FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

(Mark One)

 

For the quarterly period ended September 30, 2009

OR

 

 

Commission file number 1-11394

 

MEDTOX SCIENTIFIC, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant's telephone number including area code:              (651) 636-7466

 

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.

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

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

 

 

 

MEDTOX SCIENTIFIC, INC.

 

INDEX

 

 

Consolidated Statements of Income – Three and

 

Consolidated Balance Sheets – September 30, 2009

 

Consolidated Statements of Cash Flows – Nine

 

 

 

Management's Discussion and Analysis of

 

Item 3:

 

 

Item 4:

 

 

 

 

 

PART I      FINANCIAL INFORMATION

 

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except share and per share data)

(Unaudited)

See Notes to Consolidated Financial Statements (Unaudited).

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

 

 

See Notes to Consolidated Financial Statements (Unaudited).

 

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

See Notes to Consolidated Financial Statements (Unaudited).

 

MEDTOX SCIENTIFIC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2009

 

1. BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements of MEDTOX Scientific, Inc. (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of financial condition and results of operations have been included. Operating results for the three and nine-month periods ended September 30, 2009 are not necessarily indicative of the results that may be attained for the entire year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.

 

New Accounting Standards: In June 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) 105-10, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162.”  This Statement modifies the Generally Accepted Accounting Principles (GAAP) hierarchy by establishing only two levels of GAAP, authoritative and nonauthoritative accounting literature. Effective July 2009, the FASB Accounting Standards Codification (ASC), also known collectively as the “Codification,” is considered the single source of authoritative U.S. accounting and reporting standards, except for additional authoritative rules and interpretive releases issued by the Securities and Exchange Commission.  Nonauthoritative guidance and literature would include, among other things, FASB Concepts Statements, American Institute of Certified Public Accountants Issue Papers and Technical Practice Aids and accounting textbooks. The Codification was developed to organize GAAP pronouncements by topic so that users can more easily access authoritative accounting guidance.   The Company adopted this Statement effective July 1, 2009 and accordingly all accounting references have been updated and SFAS references have been replaced with ASC references.

 

In May 2009, the FASB issued ASC 855-10, “Subsequent Events.” ASC 855-10 provides guidance on management’s assessment of subsequent events and incorporates this guidance into accounting literature. ASC 855-10 is effective prospectively for interim and annual periods ending after June 15, 2009. The adoption of this Statement did not have an impact on the Company’s financial position or results of operations. Management has evaluated subsequent events through October 29, 2009.

 

2. SEGMENTS

 

The Company has two reportable segments: Laboratory Services and Product Sales. The Laboratory Services segment consists of MEDTOX Laboratories and the New Brighton Business Center (NBBC). Services provided include drugs-of-abuse testing services and clinical & other laboratory services, which include clinical toxicology, clinical testing for the pharmaceutical industry, clinical testing for occupational health clinics, clinical testing for physician offices, pediatric lead testing, heavy metals analyses, courier delivery, and medical surveillance. The Product Sales segment, which includes POCT (point-of-collection testing) disposable diagnostic devices, consists of MEDTOX Diagnostics, Inc. Products manufactured include easy to use, inexpensive, on-site drug tests such as PROFILE®-II, PROFILE®-II A, PROFILE®-III, PROFILE®-III A, PROFILE-II ER®, PROFILE®-III ER,

 

PROFILE®-IV, PROFILE®-V, MEDTOXScan®, VERDICT®-II and SURE-SCREEN®, in addition to a variety of other diagnostic tests for the detection of alcohol. MEDTOX Diagnostics also provides contract manufacturing services in its Food and Drug Administration (FDA) registered/ISO 13845 certified facility.

 

The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately as each business requires different products, services and marketing strategies.

 

In evaluating financial performance, management focuses on income from operations as a segment’s measure of profit or loss.

 

 

 

 

The following is a summary of revenues from external customers for each group of products and services provided within the Product Sales segment:

 

                

3. INVENTORIES

 

Inventories consisted of the following:

            

 

 

4. EARNINGS PER SHARE

 

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

 

 

5. INCOME TAXES

 

At December 31, 2008, the Company had federal net operating loss carryforwards (NOLs) of approximately $7.8 million, which are available to offset future taxable income.  The Company's federal NOLs expire in varying amounts each year from 2018 through 2028 in accordance with applicable federal tax regulations and the timing of when the NOLs were incurred. Section 382 of the Internal Revenue Code restricts the annual utilization of certain NOLs incurred prior to a change in ownership.  However, such limitation is not expected to impair the realization of these NOLs.  In the future, subsequent revisions to the estimated net realizable value of these deferred tax assets could cause the provision for income taxes to vary significantly from period to period, although the Company’s cash payments would remain unaffected until the benefit of the NOLs is completely utilized or expires unused.

 

6. CONTINGENCIES

 

Leases - The Company leases offices and facilities and office equipment under certain operating leases, which expire on various dates through March 2016. Under the terms of the facility leases, a pro rata share of operating expenses and real estate taxes are charged as additional rent.

 

Legal - The Company is party to various legal proceedings arising in the normal course of business activities, none of which, in the opinion of management, are expected to have a material adverse impact on the Company's consolidated financial position or results of operations.

 

 

On October 29, 2009, the Company entered into the Fourth Amendment to the Credit Agreement with Wells Fargo Bank, National Association (the “Bank”). The Fourth Amendment modifies certain terms and conditions of the Wells Fargo Credit Agreement as follows:

 

 

 

 

 

 

The provisions of the Wells Fargo Credit Agreement pertaining to the note or notes aggregating up to $4.9 million (loan limit) for the purchase of capital equipment with the Bank will mature on November 1, 2009. The Company reviewed its need for the capital equipment note and determined that it is no longer necessary. As such, the Company has elected not to extend the last day on which the Bank will make advances under the capital equipment notes.

 

 

Item 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This Form 10-Q contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by such acts. For this purpose, any statements that are not statements of historical fact may be deemed to be forward looking statements, including the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding our strategy, future operations, future expectations and future estimates, future financial position or results, and future plans and objectives of management. Those statements in this Form 10-Q containing the words “believes”, “anticipates”, “plans”, “expects”, and similar expressions constitute forward looking statements, although not all forward looking statements contain such identifying words. Examples of forward looking statements include, but are not limited to (i) projections of, or statements regarding, future revenues, income or loss, earnings or loss per share, capital expenditures, dividends, capital structure, margins and other financial items, (ii) statements regarding our plans and objectives and the impacts thereof, including planned introductions of new products and services, planned exiting of lines of business and planned regulatory filings, or estimates or predictions of actions by customers, suppliers, competitors or regulatory authorities, (iii) estimates of market sizes and market opportunities, (iv) statements regarding economic conditions, (v)) statements regarding the sufficiency of our existing resources to fund our planned operations through 2009 and the sufficiency of future profitable operations and access to additional capital to fund our operations beyond 2009, and (vi) statements of assumptions underlying other statements and statements about our business.

 

The forward looking statements contained in this Form 10-Q are based on our current expectations, assumptions, estimates and projections about our Company and its businesses. All such forward looking statements involve significant risks and uncertainties, including those risks identified in the next paragraph, many of which are beyond our control. Although we believe that the assumptions underlying our forward looking statements are reasonable, any of the assumptions could prove inaccurate. Actual results may differ materially from those indicated by the forward looking statements included in this Form 10-Q. In light of the significant uncertainties inherent in the forward looking statements included in this Form 10-Q, you should not consider the inclusion of such information as a representation by us or anyone else that we will achieve such results. Moreover, we assume no obligation to update these forward looking statements to reflect actual results or changes in assumptions, expectations, or projections. In addition, our financial and performance outlook concerning future revenues, margins, earnings, earnings per share, and other operating or performance results does not include the impact of any future acquisitions, future acquisition-related expenses or accruals, or any future restructuring or other charges that may occur from time to time due to management decisions and changing business circumstances and conditions.

 

The following is a listing of some of the important factors that could cause actual results to differ materially from those indicated by the forward looking statements contained in this Form 10-Q:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The above listing should not be construed as exhaustive; we cannot predict all the factors that could cause results to differ materially from those indicated by the forward looking statements.

 

Executive Overview

 

    Our Business

 

We are engaged primarily in distinct, but very much related businesses, which for financial reporting purposes are divided into two reportable segments: Laboratory Services and Product Sales. For financial information relating to our segments, see Note 2 of Notes to the Consolidated Financial Statements.

 

 

Laboratory Services

 

Our “Laboratory Services” business segment includes the activities of our wholly-owned subsidiary, MEDTOX Laboratories, Inc. MEDTOX Laboratories, Inc. engages in drugs-of-abuse testing services, providing these services to private and public companies, drug treatment counseling centers, criminal justice facilities, occupational health clinics and hospitals, as well as third party administrators. MEDTOX Laboratories, Inc. also provides clinical and other laboratory services which consist of clinical toxicology, clinical testing for the pharmaceutical industry (e.g., central laboratory services, bioanalytical, and pharmacokinetic testing), and analysis of heavy and trace metals. We provide these services to hospitals, clinics, HMOs and small to mid-sized biotech and pharmaceutical companies and other laboratories. Testing is conducted using methodologies that include various immunoassays, gas liquid chromatography, gas chromatography/mass spectrometry, and high performance liquid chromatography with tandem mass spectrometry.

 

We recently expanded our clinical & other laboratory services to include laboratory tests used by physicians and other healthcare providers for the purpose of diagnosing or treating disease or illness or the assessment of health in humans. Testing is performed on blood, body fluids or tissues. Our comprehensive clinical laboratory services includes clinical chemistry, hematology, coagulation, urinalysis, immunology/serology (viruses, infectious diseases, immune system), immunohematology (blood typing, antibody screens), microbiology (bacteria, parasites), anatomical pathology/cytology (tissue biopsies, cancer), molecular diagnostics (infectious diseases, genetic disorders) and sub-specialties of these categories.

 

We also provide services in the areas of logistics management, data management and program management. These services support our underlying business of laboratory analysis and provide added value to our clients.

 

The New Brighton Business Center, LLC (NBBC) is a wholly-owned limited liability company formed for the sole purpose of acquiring the facilities in St. Paul, Minnesota, where our Laboratory Services administrative offices and laboratory operations are located.

 

Product Sales

 

Our “Product Sales” business segment consists of our wholly-owned subsidiary, MEDTOX Diagnostics, Inc. MEDTOX Diagnostics, Inc. is engaged in the development, manufacturing, and distribution of a variety of POCT diagnostic drug screening devices, such as our PROFILE®-II, PROFILE®-II A, PROFILE®-III, PROFILE®-III A, PROFILE-II ER®, PROFILE®-III ER, PROFILE®-IV, PROFILE®-V, MEDTOXScan® reader, VERDICT®-II, and SURE-SCREEN® products, in addition to other diagnostic tests for the detection of alcohol. MEDTOX Diagnostics, Inc. also provides contract manufacturing services, such as coagulation market controls. The operations of the Product Sales segment are located in Burlington, North Carolina, where we maintain the offices, research and development laboratories, production operations, and warehouse/distribution facilities.

 

In January 2008, we announced that we were voluntarily recalling approximately 400 MEDTOXScan® electronic readers because of mis-branding. The PROFILE®-III ER devices sold for use with the readers and which are properly cleared for sale by the FDA, can be read visually without the reader. The readers were provided to customers at no cost, therefore the direct financial impact of the recall is limited to shipping fees which are estimated to be less than $10,000. It had been our original intention

 

to replace these readers with a new generation of reader having over-the-counter (OTC) approval in 2008. As a result of the recall, we sought “prescription use” clearance for the new reader. We filed a 510(k) application in March 2008. In February 2009, we received 510(k) clearance from the FDA to market our MEDTOXScan® electronic readers to be used with nine drugs. In May 2009, we filed a 510(k) application with the FDA for three more drugs to be added to the reader menu. On July 24, 2009, we received 510(k) clearance from the FDA to market our PROFILE®-V MEDTOXScan® Drugs-of-Abuse Test System with the three additional drugs. The total number of drugs detectable on the system is now twelve. Currently, we have between 300 to 400 hospital clients utilizing our PROFILE® visually read cassettes for drugs-of-abuse detection. The new Test System will be marketed not only to those clients, but to the broader hospital market which is estimated in excess of 2,500 hospitals. Since receiving FDA clearance for the expanded panel, we have shipped over 200 units.

 

 

Our management believes that there are several notable trends that are currently influencing, and are expected in the foreseeable future to continue to influence, our operating results. These include:

 

Economic Uncertainties Causing Variability in Testing Volumes in the Laboratory Services, Drugs-of-Abuse Business

 

In the first three quarters of 2009, testing volume from our existing workplace drugs-of-abuse clients was lower than in the prior year periods, which we primarily attributed to lower new job creation and reduced employment levels and corresponding drops in hiring caused by economic uncertainties. We feel economic uncertainties may continue to cause variability in our workplace drugs-of-abuse testing volume in the foreseeable future.

 

Increased POCT Diagnostic Device Test Competition

 

We have experienced increased competition with respect to our POCT diagnostic tests from systems and products developed by others, many of whom compete solely on price. As the number of firms marketing diagnostic tests has grown, we have experienced increased price competition for certain diagnostic testing devices, particularly in the probation, parole and rehabilitation market.

 

 

Our strategy is to drive profitable growth by building market share, leveraging our existing infrastructure and technical expertise, and driving innovation. We maintain a disciplined culture, focused on the successful execution of our strategy and plans.

 

Building Market Share

 

We have solid niche positions in large markets, relative to our size, that allow us to build market share by offering high quality products and services that are delivered rapidly, priced competitively, and supported by excellent customer service and value-added services. Our value added services include data management, collection site management, training, technical support and expertise, as well as review of drug testing policies for clients.

 

 

Our success in penetrating new accounts has represented a significant component of our growth in market share. Over the past three years, we have expanded our number of sales representatives from 23 to 46. The increase in sales representatives has increased our business from new accounts and helps offset risks from uncertain economic conditions that may result in lower activity from existing workplace drugs-of-abuse clients.

 

Leveraging Existing Infrastructure and Technical Expertise

 

We leverage our existing infrastructure and technical expertise to facilitate top line growth and improve operating margins.

 

In 2008, we expanded our clinical laboratory capabilities to include clinical and anatomic pathology, microbiology, molecular diagnostics, and other specialized testing capabilities. This expansion leverages existing capabilities and opens up new revenue opportunities by offering full-service testing capabilities to the physician office market.

 

Our LEAN and Six-Sigma initiatives support our effort to leverage existing infrastructure by improving quality and productivity, cutting costs, and increasing throughput. LEAN is a highly disciplined process that helps us focus on reducing waste and eliminating unnecessary steps in our business processes. Our Six-Sigma initiatives address quality and variability within processes. While all key departments in the Laboratory Services and Product Sales segments have now been through initial LEAN processes, as an organization we recognize that LEAN is an ongoing philosophy, not a project to be “finished.”

 

Driving Innovation

 

We have introduced a number of innovative products and services.

 

In 2009, we introduced the next generation PROFILE®-V MEDTOXScan® Drugs-of-Abuse Test System with added functionality for hospital laboratories and emergency rooms.

 

In 2008, we introduced ToxAssure®, a comprehensive program for effective pain management testing.

 

In 2007, we continued improvement in our manufacturing processes in the diagnostic area, resulting in greater flexibility of product configurations for clients, increased efficiency in manufacturing and improved device performance. We can now offer a higher degree of customization to our clients, both in terms of specific assays on a particular device, and supplying a “private label” device to large clients. In 2007, we initiated a relationship with one private label client.

 

In 2006, we developed and introduced MEDTOXScan®, an electronic reader, which we provide to hospitals for use with our PROFILE-II ER® and PROFILE®-III ER POCT devices in hospital laboratories and emergency rooms.

 

In 2005, we developed and introduced eChain®, our web-based electronic chain-of-custody and donor tracking system. We currently have over 1,500 clinics and collection sites utilizing eChain® throughout the country.

 

In 2005, we also introduced SURE-SCREEN®, our lower detection level POCT device targeted for the government and rehabilitation markets and our PROFILE®-III device, an integrated cup and testing device for sale to the workplace drug testing market.

 

ClearCourse®, another innovative solution we offer, is a comprehensive drug testing program that combines four essential components: Drug Abuse Recognition System (DARS™) training, SURE-SCREEN® on-site drug screening devices, laboratory based confirmation testing and WEBTOX® online data management.

 

Critical Accounting Policies

There were no significant changes to our critical accounting policies during the three and nine-month periods ended September 30, 2009 from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008.

 

Results of Operations

 

In evaluating our financial performance, our management has primarily focused on three objectives: maximizing operating income, increasing our cash flows and strengthening our balance sheet. The first of these objectives is discussed in this section. The other two are addressed under “Liquidity and Capital Resources.”

 

To maximize our operating income, we have sought revenue growth, improved gross margins and reduced selling, general and administrative (SG&A) expense as a percentage of revenues. As discussed below, during the third quarter of 2009 and the first nine months of this year, we were unable to fully achieve these goals due in part to challenging economic conditions.

 

Revenues

                

 

Our Laboratory Services segment includes revenues from workplace drugs-of-abuse testing and revenues from clinical and other laboratory services. Our revenues from drugs-of-abuse testing decreased 9% to $9.5 million and 11% to $27.5 million for the three and nine month periods ended September 30, 2009, respectively. The decrease in both periods was primarily a result of a 24% and 26% decline in revenues from our existing drugs-of-abuse clients for the three and nine month periods ended September 30, 2009, respectively, due to challenging economic conditions affecting hiring decisions by those clients. This decrease was partially mitigated by a 15% increase in revenues from new drugs-of-abuse clients for both the three and nine month periods ended September 30, 2009. We expect a continuing negative impact on revenues from our drugs-of-abuse clients in 2009 caused by the negative economic conditions affecting hiring. Pricing for our workplace drugs-of-abuse testing services tends to be fairly stable overall; however, the average price per testing specimen can vary slightly from quarter-to-quarter. Test price can vary by client based on the percentage of samples that test positive for drugs-of-abuse and the average number of samples per shipment.

 

 

Revenues from our clinical and other laboratory services for the three and nine months ended September 30, 2009, increased 17% to $8.2 million and 22% to $22.9 million, respectively. The improvement in both periods was driven primarily by growth generated by our expanded clinical laboratory capabilities. For the nine months ended September 30, 2009, the improvement was also due to strong growth in testing for clinical trial services. Revenues from clinical trial services can fluctuate from quarter-to-quarter based on the project nature, size, and the actual timing of clinical trials.

 

Our Product Sales segment includes revenues from point-of-collection on-site testing products (POCT), contract manufacturing services and other diagnostic products.

 

Sales of POCT products, which consist of the PROFILE®-II, PROFILE®-II A, PROFILE-II ER®, PROFILE®-III ER, PROFILE®-III, PROFILE®-III A, PROFILE®-IV, PROFILE®-V, VERDICT®-II and SURE-SCREEN® on-site test kits and other ancillary products for the detection of abused substances, decreased 9% to $4.1 million and 10% to $12.5 million for the three and nine months ended September 30, 2009, respectively. The decrease in both periods was due primarily to a 22% and 26% decline in revenues from device sales in the workplace market for the three and nine months ended September 30, 2009, respectively, attributable to tough economic conditions affecting hiring decisions. Overall, pricing for our POCT devices was slightly lower than the prior year periods.

 

Sales of contract manufacturing services increased 24% or $0.1 million to $0.4 million for the three months ended September 30, 2009. For the nine months ended September 30, 2009, sales of contract manufacturing services remained flat at $1.1 million.

 

Sales of other diagnostic products were flat at $0.1 million and $0.3 million for the three and nine months ended September 30, 2009, respectively, compared to the same periods in 2008.

 

Cost of Revenues and Gross Margin

 

 

 

 

 

Consolidated gross margin was 39.0% and 37.3% of revenues for the three and nine months ended September 30, 2009, respectively, compared to 42.1% and 43.2% of revenues for the same periods in 2008.

 

Laboratory Services gross margin was 33.7% and 31.6% for the three and nine months ended September 30, 2009, respectively, down from 37.4% and 38.0% for the same periods of 2008. The decrease in both periods in 2009 was due to the drop in drugs-of-abuse testing revenues over a highly fixed cost structure and increased costs associated with our clinical laboratory expansion.

 

Gross margin from Product Sales increased to 59.4% for the three months ended September 30, 2009 from 58.5% for the same period of 2008 due to changes in sales mix of point-of-collection testing (POCT) devices. Gross margin from Product Sales was 58.1% for the nine months ended September 30, 2009 down from 60.3% for the same period of 2008. The decrease in the nine month period ended September 30, 2009 primarily reflects a shift in sales mix of POCT devices, with a decrease in higher margin PROFILE® devices sold in the workplace market and an increase in sales of lower margin SURE-SCREEN® devices in the government market.

 

Operating Expenses

 

 

 

 

* Less than 1%

 

 Selling, General and Administrative Expenses. Selling, general and administrative (SG&A) expenses increased to $7.1 million, or 31.8% of revenues for the three months ended September 30, 2009, compared to $6.1 million, or 27.0% of revenues for the same period in 2008. For the nine months ended September 30, 2009, SG&A expenses increased to $19.8 million, or 30.9% of revenues, compared to $17.8 million, or 27.4% of revenues for the same period in 2008. Our increased spending in both periods of 2009 was partially associated with an increase in sales and marketing expense. The increases were also due to the reclassification of $180,000 and $330,000 for the three and nine months ended September 30, 2009, respectively, from Other Income (Expense) which was determined to be more appropriately classified in SG&A expenses. The increase in the three months ended September 30, 2009 was also due to an increase in retirement plan obligation which corresponds to increases in the related marketable equity securities held in trust to fund this obligation. The increase in retirement plan expense associated with the obligation was offset by a corresponding investment gain being recorded in Other Income (Expense).

 

 Research and Development Expenses. Research and development expenses decreased 9% to $0.6 million for the three months ended September 30, 2009 primarily due to decreased spending for on-going product development projects in our Product Sales segment. Research and development expenses were flat at $1.7 million for the nine months ended September 30, 2009, compared to the same period in 2008.

 

Other Income (Expense)

 

Other income (expense) consists primarily of interest expense, our investment gains/losses, and the net expenses associated with our building rental activities. Other income was $147,000 for the three months ended September 30, 2009, compared to other expense of $181,000 for the same period in 2008. Other expense was $110,000 for the nine months ended September 30, 2009, compared to $599,000 for the same period in 2008. The variance in both periods was due to the reclassification of $180,000 and $330,000 for the three and nine months ended September 30, 2009, respectively, from Other Income (Expense) which was determined to be more appropriately classified in SG&A expenses, as well as an investment gain on our marketable equity securities held in trust.

 

Liquidity and Capital Resources

 

Our working capital requirements have been funded primarily by profitable operations. Cash and cash equivalents at September 30, 2009 were $3.3 million, compared to $4.1 million at December 31, 2008.

 

Net cash provided by operating activities was $3.4 million for the nine months ended September 30, 2009, compared to $9.3 million for the nine months ended September 30, 2008. The decrease was primarily due to reduced operating results. The decrease was also due to a larger increase in our trade receivables from December 31, 2008 to September 30, 2009, compared to December 31, 2007 to September 30, 2008. The significant increase in accounts receivable at September 30, 2009 was primarily due to the timing of sales and cash receipts.

 

Net cash used in investing activities, consisting of capital expenditures, was $3.5 million for the nine months ended September 30, 2009, compared to $6.2 million for the same period of 2008. The decrease in the first nine months of 2009 was primarily due to the absence of costs incurred in the first nine months of 2008 associated with the expansion of our regional clinical laboratory capabilities. In both periods, these expenditures included equipment purchased and costs incurred to upgrade equipment, improve efficiencies and increase service levels to our clients.

 

Net cash used in financing activities was $0.7 million for the nine months ended September 30, 2009, compared to $1.7 million in the prior year period. The decrease was primarily due to a decrease in the repurchase of shares of our common stock. In the first nine months of 2009, we repurchased 60,644 shares of our common stock in the open market for a cost of $0.4 million. In the first nine months of 2008, we repurchased 63,140 shares of our common stock from officers of our Company for a cost of $1.0 million. The shares repurchased were placed in trust to fund our Long-Term Incentive Plan.

 

We are party to a credit security agreement (the "Wells Fargo Credit Agreement") with Wells Fargo Bank, National Association (the “Bank”). The Wells Fargo Credit Agreement, as amended through November 1, 2009, consists of:

 

(i) a revolving line of credit ("Line of Credit"), payable on demand, of up to $8.0 million bearing interest at either a fluctuating rate of 0.5% below the Bank’s prime rate or at a fixed rate of 1.9% above LIBOR, as defined and calculated by the Bank, in effect on the first day of the applicable fixed rate term; and

 

(ii) a note or notes aggregating up to $4.9 million (loan limit) for the purchase of capital equipment bearing interest at either a rate of 0.25% below the Bank’s prime rate or at a fixed rate for a period of one, two, three, or four years at a rate of 2.25% in excess of the then current yield on U.S. Treasury Securities, adjusted to a constant maturity equal to such fixed rate period.

 

Subject to certain conditions, the Wells Fargo Credit Agreement also provides for the issuance of letters of credit which, if drawn upon, would be deemed advances under the Line of Credit. We are required to pay a fee equal to 0.125% per annum on the average daily unused amount of the Line of Credit. We have granted the Bank a first priority security interest in all of the Company’s accounts receivable, other rights to payment, general intangibles, inventory, and equipment to secure all indebtedness of the Company to the Bank.

 

Extensions of credit under the Wells Fargo Credit Agreement are subject to certain conditions. The Wells Fargo Credit Agreement also requires us to comply with certain financial covenants, including maintaining, on a consolidated basis:

 

 

 

 

On October 29, 2009, we entered into the Fourth Amendment to the Credit Agreement with the Bank, which modifies certain terms and conditions of the Wells Fargo Credit Agreement as follows:

 

 

 

 

 

 

The provisions of the Wells Fargo Credit Agreement, as amended, pertaining to the note or notes aggregating up to $4.9 million (loan limit) for the purchase of capital equipment with the Bank will mature on November 1, 2009. We reviewed our need for the capital equipment note and determined that it is no longer necessary. As such, we have elected not to extend the last day on which the Bank will make advances under the capital equipment notes.

 

We are relying on expected positive cash flows from operations and our Line of Credit to fund our future working capital and asset purchases. At September 30, 2009, we had total borrowing capacity of $8.0 million on our Line of Credit. We did not have an outstanding balance on our Line of Credit at September 30, 2009.

 

In the short term, we believe that the aforementioned resources will be sufficient to fund our planned operations through 2009. While there can be no assurance that the available capital will be sufficient to fund our future operations beyond 2009, we believe that future profitable operations, as well as access to additional capital through debt or equity financings, will be the primary means for funding our operations for the long term.

 

We continue to follow a plan which includes (i) aggressively monitoring and controlling costs, (ii) increasing revenues from sales of our existing products and services (iii) developing new products and services, as well as (iv) selectively pursuing synergistic acquisitions to increase our critical mass.

 

However, there can be no assurance that costs can be controlled, revenues can be increased, financing may be obtained, acquisitions successfully consummated, or that we will be profitable.

 

Disclosures about Contractual Obligations and Commercial Commitments

 

The following table aggregates all contractual commitments and commercial obligations that affect the Company’s financial condition and liquidity position as of September 30, 2009:

 

 

 

The table above excludes our obligation for future payments to participants under our Supplemental Executive Retirement Plan of approximately $0.6 million at September 30, 2009, as the specific payment dates and amounts are unknown.

 

Off-Balance Sheet Transactions

 

The Company does not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Impact of Inflation and Changing Prices

 

The impact of inflation and changing prices on the Company has been primarily limited to salary, laboratory and operating supplies and rent increases and has historically not been material to the Company’s operations. In the future, the Company may not be able to increase the prices of laboratory testing by an amount sufficient to cover the cost of inflation, although the Company is responding to these concerns by refocusing the laboratory operations towards higher margin testing (including clinical and pharmaceutical trials) as well as emphasizing the marketing, sales and operations of the Product Sales business.

 

Seasonality

 

The Company believes that the laboratory testing business is subject to seasonal fluctuations in pre-employment screening. These seasonal fluctuations include reduced volume in the year-end holiday periods and other major holidays. In addition, inclement weather may have a negative impact on volume thereby reducing net revenues and cash flows.

 

Impact of New Accounting Standards

 

In June 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) 105-10, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles.  This Statement modifies the Generally Accepted Accounting Principles (GAAP) hierarchy by establishing only two levels of GAAP, authoritative and nonauthoritative accounting literature. Effective July 2009, the FASB ASC, also known collectively as the “Codification,” is considered the single source of authoritative U.S. accounting and reporting standards, except for additional authoritative rules and interpretive releases issued by the SEC.  Nonauthoritative guidance and literature would include, among other things, FASB Concepts Statements, American Institute of Certified Public Accountants Issue Papers and Technical Practice Aids and accounting textbooks. The Codification was developed to organize GAAP pronouncements by topic so that users can more easily access authoritative accounting guidance.   We adopted this Statement effective July 1, 2009 and accordingly all accounting references have been updated and SFAS references have been replaced with ASC references.

 

In May 2009, the FASB issued ASC 855-10, “Subsequent Events”. ASC 855-10 provides guidance on management’s assessment of subsequent events and incorporates this guidance into accounting literature. ASC 855-10 is effective prospectively for interim and annual periods ending after June 15, 2009. The adoption of this Statement did not have an impact on our financial position or results of operations. Management has evaluated subsequent events through October 29, 2009.

 

 

Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

There have been no material changes in our market risk during the quarter ended September 30, 2009. For additional information refer to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2008.

 

Item 4: CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls Procedures

 

As of the end of the period covered by this report, we conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information that is required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

Changes in Internal Controls

 

There were no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II    OTHER INFORMATION

 

 

ITEM 1A RISK FACTORS. There have been no material changes to our risk factors during the three and nine months ended September 30, 2009. For additional information refer to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008.

 

Inapplicable

 

 

 

 

 

 

 

 

 

The provisions of the Wells Fargo Credit Agreement, as amended, pertaining to the note or notes aggregating up to $4.9 million (loan limit) for the purchase of capital equipment with the Bank will mature on November 1, 2009. The Company reviewed its need for the capital equipment note and determined that it is no longer necessary. As such, the Company has elected not to extend the last day on which the Bank will make advances under the capital equipment notes.

 

The foregoing description of the Fourth Amendment is qualified by the provisions of the Fourth Amendment, which is filed herewith as Exhibit 10.1 and incorporated herein by reference.

 

 

 

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.

 

 

 

 

 

EXHIBIT INDEX

MEDTOX SCIENTIFIC, INC.

FORM 10-Q FOR QUARTER ENDED SEPTEMBER 30, 2009