Summary of SHARPS COMPLIANCE CORP

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion and analysis presented below should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. See "Information Regarding Forward Looking Statements."

RESULTS OF OPERATIONS
The following analyzes changes in the consolidated operating results and financial condition of the Company during the twelve months ended June 30, 2012, 2011 and 2010, respectively. The following table sets forth, for the periods indicated, certain items from the Company's Consolidated Statements of Operations (dollars in thousands except for percentages expressed as a percentage of revenues):

                                                          Year Ended June 30,
                                2012           %            2011           %            2010           %

Revenue                      $   21,787       100.0 %    $   19,395       100.0 %    $   39,156       100.0 %

  Cost of revenues               15,246        70.0 %        13,171        67.9 %        15,502        39.6 %
  Gross profit                    6,541        30.0 %         6,224        32.1 %        23,654        60.4 %

  SG&A expense                    8,609        39.5 %         9,837        50.7 %         8,815        22.5 %
  Special charge                      -                         570         2.9 %             -
  Depreciation and
amortization                        453         2.1 %           353         1.8 %           441         1.1 %

  Operating income (loss)        (2,521 )     (11.6 %)       (4,536 )     (23.4 %)       14,398        36.8 %

  Other income                       23         0.1 %            45         0.2 %            37         0.1 %

  Income (loss) before
income taxes                     (2,498 )                    (4,491 )                    14,435

  Income tax expense
(benefit)                         1,123         5.2 %        (1,516 )      (7.8 %)        5,079        13.0 %
Net income (loss)            $   (3,621 )     (16.6 %)   $   (2,975 )     (15.3 %)   $    9,356        23.9 %

Table of Contents

YEAR ENDED JUNE 30, 2012 AS COMPARED TO YEAR ENDED JUNE 30, 2011

Total revenues for the fiscal year ended June 30, 2012 of $21.8 million
increased by $2.4 million, or 12.3%, over the total revenues for the fiscal year
ended June 30, 2011 of $19.4 million. Billings by market are as follows (in
thousands):


                                                   Year Ended June 30,
                                        2012              2011            Variance
                                     (Unaudited)       (Unaudited)       (Unaudited)
     BILLINGS BY MARKET:
     Home Health Care               $       6,856     $       6,859     $          (3 )
     Retail                                 5,259             4,641               618
     Professional                           3,019             2,007             1,012
     Pharmaceutical                         2,129               304             1,825
     Assisted Living/ Hospitality           1,307             1,287                20
     U.S. Government Contract               1,685             2,089              (404 )
     Core Government                          419               699              (280 )
     Other                                  1,114             1,619              (505 )
     Subtotal                              21,788            19,505             2,283
     GAAP Adjustment *                         (1 )            (110 )             109
     Revenue Reported               $      21,787     $      19,395     $       2,392

*Represents the net impact of the revenue recognition adjustment required to arrive at reported generally accepted accounting principles ("GAAP") revenue. Customer billings include all invoiced amounts associated with products shipped during the period reported. GAAP revenue includes customer billings as well as numerous adjustments necessary to reflect, (i) the deferral of a portion of current period sales and (ii) recognition of certain revenue associated with products returned for disposal or treatment. The difference between customer billings and GAAP revenue is reflected in the Company's balance sheet as deferred revenue. See Note 2 "Revenue Recognition" in "Notes to Consolidated Financial Statements".

This Annual Report on Form 10-K contains certain financial information not derived in accordance with GAAP, including customer billings information. The Company believes this information is useful to investors and other interested parties as customer billings represents all invoiced amounts associated with products shipped during the period reported. Such information should not be considered as a substitute for any measures derived in accordance with GAAP, and may not be comparable to other similarly titled measures of other companies. Reconciliation of this information to the most comparable GAAP measures is included above.

The increase in revenues is primarily attributable to increased billings in the Pharmaceutical ($1.8 million), Professional ($1.0 million) and Retail ($0.6 million) markets. These increases in billings were partially offset by decreased billings in the U.S. Government Contract ($0.4 million), Core Government ($0.3 million) and Other ($0.5 million) markets. The increase in the Pharmaceutical market billings is due to the timing of customer orders including the launch of three new patient support programs announced in August and October 2011 and resupply orders for existing patient support programs. The programs include the direct fulfillment of the Sharps Recovery System® to the pharmaceutical manufacturers' program participants which provides the proper containment, return and treatment of the needles or injection devices utilized in therapy. The increase in the Professional market was a direct result of the Company's targeted telemarketing activities, e-commerce focused website, trade show participation and internet-based promotional activities to educate doctors, dentists and veterinarians on the significant cost advantage and the convenience of the Sharps Recovery System™ over the traditional pick-up service. The increase in the Retail market is primarily due to sales from a strong 2011 flu shot season, orders in advance of the 2012 flu shot season, immunizations administered in the retail setting and the initial fill of the Complete Needle™ Collection & Disposal System in two major retail pharmacy chains as well as several food and drug chains. Partially offsetting this increase was prior year sales of $1.6 million related to the initial orders of the Company's TakeAway™ Environmental Return System™ envelope solution by three large retail pharmacy chains and several food and drug chains to address growing concerns regarding the hazards of unused medications in the home and environment. U.S. Government Contract billings are associated with the Company's contract with a major U.S. government agency announced in February 2009. The decrease in the U.S. Government contract market billings is associated with the January 31, 2012 termination of the maintenance portion of a U. S. Government

Table of Contents

contract with the Division of Strategic National Stockpile ("DSNS") of the Centers for Disease Control ("CDC"). The level of Core Government market billings reflects the completion of the VA Pilot Program. The Other market consists of sales that vary due to timing of orders which order primarily from distributors.

Cost of revenues for the year ended June 30, 2012 of $15.2 million was 70.0% of revenues. Cost of revenues for the year ended June 30, 2011 of $13.2 million was 67.9% of revenue. The lower gross margin for the year ended June 30, 2012 of 30.0% (versus 32.1% for the year ended June 30, 2011) was due to ongoing facility costs associated with the maintenance portion of the U.S. government contract that was terminated as of January 31, 2012 and the recording of a $0.3 million accrued loss related to the Atlanta facility lease obligation.

Selling, general and administrative ("SG&A") expenses for the year ended June 30, 2012 of $8.6 million, decreased by $1.2 million, from SG&A expenses of $9.8 million for the year ended June 30, 2011. The decrease in SG&A is primarily due to (i) lower professional fees of $0.5 million (primarily due to regulatory and consulting fees, legal fees and other sales-related consulting fees), (ii) prior year unusual costs associated with a legal settlement of $0.35 million, (iii) lower compensation and benefit expense including payroll tax of $0.2 million (primarily due to timing of employee hires and terminations) and (iv) lower miscellaneous expense of $0.2 million (primarily related to prior year severance costs and recruiting fees).

During the first quarter of fiscal year 2011, the Company recorded a special charge of $0.6 million on a pre-tax basis, or $0.02 per diluted loss per share, which represents expenses incurred with the retirement of the Company's former Chief Executive Officer, Dr. Burton Kunik. The special charge consists of (i) severance-related items totaling $0.5 million and (ii) non-cash stock-based compensation expense of $0.1 million (resulting from accelerated vesting of stock option awards). The Company paid Dr. Kunik $0.1 million in September 2010 and $0.4 million in April 2011 related to the expenses noted above.

The Company generated an operating loss of $2.5 million for the year ended June 30, 2012 compared to an operating loss of $4.5 million for the year ended June 30, 2011. The operating margin was (11.6%) for the year ended June 30, 2012 compared to (23.4%) for the year ended June 30, 2011. The improvement in operating loss is a result of the higher sales volume as well as strong cost discipline and focused use of resources on targeted markets primarily Retail, Pharmaceutical, Professional and Core Government markets (discussed above).

The Company generated a loss before income taxes of $2.5 million for year ended June 30, 2012 versus a loss before income taxes of $4.5 million for the year ended June 30, 2011. The improvement in loss before income taxes is a result of a lower operating loss (discussed above).

The Company's effective tax rate for the year ended June 30, 2012 was 45.0% compared to (33.8%) for the year ended June 30, 2011. During the year ended June 30, 2012, the Company recorded $2.0 million to establish a deferred tax valuation allowance on net deferred tax assets. The establishment of valuation allowances and development of projected annual effective tax rates requires significant judgment and is impacted by various estimates. Both positive and negative evidence, as well as the objectivity and verifiability of that evidence, is considered in determining the appropriateness of recording a valuation allowance on deferred tax assets. Under generally accepted accounting principles, the valuation allowance has been recorded to reduce our net deferred tax asset to an amount that is more likely than not to be realized and is based upon the uncertainty of the realization of certain federal and state deferred assets related to net operating loss carryforwards and other tax attributes. Excluding the impact of the valuation allowance, the effective tax rate benefit was relatively flat at (33.5%) for the year ended June 30, 2012 compared to (33.8%) for the year ended June 30, 2011.

The Company generated a net loss of $3.6 million for year ended June 30, 2012 compared to a net loss of $3.0 million for the year ended June 30, 2011. The higher net loss was primarily due to the $2.0 million deferred tax valuation allowance (discussed above) offset by the improved loss before income taxes from fiscal year 2011 to 2012 (discussed above).

The Company reported diluted loss per share of ($0.24) for the year ended June 30, 2012 versus diluted loss per share of ($0.20) for year ended June 30, 2011. The decrease in diluted loss per share is a result of a higher net loss (discussed above).

Table of Contents

YEAR ENDED JUNE 30, 2011 AS COMPARED TO YEAR ENDED JUNE 30, 2010

Total revenues for the fiscal year ended June 30, 2011 of $19.4 million
decreased by $19.8 million, or 50.5%, over the total revenues for the fiscal
year ended June 30, 2010 of $39.2 million. Billings by market are as follows (in
thousands):


                                                   Year Ended June 30,
                                        2011              2010            Variance
                                     (Unaudited)       (Unaudited)       (Unaudited)
     BILLINGS BY MARKET:
     Home Health Care               $       6,859     $       6,543     $         316
     Retail                                 4,641             4,338               303
     U.S. Government Contract               2,089            23,200           (21,111 )
     Core Government                          699               642                57
     Professional                           2,007             1,644               363
     Assisted Living/ Hospitality           1,287             1,015               272
     Pharmaceutical                           304               742              (438 )
     Other                                  1,619             1,284               335
     Subtotal                              19,505            39,408           (19,903 )
     GAAP Adjustment *                       (110 )            (252 )             142
     Revenue Reported               $      19,395     $      39,156     $     (19,761 )

The decrease in revenues is primarily attributable to decreased billings in the U.S. Government Contract ($21.1 million) and Pharmaceutical ($0.4 million) markets. These decreases in billings were partially offset by increased billings in the Professional ($0.4 million), Home Health Care ($0.3 million), Retail ($0.3 million), Other ($0.3 million) and Assisted Living/Hospitality ($0.3 million) markets. U.S. Government Contract billings are associated with the Company's contract with a major U.S. government agency announced in February 2009. The billings for the year ended June 30, 2011 were for maintenance and the fiscal year 2010 billings included (i) $22.4 million recognized in the first half of fiscal year 2010 for the sale of the Company's Sharps MWMS to this major U.S. government agency and (ii) $0.8 million recognized in the second half of fiscal year 2010 attributable to the transition from the product build out to the maintenance phase of the Company's contract with the U.S. government agency. This resulted in a decrease in billings under this contract of $21.1 million. The decrease in the Pharmaceutical market billings is due to the timing of customer orders and the discontinuation of one the Company's patient support programs. The increase in Professional market billings was a direct result of the Company's targeted telemarketing activities to educate doctors, dentists and veterinarians on the significant cost advantage and the convenience of the Sharps Recovery System™ over the traditional pick-up service. The increase in billings in the Home Health Care market is a result of increased sales to home health care related distributors addressing the growing trend of patient volumes in the home health care industry. The increase in the Retail market billings is due to the initial orders of the Company's TakeAway Environmental Return System™ envelope solution by three large

Table of Contents

retail pharmacy chains and several food and drug chains to address growing concerns regarding the hazards of unused medications in the home and environment. The increase in the Other category is a result of referrals from the Company's strategic alliance with a leading hazardous waste solutions provider. The increase in the Assisted Living/ Hospitality market was primarily due to increased sales to existing customers as they realize growth from the aging patient population using their services as well as an increase in our assisted living facility customer base.

Cost of revenues for the year ended June 30, 2011 of $13.2 million was 67.9% of revenues. Cost of revenues for the year ended June 30, 2010 of $15.5 million was 39.6% of revenues. The lower gross margin for the fiscal year ended June 30, 2011 of 32.1% (versus 60.4% for the prior fiscal year) was a result of lower volume. The Company, which is largely leveraged on volume, made investments in its infrastructure during the first half of calendar year 2010 in order to provide for the capacity to take on large increases in volume. As a result, the combination of lower volume and greater capacity creates negative leverage and adversely impacts gross margin.

Selling, general and administrative ("SG&A") expenses for the year ended June 30, 2011 of $9.8 million, increased by $1.0 million, from SG&A expenses of $8.8 million for the year ended June 30, 2010. The increase in SG&A expense is primarily due to higher (i) professional expenses of $0.4 million (primarily due to regulatory and consulting related fees, legal fees, audit and related fees, and other sales-related consulting fees), (ii) compensation and benefit expense including payroll tax of $0.2 million (primarily due to timing of employee hires and terminations), (iii) costs associated with a legal settlement of $0.35 million and (iv) severance costs of $0.05 million.

Regarding costs associated with a legal settlement included in SG&A expense, the Company settled a suit in which the plaintiff alleged violations of the Telephone Consumer Protection Act. Although the Company believes it did not violate any laws, the Company settled the lawsuit in the interest of avoiding additional legal costs and diverting time and focus from growing the business.

During the first quarter of fiscal year 2011, the Company recorded a special charge of $0.6 million on a pre-tax basis, or $0.02 per diluted loss per share, which represents expenses incurred with the retirement of the Company's former Chief Executive Officer, Dr. Burton Kunik. The special charge consists of (i) severance-related items totaling $0.5 million, (ii) non-cash stock-based compensation expense of $0.1 million (resulting from accelerated vesting of stock option awards), and (iii) legal fees related to the separation agreement of less than $0.1 million. The Company paid Dr. Kunik $0.1 million in September 2010 and $0.4 million in April 2011 related to the expenses noted above.

The Company generated an operating loss of $4.5 million for the year ended June 30, 2011 compared to an operating income of $14.4 million for the year ended June 30, 2010. The operating margin was (23.4%) for the year ended June 30, 2011 compared to 36.8% for the year ended June 30, 2010. The decrease in operating income and operating margin is a result of the above mentioned decrease in revenue and operating leverage inherent in the Company's business model.

The Company generated a loss before income taxes of $4.5 million for the year ended June 30, 2011 versus income before income taxes of $14.4 million for the year ended June 30, 2010. The decrease in income before income taxes is a result of lower operating income (discussed above).

The Company's effective tax rate for the year ended June 30, 2011 was 33.8% compared to 35.2% for the year ended June 30, 2010. The Company uses estimates in providing for income taxes on a year to date basis and those estimates may change in subsequent interim periods.

The Company generated a net loss of $3.0 million for the year ended June 30, 2011 compared to net income of $9.4 million for the year ended June 30, 2010. The decrease in net income is a result of lower operating income (discussed above).

The Company reported diluted loss per share of ($0.20) for the year ended June 30, 2011 versus diluted earnings per share of $0.63 for the year ended June 30, 2010. The decrease in diluted earnings per share is a result of a lower net income (discussed above).

Table of Contents

PROSPECTS FOR THE FUTURE

The Company continues to take advantage of the many opportunities in the markets served as professional offices, retail pharmacies and clinics, communities, assisted living, home healthcare companies, consumers, pharmaceutical manufacturers, government agencies, health care facilities, individual self-injectors and commercial organizations become more aware of the need for the proper treatment of medical sharps waste, used healthcare materials and unused dispensed medications as well as alternatives to traditional methods of disposal.

Recent data from the Human Capital Management Services Group indicates that the number of used needles improperly disposed of outside the large healthcare setting and into the solid waste system has tripled over the past ten years to 7.8 billion each year and the number of self-injectors in the country has increased to 13.5 million over the same period. The Company estimates that it would require over 80 million Sharps Recovery System™ (formerly Sharps Disposal by Mail System®) products to properly dispose of all such syringes, which would equate to a market opportunity of over $2 billion.

There are an estimated 800,000 doctors, dentists, veterinarians, clinics, tattoo parlors and other businesses in the country that generate smaller quantities of medical waste, including used syringes. These offices and facilities, which must demonstrate proper management of their medical waste, comprise a market opportunity of approximately $600 million, based on estimates of using our solution offerings rather than the traditional pick-up service in what we characterize as a regulated market.

Additionally, an estimated 40% of the four billion dispensed medication prescriptions go unused every year in the United States generating an estimated 200 million pounds of unused medication waste. The Company estimated the market opportunity for the proper recovery and management of the unused medications to be at least $1 billion per year.

The Company continues to develop new solution offerings including the Complete Needle™ Collection and Disposal System (designed for the traditional under-served home self-injector), the TakeAway line of products for unused medications (including TakeAway Environmental Return System™) and the Medical/Professional TakeAway Recovery System. These innovative product and service offerings allow us to gain further sales from existing customers as well as gain new customers who have a need for more comprehensive products. The Company continues to develop solution offerings designed to facilitate the proper and cost effective solutions for management of medical waste, used healthcare materials and unused dispensed medication to better serve our customers and the environment. The Company believes its future growth will be driven by, among other items: (i) the convergence of issues regarding the environment, the cost of health care and changes in our health care delivery system and cost-savings initiatives which influence the decision process of our customers, (ii) the effects of the Company's extensive multi-layered marketing and awareness efforts and (iii) the Company's leadership position in the development and sales of products and services designed for the proper and cost effective solutions for management of medical waste, used healthcare materials and unused dispensed.

In August 2011, the Company introduced the Complete Needle™ Collection and Disposal System which is focused on the traditional under-served home self-injector required to regularly use needles or syringes for their health and well-being, such as people with diabetes. The Complete Needle™ Collection and Disposal System is actually two offerings in one. First, the product provides the individual self-injector with a reasonably priced containment solution designed to protect self-injectors and their family members. Second, the product includes an optional disposal feature utilizing the USPS designed to protect the individual's community, solid waste workers and the environment. The solution offers significant convenience as it utilizes the same delivery channel, the retail pharmacy that the self-injector typically uses to obtain medications, for example, insulin, and needles or syringes. The solution is also designed to enhance the interaction between the pharmacist and the individual thereby creating counseling opportunities and possibly better treatment outcomes.

The Company continues to add full-service, patient support programs with major pharmaceutical manufacturers whereby we provide a customized Sharps Recovery System™ (formerly Sharps Disposal by Mail System®) along with fulfillment, inventory management, storage and data services, as well as provide critical patient usage data that assists the manufacturers in assessing drug effectiveness and compliance.

In January 2010, the Company announced a pilot program with the United States Department of Veterans Affairs ("VA"). The program was launched within the VA Capitol Health Care Network ("Veterans Integrated Service Network 5" or "VISN 5"), which provided quality health care for eligible veterans in Maryland and portions of

Table of Contents

Virginia, West Virginia, and Pennsylvania, as well as the District of Columbia. The pilot allowed each of the participating medical centers within the VISN 5 region, both inpatient and outpatient, to provide the Sharps Recovery System™ (formerly known as the Sharps® Disposal By Mail System®) and the TakeAway Environmental Return System™ solutions to their patients. Since its original launch, the pilot program expanded to include eight VISN's (encompassing twenty-two states plus the District of Columbia). There are a total of twenty-three VISN's in the VA System. The VISN network is part of the Veterans Health Administration which encompasses the largest integrated health care system in the United States, consisting of 153 medical centers, in addition to numerous community based outpatient clinics, community living centers and Vet Centers. Together these health care facilities provide comprehensive care to . . .