended November 2001 to bear interest at 8.0% with interest onlyinstallments due on each anniversary date through 2004 and unpaid interest andprincipal due November 2005.  OnDecember 31, 2002, the note receivable was paid in full.  The Company received the principal andinterest in the amount of $358,400. There were no loans to officers outstanding at June 30, 2003.

 

F-14

----

 

**NOTE6 - NOTES PAYABLE AND LONG-TERM DEBT**

 

Notes payable and long-termdebt consisted of the following:

 
|                                                                                                                                                                                                                         |   | **June 30,** |    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------|---------|
|                                                                                                                                                                                                                         |   | **2003**     |    | **2002** |   |
| Factoring agreement with financial  institution, bearing interest at a rate of prime plus 2%, plus an  administrative fee of 0.25% of gross receivable financed                                                              |   | $            | 262,043 |   | $ | — |   |
|                                                                                                                                                                                                                         |   |         |    |   |   |
| Note payable to Futura (see note 4),  remaining balance at June 30, 2003 payable twelve equal installments of  $13,889 beginning September 1, 2003                                                                           |   | 166,667      |    | — |   |
|                                                                                                                                                                                                                         |   |         |    |   |   |
| Promissory note to a finance company for  the purchase of an automobile, due in monthly installments of principal and  interest of $674, bearing interest at 7.75% through November 2006, and is  secured by the automobile. |   | 24,227       |    | 30,191 |   |
|                                                                                                                                                                                                                         |   |         |    |   |   |
| Note payable for certain insurance  premiums. The note is due in monthly installments of $10,847, bearing  interest at 6.24% through May 2003                                                                                |   | —       |    | 108,465 |   |
|                                                                                                                                                                                                                         |   | 452,937      |    | 138,656 |   |
| Less:   notes payable and current portion of long-term debt                                                                                                                                                             |   | 407,374      |    | 114,429 |   |
|                                                                                                                                                                                                                         |   |         |    |   |   |
| Total notes payable and long-term debt                                                                                                                                                                                       |   | $            | 45,563  |   | $ | 24,227 |   |

 

The Company maintains anarrangement with a financial institution for a $1.25 million asset-based lineof credit.  The agreement allows theCompany to factor customer receivables generated out of its ordinary course ofbusiness.  The maximum amount availableunder the line of credit is $1.0 million (or $1.25 million of its grossreceivable balance).  The agreementautomatically renews on an annual basis (August 30 of each year) unlessterminated by either party. The Company may borrow up to 80% of the receivablespresented and will incur interest on borrowings at a prime rate of interestplus 2%, plus administrative fees of .25% on gross receivables presented.  During the fiscal year 2002, the Companygranted 9,000 warrants to the financial institution to purchase 9,000 shares ofcommon stock at $1.65 per share.  Thewarrants expire August 30, 2007.

 

The following are futurematurities on notes payable and long-term debt as of June 30, 2003:

 
| **Year  Ending June 30,** |   |   |    |
|---------------------------|--------|--------|---------|
| 2004                      |   | $      | 407,374 |   |
| 2005                      |   | 34,737 |    |
| 2006                      |   | 7,518  |    |
| 2007                      |   | 3,308  |    |
| 2008                      |   | — |    |
|                      |   |   |    |
|                      |   | $      | 452,937 |   |

 

F-15

----

 

**NOTE7 - OBLIGATIONS UNDER CAPITAL LEASES**

 

Capital lease obligationsconsist of the following:

 
|                                                                                                                                                                            |   | **June 30,** |    |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------|---------|
|                                                                                                                                                                            |   | **2003**     |    | **2002** |   |
| Capital lease for the purchase of  accounting and operating system software and hardware, due in monthly  installments of $4,061, interest imputed at 21% through February 2007 |   | $            | 121,000 |   | $ | — |   |
|                                                                                                                                                                            |   |         |    |   |   |
| Capital lease for purchase of phone system  due in monthly installments of $455, interest imputed at 12% through August  2007                                                   |   | 17,815       |    | — |   |
|                                                                                                                                                                            |   | 138,815      |    | — |   |
| Less:   current portion                                                                                                                                                    |   | 36,501       |    | — |   |
|                                                                                                                                                                            |   |         |    |   |   |
|                                                                                                                                                                            |   | $            | 102,314 |   | $ | — |   |

 

Minimum future lease paymentsfor each of the next five years and in the aggregate are as follows:

 
| **Year  Ending June 30,**                       |   |    |    |
|-------------------------------------------------|--------|---------|---------|
| 2004                                            |   | $       | 54,192  |   |
| 2005                                            |   | 54,192  |    |
| 2006                                            |   | 54,192  |    |
| 2007                                            |   | 33,888  |    |
| 2008                                            |   | 910     |    |
|                                            |   |    |    |
| Total future minimum lease payments             |   | 197,374 |    |
| Less: amount representing interest              |   | 58,559  |    |
|                                            |   |    |    |
| Present value of future minimum lease  payments |   | 138,815 |    |
| Less: current maturities                        |   | 36,501  |    |
|                                            |   |    |    |
| Long-term portion of capital lease  obligations |   | $       | 102,314 |   |

 

The following describes leasedequipment held under capital leases:

 
|                                  |   | **June 30,** |    |
|---------------------------------------|--------|--------------|---------|
|                                  |   | **2003**     |    | **2002** |   |
| Equipment                             |   | $            | 20,428  |   | $ | — |   |
| Computers and accounting software     |   | 132,000      |    | — |   |
|                                  |   |         |    |   |   |
|                                  |   | 152,428      |    | — |   |
| Less:   accumulated amortization |   | 8,516        |    | — |   |
|                                  |   |         |    |   |   |
|                                  |   | $            | 143,912 |   | $ | — |   |

 

F-16

----

 

**NOTE8 - INCOME TAXES**

 

The reconciliation of thestatutory income tax rate to the Company’s effective income tax rate for theyears ended June 30, 2003 and 2002 are as follows:

 
|                          |   | **Year Ended June 30,** |   |
|-------------------------------|--------|-------------------------|--------|
|                          |   | **2003**                |   | **2002** |   |
|                          |   |                    |   |   |   |
| Statutory rate                |   | (34.0                   | )%     | (34.0 | )% |
| State income taxes, net       |   | (3.0                    | )      | (2.9 | ) |
| Meals and entertainment       |   | 1.6                     |   | 2.3 |   |
| Change in valuation allowance |   | 35.4                    |   | 32.6 |   |
| Other                         |   | —                  |   | 2.0 |   |
|                          |   |                    |   |   |   |
|                          |   | —                  | %      | — | % |

 

At June 30, 2003 and 2002,significant components of net deferred tax assets are approximated as follows:

 
|                                                |   | **June 30,** |   |
|-----------------------------------------------------|--------|--------------|--------|
|                                                |   | **2003**     |   | **2002** |   |
| Deferred tax assets relating to:                    |   |         |   |   |   |
| Accounts receivable reserve                         |   | $            | 13,000 |   | $ | 4,000 |   |
| Deferred revenue                                    |   | 366,000      |   | 410,000 |   |
| Deferred compensation                               |   | 102,000      |   | 102,000 |   |
| Net operating loss carryforwards and other  credits |   | 4,147,000    |   | 3,629,000 |   |
| Total deferred tax assets                           |   | 4,628,000    |   | 4,145,000 |   |
|                                                |   |         |   |   |   |
| Deferred tax liabilities related to:                |   |         |   |   |   |
| Depreciation differences                            |   | (62,000      | )      | (14,000 | ) |
|                                                |   |         |   |   |   |
|                                                |   | 4,566,000    |   | 4,131,000 |   |
| Valuation allowance                                 |   | (4,566,000   | )      | (4,131,000 | ) |
|                                                |   |         |   |   |   |
| Net deferred tax assets                             |   | $            | — |   | $ | — |   |

 

At June 30, 2003, the Companyhad net operating loss carryforwards for income tax purposes of approximately$11.2 million, of which approximately $5.6 million was acquired in anacquisition in February 1998.  TheCompany’s ability to utilize these net operating losses to reduce future taxableincome may be limited upon a change of ownership and amounts of separateCompany taxable income, as defined by the Internal Revenue Code.  The carryforwards will begin to expire in2010 if not otherwise used.  A valuationallowance has been established to fully offset the Company’s deferred taxassets due to the Company’s history of losses since inception.  The valuation allowance relates primarily tothe Company’s net losses.  The Companyhas not made any income tax payments since inception.

 

 

**NOTE9 - STOCK TRANSACTIONS**

 

During fiscal year 2003, theCompany issued 88,333 shares of common stock in conjunction with the exerciseof stock options.  Cash proceeds to theCompany totaled $57,251.

 

On October 12, 2001, theCompany completed a private placement of 1,100,000 unregistered shares of itscommon stock for net proceeds of $1,210,000.

 

Each of the forgoingtransactions were exempt offerings, pursuant to Regulation D, and promulgatedunder the Securities Act of 1933, as amended.

 

F-17

----

 

**NOTE10 - STOCK OPTIONS**

 

The Company sponsors a StockPlan (the “Plan”) covering employees, consultants and non-employeedirectors.  The Plan, as amended,provides for the granting of options, either incentive or nonstatutory, topurchase up to 3,000,000 shares of the Company’s common stock.  Options granted vest over a period of up tofour years.  Options expire five toseven years after the date of grant.

 

The following summary ofactivity for the Plan during the years ended June 30, 2003 and 2002 ispresented in the table below:

 
|                         |   | **Options  Outstanding** |   | **Weighted  Average  Exercise  Price** |   |
|------------------------------|--------|--------------------------|--------|----------------------------------------|--------|
|                         |   |                     |   |                                   |   |
| Balance, June 30, 2001       |   | 1,080,140                |   | $                                      | 0.91   |   |
| Granted                      |   | 690,000                  |   | $                                      | 1.36   |   |
| Exercised                    |   | (16,667                  | )      | $                                      | 1.00   |   |
| Forfeited or Canceled        |   | (33,333                  | )      | $                                      | 0.63   |   |
|                         |   |                     |   |                                   |   |
| Balance, June 30, 2002       |   | 1,720,140                |   | $                                      | 1.09   |   |
| Granted                      |   | 1,123,390                |   | $                                      | 1.10   |   |
| Exercised                    |   | (88,333                  | )      | $                                      | 0.65   |   |
| Forfeited or Canceled        |   | (346,807                 | )      | $                                      | 1.44   |   |
|                         |   |                     |   |                                   |   |
| Balance, June 30, 2003       |   | 2,408,390                |   | $                                      | 1.06   |   |
|                         |   |                     |   |                                   |   |
| Exercisable at June 30, 2003 |   | 1,166,678                |   | $                                      | 0.98   |   |

 

The weighted average fairvalues of options granted during the years ended June 30, 2003 and 2002 were$0.76 and $1.13, respectively.  As ofJune 30, 2003 and 2002, there were 591,610 and 279,860 options, respectively,available for grant under the Plan.

 

The following table summarizesinformation about stock options outstanding as of June 30, 2003:

 
|                          |   | **Options  Outstanding**              |   | **Options  Exercisable**                                        |   |
|-------------------------------|--------|---------------------------------------|--------|-----------------------------------------------------------------|--------|
| **Range of  Exercise  Price** |   | **Outstanding  as of  June 30, 2003** |   | **Weighted  Average  Remaining  Contractual  Life  (in Years)** |   | **Weighted  Average  Exercise  Price** |   | **Exercisable  as of  June 30, 2003** |   | **Weighted  Average  Exercise  Price** |   |
|                          |   |                                  |   |                                                            |   |   |   |   |   |   |   |
| $ 0.50 - $1.00                |   | 945,890                               |   | 5.58                                                            |   | $ | 0.66 |   | 494,169 |   | $ | 0.57 |   |
| $ 1.01 -  $1.50               |   | 1,147,500                             |   | 5.78                                                            |   | 1.25 |   | 547,501 |   | 1.18 |   |
| $ 1.51 -  $2.00               |   | 285,000                               |   | 5.82                                                            |   | 1.53 |   | 95,008 |   | 1.53 |   |
| $ 2.01 -  $2.50               |   | 30,000                                |   | 2.42                                                            |   | 2.25 |   | 30,000 |   | 2.25 |   |
|                          |   |                                  |   |                                                            |   |   |   |   |   |   |   |
|                          |   | 2,408,390                             |   |                                                            |   | $ | 1.06 |   | 1,166,678 |   | $ | 0.98 |   |

 

F-18

----

 

**NOTE11 - COMMITMENTS AND CONTINGENCIES**

 

Litigation:  The Company operates in a regulated industryand is subject to routine and/or unannounced regulatory inspections.  The Company has received notification fromthe City of Carthage for various notices of violations which it has received fromthe Texas Natural Resource Conservation Commission (“TNRCC”).  Management believes that the ultimateresolution of these matters will not have any material adverse effect on theCompany’s consolidated financial position, results of operations or liquidity.

 

The Company is also a party tovarious legal actions and claims arising in the normal course of business.  While the outcome of these matters cannot bepredicted with certainty, management believes these matters will not have amaterial adverse effect on the Company’s consolidated financial position,results of operations or liquidity.

 

DistributorAgreements: The Company has an agreement with a supplier to be the exclusivedomestic distributor of certain of the supplier’s medical wastecontainers.  The agreement provides forautomatic renewals for two-year periods, unless either party provides notice oftermination to the other within 90 days prior to the expiration of the thencurrent term.  Exclusivity rights willlapse unless annual non-guaranteed purchase volumes are met.

 

OperatingLeases:  TheCompany leases office space, an incineration facility and equipment undercertain operating lease agreements, which expire at various dates through June2012.  The incineration facility has a$2,000 per month base rent (with annual incremental increases of $500 permonth) and a $0.02 per pound fee on incineration in excess of 100,000 poundsper month.  The incineration fee inexcess of the base rent has not been included in the table below.  Rent expense for the years ended June 30,2003 and 2002 was $196,713 and $92,034, respectively.  Future minimum lease payments under non-cancelable operatingleases as of June 30, 2003 are as follows:

 
| **Year Ending June 30,** |   |    |      |
|--------------------------|--------|---------|-----------|
| 2004                     |   | $       | 159,775   |   |
| 2005                     |   | 165,607 |      |
| 2006                     |   | 169,386 |      |
| 2007                     |   | 169,833 |      |
| 2008                     |   | 170,279 |      |
| Thereafter               |   | 270,000 |      |
|                     |   |    |      |
|                     |   | $       | 1,110,880 |   |

 

**NOTE12 - RELATED PARTY TRANSACTIONS**

 

On January 2, 2003, the ChiefExecutive Officer of the Company sold 356,000 shares of common stock in SharpsCompliance Corp. through a private sale. Purchasers of these shares included, among others, New Century EquityHoldings Corp. (“New Century”) (200,000 shares), a 9% shareholder in theCompany, John Dalton (50,000 shares), a 12.5% holder in the Company, and PhilipZerrillo (10,000 shares), a member of the Company’s Board of Directors.

 

The Chief Financial Officer(“CFO”) of the Company also serves as the CFO of New Century, a 9% shareholderin the Company.  In addition, two of theCompany’s directors also serve as directors of New Century.  The Company reimburses New Century forcertain expenses incurred by the CFO, including an allocation of the CFO’ssalary and benefits, temporary living and relocation expenses.  Included in accounts payable at June 30,2003 is $27,958 payable to New Century.

 

**NOTE13 - SUBSEQUENT EVENT**

 

On September 24, 2003, theCompany completed a private placement of 625,00 shares of common stock at theprice of $0.80 per share.  The proceedsof $500,000 will be utilized by the Company for working capital purposes aswell as to support growth plans to further expand the business into theindustrial, retail and other markets.

 

F-19

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