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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

MICROTEK MEDICAL HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)

512 LEHMBERG ROAD
COLUMBUS, MISSISSIPPI 39702
(Address of principal executive offices)

(662) 327-1863
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.

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

INDEX

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PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

MICROTEK MEDICAL HOLDINGS, INC.
Unaudited Condensed Consolidated Balance Sheets
(in thousands)

See notes to unaudited condensed consolidated financial statements.

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MICROTEK MEDICAL HOLDINGS, INC.
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income
(in thousands, except per share data)

See notes to unaudited condensed consolidated financial statements.

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MICROTEK MEDICAL HOLDINGS, INC.
Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands)

See notes to unaudited condensed consolidated financial statements.

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MICROTEK MEDICAL HOLDINGS, INC.
Notes to Unaudited Condensed Consolidated Financial Statements

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

Net revenues for the three months ended September 30, 2003 (the “2003 Quarter”) were $24.3 million, an increase of $2.2 million or 9.8 percent from the $22.2 million of net revenues reported for the three months ended September 30, 2002 (the “2002 Quarter”). Net revenues for the nine months ended September 30, 2003 (the “2003 Period”) were $72.2 million, an increase of $7.7 million or 11.9 percent over the $64.5 million in net revenues reported for the nine months ended September 30, 2002 (the “2002 Period”). Excluding licensing revenues associated with the amortization of the $10.5 million payment by Allegiance allocated to the Company’s Supply and License Agreement with Allegiance, net revenues in the 2002 Quarter and 2002 Period were $21.8 million and $63.4 million, respectively. There were no license revenues recorded in the 2003 Quarter or 2003 Period.

For the 2003 Quarter, Microtek’s net revenues totaled $23.0 million, an increase of $1.8 million or 8.4 percent over Microtek’s net revenues of $21.2 million in the 2002 Quarter. Microtek’s net revenues for the 2003 Period increased by $5.4 million to $67.9 million from $62.5 million in the 2002 Period. The following tables depict Microtek’s domestic and international revenues and the relative percentage of each to Microtek’s total revenues for the 2003 Quarter and 2002 Quarter and for the 2003 Period and the 2002 Period:

Microtek’s domestic revenues are generated through two primary channels or customer categories: branded hospital and contract manufacturing (commonly referred to as OEM). Included in the Company’s OEM revenues are sales of products to custom procedure tray companies and other “non-branded” or private label customers. Microtek’s domestic revenues in the 2003 Quarter increased by $1.9 million due to an increase of $900 thousand, or 9.1 percent, in Microtek’s branded hospital revenues and an increase of $1 million, or 13.0 percent, in Microtek’s OEM revenues. Branded hospital revenue growth in the 2003 Quarter over the 2002 Quarter was demonstrated in Microtek’s domestic equipment and patient drape business (an increase of $327 thousand or 5.5 percent) and in its CleanOp product line (an increase of $615 thousand or 40.5 percent). Microtek’s international net revenues were $3.3 million for the 2003 Quarter, a decline of $100 thousand from the 2002 Quarter.

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On a year-to-date basis, Microtek’s domestic revenues in the 2003 Period increased by $4.2 million due to an increase of $3.3 million, or 11.3 percent, in Microtek’s branded hospital revenues and an increase of $920 thousand in Microtek’s OEM revenues. Branded hospital net revenues increased in the 2003 Period due primarily to a $2.2 million increase in revenues from the CleanOp product line and to growth of 9.0 percent in Microtek’s domestic equipment and patient drape revenues. These increases in branded hospital net revenues were offset by a decrease of $568 thousand in safety products revenues in the 2003 Period. Microtek’s international revenues for the 2003 Period were $10.4 million, or $1.2 million more than the $9.2 million reported for the 2002 Period.

OTI’s net revenues were $1.3 million in the 2003 Quarter versus $951 thousand in the 2002 Quarter. OTI’s net revenues were $4.3 million in the 2003 Period as compared to $2.0 million in the 2002 Period. Licensing revenues in the 2002 Quarter and 2002 Period were $357 thousand and $1.1 million, respectively. There were no licensing revenues recorded in the 2003 Quarter and 2003 Period. Included in OTI’s net revenues for the 2003 Quarter and 2003 Period were revenues related to its nuclear operations of $835 thousand and $3.0 million, respectively, as compared to revenues from nuclear operations of $356 thousand and $470 thousand in the 2002 Quarter and 2002 Period, respectively. The growth of OTI’s nuclear revenues is attributable to growing nuclear industry usage and acceptance of the OREX products. The balance of OTI’s net revenues is attributable to sales of certain of the OREX raw materials inventory and amounted to $504 thousand in the 2003 Quarter and $1.3 million in the 2003 Period as compared to $239 thousand and $427 thousand, in the 2002 Quarter and 2002 Period, respectively.

Gross profit margins in the 2003 Quarter and 2003 Period were 40.2 percent and 39.3 percent, respectively, compared to gross profit margins of 38.7 percent recorded in the 2002 Quarter and 39.7 percent recorded in the 2002 Period. The 2002 Quarter and 2002 Period benefited from the amortization of deferred licensing revenues of $357 thousand and $1.1 million, respectively, which had no associated costs. Excluding the impact of the deferred licensing revenues in 2002, the Company’s gross profit margins in the 2002 Quarter and 2002 Period were 37.7 percent and 38.7 percent, respectively, approximately 2.5 percentage points and one-half of a percentage point lower than the actual gross profit margins for the 2003 Quarter and 2003 Period, respectively. The gross profit margin improvements in 2003 are attributable to cost reductions and efficiency and utilization improvements.

Operating expenses in the 2003 Quarter were 33.6 percent of net revenues versus 30.9 percent of net revenues in the 2002 Quarter. For the 2003 Period, operating expenses were 32.7 percent of net revenues as compared to 33.6 percent of net revenues for the 2002 Period. Selling, general and administrative expenses were $7.8 million or 32.2 percent of net revenues in the 2003 Quarter, versus $6.6 million or 29.7 percent of net revenues in the 2002 Quarter. For the 2003 Period, selling, general and administrative expenses were $22.6 million or 31.3 percent of net revenues, as compared to $20.5 million or 31.8 percent of net revenues in the 2002 Period. The increases in the absolute dollar amount of selling, general and administrative expenses in the 2003 Quarter and 2003 Period are attributable to the Company’s additional investment in branded sales and marketing and higher distribution and other variable selling costs.

Research and development expenses in the 2003 Quarter and 2003 Period were $235 thousand and $713 thousand, respectively, as compared to $155 thousand and $572 thousand in the 2002 Quarter and 2002 Period, respectively. OTI’s research and development expenses, substantially all of which are related to the nuclear industry, decreased by $64 thousand and $286 thousand in the 2003 Quarter and 2003 Period, respectively, as compared to the 2002 Quarter and 2002 Period. Offsetting these decreases was an increase in Microtek’s research and development expenses of $144 thousand and $427 thousand in the 2003 Quarter and 2003 Period, respectively, related to an expanded product development program which includes numerous product enhancements and new product introductions planned for 2003 and 2004.

Amortization of intangibles in the 2003 Quarter and 2003 Period was $102 thousand and $327 thousand, respectively, and was consistent with amortization expense recorded in the 2002 Quarter and 2002 Period.

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Income from operations for the 2003 Quarter and 2003 Period was $1.6 million and $4.8 million, respectively, versus $1.7 million in the 2002 Quarter and $4.2 million in the 2002 Period. For the 2003 Quarter, Microtek’s income from operations of $1.7 million was consistent with income from operations recorded in the 2002 Quarter. For the 2003 Period, Microtek’s income from operations was $4.8 million, approximately $100 thousand more than the income from operations recorded in the 2002 Period. The Company’s OTI division reported an operating loss of $54 thousand in the 2003 Quarter versus operating income of $32 thousand for the 2002 Quarter. OTI’s operating loss in the 2003 Period was $60 thousand, an 87.6 percent improvement over the operating loss of $485 thousand recorded in the 2002 Period.

During the 2003 Quarter, the Company recorded a gain of approximately $982 thousand related to the sale of substantially all of the assets related to the manufacture and sale of certain of its non-strategic safety products. The sale price totaled approximately $1.3 million, consisting of $400,000 in cash and a note receivable for approximately $903 thousand.

Interest expense, net of interest income, was $40 thousand and $134 thousand in the 2003 Quarter and 2003 Period, respectively, as compared to $113 thousand and $408 thousand in the 2002 Quarter and 2002 Period, respectively. The decreases in net interest expense in the 2003 Quarter and 2003 Period as compared to the 2002 Quarter and 2002 Period are attributable to lower average borrowings under the Company’s revolving credit facility and declining interest rates during the 2003 Quarter and 2003 Period and was slightly offset by lower interest income on cash and cash equivalents due to lower average interest rates.

The Company’s provision for income taxes in the 2003 Quarter and 2003 Period reflects a net income tax benefit of approximately $2.3 million and $4.7 million, respectively. During the 2003 Quarter, the Company recorded an income tax benefit of approximately $2.4 million related to the decrease in the Company’s valuation allowance with respect to certain of its deferred tax assets, bringing the total income tax benefit related to the decrease in the Company’s deferred tax asset valuation allowance for the 2003 Period to approximately $4.9 million. The income tax benefit portion of the provision for income taxes in the 2003 Quarter and 2003 Period amounted to approximately $0.05 and $0.11 per diluted share, respectively. Offsetting these income tax benefits was the Company’s state and foreign income tax provision for the 2003 Quarter and 2003 Period of approximately $30 thousand and $220 thousand, respectively. The Company’s provision for income taxes in the 2002 Quarter and 2002 Period consisted entirely of state and foreign income taxes of approximately $135 thousand and $285 thousand, respectively.

The resulting net income for the 2003 Quarter was $4.9 million, or $0.12 per basic share and $0.11 per diluted share, bringing the Company’s net income for the 2003 Period to $10.3 million, or $0.25 per basic share and $0.24 per diluted share. The Company’s earnings for the 2003 Quarter and the 2003 Period represent increases of approximately $3.5 million and $6.7 million over the net income reported for the 2002 Quarter and the 2002 Period, respectively.

Liquidity and Capital Resources

As of September 30, 2003 and December 31, 2002, the Company’s cash and cash equivalents totaled $9.8 million.

During the 2003 Period, the Company’s operating activities provided cash of $4.2 million as compared to $6.2 million in the 2002 Period. The decrease in cash provided by operating activities in the 2003 Period is attributable to increases in the Company’s accounts receivable and inventory balances resulting from higher net revenues and working capital expansion related to the successful commercialization of OTI’s nuclear business and Microtek’s expanding operations. Cash used in investing activities in the 2003 Period consisted of the purchase of property and equipment of $1.7 million offset by cash proceeds from the safety product line sale of $400 thousand as compared to purchases of property and equipment totaling $1.3 million in the 2002 Period. During the 2003 Period, cash used in financing activities was $3.0 million. Net repayments under the Company’s Credit Agreement in the 2003 Period were $3.3 million, and repayments of other long-term debt agreements in the 2003 Period totaled $31 thousand. During the 2003 Period, the Company received $424 thousand in proceeds from the exercise of stock options, generated $395 thousand from the issuance of stock and purchased 255 thousand shares of stock for $667 thousand. During the 2002 Period, cash used in financing activities was $5.5 million and consisted primarily of net repayments under the Company’s Credit Agreement of $5.5 million, and repayments of $429 thousand under other long-term debt agreements. During the 2002 Period, the Company received $487 thousand in proceeds from the exercise of stock options, generated $454 thousand from the issuance of stock and purchased 335 thousand shares of stock for $647 thousand.

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The Company maintains a $17.5 million credit agreement (as amended to date, the “Credit Agreement”) with the JP Morgan Chase Bank (the “Bank”), consisting of a revolving credit facility maturing on June 30, 2006. Borrowing availability under the revolving credit facility is based on the lesser of (i) a percentage of eligible accounts receivable and inventories or (ii) $17.5 million, less any outstanding letters of credit issued under the Credit Agreement. Outstanding borrowings under the revolving credit facility were $3.8 million and $7.1 million at September 30, 2003 and December 31, 2002, respectively. As of September 30, 2003, the Company had additional borrowing availability under the revolving facility of $9.7 million. As of November 7, 2003, the Company’s total borrowing availability under the revolving facility was $14.2 million, of which the Company had borrowed $3.3 million. Revolving credit borrowings bear interest, at the Company’s option, at either a floating rate approximating the Bank’s prime rate plus an interest margin (4.5% at November 7, 2003) or LIBOR plus an interest margin (2.69% at November 7, 2003). At September 30, 2003, the Company was in compliance with its financial covenants under the Credit Agreement.

Based on its current business plan, the Company expects that cash equivalents and short term investments on hand, the Company’s credit facility, as amended, and funds budgeted to be generated from operations will be adequate to meet its liquidity and capital requirements for the next year. The Company’s liquidity is not dependent upon the use of off-balance sheet financing arrangements. Currently unforeseen future developments and increased working capital requirements may require additional debt financing or issuance of common stock in 2003 and subsequent years.

Forward Looking Statements

Statements made in this Quarterly Report include forward-looking statements made under the provisions of the Private Securities Litigation Reform Act of 1995 including, but not limited to, the ability of the Company to meet its liquidity and capital requirements. The Company’s actual results could differ materially from such forward-looking statements and such results will be affected by risks described in the Company’s Annual Report including, without limitation, those described under “Risk Factors -History of Net Losses”, “-Reliance upon Microtek”, “-Competition”, “-Product Liability”, “-Stock Price Volatility”, “-Dependence on Key Personnel”, “-Anti-takeover Provisions”, “-Low Barriers to Entry for Competitive Products”, “-Potential Erosion of Profit Margins”, “-Risks of Completing Acquisitions”, “-Small Sales and Marketing Force”, “-Reliance upon Distributors”, “-Microtek Regulatory Risks”, “-Risks of Obsolescence”, “-Reduced OREX Market Potential”, “-OREX Commercialization Risks”, “-OREX Manufacturing and Supply Risks”, “-Risks Affecting Protection of Technologies”, “-Risks of Technological Obsolescence” and “-OTI Regulatory Risks”. We do not undertake to update our forward-looking statements to reflect future events or circumstances.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s greatest sensitivity with respect to market risk is to changes in the general level of U.S. interest rates and its effect upon the Company’s interest expense. At September 30, 2003, the Company had $4.1 million of long-term or short-term debt bearing interest at floating rates. Because these rates are variable, a 1% increase in interest rates would have resulted in additional interest expense of approximately $13 thousand and $49 thousand for the three months and nine months ended September 30, 2003, respectively, and a 1% reduction in interest rates would have resulted in reduced interest expense of approximately $13 thousand and $49 thousand for the three months and nine months ended September 30, 2003.

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Item 4. Controls and Procedures

PART II
OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable.

Item 2. Changes in Securities and Use of Proceeds

During the quarter for which this report is filed, there were no material modifications in the instruments defining the rights of shareholders. During the quarter for which this report is filed, none of the rights evidenced by the shares of the Company’s common stock were materially limited or qualified by the issuance or modification of any other class of securities.

On September 23, 2003, the Company issued 200,000 shares of the Company’s common stock to an accredited investor as deferred, contingent purchase price in connection with the acquisition of certain assets of MICROBasix LLC under a transaction originally completed on February 16, 2001. Exemption from the registration provisions of the Securities Act for this transaction was claimed under Section 4(2) of the Securities Act and the rules and regulations promulgated thereunder on the basis that such transaction did not involve any public offering, the purchaser was sophisticated with access to the kind of information registration would provide and that the purchaser acquired such securities without a view to distribution thereof.

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Item 3. Default Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Securityholders

None.

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

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(1)     Incorporated by reference to the Company’s Registration Statement on Form S-1 (File No. 33-83474).

(2)     Incorporated by reference to Exhibit 3.2 of the Company’s Annual Report on Form 10-K for the year ended December 31, 1996.

(3)     Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed April 23, 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this quarterly report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized on November 11, 2003.

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