---

Table of Contents

# UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

# FORM 10-Q

(Mark One)

||X| | Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
|--- | ---------------------------------------------------------------------------------------

For the quarterly period ended
June 30, 2006

|[  ] | Transition report pursuant to Section 13 or
        15(d) of the Securities Exchange Act of 1934
|---- | ------------------------------------------------------------------------------------------------

| | For the transition period
        from _______________ to ______________
| | ------------------------------------------------------------------------

Commission File Number:   001-31578

| |                                                        | 
| | ------------------------------------------------------ | 
| | MTS MEDICATION TECHNOLOGIES, INC.                      | 
| |                                                        | 
| | (Exact Name of Registrant as Specified in Its Charter) | 

| | Delaware                        |  | 59-2740462          | 
| | ------------------------------- |  | ------------------- | 
| |                                 |  |                     | 
| | (State or Other Jurisdiction of |  | (I.R.S. Employer    | 
| | Incorporation or Organization)  |  | Identification No.) | 

| | 2003 Gandy Boulevard North,
        Suite 800, St. Petersburg, Florida 33702 | 
| | ---------------------------------------------------------------------------- | 
| |                                                                              | 
| | (Address of Principal Executive Offices)                                     | 

| |                                                      | 
| | ---------------------------------------------------- | 
| | 727-576-6311                                         | 
| |                                                      | 
| | (Registrant's Telephone Number, Including Area Code) | 

| |                                                                                            | 
| | ------------------------------------------------------------------------------------------ | 
| | N/A                                                                                        | 
| |                                                                                            | 
| | (Former Name, Former Address and Former Fiscal Year,
        if changed since last report) | 

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
             [  ]   Yes      [X]    No

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

As of August 11, 2006, the registrant had 6,025,105 shares of common stock, $.01 par
        value per share, issued and outstanding.

---

# MTS MEDICATION
TECHNOLOGIES, INC. AND SUBSIDIARIES

# Index

| |                | Page                                                                                                                                            | 
| | -------------- | ----------------------------------------------------------------------------------------------------------------------------------------------- | 
|
|
|
| | Item 1.        | Financial Statements                                                                                                                            | 
| |                |                                                                                                                                                 | 
| |                | Condensed
        Consolidated Balance Sheets  June 30, 2006 and March 31, 2006                                                                | 
|
| |                | Condensed
        Consolidated Statements of Operations  Three Months Ended June 30, 2006 and 2005                                             | 
|
| |                | Condensed Consolidated
        Statement of Changes in Stockholders Equity and Comprehensive Income  Three Months
        Ended June 30, 2006 | 
|
| |                | Condensed
        Consolidated Statements of Cash Flows  Three Months Ended June 30 2006 and 2005                                              | 
| |                |                                                                                                                                                 | 
| |                | Notes
        to Condensed Consolidated Financial Statements                                                                                    | 
|
| | Item 2.        | Management's Discussion and
        Analysis of Financial Condition and Results of Operations                                                   | 
| |                |                                                                                                                                                 | 
| | Item 3.        | Quantitative and
        Qualitative Disclosures About Market Risk                                                                              | 
| |                |                                                                                                                                                 | 
| | Item 4.        | Controls and Procedures                                                                                                                         | 
| |                |                                                                                                                                                 | 
|
| |                |                                                                                                                                                 | 
| | Item 6.        | Exhibits                                                                                                                                        | 
|
| | Signatures     |                                                                                                                                                 | 
|
| | Certifications |                                                                                                                                                 | 

i.

---

Table of Contents

# PART 1 - FINANCIAL
INFORMATION

# Item 1.  Financial
Statements

# MTS MEDICATION
TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
                            (In Thousands)

# ASSETS

|                             | June 30, 2006 |  | March 31, 2006
|---------------------------- | ------------- |  | --------------
|
|                             | (Unaudited)   |  |               
|
|Current Assets:              |               |  |               
|Cash                         |               |  | $             
|Accounts Receivable, Net     |               |  |               
|Inventories, Net             |               |  |               
|Prepaids and Other           |               |  |               
|Deferred Tax Asset           |               |  |               
|
|Total Current Assets         |               |  |               
|
|Property and Equipment, Net  |               |  |               
|Goodwill                     |               |  |               
|Other Intangible Assets, Net |               |  |               
|Other Assets, Net            |               |  |               
|
|Total Assets                 |               |  | $             
|

# LIABILITIES AND
STOCKHOLDERS' EQUITY

|Current Liabilities:                                |  |  |   |        |   |  |   |        |  
|--------------------------------------------------- |  |  | - | ------ | - |  | - | ------ | -
|Accounts Payable and Accrued Liabilities            |  |  | $ | 5,265  |   |  | $ | 5,589  |  
|Current Maturities of Long-Term Debt                |  |  |   | 2,625  |   |  |   | 698    |  
|Current Maturities of Related Party Note Payable    |  |  |   | 313    |   |  |   | 308    |  
|
|Total Current Liabilities                           |  |  |   | 8,203  |   |  |   | 6,595  |  
|
|Long-Term Debt, Less Current Maturities             |  |  |   | 213    |   |  |   | 2,727  |  
|Related Party Note Payable, Less Current Maturities |  |  |   | 354    |   |  |   | 434    |  
|Lease Incentive                                     |  |  |   | 308    |   |  |   | 317    |  
|Deferred Tax Liability                              |  |  |   | 576    |   |  |   | 576    |  
|
|Total Liabilities                                   |  |  |   | 9,654  |   |  |   | 10,649 |  
|
|Stockholders' Equity:                               |  | 
|Preferred Stock                                     |  |  |   | 2      |   |  |   | 2      |  
|Common Stock                                        |  |  |   | 60     |   |  |   | 60     |  
|Capital In Excess of Par Value                      |  |  |   | 13,873 |   |  |   | 13,887 |  
|Accumulated Other Comprehensive Income              |  |  |   | 153    |   |  |   | 91     |  
|Accumulated Deficit                                 |  |  |   | (842   | ) |  |   | (1,279 | )
|Treasury Stock                                      |  |  |   | (328   | ) |  |   | (328   | )
|
|Total Stockholders' Equity                          |  |  |   | 12,918 |   |  |   | 12,433 |  
|
|Total Liabilities and Stockholders' Equity          |  |  | $ | 22,572 |   |  | $ | 23,082 |  
|

The accompanying
notes are an integral part of these financial statements.

1

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Table of Contents

# MTS MEDICATION
TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
         (In Thousands; Except Earnings Per Share Amounts)

(Unaudited)

|                                              | Three Months Ended June 30,
|--------------------------------------------- | ---------------------------
|
|
|
|
|Net Sales                                     |                            
|
|Costs and Expenses:                           |                            
|Cost of Sales                                 |                            
|Selling, General and Administrative           |                            
|Depreciation and Amortization                 |                            
|
|Total Costs and Expenses                      |                            
|
|Operating Profit                              |                            
|
|Other Expenses                                |                            
|Interest Expense                              |                            
|Amortization of Financing Costs               |                            
|
|Total Other Expenses                          |                            
|
|Income Before Taxes                           |                            
|
|Income Tax Expense                            |                            
|
|Net Income Before Preferred Stock Dividend    |                            
|
|Convertible Preferred Stock Dividends         |                            
|
|Net Income Available to Common Stockholders   |                            
|
|Net Income Per Common Share - Basic           |                            
|
|Net Income Per Common Share - Diluted         |                            
|
|Weighted Average Shares Outstanding - Basic   |                            
|
|Weighted Average Shares Outstanding - Diluted |                            
|

The accompanying notes
are an integral part of these financial statements.

2

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# MTS MEDICATION
TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS'
EQUITY AND COMPREHENSIVE INCOME THREE MONTHS ENDED JUNE 30, 2006 (In Thousands; Except
Shares)(Unaudited)

|                                        | Preferred Stock |       | Common Stock |    | Capital |           | Accumulated |     |  |            |   |  |      |  |          
|--------------------------------------- | --------------- | ----- | ------------ | -- | ------- | --------- | ----------- | --- |  | ---------- | - |  | ---- |  | ---------
|
|
|
|
|Balance March 31, 2006                  |                 | 2,000 |              | $2 |         | 6,017,065 |             | $60 |  | $13,887    |   |  | $91  |  | ($  1,279
|Stock Options Exercised                 |                 |       |              |    |         | 3,100     |             |     |  | 7          |   |  |      |  |          
|Share-Based Compensation                |                 |       |              |    |         | 5,000     |             |     |  | 35         |   |  |      |  |          
|Convertible Preferred Stock Dividends   |                 |       |              |    |         |           |             |     |  | (56        | ) |  |      |  |          
|Comprehensive Income:                   |                
|Net Income                              |                 |       |              |    |         |           |             |     |  |            |   |  |      |  | 437      
|Foreign Currency Translation Adjustment |                 |       |              |    |         |           |             |     |  |            |   |  | 62   |  |          
|
|Total Comprehensive Income              |                 |       |              |    |         |           |             |     |  |            |   |  |      |  |          
|
|Balance June 30, 2006                   |                 | 2,000 |              | $2 |         | 6,025,165 |             | $60 |  | $   13,873 |   |  | $153 |  | ($    842
|

The accompanying notes
are an integral part of this financial statement.

3

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# MTS MEDICATION
TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In Thousands)(Unaudited)

|                                                                                  | Three Months Ended June 30,
|--------------------------------------------------------------------------------- | ---------------------------
|
|
|
|
|Operating Activities                                                              |                            
|Net Income Before Preferred Stock Dividends                                       |                            
|Adjustments to Reconcile Net Income to Net Cash Provided By Operating Activities: |                            
|Depreciation and Amortization                                                     |                            
|Amortization of Deferred Financing Costs                                          |                            
|Deferred Income Tax Expense                                                       |                            
|Share-Based Compensation                                                          |                            
|Amortization of Lease Incentive                                                   |                            
|Changes In Operating Assets and Liabilities:                                      |                            
|Accounts Receivable                                                               |                            
|Inventories                                                                       |                            
|Prepaids and Other                                                                |                            
|Accounts Payable and Other Accrued Liabilities                                    |                            
|
|Total Adjustments                                                                 |                            
|
|Net Cash Provided By Operating Activities                                         |                            
|
|Investing Activities                                                              |                            
|Expended For Property and Equipment                                               |                            
|Expended For Product Development                                                  |                            
|
|Net Cash Used By Investing Activities                                             |                            
|
|Financing Activities                                                              |                            
|Payments On Notes Payable and Term Loans                                          |                            
|Payments On Related Party Note Payable                                            |                            
|Net Pay Downs on Revolving Line of Credit                                         |                            
|Dividends On Convertible Preferred Stock                                          |                            
|Exercise of Stock Options                                                         |                            
|
|Net Cash Used By Financing Activities                                             |                            
|
|Effect of Exchange Rate Changes On Cash                                           |                            
|
|Net Increase (Decrease) In Cash                                                   |                            
|Cash at Beginning of Period                                                       |                            
|
|Cash at End of Period                                                             |                            
|
|Supplemental Disclosure of Cash Flow Information                                  |                            
|Cash paid for Interest                                                            |                            
|Cash Paid for Taxes                                                               |                            
|Non-Cash Activities:                                                              |                            
|Reclassified machine rentals from Inventory to Equipment                          |                            
|Reclassified machine rentals from Inventory to Equipment                          |                            
|Reclassified equipment to Product Development                                     |                            

The accompanying notes
are an integral part of these financial statements.

4

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# MTS MEDICATION
TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS
ENDED JUNE 30, 2006

# NOTE A  BASIS OF
PRESENTATION

MTS
Medication Technologies, Inc., a Delaware corporation (the Company or
MTS), was incorporated in March 1984. The Company is a holding company that
operates through its subsidiaries, MTS Packaging Systems, Inc. (MTSP),
MTS Medication Technologies International, Ltd. (MTS Limited) and BAF
Printers, Ltd. (BAF).

MTS
primarily manufactures and sells consumable medication punch cards, packaging equipment
and ancillary products throughout the United States. Its customers are predominantly
pharmacies that supply nursing homes, assisted living and correctional facilities with
prescription medications for their patients. MTS manufactures its proprietary consumable
punch cards and packaging equipment primarily in its own facilities. This manufacturing
process uses integrated equipment for manufacturing the consumable medication punch cards.
The consumable medication punch cards and packaging equipment are designed to provide a
cost effective method for pharmacies to dispense medications. The Companys
medication dispensing systems and products provide innovative methods for dispensing
medications in consumable packages. MTS Limited distributes products for MTS in the United
Kingdom. In February 2006, the Company acquired BAF, a United Kingdom based manufacturer
of bags and labels for pharmacies.

The
accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America
(US GAAP) for interim financial information and with the instructions to Form 10-Q and
Rule 10 of Regulation S-X. Accordingly, they do not include all of the information and
notes required by US GAAP for complete financial statements. In the opinion of management,
all adjustments (consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three-month period ended June
30, 2006 are not necessarily indicative of the results that may be expected for future
quarters in the year ended March 31, 2007. The unaudited condensed consolidated financial
statements should be read in conjunction with the consolidated financial statements and
notes thereto included in the Companys annual report on Form 10-K for the year ended
March 31, 2006.

The
unaudited condensed consolidated financial statements include the accounts of the Company
and its subsidiaries, MTSP, MTS Limited and BAF, which was acquired in February 2006. All
other subsidiaries of the Company did not have operations during the three-month periods
ended June 30, 2006 and 2005.

# NOTE B  INVENTORIES

The
components of inventory consist of the following:

|                                     | June 30, 2006  |   | March 31, 2006
|------------------------------------ | -------------- | - | --------------
|
|                                     | (In Thousands)
|
|Raw Materials                        |                | $ | 2,583         
|Finished Goods and Work in Progress  |                |   | 3,096         
|Less:  Inventory Valuation Allowance |                |   | (237          
|
|                                     |                | $ | 5,442         
|

5

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Table of Contents

# NOTE C  EARNINGS
PER SHARE

Basic
earnings per share is calculated by dividing net income available to common stockholders
by the weighted average number of shares of common stock outstanding for the period and
any warrants outstanding that are exercisable at a de minimus amount. Diluted earnings per
share is calculated by dividing net income before preferred stock dividends by the basic
weighted average number of shares of common stock outstanding for the period, adjusted for
the dilutive effect of common stock equivalents, using the treasury stock
method and the if converted method as it relates to the convertible preferred
stock outstanding.

The
following table sets forth the computation of income per basic and diluted common share:

|                                                                              | Three Months Ended June 30,             
|----------------------------------------------------------------------------- | ----------------------------------------
|
|
|
|                                                                              | (In Thousands; Except Per Share Amounts)
|
|Numerator:                                                                    |                                         
|Net Income Before Preferred
        Stock Dividends                           |                                         
|Convertible Preferred
        Stock Dividend                                  |                                         
|
|Net Income Available to Common
        Stockholders                           |                                         
|
|Denominator:                                                                  |                                         
|Weighted Average
        Shares Outstanding  Basic                           |                                         
|Add: Effect of Dilutive
        Warrants and Options                          |                                         
|Effect of Conversion of
        Convertible Preferred Stock into Common Stock |                                         
|
|Weighted Average Shares
        Outstanding  Diluted                         |                                         
|
|Net Income Per Common Share  Basic                                           |                                         
|
|Net Income Per Common Share  Diluted                                         |                                         
|

Certain
provisions of the convertible preferred stock issued in June 2002 may result in the
issuance of additional common shares at some future date if certain events occur. Since
these events have not yet occurred, and therefore the number of additional shares is not
known, no additional shares have been included in the earnings per share calculation (see
Note G).

The
effect of 249,000 and 422,000 options were not included in the calculation of net income
per diluted common share for the three months ended June 30, 2006 and 2005, respectively,
as the effect would have been anti-dilutive.

# NOTE D 
SHARE-BASED COMPENSATION

The
Company awards share-based compensation as an incentive for employees to contribute to the
Companys long-term success. Historically, the Company has issued options and
restricted stock. At June 30, 2006, the Company had 2,100,000 shares of common stock
authorized for awards of share-based compensation under its Stock Incentive Plan (the
Plan). As of June 30, 2006, options to purchase 1,007,000 shares were
outstanding and 222,100 options were available for issuance under the Plan.

6

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On
April 1, 2006, the Company adopted Statement of Financial Accounting Standards 123(R),
Share-Based Payment. Accordingly, the Company is now recognizing share-based compensation
expense for all awards granted to employees, which is based on the fair value of the award
on the date of grant. The Company adopted FAS No. 123(R) under the modified
prospective transition method and, consequently, prior period results have not been
restated. Under this transition method, in fiscal 2007, the Companys reported
share-based compensation expense will include expense related to share-based compensation
awards granted subsequent to April 1, 2006, which is based on the grant date fair value
estimated in accordance with the provisions of FAS No. 123(R), as well as any
unrecognized compensation expense related to non-vested awards that were outstanding as of
the date of adoption. Prior to April 1, 2006, the Company applied APB Opinion No. 25
Accounting for Stock Issued to Employees in accounting for its employee
share-based compensation and applied FAS No. 123 Accounting for Stock Issued to
Employees for disclosure purposes only. Under APB 25, the intrinsic value method was
used to account for share-based employee compensation plans and compensation expense was
not recorded for awards granted with no intrinsic value. The FAS No. 123 disclosures
include pro forma net earnings (loss) and earnings (loss) per share as if the fair
value-based method of accounting had been used. Determining the appropriate fair value
model and calculating the fair value of share-based compensation awards requires the input
of certain highly complex and subjective assumptions, including the expected life of the
share-based compensation awards, the Companys common stock price volatility, and the
rate of employee forfeitures. The assumptions used in calculating the fair value of
share-based compensation awards represent managements best estimates, but these
estimates involve inherent uncertainties and the application of judgment. As a result, if
factors change and the Company deems it necessary to use different assumptions,
share-based compensation expense could be materially different from what has been recorded
in the current period.

For
the three months ended June 30, 2006, the Company recorded $34,316 of pre-tax
share-based compensation expense under FAS No. 123(R), recorded in selling and
administrative expense in the Condensed Consolidated Statement of Operations. This expense
was offset by an $11,877 deferred tax benefit for non-qualified sharebased
compensation.

Share-Based Compensation
Awards

The
following disclosures provide information regarding the Companys share-based
compensation awards, all of which are classified as equity awards in accordance with FAS
No. 123(R):

| | Restricted Stock Awards  The Company grants restricted stock to certain executive
employees in exchange for services performed, which is based on the terms of their
respective employment agreements. The restricted shares issued are valued based on the
value of the Companys common stock on the date of grant. During the three months
ended June 30, 2006 and 2005, the Company issued 5,000 shares of restricted common stock
to its Chief Operating Officer as additional compensation under his employment agreement.
The Company recorded share-based compensation expense in the amount of $30,750 ($18,873
net of tax) and $29,250 ($18,194 net of tax) during the three months ended June 30, 2006
and 2005, respectively, based on the fair value of the shares at the date of grant.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Stock Options and Warrants  The Company grants stock options to employees that allow
them to purchase shares of the Companys common stock. Options are also granted to
outside members of the Board of Directors of the Company. The Company determines the fair
value of stock options at the date of grant using the Black-Scholes valuation model.
Options generally vest immediately, however, the Company has granted options that vest
over three years. No options were granted during the three months ended June 30, 2006,
however, certain options awarded prior to March 31, 2006 vested during the three months
ended June 30, 2006. Awards generally expire ten years after the date of grant. The
Company issues new shares upon the exercise of stock options and warrants.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company has 5,900 warrants outstanding as of June 30, 2006. These warrants were issued in
1998 and no new warrants have been issued since that time. There has been no activity
relating to the warrants in the three months ended June 30, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

7

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During
the three-month period ended June 30, 2006, the Company received $7,235 in cash from
stock option exercises. No tax benefit was recognized for these exercises, as the options
exercised were qualified incentive stock options. As of June 30, 2006, the Company has
unrecognized compensation cost of approximately $29,000 expected to be recognized over the
next two years for share-based awards granted prior to April 1, 2006.

A
summary of the changes in total stock options outstanding during the three months ended
June 30, 2006 follows:

|                              |  |           |   |  | Weighted Average
|----------------------------- |  | --------- | - |  | ----------------
|
|
|
|
|Outstanding at March 31, 2006 |  | 1,048,600 |   |  | $               
|Options Granted:              |  |          
|Officers and Directors        |  |          |   |  |                 
|Employees                     |  |          |   |  |                 
|Options Exercised             |  | (3,100    | ) |  | $               
|Options Expired               |  | (38,500   | ) |  | $               
|
|Outstanding at June 30, 2006  |  | 1,007,000 |   |  | $               
|

Outstanding Shares

|                |  |         |  | Weighted Average |  |      
|--------------- |  | ------- |  | ---------------- |  | -----
|
|
|
|$1.45 -   $2.30 |  | 269,000 |  | 4.8              |  | $1.59
|$2.50 -   $5.00 |  | 271,500 |  | 4.2              |  | $3.08
|$5.60 - $12.45  |  | 466,500 |  | 9.0              |  | $6.37

Exercisable Shares

|                |  |         |  | Weighted Average |  |      
|--------------- |  | ------- |  | ---------------- |  | -----
|
|
|
|$1.45 -   $2.30 |  | 269,000 |  | 4.8              |  | $1.59
|$2.50 -   $5.00 |  | 239,500 |  | 3.8              |  | $2.96
|$5.60 - $12.45  |  | 466,500 |  | 9.0              |  | $6.37

Warrants

|                              |  |       | Weighted Average
|----------------------------- |  | ----- | ----------------
|
|
|
|Outstanding at March 31, 2006 |  | 5,900 |                 
|Warrants Granted              |  |      |                 
|Warrants Exercised            |  |      |                 
|Warrants Expired              |  |      |                 
|
|Outstanding at June 30, 2006  |  | 5,900 |                 
|

8

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At
June 30, 2006, exercisable options had aggregate intrinsic values of approximately
$1,801,000. At June 30, 2006, exercisable warrants had aggregate intrinsic values of
approximately $25,000.

Options
exercised during the three-month period ended June 30, 2006, had intrinsic values of
approximately $12,000. The Company did not grant any options during the three months ended
June 30, 2006. The weighted average grant date fair value for options issued during the
three months ended June 30, 2006 and 2005 was $0 and $3.99, respectively. The weighted
average grant date fair value of the Companys options to which share-based
compensation expense was recognized during the three months ended June 30, 2006 was
$2.38. The fair values were estimated on the date of the grant using the Black-Scholes
valuation model with the following weighted-average assumptions:

|                                    | Three Months Ended June 30,
|----------------------------------- | ---------------------------
|
|
|
|
|
|Expected Dividend Yield (1)         |                            
|Expected Stock Price Volatility (2) |                            
|Risk-Free Interest Rate (3)         |                            
|Expected Life in Years (4)          |                            

---

|(1) | The
dividend yield assumption is based on the history and expectation of the Companys
dividend payouts. The Company has not paid dividends in the past and is
prohibited from paying dividends without the consent of its secured lender.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The
determination of expected stock price volatility for options granted was based
on historical MTS common stock prices over a period commensurate with the
expected life of the option.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | The
risk-free interest rate is based on the yield of a U.S. treasury bond with a
similar maturity as the expected life of the options.
|--- | --------------------------------------------------------------------------------------------------------------------------------------

|(4) | The
expected life in years for options granted during the three months ended June
30, 2006 and 2005 was based on the historical exercise patterns experienced by
the Company.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

On
February 24, 2005, in response to FAS No. 123(R), the Compensation Committee of the
Companys Board of Directors approved accelerating the vesting of options to acquire
205,000 shares of the Companys stock, which accounted for all outstanding options
with an exercise price of $6.50 per share or greater. All of these options were
in-the-money and all were held by two executive officers and one employee. An option was
considered in-the-money if the stated option exercise price was less than $6.55, the
closing price of the Companys common stock on the day the Compensation Committee
approved the acceleration. The accelerated vesting was effective as of the close of
business on February 24, 2005. The acceleration of these options resulted in a charge in
the Companys quarter ended March 31, 2005 of approximately $10,250. The decision to
accelerate vesting of these options was made primarily to avoid recognizing compensation
cost in the statement of earnings in future financial statements upon the effectiveness of
FAS No. 123(R). It is estimated that the maximum future share-based compensation expense
that was avoided, based on the Companys implementation date for FAS No. 123(R) of
April 1, 2006, is approximately $582,000, all of which is related to options that were
held by two executive officers and one employee of the Company. Options granted in the
fiscal year ended March 31, 2006 vested on the grant date.

9

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Table of Contents

The
impact of FAS No. 123(R), if it had been in effect, on the net income and related per
share amounts of each of our years ended March 31, 2006, 2005 and 2004 was disclosed in
Note 2, Stock-based employee compensation included in our Form 10-K for the year
ended March 31, 2006. Reported net earnings for the three months ended June 30, 2006 and
2005, adjusting for share-based compensation that would have been recognized if FAS
No. 123(R) had been followed, is as follows:

|                                                                                                               | Three Months Ended June 30,             
|-------------------------------------------------------------------------------------------------------------- | ----------------------------------------
|
|
|
|                                                                                                               | (In Thousands; Except Per Share Amounts)
|
|Net Income as Reported                                                                                         |                                         
|
|Add:  Total share-based
        employee compensation programs reported as expense, net of related tax effects |                                         
|
|Deduct:  Total share-based
        employee compensation expense determined under fair value-based             |                                         
|method for all
        awards, net of related tax effects                                                      |                                         
|
|Pro Forma Net Income                                                                                           |                                         
|
|Net Income per Common Share:                                                                                   |                                         
|Basic  as reported                                                                                            |                                         
|Basic  pro forma                                                                                              |                                         
|Diluted  as reported                                                                                          |                                         
|Diluted  pro forma                                                                                            |                                         

# NOTE E  LONG-TERM
DEBT

|                                                                                                                               | June 30, 2006  |   | June 30, 2005
|------------------------------------------------------------------------------------------------------------------------------ | -------------- | - | -------------
|
|                                                                                                                               | (In Thousands)
|
|Revolving line of credit due June
        2007; interest payable monthly at 1% above the prime rate (8.25% at June 30, 2006)   |                | $ | 1,868        
|
|Bank term loan payable in graduated monthly
        installments of $32,000 -$52,000 plus interest at 0.50% above              |                |   |              
|the prime rate (8.25% at June 30, 2006) through June 2007                                                                      |                |   | 656          
|
|Note payable to related party payable in
        monthly installments of $28,785 including interest at 6.25% through July 2008 |                |   | 666          
|
|Capital leases expiring at various times
        through fiscal year 2010 at interest rates ranging from 6.29% to 9.5%         |                |   | 308          
|
|Other Notes and Agreements                                                                                                     |                |   | 7            
|
|Total Long-Term Debt                                                                                                           |                |   | 3,505        
|
|Less Current Portion (including $313,000
        and $308,000, respectively due to a related party)                            |                |   | (2,938       
|
|Long-Term Debt Due After One Year                                                                                              |                | $ | 567          
|

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The
revolving line of credit and bank term loans are collateralized by a first security
interest in all of the assets of the Company. The revolving line of credit matures in June
2007. Accordingly, the entire outstanding balance on the line has been classified as
current as of June 30, 2006.

There
was approximately $1.9 million borrowed and an additional $4.6 million available on the
Companys revolving line of credit at June 30, 2006 based upon eligible collateral.

The
revolving line of credit and bank term loans contain provisions that require the Company
to maintain certain financial covenants that, among other things, require the maintenance
of tangible net worth and debt service coverage ratios, limit the amount of capital
expenditures and require lender approval for certain matters. The Company was in
compliance with all provisions of the loan agreements as of June 30, 2006 and March 31,
2006.

At
June 30, 2006, the Company also had a $1,000,000 line of credit available for purchases of
equipment at an interest rate of prime plus 0.75%. Advances on the line of credit are
repayable over a three-year term. There were no amounts outstanding on this line of credit
at June 30, 2006 or March 31, 2006.

# NOTE F 
CONTINGENCIES

In
November 1998, Medical Technology Laboratories, Inc. (MTL), a discontinued
operation, received a refund request in the amount of $1.8 million from Medicare Program
Safeguards (MPS). MTL disputed the refund request in its response to MPS in
December 1998. To date, MTL has not received any further correspondence from MPS regarding
this matter.

The
Company is involved in certain claims and legal actions arising in the ordinary course of
business including the matter referred to above. There can be no assurances that these
matters will be resolved on terms acceptable to the Company. In the opinion of management,
based upon advice of counsel and consideration of all facts available at this time, the
ultimate disposition of these matters is not expected to have a material adverse effect on
the financial position, results of operations or liquidity of the Company.

# NOTE G 
STOCKHOLDERS EQUITY

In
June 2002, the Company issued 2,000 shares of convertible preferred stock at $1,000 per
share. The holders of the convertible preferred stock are entitled to receive quarterly
dividends at the rate of 11% per annum. The dividends are payable in cash or shares of
convertible preferred stock at the Companys option and are cumulative. Through the
period ended June 30, 2006, all dividends were paid in cash. Based on a conversion price
of $2.36 per share, the preferred stock is convertible into 847,457 shares of the
Companys common stock. The terms of the convertible preferred stock agreement
contains certain anti-dilution provisions and also contains a make-whole provision that
obligates the Company to pay certain amounts to the holder of the convertible preferred
stock if they do not ultimately receive an amount equal to the price per share of the
common stock on the date they exercise their right to convert the convertible preferred
stock into common stock.

The
make-whole provision and certain anti-dilution provisions also represent a contingent
beneficial conversion feature of the convertible preferred stock. The effect of this
feature may result in the issuance of additional shares of common stock at some future
date; however, since the issuance of these shares is contingent on future events, the
effect of this feature will be recorded at the time the events occur. In addition, if the
holder of the preferred stock receives a certain multiple of its investment once the
convertible preferred shares are converted into common stock and the common stock is
subsequently sold, the make-whole provision is no longer applicable.

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In
the event that the Company is required to make payments to the holders of the convertible
preferred stock, it may elect to issue additional convertible preferred stock in lieu of a
cash payment. Although the make-whole provision and other provisions of the convertible
preferred stock agreement provide for a maximum of 12,500,000 shares of common stock that
may be issued pursuant to those provisions, based upon current conditions, the Company
believes it is unlikely that the maximum number of shares would be issued.

During
the three months ended June 30, 2006 and 2005, the Company issued 5,000 shares of
restricted common stock to its Chief Operating Officer as additional compensation under
his employment agreement.  The Company recorded compensation expense in the amount of
$30,750 ($18,873 net of tax) and $29,250 ($18,194 net of tax) during the three months
ended June 30, 2006 and 2005, respectively, based on the fair value of the shares at the
grant date.

# NOTE H  OTHER
ASSETS

Other
assets consist of the following:

|                                           | Amortization Period |        | June 30, |   | March 31,
|------------------------------------------ | ------------------- | ------ | -------- | - | ---------
|
|
|                                           | (In Thousands)     
|
|Product Development                        |                     | 3  5  |          | $ | 3,373    
|Less:  Accumulated
         Amortization   |                     |        |          |   | (1,835   
|
|                                           |                     |        |          | $ | 1,538    
|
|
|Patents                                    |                     | 5  17 |          | $ | 2,472    
|Less:  
        Accumulated Amortization   |                     |        |          |   | (1,638   
|
|                                           |                     |        |          | $ | 834      
|
|
|Financing Costs                            |                     | 3  5  |          | $ | 132      
|Less:  
          Accumulated Amortization |                     |        |          |   | (78      
|
|                                           |                     |        |          | $ | 54       
|
|
|Other                                      |                     | 5      |          | $ | 107      
|Less:  
          Accumulated Amortization |                     |        |          |   |         
|
|                                           |                     |        |          | $ | 107      
|
|Total Other Assets, Net                    |                     |        |          | $ | 2,533    
|

All
of the Companys other assets are pledged as collateral on bank notes.

# NOTE I  RECENT
ACCOUNTING PRONOUNCEMENTS

In
November 2004, the FASB issued SFAS 151, Inventory Costs, an amendment of ARB No. 43,
which is effective for inventory costs incurred by the Company beginning fiscal year 2006.
The amendments made by SFAS 151 will improve financial reporting by clarifying that
abnormal amounts of idle facility expense, freight, handling costs, and wasted materials
(spoilage) should be recognized as current-period charges and by requiring the allocation
of fixed production overheads to inventory based on the normal capacity of the production
facilities. The adoption of SFAS 151 did not have a significant effect on the
Companys financial statements.

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In
July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes, an Interpretation of FASB Statement No. 109, (FIN 48). FIN
48 prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken in a tax return. The Company
must determine whether it is more-likely-than-not that a tax position will be
sustained upon examination, including resolution of any related appeals or litigation
processes, based on the technical merits of the position. Once it is determined that a
position meets the more-likely-than-not recognition threshold, the position is measured to
determine the amount of benefit to recognize in the financial statements. FIN 48 applies
to all tax positions related to income taxes subject to FASB Statement No. 109,
Accounting for Income Taxes.The Company anticipates adopting the provisions of
this interpretation on April 1, 2007 and is currently assessing the impact of FIN 48 on
its consolidated financial statements.

# NOTE J  SEGMENT
INFORMATION

The
individual subsidiaries comprising the Company operate predominantly in a single industry
as manufacturers of consumable medication punch cards, packaging equipment and ancillary
products. The Company has operations in the United States and subsidiaries in the United
Kingdom. In computing operating profit for foreign subsidiaries, allocations of general
corporate expenses have been made and intercompany sales were recorded at values that
approximate fair value exchanges between unrelated parties. Management evaluates the
Companys business performance on a geographic basis.

Total
assets of the foreign subsidiaries are those assets related to the operations of those
companies. United States total assets consist of all other operating assets of the
Company. Segment information is as follows:

|                                 | United States |  | United Kingdom |        | Elimination |   | Consolidated
|-------------------------------- | ------------- |  | -------------- | ------ | ----------- | - | ------------
|
|
|
|Three Months Ended June 30, 2006 |               |  |                |        |             |   |             
|
|Sales to Unaffiliated Customers  |               |  | $              | 10,013 |             | $ | 1,503       
|Intercompany Sales               |               |  | $              | 558    |             | $ |            
|Operating Income                 |               |  | $              | 953    |             | $ | (89         
|Total Assets                     |               |  | $              | 18,349 |             | $ | 4,269       
|Depreciation and Amortization    |               |  | $              | 507    |             | $ | 45          
|Capital Expenditures             |               |  | $              | 287    |             | $ | 22          
|
|Three Months Ended June 30, 2005 |               | 
|
|Sales to Unaffiliated Customers  |               |  | $              | 8,448  |             | $ | 1,048       
|Intercompany Sales               |               |  | $              | 477    |             | $ |            
|Operating Income                 |               |  | $              | 425    |             | $ | 138         
|Total Assets                     |               |  | $              | 19,921 |             | $ | 1,695       
|Depreciation and Amortization    |               |  | $              | 427    |             | $ | 9           
|Capital Expenditures             |               |  | $              | 195    |             | $ | 2           

Sales
to Canada have been included in the United States because they are not material.

Net
foreign currency gains reflected in results of operations were immaterial for the three
months ended June 30, 2006 and 2005. Operating income is total sales and other operating
income less operating expenses. Segment operating income does not include interest expense
and net miscellaneous income/expense.

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# MTS MEDICATION
TECHNOLOGIES, INC. AND SUBSIDIARIES  MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2006

# Item 2.   
Managements Discussion And Analysis Of Financial Condition And Results Of Operations

References
in this Form 10-Q to the Company, MTS, we,
our or us means MTS Medication Technologies, Inc., together with
its subsidiaries, except where the context otherwise indicates. This Form 10-Q contains
forward-looking statements within the meaning of that term in Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Additional
written or oral forward-looking statements may be made by us from time to time, in filings
with the Securities and Exchange Commission or otherwise. Statements contained herein that
are not historical facts are forward-looking statements made pursuant to the safe harbor
provisions described above. Forward-looking statements may include, but are not limited
to, projections of revenues, income or losses, capital expenditures, plans for future
operations, the elimination of losses under certain programs, financing needs or plans,
compliance with financial covenants in loan agreements, plans for sale of assets or
businesses, plans relating to our products or services, assessments of materiality,
predictions of future events and the effects of pending and possible litigation, as well
as assumptions relating to the foregoing. In addition, when used in this discussion, the
words anticipates, estimates, expects,
intends, believes, plans and variations thereof and
similar expressions are intended to identify forward-looking statements.

Forward-looking
statements are inherently subject to risks and uncertainties, some of which cannot be
predicted or quantified based on current expectations. Consequently, future events and
actual results could differ materially from those set forth in, contemplated by, or
underlying the forward-looking statements contained herein. Statements in Quarterly
Reports, particularly in Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations and Notes to Condensed Consolidated
Financial Statements, describe factors, among others, that could contribute to or cause
such differences. Other factors that could contribute to or cause such differences
include, but are not limited to, unanticipated increases in operating costs, labor
disputes, capital requirements, increases in borrowing costs, product demand, pricing,
market acceptance, intellectual property rights and litigation, risks in product and
technology development and other risk factors detailed in our Securities and Exchange
Commission filings. In particular any comments regarding possible default waivers related
to our loan agreement are forward-looking statements.

Readers
are cautioned not to place undue reliance on any forward-looking statements contained
herein, which speak only as of the date hereof. We undertake no obligation to publicly
release the result of any revisions of these forward-looking statements that may be made
to reflect events or circumstances after the date hereof or to reflect the occurrence of
unexpected events.

# Summary of Results

Our
net sales in the first quarter ended June 30, 2006 was $11.5 million compared with $9.5
million in the same period of the prior year. Net sales from sales of our consumable
products to existing and new customers increased approximately 13%, and net sales
associated with our prepack machines increased approximately 8%. Sales of our OnDemand®
machines increased approximately 166%. We believe the net sales increase in our consumable
products is the result of: (1) increased penetration of independent pharmacies; (2) growth
in market demands due to the aging demographics of the U.S. population; (3) a continued
shift toward punch-card use; and (4) growth in international markets. Our net sales in the
United Kingdom was up approximately 43% this quarter compared to the quarter ended June
30, 2005 primarily due to the net sales associated with BAF, which we acquired in February
2006.

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The
following table sets forth, for the three-month periods indicated, certain key operating
results and other financial information.

|                                            | Three Months Ended June 30,             
|------------------------------------------- | ----------------------------------------
|
|
|
|                                            | (In Thousands; Except Per Share Amounts)
|
|Net Sales                                   |                                         
|Gross Profit                                |                                         
|Operating Income                            |                                         
|Net Income Available to Common Stockholders |                                         
|Net Income Per Common Share - Diluted       |                                         

# ESTIMATES AND CRITICAL
ACCOUNTING POLICIES

The
preparation of our consolidated financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the date of
the financial statements and revenue and expenses for the respective period-ended for such
statements. The determination of estimates requires the use of judgment since future
events and their affect on our operations cannot be determined with absolute certainty.
Actual results typically differ from these estimates in some fashion, and at times, these
variances may be material to our financial statements. Our management continually
evaluates its estimates and assumptions, which are based on historical experience and
other factors that are believed to be reasonable under these circumstances. These
estimates and our actual results are subject to the risk factors listed under Item
1. Business in our Form 10-K for the year ended March 31, 2006. Nevertheless, our
management believes the following items involve a higher degree of complexity and,
judgment and therefore, has commented on these items below.

Consolidation

The
consolidated financial statements include the accounts of the Company and its
subsidiaries, MTSP, MTS Limited and BAF. All significant inter-company accounts and
transactions have been eliminated in consolidation.

Revenue Recognition

The
Company recognizes revenue on the sale of machines, other than OnDemand machines, and all
consumables when title and risk of loss to the products shipped has transferred to the
customer. The Company recognizes revenue related to the sale of its OnDemand machines as
prescribed in SOP 97-2 Software Revenue Recognition because the software
component of the OnDemand machine is significant and not incidental to the value and
functionality of the machine. In addition, the sale of an OnDemand machine represents an
arrangement that encompasses multiple deliverables and therefore each deliverable
represents a separate unit of accounting. The separate deliverables are comprised of (a)
the OnDemand machine installed at the customers location; (b) the user training; (c)
certain component parts that are sold separately, principally cassettes that hold
medications; and (d) maintenance. These separate deliverables are incidental to the
functionality of the machine. The vendor specific objective evidence (VSOE) of fair value
of the deliverables outlined in (b-d) has been determined based upon the value of these
deliverables if they were sold separately. The fair value of the deliverable outlined in
(a) has been determined using the residual method which equals the total selling price of
the OnDemand machine, including installation, training and cassettes, less the aggregate
fair value of (b-d). The terms of the sale arrangement for an OnDemand machine is
typically FOB shipping point, at which time title and risk of loss transfers to the
customer, however, because the installation of the machine is essential to the
functionality of the machine the recognition of any of the revenue associated with the
machine is deferred until the machine is installed. For those cassettes that are provided
to the customer after the OnDemand machine is installed, the revenue associated with those
cassettes is recognized upon their delivery. When the training is performed, the Company
recognizes the revenue associated with the training.

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Revenue
includes certain amounts invoiced to customers for freight and handling charges. The
Company includes the actual cost of freight and handling incurred in cost of sales.

Revenue
is reported net of rebates and discounts provided to customers. Rebates are generally
determined based upon pricing agreements that offer certain customers incentives to
purchase products from the Company. Discounts are provided from time to time primarily to
compensate customers for inconveniences caused by late shipments, defective product or
pricing errors. Rebates and discounts were $320,000 and $379,000 for the three months
ended June 30, 2006 and 2005, respectively. Rebates and discounts are recorded at the time
they are earned by the customer.

Accounts Receivable

Trade
accounts receivable are recorded based upon the invoiced amount, are generally not
interest bearing and are considered past due when full payment is not received by the
specified credit terms. The Company does not typically require collateral when granting
credit; however, customer credit worthiness is reviewed prior to granting credit. The
Company normally estimates the uncollectibility of its accounts receivable. The Company
considers many factors when making its estimates, including analyzing accounts receivable
and historical bad debts, customer concentrations, customer credit worthiness, current
economic trends and changes in its customer payment terms when evaluating the adequacy of
the reserve for uncollectible accounts. The Company reviews the status of its accounts
monthly, assessing the customers ability to pay. When a specific account is deemed
uncollectible, the account is written off against the reserve for uncollectible accounts.
As of June 30, 2006 and March 31, 2006, the Company has established an allowance for
doubtful accounts of approximately $217,000 and $236,000, respectively, to account for
estimated uncollectible accounts.

Inventories

Inventories
are stated at the lower of cost or market. Cost is determined by the first-in, first-out
(FIFO) method. The elements of costs included in the valuation of inventory
are the direct costs associated with materials purchased, direct labor expended to
manufacture the inventory and an allocation of general overhead expenses incurred to
operate the manufacturing facilities. The allowance for inventory obsolescence and slow
moving inventory is reviewed on a regular basis. The Company reviews various information
related to the age and turnover of specific inventory items to assist its assessment. As
of June 30, 2006 and March 31, 2006, we established an inventory valuation allowance of
approximately $237,000 and $192,000, respectively, to account for the estimated loss in
value of inventory due to obsolescence.

Self-Insurance Plan
Reserve

The
Company has a medical health benefit self-insurance plan, which covers substantially all
of its employees. During the year ended March 31, 2006, the Company was reinsured for
claims that exceed $50,000 per participant and an annual maximum aggregate limit of
approximately $783,000. Reinsurance limits for the fiscal year ending March 31, 2007 were
raised to $100,000 per participant and $898,000 in the aggregate. Future claims experience
may affect the reinsurance limits that may be available to the Company in subsequent
fiscal years. The Company has established a reserve of approximately $74,000 and $90,000
at June 30, 2006 and March 31, 2006, respectively, for all unpaid claims incurred and
reported during the quarter ended June 30, 2006 and the fiscal year March 31, 2006.
Self-insured medical claims costs incurred during the periods ended June 30, 2006 and June
30, 2005 totaled approximately $160,000 and $85,000, respectively.

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Income Taxes

Income
taxes are provided for under the liability method in accordance with FASB No. 109,
Accounting for Income Taxes, whereby deferred tax assets are recognized for
deductible temporary differences and operating loss and tax credit carryforwards and
deferred tax liabilities are recognized for taxable temporary differences. Temporary
differences are the differences between the reported amounts of assets and liabilities and
their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion or all of the deferred
tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.

Our
deferred tax asset is comprised primarily of a tax loss carryforward. We believe that it
is more likely than not that the income tax benefits associated with the tax loss
carryforward will be realized in the future. Management bases this belief, in part, on the
historical profitability of its operations and its expectations that profitable operations
will continue in the future. Based upon these expectations regarding the realization of
the tax benefits, management has not established a valuation allowance for its deferred
tax asset.

Goodwill and Other
Intangible Assets

The
Company follows SFAS No. 142, Goodwill and Other Intangible Assets, and
accordingly will not amortize goodwill, but will annually review it for impairment. Any
impairment charges related to goodwill will not be deductible for tax purposes. Other
intangible assets acquired in the BAF acquisition are amortized on a straight-line basis
over a period ranging from seven to fifteen years, the estimated useful life of the
assets.

Valuation of Long-Lived
Assets and Certain Identifiable Intangibles

Long-lived
assets and certain identifiable intangibles that are held and used by the Company are
reviewed for impairment whenever events or changes in circumstance indicate that the
carrying amount of these assets may not be recoverable in accordance with Financial
Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. In
performing the review for recoverability, the Company estimates the future cash flows
expected to result from the use of the assets and their eventual disposition. If the sum
of the expected future cash flows is less than the carrying amount of the assets, an
impairment loss is recognized based on a discounted cash flow analysis. Management
believes no impairment loss existed for any of the periods presented.

Product Development

All
costs incurred subsequent to the completion of research and development activities
associated with a products hardware components and the software components
achievement of technological feasibility are capitalized until the product is available
for general release to customers. Product development costs are generally amortized over a
five-year period beginning on the date the product is released for sale to customers. On a
quarterly basis, we review the viability and recoverability of these project costs.

Estimated Liabilities

We
make a number of estimates in the ordinary course of business. Historically, past changes
to these estimates have not had a material impact on our financial condition. However,
circumstances could change, which would alter future financial information based upon a
change in estimated-vs.-actual results.

We
are subject to various matters of litigation in the ordinary course of business. As the
outcome of any litigation is unknown, management estimates the potential amount of
liability, if any, in excess of any applicable insurance coverage, based on historical
experience and/or the best estimate of the matter at hand. Significant changes in
estimated amounts could occur. To date, we have not had to pay any legal settlements in
excess of existing insurance coverage.

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Warranty

We
establish a reserve for warranty costs we may incur during the warranty period that is
provided for in the OnDemand machine sales agreements (generally six months) with our
customers. Warranty and service costs incurred during the periods ended June 30, 2006 and
2005 totaled approximately $85,000 and $40,000, respectively.

Foreign Currency
Transactions and Translation

For
the Companys foreign subsidiaries that use a currency other than the U.S. dollar as
their functional currency, assets and liabilities are translated at exchange rates in
effect at the balance sheet date, and revenue and expenses are translated at the average
exchange rate for the period. The effects of these translation adjustments are reported in
other comprehensive income. Gains and losses arising from transactions denominated in a
currency other than the functional currency of the entity involved are included in
operating income.

# RESULTS OF OPERATIONS

Three Months Ended June
30, 2006 and 2005

Net
sales for the three months ended June 30, 2006 increased 21.3% to $11.5 million compared
with $9.5 million during the same period of the prior year. Net sales increased for
consumable punch cards and machines sold primarily because of additional sales made to
existing customers. In addition, revenue associated with the sale of OnDemand machines was
$667,000 during the three months ended June 30, 2006 compared with $250,000 during the
same period of the prior year. Average selling prices for disposable products were
slightly higher during the first quarter of fiscal 2007 compared with the same period of
the prior fiscal year.

Cost
of sales for the three months ended June 30, 2006 was $7.2 million compared with $5.8
million during the same period of the prior year. Cost of sales as a percentage of sales
increased to 62.6% from 61.2% during the same period of the prior year. Cost of sales as a
percentage of sales increased primarily because of higher factory overhead costs, as well
as increases in the cost of materials used to manufacture consumable products and
machines.

Selling,
general and administration expenses for the three months ended June 30, 2006 increased
11.9% to $3.0 million from $2.6 million of the prior year primarily due to costs
associated with product management, automation support and general administrative and
selling costs incurred by BAF.

Depreciation
and amortization expenses for the three months ended June 30, 2006 increased 26.6% to
$552,000 from $436,000 during the same period of the prior year. The increase resulted
primarily from increased depreciation and amortization associated with capital
expenditures made to our new facility.

Interest
expense for the three months ended June 30, 2006 decreased 28.9% to $63,000 from $90,000
during the same period of the prior fiscal year. The decrease results primarily from lower
levels of debt, partially offset by higher interest rates.

Income
tax expense increased 59.0% to $275,000 during the three months ended June 30, 2006
compared with $173,000 during the same period of the prior fiscal year. The increase
results from the fact that our net income before tax increased and our effective tax rate
increased to 38.6% from 34.6%. Our effective tax rate increased as a result of potential
liabilities in certain states that we have not previously filed tax returns. In addition,
provision has been made, during the three months ended June 30, 2006, for estimated
permanent differences between net income reported in our financial statements and our
taxable net income.

18

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# LIQUIDITY AND CAPITAL
RESOURCES

During
the three months ended June 30, 2006, we had net income before preferred stock dividends
of $437,000 compared with $327,000 during the same period of the prior fiscal year. Cash
provided by operations was approximately $1.3 million during the three months ended June
30, 2006 and 2005. We had working capital of $5.9 million at June 30, 2006.

Investing
activities used $439,000 during the three months ended June 30, 2006 compared with
$363,000 during the same period of the prior fiscal year. The increase results primarily
from an increase in expenditures for manufacturing equipment and information technology
upgrades.

Financing
activities used $710,000 during the three months ended June 30, 2006 compared with $1.1
million during the same period of the prior fiscal year. The decrease results primarily
from lower pay-downs on the revolving line of credit.

Our
short-term and long-term liquidity is primarily dependent on our ability to generate cash
flow from operations. Inventory levels may change significantly if we are successful in
selling our OnDemand machines. Increases in net sales may result in corresponding
increases in accounts receivable. Cash flow from operations and borrowing availability on
the revolving line of credit is anticipated to support an increase in accounts receivable
and inventory.

We
have new product development projects underway, principally new versions of our OnDemand
machine and our MedLocker system, that are expected to be funded by cash flow from
operations. These projects are monitored on a regular basis to attempt to ensure that the
anticipated costs associated with them do not exceed our ability to fund them from cash
flow from operations and other sources of capital.

There
was $1.9 million borrowed and an additional $4.6 million available on our revolving line
of credit at June 30, 2006 based upon eligible collateral.  In addition, we had $1,000,000 available on our
capital equipment line of credit.

The
revolving line of credit and term loans contain financial covenants that, among other
things, require us to maintain certain financial ratios, tangible net worth and limits the
amount of capital expenditures we can make. We were in compliance with all provisions of
the loan agreements at June 30, 2006 and March 31, 2006.

We
believe that the cash generated from operations during this fiscal year, and amounts
available on our revolving line of credit and our capital equipment line of credit, will
be sufficient to meet our capital expenditures, product development, working capital needs
and the principal payments required by our term loan agreements.

# Item 3.   Quantitative and
Qualitative Disclosures About Market Risk

The
Company is exposed to the impact of interest rate changes as borrowings under its Senior
Credit Agreement bear interest at variable interest rates. The Company does not currently
actively manage this interest rate risk exposure. A 1% change in interest rates up or down
would have affected the Companys statement of operations on an annual basis by
approximately $25,000 at the variable-rate outstanding level of debt at June 30, 2006.

In
addition, the Company is exposed to foreign rate changes of the British Pound as it
impacts the net asset value of its subsidiaries located in the United Kingdom. The Company
does not currently actively manage this foreign currency exchange rate risk exposure. The
Company believes that the exposure to foreign currency translation gains or losses is
minimal.

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# Item 4.    Controls and
Procedures

Evaluation of Disclosure
Controls and Procedures

Our
chief executive officer and chief financial officer are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) for MTS. Accordingly, our chief executive officer and chief financial
officer designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under their supervision, to ensure that material
information relating to MTS, including our consolidated subsidiaries, is made known to our
chief executive officer and chief financial officer by others within those entities. We
regularly evaluate the effectiveness of disclosure controls and procedures and report our
conclusions about the effectiveness of the disclosure controls quarterly on our Form 10-Q
and annually on our Form 10-K. Based upon the evaluation for the period ended June 30,
2006, for the reasons described below, our chief executive officer and chief financial
officer concluded that our disclosure controls and procedures were not effective, as of
the end of the period ended June 30, 2006 in ensuring that material information relating
to the Company required to be disclosed by the Company in reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms and that such information is
accumulated and communicated to management, including the chief executive officer and the
chief financial officer, as appropriate, to allow timely decisions regarding required
disclosure. Notwithstanding the material weaknesses described below, our management has
concluded that the Consolidated Financial Statements fairly state, in all material
respects, our financial condition, results of operations and cash flows for the periods
presented in conformity with generally accepted accounting principles.

Based
on the definition of material weakness in the Public Company Accounting
Oversight Boards Auditing Standard No. 2, An Audit of Internal Control Over
Financial Reporting Performed in Conjunction With an Audit of Financial
Statements, we have determined that a material weakness exists in our internal
controls over financial reporting related to the limited number of accounting personnel in
the Company. We disclosed this to our Audit Committee and to the independent registered
public accountants.

We
previously determined that a material weakness existed in the design or operation of
internal controls over financial reporting because we had not maintained effective
controls regarding the authorization and/or communication of selling terms provided to
customers. We have instituted manual controls during the period ended June 30, 2006 that
we believe have remediated this weakness.

Plan for Remediation of
Material Weaknesses Related to Accounting Personnel

The
Company has commenced a search for qualified personnel to fill a newly created position in
its accounting department. This position is expected to be filled in the near future. In
addition, the Company has determined that its operations in the United Kingdom require a
full-time financial controller. An appropriate candidate has been identified and is
expected to be employed in the near future.

Changes in Internal
Controls

There
has not been any change in our internal control over financial reporting identified in
connection with the evaluation that occurred, other than those changes described above,
during the three months ended June 30, 2006, that has materially affected, or is
reasonably likely to materially affect, those controls.

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Limitations on the
Effectiveness of Controls

Our
management, including our CEO and CFO, does not expect that our disclosure controls and
internal controls will prevent all error and all fraud. 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. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Due to the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, 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 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 occurring. There can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions; over time, a
control may become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate. Due to the inherent
limitations in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected.

CEO and CFO
Certifications

Exhibits
31.1 and 31.2 are Certifications of the CEO and the CFO, respectively. The Certifications
are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the
Section 302 Certifications). This Item of this report, which you are currently
reading, is the information concerning the Evaluation referred to in the Section 302
Certifications and this information should be read in conjunction with the Section 302
Certifications for a more complete understanding of the topics presented.

21

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Table of Contents

# PART II  OTHER
INFORMATION

# Item 6.   Exhibits

| | 31.1 | Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
| | ---- | ---------------------------------------------------------------------------------------------------------------------

| | 31.2 | Certification of the Vice President and Chief Financial  Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------

| | 32.1 | Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. §1350.
| | ---- | ---------------------------------------------------------------------------------------

| | 32.2 | Certification the Vice President and Chief Financial Officer pursuant to 18 U.S.C. §1350.
| | ---- | -----------------------------------------------------------------------------------------

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Table of Contents

# SIGNATURES

Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.

|                        | MTS MEDICATION TECHNOLOGIES, INC.
|----------------------- | ---------------------------------
|
|Date:   August 14, 2006 |                                  
|                        |                                  
|                        |                                  
|                        |                                  

|                        | 
|----------------------- | 
|
|Date:   August 14, 2006 | 
|                        | 
|                        | 
|                        | 

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# CERTIFICATIONS

EXHIBIT 31.1

I, Todd E. Siegel, certify that:

| | 1. | I
have reviewed this quarterly report on Form 10-Q of MTS Medication  Technologies, Inc.;
| | -- | -----------------------------------------------------------------------------------------

| | 2. | Based
on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Based
on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | The
registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | Designed
such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | Evaluated
the effectiveness of the registrants disclosure controls and
procedures presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c) | Disclosed
in this report any change in the registrants internal control over
financial reporting that occurred during the registrants most recent
fiscal quarter (the registrants fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial
reporting; and
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | The
registrants other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrants auditors and the audit committee of the registrants
board of directors (or persons performing the equivalent functions):
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | All
significant deficiencies and material weaknesses in the design or operation
of internal control over financial reporting which are reasonably likely
to adversely affect the registrants ability to record, process,
summarize and report financial information; and
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | Any
fraud, whether or not material, that involves management or other employees
who have a significant role in the registrants internal control over
financial reporting.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date:   August 14, 2006 |  | By: | /s/ Todd E. Siegel                    | 
|----------------------- |  | --- | ------------------------------------- | 
|                        |  |     |                                       | 
|                        |  |     | Todd E. Siegel                        | 
|                        |  |     | President and Chief Executive Officer | 

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EXHIBIT 31.2

I, Michael P. Conroy, certify that:

| | 1. | I
have reviewed this quarterly report on Form 10-Q of MTS Medication
               Technologies, Inc.;
| | -- | -------------------------------------------------------------------------------------------------------

| | 2. | Based
on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not  misleading with respect to the period covered by this
report;
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Based
on my knowledge, the financial statements, and other financial information
 included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | The
registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | Designed
such disclosure controls and procedures, or caused such disclosure
 controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | Evaluated
the effectiveness of the registrants disclosure controls and
 procedures presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c) | Disclosed
in this report any change in the registrants internal control
over financial reporting that occurred during the registrants most recent
fiscal quarter (the registrants fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial
reporting; and
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | The
registrants other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrants auditors and the audit committee of the registrants
board of directors (or persons performing the equivalent functions):
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | All
significant deficiencies and material weaknesses in the design or operation
of internal control over financial reporting which are reasonably likely
to adversely affect the registrants ability to record, process,
summarize and report financial information; and
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | Any
fraud, whether or not material, that involves management or other employees
who have a significant role in the registrants internal control over
financial reporting.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date:   August 14, 2006 |  | By: | /s/ Michael P. Conroy                      | 
|----------------------- |  | --- | ------------------------------------------ | 
|                        |  |     |                                            | 
|                        |  |     | Michael P. Conroy                          | 
|                        |  |     | Vice President and Chief Financial Officer | 

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EXHIBIT 32.1

CERTIFICATION PURSUANT
TO 18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY
ACT OF 2002

In connection with the quarterly
report of MTS Medication Technologies, Inc. (the Company) on Form 10-Q for the
quarter ended June 30, 2006 as filed with the Securities and Exchange Commission on the
date hereof (the Form 10-Q), I, Todd E. Siegel, President and Chief Executive
Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to
§ 906 of the Sarbanes-Oxley Act of 2002, that:

| | (1) | The
Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of
 the Securities Exchange Act of 1934 (15 U.S.C. § 78m or § 78o(d));
and
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
information contained in the Form 10-Q fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|                                      | 
|------------------------------------- | 
|Dated:
          August 14, 2006      | 
|                                      | 
|/s/ Todd E. Siegel                    | 
|Todd E. Siegel                        | 
|President and Chief Executive Officer | 
|                                      | 
|                                      | 

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EXHIBIT 32.2

CERTIFICATION PURSUANT
TO 18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY
ACT OF 2002

In connection with the quarterly
report of MTS Medication Technologies, Inc. (the Company) on Form 10-Q for the
quarter ended June 30, 2006 as filed with the Securities and Exchange Commission on the
date hereof (the Form 10-Q), I, Michael P. Conroy, Vice President and Chief
Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted
pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

| | (1) | The
Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934 (15 U.S.C. § 78m or § 78o(d));
and
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
information contained in the Form 10-Q fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|                                           | 
|------------------------------------------ | 
|Dated:
          August 14, 2006           | 
|                                           | 
|/s/ Michael P. Conroy                      | 
|Michael P. Conroy                          | 
|Vice President and Chief Financial Officer | 
|                                           | 
|                                           | 

27