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

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

For the quarterly period ended June 30, 2010
OR
(  )
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period   _________________________    to    _________________________________                                       

Commission file number 1-11394

MEDTOX SCIENTIFIC, INC.
(Exact name of registrant as specified in its charter)

Delaware
95-3863205
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

402 West County Road D, St. Paul, Minnesota
55112
(Address of principal executive offices)
(Zip Code)

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.
Yes [ X ]                      No [   ]

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).
                                                                                                Yes [   ]                      No [   ]                      

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.
Large accelerated filer [   ]                                                            Accelerated filer [ X ]                                          Non-accelerated filer [  ]Smaller reporting company  [   ]

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

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

Class
 
Outstanding at July 15, 2010
 
Common Stock, $0.15 par value per share
    8,717,314  


 
 

 

MEDTOX SCIENTIFIC, INC.

INDEX

     
 Page
Part I
Financial Information:
 
       
 
Item 1:
Financial Statements (Unaudited)
 
       
   
Consolidated Statements of Income – Three and Six
 
   
Months Ended June 30, 2010 and 2009
3
       
   
Consolidated Balance Sheets – June 30, 2010
 
   
and December 31, 2009
4
       
   
Consolidated Statements of Cash Flows – Six Months
 
   
Ended June 30, 2010 and 2009
5
       
   
Notes to Consolidated Financial Statements
6
       
 
Item 2:
Management's Discussion and Analysis of
 
   
Financial Condition and Results of Operations
10
       
 
Item 3:
Quantitative and Qualitative Disclosures
 
   
About Market Risk
20
       
 
Item 4:
Controls and Procedures
20
       
Part II
Other Information
21
       
 
Item 1A:
Risk Factors
21
       
 
Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds
21
       
 
Item 5:
Other Information
21
       
 
Item 6:
Exhibits
21
       
   
Signatures
22
       
   
Exhibit Index
23


 
- 2 -

 

PART I                 FINANCIAL INFORMATION
Item 1:                 FINANCIAL STATEMENTS (UNAUDITED)

MEDTOX SCIENTIFIC, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share data)
(Unaudited)

   
Three Months Ended
   
Six Months Ended
 
   
June 30, 2010
   
June 30, 2009
   
June 30, 2010
   
June 30, 2009
 
                         
REVENUES:
                       
   Laboratory services:
                       
      Drugs-of-abuse testing services
  $ 10,160     $ 9,618     $ 18,956     $ 18,064  
      Clinical & other laboratory services
    7,578       5,377       14,468       10,774  
      Clinical trial services
    2,037       1,592       2,870       3,907  
   Product sales
    5,410       4,745       10,052       9,245  
      25,185       21,332       46,346       41,990  
                                 
COST OF REVENUES:
                               
  Cost of services
    12,551       11,634       23,584       22,751  
  Cost of sales
    2,293       2,032       4,321       3,930  
      14,844       13,666       27,905       26,681  
                                 
GROSS PROFIT
    10,341       7,666       18,441       15,309  
                                 
OPERATING EXPENSES:
                               
   Selling, general and administrative
    8,231       6,521       15,664       12,742  
   Research and development
    573       589       1,122       1,159  
      8,804       7,110       16,786       13,901  
                                 
INCOME FROM OPERATIONS
    1,537       556       1,655       1,408  
                                 
OTHER INCOME (EXPENSE):
                               
   Interest expense
    -       (5 )     (1 )     (11 )
   Other income (expense)
    56       (62 )     61       (246 )
      56       (67 )     60       (257 )
                                 
INCOME BEFORE INCOME TAX EXPENSE
    1,593       489       1,715       1,151  
                                 
INCOME TAX EXPENSE
    (581 )     (178 )     (626 )     (420 )
                                 
NET INCOME
  $ 1,012     $ 311     $ 1,089     $ 731  
                                 
BASIC EARNINGS PER COMMON SHARE
  $ 0.12     $ 0.04     $ 0.13     $ 0.09  
                                 
DILUTED EARNINGS PER COMMON SHARE
  $ 0.11     $ 0.04     $ 0.12     $ 0.08  
                                 
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
                               
          Basic
    8,700,838       8,538,965       8,669,326       8,518,524  
          Diluted
    8,963,870       8,816,645       8,907,773       8,759,333  

See Notes to Consolidated Financial Statements (Unaudited).

 
- 3 -

 

MEDTOX SCIENTIFIC, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)


   
June 30,
2010
   
December 31,
2009
 
ASSETS
           
CURRENT ASSETS:
           
   Cash and cash equivalents
  $ 4,946     $ 4,165  
   Accounts receivable:
               
         Trade, less allowance for doubtful accounts ($718 in 2010 and $529 in 2009)
    19,370       14,916  
         Other
    1,219       1,257  
             Total accounts receivable
    20,589       16,173  
   Inventories
    3,547       3,593  
   Prepaid expenses and other
    1,501       1,429  
   Deferred income taxes
    2,977       3,603  
             Total current assets
    33,560       28,963  
BUILDING, EQUIPMENT AND IMPROVEMENTS, net
    28,696       29,509  
GOODWILL
    15,967       15,967  
INTANGIBLE ASSETS, net
    236       273  
OTHER ASSETS
    1,017       1,405  
TOTAL ASSETS
  $ 79,476     $ 76,117  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
CURRENT LIABILITIES:
               
   Accounts payable
  $ 4,066     $ 4,143  
   Accrued expenses
    6,827       4,670  
   Current portion of long-term debt
    -       302  
             Total current liabilities
    10,893       9,115  
OTHER LONG-TERM LIABILITIES
    3,287       3,224  
DEFERRED INCOME TAXES, net
    2,346       2,346  
                 
STOCKHOLDERS' EQUITY:
               
   Preferred stock, $1.00 par value; authorized shares, 50,000; none issued and outstanding
    -       -  
   Common stock, $0.15 par value; authorized shares, 28,000,000; issued shares, 8,820,745 in
               
        2010 and 8,675,510  in 2009
    1,323       1,301  
   Additional paid-in capital
    88,729       88,078  
   Accumulated deficit
    (21,834 )     (22,923 )
   Common stock held in trust, at cost, 388,531 shares in 2010 and 367,911 shares in 2009
    (4,268 )     (4,024 )
   Treasury stock, at cost, 103,431 shares in 2010 and 2009
    (1,000 )     (1,000 )
             Total stockholders' equity
    62,950       61,432  
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 79,476     $ 76,117  

See Notes to Consolidated Financial Statements (Unaudited).

 
- 4 -

 

MEDTOX SCIENTIFIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

   
Six Months Ended
 
   
June 30, 2010
   
June 30, 2009
 
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
           
   Net income
  $ 1,089     $ 731  
   Adjustments to reconcile net income to net cash provided by
               
           operating activities:
               
      Depreciation and amortization
    2,840       2,641  
      Provision for losses on accounts receivable
    582       310  
      Loss on sale of equipment
    6       13  
      Deferred and stock-based compensation
    541       378  
      Deferred income taxes
    626       420  
      Changes in operating assets and liabilities:
               
         Accounts receivable
    (4,998 )     (1,851 )
         Inventories
    46       171  
         Prepaid expenses and other current assets
    (72 )     191  
         Other assets
    (45 )     (153 )
         Accounts payable and accrued expenses
    2,497       (1,003 )
                Net cash provided by operating activities
    3,112       1,848  
                 
CASH FLOWS USED IN INVESTING ACTIVITIES:
               
    Purchase of building, equipment and improvements
    (2,413 )     (2,144 )
                Net cash used in investing activities
    (2,413 )     (2,144 )
                 
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
               
    Principal payments on long-term debt
    (302 )     (339 )
    Purchase of common stock for incentive plan
    (289 )     (410 )
    Net proceeds from the exercise of stock options
    673       236  
              Net cash provided by (used in) financing activities
    82       (513 )
                 
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    781       (809 )
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    4,165       4,069  
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 4,946     $ 3,260  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
               
   Cash paid for:
               
          Interest
  $ 2     $ 12  
          Income taxes
    25       31  
                 
Supplemental noncash activities:
               
          Asset additions and related obligations in payables
    822       656  

See Notes to Consolidated Financial Statements (Unaudited).

 
- 5 -

 

MEDTOX SCIENTIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2010

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 six month periods ended June 30, 2010 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, 2009.

2.  SEGMENTS

The Company has two reportable segments:  Laboratory Services and Product Sales.  The Laboratory Services segment consists of MEDTOX Laboratories, Inc. and New Brighton Business Center, LLC (NBBC).  Services provided include drugs-of-abuse testing services; clinical & other laboratory services, which include clinical toxicology, clinical testing for occupational health clinics, clinical testing for physician offices, pediatric lead testing, heavy metals analyses, courier delivery, and medical surveillance; and clinical trial services which include central laboratory services, assay development, bio-analytical, bio-equivalence and pharmacokinetic testing.  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.

 
- 6 -

 


(In thousands)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
     Laboratory Services:
                       
  Revenues
  $ 19,775     $ 16,587     $ 36,294     $ 32,745  
  Depreciation and amortization
    1,218       1,172       2,441       2,323  
  Income (loss) from operations
    495       (297 )     (66 )     (223 )
  Capital expenditures for segment assets
    1,267       1,348       2,268       1,971  
                                 
     Product Sales:
 
                               
  Revenues
  $ 5,410     $ 4,745     $ 10,052     $ 9,245  
  Depreciation and amortization
    202       170       399       318  
  Income from operations
    1,042       853       1,721       1,631  
  Capital expenditures for segment assets
    98       76       145       173  
                                 
     Corporate (unallocated):
                               
  Other income (expense)
  $ 56     $ (67 )   $ 60     $ (257 )
                                 
    Company:
                               
  Revenues
  $ 25,185     $ 21,332     $ 46,346     $ 41,990  
  Depreciation and amortization
    1,420       1,342       2,840       2,641  
  Income from operations
    1,537       556       1,655       1,408  
  Other income (expense)
    56       (67 )     60       (257 )
  Income before income tax expense
    1,593       489       1,715       1,151  
  Capital expenditures for assets
    1,365       1,424       2,413       2,144  


(In thousands)
 
June 30, 2010
   
December 31, 2009
 
    Assets:
           
  Laboratory Services
  $ 62,365     $ 60,630  
  Product Sales
    14,134       11,884  
  Corporate (unallocated)
    2,977       3,603  
  Company
  $ 79,476     $ 76,117  

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

(In thousands)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
POC on-site testing products
  $ 4,682     $ 4,316     $ 8,791     $ 8,341  
Contract manufacturing services
    553       327       948       705  
Other diagnostic products
    175       102       313       199  
    $ 5,410     $ 4,745     $ 10,052     $ 9,245  

 
 
- 7 -

 
 
3.  INVENTORIES

Inventories consisted of the following:

(In thousands)
 
June 30, 2010
   
December 31, 2009
 
             
Raw materials
  $ 691     $ 653  
Work in process
    396       400  
Finished goods
    317       360  
Supplies, including off-site inventory
    2,143       2,180  
    $ 3,547     $ 3,593  

4.  EARNINGS PER SHARE

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

(In thousands, except share and
per share data)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net income (A)
  $ 1,012     $ 311     $ 1,089     $ 731  
Weighted average number of basic common shares outstanding (B)
    8,700,838       8,538,965       8,669,326       8,518,524  
Dilutive effect of stock options  computed based on the treasury stock method
    263,032       277,680       238,447       240,809  
Weighted average number of diluted common shares outstanding (C)
    8,963,870       8,816,645       8,907,773       8,759,333  
Basic earnings per common share (A/B)
  $ 0.12     $ 0.04     $ 0.13     $ 0.09  
Diluted earnings per common share (A/C)
  $ 0.11     $ 0.04     $ 0.12     $ 0.08  

5.  INCOME TAXES

At December 31, 2009, the Company had federal net operating loss carryforwards (NOLs) of approximately $9.0 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.

 
- 8 -

 

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.


 
- 9 -

 

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, and (v) 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:

·  
increased competition, including price competition

·  
changes in demand for our services and products by our customers

·  
changes in general economic and business conditions, both nationally and internationally, which can influence the level of job growth and, in turn, the level of pre-employment drug screening activity

 
- 10 -

 

·  
technological or regulatory developments, or evolving industry standards, that could affect or delay the sale of our products

·  
our ability to attract and retain experienced and qualified personnel

·  
risks and uncertainties with respect to our patents and proprietary rights, including:
o  
other companies challenging our patents
o  
patents issued to other companies that may harm our ability to do business
o  
other companies designing around technologies we have developed
o  
our inability to obtain appropriate licenses from third parties
o  
our inability to protect our trade secrets
o  
risk of infringement upon the proprietary rights of others
o  
our inability to prevent others from infringing on our proprietary rights

·  
our inability to control the costs in our business

·  
our inability to obtain sufficient financing to continue to sustain or expand our operations

·  
adverse results in litigation matters

·  
our inability to continue to develop innovative products and services

·  
our inability to provide our services in a timely manner

·  
an unforeseen decrease in the acceptance of current new products and services, including in the market for clinical laboratory testing for physicians offices and patients

·  
fluctuations in clinical trial activities

·  
inaccurate information regarding market opportunities

·  
failure to receive regulatory approvals and clearances

·  
other factors, including those set forth in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009

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.

 
- 11 -

 

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 occupational health clinics, and heavy metal, trace element and solvent analyses.  We provide these services to hospitals, clinics, HMOs 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 include 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.

MEDTOX Laboratories, Inc. also provides clinical trial services which includes central laboratory services, assay (test) development, bio-analytical, bio-equivalence and pharmacokinetic testing.  Central laboratory services include tests that are used to monitor the safety and efficacy of a drug.  These tests or “safety labs” include tests that are performed in our general clinical laboratory and pathology laboratory such as clinical chemistries (liver function, kidney function, cardiac and bone), hematology (blood count), immunology (immune status), and flow cytometry (cell identification).  Assay development, bio-analytical and bio-equivalence studies are performed in our bio-analytical laboratory.  These tests are conducted using methodologies such as immunoassay, gas chromatography, high performance liquid chromatography, gas chromatography/mass spectrometry and tandem mass spectrometry.  Clients for our clinical testing services include clinical trial sponsors (pharmaceutical and biotech companies), clinical research organizations (CROs), research organizations, and investigators with trial management, patient recruitment/enrollment and site management.

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.


 
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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 point-of-collection testing (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.

Key Trends Influencing Our Operating Results

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 and Product Sales, Drugs-of-Abuse Business

In the first and second quarters of 2010, 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.  Due to the recent downturn in the economy, we have experienced increased price competition for certain diagnostic testing devices, particularly in the probation, parole and rehabilitation market.

Our Strategy

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.


 
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Our success in penetrating new accounts has represented a significant component of our growth in market share.  Over the past four years, we have expanded our number of sales representatives from 23 to 51.  The increase in sales representatives has increased our business from new accounts and helps offset risks from uncertain economic conditions that may cause 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.

Critical Accounting Policies
 
There were no significant changes to our critical accounting policies during the three and six-month periods ended June 30, 2010 from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009.

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 margin and reduced selling, general and administrative (SG&A) expense as a percentage of revenues.  As discussed below, during the second quarter of 2010 and the first six months of this year, we were able to achieve revenue growth and improved gross margin, but we experienced an increase in SG&A expenses as a percentage of revenues.


 
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Revenues

   
Three Months Ended
   
Six Months Ended
 
(In thousands, except percentages)
 
June 30,
2010
   
June 30,
2009
   
$ Change
   
% Change
   
June 30,
2010
   
June 30,
2009
   
$ Change
   
% Change
 
Revenues:
                                               
                                                 
Laboratory Services
                                               
Drugs-of abuse testing  services
  $ 10,160     $ 9,618     $ 542       6 %   $ 18,956     $ 18,064     $ 892       5 %
Clinical & other laboratory services
    7,578       5,377       2,201       41 %     14,468       10,774       3,694       34 %
Clinical trial services
    2,037       1,592       445       28 %     2,870       3,907       (1,037 )     (27 )%
                                                                 
Product Sales
    5,410       4,745       665       14 %     10,052       9,245       807       9 %
                                                                 
    $ 25,185     $ 21,332     $ 3,853       18 %   $ 46,346     $ 41,990     $ 4,356       10 %

Our Laboratory Services segment includes revenues from workplace drugs-of-abuse testing, clinical and other laboratory services and clinical trial services.  Our revenues from drugs-of-abuse testing increased 6% to $10.2 million and 5% to $19.0 million for the three and six month periods ended June 30, 2010, respectively.  The increase in both periods was primarily a result of an increase in new account revenues.  The increases were partially offset by a 9% and 8% decline in revenues from our existing drugs-of-abuse clients for the three and six months periods ended June 30, 2010, respectively, due to challenging economic conditions affecting hiring decisions.  We expect a continuing negative impact on revenue from our drugs-of-abuse clients in 2010 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 in our clinical and other laboratory services increased 41% to $7.6 million and 34% to $14.5 million for the three and six month periods ended June 30, 2010, respectively.  The improvement in both periods was due to continued strong growth generated by our expanded clinical laboratory capabilities and diversification initiatives undertaken in 2008.

Revenues in clinical trial services increased 28% to $2.0 million for the three months ended June 30, 2010 and reflects an increase in activity and deferral of work into this period after the slow-down of projects experienced in the first quarter.    For the six months ended June 30, 2010, revenues decreased 27% to $2.9 million due to a slow-down of projects in the first quarter of 2010.   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, increased 8% to $4.7 million and 5% to $8.8 million for the three and six months ended June 30, 2010, respectively.  The increase in both periods was due primarily to an increase in revenues from device sales in the workplace and hospital markets.  Overall, pricing for our POCT devices was slightly lower than the prior year periods.
 
 
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Sales of contract manufacturing services increased 69% to $0.6 million and 35% to $0.9 million for the three and six months ended June 30, 2010, respectively.   After an analysis of this product category in 2007, we concluded that it had diminishing opportunities for us, and we are phasing out contract manufacturing services.  The increase in both periods was due to additional revenue from one of our clients whose contract expired on June 30, 2010.  Based on the expected increased sales of higher-margin POCT products, we do not anticipate a significant impact on our results of operations from exiting this business.

Sales of other diagnostic products increased $73,000 to $175,000 for the three months ended June 30, 2010 and increased $114,000 to $313,000 for the six months ended June 30, 2010 due to the sale of the new NexScreen 12 panel diagnostic product.

Cost of Revenues and Gross Margin

   
Three Months Ended
   
Quarter-over-Quarter
 
(In thousands, except percentages)
 
June 30,
2010
   
% of Revenues
   
June 30,
2009
   
% of Revenues
   
$ Change
   
%
Change
 
Cost of Revenues:
                                   
                                     
Cost of Services
  $ 12,551       63.5 %*   $ 11,634       70.1 %*   $ 917       8 %
                                                 
Cost of Sales
    2,293       42.4 %**     2,032       42.8 %**     261       13 %
                                                 
    $ 14,844       58.9 %   $ 13,666       64.1 %   $ 1,178       9 %

   
Six Months Ended
   
Year-over-Year
 
(In thousands, except percentages)
 
June 30,
2010
   
% of Revenues
   
June 30,
2009
   
% of Revenues
   
$ Change
   
%
Change
 
Cost of Revenues:
                                   
                                     
Cost of Services
  $ 23,584       65.0 %*   $ 22,751       69.5 %*   $ 833       4 %
                                                 
Cost of Sales
    4,321       43.0 %**     3,930       42.5 %**     391       10 %
                                                 
    $ 27,905       60.2 %   $ 26,681       63.5 %   $ 1,224       5 %

*      Cost of services as a percentage of Laboratory Services revenues
**      Cost of sales as a percentage of Product Sales revenues

Consolidated gross margin was 41.1% and 39.8% of revenues for the three and six months ended June 30, 2010, respectively, compared to 35.9% and 36.5% of revenues for the same periods in 2009.

Laboratory Services gross margin was 36.5% and 35.0% for the three and six months ended June 30, 2010, respectively, up from 29.9% and 30.5% for the same periods of 2009.  The increase in both periods in 2010 was primarily due to an increase in higher margin clinical testing revenues.

 
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Gross margin from Product Sales was 57.6% and 57.0% for the three and six months ended June 30, 2010, respectively, compared to 57.2% and 57.5% for the same periods of 2009.

Operating Expenses

   
Three Months Ended
   
Quarter-over-Quarter
 
(In thousands, except percentages)
 
June 30, 2010
   
% of Revenues
   
June 30, 2009
   
% of Revenues
   
$ Change
   
% Change
 
Operating Expenses:
                                   
                                     
Selling, general and
   administrative
  $ 8,231       32.7 %   $ 6,521       30.6 %   $ 1,710       26 %
                                                 
Research and
   development
    573       2.3 %     589       2.8 %     (16 )     (3 )%
                                                 
    $ 8,804       35.0 %   $ 7,110       33.3 %   $ 1,694       24 %

   
Six Months Ended
   
Year-over-Year
 
(In thousands, except percentages)
 
June 30, 2010
   
% of Revenues
   
June 30, 2009
   
% of Revenues
   
$ Change
   
% Change
 
Operating Expenses:
                                   
                                     
Selling, general and
   administrative
  $ 15,664       33.8 %   $ 12,742       30.3 %   $ 2,922       23 %
                                                 
Research and
   development
    1,122       2.4 %     1,159       2.8 %     (37 )     (3 )%
                                                 
    $ 16,786       36.2 %   $ 13,901       33.1 %   $ 2,885       21 %

   Selling, General and Administrative Expenses.  Selling, general and administrative (SG&A) expenses increased to $8.2 million, or 32.7% of revenues for the three months ended June 30, 2010, compared to $6.5 million, or 30.6% of revenues for the same period in 2009.  For the six months ended June 30, 2010, SG&A expenses increased to $15.7 million, or 33.8% of revenues, compared to $12.7 million, or 30.3% of revenues for the same period in 2009.  The increase in both periods was primarily due to increased costs associated with the growth in clinical revenue and increased incentive-based compensation.  Increased expenses associated with the growth in our clinical & other laboratory services business include the expansion of our sales force in the second half of last year,  higher sales related expenses including sales commissions and travel-related expenses, and an increase in expenses related to third party and patient billing.

Other Income (Expense)

Other income  (expense) consists primarily of our investment gains/losses, the net expenses associated with our building rental activities and interest expense.  Other income was $56,000 for the three months ended June 30, 2010 compared to other expense of $67,000 for the same period in 2009.  Other income was $60,000 for the six months ended June 30, 2010 compared to other expense of $257,000 for the same period in 2009.  The variance in both periods was due to an investment gain on our marketable equity securities held in trust in the second quarter of 2010 compared to an investment loss in the same period of 2009.  The variance in the six month period was also due to the reclassification of $195,000 in the first quarter of 2010 from Other Income (Expense) which was determined to be more appropriately classified in SG&A expenses.
 
 
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Liquidity and Capital Resources

Our working capital requirements have been funded primarily by profitable operations.  Cash and cash equivalents at June 30, 2010 were $4.9 million, compared to $4.2 million at December 31, 2009.

Net cash provided by operating activities was $3.1 million for the six months ended June 30, 2010, compared to $1.8 million for the six months ended June 30, 2009.  The increase was attributable to an increase in net earnings, excluding non-cash charges such as depreciation, amortization, deferred compensation and provision for losses on accounts receivable.

Net cash used in investing activities, consisting of capital expenditures, was $2.4 million for the six months ended June 30, 2010, compared to $2.1 million for the same period of 2009.   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 provided by financing activities was $0.1 million for the six months ended June 30, 2010, compared to net cash used in financing activities of $0.5 million in the prior year period.  The change was primarily due to an increase in the net proceeds from the exercise of stock options, as well as a  decrease in the repurchase of shares of our common stock.  In the first six months of 2010, we repurchased 23,290 shares of our common stock in the open market for a cost of $0.3 million.  In the first six months of 2009, we repurchased 60,644 shares of our common stock in the open market for a cost of $0.4 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, consists of a revolving line of credit ("Line of Credit") of up to $8.0 million bearing interest at a fluctuating rate of 2.25% above the daily three month LIBOR, as defined and calculated by the Bank.  We did not have an outstanding balance on the Line of Credit at June 30, 2010 or December, 31, 2009.

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 0.25% 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:

·  
Tangible Net Worth not less than $40,000,000 at any time, with “Tangible Net Worth” defined as the aggregate of total stockholders’ equity plus subordinated debt less any intangible assets.


 
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·  
Current Ratio not less than 1.3 to 1.0 at each month end, with “Current Ratio” defined as total current assets divided by total current liabilities.

·  
Total Liabilities divided by Tangible Net Worth not greater than 1.75 to 1.0 at any time, with “Total Liabilities” defined as the aggregate of current liabilities and non-current liabilities less subordinated debt, and with “Tangible Net Worth” as defined above.

·  
A Debt Service Coverage Ratio not less than 1.5 to 1.0 as of each fiscal quarter end, determined on a rolling four-quarter basis, with “Debt Service Coverage Ratio” defined as the aggregate of net income before non-cash tax expense plus depreciation expense and amortization expense, divided by the aggregate of the current maturity of long-term debt for the previous four fiscal quarters plus current capital lease obligations for the previous four fiscal quarters.

We were in compliance with all of the financial covenants under the Wells Fargo Credit Agreement at June 30, 2010.

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.


 
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Item 3:                  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material changes in our market risk during the quarter ended June 30, 2010.  For additional information refer to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2009.

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.


 
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PART II                     OTHER INFORMATION

ITEM 1A                   RISK FACTORS.  There have been no material changes to our risk factors during the three and six months ended June 30, 2010.  For additional information refer to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009.

ITEM 2                      UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

Issuer Purchases of Equity Securities

Period
 
Total Number of Shares Purchased (a)
   
Average Price Paid per Share
   
Total Number of Shares Purchased as part of Publicly Announced Plans or Programs
   
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
 
                         
April 1 - 30
    23,259     $ 12.37       -       -  
May 1 - 31
    -       -       -       -  
June 1 - 30
    31       12.81       -       -  
    Total
    23,290     $ 12.37       -       -  
                                 

(a)  Represents the number of shares of the Company’s common stock repurchased to fund the Company’s Long-Term Incentive Plan and Supplemental Executive Retirement Plan.  Repurchases of shares may be made through open market or privately negotiated transactions at times and in such amounts as management deems appropriate.

ITEM 5                      OTHER INFORMATION.  The MEDTOX Scientific, Inc. 2010 Stock Incentive Plan (the ‘Plan”) was approved by the stockholders on June 15, 2010.  A description of the material terms of the Plan appeared in the Definitive Proxy Statement for the 2010 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on April 22, 2010, which is incorporated by reference herein.
 
ITEM 6
EXHIBITS.  See Exhibit Index on page following signature page



 
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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.

Signature
Title
Date
/s/ Richard J. Braun
President, Chief Executive Officer, and
July 29, 2010
Richard J. Braun
Chairman of the Board of Directors (Principal Executive Officer)
 
     
/s/ Kevin J. Wiersma
Vice President and Chief Financial Officer
July 29, 2010
Kevin J. Wiersma
(Principal Financial Officer)
 
     
/s/ Angela M. Lacis
Corporate Controller
July 29, 2010
Angela M. Lacis
(Principal Accounting Officer)
 
     


 
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EXHIBIT INDEX
MEDTOX SCIENTIFIC, INC.
FORM 10-Q FOR QUARTER ENDED JUNE 30, 2010
 
 
Exhibit
Number                   Description

 
 
10.1
MEDTOX Scientific, Inc. 2010 Stock Incentive Plan

 
31.1  
Section 302 Certification

 
31.2  
Section 302 Certification

 
32.1
Section 906 Certification of Chief Executive Officer pursuant to the Sarbanes-Oxley Act of 2002.

 
32.2
Section 906 Certification of Chief Financial Officer pursuant to the Sarbanes-Oxley Act of 2002.

 
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