**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**FORM
      10-Q**





**QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15 (d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**











For
                Quarter Ended
            September
                30, 2006
            Commission
                File No.
            0-24866








MICROTEK
      MEDICAL HOLDINGS, INC.


(Exact
      name of Registrant as specified in its charter)








Georgia
            58-1746149(State
                or other jurisdiction of
            (IRS
                Employerincorporation
                or organization)
            Identification
                No.)





13000
      DEERFIELD PARKWAY, SUITE 300


ALPHARETTA,
      GA 30004


(Address
      of principal executive offices)





(678)
      896-4400


(Registrant's
      telephone number, including area code)











Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      at least the past 90 days. Yes
x  
No
o





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.


Large
      accelerated filer o Accelerated
      filer x Non-accelerated
      filer  o





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





Indicate
      the number of shares outstanding of each of the issuer's classes of common
      equity, as of the latest practicable date.





Class
            Outstanding
                at November 6, 2006Common
                Stock, $.001 par value
            43,266,015








Index





**INDEX**





**PART
                I:**
            **FINANCIAL
                INFORMATION**Item
                1.
            Financial
                Statements:Unaudited
                Condensed Consolidated Balance Sheets as
                of September 30, 2006 and December 31, 2005Unaudited
                Condensed Consolidated Statements of
                Operations and Comprehensive Income for the Three Months ended September
                30, 2006 and September 30, 2005 and for the Nine Months ended September
                30, 2006 and September 30, 2005Unaudited
                Condensed Consolidated Statements of Cash
                Flows for the Nine Months ended September 30, 2006 and September
                30,
                2005Notes
                to Unaudited Condensed Consolidated Financial
                StatementsItem
                2.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of OperationsItem
                3.
            Quantitative
                and Qualitative Disclosures About Market
                RiskItem
                4.
            Controls
                and Procedures**PART
                II:**
            **OTHER
                INFORMATION**Item
                1.
            Legal
                ProceedingsItem
                1A.
            Risk
                FactorsItem
                2.
            Unregistered
                Sales of Equity Securities and Use
                of ProceedsItem
                3.
            Defaults
                Upon Senior SecuritiesItem
                4.
            Submission
                of Matters to a Vote of Security
                HoldersItem
                5.
            Other
                InformationItem
                6.
            Exhibits











Index
 2







**PART
      I**


**FINANCIAL
      INFORMATION**


**Item
      1. Financial Statements**





**MICROTEK
                MEDICAL HOLDINGS,
                INC.**Unaudited
                Condensed Consolidated Balance Sheets(in
                thousands)**Assets**
            
            **September
                30, 2006**
            
            **December
                31, 2005**Current
                assets:Cash
                and cash equivalents
            
            $
            15,496
            
            $
            14,765Accounts
                receivable, net of allowances of $1,701
              and
                $1,635, respectively
            
            
            19,755
            
            
            19,530Other
                receivables
            
            
            1,212
            
            
            908Inventories
            
            
            36,892
            
            
            31,043Deferred
                income taxes
            
            
            3,515
            
            
            3,007Prepaid
                expenses and other current assets
            
            
            1,613
            
            
            2,480Total
                current assets
            
            
            78,483
            
            
            71,733Property
                and equipment
            
            
            30,635
            
            
            29,125Less
                accumulated depreciation
            
            
            (23,655
            )
            
            (22,132
            )Property
                and equipment, net
            
            
            6,980
            
            
            6,993Goodwill
            
            
            32,365
            
            
            30,956Other
                intangible assets, net
            
            
            6,564
            
            
            6,041Deferred
                income taxes
            
            
            16,138
            
            
            19,812Other
                assets
            
            
            6,619
            
            
            5,223Total
                assets
            
            $
            147,149
            
            $
            140,758**Liabilities
                and Shareholders’ Equity**Current
                liabilities:Accounts
                payable
            
            $
            7,057
            
            $
            6,903Accrued
                expenses
            
            
            6,241
            
            
            4,539Income
                taxes payable
            
            
            334
            
            
            717Current
                portion of long-term debt
            
            
            87
            
            
            420Total
                current liabilities
            
            
            13,719
            
            
            12,579Long-term
                debt, excluding current portion
            
            
            8
            
            
            1,249Other
                long-term liabilities, excluding current portion
            
            
            3,690
            
            
            2,864Total
                liabilities
            
            
            17,417
            
            
            16,692Shareholders’
                equity:Common
                stock
            
            
            45
            
            
            45Additional
                paid-in capital
            
            
            218,497
            
            
            217,858Accumulated
                deficit
            
            
            (83,721
            )
            
            (89,774
            )Accumulated
                other comprehensive loss, net
              of
                income taxes of ($125) and ($51), respectively
            
            
            158
            
            
            (817
            )134,979
            
            
            127,312Treasury
                shares, at cost
            
            
            (5,247
            )
            
            (3,246
            )Total
                shareholders’ equity
            
            
            129,732
            
            
            124,066Total
                liabilities and shareholders’ equity
            
            $
            147,149
            
            $
            140,758


See
        notes
        to unaudited condensed consolidated financial statements.






Index
 3





**MICROTEK
                MEDICAL HOLDINGS,
                INC.**Unaudited
                Condensed Consolidated Statements of Operations and Comprehensive
                Income(in
                thousands, except per share data)**Three
                months ended**
            
            **Nine
                months ended****September
                30, 2006**
            
            **September
                30, 2005**
            
            **September
                30, 2006**
            
            **September
                30, 2005**Net
                revenues
            
            $
            35,108
            
            $
            33,487
            
            $
            104,849
            
            $
            101,736Cost
                of goods sold
            
            
            21,368
            
            
            21,542
            
            
            63,399
            
            
            62,573Gross
                profit
            
            
            13,740
            
            
            11,945
            
            
            41,450
            
            
            39,163Operating
                expenses:Selling,
                general and administrative
            
            
            10,782
            
            
            10,014
            
            
            31,324
            
            
            30,947Research
                and development
            
            
            159
            
            
            172
            
            
            448
            
            
            643Amortization
                of intangibles
            
            
            254
            
            
            243
            
            
            722
            
            
            726Total
                operating expenses
            
            
            11,195
            
            
            10,429
            
            
            32,494
            
            
            32,316Gain
                (loss) on disposition of assets
            
            
            -
            
            
            17
            
            
            -
            
            
            (139
            )Income
                from operations
            
            
            2,545
            
            
            1,533
            
            
            8,956
            
            
            6,708Interest
                income
            
            
            129
            
            
            40
            
            
            328
            
            
            122Interest
                expense
            
            
            (16
            )
            
            (41
            )
            
            (37
            )
            
            (209
            )Equity
                in earnings of investee
            
            
            80
            
            
            64
            
            
            203
            
            
            199Foreign
                currency exchange gain (loss)
            
            
            -
            
            
            7
            
            
            -
            
            
            (416
            )Income
                before income taxes
            
            
            2,738
            
            
            1,603
            
            
            9,450
            
            
            6,404Income
                tax provision
            
            
            1,090
            
            
            (6,254
            )
            
            3,397
            
            
            (5,753
            )Net
                income
            
            $
            1,648
            
            $
            7,857
            
            $
            6,053
            
            $
            12,157Other
                comprehensive income (loss):Foreign
                currency translation gain (loss), net of income taxes
            
            
            219
            
            
            (120
            )
            
            1,036
            
            
            (1,269
            )Unrealized
                gain (loss) on available for sale
              securities,
                net of income taxes
            
            
            (39
            )
            
            (25
            )
            
            (61
            )
            
            15Comprehensive
                income
            
            $
            1,828
            
            $
            7,712
            
            $
            7,028
            
            $
            10,903Net
                income per common share - Basic
            
            $
            0.04
            
            $
            0.18
            
            $
            0.14
            
            $
            0.28Net
                income per common share - Diluted
            
            $
            0.04
            
            $
            0.18
            
            $
            0.14
            
            $
            0.27Weighted
                average number of common sharesoutstanding:Basic
            
            
            43,434
            
            
            43,369
            
            
            43,581
            
            
            43,305Diluted
            
            
            44,431
            
            
            44,563
            
            
            44,574
            
            
            44,479




See
      notes
      to unaudited condensed consolidated financial statements.






Index
 4








**MICROTEK
                MEDICAL HOLDINGS,
                INC.**Unaudited
                Condensed Consolidated Statements of Cash Flows(in
                thousands)**Nine
                months ended**
            
            **Nine
                months ended****September
                30, 2006**
            
            **September
                30, 2005**Cash
                flows from operating activities:Net
                income
            
            $
            6,053
            
            $
            12,157Adjustments
                to reconcile net income to net cash provided byoperating
                activities:Depreciation
            
            
            1,517
            
            
            1,627Amortization
                of intangibles
            
            
            722
            
            
            726Provision
                for doubtful accounts
            
            
            419
            
            
            530Deferred
                income taxes
            
            
            3,093
            
            
            (6,317
            )Equity
                in earnings of investee
            
            
            (203
            )
            
            (199
            )Other
            
            
            (3
            )
            
            (66
            )Changes
                in operating assets and liabilities, net ofacquisitions
            
            
            (3,282
            )
            
            (2,521
            )**Net
                cash provided by operating activities**
            
            
            **8,316**
            
            
            **5,937**Cash
                flows from investing activities:Purchase
                of and deposits for property and equipment
            
            
            (1,204
            )
            
            (859
            )Acquisition
                of Samco, net of cash acquired
            
            
            (2,346
            )
            
            -Acquisition
                of Ceres Medical, net of cash acquired
            
            
            (483
            )
            
            -Proceeds
                from dispositions of equipment
            
            
            6
            
            
            215**Net
                cash used in investing activities**
            
            
            **(4,027**
            **)**
            
            **(644**
            **)**Cash
                flows from financing activities:Borrowings
                under line of credit agreement
            
            
            91,080
            
            
            82,415Repayments
                under line of credit agreement
            
            
            (92,311
            )
            
            (86,510
            )Changes
                in bank overdraft
            
            
            (1,018
            )
            
            (1,268
            )Repayments
                under notes payable
            
            
            (343
            )
            
            (369
            )Proceeds
                from exercise of stock options
            
            
            68
            
            
            88Repurchase
                of treasury stock
            
            
            (2,001
            )
            
            -Proceeds
                from issuance of common stock
            
            
            571
            
            
            586**Net
                cash used in financing activities**
            
            
            **(3,954**
            **)**
            
            **(5,058**
            **)**Effect
                of exchange rate changes on cash
            
            
            396
            
            
            (131
            )Net
                increase in cash and cash equivalents
            
            
            731
            
            
            104Cash
                and cash equivalents at beginning of period
            
            
            14,765
            
            
            8,964**Cash
                and cash equivalents at end of period**
            
            **$**
            **15,496**
            
            **$**
            **9,068**Supplemental
                disclosures of noncash investing and financingactivities:Tax
                benefits related to stock options
            
            $
            -
            
            $
            1,340




See
        notes
        to unaudited condensed consolidated financial statements.




Index
 5


**MICROTEK
        MEDICAL HOLDINGS, INC.**
 **Notes
        to Unaudited Condensed Consolidated Financial Statements**
 
 **1.**  **NATURE
        OF BUSINESS AND BASIS OF PRESENTATION**
 
 Microtek
        Medical Holdings, Inc. and subsidiaries (the “Company”) manufactures and
        supplies innovative product solutions for patient care, occupational safety
        and
        management of infectious and hazardous waste for the healthcare market, which
        represents one business segment. The Company markets its products to hospitals
        and other end users through a broad distribution system consisting of multiple
        channels including distributors, directly through its own sales force, original
        equipment manufacturers, and private label customers. The Company also markets
        certain of its products through custom procedure tray companies. Substantially
        all of the Company’s revenues are generated by its primary operating unit,
        Microtek Medical, Inc. (“Microtek”), a subsidiary of the Company. As described
        in Note 7 to these unaudited condensed consolidated financial statements,
        in
        September 2004, the Company entered into an agreement which grants to Eastern
        Technologies, Inc. a worldwide exclusive license to manufacture, use and
        sell
        the Company’s OREX materials and processing technology in the nuclear industry
        and homeland security industry, and for certain other industrial
        applications.
 
 The
        unaudited condensed consolidated financial statements include the accounts
        of
        the Company and its wholly owned subsidiaries. All significant intercompany
        balances and transactions have been eliminated in consolidation.
 
 The
        accompanying unaudited condensed consolidated financial statements have been
        prepared in accordance with Rule 10-01 of Regulation S-X for interim financial
        statements required to be filed with the Securities and Exchange Commission
        and
        do not include all information and footnotes required by generally accepted
        accounting principles for complete financial statements. In
        the
        opinion of management, the information furnished reflects all adjustments
        (consisting only of normal recurring adjustments) necessary for a fair
        presentation of the financial position, results of operations and cash flows
        for
        the interim periods presented. Results for the interim periods are not
        necessarily indicative of results to be expected for the full year. The
        consolidated financial statements herein should be read in conjunction with
        the
        consolidated financial statements and notes thereto contained in the Company's
        Annual Report on Form 10-K for the year ended December 31, 2005 (the “Annual
        Report”).
 
 **2.**  **CRITICAL
        ACCOUNTING POLICIES AND ESTIMATES**
 
 The
        Company's discussion of results of operations and financial condition relies
        on
        its consolidated financial statements that are prepared based on certain
        critical accounting policies that require management to make judgments and
        estimates that are subject to varying degrees of uncertainty. The
        Company believes that investors need to be aware of these policies and how
        they
        impact its financial statements as a whole, as well as its related discussion
        and analysis presented herein. While the Company believes that these accounting
        policies are based on sound measurement criteria, actual future events can
        and
        often do result in outcomes that can be materially different from these
        estimates or forecasts. The accounting policies and related risks described
        in
        the Company's Annual Report on Form 10-K for the year ended December 31,
        2005
        are those that depend most heavily on these judgments and estimates. During
        the
        three months and nine months ended September 30, 2006, there have been no
        material changes to any of the Company’s critical accounting
        policies.
  **3.**  **NEWLY
        ISSUED ACCOUNTING STANDARDS**
 
 In
        June
        2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation
        No. 48, *Accounting
        for Uncertainty in Income Taxes - An interpretation of FASB Statement No.
        109* ,
        or FIN
        48, which clarifies the accounting and disclosure requirements for uncertainty
        in tax positions, as defined. The Company is currently evaluating the provisions
        of FIN 48, which is effective for fiscal years beginning after December 15,
        2006.
   Index
 6
 
 In
        September 2006, the FASB issued Statement of Financial Accounting Standards
        (“SFAS”) No. 158, *Employer’s Accounting for Defined Benefit Pension and Other Postretirement
        Plans- an amendment of FASB Statements No. 87, 88, 106, and 132(R)* (“SFAS
        No. 158”). SFAS No. 158 requires an employer to recognize the overfunded or
        underfunded status of a defined benefit pension plan as an asset or liability
        in
        its statement of financial position and to recognize changes in that funded
        status in the year in which the changes occur through comprehensive income.
        The
        funded status of a defined benefit pension plan is measured as the difference
        between plan assets at fair value and the projected benefit obligation.
        Additionally, SFAS No. 158 requires an employer to measure the funded status
        of
        a plan as of the Company’s fiscal year-end, with limited exceptions, and expands
        financial statement disclosures. SFAS No. 158 is effective as of the end
        of
        fiscal years ending after December 15, 2006; however, the requirement to
        measure
        plan assets and benefit obligations as of the Company fiscal year-end is
        effective for fiscal years ending after December 15, 2008. The Company currently
        expects to adopt all requirements of SFAS No. 158 with respect to its
        international defined benefit pension plan on December 31, 2006, except for
        the
        funded status measurement date requirement which will be adopted on December
        31,
        2008, as allowed under SFAS No. 158. The Company is currently evaluating
        the
        impact that the adoption of SFAS No. 158 will have on its consolidated financial
        statements.
 
 In
        September 2006, the Securities and Exchange Commission issued Staff Accounting
        Bulletin (“SAB”) No. 108, *Considering
        the Effects of Prior Year Misstatements when Quantifying Misstatements in
        Current Year Financial Statements* (“SAB
        108”), to address diversity in practice in quantifying financial statement
        misstatements. SAB 108 requires companies to quantify misstatements based
        on
        their impact on each of their financial statements and related disclosures.
        SAB
        108 is effective as of the end of the Company’s 2006 fiscal year, allowing a
        one-time transitional cumulative effect adjustment to retained earnings as
        of
        January 1, 2006 for errors that were not previously deemed material but are
        material under the guidance in SAB 108. The Company is currently evaluating
        the
        impact that the adoption of SAB 108 will have on its consolidated financial
        statements, if any.
 
 **4.**  **STOCK-BASED
        COMPENSATION**
  ***Adoption
        of New Accounting Pronouncement.*** Effective
        January 1, 2006, the Company adopted the provisions of SFAS No. 123(R), *Share-Based
        Payment,* and
        related interpretations (collectively, “SFAS No. 123(R)”) to account for
        stock-based compensation using the modified prospective transition method
        and
        therefore will not restate its prior period results. SFAS No. 123(R) supersedes
        Accounting Principles Board (“APB”) Opinion No. 25, *Accounting
        for Stock Issued to Employees* , ** and
        revises guidance in SFAS No. 123, *Accounting
        for Stock-Based Compensation* .
        SFAS
        No. 123(R) establishes accounting requirements for share-based compensation
        to
        employees and carries forward prior guidance on accounting for awards to
        non-employees. Specifically, SFAS No. 123(R) requires that compensation expense
        be recognized in the financial statements for share-based awards based on
        the
        grant date fair value of those awards. SFAS No. 123(R) also requires the
        benefits of tax deductions in excess of recognized compensation expense to
        be
        reported as a financing cash flow activity, rather than as an operating cash
        flow activity as previously required.
 
 The
        Company’s initial adoption of SFAS No. 123(R)’s fair value method on January 1,
        2006 did not have an impact on the Company’s results of operations or overall
        financial position. However, the future impact of the adoption of SFAS No.
        123(R) on the Company’s results of operations cannot be predicted at this time
        because it will depend on levels of future grants of share-based payments.
 
 Pursuant
        to SFAS No. 123(R)’s modified prospective transition method, the Company
        recognizes stock-based compensation expense based on the grant-date fair
        value
        of any new share-based awards granted subsequent to December 31, 2005 that
        are
        expected to vest. Compensation expense is recognized on a straight-line basis
        over the requisite service period, which is generally commensurate with the
        vesting term. Compensation expense is recognized immediately for share-based
        awards that are fully vested on the date of the grant. During the three months
        ended September 30, 2006, there was no compensation expense recognized in
        the
        Company’s financial statements related to share-based awards. For the nine
        months ended September 30, 2006, compensation expense recognized in the
        Company’s financial statements related to share-based awards totaled
        approximately $19,000. For the three months and nine months ended September
        30,
        2006, the Company did not record any excess tax benefits generated from stock
        option exercises because of the Company’s significant net operating loss
        carryforwards for Federal income tax purposes.
   Index
 7
 
 Prior
        to
        January 1, 2006, the Company accounted for its share-based payments to employees
        under the intrinsic value recognition and measurement principles of APB Opinion
        No. 25 and related interpretations, including FASB Interpretation No. 44, *Accounting
        for Certain Transactions Involving Stock Compensation, an interpretation
        of APB
        Opinion No. 25* .
        Accordingly, no stock-based employee compensation cost was reflected in the
        Company’s results of operations as all options granted under the Company’s stock
        options plans had an exercise price equal to the market value of the underlying
        common stock on the date of the grant. Prior to its adoption of SFAS 123(R),
        the
        Company followed the disclosure requirements of SFAS 148, *Accounting
        for Stock-Based Compensation - Transition and Disclosure, an amendment of
        FASB
        Statement No. 123* and
        accordingly provided pro forma disclosures of net income and net income per
        basic and diluted share as if the fair-value-based method had been applied
        to
        all outstanding and unvested awards for each period presented.
 
 The
        following table illustrates the effect on net income and net income per basic
        and diluted share as if the Company had applied the fair value recognition
        provisions of SFAS No. 123 to its stock-based employee compensation plans
        for
        the three months and nine months ended September 30, 2005 (in thousands,
        except
        per share data).
 
 **Three
                  months ended**
                **September
                  30, 2005**
              
              **Nine
                  months ended****September 30, 2005**Net
                  income, as reported
              
              $
              7,857
              
              $
              12,157Deduct:
                  Total stock-based employee
                compensation
                  expense determined under
                fair
                  value based method for all awards,
                net
                  of related tax effects
              
              
              (210
              )
              
              (916
              )Pro
                  forma net income
              
              $
              7,647
              
              $
              11,241Net
                  income per share:Basic
                  - as reported
              
              $
              0.18
              
              $
              0.28Diluted
                  - as reported
              
              $
              0.18
              
              $
              0.27Basic
                  - pro forma
              
              $
              0.18
              
              $
              0.26Diluted
                  - pro forma
              
              $
              0.17
              
              $
              0.25
 
 The
        Company uses the Black-Scholes option pricing model to determine the fair
        value
        of the Company’s share-based awards under SFAS No. 123 (R), which is the same
        valuation technique previously used for pro forma disclosures under SFAS
        No.
        123. The Black-Scholes option valuation model was developed for use in
        estimating the fair value of traded options which have no vesting restrictions
        and are fully transferable. In addition, option valuation models require
        the
        input of highly subjective assumptions including the expected stock price
        volatility. Because the Company’s employee stock options have characteristics
        significantly different from those of traded options, and because changes
        in the
        subjective input assumptions can materially affect the fair value estimate,
        in
        management’s opinion, the existing models do not necessarily provide a reliable
        single measure of the fair value of its employee stock options.
 
 The
        following table summarizes the assumptions used to compute the stock-based
        compensation expense and pro forma information for stock option grants issued
        during the three months ended September 30, 2005 and the nine months ended
        September 30, 2006 and 2005. (There were no stock option grants issued during
        the three months ended September 30, 2006.)
  Index
 8
  
 **Three
                  months ended**
                **September
                  30,**
              
              **Nine
                  months ended**
                **September
                  30,****2005**
              
              **2006**
              
              **2005**Dividend
                  yield
              
              
              0.0%
              
              
              0.0%
              
              
              0.0%Forfeiture
                  rate
              
              
              0.0%
              
              
              0.0%
              
              
              0.0%Expected
                  volatility
              
              
              41.6%
              
              
              40.6%
              
              
              42.5%Risk
                  free interest rate
              
              
              4.4%
              
              
              5.0%
              
              
              4.1%Expected
                  term, in years
              
              
              10.0
              
              
              5.0
              
              
              9.3
 
 Pursuant
        to the Company’s Credit Agreement (see Note 11), the Company is not permitted to
        pay any dividends and does not anticipate paying any cash dividends in the
        foreseeable future. Therefore, an expected dividend yield of zero is assumed
        for
        purposes of the Company’s Black Scholes calculations. Pre-vesting forfeiture
        rates are estimated based on the Company’s historical experience and
        expectations about future forfeitures. The
        Company has assumed a pre-vesting forfeiture rate of zero for the nine months
        ended September 30, 2006 because all options issued during this period were
        to
        members of the Company’s Board of Directors who have historically exercised
        their options prior to expiration. Expected
        price volatility is determined using a weighted average of daily historical
        volatility of the Company’s stock price over the corresponding expected option
        life. The average risk-free interest rate is determined using the Federal
        Reserve nominal rates in effect as of the date of grant for U.S. Treasury
        zero-coupon bonds with maturities similar to those of the expected term of
        the
        share-based award being valued. The expected term of stock options is determined
        using historical data.
 
 The
        weighted average grant date fair value of options granted during the nine
        months
        ended September 30, 2006 was $1.59 per option. The weighted average grant
        date
        fair value of options granted during the three months and nine months ended
        September 30, 2005 was $2.19 and $2.09 per option, respectively.
 
 ***Stock-Based
        Employee Compensation Plans*** .
        At
        September 30, 2006, the Company has two stock-based employee compensation
        plans:
        the 1992 Stock Option Plan (the “1992 Plan”) and the 1999 Stock Option Plan (the
“1999 Plan”).
 
 The
        1992
        Plan was adopted on April 28, 1992 and, as amended, authorized the issuance
        of
        up to 4,800,000 shares of common stock to certain employees, consultants
        and
        directors of the Company under incentive and/or nonqualified options and/or
        alternate rights. An alternate right is defined as the right to receive an
        amount of cash or shares of stock having an aggregate market value equal
        to the
        appreciation in the market value of a stated number of shares of the Company’s
        common stock from the alternate right grant date to the exercise date. Options
        and/or rights under the 1992 Plan were granted through April 27, 2002 at
        prices not less than 100 percent of the market value at the date of grant.
        Options and/or rights become exercisable based upon a vesting schedule
        determined by the 1992 Plan Committee and become fully exercisable upon a
        change
        in control, as defined. Options expire not more than ten years from the date
        of
        grant and alternate rights expire at the discretion of the 1992 Plan Committee.
        At September 30, 2006, currently exercisable options for 821,806 shares were
        outstanding under the 1992 Plan. There were no alternate rights issued under
        the
        1992 Plan. The expiration of the 1992 Plan on April 27, 2002 does not affect
        options currently outstanding.
 
 The
        1999
        Plan was approved by the shareholders on May 27, 1999, and as amended on
        May 19,
        2004, authorizes the issuance of up to 5,345,000 shares of common stock to
        certain employees, consultants and directors of the Company under incentive
        and/or nonqualified options, stock appreciation rights (“SARs”) and other stock
        awards (collectively, “Stock Awards”). Stock Awards under the 1999 Plan may be
        granted at prices not less than 100 percent of the market value at the date
        of
        grant. Options and/or SARs become exercisable based upon a vesting schedule
        determined by the 1999 Plan Committee and become fully exercisable upon a
        change
        in control, as defined. Options expire not more than ten years from the date
        of
        grant and SARs and other stock awards expire at the discretion of the 1999
        Plan
        Committee. The 1999 Plan is unlimited in duration. At September 30, 2006,
        currently exercisable options for 3,208,750 shares were outstanding under
        the
        1999 Plan.
   Index
 9
 
 On
        December 20, 2005, the Company accelerated the vesting of all unvested stock
        options previously awarded to the Company’s employees. The primary purpose of
        the accelerated vesting was to eliminate future compensation expense of
        approximately $1.6 million that the Company would have otherwise recognized
        in
        its consolidated statement of operations with respect to these options upon
        the
        adoption of SFAS 123(R) on January 1, 2006. As a result of this action, options
        to purchase approximately 950,000 shares of the Company’s common stock at
        exercise prices ranging from $1.90 to $4.72 per share and having a weighted
        average exercise price of $3.96 per share became exercisable immediately.
        The
        exercise prices and number of shares subject to the accelerated options were
        unchanged.
 
 A
        summary
        of option activity during the nine months ended September 30, 2006 is as
        follows:
 
 **Shares**
              
              **Weighted
                  Average**
                **Exercise
                  Price**Outstanding
                  - December 31, 2005
              
              
              4,144,306
              
              $
              2.96Granted
              
              
              17,000
              
              
              3.57Exercised
              
              
              (60,750
              )
              
              1.11Canceled
              
              
              (70,000
              )
              
              4.03Outstanding
                  - September 30, 2006
              
              
              4,030,556
              
              $
              2.97
 
 At
        September 30, 2006 and December 31, 2005, exercisable options under the
        Company’s stock option plans were 4,030,556 and 4,144,306, respectively, at
        weighted average exercise prices of $2.97 and $2.96, respectively. At September
        30, 2006, there were 1,571,100 shares available for future grants under the
        Company’s stock option plans.
  The
        following table summarizes information pertaining to options outstanding
        and
        exercisable at September 30, 2006:
 
 **Range
                  of**
                **Exercise**
                **Prices**
              
              **Number**
                **Outstanding**
              
              **Average**
                **Remaining**
                **Contractual**
                **Life
                  (Years)**
              
              **Weighted**
                **Average**
                **Exercise**
                **Price**
              
              **Number**
                **Exercisable**
              
              **Weighted**
                **Average**
                **Exercise**
                **Price**$0.72
                  - $1.50
              
              470,011
              
              4.5
              
              $
                  1.33
              
              470,011
              
              $
                  1.33$1.66
                  - $2.28
              
              1,280,081
              
              4.8
              
              1.96
              
              1,280,081
              
              1.96$2.35
                  - $3.59
              
              649,464
              
              4.9
              
              2.98
              
              649,464
              
              2.98$3.60
                  - $3.99
              
              816,500
              
              7.6
              
              3.72
              
              816,500
              
              3.72$4.00
                  - $5.02
              
              814,500
              
              7.1
              
              4.77
              
              814,500
              
              4.774,030,556
              
              5.8
              
              $
                  2.97
              
              4,030,556
              
              $
                  2.97
 
 The
        aggregate intrinsic value of options outstanding and exercisable was
        approximately $3.3 million at September 30, 2006. There were no options
        exercised during the three months ended September 30, 2006. The total intrinsic
        value of options exercised during the nine months ended September 30, 2006,
        determined as of the date of exercise, was $152,000. Cash received from option
        exercises during the nine months ended September 30, 2006 totaled
        $68,000.
 
 ***Employee
        Stock Purchase Plan*** .
        In
        March 1999, the Company adopted an Employee Stock Purchase Plan (the “1999
        ESPP”) which authorizes the issuance of up to 700,000 shares of common stock.
        Under the 1999 ESPP, eligible employees may contribute up to ten percent
        of
        their compensation toward the purchase of common stock at each year-end.
        The
        employee purchase price is derived from a formula based on fair market value
        of
        the Company’s common stock. Compensation cost associated with the rights granted
        under the 1999 ESPP is estimated based on fair market value. At September
        30,
        2006 and December 31, 2005, there were 182,143 shares available for future
        issuance under the 1999 ESPP.
   Index
 10
  **5.**  **STOCK
        REPURCHASE PROGRAM**
  In
        August
        2006, the Board of Directors amended the Company’s existing stock repurchase
        program to authorize the repurchase of an aggregate of 4.0 million shares
        over
        an indefinite period, including approximately 1.7 million shares previously
        repurchased under the program. During the three months and nine months ended
        September 30, 2006, the Company repurchased 315,000 and 550,241 shares under
        this program for approximately $1.1 million and $2.0 million, respectively,
        at
        average repurchase prices of approximately $3.55 and $3.64 per share in the
        three month and nine month period, respectively. There were no shares
        repurchased under this program during the three months and nine months ended
        September 30, 2005. As of September 30, 2006, the Company had repurchased
        approximately 1.9 million shares for an aggregate repurchase price of
        approximately $4.8 million.
  **6.**  **ACQUISITION**
  Effective
        March 1, 2006, Microtek acquired KMMS Holdings, Ltd. and its European
        manufacturing and distribution operations (collectively, “Samco”) for
        approximately $2.3 million in cash, including acquisition costs. Based on
        estimated fair values and other information currently available, the preliminary
        allocation of the total purchase price is summarized as follows (in thousands):
 
 Purchase
                  consideration in cash
              
              
              
              
              $
              2,346Allocated
                  to:Accounts
                  receivable
              
              $
              341Inventories
              
              
              774Property
                  and equipment
              
              
              269Accounts
                  payable and other accrued liabilities
              
              
              (615
              )Total
                  allocation
              
              
              
              
              
              769Other
                  intangible assets and goodwill
              
              
              
              
              $
              1,577
 
 Effective
        July 1, 2006, Microtek acquired substantially all of the assets of Ceres
        Medical, LLC (Ceres Medical), a
        marketer of a small line of products sold primarily to cardiology and
        interventional radiology specialties. The
        purchase price of approximately $483,000 in cash, including certain acquisition
        costs, has been preliminarily allocated to the assets and liabilities acquired,
        primarily accounts receivable, inventories, property and equipment, identifiable
        intangibles and trade accounts payable, based on the respective estimated
        fair
        values of those assets and liabilities, with the excess allocated to goodwill.
        The terms of the related purchase agreement also provide for additional cash
        consideration up to $550,000 if future contribution margins from the acquired
        product line exceed certain levels, as defined in the agreement, through
        2011.
        The additional consideration will be recorded when it is determinable that
        the
        payment of such amounts is probable and is expected to result in additional
        goodwill.
 
 The
        Company is currently evaluating the fair value of the assets acquired in
        the
        Samco and Ceres Medical acquisitions, principally other identifiable intangible
        assets and goodwill. The preliminary allocations of the total purchase price
        for
        each of these acquisitions are subject to revision based on the final
        determination of these fair values.
 
 The
        Samco
        and Ceres Medical acquisitions were accounted for as a business combination
        pursuant to SFAS No. 141, *Business
        Combinations* .
        Accordingly, results of operations for Samco and Ceres Medical are reflected
        in
        the Company’s unaudited condensed consolidated financial statements from the
        acquisition date. The following unaudited pro forma financial information
        for
        the three months and nine months ended September 30, 2006 and 2005 reflects
        the
        Company’s results of operations as if the Samco and Ceres Medical acquisitions
        had been completed on January 1, 2005 (in thousands, except per share
        data):
  Index
 11
  
 
 **Three
                  months ended**
                **September
                  30,**
              
              **Nine
                  months ended**
                **September
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Net
                  revenues
              
              $
              35,108
              
              $
              34,433
              
              $
              105,675
              
              $
              104,573Net
                  income
              
              $
              1,648
              
              $
              7,957
              
              $
              6,118
              
              $
              12,455Net
                  income per share - basic and diluted
              
              $
              0.04
              
              $
              0.18
              
              $
              0.14
              
              $
              0.29Net
                  income per share - diluted
              
              $
              0.04
              
              $
              0.18
              
              $
              0.14
              
              $
              0.28
 
 The
        pro
        forma financial information above is based on estimates and assumptions which
        management believes are reasonable. However, the pro forma results are not
        necessarily indicative of the operating results that would have occurred
        had the
        Samco and Ceres Medical acquisitions been consummated as of the dates indicated,
        nor are they necessarily indicative of future operating results.
 
 **7.**  **LICENSE
        AGREEMENT**
 
 In
        September 2004, the Company entered into an agreement (the “License Agreement”)
        which grants to Eastern Technologies, Inc. (“ETI”) a worldwide exclusive license
        to manufacture, use and sell the Company’s OREX materials and processing
        technology in the nuclear industry and homeland security industry, and for
        certain other industrial applications. Under the terms of the License Agreement,
        the Company will receive license royalties equal to $75,000 per quarter for
        the
        first three years of the agreement. Thereafter and generally until the
        expiration of the underlying patents related to the products or services
        generating the subject royalties, the Company will receive license royalties
        equal to the greater of: (i) generally 5% of net sales, as defined in the
        agreement, or (ii) $300,000 per year. The royalty rate is subject to downward
        adjustment in certain events with respect to net sales of certain products.
        The
        Company also entered into an exclusive three-year supply agreement (the “Supply
        Agreement”) under which the Company has agreed to provide certain sourcing and
        supply chain management services to ETI, and ETI has agreed to purchase a
        total
        of approximately $4.8 million of inventory over the term of the Supply
        Agreement. For these services, the Company will receive management fees totaling
        $2.7 million, $600,000 of which was received at the signing of the Supply
        Agreement. The balance of the management fees are payable in quarterly
        installments of $175,000 beginning December 31, 2004 and at the end of each
        quarter thereafter until September 30, 2007. The cash payment of $600,000
        was
        recorded as deferred revenue (included in accrued expenses, a current liability)
        upon receipt. This amount, together with all future management fees collected
        from ETI, will be recognized into income ratably over the term of the Supply
        Agreement as nuclear finished goods inventories on hand are sold to ETI.
        At
        September 30, 2006 and December 31, 2005, amounts recognized into income
        exceeded cash receipts from ETI by approximately $417,000 and $618,000,
        respectively, which amounts were recorded in the accompanying
        unaudited condensed consolidated balance sheet in
        prepaid expenses and other current assets.
 
 **8.**  **SALE
        OF INVENTORIES TO RELATED PARTY**
 
 In
        September 2004, the Company entered into an agreement with Global Resources
        International, Inc. (“GRI”), a related party as described in Note 9 below, for
        the sale of certain of its raw material inventories used in the manufacture
        of
        finished goods for sale to the nuclear industry. At closing, the Company
        received cash proceeds of $200,000 and a promissory note in the amount of
        $1.051
        million. The promissory note, including interest at 5%, was repaid ratably
        as
        the raw material inventories purchased by GRI in the transaction were consumed
        by GRI. The final note payment was received in August 2006. The total gain
        on
        the sale of these raw material inventories approximated $467,000. Of this
        total
        gain, approximately $91,000, an amount commensurate with the Company’s relative
        ownership interest in GRI, was deferred and recognized into income as the
        raw
        material inventories purchased by GRI in the transaction were sold by GRI.
        Approximately $37,000 and $63,000 of this deferred gain was recognized into
        income during the three months and nine months ended September 30, 2005.
        During
        the three months and nine months ended September 30, 2006, approximately
        $11,000
        and $13,000 of this deferred gain was recognized into income. At September
        30,
        2006, all of the deferred gain on this transaction has been recognized into
        income.
   Index
 12
  **9.**  **INVESTMENT
        IN AFFILIATED COMPANY**
 
 In
        May
        2000, the Company and certain of its affiliates and employees organized GRI.
        From its manufacturing facilities located in China, GRI provides certain
        material sourcing and manufacturing of various Microtek’s products where such
        supply arrangements are advantageous to Microtek based on favorable pricing
        and
        other considerations. The Company and a non-executive member of the Company’s
        management own 19.5 percent and 30 percent, respectively, of GRI. Accordingly,
        the Company accounts for its investment in GRI under the equity method. The
        Company’s investment in GRI was approximately $705,000 and $502,000 at September
        30, 2006 and December 31, 2005, respectively. The Company recorded $80,000
        and
        $203,000 of income during the three months and nine months ended September
        30,
        2006, respectively, and $64,000 and $199,000 of income during the three months
        and nine months ended September 30, 2005, respectively, related to this
        investment.
 
 **10.**  **INVENTORIES**
 
 Inventories
        are stated at the lower of cost or market. The first-in first-out (“FIFO”)
        valuation method is used to determine the cost of inventories. Cost includes
        material, labor and manufacturing overhead for manufactured and assembled
        goods
        and materials only for goods purchased for resale. Inventories are summarized
        by
        major classification at September 30, 2006 and December 31, 2005 as follows
        (in
        thousands):
 
 **September
                  30, 2006**
              
              **December
                  31, 2005**Raw
                  materials
              
              $
              14,470
              
              $
              12,381Work-in-progress
              
              
              2,216
              
              
              1,716Finished
                  goods
              
              
              20,206
              
              
              16,946Total
                  inventories
              
              $
              36,892
              
              $
              31,043
 
 At September
        30, 2006 and December 31, 2005, OREX inventories approximated $468 thousand
        and
        $1.0 million, respectively, and consisted primarily of finished goods.
 
 **11.**  **LONG-TERM
        DEBT**
 
 *The
        Credit Agreement.* The
        Company maintains a credit agreement with a Bank (the “Credit Agreement”). As
        amended to date, the Credit Agreement provides for a $23.5 million revolving
        credit facility, which matures on June 30, 2008. Borrowing availability under
        the revolving credit facility is based on the lesser of (i) a percentage
        of
        eligible accounts receivable and inventory or (ii) $23.5 million, less any
        outstanding letters of credit issued under the Credit Agreement. Revolving
        credit borrowings bear interest at a floating rate approximating the Bank’s
        prime rate plus an interest margin (8.5% at September 30, 2006). Borrowing
        availability under the revolving facility at September 30, 2006 and December
        31,
        2005 totaled $17.1 million and $15.4 million, respectively. There were no
        outstanding borrowings under the revolving credit facility as of September
        30,
        2006. Outstanding borrowings under the revolving credit facility totaled
        $1.2
        million at December 31, 2005. Borrowings under the Credit Agreement are
        collateralized by the Company’s accounts receivable, inventory, equipment, the
        Company’s stock of its subsidiaries and certain of the Company’s plants and
        offices.
 
 The
        Credit Agreement contains certain restrictive covenants, including the
        maintenance of certain financial ratios, and places limitations on acquisitions,
        dispositions, capital expenditures and additional indebtedness. In addition,
        the
        Company is not permitted to pay any dividends. At
        September 30, 2006 and December 31, 2005, the Company was in compliance with
        its
        financial covenants under the Credit Agreement.
 
 The
        Credit Agreement provides for the issuance of up to $1.0 million in letters
        of
        credit. There were no outstanding letters of credit at September 30, 2006
        or
        December 31, 2005. The Credit Agreement also provides for a fee of 0.3% per
        annum on the unused commitment, an annual collateral monitoring fee of $35,000
        and an outstanding letter of credit fee of 2.0% per annum.
   Index
 13
 
 *Other
        Long-Term Debt.* The
        Company is obligated under certain long-term lease arrangements and notes
        payable which aggregated $22,000 and $145,000 at September 30, 2006 and December
        31, 2005, respectively. In addition, in conjunction with the acquisition
        of
        substantially all of the assets of Plasco, Inc. in November 2003, the Company
        signed a promissory note in the original principal amount of $1.1 million.
        This
        principal amount was reduced in December 2003 to $866,000 as a result of
        adjustments made to the original purchase price. This note payable, as adjusted,
        bears interest at 6%, is payable in quarterly installments of principal and
        interest beginning in March 2004 through October 2006, and amounted to $73,000
        and $293,000 at September 30, 2006 and December 31, 2005, respectively. This
        note payable arrangement is subordinated to the Credit Agreement.
 
 The
        carrying value of long-term debt at September 30, 2006 and December 31, 2005
        approximates fair value based on interest rates that are believed to be
        available to the Company for debt with similar prepayment provisions provided
        for in the existing debt agreements.
 
 **12.**  **EARNINGS
        PER SHARE**
  Earnings
        per share is calculated in accordance with SFAS No. 128, *Earnings
        Per Share* ,
        which
        requires dual presentation of basic and diluted earnings per share on the
        face
        of the income statement for all entities with complex capital structures. Basic
        per
        share income is computed using the weighted average number of common shares
        outstanding for the period. Diluted per share income is computed including
        the
        dilutive effect of all contingently issuable shares. Dilutive potential common shares are calculated
        in
        accordance with the treasury stock method, which assumes that proceeds from
        the
        exercise of all options are used to repurchase common shares at market value.
        The number of shares remaining after the exercise proceeds are exhausted
        represents the potentially dilutive effect of the options. The following
        table
        reflects the weighted average number of shares used to calculate basic and
        diluted earnings per share for the periods presented (in
        thousands):
 
 **Three
                  months ended September 30,**
              
              **Nine
                  months ended****September
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Basic
                  Shares
              
              
              43,434
              
              
              43,369
              
              
              43,581
              
              
              43,305Dilutive
                  Shares (due to stock options)
              
              
              997
              
              
              1,194
              
              
              993
              
              
              1,174Diluted
                  Shares
              
              
              44,431
              
              
              44,563
              
              
              44,574
              
              
              44,479
 
 For
        the
        three months and nine months ended September 30, 2006, options to purchase
        approximately 1.6 million shares were not included in the computation of
        diluted
        net income per share because the exercise price of the options was greater
        than
        the average market price of the common shares, and therefore, the effect
        would
        be antidilutive. For the three months and nine months ended September 30,
        2005,
        there were 1.0 million and 1.1 million antidilutive shares,
        respectively.
 
 **13.**
              **GEOGRAPHIC
                  CONCENTRATIONS**
  A
        significant portion of the Company’s products are manufactured at its facilities
        in the Dominican Republic, Mexico, the Netherlands and Malta or at GRI’s
        facilities in China. Included in the Company’s consolidated balance sheet at
        September 30, 2006 and December 31, 2005 are the net assets of the Company’s
        sales, manufacturing and distribution facilities located in the United Kingdom
        and the Dominican Republic which totaled $18.1 million and $17.4 million,
        respectively. Additionally, at September 30, 2006 and December 31, 2005,
        the net
        assets of the Company’s sales, manufacturing and distribution operations in the
        Netherlands, Malta and Germany totaled $16.5 million and $13.2 million,
        respectively. The Company’s Dominican Republic and Mexico facilities are engaged
        in manufacturing operations only and do not sell products to external customers.
        Total international sales by the Company were $8.9 million and $27.4 million
        for
        the three months and nine months ended September 30, 2006, respectively,
        and
        $7.9 million and $25.2 million for the three months and nine months ended
        September 30, 2005, respectively.
  The
        Company’s operations are subject to various political, economic and other risks
        and uncertainties inherent in the countries in which the Company operates.
        Among
        other risks, the Company’s operations are subject to the risks of restrictions
        on transfer of funds; export duties, quotas, and embargoes; domestic and
        international customs and tariffs; changing taxation policies; foreign exchange
        restrictions; and political conditions and governmental
        regulations.
  Index
 14
 **14.**  **COMMITMENTS
        AND CONTINGENCIES**
 
 The
        Company is involved in routine litigation and proceedings in the ordinary
        course
        of business. Management believes that pending litigation matters will not
        have a
        material adverse effect on the Company’s consolidated financial position or
        results of operations.
 
 **15.**  **SUBSEQUENT
        EVENT**
 
 Effective
        October 2, 2006, Microtek acquired Europlak, a surgeon-owned marketer of
        minimally invasive surgical products and devices primarily in urology,
        gastroenterology and related surgical specialties in France. The initial
        purchase price of approximately $6.4 million in cash, including certain
        acquisition costs, is expected to be allocated to the assets and liabilities
        acquired, primarily accounts receivable, inventories, identifiable intangibles
        and accounts payable, based on the respective estimated fair values of those
        assets and liabilities, with the excess allocated to goodwill. The terms
        of the
        related purchase agreement also provide for additional cash consideration
        up to
        approximately $12.4 million through 2021 if certain revenue hurdles, as defined
        in the agreement, are achieved. The additional consideration will be recorded
        when it is determinable that the payment of such amounts is probable and
        is
        expected to result in additional goodwill.
 
 **Item
        2. Management’s Discussion and Analysis of Financial Condition and
        Results of Operations**
 
 **General**
 
 The
        Company conducts substantially all of its operations through its subsidiary,
        Microtek Medical, Inc. (“Microtek”). OREX Technologies International (“OTI”), a
        division of the Company, focused on the commercialization of the Company's
        OREX
        degradable products and disposal technologies to the nuclear power generating
        industry until this business was licensed to a third party in September
        2004.
 
 Microtek,
        a market leading healthcare company within its area of focus, manufactures
        and
        sells infection control products, fluid control products, safety products
        and
        other products to healthcare professionals for use in environments such as
        operating rooms and ambulatory surgical centers. Microtek's core product
        line
        consists of a large variety of disposable equipment drapes and specialty
        patient
        drapes. Microtek has established a broad distribution system through multiple
        channels including distributors, directly through its own sales force, original
        equipment manufacturers, and private label customers. Additionally, Microtek
        has
        a strong presence as a branded component supplier to custom procedure tray
        companies. Through its acquisition of certain businesses of International
        Medical Products, B.V. and affiliates (collectively, “IMP”) on May 28, 2004,
        Microtek added to its operations the development, manufacture, marketing
        and
        distribution in Europe of high quality dip-molded medical devices (primarily
        ultrasound probe covers), other equipment covers, cardiac thoracic drain
        systems, gynecological devices and wound care products. Microtek’s acquisition
        in March 2006 of the European manufacturing and distribution operations of
        Samco
        added additional European manufacturing capacity, primarily in Malta, and
        an
        expanded sales presence in Germany. In July 2006, Microtek acquired Ceres
        Medical, a marketer of a small line of products sold primarily to cardiology
        and
        interventional radiology specialties within the U.S. On October 2, 2006,
        Microtek acquired Europlak, a marketer of minimally invasive surgical products
        and devices primarily to urology, gastroenterology and related surgical
        specialties. The Europlak acquisition is not reflected in the Company’s
        financial condition or results of operations as of and for the three months
        and
        nine months ending September 30, 2006, because the acquisition occurred
        subsequently.
 
 OTI’s
        most recent efforts have focused primarily on the commercialization of its
        OREX
        degradable products and technology for disposing of such products in the
        nuclear
        power generating industry. In September 2004, the Company entered into an
        agreement (the “License Agreement”) which grants to Eastern Technologies, Inc.
        (“ETI”) a worldwide exclusive license to manufacture, use and sell the Company’s
        OREX materials and processing technology in the nuclear industry and the
        homeland security industry and for certain other industrial applications.
        Concurrent with the signing of the License Agreement, the Company also entered
        into an exclusive three-year supply agreement (the “Supply Agreement”) under
        which the Company has agreed to provide certain sourcing and supply chain
        management services and to sell a total of approximately $4.8 million of
        inventory to ETI over the term of the Supply Agreement.
   Index
 15
 
 The
        Company provides healthcare professionals with innovative product solutions
        that
        encompass a high level of patient care and prevention of cross infection.
        The
        Company intends to maintain this business by continually improving its existing
        capabilities and simultaneously developing and acquiring new business
        opportunities while maintaining its customer focus and providing the highest
        levels of customer support. The Company seeks to increase sales and earnings
        from its infection control business by completing strategic acquisitions,
        enhancing marketing and distribution efforts both domestically and
        internationally, introducing new products, increasing direct sales
        representation, employing tele-sales agents for added sales coverage, and
        capitalizing on low-cost manufacturing opportunities primarily in the Dominican
        Republic and China.
 
 **Results
        of Operations**
 
 The
        following tables set forth certain unaudited income statement data, including
        amounts expressed as a percentage of net revenues, for the three months and
        six
        months ended September 30, 2006 and 2005 (in thousands):
 
 **Three
                  months ended**
                **September
                  30, 2006**
              
              **Three
                  months ended**
                **September
                  30, 2005****Amount
                  ($)**
              
              **%
                  of Net Revenues**
              
              **Amount
                  ($)**
              
              **%
                  of Net Revenues**Net
                  revenues
              
              $
              35,108
              
              
              100.0
              %
              $
              33,487
              
              
              100.0
              %Gross
                  profit
              
              
              13,740
              
              
              39.1
              %
              
              11,945
              
              
              35.7
              %Selling,
                  general and administrative expenses
              
              
              10,782
              
              
              30.7
              %
              
              10,014
              
              
              29.9
              %Income
                  from operations
              
              
              2,545
              
              
              7.2
              %
              
              1,533
              
              
              4.6
              %Net
                  income
              
              
              1,648
              
              
              4.7
              %
              
              7,857
              
              
              23.5
              %
 
 **Nine
                  months ended**
                **September
                  30, 2006**
              
              **Nine
                  months ended**
                **September
                  30, 2005****Amount
                  ($)**
              
              **%
                  of Net Revenues**
              
              **Amount
                  ($)**
              
              **%
                  of Net Revenues**Net
                  revenues
              
              $
              104,849
              
              
              100.0
              %
              $
              101,736
              
              
              100.0
              %Gross
                  profit
              
              
              41,450
              
              
              39.5
              %
              
              39,163
              
              
              38.5
              %Selling,
                  general and administrative expenses
              
              
              31,324
              
              
              29.9
              %
              
              30,947
              
              
              30.4
              %Income
                  from operations
              
              
              8,956
              
              
              8.5
              %
              
              6,708
              
              
              6.6
              %Net
                  income
              
              
              6,053
              
              
              5.8
              %
              
              12,157
              
              
              11.9
              %
 
 **Three
        and Nine Months Ended September 30, 2006 Compared to Three and Nine Months
        Ended
        September 30, 2005**
 
 **Net
        Revenues.** Consolidated net revenues for the three months and nine months ended September
        30, 2006 (the “2006 Quarter” and the “2006 Period”, respectively) of $35.1
        million and $104.8 million, respectively, increased by approximately $1.6
        million, or 4.8 percent, and $3.1 million, or 3.1 percent, over consolidated
        net
        revenues of $33.5 million reported for the three months ended September 30,
        2005
        (the “2005 Quarter”) and $101.7 million reported for the nine months ended
        September 30, 2005 (the “2005 Period”). For the 2006 Quarter and 2006 Period,
        Microtek’s net revenues totaled $34.7 million and $103.8 million, respectively,
        up from $32.5 million and $97.8 million in the respective 2005 quarter and
        year-to-date periods. Excluding revenue contribution from the Samco transaction
        (which was approximately $740 thousand in the 2006 Quarter and $2.2 million
        in
        the 2006 Period) and from the Ceres Medical transaction (which was approximately
        $110 thousand in the 2006 Quarter and 2006 Period), Microtek’s net revenues
        increased approximately $1.3 million and $3.8 million, respectively,
        representing growth of approximately 4.1 percent and 3.8 percent over the
        2005
        Quarter and 2005 Period, respectively.
   Index
 16
 
 The
        following tables depict Microtek’s domestic and international revenues and the
        relative percentage of each to Microtek’s total revenues for the 2006 Quarter
        and 2005 Quarter and for the 2006 Period and 2005 Period (in
        millions):
 
 **Three
                  months ended**
                **September
                  30, 2006**
              
              **Three
                  months ended**
                **September
                  30, 2005********Amount**
              
              ******%
                  of Total**
              
              ******Amount**
              
              ******%
                  of Total**Domestic
              
              $
              25.8
              
              
              74.4
              %
              $
              24.6
              
              
              75.7
              %International
              
              
              8.9
              
              
              25.6
              %
              
              7.9
              
              
              24.3
              %Total
              
              $
              34.7
              
              
              100.0
              %
              $
              32.5
              
              
              100.0
              %
 
 
 **Nine
                  months ended**
                **September
                  30, 2006**
              
              **Nine
                  months ended**
                **September
                  30, 2005********Amount**
              
              ******%
                  of Total**
              
              ******Amount**
              
              ******%
                  of Total**Domestic
              
              $
              76.4
              
              
              73.6
              %
              $
              72.6
              
              
              74.2
              %International
              
              
              27.4
              
              
              26.4
              %
              
              25.2
              
              
              25.8
              %Total
              
              $
              103.8
              
              
              100.0
              %
              $
              97.8
              
              
              100.0
              %
 
 Microtek’s
        domestic revenues are generated through two primary channels or customer
        categories: domestic branded and contract manufacturing (commonly referred
        to as
        OEM). Domestic branded revenues were 68.3 percent and OEM revenues were 31.7
        percent of total domestic revenues in the 2006 Quarter, as compared to 65.0
        percent and 35.0 percent, respectively, in the 2005 Quarter. For the 2006
        Period, domestic branded revenues were 65.3 percent and OEM revenues were
        34.7
        percent of total domestic revenues, as compared to 64.7 percent and 35.3
        percent, respectively, in the 2005 Period. Included in the Company’s OEM
        revenues are sales of products to “non-branded” or private label customers.
 
 Domestic
        branded revenues in the 2006 Quarter and 2006 Period increased by $1.6 million
        (or 10.2 percent) and $3.0 million (or 6.4 percent), respectively, as compared
        to the 2005 Quarter and 2005 Period. These increases are primarily the result
        of
        a $983 thousand, or 11.4 percent, increase in specialty product revenues
        (which
        includes Microtek’s CleanOp product sales and its specialty procedure patient
        drapes) in the 2006 Quarter and a $2.3 million, or 9.3 percent, increase
        in
        specialty product revenues in the 2006 Period. For the 2006 Quarter and 2006
        Period, OEM revenues decreased by $431 thousand, (or 5.0 percent) and increased
        by $876 thousand (or 3.4 percent), respectively. OEM revenues can be volatile
        as
        they are heavily dependent on the buying patterns of the Company’s OEM partners.
        The Company’s private label revenues in the 2006 Quarter were essentially the
        same at the 2005 Quarter but for the 2006 Period demonstrated growth over
        the
        2005 Period of $2.2 million, or 13.3 percent. Woundcare and triad product
        revenues demonstrated decreases in the 2006 Quarter and 2006 Period, as compared
        to the 2005 Quarter and 2005 Period, as a result of a customer’s decision to
        move the manufacture of certain of these products in-house. Overall, Microtek’s
        total domestic revenues in the 2006 Quarter and 2006 Period increased by
        approximately $1.2 million, or 4.9 percent, and $3.8 million, or 5.3 percent,
        from the 2005 Quarter and 2005 Period, respectively.
 
 Microtek’s
        international net revenues for the 2006 Quarter and 2006 Period increased
        by
        approximately $1 million, or 12.4 percent, over the 2005 Quarter and by
        approximately $2.2 million, or 8.7 percent, over the 2005 Period to $8.9
        million
        and $27.4 million, respectively, primarily as a result of the revenues related
        to the March 2006 acquisition of Samco.
 
 OTI’s
        net
        revenues, consisting primarily of sales of finished goods inventories to
        ETI and
        royalties under the license agreement of $75 thousand per quarter, totaled
        $421
        thousand and $1.0 million in the 2006 Quarter and 2006 Period, respectively,
        as
        compared to $1.0 million and $3.9 million in the 2005 Quarter and 2005 Period,
        respectively. The decreases in OTI’s net revenues of $560 thousand and $2.9
        million in the 2006 Quarter and 2006 Period, respectively, relate to the
        anticipated slowing of sales to ETI as the Company’s finished goods inventories
        have been depleted since the inception of the license agreement. As a result
        of
        the September 2004 licensing transaction, the Company expects that future
        OTI
        division revenues will consist of license royalties totaling $75 thousand
        per
        quarter through September 2007 and sales of finished goods inventories to
        ETI,
        including a pro rata share of management fee income, aggregating approximately
        $7.5 million over the three-year term of the Supply Agreement.
   Index
 17
 
 **Gross
        Margin.** The
        Company’s consolidated gross profit was $13.7 million, or 39.1 percent of net
        revenues, in the 2006 Quarter, as compared to $11.9 million, or 35.7 percent
        of
        net revenues, for the 2005 Quarter. For the 2006 Period, the Company’s
        consolidated gross profit was $41.5 million, or 39.5 percent of net revenues,
        versus $39.2 million, or 38.5 percent of net revenues for the 2005 Period.
        The
        Company attributes the improvement in its gross margins in the 2006 Quarter
        and
        2006 Period to improved productivity and cost control and other manufacturing
        process improvements which have helped mitigate the impacts of changes in
        the
        Company’s sales mix and rising prices for fuel and other petroleum-based
        products which result in increases in raw material and freight costs.
        Additionally, the stabilization of the Dominican peso versus the U.S. dollar
        in
        2006 has eliminated significant cost pressures experienced in 2005 which
        increased certain expenses associated with the Company’s manufacturing
        operations in the Dominican Republic.
 
 **Operating
        Expenses.** Consolidated operating expenses for the 2006 Quarter and the 2006 Period
        of
        $11.2 million and $32.5 million, respectively, represented 31.9 percent and
        31.0
        percent of net revenues, respectively, as compared to consolidated operating
        expenses of $10.4 million (31.1 percent of net revenues) and $32.3 million
        (31.8
        percent of net revenues) in the 2005 Quarter and 2005 Period, respectively.
 
 Consolidated
        selling, general and administrative (“SG&A”) expenses in the 2006 Quarter
        and 2006 Period were $10.8 million and $31.3 million, respectively, as compared
        to $10.0 million in the 2005 Quarter and $30.9 million in the 2005 Period.
        As a
        percentage of net revenues, the Company’s consolidated SG&A expenses were
        30.7 percent in the 2006 Quarter and 29.9 percent in the 2006 Period, as
        compared to 29.9 percent and 30.4 percent in the 2005 Quarter and 2005 Period,
        respectively.
 
 Microtek’s
        total SG&A expenses increased by $905 thousand and $548 thousand in the 2006
        Quarter and 2006 Period, respectively, versus the comparable 2005 periods.
        For
        the 2006 Quarter, Microtek’s domestic SG&A expenses increased $208 thousand
        as a result of a $312 thousand increase in general and administrative expenses
        (primarily salaries and benefits) and an offsetting $88 thousand decrease
        in
        sales and marketing expenses. For the 2006 Period, domestic SG&A expenses
        decreased approximately $1.0 million as a result of the second quarter 2005
        closure of the Company’s Gurnee, Illinois facilities (which resulted in savings
        of approximately $854 thousand in the 2006 Period) and from the 2005 realignment
        of the Company’s domestic branded sales and marketing force, net of increased
        selling costs associated with the Company’s increased revenues (which resulted
        in a net decrease in sales and marketing expenses of approximately $940 thousand
        for the 2006 Period). Offsetting these sales and marketing expense savings
        were
        increases in distribution and general and administrative expenses (primarily
        variable distribution freight, general and administrative salaries and benefits
        and professional fees) of $82 thousand and $679 thousand, respectively.
 
 For
        the
        2006 Quarter and 2006 Period, SG&A expenses of the Company’s Netherlands,
        Malta and Germany operations increased approximately $697 thousand and $1.6
        million, respectively, primarily as a result of additional investments in
        the
        Company’s sales, marketing and administrative infrastructure in the Netherlands
        during 2006, restructuring charges of approximately $450 thousand related
        to the
        Company’s plans to move certain of its manufacturing operations from the
        Netherlands to Malta and to China, and SG&A expenses in the 2006 Quarter and
        2006 Period of approximately $161 thousand and $594 thousand, respectively,
        related to the Samco businesses which were acquired in March 2006.
 
 SG&A
        expenses of the Company’s OTI division, consisting primarily of franchise taxes
        and miscellaneous administrative costs, totaled $30 thousand and $63 thousand
        in
        the 2006 Quarter and 2006 Period, respectively, a decrease of approximately
        $136
        thousand and $171 thousand as compared to the 2005 Quarter and 2005 Period,
        respectively.
 
 Consolidated
        research and development expenses of $159 thousand and $448 thousand for
        the
        2006 Quarter and 2006 Period, respectively, decreased from $172 thousand
        in the
        2005 Quarter and $643 thousand in the 2005 Period primarily as a result of
        the
        Company’s more focused research and development program which has reduced
        spending for Microtek’s research and development activities by approximately $13
        thousand in the 2006 Quarter and $132 thousand in the 2006 Period, as compared
        to the same 2005 periods. OTI’s research and development expenses, consisting
        primarily of expenses related to maintenance and protection of OTI’s
        intellectual property, was relatively unchanged in the 2006 Quarter as compared
        to the 2005 Quarter and decreased by approximately $63 thousand in the 2006
        Period as compared to the 2005 Period.
   Index
 18
 
 Consolidated
        amortization of intangibles in the 2006 Quarter and 2006 Period was $254
        thousand and $722 thousand, respectively, consistent with $243 thousand in
        the
        2005 Quarter and $726 thousand in the 2005 Period as amortization expense
        associated with intangibles acquired in the Samco and Ceres Medical transactions
        was offset by the fact that certain of Microtek’s intangibles, primarily patent
        related expenses, are now fully amortized.
 
 **Income
        from Operations.** Consolidated income from operations for the 2006 Quarter improved 66.0 percent
        to $2.5 million, or 7.2 percent of net revenues, versus $1.5 million, or
        4.6
        percent of net revenues, in the 2005 Quarter. For the 2006 Quarter, Microtek’s
        income from operations was approximately $2.4 million, an improvement of
        more
        than 70 percent over income from operations of $1.4 million recorded in the
        2005
        Quarter. The Company’s OTI division reported income from operations in the 2006
        Quarter of $142 thousand, compared to income from operations of $173 thousand
        in
        the 2005 Quarter.
 
 For
        the
        2006 Period, consolidated income from operations improved 33.5 percent to
        $9.0
        million, or 8.5 percent of net revenues, versus $6.7 million, or 6.6 percent
        of
        net revenues, in the 2005 Period. Microtek’s income from operations for the 2006
        Period was approximately $8.7 million, a 55.7 percent improvement over income
        from operations of $5.6 million in the 2005 Period. OTI’s income from operations
        for the 2006 Period totaled $269 thousand, compared to income from operations
        of
        $1.1 million in the 2005 Period.
 
 **Interest
        Expense and Interest Income.** Consolidated
        interest expense for the 2006 Quarter and 2006 Period was $16 thousand and
        $37
        thousand, respectively, as compared to $41 thousand in the 2005 Quarter and
        $209
        thousand in the 2005 Period. The decreases in consolidated interest expense
        in
        the 2006 Quarter and 2006 Period resulted primarily from lower average
        borrowings under the Company’s Credit Agreement. Interest income of $129
        thousand and $328 thousand in the 2006 Quarter and 2006 Period, respectively,
        increased from $40 thousand in the 2005 Quarter and $122 thousand in the
        2005
        Period as a result of higher interest rates applicable to the Company’s cash and
        cash equivalents, higher average cash and cash equivalent balances and interest
        income attributable to the GRI promissory note related to the September 2004
        sale of certain raw material inventories.
 
 **Other
        Income/Expense, Net.** Other
        income and expense include the Company’s equity in earnings of its investee,
        GRI, and foreign currency exchange gains and losses resulting from the
        translation of certain intercompany transactions of the Company’s Netherlands
        subsidiaries which were denominated in a currency other than the functional
        currency of those subsidiaries. The Company recorded foreign currency exchange
        gains of approximately $7 thousand in the 2005 Quarter and foreign currency
        exchange losses of approximately $416 thousand in the 2005 Period. There
        were no
        such foreign currency exchange losses in the 2006 Quarter and 2006 Period.
        Changes made to the structure of these intercompany transactions during the
        second quarter of 2005 have significantly minimized the occurrence of these
        foreign currency exchange losses. In the 2006 Quarter and 2006 Period, the
        Company’s equity in earnings of its investee, GRI, were $80 thousand and $203
        thousand, respectively, as compared to $64 thousand for the 2005 Quarter
        and
        $199 thousand for the 2005 Period.
 
 **Income
        Taxes.** The
        Company’s provision for income taxes in the 2006 Quarter and 2006 Period
        reflects income tax expense of $1.1 million and $3.4 million, respectively,
        consisting of current and deferred Federal, state and foreign income tax
        expense. The Company’s provision for income taxes in the 2005 Quarter reflects a
        net income tax benefit of $6.3 million, consisting of a $6.5 million net
        non-cash deferred income tax benefit due primarily to the decrease in the
        Company’s valuation allowance associated with its deferred tax assets, and the
        offsetting state, foreign and Federal alternative minimum tax expense of
        $225
        thousand. For the 2005 Period, the Company’s provision for income taxes reflects
        a net income tax benefit of $5.8 million, consisting of a $6.3 million net
        non-cash deferred income tax benefit and the offsetting state, foreign and
        Federal alternative minimum tax expense of $564 thousand.
 
 The
        Company has significant net operating loss carryforwards (“NOL’s”) for Federal
        and state income tax purposes. Until the third quarter of 2005, the Company
        had
        recorded a valuation allowance with respect to a portion of these NOL’s. As
        described in the discussion of the Company’s critical accounting policies
        contained in its 2005 Annual Report, the Company reviews on a quarterly basis
        its estimates of future taxable income over the period during which these
        NOL’s
        are scheduled to expire to determine the amount of valuation allowance
        necessary, if any. This review at the end of the third quarter of 2005 resulted
        in the elimination of the Company’s valuation allowance with respect to its
        NOL’s for Federal income tax purposes. Beginning with the fourth quarter of
        2005, the Company began to record an expense for Federal income taxes in
        its
        quarterly financial statements, which results in recording income tax expenses
        at higher amounts than previously recorded by the Company. The Company, however,
        continues to offset its obligation to pay Federal income taxes with its Federal
        NOL’s which reduces the Company’s cash payments for income taxes substantially
        below the amount which the Company is required to record for its income tax
        expenses in its financial statements.
   Index
 19
 
 **Net
        Income.** The
        resulting net income for the 2006 Quarter and 2006 Period was $1.6 million,
        or
        $0.04 per diluted share, and $6.1 million, or $0.14 per diluted share,
        respectively. Net income for the 2005 Quarter and 2005 Period was $7.9 million,
        or $0.18 per diluted share, and $12.2 million, or $0.27 per diluted share,
        respectively.
 
 **Liquidity
        and Capital Resources**
 
 As
        of
        September 30, 2006 and December 31, 2005, the Company’s cash and cash
        equivalents totaled $15.5 million and $14.8 million, respectively. The Company’s
        cash flow activity in the 2006 Period and 2005 Period was as follows (in
        thousands):
 
 **Nine
                  months ended September 30,****2006**
              
              **2005**Cash
                  provided by operating activities
              
              $
              8,316
              
              $
              5,937Cash
                  used in investing activities
              
              
              (4,027
              )
              
              (644
              )Cash
                  used in financing activities
              
              
              (3,954
              )
              
              (5,058
              )
 
 The
        Company’s principal sources of liquidity have been net cash from operating
        activities and borrowings under the Company’s Credit Agreement. The Company’s
        liquidity requirements arise primarily from the funding of the Company’s working
        capital needs, obligations incurred in connection with acquisitions of
        businesses and capital investment in property and equipment.
 
 During
        the 2006 Period, the Company’s operating activities generated cash of
        approximately $8.3 million and consisted primarily of net income from
        operations, net of deferred income taxes, depreciation and amortization,
        of
        approximately $11.4 million, an increase in accounts payable of $732 thousand,
        an increase in accrued compensation of $1.5 million, an increase in other
        liabilities of $173 thousand and a decrease in prepaid expenses and other
        assets
        of $494 thousand. Offsetting these sources of cash were a $947 thousand increase
        in accounts receivable, net of allowances, and an increase of $4.8 million
        in
        inventories. The increase in inventories in the 2006 Period was due to certain
        purchasing strategies employed by the Company to ensure a continuous supply
        of
        certain inventory items as the Company seeks to transfer additional
        manufacturing processes offshore to the Dominican Republic and to China.
 
 During
        the 2005 Period, the Company’s operating activities generated cash of $5.9
        million and consisted primarily of net income from operations, net of deferred
        income taxes, depreciation and amortization, of approximately $8.2 million,
        a
        $2.1 million decrease in inventories and a $293 thousand increase in other
        liabilities. Offsetting these sources of cash were a $1.0 million increase
        in
        accounts receivable, net of allowances, a $1.1 million increase in prepaid
        expenses and other assets, a $1.9 million decrease in accounts payable, and
        decreases in accrued compensation and other liabilities of $419 thousand.
 
 Cash
        used
        in investing activities in the 2006 Period totaled approximately $4.0 million
        as
        a result of cash consideration of approximately $2.3 million and $483 thousand
        for the Samco and Ceres Medical acquisitions, respectively, and purchases
        of
        capital property and equipment of $1.2 million. Investing activities in the
        2005
        Period used $644 thousand in cash which was the net effect of purchases of
        capital property and equipment of $859 thousand and proceeds from dispositions
        of approximately $215 thousand.
 
 During
        the 2006 Period, financing activities used approximately $4.0 million in
        cash.
        Financing cash outflows in the 2006 Period included net repayments of borrowings
        under the Company’s Credit Agreement of $1.2 million, repayments of other
        long-term debt agreements of $343 thousand, a decrease in the Company’s bank
        overdraft of approximately $1.0 million and repurchases of treasury stock
        of
        approximately $2.0 million. Financing cash inflows included proceeds from
        the
        exercise of stock options and other stock issuances of $639 thousand. Cash
        used
        in financing activities for the 2005 Period of $5.1 million consisted of
        net
        repayments of borrowings under the Company’s Credit Agreement of $4.1 million,
        repayments of other long-term debt agreements of $369 thousand and a decrease
        in
        the Company’s bank overdraft of approximately $1.3 million, offset by
        approximately $674 thousand from the exercise of stock options and other
        stock
        issuances.
   Index
 20
 
 Effective
        October 2, 2006, Microtek acquired Europlak, a surgeon-owned marketer of
        minimally invasive surgical products and devices primarily in urology,
        gastroenterology and related surgical specialties in France. The initial
        purchase price was approximately $6.4 million in cash, including certain
        acquisition costs. The terms of the related purchase agreement also provide
        for
        additional cash consideration up to approximately $12.4 million through 2021
        if
        certain revenue hurdles, as defined in the agreement, are achieved.
 
 The
        Company maintains a $23.5 million credit agreement (as amended to date, the
        “Credit Agreement”) with the JP Morgan Chase Bank (the “Bank”), consisting of a
        revolving credit facility maturing on June 30, 2008. Borrowing availability
        under the revolving credit facility is based on the lesser of (i) a percentage
        of eligible accounts receivable and inventories or (ii) $23.5 million, less
        any
        outstanding letters of credit issued under the Credit Agreement. There were
        no
        outstanding borrowings under the revolving credit facility at September 30,
        2006. Outstanding borrowings under the revolving credit facility totaled
        $1.2
        million at December 31, 2005. As of September 30, 2006, the Company had total
        borrowing availability under the revolving facility of $17.1 million. As
        of
        November 6, 2006, the Company had no borrowings under the revolving facility
        and
        a total borrowing availability of approximately $17.5 million. Revolving
        credit
        borrowings bear interest at a floating rate approximating the Bank’s prime rate
        plus an interest margin (8.5% at November 6, 2006). At September 30, 2006,
        the
        Company was in compliance with its financial covenants under the Credit
        Agreement.
 
 Based
        on
        its current business plan, the Company expects that cash and cash equivalents
        on
        hand, the Company’s credit facility, as amended, and funds budgeted to be
        generated from operations will be adequate to meet its liquidity and capital
        requirements for the next year. However, currently unforeseen future
        developments, potential acquisitions and increased working capital requirements
        may require additional debt financing or issuance of common stock in 2006
        and
        subsequent years.
 
 **Off-Balance
        Sheet Arrangements**
 
 The
        Company does not have any off-balance sheets arrangements that have or are
        reasonably likely to have a current or future effect on the Company’s financial
        condition, changes in financial condition, revenues or expenses, results
        of
        operations, liquidity, capital expenditures or capital resources that are
        material to investors.
 
 **Inflation**
 
 Inflation
        has not had a material effect on the Company’s operations in the past. Recently,
        rising petroleum prices have increased the Company’s costs of raw materials and
        distribution expenses included in the Company’s selling, general and
        administrative expenses. The Company has not yet passed these increased costs
        to
        its customers by increasing prices and may not be able to do so due to
        competitive pricing pressures. The Company seeks to offset these increased
        costs
        in part through cost savings measures in other areas.
 
 **Recent
        Accounting Pronouncements**
 
 **Stock-Based
        Compensation.** Effective
        January 1, 2006, the Company adopted the provisions of Statement of Financial
        Accounting Standard (“SFAS”) No. 123(R), *Share-Based
        Payment,* and
        related interpretations (collectively, “SFAS No. 123(R)”) to account for
        stock-based compensation using the modified prospective transition method
        and
        therefore will not restate its prior period results. SFAS No. 123(R) supersedes
        Accounting Principles Board (“APB”) Opinion No. 25, *Accounting
        for Stock Issued to Employees* , ** and
        revises guidance in SFAS No. 123, *Accounting
        for Stock-Based Compensation* .
        SFAS
        No. 123(R) establishes accounting requirements for share-based compensation
        to
        employees and carries forward prior guidance on accounting for awards to
        non-employees. Specifically, SFAS No. 123(R) requires that compensation expense
        be recognized in the financial statements for share-based awards based on
        the
        grant date fair value of those awards. SFAS No. 123(R) also requires the
        benefits of tax deductions in excess of recognized compensation expense to
        be
        reported as a financing cash flow activity, rather than as an operating cash
        flow activity as previously required.
 
 The
        Company’s initial adoption of SFAS No. 123(R)’s fair value method on January 1,
        2006 did not have an impact on the Company’s results of operations or overall
        financial position. However, the future impact of the adoption of SFAS No.
        123(R) on the Company’s results of operations cannot be predicted at this time
        because it will depend on levels of future grants of share-based payments.
   Index
 21
  Pursuant
        to SFAS No. 123(R)’s modified prospective transition method, the Company
        recognizes stock-based compensation expense based on the grant-date fair
        value
        of any new share-based awards granted subsequent to December 31, 2005 that
        are
        expected to vest. Compensation expense is recognized on a straight-line basis
        over the requisite service period, which is generally commensurate with the
        vesting term. Compensation expense is recognized immediately for share-based
        awards that are fully vested on the date of the grant. During the three months
        ended September 30, 2006, there was no compensation expense recognized in
        the
        Company’s financial statements related to share-based awards. For the nine
        months ended September 30, 2006, compensation expense recognized in the
        Company’s financial statements related to share-based awards totaled
        approximately $19,000. For the three months and nine months ended September
        30,
        2006, the Company did not record any excess tax benefits generated from stock
        option exercises because of the Company’s significant net operating loss
        carryforwards for Federal income tax purposes.
 .
 Prior
        to
        January 1, 2006, the Company accounted for its share-based payments to employees
        under the intrinsic value recognition and measurement principles of APB Opinion
        No. 25 and related interpretations, including Financial Accounting Standards
        Board (“FASB”) Interpretation No. 44, *Accounting
        for Certain Transactions Involving Stock Compensation, an interpretation
        of APB
        Opinion No. 25* .
        Accordingly, no stock-based employee compensation cost was reflected in the
        Company’s results of operations as all options granted under the Company’s stock
        options plans had an exercise price equal to the market value of the underlying
        common stock on the date of the grant. Prior to its adoption of SFAS 123(R),
        the
        Company followed the disclosure requirements of SFAS 148, *Accounting
        for Stock-Based Compensation - Transition and Disclosure, an amendment of
        FASB
        Statement No. 123* and
        accordingly provided pro forma disclosures of net income and net income per
        basic and diluted share as if the fair-value-based method had been applied
        to
        all outstanding and unvested awards for each period presented.
 
 As
        permitted under SFAS No. 123(R), the Company uses the Black-Scholes option
        pricing model to determine the fair value of the Company’s share-based awards
        under SFAS No. 123 (R), which is the same valuation technique previously
        used
        for pro forma disclosures under SFAS No. 123. The Black-Scholes option valuation
        model, like other option valuation models, requires the input of highly
        subjective assumptions including the expected stock price volatility. Because
        the Company’s employee stock options have characteristics significantly
        different from those of traded options, and because changes in the subjective
        input assumptions can materially affect the fair value estimate, in management’s
        opinion, the existing models do not necessarily provide a reliable single
        measure of the fair value of its employee stock options.
 
 The
        guidance in SFAS No. 123(R) is relatively new and best practices are not
        well
        established. The application of these principles may be subject to further
        interpretation and refinement over time. There are significant differences
        among
        valuation models and there is a possibility that the Company will adopt
        different valuation models in the future. This may result in a lack of
        comparability with other companies that use different models, methods and
        assumptions and in a lack of consistency in future periods.
 
 **Accounting
        for Uncertainty in Income Taxes.** In June
        2006, the FASB issued Interpretation No. 48, *Accounting
        for Uncertainty in Income Taxes - An interpretation of FASB Statement No.
        109* ,
        or FIN
        48, which clarifies the accounting and disclosure requirements for uncertainty
        in tax positions, as defined. The Company is currently evaluating the provisions
        of FIN 48, which is effective for fiscal years beginning after December 15,
        2006.
 
 **Employer’s
        Accounting for Defined Benefit Pension and Other Postretirement Plans.** In
        September 2006, the FASB issued SFAS No. 158, *Employer’s Accounting for Defined Benefit Pension and Other Postretirement
        Plans- an amendment of FASB Statements No. 87, 88, 106, and 132(R)* (“SFAS
        No. 158”). SFAS No. 158 requires an employer to recognize the overfunded or
        underfunded status of a defined benefit pension plan as an asset or liability
        in
        its statement of financial position and to recognize changes in that funded
        status in the year in which the changes occur through comprehensive income.
        The
        funded status of a defined benefit pension plan is measured as the difference
        between plan assets at fair value and the projected benefit obligation.
        Additionally, SFAS No. 158 requires an employer to measure the funded status
        of
        a plan as of the Company’s fiscal year-end, with limited exceptions, and expands
        financial statement disclosures. SFAS No. 158 is effective as of the end
        of
        fiscal years ending after December 15, 2006; however, the requirement to
        measure
        plan assets and benefit obligations as of the Company fiscal year-end is
        effective for fiscal years ending after December 15, 2008. The Company currently
        expects to adopt all requirements of SFAS No. 158 with respect to its
        international defined benefit pension plan on December 31, 2006, except for
        the
        funded status measurement date requirement which will be adopted on December
        31,
        2008, as allowed under SFAS No. 158. The Company is currently evaluating
        the
        impact that the adoption of SFAS No. 158 will have on its consolidated financial
        statements, if any.
   Index
 22
 
 **Considering
        the Effects of Prior Year Financial Statement
        Misstatements.** In
        September 2006, the Securities and Exchange Commission issued Staff Accounting
        Bulletin (“SAB”) No. 108, *Considering
        the Effects of Prior Year Misstatements when Quantifying Misstatements in
        Current Year Financial Statements* (“SAB
        108”), to address diversity in practice in quantifying financial statement
        misstatements. SAB 108 requires companies to quantify misstatements based
        on
        their impact on each of their financial statements and related disclosures.
        SAB
        108 is effective as of the end of the Company’s 2006 fiscal year, allowing a
        one-time transitional cumulative effect adjustment to retained earnings as
        of
        January 1, 2006 for errors that were not previously deemed material but are
        material under the guidance in SAB 108. The Company is currently evaluating
        the
        impact that the adoption of SAB 108 will have on its consolidated financial
        statements.
 
 **Forward
        Looking Statements**
 
 Statements
        made in this Quarterly Report include forward-looking statements made under
        the
        provisions of the Private Securities Litigation Reform Act of 1995 including,
        but not limited to, the effect of newly issued accounting standards on the
        Company’s consolidated financial statements described in the notes to the
        unaudited condensed consolidated financial statements; the Company’s ability to
        grow its business by continually improving its existing capabilities and
        simultaneously developing and acquiring new business opportunities while
        maintaining its customer focus and providing the highest levels of customer
        support; the Company’s ability to increase sales and earnings from its infection
        control business by completing strategic acquisitions, enhancing marketing
        and
        distribution efforts both domestically and internationally, introducing new
        products, increasing direct sales representation, employing tele-sales agents
        for added sales coverage, and capitalizing on low-cost manufacturing
        opportunities in the Dominican Republic and China; the Company’s expectation
        about the composition and amount of revenues to be received by the Company’s OTI
        division; the Company’s expectations concerning its future income tax expenses
        and income tax cash payments; the Company’s current expectation that cash and
        cash equivalents on hand, the Company’s existing credit facility and funds
        budgeted to be generated from operations will be adequate to meet its liquidity
        and capital requirements for the next year; and the Company’s belief that
        changes made to the structure of certain intercompany transactions formerly
        denominated in other than an entity’s functional currency will significantly
        minimize the occurrence of foreign currency exchange losses arising from
        these
        transactions in future periods.
 
 The
        Company’s actual results could differ materially from such forward-looking
        statements and such results will be affected by risks described in the Company’s
        Annual Report on Form 10-K for the year ended December 31, 2005, filed with
        the
        Securities and Exchange Commission. These risks include, without limitation,
        the
        following: low barriers to entry for competitive products could cause the
        Company to reduce the prices for its products or lose customers; large
        purchasers of the Company’s products regularly negotiate for reductions in
        prices for the Company’s products, which may reduce the Company’s profits;
        because a few distributors control much of the delivery of hospital supplies
        to
        hospitals, the Company relies significantly on these distributors in connection
        with the sale of the Company’s branded products; the Company’s relatively small
        sales and marketing force may place the Company at a competitive disadvantage
        to
        its competition; the Company’s contract manufacturing division relies upon a
        small number of customers, the loss of any of which could have a material
        adverse impact on the Company; the inability of the Company to complete
        acquisitions of businesses at an attractive cost could adversely affect the
        Company’s growth; if the Company is successful in acquiring businesses, the
        failure to successfully integrate those businesses could adversely affect
        the
        Company; the Company’s growing international operations subject the Company’s
        operating results to numerous additional risks; markets in which the Company
        competes are highly competitive, which may adversely affect the Company’s growth
        and operating results; the Company’s products are subject to extensive
        governmental regulations, compliance or non-compliance with which could
        adversely affect the Company; the Company’s strategies to protect its
        proprietary assets may be ineffective, allowing increased competition with
        the
        Company; fluctuations in the value of the dollar against foreign currencies
        have
        in the past and may in the future adversely affect the Company’s operating
        results; and the Company’s expenses for raw materials and product distribution
        are adversely affected by increases in the price for petroleum *.* The
        Company does not undertake to update its forward-looking statements to reflect
        future events or circumstances.
  
 Index
 23
 **Item
        3. Quantitative and Qualitative Disclosures about Market
        Risk**
 
 The
        Company's operating results and cash flows are subject to fluctuations from
        changes in foreign currency exchange rates and interest rates.
 
 The
        financial position and results of operations of the Company’s foreign
        subsidiaries in the United Kingdom, Netherlands, Malta and Germany are measured
        using the foreign subsidiary’s local currency as the functional currency.
        Revenues and expenses of such subsidiaries are translated into U.S. dollars
        at
        average exchange rates prevailing during the period. Assets and liabilities
        are
        translated at the rates of exchange on the balance sheet date. The resulting
        translation gain and loss adjustments are recorded directly as a separate
        component of shareholders’ equity. Foreign currency translation adjustments, net
        of applicable taxes, resulted in gains of $219 thousand and $1.0 million
        for the
        three months and nine months ended September 30, 2006, respectively. For
        the
        three months and nine months ended September 30, 2005, foreign currency
        translation adjustments, net of applicable taxes, resulted in losses of $120
        thousand and $1.3 million, respectively.
 
 Transaction
        gains and losses that arise from exchange rate fluctuations on transactions
        denominated in a currency other than the subsidiary’s functional currency are
        included in the results of operations as incurred. Included in the Company’s
        results of operations for three months and nine months ended September 30,
        2005
        were foreign currency exchange gains of approximately $7 thousand and foreign
        currency exchange losses of approximately $416 thousand, respectively, resulting
        from the translation of certain intercompany transactions of the Netherlands
        subsidiaries which were denominated in a currency other than the functional
        currency of those subsidiaries. The effect of foreign currency transactions
        was
        not material to the Company’s results of operations for the three months and
        nine months ended September 30, 2006. The Company believes that changes made
        to
        the structure of these intercompany transactions during the second quarter
        of
        2005 will significantly minimize the occurrence of foreign currency exchange
        losses arising from the translation of these intercompany transactions in
        future
        periods.
 
 Currency
        translations and transactions that are billed and paid in foreign currencies
        could be adversely affected in the future by the relationship of the U.S.
        dollar
        and the functional currencies of the Company’s foreign subsidiaries with foreign
        currencies.
 
 The
        Company is also subject to fluctuations in the value of the Dominican peso
        relative to the U.S. dollar. As the value of the Dominican peso increases
        with
        respect to the U.S. dollar, the costs of the Company’s inventory increase
        because the Company manufactures a material portion of its inventory at its
        facilities located in the Dominican Republic. The appreciation of the Dominican
        peso relative to the U.S. dollar in the future could adversely affect the
        Company’s operating results.
 
 The
        Company’s cash and cash equivalents are short-term, highly liquid investments
        with original maturities of three months or less. As a result of the short-term
        nature of the Company’s cash and cash equivalents, a change of market interest
        rates does not materially impact interest income accruing on these investments
        or, consequently, the Company’s operating results or cash flow. The Company's
        greatest sensitivity with respect to the general level of U.S. interest rates
        relates to the effect that changes in those rates have on the Company's interest
        expense. At September 30, 2006, the Company had repaid all of its borrowings
        under its Credit Agreement which bear interest at a floating rate approximating
        the prime rate. An increase or decrease in the Company's average interest
        rate
        of ten percent would have had an immaterial impact on the Company’s recorded
        interest expense during the three months and nine months ended September
        30,
        2006.
 
 The
        Company does not use derivative instruments for trading purposes or to hedge
        its
        market risks, and the use of such instruments would be subject to strict
        approvals by the Company’s senior officers. Therefore, the Company’s exposure
        related to such derivative instruments is not expected to be material to
        the
        Company’s financial position, results of operations or cash flows.
 
 **Item
        4. Controls and Procedures**
 
 **(a)**
            *Evaluation
                of disclosure controls and procedures.*Under
                the supervision and with the participation of the Company’s management,
                including the Company’s President and Chief Executive Officer and its
                Chief Financial Officer, the Company carried out an evaluation (the
                “Evaluation”) of the effectiveness of the Company’s “disclosure controls
                and procedures” (as defined in the Securities Exchange Act of 1934 Rules
                13a-15(e) and 15d-15(e)). Based upon the Evaluation, the Company’s
                President and Chief Executive Officer and its Chief Financial Officer
                have
                concluded that the Company’s disclosure controls and procedures are
                effective at the reasonable assurance level as of the end of the
                quarter
                for which this report is being filed to ensure that (i) information
                required to be disclosed by the Company in reports that it files
                or
                submits under the Securities Exchange Act of 1934 is recorded, processed,
                summarized and reported within the time periods specified in the
                SEC’s
                rules and forms and (ii) such information is accumulated and communicated
                to the Company’s management, including the Company’s President and Chief
                Executive Officer and its Chief Financial Officer, as appropriate,
                to
                allow timely decisions regarding required
                disclosure.  
 Index
 24
 The
        Company is committed to a continuing process of identifying, evaluating and
        implementing improvements to the effectiveness of the Company’s disclosure and
        internal controls and procedures. The Company’s management, including its
        President and Chief Executive Officer and its Chief Financial Officer, does
        not
        expect that the Company’s controls and procedures will prevent all errors. A
        control system, no matter how well conceived and operated, can provide only
        reasonable, not absolute, assurance that the objectives of the control system
        are met. Because of the inherent limitations in all control systems, no
        evaluation of controls can provide absolute assurance that all control issues
        within the Company have been detected. These inherent limitations include
        the
        realities that judgments in decision-making can be faulty and that breakdowns
        can occur because of a simple error or mistake. Additionally, controls can
        be
        circumvented by the individual acts of some persons, by collusion of two
        or more
        people, or by management override of the control. The design of any system
        of
        controls is also based in part upon certain assumptions about the likelihood
        of
        future events, and there can be no assurance that any design will succeed
        in
        achieving its stated goals under all potential future conditions. Over time,
        controls may become inadequate because of changes in conditions, or the degree
        of compliance with the policies or procedures may deteriorate. Because of
        the
        inherent limitations in any control system, misstatements due to error or
        violations of law may occur and not be detected. The Company has, however,
        designed its disclosure controls and procedures to provide, and believes
        that
        such controls and procedures do provide, reasonable assurance that information
        required to be disclosed by the Company in reports that it files or submits
        under the Securities Exchange Act of 1934 is recorded, processed, summarized
        and
        reported within the time periods specified in the SEC’s rules and forms. The
        disclosure in this paragraph about inherent limitations of control systems
        does
        not modify the conclusions set forth in the immediately preceding paragraph
        of
        the Company’s President and Chief Executive Officer and its Chief Financial
        Officer concerning the effectiveness of the Company’s disclosure controls and
        procedures.
 
 **(b)**
            *Changes
                in internal controls.*There
                have not been any changes in the Company’s internal controls over
                financial reporting identified in connection with the Evaluation
                that
                occurred during the Company’s last quarter that has materially affected
                or, to the knowledge of management, is reasonably likely to materially
                affect the Company’s internal controls. 
 **PART
        II**
 **OTHER
        INFORMATION**
 
 **Item
        1. Legal Proceedings**
 
 Not
        applicable.
 
 **Item
        1A. Risk Factors**
 
 See
        the
        risk factors described in the Company’s Annual Report on Form 10-K for the year
        ended December 31, 2005.
 
 **Item
        2. Unregistered Sales of Equity Securities and Use
        of Proceeds**
 
 During
        the quarter for which this report is filed, there were no material modifications
        in the instruments defining the rights of shareholders. During the quarter
        for
        which this report is filed, none of the rights evidenced by the shares of
        the
        Company's common stock were materially limited or qualified by the issuance
        or
        modification of any other class of securities.
 
  Index
 25
 **Purchases
        of Equity Securities by the Issuer and Affiliated
        Purchasers**
 
 In
        February 2000, the Board of Directors authorized the repurchase of up to
        five
        percent (5%) of the Company’s outstanding common stock from time to time in open
        market or private transactions. As amended most recently on August 25, 2006,
        the
        Company’s share repurchase program currently authorizes the repurchase of up to
        an aggregate of 4,000,000 shares over an indefinite period of time. As of
        September 30, 2006, the Company had repurchased 1,931,755 shares for an
        aggregate repurchase price of $4.8 million. The following table summarizes
        the
        Company’s share repurchases during the Company’s third quarter of
        2006:
 
 
 Period
              
              Total
                  Number of Shares Purchased
              
              Average
                  Price Paid per Share
              
              Total
                  Number of Shares Purchased as Part of Publicly Announced Repurchase
                  Plans
              
              Maximum
                  Number of Shares that May Yet Be Purchased Under the Repurchase
                  PlansJuly
                  1 to 31, 2006
              
              
              -
              
              $
              -
              
              
              -
              
              
              383,245August
                  1 to 31, 2006
              
              
              195,800
              
              $
              3.53
              
              
              195,800
              
              
              2,187,445September
                  1 to 30, 2006
              
              
              119,200
              
              $
              3.59
              
              
              119,200
              
              
              2,068,245Total
              
              
              315,000
              
              $
              3.55
              
              
              315,000
              
              
              2,068,245
 
  **Item
        3. Default Upon Senior
        Securities**
 
 Not
        applicable.
 
 **Item
        4. Submission of Matters to a Vote of Security
        Holders**
 
 None.
 
 **Item
        5. Other Information**
 
 Not
        applicable.
 
 **Item
        6. Exhibits**
  Exhibit
                  No.
              Description3.1(1)
              Articles
                  of Incorporation of Isolyser Company, Inc.3.3(2)
              Amended
                  and Restated Bylaws of Microtek Medical Holdings, Inc.4.1(3)
              Specimen
                  Certificate of Common Stock4.2(4)
              Second
                  Amendment to Shareholder Protection Rights Agreement31.1
              Certification
                  of Chief Executive Officer31.2
              Certification
                  of Chief Financial Officer32.1
              Certification
                  pursuant to Section 906 of the Sarbanes-Oxley Act of
                  200232.2
              Certification
                  pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002
 
 
 Index
 26
  
 (1)
            Incorporated
                by reference to Exhibit 3.1 of the Company's Annual Report on Form
                10-K
                for the year ended December 31, 2004. 
 (2)
            Incorporated
                by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K
                dated May 18, 2006. 
 (3)
            Incorporated
                by reference to Exhibit 4.1 of the Company’s Quarterly Report on Form 10-Q
                for the quarter ended June 30, 2006. 
 (4)
            Incorporated
                by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K
                dated August 25, 2006. 
  Index
 27
  **SIGNATURES**
 
 
 Pursuant
        to the requirements of the Securities Exchange Act of 1934, the registrant
        has
        caused this quarterly report on Form 10-Q to be signed on its behalf by the
        undersigned thereunto duly authorized on November 9, 2006.
 
 
 MICROTEK
                  MEDICAL HOLDINGS, INC.By:/s/
                  Dan R. LeeDan
                  R. LeeChairman,
                  President and Chief Executive Officer(principal
                  executive officer)By:/s/ Roger G. WilsonRoger
                  G. WilsonChief
                  Financial Officer(principal
                  financial officer)
 
 
 
  Index
 28