10-K 1 file10-k.htm 10-K file10-k.htm

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011

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

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

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.15 per share
NASDAQ Global Select Market
(Title of Class)
Name of Exchange on Which Registered

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes [  ]  No [X]
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes [  ]  No [X]
 
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 [X]  No [   ]
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, 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]
 
As of June 30, 2011, the aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant was $129,769,414 on the closing price as reported on the NASDAQ Global Select Market.
 
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 February 27, 2012
Common Stock, $0.15 par value per share
 
8,945,190 shares

DOCUMENTS INCORPORATED BY REFERENCE
Document
 
Parts Into Which Incorporated
Definitive Proxy Statement for the 2012 Annual Meeting of Stockholders to be held May 21, 2012 (Proxy Statement)
 
Part III
 
 

 

MEDTOX SCIENTIFIC, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2011

Table of Contents
ITEM NO.
 
PAGE
Part I
   
     
   1.
Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5
     
1A.
Risk Factors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
16
     
   2.
Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20
   
 
   3.
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21
     
Part II
   
     
   5.
Market for the Registrant's Common Equity, Related Stockholder
 
 
 Matters and Issuer Purchases of Equity Securities. . . . . . . . . . . . . . . .
22
     
   6.
Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24
     
   7.
Management's Discussion and Analysis of Financial Condition and
 
 
 Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
25
     
 7A.
Quantitative and Qualitative Disclosures About Market Risk . . . . . . . .
36
     
   8.
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . .
37
     
   9.
Changes in and Disagreements With Accountants on
 
 
 Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . .
37
     
 9A.
Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
37
     
 9B.
Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
38
     
Part III
   
 
   
   10.
Directors, Executive Officers and Corporate Governance . . . . . . . . . . . .
39
     
   11.
Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
39
     
   12.
Security Ownership of Certain Beneficial Owners and Management and
 
   Related Stockholder Matters. . .  . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
39
     
   13.
Certain Relationships and Related Transactions, and Director
 
   Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
39
 
 
 
   14.
Principal Accounting Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . .
39
     
Part IV
   
     
   15.
Exhibits, Financial Statement Schedules. . . . . . . . . . . . . . . . . . . . . . . . . .
40
     
 
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
46

 
- 2 -

 

PART I

CAUTIONARY STATEMENT IDENTIFYING IMPORTANT FACTORS
THAT COULD CAUSE THE COMPANY’S ACTUAL RESULTS TO DIFFER
FROM THOSE PROJECTED IN FORWARD LOOKING STATEMENTS

In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, readers of this document and any document incorporated by reference herein are advised that this document and documents incorporated by reference into this document contain both statements of historical facts and forward looking statements.  Forward looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those indicated by the forward looking statements.  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, inflation, 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, planned regulatory filings, and the impact of patent expirations, 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 our reliance on expected positive cash flow from operations and our Line of Credit to fund future working capital and asset purchases, the sufficiency of our capital resources to fund our planned operations through 2012, and our belief 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, and (vi) statements of assumptions underlying other statements and statements about our business.

This document and any documents incorporated by reference herein also identify important factors which could cause actual results to differ materially from those indicated by the forward looking statements.  The factors that could affect our actual results include the following:
 
·  
changes in federal, state, local and third party payer regulations or policies or other future reforms in the health care system (or in the interpretation of current regulations), affecting governmental and third-party coverage or reimbursement for laboratory testing

·  
loss or suspension of a license or imposition of a fine or penalties under, or future changes in, or interpretations of, the law or regulations of the Clinical Laboratory Improvement Act of 1967, the Clinical Laboratory Improvement Amendments of 1988, the Substance Abuse and Mental Health Services Administration (SAMHSA), or those of Medicare, Medicaid, the False Claims Act or other federal, state or local agencies

·  
failure to comply with HIPAA (Health Insurance Portability and Accountability Act), including changes to federal and state privacy and security obligations and changes to HIPAA, including those changes included within HITECH (Health Information Technology for Economic and Clinical Health) and any subsequent amendments, which could result in increased costs, denial of claims and/or significant penalties

·  
failure to maintain the security of customer-related information could damage the Company’s reputation with customers, cause it to incur substantial additional costs and become subject to litigation

·  
changes in FDA (Food and Drug Administration) regulations or policies (or in the interpretation of current regulations) affecting laboratory developed tests and the 510(k) clearance process

·  
increased competition, including price competition

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

 
- 3 -

 


·  
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

·  
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 this Annual Report on Form 10-K

Many factors could cause our actual results, performance or achievements to be materially different from those anticipated in our forward looking statements.  Any written or oral forward looking statements made by us or on our behalf are subject to these factors.  Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward looking statements prove incorrect, actual results, performance or achievements may vary materially from those described in this Annual Report on Form 10-K as intended, planned, anticipated, believed, estimated or expected.  The risk factors included in this Annual Report on Form 10-K are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward looking statements.  Other unknown or unpredictable factors could also harm our future results.  Given these uncertainties, readers are cautioned not to place undue reliance on such forward looking statements.

The forward looking statements included in this Annual Report on Form 10-K are made only as of the date of this Annual Report on Form 10-K.  We do not intend, and do not assume any obligations, to update these forward looking statements, except as required by law.


 
- 4 -

 

ITEM 1.              BUSINESS.

1.           General.

MEDTOX Scientific, Inc., a Delaware corporation, was organized in September 1986. MEDTOX Scientific, Inc. and its wholly-owned subsidiaries: MEDTOX Laboratories, Inc., MEDTOX Diagnostics, Inc. and New Brighton Business Center, LLC are collectively referred to herein as the “Company”, “MEDTOX”, “we”, “us” or “our”.

We are engaged primarily in two distinct, but related businesses.  MEDTOX Laboratories, Inc., based in St. Paul, Minnesota, provides forensic and clinical laboratory services.  MEDTOX Diagnostics, Inc., based in Burlington, North Carolina, manufactures and distributes diagnostic devices and other similar products.  For the year ended December 31, 2011, MEDTOX Laboratories, Inc. and MEDTOX Diagnostics, Inc. accounted for 79% and 21% of our consolidated revenues, respectively.

     2. 
Principal Services, Products and Markets.

General.  We have two reportable segments: “Laboratory Services”, which consists of the activities conducted by MEDTOX Laboratories, Inc. and New Brighton Business Center, LLC, and “Product Sales”, conducted by MEDTOX Diagnostics, Inc.  Laboratory Services includes drugs of abuse testing services.  MEDTOX Laboratories also provides clinical and other laboratory services which consist of clinical toxicology, clinical testing for occupational health clinics, clinical testing for physician offices, pediatric lead testing, analysis of heavy and trace metal, and prescription management testing.  We also provide services in the area of logistical support, data management and overall program management services.  Additionally, MEDTOX Laboratories provides clinical trial services which include central laboratory services, assay (test) development, bio-analytical, bio-equivalence and pharmacokinetic testing.  The Product Sales segment includes sales of a variety of on-site drug screening products and contract manufacturing.  For financial information relating to our segments, see Note 2 of notes to the consolidated financial statements included in this Annual Report on Form 10-K.

Laboratory Services

A.           Drugs-of-Abuse Testing Services.  As reflected in the table below, our Laboratory Services segment derives a substantial percentage of its revenues from laboratory testing services for the identification of drugs-of-abuse.

(In thousands)
2011
2010
2009
       
Drugs-of-abuse testing services revenues
$   41,343
$   39,624
$   36,040
       
% of Laboratory Services revenues
48%
51%
55%

Industry analysts have estimated that the industry-wide revenues derived from workplace laboratory-based drugs-of-abuse testing in the United States are in excess of $500 million.  Public information highlights the motivations behind such testing.  For example, according to results of a National Institute of Drug Abuse-sponsored survey, drug using employees are 2.2 times more likely to require early dismissal or request time off, 2.5 times more likely to have absences of eight days or more, 3 times more likely to be late for work, 3.6 times more likely to be involved in a workplace accident, and 5 times more likely to file a workers’ compensation claim.  We believe the percentage of employers with drug testing programs has remained fairly consistent over the past five years, with drug testing more prevalent among larger employers. The number of SAMHSA (Substance Abuse Mental Health Services Administration)-certified laboratory service providers has declined in recent years, providing opportunities for the remaining industry participants.

 
- 5 -

 

Drugs-of-abuse testing remains predominately laboratory-based.  However, we do offer on-site drug testing devices through our Product Sales segment.  Our sale of on-site drug testing devices supports our Laboratory Services business as confirmation testing, logistics, data and program management services are often sold along with on-site testing devices.

Our customers for substance abuse testing include public and private companies, as well as service firms; such as, drug treatment counseling centers, criminal justice facilities, occupational health clinics, third party administrators and hospitals.

B.           Clinical & Other Laboratory Services.   As reflected in the table below, our Laboratory Services segment also derives revenues from other services, including: clinical toxicology; physician office-based clinical testing; occupational health clinical testing; heavy metal, trace element and solvent analyses; prescription management testing; and logistics, data and program management services.

(In thousands)
2011
2010
2009
       
Clinical & Other Laboratory Services revenues
$   34,852
$   29,923
$   22,885
       
% of Laboratory Services revenues
41%
39%
35%

The services we provide within the clinical laboratory industry market enable us to leverage our core competencies and expertise.

Clinical Toxicology.  We have a fully certified clinical toxicology reference laboratory specializing in esoteric therapeutic drug monitoring and emergency toxicology.  Esoteric tests are more sophisticated tests used to obtain information not provided by routine tests and generally involve a higher level of complexity and more substantial human involvement than routine tests.  The tests performed in the clinical laboratory are conducted using methodologies such as various immunoassays (a test that uses binding of antibodies to antigens to identify and measure certain substances), gas liquid chromatography, high performance liquid chromatography, gas chromatography/mass spectrometry and tandem mass spectrometry.  Chromatography is a technique for separating, identifying and quantifying the individual chemical components of substances based on the physical and chemical characteristics specific to each component.  Mass spectrometry is a technique for analyzing the individual chemical components of substances by breaking molecules into multiple electrically charged ions that are then sorted for analysis according to their mass-to-charge ratios.

We perform analytical testing for a wide variety of drug classes including: analgesic, antianxiety, anticholinergic, anticoagulant, anticonvulsant, antidepressant, antidiabetic, antiemetic, antihistamine, antiinflammatory, antimicrobial, antipsychotic, bronchodilator, cardiovascular, stimulant, decongestant, immunosuppressant, local anesthetic, muscle relaxant, narcotic analgesic and sedative medications.  Clients for our clinical toxicology services consist of hospitals, clinics and other laboratories.

Clinical Testing for Occupational Health Clinics.  We perform basic clinical testing for our occupational clinic clients that send us drug testing samples.  The most common clinical testing includes blood chemistries, complete blood cell counts, lead/zinc protoporphyrin (ZPP) testing, urinalysis and lipid panels.

Clinical Testing for Physician Offices.  We offer 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.

 
- 6 -

 

Heavy Metal, Trace Element and Solvent Analyses.  We operate a laboratory in which blood and urine are tested for heavy metals (for example, lead), trace elements and solvents.  Our clients for these services are other laboratories, occupational health clinics, companies that are required to comply with OSHA (Occupational Safety and Health Administration) guidelines for monitoring occupational exposure to hazardous materials, and pediatricians who test children for exposure to lead. Current Centers for Medicare and Medicaid Services policy requires a screening blood lead test for all Medicaid-eligible children at 12 and 24 months of age.  In addition, children over the age of 24 months, up to 72 months of age, should receive a lead screening test if there is no record of a previous test.

Prescription Management.  We continued to expand our prescription management product line in 2011.  Our original client base was primarily comprised of local hospital-based pain management groups.  In the past few years we have been marketing our prescription management product line to a rapidly growing number of pain management clinics and other physician practices involved in the management of chronic pain throughout the United States.  We now offer a comprehensive testing program serving this market under the name ToxAssure®.  In 2011 we expanded our marketing efforts with a focus on hospital systems throughout the United States.

Logistics, Data and Program Management Services.  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.  Value-added services include courier services for medical specimen transportation, management programs for laboratory-based and on-site drug testing, coordination of specimen collection sites, and data collection/reporting services including the use of our MyMEDTOX® internet-based reporting system.  In the data management area, we offer our clients the eChain® System, our web-based electronic chain-of-custody and donor tracking system.

C.           Clinical Trial Services.  We provide central laboratory services, assay (test) development, bio-analytical, bio-equivalence and pharmacokinetic testing (a process by which a drug is absorbed, distributed, metabolized and eliminated by the body) for Phase I-IV clinical trials.  Phase I clinical trials focus primarily on testing the safety of the drug and involve generally only a small number of patients.  In Phase II trials, the results of people taking a new treatment are compared with results of people taking standard treatment or a placebo.  A Phase II trial typically involves hundreds of patients.  A Phase III trial involves several thousands of patients and is designed to further evaluate the efficacy and safety of the drug.  Phase IV clinical trials involve further evaluation of the study drug generally after the drug is already approved and in the market place.  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. MEDTOX Laboratories, Inc. is a FDA registered establishment and adheres to applicable GLP (Good Laboratory Practices) requirements.

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.

(In thousands)
2011
2010
2009
       
Clinical Trial Services revenues
$   9,667
$   7,500
$   6,926
       
% of Laboratory Services revenues
11%
10%
10%



 
- 7 -

 

Clinical trial services revenues can fluctuate from quarter-to-quarter based on the project nature, size, and the actual timing of clinical trials as shown in the table below:

 
First
Second
Third
Fourth
(In thousands)
Quarter
Quarter
Quarter
Quarter
         
Clinical Trial Services revenues:
       
         
2011
$       2,536
$      2,323
   $     2,375
    $      2,433
         
2010
$          833
$      2,037
   $     2,358
    $      2,272

Product Sales

A.           Substance Abuse Testing Products. The table below reflects information regarding the revenues derived by our Product Sales segment during the last three years from the sale of point-of-collection testing (POCT) products for drugs-of-abuse, the primary component of Product Sales segment revenues.

(In thousands)
2011
2010
2009
       
POCT product revenues
$   20,292
$   17,796
$  16,431
       
% of Product Sales revenues
91%
89%
90%

The primary markets for our POCT products for drugs-of-abuse are workplace drugs-of-abuse testing and testing in support of hospital emergency departments, the criminal justice system and rehabilitation centers.  We manufacture and distribute our EZ-SCREEN® Cup, PROFILE®-II, PROFILE®-II A, PROFILE®-III, and PROFILE®-III A POCT products into this market.  These products are often sold in conjunction with confirmation testing, logistic, data management, and program management services provided by our Laboratory Services segment.  Our customers for substance abuse testing products include public and private companies, as well as occupational health clinics and third party administrators.

Drug abuse is frequently a factor in emergency room treatment of patients. We manufacture and distribute the PROFILE-II ER® and PROFILE®-III ER and PROFILE®-V line of diagnostic drug screening products to hospital markets for drug detection in patients seen in the hospital and emergency rooms.  The PROFILE-II ER®, PROFILE®-III ER, and PROFILE®-V devices are Food and Drug Administration (FDA)-cleared one step qualitative screening assays for the detection of the following drugs and/or their metabolites (any substance produced by metabolism):

·  
amphetamines
·  
methamphetamines/methylenedioxymethyl amphetamine (ecstasy, speed, crystal)
·  
barbiturates (Phenobarbital)
·  
benzodiazepines (Valium, Librium, Halcion)
·  
cannabinoids/THC (pot, marijuana)
·  
cocaine (crack)
·  
methadone (Methadose)
·  
opiates (heroin)
·  
oxycodone
·  
phencyclidine/PCP (angel dust)
·  
propoxyphene (Darvon)
·  
tricyclic antidepressants

We also market the MEDTOXScan® Reader, an electronic reader, for use with our new PROFILE®-V device in hospital laboratories and emergency rooms.

 
- 8 -

 

We also manufacture and distribute diagnostic drug screening products within the criminal justice and drug rehabilitation markets.  Our EZ-SCREEN® Cup, VERDICT®-II and SURE-SCREEN® product lines are primarily sold within these markets and are sold alone or as part of our comprehensive drug testing program solution, ClearCourse®.  ClearCourse® is a unique and 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.

SURE-SCREEN® is a diagnostic device utilizing lower drug cut-off levels that assists criminal justice agencies in their "no drug use" mandate and supports efforts at early intervention.  The chart below shows the specific cut-offs for the SURE-SCREEN® device as compared to the traditional National Institute of Drug Abuse (NIDA) cut-offs:

Drug
Screening Cut-Off
 
Traditional
SURE-SCREEN®
Amphetamine
1000 ng/ml
300 ng/ml
Methamphetamine
1000 ng/ml
300 ng/ml
Benzoylecgonine
300 ng/ml
100 ng/ml
Morphine
 NA
100 ng/ml
Methadone
 NA
200 ng/ml
Phencyclidine
25 ng/ml
25 ng/ml
Benzodiazepines
 NA
200 ng/ml
Cannabinoids
50 ng/ml
40 ng/ml

B.           Contract Manufacturing Services and Other Diagnostic Products. We are phasing-out of our contract manufacturing services business and expect negligible revenue in 2012, as it is not viewed by management as a sustainable, growth-oriented business. In terms of ancillary diagnostic products, MEDTOX distributes other diagnostic tests, including the NexScreen 12 panel CLIA-waived diagnostic test, as well as diagnostic tests for the detection of alcohol with the our private labeled Breath Alcohol Test.  The table below reflects information regarding the revenues derived by our Product Sales segment from contract manufacturing services and the distribution of other diagnostic products.

(In thousands)
2011
2010
2009
       
Contract manufacturing services revenues
$   1,210
$   1,567
$  1,391
% of Product Sales revenues
5%
8%
8%
       
Other diagnostic products revenues
$      785
$      691
$     435
% of Product Sales revenues
4%
3%
2%

3.           Marketing and Sales.

We believe that the combined operations of the Laboratory Services business and the on-site test kits manufactured by the Product Sales segment have created synergy in the marketing of comprehensive, on-site and laboratory testing programs to a common customer base. We are in a position to offer a full line of products and services for the substance abuse testing and occupational medicine marketplace, including (1) on-site tests for the detection of drugs-of-abuse; (2) SAMHSA (Substance Abuse Mental Health Services Administration) certified laboratory testing (screening and confirmation); (3) biological monitoring of occupational toxins; (4) consultation; and (5) logistics, data management and program management services.

 
- 9 -

 


We have expanded our sales effort in the pharmaceutical market by offering testing services for Phase I-IV clinical trials and working with sponsors and CROs on assay development and bio-analytical and pharmacokinetic studies.  In addition, we have begun to market clinical diagnostic testing services to clinics, hospitals and physician offices on a regional basis.

We use several distribution channels to sell our products and services.  We employ a direct sales force which consists of 58 sales representatives and six sales managers. In addition, we are a party to a distribution agreement with Cardinal Health for our PROFILE® products sold into the hospital laboratory market.  We also benefit from sales efforts on our behalf conducted by third party administrator organizations and occupational health clinic groups.

We have a strategic relationship in the area of pediatric lead testing with Sustainable Resource Center (SRC), a not-for-profit organization dedicated to the eradication of lead exposure in homes within the United States.  We provide annual funding to SRC which is primarily utilized for educational purposes.

We have developed strategic sales plans for each of the primary markets served.  These plans include the utilization of supporting materials for advertising and direct marketing efforts, lead generation activities and attending pertinent industry tradeshows.

Major Customers.  No single customer had sales that amounted to more than 10% of our consolidated revenues during 2011, 2010 or 2009.

4.           New Products, Research and Development.

Laboratory Services.  Our Laboratory Services’ research and development group: develops assays for new drugs and compounds; develops new assays for existing drugs and other toxins; and improves existing assays with the goal of improving assay robustness, sensitivity, accuracy, precision, specificity and efficiency.  This group also investigates and develops assays for commonly tested compounds in alternative matrices and novel formats.  During 2011, this group developed and validated 156 analytes using immunochemistry, liquid chromatography (LC), gas chromatography (GC), gas chromatography with mass spectrometry (GC/MS), inductively coupled plasma mass spectrometry (ICP/MS), and LC with tandem mass spectrometry (LC/MS/MS).  These activities continue to enhance our test menu and ability to realize efficiencies of new technologies.

We have entered the market for full service clinical laboratory testing for physicians offices and patients on a regional basis.  We validated 24 assays to enhance our test menu in clinical chemistry, diagnostic immunology (immune system) virology (viruses), endocrinology (hormones), serology (infectious diseases), and allergy.  We added 44 new tests in pathology/histology/cytology, molecular diagnostics, flow cytometry and microbiology. These new specialties include tests for infectious diseases, viruses, tissue biopsies, cancer, genetic disorders, immune disorders, drug effectiveness, bacteria and parasites.   Based on our local presence, company-owned courier network and advanced instrumentation and technology, we believe we offer superior turn-around times for physicians and patients than our national competitors.

Product Sales.  We continue to develop new and innovative products and services for the drug testing market.  We are continually improving our product performance, result hold time (length of time the result is readable on the device) and cost effectiveness in order to meet the evolving demands of the marketplace.

In 2011, 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.


 
- 10 -

 

In late 2011, we introduced our EZ-Screen® Cup product.  The EZ-Screen® Cup is targeted for the government, corporate and occupational health clinic markets.  The use of a cup format in these markets is advantageous due to the elimination of the standard pipette (laboratory instrument used to transport a measured quantity of liquid) used in a cassette device.  The cup format provides an enclosed system where the testing personnel are not exposed to the urine sample. The EZ-Screen® Cup design adds simplicity and time savings to the drug screening process.

Research and Development.  We incurred costs of $2.5 million, $2.3 million, and $2.3 million for research and development activities in 2011, 2010, and 2009, respectively.  At December 31, 2011, we employed 16 scientists in research and development activities for the Laboratory Services and Product Sales segments. Their primary duties are focused on new methods and assay development for Laboratory Services and developing on-site, rapid in vitro diagnostic devices at the Product Sales facility.

 
5.
Raw Materials.

Laboratory Services.  The raw materials required by the laboratory for urine drug testing consist primarily of two types: specimen collection supplies and reagents for laboratory analysis.  The collection supplies include drug testing custody and control forms that identify the specimen and the client, as well as document the chain-of-custody.  Collection supplies also consist of specimen bottles and shipping supplies.  Reagents for drug testing are primarily immunoassay screening products and various chemicals used for confirmation testing.  We believe all of these materials are available at competitive prices from numerous suppliers.

Product Sales.  The primary raw materials required for the immunoassay-based test kits produced by us consist of antibodies, antigens and other reagents, plastic molded devices, wicking materials, filter materials, absorbent materials and packaging materials.  We maintain an inventory of raw materials which, to date, has been acquired primarily from third parties.  Currently, most raw materials are available from several sources.  The molds and tooling for plastic-molded components are owned by us, which provides supply chain management flexibility.  We possess the technical capability to produce our own antibodies and antigens and have initiated production of antibodies and antigens for certain tests.  Antibodies are part of the immune system and are proteins which are produced by white blood cells.  Their task is to circulate in the body and to attach themselves to any foreign particles (antigen) which they may come across.  If we were to change certain raw materials used in a specific test, additional development, validation and accompanying costs may be required to adapt the alternate material to the specific diagnostic test.

 
6.
Patents, Trademarks, Licensing and Other Proprietary Information.

Laboratory Services.  We believe that the basic technologies requisite to the production of antibodies are in the public domain and are not patentable.  We rely upon trade secret protection of certain proprietary information, rather than patents, where we believe disclosure could cause us to be vulnerable to competitors that could successfully replicate our techniques and processes.

Product Sales.  We file patent applications to protect our intellectual property as it relates to our technologies, inventions and improvements which can be utilized in the development and manufacture of our Product Sales business, as protection of this intellectual property is very important to our Product Sales segment.  These patents relate to our core technologies and designs for diagnostic testing, screening and services.  We hold seven United States issued patents with expiration dates ranging from 2012 to 2025.  The patent expiring in 2012 will not have an impact on our business since it is not used in any of our products.

General.  At December 31, 2011, we held 30 registered trade names and/or trademarks in reference to our products and corporate names.  Our trade names and/or trademarks range in duration from 10 to 20 years with expiration dates ranging from 2012 to 2021.  Applications have also been made for additional trade names.


 
- 11 -

 

 
7.
Seasonality.

Laboratory Services.  We believe 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 revenues and cash flow.

Product Sales. We do not believe that seasonality is a significant factor in the sale of our on-site immunoassay testing devices.

 
8.
Backlog.

Laboratory Services.  At December 31, 2011, MEDTOX Laboratories, Inc. did not have any significant backlog.  We do not believe that sales backlog is a significant factor in the Laboratory Services segment of our business.  However, the time from when an account becomes a client to the time the laboratory starts receiving specimens may be up to four months.  The delay in receiving samples is primarily due to the necessity of establishing communication capabilities between the client and us, the requirement to ship out collection kits and forms, and the establishment of a collection site network.  At December 31, 2011, we had several accounts that were in the process of being set up where revenues will not be realized until 2012.

Product Sales.  At December 31, 2011, MEDTOX Diagnostics, Inc. did not have any significant backlog.  We do not believe that sales backlog is a significant factor in the Product Sales segment of our business.

 
9.
Competition.

Laboratory Services.  Our Laboratory Services segment competes in a fragmented, though highly competitive, industry.  At December 31, 2011, 38 labs, including MEDTOX Laboratories, Inc., were certified by the Department of Health and Human Services as having met the standards for Subpart C of the Mandatory Guidelines for Federal Workplace Drug Testing Programs (59 FR 29916, 29925) and were involved in workplace drugs-of-abuse testing.  Without ongoing certification in this program, a laboratory would not be permitted to conduct drug testing for Federal Workplace Drug Testing Programs such as testing for the Department of Transportation and other similar programs.  Competitors include Quest Diagnostics, Laboratory Corporation of America, Clinical Reference Laboratory, Dominion Diagnostics, Ameritox, Millennium Laboratories, and Psychemedics Corporation, as well as the testing units of other clinical laboratories, including independent laboratories, specialized laboratories and in-house testing facilities maintained by hospitals.

Our Laboratory Services segment competes on the basis of the reliability and accuracy of its test results, price structure, service, transportation and collection network, and the ability to establish relationships with hospitals, physicians and users of drug abuse testing programs.  Many of the segment’s competitors and potential competitors have substantially greater financial and other resources than we do.

The laboratory services drugs-of-abuse industry is consolidating.  The consolidation is being driven by customers’ desires to minimize the number of laboratories they work with, the need for operating efficiencies in the form of critical mass (testing volumes), required investment levels and government regulation.  In light of these forces, we face an increasing challenge to differentiate ourselves through our technology and value-added services, such as data management, collection site management, training and technical support and expertise.  Our ability to successfully compete in the future and maintain our margins will be based on our ability to maintain our quality and customer service while maintaining efficiencies and low cost operations.

Product Sales.  Many large companies with greater research and development, marketing, financial and other capabilities, as well as smaller research firms, are engaged in research, development and marketing of diagnostic assays for application in the areas for which we produce our products.

The diagnostics’ market has become highly competitive with respect to the price, quality and ease of use of various tests, and is characterized by rapid technological changes.  We have designed our diagnostic screening products to be inexpensive, on-site tests for use by unskilled personnel, and have not endeavored to compete with laboratory-based systems.  These laboratory-based systems consist of bench-top auto analyzers that have fast, automated throughput.  Our POCT devices are not designed to compete with such automated systems.

 
- 12 -

 
The recent downturn in the economy has led to increased price competition for certain diagnostic testing devices.  Competitors of this nature include Phamatech, American Bio Medica, and Alere, Inc.

 
10.
Government Regulation.

Our products and services are subject to the regulations of a number of governmental agencies as listed below.  We believe we are currently in compliance with all applicable regulations.  We cannot predict whether future changes in governmental regulations might significantly increase compliance costs or adversely affect the time or cost required to develop and introduce new products.

A.           Substance Abuse and Mental Health Services Administration (SAMHSA). MEDTOX Laboratories, Inc. has been certified by SAMHSA since 1988.  SAMHSA certifies laboratories meeting strict standards under Subpart C of the Mandatory Guidelines for Federal Workplace Drug Testing Programs.  Continued certification is accomplished through periodic inspection by SAMHSA to assure compliance with applicable regulations.  Without ongoing certification in this program, our laboratory would not be permitted to conduct drug testing for Federal Workplace Drug Testing Programs such as testing for the Department of Transportation and other similar programs. Testing performed under the SAMHSA program comprises 25% to 30% of our workplace drug testing customer base.
 
B.           Food and Drug Administration (FDA).  Certain tests for human diagnostic purposes must be cleared by the FDA prior to their marketing for in vitro diagnostic use in the United States.  In vitro diagnostic products are those reagents, instruments and systems intended for use in diagnosis of disease or other conditions, including a determination of the state of health, in order to cure, mitigate, treat or prevent disease or its complications.  Such products are intended for use in the collection, preparation and examination of specimens taken from the human body.  The FDA provides clear guidance that in vitro diagnostic devices used for workplace drug testing must be cleared by the FDA prior to being marketed.  The FDA-regulated products we produce are in vitro diagnostic products subject to FDA clearance through the Federal Food, Drug and Cosmetic Act, Section 510(k) process, which requires the submission of information and data to the FDA that demonstrates that the device to be marketed is substantially equivalent to a currently marketed device.  This data is generated by performing clinical studies comparing the results obtained using our device to those obtained using an existing test product.  Although no maximum statutory response time has been set for review of a 510(k) submission, as a matter of policy the FDA has attempted to complete review of 510(k) submissions within 90 days.  To date, we have received 510(k) clearance for 22 different products.  Products subject to 510(k) regulations may not be marketed for in vitro diagnostic use until the FDA issues a letter stating that a finding of substantial equivalence has been made.
 
As a registered manufacturer of FDA-regulated products, we are subject to a variety of FDA regulations including the Good Manufacturing Practices (GMP) regulations, which define the conditions under which FDA regulated products are to be produced.  These regulations are enforced by the FDA and failure to comply with GMP or other FDA regulations can result in the delay of pre-market product reviews, fines, civil penalties, recalls, seizures, injunctions and/or criminal prosecution.  With the exception of the forensic market, FDA clearance of our diagnostic products is required by our clients and regulatory agencies.
 
As an accredited laboratory performing testing for clinical trials, our laboratory is subject to FDA regulations including Good Laboratory Practices (GLP) and related requirements.

C.           Drug Enforcement Administration (DEA).  Our primary business involves either testing for drugs-of-abuse or developing test kits for the detection of drugs/drug metabolites in urine.  MEDTOX Laboratories, Inc. is registered with the DEA to conduct chemical analyses with controlled substances.  The MEDTOX Diagnostics, Inc. facility in Burlington, North Carolina is registered by the DEA to manufacture and distribute controlled substances and to conduct research with controlled substances.  Maintenance of these registrations requires that we comply with applicable DEA regulations.
 
 
- 13 -

 
D.           Canadian Medical Devices Conformity Assessment System (CMDCAS). MEDTOX Diagnostics, Inc. maintains a quality system which satisfies the requirements for ensuring the safety and effectiveness of our products and meeting the customer needs in accordance with FDA requirements as described in 21 CFR Part 820 (Quality Systems), and that satisfies the requirements of the Canadian Medical Devices Regulations (CMDR) and CAN/CSA ISO 13485:1998 and ISO 9001:2003.  Our product sales to Canada are immaterial to our overall operations.
 
       CMDCAS addresses the quality system requirements found in the CMDR. To sell a medical device in Canada, manufacturers must meet the regulatory requirements as defined in the CMDR. The quality system implemented by the manufacturer for design and manufacture of medical devices must satisfy the quality system requirements of ISO 13485 and the manufacturer is required to have its quality system registered by an approved CMDCAS registrar. A CMDCAS approved registrar audits the manufacturer’s quality system to ISO 13485:1998 and ISO 9001:2003. MEDTOX Diagnostics, Inc. maintains a quality system fulfilling the requirements of EN ISO 13485 and CMDCAS ISO 13485, Quality Systems – Medical Devices and ISO 9001:2000 — Quality Management Systems – Requirements. MEDTOX Diagnostics, Inc. has been issued the TUV Rheinland Product Safety GmbH quality system certificate to EN ISO 13485:2000 and the TUV Rheinland of North America Inc. quality system certificate to ISO 13485 under CMDCAS.

E.           Centers for Medicare and Medicaid Services (CMS).  The Clinical Laboratory Improvement Act (CLIA) introduced in 1992 requires that all in vitro diagnostic products be categorized as to level of complexity.  A request for CLIA categorization of any new clinical laboratory test system must be made simultaneously with FDA 510(k) submission.  The PROFILE®, PROFILE®-II, PROFILE®-III, PROFILE®-V, VERDICT®, VERDICT®-II, EZ-SCREEN® Cup and MEDTOXScan® drugs-of-abuse tests currently marketed by MEDTOX Diagnostics, Inc. have been categorized as moderately complex.  The complexity category to which a clinical laboratory test system is assigned may limit the number of laboratories qualified to use the test system, thus impacting product sales.  MEDTOX Laboratories, Inc. is a CLIA-licensed high complexity laboratory and is accredited by the College of American Pathologists (CAP) Laboratory Accreditation Program.  All laboratory specialties and sub-specialties, as they relate to the expanded laboratory test menu, have been added to MEDTOX Laboratories, Inc.’s CLIA/CAP certificates.

F.           Health Insurance Portability and Accountability Act (HIPAA). MEDTOX Laboratories, Inc. is committed to safeguarding the privacy and confidentiality of its patients’ protected health information.  Our policy is to be in compliance with the requirements of federal and Minnesota state law related to protecting the privacy of health information, including the Standards for Privacy of Individually Identifiable Health Information (45 CFR, Parts 160 and 164 - commonly called the “HIPAA Final Privacy Rule”).  MEDTOX Laboratories, Inc. complies with out-of-state regulations as applicable.  MEDTOX Laboratories, Inc. has compiled several policies and procedures that outline the steps that are taken to ensure compliance with the HIPAA privacy standards and Minnesota state laws related to protected health information.  All employees receive appropriate training on these policies and procedures, and it is the responsibility of each individual to follow the policies and procedures in the performance of their jobs.  The “Notice of Privacy Practices” and “HIPAA Privacy Policy” for MEDTOX Laboratories, Inc. are posted on our website (www.medtox.com).

G.           Additional Laboratory Regulations.  MEDTOX Laboratories, Inc. and certain of its laboratory personnel are licensed or otherwise regulated by certain federal agencies, states and localities in which it conducts business.  Federal, state and local laws and regulations require MEDTOX Laboratories, Inc., among other things, to meet standards governing the qualifications of laboratory owners and personnel, as well as the maintenance of proper records, facilities, equipment, test materials and quality control programs.  In addition, the laboratories are subject to a number of other federal, state and local requirements that provide for inspection of laboratory facilities and participation in proficiency testing, as well as govern the transportation, packaging and labeling of specimens tested.  The laboratories are also subject to laws and regulations prohibiting the unlawful rebate of fees and limiting the manner in which business may be solicited.
 

 
- 14 -

 

Our laboratory located in St. Paul, Minnesota receives and uses small quantities of hazardous chemicals and radioactive materials in its operations and is licensed to handle and dispose of such chemicals and materials.  We comply with all federal, state and local regulations regarding the safe handling, storage and disposal of such chemicals and materials.  Employees working with chemicals are trained initially regarding safe practices, procedures and policies and also participate in annual safety reviews.  Periodic inspections by laboratory accrediting agencies and local authorities assure adherence to safe practices and compliance with applicable regulations.

11.         Product and Professional Liability.

Laboratory Services.  Our laboratory testing services are primarily diagnostic and expose us to the risk of liability claims.  Our laboratories have maintained continuous professional and general liability insurance since 1984.  The insurance policy covers those amounts we are legally obligated to pay for damages resulting from a medical incident, which arises out of a failure to render professional services.  To date, we have not paid any material amounts for claims of this type and no material professional service claims are currently pending.

Product Sales.  Manufacturing and marketing of products by us entails a risk of product liability claims.  Since 1993, we have maintained insurance coverage against the risk of product liability arising out of events after such date. As of the date of filing this Annual Report on Form 10-K, no product liability claims are pending.

 
12.
Employees.

At December 31, 2011, we had a total of 667 full-time employee equivalents compared to 633 full-time employee equivalents at December 31, 2010.

Our employees are not covered by any collective bargaining agreements and we have not experienced any work stoppages. We believe that we maintain good relations with our employees.

 
13.
Available Information.

We make available free of charge on or through our website (www.medtox.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission.

 
- 15 -

 

ITEM 1A.              RISK FACTORS.

A substantial portion of our revenue is derived from the provision of testing services for the identification of drugs-of-abuse in the workplace and government markets, a business that is influenced by general economic conditions.  As such, our operating results are subject to volatility.
 
In 2011, approximately 48% and 57% of our Laboratory Services and Product Sales segment’s revenues, respectively, were derived from the provision of testing services for the identification of drugs-of-abuse in the workplace and government markets.  We expect that a substantial percentage of our revenues will continue to be derived from the provision of such services for the foreseeable future.  This business is influenced by the strength of the U.S. economy.  When the U.S. economy is growing and characterized by job creation, this business tends to experience increased testing levels.  Conversely, lower testing levels tend to be associated with periods of job contraction in the U.S.  As a result, our revenues and operating results are subject to volatility.
 
The laboratory services drugs-of-abuse industry is consolidating.  With the market forces driving such consolidation tending to favor the larger industry participants, we face an increasing challenge to differentiate ourselves through our technology and value-added services.
 
Our Laboratory Services segment competes in what is currently a fragmented, but highly competitive, industry.  At December 31, 2011, 38 labs, including MEDTOX Laboratories, Inc., were certified by the Department of Health and Human Services as having met the standards for Subpart C of the Mandatory Guidelines for Federal Workplace Drug Testing Programs and were involved in workplace drugs-of-abuse testing. Our major competitors include Quest Diagnostics, Laboratory Corporation of America as well as the testing units of other clinical laboratories, including independent laboratories, specialized laboratories, and in-house testing facilities maintained by hospitals.  Many of our competitors have substantially greater financial and other resources than we do.  The laboratory services, drugs-of-abuse industry is consolidating.  The consolidation is being driven by the larger laboratories whose greater resources enable them to be more responsive and better able to increase operating efficiencies in the form of critical mass (testing volumes) and required investment levels.    In light of these forces, we face an increasing challenge to differentiate ourselves through our technology and value-added services, such as data management, collection site management, training and technical support and expertise.  If we are unsuccessful in these differentiation efforts, we may experience declining revenues and gross margins, and reduced cash flows.
 
We are experiencing increased competition in our Product Sales business segment.  Such competition may have a negative effect on our business and future financial prospects.
 
We are experiencing increased competition, including increased price competition, in our Product Sales business segment.  We have experienced increased competition with respect to our immunoassay 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.  A further increase in competition may reduce our ability to compete in the diagnostic market and have a negative effect on our financial results and future prospects.

Our quarterly operating results may vary.
 
Clinical trial services testing for the pharmaceutical industry is project-based, and as such, may vary from quarter to quarter due to factors over which we have little control such as the commencement, completion or cancellation of clinical trial contracts and the progress of ongoing clinical trial contracts.
 
Such variations may cause operating results to vary quarter to quarter, negatively or positively affecting the market price of our common stock.  We believe that such variations in any particular quarter are not necessarily a meaningful indication of future results and that these fluctuations may not be related to our future overall operating performance.
 



 
- 16 -

 

If reimbursement for our services by third party payers is reduced, our net revenues could diminish.

There has been and will likely continue to be significant efforts by both federal and state agencies to reduce costs in government healthcare programs and otherwise implement government control of healthcare costs.  In addition, increasing emphasis on managed care in the U.S. may continue to put pressure on the pricing of healthcare services.  Third party payers, including state payers and Medicare, are challenging the prices charged for medical products and services. Government and other third party payers increasingly are limiting both coverage and the level of reimbursement for our services.  In 2011 and 2010, third party payers accounted for approximately 10.9% and 8.8%, respectively, of our net revenues.  A portion of the testing for which we bill our hospital and laboratory clients is ultimately paid by third party payers.  Any pricing pressure exerted by these third party payers on our customers may, in turn, be exerted by our customers on us.  If government and other third party payers do not provide adequate coverage and reimbursement for our services, our net revenues could decline. If we cannot offset additional reductions in the payments we receive for our services by reducing costs, increasing test volume and/or introducing new procedures, our net revenues and profitability could decline.  Health care reform changes in government reimbursement could also reduce our net revenues.

A significant increase in our days sales outstanding could increase bad debt expense and have an adverse effect on our business.

We are seeing an increase in the percentage of revenues that are billed to patients and third-party payers, including insurance companies and Medicaid and Medicare agencies.  The increase is a result of growth in our clinical laboratory.  Billing to third party payers is complex and is subject to extensive and non-uniform rules and administrative requirements.   It is subject to risks including delayed reimbursement, difficulties in gathering complete and accurate billing information, inabilities to collect and long collection cycles.  Failure to timely or correctly bill may lead to our not being reimbursed for our services or an increase in the aging of our accounts receivable, which could adversely affect our results of operations and cash flows.  In addition, we are experiencing more billing to patients.  Patient billing is increasing as a result of the growth in patient copayments, coinsurance and deductibles and an increase in high deductible health plans.  Patient billings are subject to the risk of difficulties in gathering accurate billing information, inabilities to collect and long collection cycles which also could adversely affect our results of operations and cash flows. We believe our allowance for doubtful accounts is adequate.  However, we cannot assure that our ongoing assessment of accounts receivable will not result in the need for additional provisions, which would adversely affect our results of operations and cash flows.

FDA regulation of laboratory developed tests (LDTs)  and clinical laboratories may result in significant change, and our business could be adversely impacted if we fail to adapt.

During 2010, the FDA publicly announced that it has decided to exercise regulatory authority over LDTs, and that it plans to issue guidance to the industry regarding its regulatory approach. The FDA has indicated that it will use a risk-based approach to regulation and will direct more resources to tests with the highest risk of injury, but that it will be sensitive to the need to not adversely impact patient care or innovation. The FDA did not publish a guidance document in 2011 and has not announced a framework or timetable for implementing its new regulatory approach. The regulatory approach adopted by the FDA may lead to an increased regulatory burden, including additional costs and delays in introducing new tests. While the ultimate impact of the FDA’s approach is unknown, there is an associated risk for us that some of the tests that we currently offer may be subject to approval by the FDA.

We could face significant monetary damages and penalties and/or exclusion from the Medicare and Medicaid programs if we violate health care anti-fraud and abuse laws.

We are subject to extensive government regulation at the federal, state and local levels.  Our failure to meet governmental requirements under these regulations, including those relating to billing practices and relationships with physicians and hospitals, could lead to civil and criminal penalties, exclusion from participation in Medicare and Medicaid and possible prohibitions or restrictions on the use of our laboratory.  While we believe that we conduct our operations and relationships with care in an effort to meet all statutory and regulatory requirements, there is a risk that government authorities might take a contrary position.  Such occurrences, regardless of their outcome, could damage our reputation and adversely affect important business relationships we have with third parties.

 
- 17 -

 
Failure to maintain the security of customer-related information could damage our reputation with  customers and cause us to incur substantial additional costs and become subject to litigation.
 
               We receive certain personal information about our customers.  In addition, we depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments.  A compromise in our security systems that results in customer personal information being obtained by unauthorized persons could adversely affect our reputation with our customers and others, as well as our results of operations, financial condition and liquidity.  It could also result in litigation against us or the imposition of penalties.

If we fail to keep up with technological advancements and fail to develop our products, we may be at a competitive disadvantage and our products may become less attractive or obsolete.

The continuing changes in modern biotechnology could render our products or services as unmarketable or obsolete.  These changes come in the form of technological innovation, changes in customer requirements, declining prices and evolving industry requirements.  Historically, our product and service obsolescence has not had a material impact on our profitability.  New products and services, as well as new technology, may render existing technology products and services obsolete, or too costly and unmarketable.  If we do not commit the resources necessary to develop and sell products incorporating new technologies as demanded by our markets, our products and services may be rendered obsolete, impacting our revenues and profitability.  Even with the development of new technologically advanced products and services, we cannot assure you that they will gain market acceptance.  Lack of market acceptance for any of these products and services could reduce our revenues and negatively affect our profitability.
 
Our business and products are subject to stringent laws and regulations and if we are unable to comply, our business may be significantly harmed.

 Our products and services are subject to the regulations of a number of governmental agencies as listed in Item 1, “Business” under the heading “10. Government Regulation”.  We cannot predict whether future changes in governmental regulations might significantly increase compliance costs or adversely affect the time or cost required to develop and introduce new products.  In addition, our products are or may become subject to foreign regulations.  If we do not comply with existing or additional laws or regulations, or if we incur penalties, it could increase our expenses, prevent us from increasing net revenues, or hinder our ability to conduct our business.

 Our operations might be affected by the occurrence of a natural disaster or other catastrophic event.

We depend on our customers and our laboratory in St. Paul, Minnesota and the production facilities in Burlington, North Carolina for the continued operation of our business.  Although we have contingency plans in effect for natural disasters or other catastrophic events, these events could still disrupt our operations or those of our customers, which could also affect us.  Even though we carry business interruption insurance policies and typically have provisions in our contracts that protect us in certain events, we might suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies or for which we do not have coverage.  Any natural disaster or catastrophic event affecting us or our customers could have a significant negative impact on our operations and financial performance.

We may be exposed to liability claims.

We are exposed to the risk of liability claims from our testing services and other aspects of our business.  We currently maintain insurance for all of our entities to cover professional and general liability claims.  In the past, all professional and general liability claims have been covered under our insurance policy.  However, in the future, we may be faced with litigation claims which exceed our insurance coverage or are not covered under our insurance policy, which could have a significant impact on our results of operations and financial condition.
 
 
- 18 -

 
We may have product liability exposure not covered by insurance.

We face financial exposure to product liability claims if the use of our products results in an improper diagnosis, bodily injury or property damage. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of our insurance policy.  We currently maintain insurance to cover such product liability claims.  To the extent any such claim is uncovered or our insurance coverage is inadequate, we could be required to pay any and all costs associated with such claim, the cost of defense whatever the outcome of the action, and possible settlement or damages if a court rendered a judgment in favor of any plaintiff asserting such claim against us.  Damages assessed in connection with, and the costs of defending, any legal action could be substantial.  Damages may include punitive damages, which may substantially exceed actual damages.  The obligation to pay such damages could exceed our ability to pay such damages, which could have a significant impact on our results of operations and financial condition.

We rely on intellectual property, which we may not be able to protect fully or effectively.

We rely on a combination of patents, copyrights, trademarks, trade secret rights, employee confidentiality agreements and non-disclosure agreements in order to develop and protect our proprietary technology and information.  Notwithstanding our efforts to protect our proprietary rights, existing trade secret, copyright, and trademark laws afford only limited protection.  Despite our efforts to protect our proprietary rights and other intellectual property, unauthorized parties may attempt to copy aspects of our products, obtain and use information that we regard as proprietary or misappropriate our copyrights, trademarks, tradenames and similar proprietary rights.  Our means of protecting our proprietary rights may not be adequate.  In addition, our competitors might independently develop similar technology or duplicate our products or circumvent any patents or our other intellectual property rights.

The technologies used in all of our diagnostic POCT products are covered by one or more patents.  As these patents expire over the next several years, we will no longer have protection from competitors, unless we develop new technology, which could impact our ability to compete in the biotechnology industry and reduce our revenues.

If our tests and business processes infringe on the intellectual property rights of others, we could be forced to engage in costly litigation, pay substantial damages or be prohibited from selling certain tests or products.

Other companies or individuals, including our competitors, may obtain patents or other property rights that would prevent, limit or interfere with our ability to develop, perform or sell our tests or products or operate our business.  As a result, we may be involved in intellectual property litigation and we may be found to infringe on the proprietary rights of others, which could force us to do one or more of the following:

·  
cease developing, performing or selling tests of products that incorporate the challenged intellectual property;
·  
change our business processes; or
·  
pay substantial damages, court costs and attorneys' fees, including potentially increased damages for any infringement held to be willful.

Patents generally are not issued until several years after an application is filed. Our performing a test or other activity prior to the issuance of a patent to a third party is not a defense to an infringement claim.  Thus, even tests or products that we develop could become the subject of infringement claims if a third party obtains a patent covering those tests or products.

 
- 19 -

 

Infringement and other intellectual property claims, regardless of their merit, can be expensive and time consuming to litigate.  In addition, any requirement to reengineer our tests or products or change our business processes could substantially increase our costs, force us to interrupt product sales or delay new test releases.  In the past, we have not been subject to a dispute regarding infringement of intellectual property of third parties.  However, infringement claims could arise in the future as patents could be issued on tests or processes that we may be performing.
 
Adverse results in material litigation matters could have a material adverse effect upon our business.
 
We may become subject in the ordinary course of business to material legal action related to, among other things, professional liability and employee-related matters, as well as inquiries from governmental agencies and Medicare or Medicaid carriers regarding billing issues.  Legal actions could result in substantial monetary damages as well as damage to our reputation with customers, which could have a material adverse effect upon our business.
 
If we lose our key personnel or are unable to attract and retain qualified personnel as necessary, our business could be harmed.

We are dependent on the expertise and experience of our senior management team, including Richard Braun, Chairman, President, and Chief Executive Officer; Kevin Wiersma, Vice President, Chief Financial Officer, Chief Administrative Officer and Chief Operating Officer of Forensic Laboratory Operations; James Schoonover, Vice President and Chief Marketing Officer; B. Mitchell Owens, Vice President and Chief Operating Officer of MEDTOX Diagnostics; and Susan Puskas, Vice President, Quality Assurance, Regulatory Affairs and Chief Operating Officer of Clinical Laboratory Operations, for our future success.  Although we have employment contracts with all members of our senior management team listed above, we do not maintain any key man life insurance policies on any management personnel.  The loss of services of any of our key employees could delay the development of our business and have a negative impact on our operating results and financial condition.
 

ITEM 2.                      PROPERTIES.

The administrative offices and laboratory operations for the Laboratory Services segment of our business are located primarily in a 109,000 square foot facility in St. Paul, Minnesota.  Until March 2001, we leased this space.  In March 2001, we purchased the entire three building complex with a total of 129,000 square feet, which includes the 109,000 square feet utilized by our Laboratory Services segment and an additional 15,000 square feet held for future expansion of our Laboratory Services segment.  The purchasing entity was New Brighton Business Center, LLC, a limited liability company, established by us for the sole purpose of purchasing the entire three building complex.  The facility includes one commercial tenant with a remaining lease term of less than two years in duration.  In 2011, the annual rent paid by third-party tenants, excluding their pro-rata share of operating expenses, was approximately $125,000.

In addition, effective September 2000, the Laboratory Services segment entered into a seven year lease for a 30,000 square foot facility to be used in connection with its courier business and also as additional warehouse and shipping space.  As amended, this lease extends the term of the lease to August 31, 2012.  This building is a special purpose facility and enables us to store our vehicles indoors, when appropriate, and to perform routine maintenance on the vehicles. The annual base rent on this second facility, exclusive of operating expenses, is currently $152,000 per year.

The operations for the Product Sales segment of our business are located in Burlington, North Carolina where we maintain the offices, research and development laboratories, production operations and warehouse for MEDTOX Diagnostics, Inc.  We lease an entire building (approximately 39,500 square feet), as well as an additional 30,000 square feet of space located in an adjacent building, which we use for warehousing and distribution.  The lease for these buildings, as amended and restated, includes a term that expires on March 31, 2016.  In January 2008, we prepaid approximately $430,000 of the lease agreement for the facilities in Burlington, North Carolina relating to the leasehold improvements after determining that the prepayment would be financially beneficial to us.  The prepayment was recorded as prepaid rent and will continue to be amortized over the remaining life of the lease as additional rent.  In 2011, the annual base rent was approximately $444,000, exclusive of operating expenses, and including a Consumer Price Index adjustment and amortization of $600,000 of improvements made to the building by us.

 
- 20 -

 
The Burlington facilities have always been owned and leased to us by Dr. Samuel C. Powell, a member of our Board of Directors.  We believe we are renting these facilities in Burlington on terms similar to those available from third parties for equivalent premises based upon our review of prevailing market rates at the time of lease renewal.

We have the exclusive option and right to purchase the facilities from Dr. Powell according to the terms and conditions defined in the lease agreement.

We believe that our existing facilities are adequate for the purposes being used to accommodate our product development, manufacturing and laboratory testing requirements.


ITEM 3.                      LEGAL PROCEEDINGS.

Not applicable.





 
- 21 -

 

PART II

ITEM 5.
MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Common Stock

Our common stock is listed on the Nasdaq Global Select Market under the symbol “MTOX”.  At February 27, 2012, the number of holders of record of our common stock was 839.  The following tables set forth, for the calendar quarters indicated, the high, low, and closing prices per share for our common stock, as reported by the Nasdaq Global Select Market.  The quotations shown represent inter dealer prices without adjustment for retail markups, markdowns or commissions, and do not necessarily reflect actual transactions.

2011:
 
High
 
Low
 
Close*
First Quarter.............................
$
16.62
$
12.60
$
16.40
Second Quarter........................
 
18.21
 
14.94
 
17.47
Third Quarter...........................
 
19.21
 
11.64
 
13.09
Fourth Quarter......................…
 
15.42
 
12.23
 
14.05

2010:
 
High
 
Low
 
Close*
First Quarter.............................
$
10.25
$
7.01
$
10.25
Second Quarter........................
 
13.28
 
9.53
 
12.30
Third Quarter...........................
 
12.75
 
10.80
 
11.63
Fourth Quarter......................…
 
13.37
 
10.90
 
13.10

*Closing price as of the last day of the calendar quarter

Dividends

On November 12, 2010, the Board of Directors declared a special one-time cash dividend of $1.25 per share, which was paid on December 1, 2010 to stockholders of record on November 22, 2010.  This was the only cash dividend declared or paid by the Board of Directors since our inception.    Our financial covenants under our credit agreement limit our ability to pay cash dividends without approval.

Issuer Purchases of Equity Securities

The following table provides information with respect to purchases made by us of shares of our common stock during the fourth quarter of 2011.

Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as part of Publicly Announced Plans or Programs (a)
 
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (a)
                 
October 1 - 31
 
-
 
$       -
 
-
 
10,173
November 1 - 30
 
4,955
 
  13.68
 
4,955
 
  5,218
December 1 - 31
 
5,218
 
   12.99 
 
5,218
 
-
    Total
 
10,173
 
  13.33
 
        10,173         
 
-


 
- 22 -

 

(a)           Represents shares of common stock surrendered by employees to satisfy the exercise price on stock option exercises of options granted under the MEDTOX Restated Equity Compensation Plan (the "Plan"), which was originally effective on October 26, 1993 and amended and restated as of May 10, 2000.  The Plan expired in 2003, and no shares remain available for issuance under the Plan, but exercise of outstanding options granted under the Plan still occurs in accordance with the terms of the individual option grants. Subject to the terms of the individual award agreements, the Plan allowed option holders to surrender shares of common stock they hold to satisfy the exercise price on stock option exercises, but the Plan did not approve any maximum dollar amount of shares that may be surrendered.  The number of shares to be surrendered under the Plan depends upon, and is limited by, the number of options issued and exercised, the exercise prices of those options, the market price of our common stock at any time when options are exercised, and the election of option holders to surrender shares that they hold rather than pay the exercise price through another method permissible under the Plan and their individual award agreements.


Securities Authorized For Issuance Under Equity Compensation Plans
 
For information on our equity compensation plans, refer to Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

 
 

 
- 23 -

 

ITEM 6.                      SELECTED FINANCIAL DATA.

The selected financial data for the five years ended December 31, 2011 have been derived from our audited consolidated financial statements. The selected financial data presented below should be read in conjunction with, the financial statements and notes thereto and other financial and statistical information referenced elsewhere herein including the information referenced under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

(In thousands, except share and per share data)
 
2011
   
2010
   
2009
   
2008
   
2007
                             
STATEMENT OF INCOME DATA:
                           
                             
Revenues
$
108,149
 
$
97,101
 
$
84,108
 
$
85,813
 
$
80,285
Cost of revenues
 
63,314
   
57,461
   
53,213
   
49,487
   
43,929
Selling, general, and administrative
 
35,144
   
32,691
   
26,663
   
24,327
   
23,737
Research and development
 
2,519
   
2,261
   
2,264
   
2,352
   
2,603
Other income (expense)
 
(161)
   
157
   
79
   
(991)
   
(707)
Income tax expense
 
2,559
   
1,828
   
748
   
3,084
   
2,619
Net income
$
4,452
 
$
3,017
 
$
1,299
 
$
5,572
 
$
6,690
                             
Basic earnings per common share
$
0.50
 
$
0.35
 
$
0.15
 
$
0.66
 
$
0.80
                             
Diluted earnings per common share
$
0.49
 
$
0.34
 
$
0.15
 
$
0.62
 
$
0.75
                             
Weighted average number of shares outstanding:
                           
Basic
 
8,853,643
   
8,715,391
   
8,536,768
   
8,455,092
   
8,322,092
Diluted
 
9,035,895
   
8,867,530
   
8,788,663
   
8,938,213
   
8,907,320
                             
BALANCE SHEET DATA:
                           
Total assets
$
76,854
 
$
75,457
 
$
76,117
 
$
73,526
 
$
69,949
Total debt
 
-
   
2,725
   
302
   
979
   
1,656
Total stockholders’ equity
 
57,628
   
54,119
   
61,432
   
60,465
   
55,656
                             
SEGMENT DATA:
                           
Net revenues:
                           
Laboratory Services
$
85,862
 
$
77,047
 
$
65,851
 
$
66,127
 
$
61,310
Product Sales
 
22,287
   
20,054
   
18,257
   
19,686
   
18,975
Total net revenues
$
108,149
 
$
97,101
 
$
84,108
 
$
85,813
 
$
80,285
Operating income (loss):
                           
Laboratory Services
$
2,145
 
$
1,187
 
$
(1,037)
 
$
5,364
 
$
6,387
Product Sales
 
5,027
   
3,501
   
3,005
   
4,283
   
3,629
Total operating income
$
7,172
 
$
4,688
 
$
1,968
 
$
9,647
 
$
10,016
Assets:
                           
Laboratory Services
$
65,739
 
$
64,193
 
$
60,630
 
$
59,812
 
$
56,430
Product Sales
 
8,339
   
7,499
   
11,884
   
10,102
   
8,701
Corporate (unallocated)
 
2,776
   
3,765
   
3,603
   
3,612
   
4,818
Total assets
$
76,854
 
$
75,457
 
$
76,117
 
$
73,526
 
$
69,949
                             
OTHER DATA:
                           
Cash dividends declared per common share
 
-
 
$
1.25
   
-
   
-
   
-
                             


 
- 24 -

 

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

This Annual Report on Form 10-K 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 this “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 Annual Report on Form 10-K containing the words “believes”, “anticipates”, “plans”, “expects” and similar expressions constitute forward looking statements, although not all forward looking statements contain such identifying words.

The forward looking statements contained in this Annual Report on Form 10-K 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 Item 1A of this Annual Report on Form 10-K and in the Cautionary Statement appearing at the beginning of Part I of this Annual Report on Form 10-K, 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 Annual Report on Form 10-K.  In light of the significant uncertainties inherent in the forward looking statements included in this Annual Report on Form 10-K, 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, except as otherwise required by law.  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.

Executive Overview

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.

 
- 25 -

 
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.

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 A, PROFILE-II ER®, PROFILE®-III ER, PROFILE®-IV, PROFILE®-V, MEDTOXScan®, VERDICT®-II and SURE-SCREEN®, and EZ-SCREEN® Cup, 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 Drugs-of-Abuse Business

In 2011, testing volume from our existing workplace drugs-of-abuse clients was lower than in the prior year, 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.  We have continued to experience increased price competition for certain diagnostic testing devices, particularly in the probation, parole and rehabilitation market.


 
- 26 -

 

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.

Our success in penetrating new accounts has represented a significant component of our growth in market share.  Over the past few years, we have expanded our number of sales representatives which 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.

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 continuously introduced a number of innovative products and services, including:

In 2011, we introduced a new “self-contained” rapid drug testing device, the EZ-SCREEN® Cup.  This cup can be used in both the government and workplace markets.  Designed to meet the needs of non-laboratory personnel in order to easily run a drug test with minimal urine handling, the new cup also reduces the chance of specimens leaking during transit to the laboratory due to a new lid design.

In 2011 and 2010, we continued the expansion of our prescription management business.  We offer a comprehensive testing program serving this market under the name ToxAssure®.

 
- 27 -

 

Critical Accounting Policies

We have identified the policies outlined below as critical to understanding our business and results of operations.  The listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States of America, with no need for management's judgment in their application. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.  For a detailed discussion on the application of these and other accounting policies, see Note 1 of Notes to the Consolidated Financial Statements in Item 15.  Note that the preparation of this Annual Report on Form 10-K requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

Our critical accounting policies are as follows:

Revenue Recognition, accounts receivable and allowance for doubtful accounts:

Our sales are generally billed to three types of payers – clients, patients and third parties, such as Medicare, Medicaid, and insurance companies.  We are seeing an increase in the percentage of revenues that are billed to third-party payers and patients as a result of growth in our clinical laboratory.

Client sales are recorded at our list price, less any negotiated discount.  Net receivables due from clients represented approximately 86% of our consolidated net accounts receivable balance at December 31, 2011.

Patients are billed at established patient fee schedules, net of any discounts negotiated with healthcare insurers or physicians on behalf of their patients. Patient billing is increasing as a result of the growth in patient copayments, coinsurance and deductibles and an increase in high deductible health plans.  Collection of receivables due from patients is subject to credit risk and ability of the patients to pay.  Net receivables due from patients represented approximately 1% of our consolidated net accounts receivable balance at December 31, 2011.

We bill third-party payers at our list price and third-party revenue is recorded net of contractual discounts. These discounts are recorded at the transaction level at the time of sale based on a fee schedule or estimated fee schedule that is maintained for each third-party payer.  Our third-party sales are recorded for each payer using a contracted fee schedule or an estimated fee schedule.  Adjustments to the estimated payment amounts are recorded at the time of final collection and settlement of each transaction as an adjustment to net revenues. These adjustments are not material to our results of operations in any period presented.  We periodically adjust these estimated fee schedules based upon historical payment trends.  Net receivables due from third-parties represented approximately 13% of our consolidated net accounts receivable balance at December 31, 2011.

We have a standardized approach to estimate and review the collectability of our receivables based on the period of time they have been outstanding.  Our process for determining the appropriate level of the allowance for doubtful accounts involves judgment, and considers such factors as the age of the underlying receivables, specific account reviews, historical collection experience, and other external factors that could affect the collectability of our receivables.  Revisions to the allowance for doubtful accounts are recorded as an adjustment to bad debt expense within selling, general and administrative. Accounts are written off against the allowance for doubtful accounts when they are deemed to be uncollectible.  Our consolidated trade accounts receivable balance at December 31, 2011 was $17.0 million, net of allowance for doubtful accounts of $1.9 million.

 
- 28 -

 

Goodwill:

Goodwill is reviewed for impairment at least annually and between annual test dates if events or changes in circumstances indicate potential impairment.  We perform our annual impairment test for goodwill in the fourth quarter of each year.  The entire amount of goodwill is included within the Laboratory Services segment.

The impairment test is performed using a two-step process.  In the first step, the fair value of the reporting unit is compared with the carrying amount of the reporting unit, including goodwill.  If the estimated fair value is less than the carrying amount of the reporting unit, an indication that goodwill impairment exists and a second step must be completed in order to determine the amount of the goodwill impairment, if any that should be recorded.  In the second step, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill.  The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation.

The fair value of the reporting unit is determined using a discounted cash flow analysis.  Projected discounted future cash flows requires us to make significant estimates regarding future revenues and expenses, projected capital expenditures, changes in working capital and the appropriate discount rate.  In developing this discounted cash flow analysis, assumptions about future revenues and expenses, capital expenditures and changes in working capital are based on our annual forecast for the reporting unit, historical experience, and anticipated future economic conditions.  Discount rate assumptions for the reporting unit take into consideration our assessment of risks inherent in the future cash flows of the reporting unit and our weighted-average cost of capital.  To assess the reasonableness of the fair value of the reporting unit, we use a market approach which consists of comparisons to comparable publicly-traded companies in our industry.

At December 31, 2011, our goodwill was $16.0 million.  If we experience significant negative economic trends or disruptions to our business, we may be subject to future impairments.  Additionally, changes in assumptions regarding the future performance of our business, an increase in the discount rate used to determine the discounted cash flows, or significant declines in our stock price or the market as a whole could result in additional impairment indicators.  Any future impairment of goodwill could have a material adverse effect on our financial results.

Accounting for Income Taxes:

As part of the process of preparing the consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes.  These differences result in deferred tax assets and liabilities.  We must then assess the likelihood that deferred tax assets will be recovered from future taxable income and tax planning strategies, and to the extent management believes that recovery is not likely, we must establish a valuation allowance.  To the extent we increase or decrease the valuation allowance in a period, we must include an expense or benefit within the tax provision in the consolidated statement of operations.

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against net deferred tax assets.  Our deferred tax assets and liabilities primarily consist of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  In the future, revisions to the estimated net realizable value of these deferred tax assets and liabilities could cause the provision for income taxes to vary significantly from period-to-period, although our cash payments would remain unaffected until the benefit of our net operating loss carryforwards (NOLs) is completely utilized or expires unused.  At December 31, 2011, we did not have a valuation allowance on deferred tax assets.

 
- 29 -

 

We account for uncertain tax positions in accordance with generally accepted accounting principles.  The application of income tax law is inherently complex.  Laws and regulations in this area are voluminous and are often ambiguous.  As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures.  Interpretations of and guidance surrounding income tax laws and regulations change over time.  As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income.  At December 31, 2011, we did not have any unrecognized tax benefits.

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 expense as a percentage of revenues. As discussed below, during 2011, we made positive strides on all three fronts.

Revenues

 
Year Ended December 31
 
2011 vs 2010
2010 vs 2009
(In thousands)
2011
2010
2009
 
$
Change
%
Change
$
Change
%
Change
                 
Revenues:
               
                 
Laboratory Services
               
 Drugs-of-abuse testing services
$   41,343
$  39,624
$  36,040
 
$    1,719
  4%
$  3,584
  10%
 Clinical & other laboratory services
    34,852
    29,923
    22,885
 
     4,929
  17%
     7,038
  31%
 Clinical trial services
9,667
7,500
      6,926
 
        2,167
  29%
        574
   8%
                 
Product Sales
22,287
20,054
18,257
 
2,233
11%
1,797
10%
 
$  108,149
$  97,101
$  84,108
 
$   11,048
 11%
$   12,993
 15%

Our Laboratory Services segment includes revenues from drugs-of-abuse testing services, clinical & other laboratory services and clinical trial services.

Our revenues from drugs-of-abuse testing increased 4% to $41.3 million in 2011 and 10% to $39.6 million in 2010.  The increase in 2011 was due to revenue growth of 14% from new clients, partially offset by a 10% decline in revenue from existing clients.  Revenues from our existing client base continue to be negatively impacted by economic conditions.  While economic conditions may continue to have a negative impact on laboratory drugs-of-abuse testing volumes from our existing client base, we have demonstrated a consistent ability to add new business year over year.  We will be adding sales resources in this area in 2012 in an effort to maintain market-share gains.  The increase in 2010 was primarily due to revenue growth from new clients, partially offset by a decline in revenue from existing drugs-of-abuse clients.  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 increased 17% to $34.9 million and 31% to $29.9 million in 2011 and 2010, respectively.  The improvement in 2011 and 2010 was primarily due to continued strong growth generated by our expanded clinical laboratory capabilities and diversification initiatives, including testing for prescription management.

 
- 30 -

 
Revenues from clinical trial services increased 29% to $9.7 million and 8% to $7.5 million in 2011 and 2010, respectively.  The significant increase in 2011 reflects the impact of the reversal of the slow-down of projects, which we experienced in the first quarter of 2010.  The increase in 2010 over 2009 reflects the return to a more normalized level of activity after being negatively impact by our biopharmaceutical clients deferring projects and slowing down in research and development efforts in the fourth quarter of 2009 and 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 as shown in the table below:

Revenues from clinical trial services:

 
First
Second
Third
Fourth
(In thousands)
Quarter
Quarter
Quarter
Quarter
         
Revenues:
       
         
2011
$       2,536
$       2,323
$     2,375
 $     2,433
         
2010
$          833        
$       2,037
$     2,358
 $     2,272

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®-V, VERDICT®-II and SURE-SCREEN®, and EZ-SCREEN® Cup on-site test kits and other ancillary products for the detection of abused substances, increased 14% to $20.3 million in 2011 and 8% to $17.8 million in 2010.  The increase in 2011 was primarily due to increased sales of Profile®-V sold into the hospital market with our MEDTOXScan® Reader and increased sales into the government market with our SURE-SCREEN® devices.  The increase in 2010 was largely due to strong sales in the workplace drugs-of-abuse market with our Profile®-II A and Profile®-III A products, and increased sales of Profile®-V sold into the hospital market with our MEDTOXScan® Reader.  Overall, pricing for our POCT devices in 2011 was fairly stable with the prior year.

Sales of contract manufacturing services decreased 23% to $1.2 million in 2011 as we are phasing out of this business and expect negligible revenue in 2012.  Sales of contract manufacturing services increased 13% to $1.6 million in 2010 primarily due to additional revenue from one of our clients whose contract expired on June 30, 2010.

Sales of other diagnostic products increased 14% to $0.8 million in 2011 and 59% to $0.7 million in 2010 due to sales of the NexScreen 12 panel diagnostic product which we began distributing in 2010.

 
- 31 -

 

Cost of Revenues and Gross Margin

 
Year Ended December 31
 
2011 vs 2010
2010 vs 2009
(In thousands)
2011
% of
Revenues
2010
% of
Revenues
2009
% of
Revenues
 
$
Change
%
Change
$
Change
%
Change
                       
Cost of Revenues:
                     
                       
Cost of Services
$  54,346
63.3%*
$  49,036
63.6%*
$  45,432
69.0%*
 
$ 5,310
11%
$ 3,604
  8%
                       
Cost of Sales
8,968
    40.2%**
8,425
    42.0%**
7,781
    42.6%**
 
543
6%
644
8%
                       
 
$  63,314
58.5%
$  57,461
59.2%
$  53,213
63.3%
 
$ 5,853
10%
$ 4,248
8%

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

Consolidated gross margin was 41.5% of revenues in 2011, compared to 40.8% of revenues in 2010 and 36.7% of revenues in 2009.

Laboratory Services gross margin was 36.7% in 2011, compared to 36.4% in 2010 and 31.0% in 2009. The increase in 2011 was primarily due to a change in test mix and an increase in volume, partially offset by increased transportation expenses as a result of higher fuel costs from our service providers.  The increase in 2010 was primarily due to a change in test mix and an increase in volume.

Gross margin from Product Sales was 59.8% in 2011, compared to 58.0% in 2010 and 57.4% in 2009.  The increase in 2011 was primarily due to sales mix of POCT devices, with an increase in our higher margin PROFILE®-V devices sold into the hospital market, partially offset by an increase in sales of our lower margin SURE-SCREEN® devices into the government market.  The increase in 2010 primarily reflects a shift in sales mix, with an increase in higher margin Profile® devices sold into the workplace and hospital markets and a decrease in sales of lower margin SURE-SCREEN® devices into the government market.

Operating Expenses

 
Year Ended December 31
 
2011 vs 2010
2010 vs 2009
(In thousands)
2011
% of
Revenues
2010
% of
Revenues
2009
% of Revenues
 
$
Change
%
Change
$
Change
%
Change
                       
Operating Expenses:
                     
                       
Selling, general and administrative
$  35,144
32.5%
$  32,691
33.7%
$  26,663
31.7%
 
$ 2,453
    8%
$ 6,028
23%
                       
Research and development
2,519
  2.3%
2,261
  2.3%
2,264
  2.7%
 
258
  11%
(3)
  (1)%
 
$  37,663
34.8%
$  34,952
36.0%
$  28,927
34.4%
 
$ 2,711
    8%
$ 6,025
  21%

Selling, General and Administrative Expenses.  Selling, general and administrative expenses increased to $35.1 million, or 32.5% of revenues in 2011, compared to $32.7 million, or 33.7% of revenues in 2010 and $26.7 million, or 31.7% of revenues in 2009.  The increase in 2011 was primarily due to increased costs associated with the growth in our clinical & other laboratory services business, partially offset by decreased incentive-based compensation.  Increased expenses associated with the growth in our clinical and other laboratory services business include increased bad debt and billing and collection expenses related to increased third- party and patient billings.  We recognized approximately $1.6 million of bad debt expense in 2011 which related to a change in estimate of our allowance for doubtful accounts for patient and third party receivables at December 31, 2010.  The revision was based on our increased experience and the increased actual collection data that we obtained in 2011 relating to these receivables.  Bad debt expense was $3.9 million, $2.1 million and $0.6 million in 2011, 2010, and 2009, respectively. The increase in selling, general and administrative expenses in 2010 compared to 2009 was primarily due to increased costs associated with the growth in clinical revenue and increased incentive-based compensation.

 
- 32 -

 
Research and Development Expenses.  Research and development expenses were $2.5 million, $2.3 million and $2.3 million in 2011, 2010 and 2009, respectively.  The increase in 2011 was primarily due to increased spending for on-going product development projects in our Product Sales segment.

Other Income (Expense)

Other income and expense consists primarily our investment gains/losses, the net expenses associated with our building rental activities and interest expense.  Other expense was $161,000 in 2011 compared to other income of $157,000 and $79,000 in 2010 and 2009, respectively.  The expense in 2011 was primarily due to increased expenses associated with our building rental activities, as well as an investment loss on our marketable equity securities held in trust for our deferred compensation plans compared to an investment gain in 2010.  Our investment loss/gain is offset by a corresponding gain/loss being recorded in SG&A expenses to reflect the change in the retirement plan obligation.

Income Taxes

In 2011, we recorded $2.6 million in income tax expense, or an effective rate of 36.5%, compared to an effective rate of 37.7% in 2010 and 36.5% in 2009.

Liquidity and Capital Resources

Our working capital requirements have been funded primarily by various combinations of profitable operations and cash received from our revolving line of credit.  Cash and cash equivalents were $5.3 million and $1.3 million at December 31, 2011 and 2010, respectively.

We are focusing on increasing our cash flow, while continuing to fund our capital investment, sales and marketing, and research and development initiatives. Our intent is to maintain a solid liquidity position.

Net cash provided by operating activities was $14.4 million in 2011 compared to $10.1 million and $5.8 million in 2010 and 2009, respectively.  The increase in 2011 was attributable to an increase in net income, excluding non-cash charges such as depreciation and amortization, deferred compensation, deferred income taxes and provision for losses on accounts receivable.  Our increased revenues in 2011 have continued to drive increases in working capital.  The increase in 2010 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.

We anticipate fully utilizing our NOLs and expect an increase in income tax payments in 2012.

Net cash used in investing activities, consisting of capital expenditures, was $5.9 million in 2011 compared to $5.1 million and $4.9 million in 2010 and 2009, respectively.  These expenditures included equipment purchased and costs incurred to upgrade equipment, improve efficiencies and increase service levels to our clients.   We expect equipment and capital improvement expenditures to be between $6.5 million and $7.0 million in 2012, with increased investment in instrumentation and facility improvements.  Such expenditures are expected to be funded through cash provided by operating activities.

 
- 33 -

 
Net cash used in financing activities was $4.4 million in 2011, compared to $7.8 million and $0.8 million in 2010 and 2009, respectively.  Net cash used in financing activities was high in 2010 due to the payment of a special one-time cash dividend of $10.6 million (see below).

In 2010, we paid a special one-time cash dividend of $1.25 per share.  Cash for the dividend was funded from cash on hand and borrowings from our revolving credit facility.  We declared the dividend based upon our improving performance, cash balance and anticipated ability to generate cash flow from operations, and therefore believed it was appropriate to return some capital to stockholders through a one-time cash dividend.

In 2011, 2010 and 2009, we repurchased 108,963, 63,355 and 60,644 shares, respectively, of our common stock in the open market for a cost of $1.7 million, $0.8 million and $0.4 million, respectively.  The shares repurchased were placed in trust to fund our Long-Term Incentive Plan and Supplemental Executive Retirement Plan.

We are a party to a credit security agreement (the "Wells Fargo Credit Agreement") with Wells Fargo Bank, National Association (the “Bank”) maturing on August 31, 2013.  The Wells Fargo Credit Agreement, as amended, consists of a revolving line of credit ("Line of Credit") of up to $12.0 million bearing interest at a fluctuating rate of 1.95% above the daily three month LIBOR, as defined and calculated by the Bank, which was 2.45% at December 31, 2011.

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 of not less than $35,000,000 at each month end, with “Tangible Net Worth” defined as the aggregate of total stockholders’ equity plus subordinated debt less any intangible assets.

·  
Current Ratio of not less than 1.45 to 1.0 at each month end, with “Current Ratio” defined as total current assets divided by total current liabilities.

·  
Pre-tax profit of not less than $1,500,000 on a rolling four-quarter basis, determined as of each fiscal quarter-end.

We were in compliance with all of the financial covenants under the Wells Fargo Credit Agreement at December 31, 2011.

We are relying on expected positive cash flow from operations and our Line of Credit to fund our future working capital and asset purchases.  At December 31, 2011, we had total borrowing capacity of $12.0 million on our Line of Credit.  We did not have an outstanding balance on our Line of Credit at December 31, 2011.


 
- 34 -

 

In the short term, we believe that the aforementioned resources will be sufficient to fund our planned operations through 2012.  While there can be no assurance that the available capital will be sufficient to fund our future operations beyond 2012, 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 at December 31, 2011:

 
Payments Due by Period
 
(In thousands)
 
Total
 
Less than 1 year
 
 
1-3 years
 
 
3-5 years
 
More than 5 years
                   
Operating leases
$    2,532
 
$         725
 
$       1,202
 
$           605
 
$               -
                   
Total contractual obligations
$    2,532
 
  $         725
 
$       1,202
 
$           605
 
$               -

The table above excludes our obligation for future payments to participants under our Supplemental Executive Retirement Plan of approximately $0.9 million at December 31, 2011 as the specific payment dates and amounts are unknown.

Off-Balance Sheet Transactions

We do 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 our 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 in our last three fiscal years has been primarily limited to salary, laboratory and operating supplies and rent increases and has historically not been material to our operations.  In the future, we may not be able to increase the prices of laboratory testing by an amount sufficient to cover the cost of inflation, although we are responding to these concerns by offering the highest quality products and services, delivered rapidly, priced competitively and supported by value-added services for customers.

Seasonality

We believe 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 flow.


 
- 35 -

 

Impact of New Accounting Standards
 
In September 2011, the Financial Accounting Standards Board (FASB) issued updated guidance on the periodic testing of goodwill for impairment.  This guidance will allow companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards.  This new guidance was effective for us beginning January 1, 2012.  We do not expect the adoption of this guidance will have a material impact on our consolidated financial statements.
 
In July 2011, the FASB issued guidance on the presentation and disclosure of patient service revenue, provision for bad debts, and the allowance for doubtful accounts for certain health care entities.  This guidance requires certain health care entities to change the presentation of their statement of income by reclassifying the provision for bad debts associated with patient service revenue from an operating expense to a deduction from patient service revenue (net of contractual allowances and discounts).  Additionally, those health care entities are required to provide enhanced disclosure about their policies for recognizing revenue and assessing bad debts.  The guidance also requires disclosures of patient service revenue (net of contractual allowances and discounts by major payor source) as well as qualitative and quantitative information about changes in the allowance for doubtful accounts.  This new guidance was effective for us beginning January 1, 2012.  The adoption of this guidance will decrease both our gross profit and selling, general and administrative expenses.  The table below shows the estimated impact on revenues, gross margin, and selling, general and administrative expenses, by quarter in 2011 and 2010, of adopting this guidance.
 

($'s in thousands)
2010
 
2011
 
Q1-10
Q2-10
Q3-10
Q4-10
Full Year
 
Q1-11
Q2-11
Q3-11
Q4-11
Full Year
                       
Revenues, as reported
$ 21,161
$ 25,185
$ 25,799
$ 24,956
$ 97,101
 
$ 25,736
$ 27,921
$ 27,578
$ 26,914
 $ 108,149
Revenues, as restated
20,962
24,942
25,424
23,969
95,297
 
25,098
26,931
26,521
25,889
    104,439
                       
Gross Margin, as reported
38.3%
41.1%
41.9%
41.6%
40.8%
 
40.6%
43.3%
41.2%
40.6%
41.5%
Gross Margin, as restated
37.7%
40.5%
41.1%
39.2%
39.7%
 
39.1%
41.2%
38.9%
38.3%
39.4%
                       
SG&A, as reported
7,433
8,231
8,394
8,633
32,691
 
8,624
9,281
8,633
8,606
35,144
SG&A, as restated
7,234
7,988
8,019
7,646
30,887
 
7,986
8,291
7,576
7,581
31,434
                       
SG&A %, as reported
35.1%
32.7%
32.5%
34.6%
33.7%
 
33.5%
33.2%
31.3%
32.0%
32.5%
SG&A %, as restated
34.5%
32.0%
31.5%
31.9%
32.4%
 
31.8%
30.8%
28.6%
29.3%
30.1%
 

ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Market risk is the risk that we will incur losses due to adverse changes in interest rates or currency exchange rates and prices.  Our primary market risk exposures are to changes in interest rates.  During 2011, 2010, and 2009, we did not have sales denominated in foreign currencies nor did we have any subsidiaries located in foreign countries.  As such, we are not exposed to market risk associated with currency exchange rates and prices.

At December 31, 2011, we did not have an outstanding balance on our line of credit with Wells Fargo Bank. At December 31, 2010, we had approximately $2.7 million outstanding on our line of credit.  The line of credit with Wells Fargo Bank bears interest at a variable rate of 1.95% above the daily three month LIBOR, which was 2.45% at December 31, 2011.  We have cash flow exposure on our committed and uncommitted line of credit with Wells Fargo Bank due to its variable LIBOR rate pricing.  At December 31, 2011, a 1 percentage point change in the prime rate would increase or decrease interest expense or cash flows by less than $0.1 million.

 
- 36 -

 
We do not enter into derivative or other financial instruments or hedging transactions for trading or speculative purposes.

ITEM 8.               FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Reference is made to the consolidated financial statements, financial statement schedule, and notes thereto included later in this Annual Report on Form 10-K under Item 15.

ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
 
ON ACCOUNTING AND FINANCIAL DISCLOSURE.

Not Applicable.

ITEM 9A.
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.

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.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal controls over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation management has concluded that our internal control over financial reporting was effective as of December 31, 2011.

Deloitte & Touche LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report on Form 10-K, has also audited our internal control over financial reporting as of December 31, 2011, as stated in their attestation report included in Part IV, Item 15 of this Annual Report on Form 10-K.


 
- 37 -

 

Limitations on Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met.  The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

ITEM 9B.
OTHER INFORMATION.

Not Applicable.



 
- 38 -

 

PART III

ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE.

The information required by this Item is incorporated by reference from the sections labeled “Proposal 1 - Election of Directors” and “Executive Officers” that will appear in the Definitive Proxy Statement to be used in connection with the 2012 Annual Meeting of Stockholders of MEDTOX Scientific, Inc.

The Company has adopted the MEDTOX Scientific, Inc. Code of Ethics for senior financial and executive officers and directors ("Code of Ethics").  The Code of Ethics is available on the Company's website at www.medtox.com or at no charge to anyone who sends a request for a paper copy to: MEDTOX Scientific, Inc. 402 West County Road D, St. Paul, Minnesota, 55112.  If the Company makes any substantive amendments to the Code of Ethics or grants any waiver, including any implicit waiver from a provision of the Code of Ethics to its directors or executive officers, the Company will disclose the nature of such amendments or waiver on its website at www.medtox.com or in a report on Form 8-K.

ITEM 11.
EXECUTIVE COMPENSATION.

The information required by this Item is incorporated by reference from the section labeled “Executive Compensation” that will appear in the Definitive Proxy Statement to be used in connection with the 2012 Annual Meeting of Stockholders of MEDTOX Scientific, Inc.

ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The information required by this Item is incorporated by reference from the sections labeled “Common Stock Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” that will appear in the Definitive Proxy Statement to be used in connection with the 2012 Annual Meeting of Stockholders of MEDTOX Scientific, Inc.

ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPEDENCE.

The information required by this Item is incorporated by reference from the section labeled “Certain Relationships and Related Transactions” that will appear in the Definitive Proxy Statement to be used in connection with the 2012 Annual Meeting of Stockholders of MEDTOX Scientific, Inc.

ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES.

The information required by this Item is incorporated by reference from the section labeled “Fees to Independent Registered Public Accounting Firm” that will appear in the Definitive Proxy Statement to be used in connection with the 2012 Annual Meeting of Stockholders of MEDTOX Scientific, Inc.



 
- 39 -

 

PART IV

ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

a.
Financial Statements
Page
     
 
Reports of Independent Registered Public Accounting Firm. . .  .
47
     
 
Consolidated Balance Sheets at December 31, 2011 and 2010. . .
50
     
 
Consolidated Statements of Income for the Years Ended
December 31, 2011, 2010 and 2009. . . . . . . . . . . . . . . . . . . . . . .
51
     
 
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2011, 2010 and 2009. . . . . . . . . . . . . . . . . .
52
     
 
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2011, 2010 and 2009. . . . . . . . . . . . . . . . . . . . . . .
 
53
     
 
Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . .
54
     
b.
Consolidated Financial Statements Schedule
 
     
 
Schedule II - Valuation and Qualifying Accounts. . . . . . . . . . . .
69
     
All other financial statement schedules normally required under Regulation S-X are omitted as the required information is not applicable.
     
c.
Exhibits
 

The exhibits included in the Report are set forth on the exhibit index and follow the signature page of this Annual Report on Form 10-K.

3.1  
Bylaws of the Registrant, as amended.   (Incorporated by reference to exhibit 3.1 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2007).

3.2  
Restated Certificate of Incorporation, as amended. (Incorporated by reference to exhibit 3.2 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2005).

3.3  
Amended Certificate of Designations of Preferred Stock (Series A Convertible Preferred Stock) of the Registrant, filed with the Delaware Secretary of State on January 29, 1996 (incorporated by reference to Exhibit 3.1 filed with the Registrant’s report on Form 8-K dated January 30, 1996, Commission File No. 001-11394).

10.1  
Second Amendment dated December 31, 1986 to Exclusive License Agreement amending and restating exclusive license granted by the Registrant to Disease Detection International, Inc. (incorporated by reference to Exhibit 10.25 filed with the Registration Statement on Form S-1 dated August 26, 1987, Commission File No. 33-15543).

 
- 40 -

 


10.2  
Agreement regarding rights to “MEDTOX” name dated as of January 30, 1996 between the Registrant and Harry G. McCoy.  (Incorporated by reference to Exhibit 10.38 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 1995, Commission File No. 001-11394).

10.3  
Registrant’s Restated Equity Compensation Plan dated May 10, 2000.  (Incorporated by reference to exhibit 10.46 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2000, Commission File No. 001-11394).**

10.4  
Registration Rights Agreement dated July 31, 2000 among the Registrant, certain investors, and Miller, Johnson, & Kuehn, Inc. (“MJK”).  (Incorporated by reference to exhibit 10.50 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2000, Commission File No. 001-11394).

10.5  
Employment Agreement dated January 1, 2003, between the Registrant and Richard J. Braun. (Incorporated by reference to exhibit 10.59 filed with the Registrant’s Report on Form 10-K for the year ended December 31, 2002, Commission File No. 001-11394).**

10.6  
Amended and Restated Nova Building Lease dated November 1, 2003 by and between Powell Enterprises and MEDTOX Diagnostics, Inc. (Incorporated by reference to exhibit 10.23 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2003).

10.7  
Credit Agreement between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated December 1, 2005.  (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated December 6, 2005).

10.8  
Revolving Line of Credit Note between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated December 1, 2005.  (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated December 6, 2005).

10.9  
Security Agreement:  Equipment between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated December 1, 2005.  (Incorporated by reference to exhibit 10.3 filed with the Registrant’s Report on Form 8-K dated December 6, 2005).

10.10  
Continuing Security Agreement:  Rights to Payment and Inventory between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated December 1, 2005.  (Incorporated by reference to exhibit 10.4 filed with the Registrant’s Report on Form 8-K dated December 6, 2005).

10.11  
Term Note between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated December 1, 2005.  (Incorporated by reference to exhibit 10.5 filed with the Registrant’s Report on Form 8-K dated December 6, 2005).

 
- 41 -

 


10.12  
Agreement and Acknowledgment of Security Interest between Wells Fargo Bank, MEDTOX Diagnostics, Inc., and Powell Enterprises, Inc. dated December 1, 2005.  (Incorporated by reference to exhibit 10.6 filed with the Registrant’s Report on Form 8-K dated December 6, 2005).

10.13  
Term Note between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated March 16, 2006. (Incorporated by reference to exhibit 10.23 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2005).

10.14  
Continuing Guaranty between New Brighton Business Center, LLC and Wells Fargo Bank dated March 16, 2006. (Incorporated by reference to exhibit 10.24 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2005).

10.15  
First Amendment to Credit Agreement between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated March 16, 2006.  (Incorporated by reference to exhibit 10.25 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2005).

10.16  
Negative Pledge Agreement between New Brighton Business Center, LLC and Wells Fargo Bank dated March 16, 2006.  (Incorporated by reference to exhibit 10.26 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2005).

10.17  
Employment Agreement dated December 27, 2006, between the Registrant and B. Mitchell Owens. (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated January 4, 2007).**

10.18  
Employment Agreement dated December 27, 2006, between the Registrant and Susan E. Puskas. (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated January 4, 2007).**

10.19  
Employment Agreement dated December 27, 2006, between the Registrant and James A. Schoonover. (Incorporated by reference to exhibit 10.3 filed with the Registrant’s Report on Form 8-K dated January 4, 2007).**

10.20  
Employment Agreement dated December 27, 2006, between the Registrant and Kevin J. Wiersma. (Incorporated by reference to exhibit 10.4 filed with the Registrant’s Report on Form 8-K dated January 4, 2007).**

10.21  
Registrant’s Executive Incentive Compensation Plan dated December 27, 2006, (Incorporated by reference to exhibit 10.5 filed with the Registrant’s Report on Form 8-K dated January 4, 2007).**

10.22  
Commercial Lease between MEDTOX Laboratories, Inc. and St. Paul Properties, Inc. dated July 28, 2000.  (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated May 30, 2007).

10.23  
Amendment to Lease between MEDTOX Laboratories, Inc. and St. Paul Properties, Inc. dated May 25, 2007.  (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated May 30, 2007).

 
- 42 -

 


10.24  
Second Amendment to Credit Agreement between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated July 31, 2007.  (Incorporated by reference to exhibit 10.29 filed with the Registrant’s Report on Form 10-Q for the quarter ended June 30, 2007).

10.25  
Third Amendment to Credit Agreement between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated October 25, 2007.  (Incorporated by reference to exhibit 10.30 filed with the Registrant’s Report on Form 10-Q for the quarter ended September 30, 2007).

10.26  
Registrant’s Long-Term Incentive Plan as Amended and Restated dated December 31, 2007, (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated January 7, 2008).**

10.27  
Registrant’s Supplemental Executive Retirement Plan as Amended and Restated dated December 31, 2007, (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated January 7, 2008).**

10.28  
Amendment to Employment Agreement, effective January 1, 2009, between the Registrant and B. Mitchell Owens. (Incorporated by reference to exhibit 10.5 filed with the Registrant’s Report on Form 8-K dated December 23, 2008).**

10.29  
Amendment to Employment Agreement, effective January 1, 2009, between the Registrant and Susan E. Puskas. (Incorporated by reference to exhibit 10.4 filed with the Registrant’s Report on Form 8-K dated December 23, 2008).**

10.30  
Amendment to Employment Agreement, effective January 1, 2009, between the Registrant and James A. Schoonover. (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated December 23, 2008).**

10.31  
Amendment to Employment Agreement, effective January 1, 2009, between the Registrant and Kevin J. Wiersma. (Incorporated by reference to exhibit 10.3 filed with the Registrant’s Report on Form 8-K dated December 23, 2008).**

10.32  
Amendment to Employment Agreement, effective January 1, 2009, between the Registrant and Richard J. Braun. (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated December 23, 2008).**

10.33  
Fourth Amendment to Credit Agreement between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated October 29, 2009.  (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 10-Q for the quarter ended September 30, 2009).

10.34  
Registrant’s Supplemental Executive Retirement Plan as Amended and Restated dated January 1, 2010. (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated January 7, 2010).**

10.35  
Director Compensation for Fiscal Year 2012.* & **


 
- 43 -

 

10.36  
Executive Salaries for Fiscal Year 2011.  (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 10-Q for the quarter ended March 31, 2011).**

10.37  
Target Financial Objectives for Fiscal Year 2011 under the Annual Incentive Plan and Long Term Incentive Plan.  (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 10-Q for the quarter ended March 31, 2011).**

10.38  
Form of Restricted Stock Agreement under 2010 Stock Incentive Plan. (Incorporated by reference to exhibit 99.2 filed with the Registrant’s Registration Statement on Form S-8 filed on August 18, 2010).**

10.39  
Registrant’s Supplemental Executive Retirement Plan as Amended and Restated dated October 29, 2010. (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated November 3, 2010).**

10.40  
Registrant’s 2010 Stock Incentive Plan as Amended and Restated dated October 29, 2010 (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated November 3, 2010).**

10.41  
Fifth Amendment to Credit Agreement between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated November 23, 2010.  (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated November 24, 2010).

10.42  
First Modification to Promissory Note between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated November 23, 2010.  (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated November 24, 2010).

10.43  
Sixth Amendment to Credit Agreement dated as of August 15, 2011, by and among MEDTOX Scientific, Inc., MEDTOX Laboratories, Inc., and MEDTOX Diagnostics, Inc., and Wells Fargo Bank, National Association.  (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated August 16, 2011).

10.44  
Revolving Line of Credit Note dated as of August 15, 2011, by and among MEDTOX Scientific, Inc., MEDTOX Laboratories, Inc., and MEDTOX Diagnostics, Inc., and Wells Fargo Bank, National Association.  (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated August 16, 2011).

21.1  
Subsidiaries of Registrant*

23     
Consent of Independent Registered Public Accounting Firm*

31.1  
Section 302 Certification of Chief Executive Officer pursuant to the Sarbanes-Oxley Act of 2002.*

31.2  
Section 302 Certification of Chief Financial Officer pursuant to the Sarbanes-Oxley Act of 2002.*

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

 
- 44 -

 

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

101   
Financial statements from the annual report on Form 10-K of the Company for the year ended December 31, 2011, formatted in XBRL: (i) the Consolidated Statements of Income, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Cash Flows, (iv) the Consolidated Statements of Stockholders’ Equity and (v) the Notes to Consolidated Financial Statements.

 
*
Filed herewith
 
**
Denotes a management contract or compensatory plan or arrangement

 
- 45 -

 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 8th of March, 2012.

MEDTOX Scientific, Inc.
Registrant

By: /s/ Richard J. Braun
Richard J. Braun
President, Chief Executive Officer and
Chairman of the Board of Directors

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.


Signature
Title
Date
/s/ Richard J. Braun
President, Chief Executive Officer, and
March 8, 2012
Richard J. Braun
Chairman of the Board of Directors (Principal Executive Officer)
 
     
/s/ Kevin J. Wiersma
Vice President and Chief Financial Officer
March 8, 2012
Kevin J. Wiersma
(Principal Financial Officer)
 
     
/s/ Angela M. Lacis
Corporate Controller
March 8, 2012
Angela M. Lacis
(Principal Accounting Officer)
 
     
/s/ Brian P. Johnson
Director
March 8, 2012
Brian P. Johnson
   
     
/s/ Robert J. Marzec
Director
March 8, 2012
Robert J. Marzec
   
     
/s/ Samuel C. Powell
Director
March 8, 2012
Samuel C. Powell, Ph.D.
   
     
/s/ Robert A. Rudell
Director
March 8, 2012
Robert A. Rudell
   
     

 
- 46 -

 

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
MEDTOX Scientific, Inc.
St. Paul, Minnesota
 
We have audited the internal control over financial reporting of MEDTOX Scientific, Inc. and subsidiaries (the "Company") as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting.  Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.  Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinion.
 
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.  Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 

 
- 47 -

 

 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2011, of the Company and our report dated March 8, 2012 expressed an unqualified opinion on those financial statements and financial statement schedule.
 
 
DELOITTE & TOUCHE LLP
 
Minneapolis, Minnesota
March 8, 2012

 
- 48 -

 

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
MEDTOX Scientific, Inc.
St. Paul, Minnesota

We have audited the accompanying consolidated balance sheets of MEDTOX Scientific, Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15.b. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of MEDTOX Scientific, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2012, expressed an unqualified opinion on the Company’s internal control over financial reporting.

 
DELOITTE & TOUCHE LLP
 
Minneapolis, Minnesota
March 8, 2012
 

 

 
- 49 -

 

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2011 AND 2010
(In thousands, except share and per share data) 


   
2011
   
2010
 
ASSETS
           
CURRENT ASSETS:
           
Cash and cash equivalents
$
5,269
 
$
1,285
 
Accounts receivable:
           
Trade, less allowance for doubtful accounts ($1,945 in 2011 and $1,592 in 2010)
 
16,982
   
18,618
 
Other
 
227
   
957
 
Total accounts receivable
 
17,209
   
19,575
 
Inventories
 
4,568
   
3,902
 
Prepaid expenses
 
1,704
   
1,532
 
Deferred income taxes
 
2,776
   
3,765
 
Total current assets
 
31,526
   
30,059
 
BUILDING, EQUIPMENT AND IMPROVEMENTS, net
 
28,105
   
28,164
 
GOODWILL
 
15,967
   
15,967
 
OTHER INTANGIBLE ASSETS, net
 
313
   
198
 
OTHER ASSETS
 
943
   
1,069
 
TOTAL ASSETS
$
76,854
 
$
75,457
 
             
LIABILITIES AND STOCKHOLDERS’ EQUITY
           
CURRENT LIABILITIES:
           
Line of credit
$
-
 
$
2,725
 
Accounts payable
 
4,504
   
4,079
 
Accrued expenses
 
8,221
   
7,101
 
Total current liabilities
 
12,725
   
13,905
 
OTHER LONG-TERM LIABILITIES
 
1,885
   
3,871
 
DEFERRED INCOME TAXES
 
4,616
   
3,562
 
COMMITMENTS AND CONTINGENCIES (Note 13)
           
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, 9,044,525
           
in 2011 and 9,022,888 in 2010
 
1,357
   
1,353
 
Additional paid-in capital
 
78,792
   
78,425
 
Accumulated deficit
 
(15,454
)
 
(19,906
)
Common stock held in trust, at cost,  512,372 shares in 2011 and 428,596 shares in 2010
 
(6,067
)
 
(4,753
)
Treasury stock, at cost, 103,460 shares in 2011 and 2010
 
(1,000
)
 
(1,000
)
Total stockholders' equity
 
57,628
   
54,119
 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
76,854
 
$
75,457
 

See notes to consolidated financial statements.

 
- 50 -

 

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2011, 2010, AND 2009
(In thousands, except share and per share data) 

 
   
2011
   
2010
   
2009
 
REVENUES:
                 
Laboratory services:
                 
   Drugs-of-abuse testing services
$
41,343
 
$
39,624
 
$
36,040
 
   Clinical & other laboratory services
 
34,852
   
29,923
   
22,885
 
   Clinical trial services
 
9,667
   
7,500
   
6,926
 
Product sales
 
22,287
   
20,054
   
18,257
 
   
108,149
   
97,101
   
84,108
 
COST OF REVENUES:
                 
Cost of services
 
54,346
   
49,036
   
45,432
 
Cost of sales
 
8,968
   
8,425
   
7,781
 
   
63,314
   
57,461
   
53,213
 
                   
GROSS PROFIT
 
44,835
   
39,640
   
30,895
 
                   
OPERATING EXPENSES:
                 
Selling, general and administrative
 
35,144
   
32,691
   
26,663
 
Research and development
 
2,519
   
2,261
   
2,264
 
   
37,663
   
34,952
   
28,927
 
                   
INCOME FROM OPERATIONS
 
7,172
   
4,688
   
1,968
 
                   
OTHER (EXPENSE) INCOME:
                 
Interest expense
 
(49
)
 
(10
)
 
(17
)
Other (expense) income
 
(112
)
 
167
   
96
 
   
(161
)
 
157
   
79
 
                   
INCOME BEFORE INCOME TAX EXPENSE
 
7,011
   
4,845
   
2,047
 
                   
INCOME TAX EXPENSE
 
(2,559
)
 
(1,828
)
 
(748
)
                   
NET INCOME
$
4,452
 
$
3,017
 
$
1,299
 
                   
BASIC EARNINGS PER COMMON SHARE
$
0.50
 
$
0.35
 
$
0.15
 
                   
WEIGHTED AVERAGE NUMBER OF BASIC SHARES
OUTSTANDING
 
 
8,853,643
   
 
8,715,391
   
 
8,536,768
 
                   
DILUTED EARNINGS PER COMMON SHARE
$
0.49
 
$
0.34
 
$
0.15
 
                   
WEIGHTED AVERAGE NUMBER OF DILUTED SHARES
OUTSTANDING
 
 
9,035,895
   
 
8,867,530
   
 
8,788,663
 

See notes to consolidated financial statements.

 
- 51 -

 

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2011, 2010, AND 2009
(In thousands, except share data)
 

 
Common Stock
 
Additional
Paid-in
Capital
 
 
Accumulated
Deficit
 
Common Stock Held in Trust
 
Treasury
Stock
 
Total
 
Shares
 
Par Value
                                       
BALANCE AT DECEMBER 31, 2008
8,563,087
 
$
1,284
 
$
88,017
 
$
(24,222)
 
$
(3,614)
 
$
(1,000)
 
$
60,465
                                       
Exercise of stock options
114,302
   
17
   
328
                     
345
Traded shares for payment of taxes
(1,879)
         
(72)
                     
(72)
Share-based compensation
           
5
                     
5
Purchase of common stock for incentive
plan
                       
(410)
         
(410)
Tax expense related to stock-based
compensation plans
           
(200)
                     
(200)
Net income
                 
1,299
               
1,299
                                       
BALANCE AT DECEMBER 31, 2009
8,675,510
 
$
1,301
 
$
88,078
 
$
(22,923)
 
$
(4,024)
 
$
(1,000)
 
$
61,432
                                       
Exercise of stock options
278,178
   
42
   
1,027
                     
1,069
Issuance of nonvested share awards
69,200
   
10
   
(10)
                     
-
Share-based compensation
           
12
                     
12
Purchase of common stock for incentive
plans
                       
(774)
         
(774)
Tax benefit related to stock-based
compensation plans
           
192
                     
192
Tax benefit related to participating dividends
           
177
                     
177
Issuance of common stock shares held in trust
                       
45
         
45
Dividend declared
           
(11,051)
                     
(11,051)
Net income
                 
3,017
               
3,017
                                       
BALANCE AT DECEMBER 31, 2010
9,022,888
 
$
1,353
 
$
78,425
 
$
(19,906)
 
$
(4,753)
 
$
(1,000)
 
$
54,119
                                       
Exercise of stock options
27,951
   
4
   
135
                     
139
Traded shares for payment of taxes
(6,314)
         
(151)
                     
(151)
Share-based compensation
           
283
                     
283
Purchase of common stock for incentive
plans
                       
(1,705)
         
(1,705)
Tax benefit related to stock-based
compensation plans
           
100
                     
100
Issuance of common stock shares held in trust
                       
391
         
391
Net income
                 
4,452
               
4,452
                                       
BALANCE AT DECEMBER 31, 2011
9,044,525
 
$
1,357
 
$
78,792
 
$
(15,454)
 
$
(6,067)
 
$
(1,000)
 
$
57,628

See notes to consolidated financial statements.

 
- 52 -

 

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2011, 2010, AND 2009
(In thousands)


     
2011
   
2010
   
2009
 
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
                   
Net income
 
$
4,452
 
$
3,017
 
$
1,299
 
 Adjustments to reconcile net income to net cash provided by operating activities:
                   
Depreciation and amortization
   
6,172
   
5,815
   
5,437
 
Provision for losses on accounts receivable
   
3,916
   
2,050
   
640
 
Loss on sale of equipment
   
19
   
12
   
14
 
Deferred and stock-based compensation
   
1,495
   
1,135
   
1,172
 
Deferred income taxes
   
2,043
   
1,666
   
748
 
Changes in operating assets and liabilities:
                   
Accounts receivable
   
(1,550
)
 
(5,452
)
 
(2,731
)
Inventories
   
(666
)
 
(309
)
 
307
 
Prepaid expenses
   
(172
)
 
(103
)
 
(76
)
Other assets
   
(138
)
 
(97
)
 
(466
)
Accounts payable and accrued expenses
   
(1,352
)
 
2,615
   
(833
)
Other
   
145
   
(243
)
 
329
 
Net cash provided by operating activities
   
14,364
   
10,106
   
5,840
 
                     
CASH FLOWS USED IN INVESTING ACTIVITIES:
                   
Purchase of building, equipment and improvements
   
(5,938
)
 
(5,138
)
 
(4,930
)
Net cash used in investing activities
   
(5,938
)
 
(5,138
)
 
(4,930
)
                     
CASH FLOWS USED IN FINANCING ACTIVITIES:
                   
Principal payments on long-term debt
   
-
   
(302
)
 
(677
)
Payments on line of credit
   
(29,237
)
 
(4,275
)
 
-
 
Proceeds from line of credit
   
26,512
   
7,000
   
-
 
Purchase of common stock for incentive plans
   
(1,705
)
 
(774
)
 
(410
)
Net proceeds from the exercise of stock options
   
139
   
1,069
   
345
 
Payment of taxes from traded shares
   
(151
)
 
-
   
(72
)
Payment of cash dividend
   
-
   
(10,566
)
 
-
 
Net cash used in financing activities
   
(4,442
)
 
(7,848
)
 
(814
)
                     
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
   
3,984
   
(2,880
)
 
96
 
                     
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
   
1,285
   
4,165
   
4,069
 
                     
CASH AND CASH EQUIVALENTS AT END OF YEAR
 
$
5,269
 
$
1,285
 
$
4,165
 
                     
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
                   
                     
  Cash paid during the year for:
                   
       Interest
 
$
49
 
$
2
 
$
19
 
       Income taxes
   
146
   
73
   
49