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

Overview

The Company experienced a decline in net sales during the three months ended June 30, 2009 compared with the same period of the prior fiscal year. This decline results primarily from the fact that in the three months ended June 30, 2008, the Company recognized revenue for several OnDemand machines that were sold to our largest customer. The Company did not sell any OnDemand machines to this customer during the three months ended June 30, 2009.

Net sales in our Consumables segment grew approximately 4.2% in the U.S. long-term care market during the three months ended June 30, 2009. Net sales of consumables in Europe grew approximately 16.6% when measured in the functional currency of the country in which the sales were made. However, as a result of fluctuations in foreign currency, our revenue declined in Europe by approximately 6.6% for the three months ended June 30, 2009 when the revenue is translated into U.S. dollars.

The operating loss for our Packaging Automation segment increased during the three months ended June 30, 2009 over the same period of the prior fiscal year primarily due to the fact that in the prior fiscal year we had higher revenue and gross profit in this segment related to a contract for OnDemand machines with our largest customer. In addition, during the three months ended June 30, 2009, we incurred higher research and development costs related to enhancements to products sold in our Packaging Automation segment.

Revenue in our Medication Administration Systems segment is comprised solely of sales of MedLocker® and service and support of existing MedLocker installations. The operations of this segment have resulted in an operating loss of approximately $316,000 during the three months ended June 30, 2009. We are optimistic that our MedTimes® product will be released for sale shortly and begin to result in additional gross profit to reduce operating losses for this segment in the future.

Our consolidated operating income and net income declined during the three months ended June 30, 2009 compared to the same period of the prior fiscal year primarily due to the following factors:

1. Sales in Europe are made to customers in the functional currency of the country in which the sale is made, but product that is sold in Europe is manufactured in the U.S. and paid for in U.S. dollars. The U.S. dollar has strengthened, and therefore, our gross profit margins have declined on these sales compared to the same period of the previous year.

2. Increased costs associated with the Merger Agreement.

3. Increased research and development costs associated with improvements to OnDemand technologies.

We use many metrics to evaluate and monitor our business, including the following:

1. Revenue growth, gross profit margins, operating income and net income by segment and by geographic area;

2. Inventory turnover;

3. Account receivable collection days;

4. Consolidated net income and operating cash flow; and

5. Investing activities.

Each of these key metrics is more fully discussed in this "Part I, Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations."

On August 7, 2009, the Company entered into the Merger Agreement, which contemplates that all outstanding shares of the Company's common stock, other than those held by MTS, Parent, Merger Sub, those who properly exercise appraisal rights, and certain of our directors and officers who will be contributing a portion of the shares of the Company's common stock held by each of them to Parent for a combination of preferred stock and voting common stock, will be purchased for $5.75 per share. The Merger Agreement is subject to stockholder approval at a special meeting that will be convened to vote on it and certain other conditions.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2009 and 2008

Net sales for the three months ended June 30, 2009 decreased 10.4% to $17.4 million compared with $19.4 million during the same period of the prior fiscal year. The decline primarily relates to a decline in revenue from sales of OnDemand machines. During the three months ended June 30, 2009, the Company recorded approximately $2.7 million in net sales associated with the sale of three OnDemand machines compared to $5.1 million on sales of nine OnDemand machines during the same period in the prior fiscal year. Net sales for consumables increased approximately $329,000 during the three months ended June 30, 2009 compared to the same period the fiscal prior year. The increase was primarily related to increased sales of punch cards to customers in the U.S.

Cost of sales for the three months ended June 30, 2009 was $11.2 million compared with $13.3 million during the same period in the prior fiscal year. Cost of sales as a percentage of sales decreased to 64.4% from 68.8% during the same period of the prior fiscal year. Cost of sales as a percentage of sales decreased primarily because the proportion of revenue associated with OnDemand machines, which have a higher cost of sales percentage than consumables, was higher during the prior fiscal year.

Selling, general and administration expenses for the three months ended June 30, 2009 increased 13.4% to $5.1 million from $4.5 million in the prior fiscal year primarily due to approximately $421,000 in costs associated with the Merger Agreement, as well as an increase of approximately $232,000 in research and development costs primarily associated with development of new OnDemand machine technology.

Depreciation and amortization expense for the three months ended June 30, 2009 decreased 1.0% to $787,000 from $795,000 during the same period of the prior fiscal year. The decrease resulted primarily from decreased amortization associated with capitalized product development costs, which became fully amortized in March 2009.

Interest expense for the three months ended June 30, 2009 decreased 28.6% to $90,000 from $126,000 during the same period of the prior fiscal year. The decrease results from a decrease in interest rates and lower long-term debt outstanding.

Income tax expense decreased 4.7% to $203,000 during the three months ended June 30, 2009 compared with $213,000 during the same period of the prior fiscal year. The decrease results from the fact that our net income before taxes decreased. Our effective tax rate increased to 119.4% from 36.3% due to the fact that $421,000 in costs incurred in the first quarter of this fiscal year associated with the merger agreement are not deductible for tax purposes.

Segments

We evaluate our business under three segments: (a) Consumables; (b) Packaging Automation; and (c) Medication Administration Systems. The Consumables segment primarily consists of the manufacturing of punch cards and blisters and other consumable medication packaging. The Packaging Automation segment consists of products that provide our customers with the ability to package medication into our consumable products in an efficient manner. This type of automation allows the packaging of medication in either a pre-pack or an on-demand manner, which means that our pharmacy customers can elect to package medications for inventory awaiting an order from their long-term care customers or wait until the long-term care customers require the medication and package it at that time. The Medication Administration Systems segment consists of automation products designed to provide our customers with a system to administer medication to residents at long-term care facilities. We currently sell one product, MedLocker, and have developed another product, MedTimes, which is now in beta stage. These segments represent the manner in which we manage our operations.

Segment Results of Operations

    Operating income (loss), as presented below is net sales less cost of sales
and other operating expenses that are directly identifiable to the respective
segment or allocated on the basis of sales or manpower. Operating income is
reconciled to earnings before income taxes in Note 9 to the Consolidated
Financial Statements included in the report.

Consumables
                           Three Months Ended June 30,
                     ----------------------------------------
                             2009                  2008
                     --------------------     ---------------
                        (In Thousands, Except Percentages)

Net Sales              $       13,421          $     13,092
Operating Income       $        2,388          $      1,615
Operating Margin                 17.8 %                12.3 %

Net sales in the three months ended June 30, 2009 increased approximately $329,000, or 2.5% over the same period in the prior fiscal year, primarily due to growth in sales to the U.S. long-term care market of approximately 4.2%. The growth in the U.S. is primarily attributable to the increase in medications dispensed in long-term care facilities. Net sales of consumable products in Europe increased 16.6% when expressed in the functional currency of the country in which the sales are made, but decreased 6.6% in terms of the U.S. Dollars as a result of the exchange rate fluctuations between the U.S. Dollar and the British Pound and Euro.

Operating margins increased in the three months ended June 30, 2009 over the same period in the prior fiscal year primarily due to (a) lower freight costs;
(b) decreases in raw material costs primarily related to materials that have a high petroleum-based content; and (c) decreased scrap rates and labor costs.

Packaging Automation
                           Three Months Ended June 30,
                     ----------------------------------------
                             2009                  2008
                     --------------------     ---------------
                        (In Thousands, Except Percentages)

Net Sales              $       3,911            $    6,191
Operating Loss         $      (1,171 )          $     (246 )
Operating Margin               (29.9 %)               (4.0 %)

Net sales for the three months ended June 30, 2009 decreased $2.3 million, or 36.8%, from the same period in the prior fiscal year due to a decline in OnDemand sales. During the three months ended June 30, 2009, the Company recorded $2.7 million in revenue associated with the sale of three OnDemand machines compared to $5.1 million in revenue on the sale of nine OnDemand machined during the same period the prior fiscal year.

Our operating margin during the three months ended June 30, 2009 decreased from the same period in the prior fiscal year due to decreased net sales, as well as higher-than-normal engineering and research and development costs incurred in the first quarter of this fiscal year as a result of investments in the development of new products, including a high-speed vision and infrared inspection system that will be used in conjunction with our OnDemand Express II and CentraFill products.

Medication Administration Systems

                           Three Months Ended June 30,
                     ----------------------------------------
                              2009                   2008
                     -----------------------     ------------
                        (In Thousands, Except Percentages)

Net Sales              $             27           $     83
Operating Loss         $           (316 )         $   (480 )
Operating Margin               (1,170.4 %)          (578.3 %)

Net sales in the first quarter decreased due to decreased sales of our MedLocker systems.

Our operating loss for the three months ended June 30, 2009 decreased from the same period of the prior fiscal year because there were less overhead costs allocated to this segment due to lower revenue.

LIQUIDITY AND CAPITAL RESOURCES

During the three months ended June 30, 2009, we had a net loss of $33,000 compared with net income of $374,000 during the same period of the prior fiscal year. Cash provided by operations decreased to $537,000 from $1.08 million during the three months ended June 30, 2009 and 2008, respectively, primarily due to lower net income in the three months ended June 30, 2009 compared to the same period in the prior fiscal year, as well as due to a decline in inventory balances during the prior fiscal year from the sale of nine OnDemand machines. We had working capital of $13.9 million at June 30, 2009 compared to $13.8 million at June 30, 2008.

Investing activities used $656,000 during the three months ended June 30, 2009 compared with $1.2 million during the same period of the prior fiscal year. The decrease resulted primarily from a decrease in expenditures for manufacturing equipment used principally in our Consumables segment.

Financing activities provided $457,000 during the three months ended June 30, 2009 compared with $0 used in the same period of the prior fiscal year. The change results primarily from higher net advances under the Credit Facility, which were used to fund working capital requirements.

Our short-term and long-term liquidity is primarily dependent on our ability to generate cash flow from operations. Inventory levels may change significantly as we complete the manufacturing and installation of our OnDemand machines pursuant to the contract with our largest customer. Increases in net sales may result in corresponding increases in accounts receivable. Cash flow from operations and borrowing availability under the Credit Facility is anticipated to support an increase in accounts receivable and inventory.

We have new product development projects underway, principally related to our MedTimes system, which 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 $8.7 million borrowed and an additional $3.3 million available under our Credit Facility at June 30, 2009.

The Credit Facility contains financial covenants that, among other things, require us to maintain certain financial ratios. We were in compliance with all provisions of the loan agreements at June 30, 2009.

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

ESTIMATES AND CRITICAL ACCOUNTING POLICIES

The preparation of our Consolidated Financial Statements in conformity with U.S. GAAP 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 effect 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 the circumstances. These estimates and our actual results are subject to the risk factors listed under Part II, "Item 1A. Risk Factors" of the Form 10-Q for the fiscal quarter ended June 30, 2009 and those listed under "Item 1A. Risk Factors" in our Form 10-K for the fiscal year ended March 31, 2009. Nevertheless, our management believes the following items involve a higher degree of complexity and judgment.

Revenue Recognition

We recognize 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. We recognize revenue related to the sale of our 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 a 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) through (d) above has been determined based upon the value of these deliverables if they were sold separately. The fair value of the deliverable outlined in (a) above 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) through (d) above. The terms of the sale arrangement for an OnDemand machine are 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, we recognize the revenue associated with the training. Revenue associated with annual maintenance contracts is recognized in equal amounts over a 12-month period.

Revenue includes certain amounts invoiced to customers for freight and handling charges. We include the actual cost of freight and handling incurred in the 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 us. Discounts are provided from time to time primarily to compensate customers for inconveniences caused by late shipments, defective product or pricing errors.

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. We do not typically require collateral when granting credit; however, customer credit worthiness is reviewed prior to granting credit. We normally estimate the uncollectibility of our accounts receivable. We consider many factors when making our estimates, including analyzing accounts receivable and historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the reserve for uncollectible accounts. We review the status of our 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. An additional reserve of one percent of accounts receivable would require an increase in the allowance for doubtful accounts and would result in additional expense of approximately $86,000.

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. We review various information related to the age and turnover of specific inventory items to assist with this assessment. An additional reserve of one percent of inventory would require an increase in the inventory reserve accounts and would result in additional expense of approximately $95,000.

Self-Insurance Plan Reserve

We have a medical health benefit self-insurance plan, which covers substantially all of our employees. During the three months ended June 30, 2009, we were reinsured for claims that exceed $100,000 per participant and an annual maximum aggregate limit of approximately $1.6 million. Future claims may affect the reinsurance limits that may be available to us.

Income Taxes

Income taxes are provided for under the liability method in accordance with SFAS 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. Management considers anticipated future taxable income, the reversal of taxable temporary differences, and tax planning strategies in making the determination. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. We also report interest and penalties related to uncertain income tax positions as income taxes.

Goodwill and Other Intangible Assets

We follow SFAS No. 142, Goodwill and Other Intangible Assets, and accordingly do not amortize goodwill, but will annually review it for impairment. We test goodwill for impairment at least annually and whenever events occur or circumstances change that indicate there may be impairment. These events or circumstances could include a significant adverse change in the business climate, poor indicators of operating performance or a sale or disposition of a significant portion of a reporting unit. Testing goodwill for impairment requires us to determine the amount of goodwill associated with reporting units, estimate fair values of those reporting units and determine their carrying values. These processes are subjective and require significant estimates. These estimates include judgments about future cash flows that are dependent on internal forecasts, long-term growth rates, allocations of commonly shared assets and estimates of the weighted-average cost of capital used to discount future cash flows. Changes in these estimates and assumptions could materially affect the results of our reviews for impairment of goodwill.

Other intangible assets acquired in acquisitions are amortized on a straight-line basis over a period ranging from seven to fifteen years, the estimated useful lives of the assets. Other intangible assets are tested for potential impairment whenever events or changes in circumstances suggest that the carrying value of an asset may not be fully recoverable in accordance with SFAS No. 144.

Off-Balance Sheet Arrangements

We currently do not have any off-balance sheet arrangements.

Contractual Obligations

Not Applicable.