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

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

For the quarterly period ended June 30, 2012
OR
(  )
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period                                                                                      to                                           

Commission file number 1-11394

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

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ X ]                      No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
                                                                                                                                     Yes [ X ]                      No [   ]                      

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 ]

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

Class
 
Outstanding at July 12, 2012
Common Stock, $0.15 par value per share
 
9,020,530


 
 
 

MEDTOX SCIENTIFIC, INC.

INDEX

     
  Page
Part I
Financial Information:
 
       
 
Item 1:
Financial Statements (Unaudited)
 
       
   
Consolidated Statements of Income – Three and Six
 
   
Months Ended June 30, 2012 and 2011
3
       
   
Consolidated Balance Sheets – June 30, 2012
 
   
and December 31, 2011
4
       
   
Consolidated Statements of Cash Flows – Six Months
 
   
Ended June 30, 2012 and 2011
5
       
   
Notes to Consolidated Financial Statements
6
       
 
Item 2:
Management's Discussion and Analysis of
 
   
Financial Condition and Results of Operations
13
       
 
Item 3:
Quantitative and Qualitative Disclosures
 
   
About Market Risk
24
       
 
Item 4:
Controls and Procedures
24
       
Part II
Other Information
25
       
 
Item 1:
Legal Proceedings
25
       
 
Item 1A:
Risk Factors
26
       
 
Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds
27
       
 
Item 6:
Exhibits
27
       
   
Signatures
28
       
   
Exhibit Index
29


 
- 2 -
 

PART I                FINANCIAL INFORMATION
Item 1:                   FINANCIAL STATEMENTS   (UNAUDITED)
MEDTOX SCIENTIFIC, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share data)
(Unaudited)

 
Three Months Ended
 
Six Months Ended
 
June 30,
 2012
 
June 30,
 2011
 
June 30,
 2012
 
June 30,
 2011
REVENUES:
             
   Laboratory services:
             
      Drugs-of-abuse testing services
$           11,709
 
$           10,806
 
$         22,287
 
$       20,446
               
      Clinical & other laboratory services:
             
Other clinical and laboratory services
5,848
 
5,292
 
11,334
 
10,032
Net patient services, less provision for bad debts of $869 and $1,607 for the three and six months ended June 30, 2012, respectively, and $990 and $1,629 for the three and six months ended June 30, 2011, respectively
3,736
 
2,851
 
7,435
 
5,447
 
9,584
 
8,143
 
18,769
 
15,479
               
      Clinical trial services
2,148
 
2,323
 
4,522
 
4,859
               
   Product sales
6,536
 
5,659
 
12,979
 
11,244
 
29,977
 
26,931
 
58,557
 
52,028
               
COST OF REVENUES:
             
  Cost of services
14,843
 
13,623
 
28,893
 
26,575
  Cost of sales
2,503
 
2,222
 
5,177
 
4,555
 
17,346
 
15,845
 
34,070
 
31,130
               
GROSS PROFIT
12,631
 
11,086
 
24,487
 
20,898
               
OPERATING EXPENSES:
             
   Selling, general and administrative
              9,993
 
8,291
 
18,800
 
16,276
   Research and development
755
 
622
 
1,444
 
1,216
 
10,748
 
8,913
 
20,244
 
17,492
               
INCOME FROM OPERATIONS
1,883
 
2,173
 
             4,243
 
           3,406
               
OTHER INCOME (EXPENSE):
             
   Interest expense
-
 
                 (18
)
             -
 
              (42)
   Other income
70
 
57
 
                 66
 
                73
 
70
 
39
 
              66
 
              31
               
INCOME BEFORE INCOME TAX EXPENSE
1,953
 
2,212
 
4,309
 
3,437
               
INCOME TAX EXPENSE
                 (713
)
                 (808
)
            (1,573
)
         (1,255)
               
NET INCOME
$             1,240
 
$              1,404
 
$           2,736
 
$         2,182
               
BASIC EARNINGS PER COMMON
SHARE
$               0.14
 
$                0.16
 
$             0.31
 
$           0.25
               
DILUTED EARNINGS PER COMMON SHARE
$               0.14
 
$                0.16
 
$             0.30
 
$           0.24
               
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
             
          Basic
8,901,618
 
8,847,870
 
8,888,702
 
8,849,042
          Diluted
9,126,327
 
9,052,714
 
9,099,698
 
9,048,185
See Notes to Consolidated Financial Statements (Unaudited).
 
- 3 -
 

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


 
June 30,
2012
 
December 31,
2011
 
ASSETS
           
CURRENT ASSETS:
           
   Cash and cash equivalents
$
6,819
 
$
5,269
 
   Accounts receivable:
           
         Trade, less allowance for doubtful accounts  of $1,503 in 2012 and $1,945 in 2011
 
19,733
   
16,982
 
         Other
 
714
   
227
 
             Total accounts receivable
 
20,447
   
17,209
 
   Inventories
 
4,774
   
4,568
 
   Prepaid expenses
 
1,829
   
1,704
 
   Deferred income taxes
 
1,311
   
2,776
 
             Total current assets
 
35,180
   
31,526
 
BUILDING, EQUIPMENT AND IMPROVEMENTS, net
 
28,088
   
28,105
 
GOODWILL
 
15,967
   
15,967
 
OTHER INTANGIBLE ASSETS, net
 
275
   
313
 
OTHER ASSETS
 
986
   
943
 
TOTAL ASSETS
$
80,496
 
$
76,854
 
             
LIABILITIES AND STOCKHOLDERS’ EQUITY
           
CURRENT LIABILITIES:
           
   Accounts payable
$
4,880
 
$
4,504
 
   Accrued expenses
 
6,897
   
8,221
 
             Total current liabilities
 
11,777
   
12,725
 
LONG-TERM LIABILITIES
 
1,768
   
1,885
 
DEFERRED INCOME TAXES, net
 
4,616
   
4,616
 
             
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, 9,097,850 in
           
        2012 and 9,044,525 in 2011
 
1,365
   
1,357
 
   Additional paid-in capital
 
79,541
   
78,792
 
   Accumulated deficit
 
(12,718
)
 
(15,454
)
   Common stock held in trust, at cost, 316,595 shares in 2012 and 512,372 shares in 2011
 
(4,841
)
 
(6,067
)
   Treasury stock, at cost, 77,320 shares in 2012 and 103,460 shares in 2011
 
(1,012
)
 
(1,000
)
             Total stockholders' equity
 
62,335
   
57,628
 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
80,496
 
$
76,854
 

See Notes to Consolidated Financial Statements (Unaudited).


 
- 4 -
 

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

 
Six Months Ended
 
 
June 30, 2012
 
June 30, 2011
 
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
           
   Net income
$
2,736
 
$
2,182
 
   Adjustments to reconcile net income to net cash provided by
           
           operating activities:
           
      Depreciation and amortization
 
3,121
   
2,972
 
      Provision for losses on accounts receivable
 
1,788
   
1,743
 
      Loss on sale of equipment
 
(2
)
 
4
 
      Deferred and stock-based compensation
 
924
   
752
 
      Deferred income taxes
 
1,465
   
1,169
 
      Changes in operating assets and liabilities:
           
         Accounts receivable
 
(5,026
)
 
(2,704
)
         Inventories
 
(206
)
 
(531
)
         Prepaid expenses
 
(125
)
 
(16
)
         Other assets
 
(85
)
 
(217
)
         Accounts payable and accrued expenses
 
1,630
   
(197
)
         Other
 
(5
)
 
-
 
               Net cash provided by operating activities
 
6,215
   
5,157
 
             
CASH FLOWS USED IN INVESTING ACTIVITIES:
           
    Purchases of building, equipment and improvements
 
(3,124
)
 
(2,575
)
                Net cash used in investing activities
 
(3,124
)
 
(2,575
)
             
CASH FLOWS USED IN FINANCING ACTIVITIES:
           
    Proceeds from line of credit
 
-
   
18,757
 
    Payments on line of credit
 
-
   
(19,585
)
    Purchase of common stock for incentive plans
 
-
   
(1,705
)
    Net proceeds from the exercise of stock options
 
39
   
21
 
    Payment of taxes from traded shares
 
(1,580
)
 
(104
)
              Net cash used in financing activities
 
(1,541
)
 
(2,616
)
             
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
 
1,550
   
(34
)
             
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
 
5,269
   
1,285
 
             
CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
6,819
 
$
1,251
 
             
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
           
   Cash paid for:
           
          Interest
$
128
 
$
46
 
          Income taxes
 
631
   
227
 
             
Supplemental noncash activities:
           
          Asset additions and related obligations in payables
$
587
 
$
1,398
 
          Distribution of common stock from incentive plan
 
3,309
   
-
 
          Treasury stock transferred to fund contribution of common stock for incentive plans
 
2,084
   
-
 

See Notes to Consolidated Financial Statements (Unaudited).

 
- 5 -
 

MEDTOX SCIENTIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Periods Ended June 30, 2012

1.           BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements of MEDTOX Scientific, Inc. (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by generally accepted accounting principles.  In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of financial condition and results of operations have been included.  Operating results for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results that may be attained for the entire year.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

On January 1, 2012, the Company adopted new accounting 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 certain patient service revenue from an operating expense to a deduction from patient service revenue (net of contractual allowances and discounts).  Results for the three and six month periods ended June 30, 2011 have been restated in accordance with this new guidance, which resulted in a $990,000 and $1,629,000 decrease in revenues and selling, general and administrative expenses, respectively.

Patient Service Revenue, Accounts Receivable and Allowance for Doubtful Accounts - Patient accounts receivable are reported at realizable value, net of allowance for doubtful accounts.  In evaluating the collectibility of accounts receivable, the Company analyzes its past history and identifies trends for each of its major payor sources of revenue to estimate the appropriate allowance for doubtful accounts and provision for bad debts.  Management regularly reviews data about these major payor sources of revenue in evaluating the sufficiency of the allowance for doubtful accounts.  For receivables associated with services provided to patients who have third-party coverage, the Company analyzes contractually due amounts and provides an allowance for doubtful accounts and a provision for bad debts, if necessary.   For receivables associated with self-pay patients (which includes both patients without insurance and patients with deductible and copayment balances due for which third-party coverage exists for part of the bill), the Company records a provision for bad debts in the period of service on the basis of its past experience, which indicates that many patients are unable or unwilling to pay the portion of their bill for which they are financially responsible.  The difference between the standard rates (or the discounted rates, if negotiated) and the amounts actually collected after all reasonable collection efforts have been exhausted is charged against the allowance for doubtful accounts.

The Company’s allowance for doubtful accounts was 35% of net patient accounts receivable at June 30, 2012, compared to 44% of net patient accounts receivable at December 31, 2011.  The Company’s writeoffs, net of recoveries were $1,180,000 and $2,086,000 for the three and six months ended June 30, 2012, respectively, compared to $1,085,000 and $1,390,000 for the same periods of 2011.  The increase in write-offs in the six month period ended June 30, 2012 was the result of writing off claims earlier in the first quarter of 2012 compared to the first quarter of 2011 based on historical collection experience.

 
- 6 -
 
The Company’s 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 its receivables.  Revisions to the allowance for doubtful accounts are recorded as an adjustment to bad debt expense.   Accounts are written off against the allowance for doubtful accounts when they are deemed to be uncollectible.  Recoveries of receivables previously written-off are recorded as credits to the allowance for doubtful accounts.

The Company recognizes net patient service revenue associated with services provided to patients who have third-party payor coverage on the basis of contractual rates for the services rendered.  For uninsured patients, the Company recognizes revenue on the basis of its standard rates for services provided (or on the basis of discounted rates, if negotiated or provided by policy).

Patient service revenue, net of contractual allowances and discounts (but before the provision for bad debts), recognized in the period from these major payor sources, is as follows:

(In thousands)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
                       
Medicaid
$
1,512   
 
$
1,143   
 
$
3,090   
 
$
2,152   
Medicare
 
1,050   
   
607   
   
2,015   
   
1,151   
Blue Cross Blue Shield plans
 
666   
   
840   
   
1,222   
   
1,425   
Self-pay and other third party payors
 
1,377   
   
1,251   
   
2,715   
   
2,348   
Total net patient service revenue
$
4,605   
 
$
3,841   
 
$
 9,042   
 
$
7,076   

2.           SEGMENTS

The Company has two reportable segments:  Laboratory Services and Product Sales.  The Laboratory Services segment consists of MEDTOX Laboratories, Inc. and New Brighton Business Center, LLC (NBBC).  Services provided include drugs-of-abuse testing services; clinical & other laboratory services, which include clinical toxicology, clinical testing for occupational health clinics, clinical testing for physician offices, pediatric lead testing, heavy metals analyses, prescription management testing, courier delivery, and medical surveillance; and clinical trial services which include central laboratory services, assay development, bio-analytical, bio-equivalence and pharmacokinetic testing.  The Product Sales segment, which includes POCT (point-of-collection testing) disposable diagnostic devices, consists of MEDTOX Diagnostics, Inc.  Products manufactured include easy to use, inexpensive, on-site drug tests such as PROFILE ® -II, PROFILE ® -II A, PROFILE ® -III A, PROFILE-II ER ® , PROFILE ® -III ER,  PROFILE ® -V, MEDTOXScan ® , VERDICT ® -II and SURE-SCREEN ® , and EZ-SCREEN ® Cup, in addition to a variety of other diagnostic tests for the detection of alcohol.  MEDTOX Diagnostics also provides contract manufacturing services in its Food and Drug Administration (FDA) registered/ISO 13845 certified facility.


 
- 7 -
 

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

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

(In thousands)
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
     Laboratory Services:
                     
  Revenues
$
23,441
 
$
21,272
 
$
45,578
 
$
40,784
  Depreciation and amortization
 
1,342
   
1,271
   
2,656
   
2,567
  Income from operations
 
443  
   
1,028  
   
1,425  
   
1,130  
  Capital expenditures for segment assets
 
2,030  
   
1,668  
   
2,539  
   
2,740  
                       
     Product Sales:
 
                     
  Revenues
$
6,536
 
$
5,659
 
$
12,979
 
$
11,244
  Depreciation and amortization
 
235
   
205
   
465
   
405
  Income from operations
 
1,440  
   
1,145  
   
2,818  
   
2,276  
  Capital expenditures for segment assets
 
438  
   
311  
   
528  
   
725  
                       
     Corporate (unallocated):
                     
  Other income (expense)
$
70  
 
$
39  
 
$
66  
 
$
31  
                       
     Company:
                     
  Revenues
$
29,977
 
$
26,931
 
$
58,557
 
$
52,028
  Depreciation and amortization
 
1,577
   
1,476
   
3,121
   
2,972
  Income from operations
 
1,883  
   
2,173  
   
4,243  
   
3,406  
  Other income (expense)
 
70  
   
39  
   
66  
   
31  
  Income before income tax expense
 
1,953  
   
2,212  
   
4,309  
   
3,437  
  Capital expenditures for assets
 
2,468  
   
1,979  
   
3,067  
   
3,465  


(In thousands)
June 30,
2012
 
December 31,
2011
     Assets:
         
    Laboratory Services
$
68,312  
 
$
65,739  
    Product Sales
 
10,873  
   
8,339  
    Corporate (unallocated)
 
1,311  
   
2,776  
    Company
$
80,496  
 
$
76,854  

 
- 8 -
 

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

(In thousands)
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
                       
POC on-site testing products
$
6,261
 
$
5,248
 
$
11,859
 
$
10,107
Contract manufacturing services
 
42  
   
214  
   
683
   
750
Other diagnostic products
 
233  
   
197  
   
437
   
387
 
$
6,536  
 
$
5,659  
 
$
12,979
 
$
11,244

3.           INVENTORIES

Inventories consisted of the following:

(In thousands)
June 30,
2012
 
December 31,
2011
           
Raw materials
$
937
 
$
986
Work in process
 
551
   
479
Finished goods
 
499
   
389
Supplies, including off-site inventory
 
2,787
   
2,714
 
$
4,774
 
$
4,568

4.           EARNINGS PER SHARE

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

(In thousands, except share and
per share data)
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
                       
Net income (A)
$
1,240
 
$
1,404
 
$
2,736
 
$
2,182
Weighted average number of basic common shares outstanding (B)
 
8,901,618  
   
8,847,870  
   
8,888,702  
   
8,849,042  
Dilutive effect of stock options  computed based on the treasury stock method
 
224,709  
   
204,844  
   
210,996  
   
199,143  
Weighted average number of diluted common shares outstanding (C)
 
9,126,327  
   
9,052,714  
   
9,099,698  
   
9,048,185  
Basic earnings per common share (A/B)
$
0.14
 
$
0.16
 
$
0.31
 
$
0.25
Diluted earnings per common share (A/C)
$
0.14
 
$
0.16
 
$
0.30
 
$
0.24


 
- 9 -
 

5.       INCOME TAXES

At December 31, 2011, the Company had federal net operating loss carryforwards (NOLs) of approximately $1.1 million, which are available to offset future taxable income.  The Company's federal NOLs expire in varying amounts each year from 2029 through 2030 in accordance with applicable federal tax regulations and the timing of when the NOLs were incurred.  Section 382 of the Internal Revenue Code restricts the annual utilization of certain NOLs incurred prior to a change in ownership.  However, such limitation is not expected to impair the realization of these NOLs.  In the future, subsequent revisions to the estimated net realizable value of these deferred tax assets could cause the provision for income taxes to vary significantly from period to period, although the Company’s cash payments would remain unaffected until the benefit of the NOLs is completely utilized or expires unused.  The Company anticipates fully utilizing its NOLs and expects an increase in income tax payments in 2012.
 
6.        MERGER AGREEMENT

On June 3, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Laboratory Corporation of America Holdings (“Parent” or “LabCorp”) and Mercer Acquisition Corp., a wholly owned subsidiary of Parent (“Merger Sub”).

The Merger Agreement provides for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Parent.  In the Merger, each outstanding share of common stock, par value $0.15 per share, of the Company, other than any dissenting shares, shares held by Parent, Merger Sub, the Company or any of their respective subsidiaries and treasury shares, will be cancelled and converted into the right to receive $27.00 in cash, without interest.
  
The closing of the Merger is subject to customary closing conditions, including adoption of the Merger Agreement by the Company’s stockholders and regulatory approvals.  The closing is not subject to any financing condition or a vote of Parent’s stockholders.  On July 13, 2012, the Company announced that the Federal Trade Commission has granted early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 applicable to the acquisition of the Company by LabCorp.  Assuming approval of the Company’s stockholders, the transaction is expected to close in the third quarter of 2012.

Under the Merger Agreement, the Company may not solicit competing proposals or, subject to exceptions that permit the Company’s Board of Directors to take actions required by their fiduciary duties, participate in any discussions or negotiations regarding alternative business combination transactions.

The Merger Agreement also includes customary termination provisions for both the Company and Parent and provides that, in connection with the termination of the Merger Agreement under specified circumstances, including in connection with the Company accepting an unsolicited acquisition proposal determined by the Board of Directors to be a Superior Proposal (as defined in the Merger Agreement), the Company may be required to pay to Parent a termination fee of $8.2 million.
 
 
- 10 -
 
Under certain circumstances, the Merger Agreement also provides for Parent to reimburse the Company for expenses incurred upon termination of the Merger Agreement if the Merger is not completed by December 31, 2012, in an amount not to exceed $750,000.
 
The Merger Agreement contains customary representations, warranties and covenants by the Company, Parent and Merger Sub, including covenants regarding operation of the business of the Company and its subsidiaries prior to the closing.

Results for the three and six month periods ended June 30, 2012 include approximately $515,000 of expenses attributable to the planned Merger.  These costs are included in selling, general and administrative on the income statement.

For further information regarding the Merger, see the Definitive Proxy Statement of the Company, as filed with the Securities and Exchange Commission on June 27, 2012, and the additional proxy soliciting materials filed by Company subsequent to June 27, 2012. 

7.        CONTINGENCIES

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

Legal - The Company is party to various legal proceedings arising in the normal course of business activities, none of which, in the opinion of management, are expected to have a material impact on the Company's consolidated financial position or results of operations.
 
We are party to several legal proceedings relating to the proposed transaction with Laboratory Corporation of America Holdings (“LabCorp”), as follows:

On June 6, 2012, a putative class action lawsuit was commenced against us and our directors in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota. The lawsuit is captioned John Siciliano v. MEDTOX Scientific, Inc. et al. In the lawsuit, plaintiff alleges generally that our directors breached their fiduciary duties in connection with the transaction by, among other things, carrying out an unfair process and agreeing to a transaction that was unfair to our stockholders and that the Company aided and abetted our directors’ breach of fiduciary duty. Plaintiff purports to bring the lawsuit on behalf of the public stockholders of the Company and seeks equitable relief to enjoin consummation of the merger, rescission of the merger and fees and costs, among other relief. The Company believes the lawsuit is without merit.

On June 12, 2012, a putative class action lawsuit was commenced against us, our directors, LabCorp and Merger Sub in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota. The lawsuit is captioned Carol A. Kiel v. Richard Braun et al. In the lawsuit, plaintiff alleges generally that our directors breached their fiduciary duties in connection with the transaction by, among other things, agreeing to a transaction that was unfair to our stockholders, that provisions of the merger agreement unlawfully preclude our directors from further soliciting potential buyers and that the Company, LabCorp and Merger Sub aided and abetted our directors’ breach of fiduciary duties. Plaintiff purports to bring the lawsuit on behalf of the public stockholders of the Company and seeks equitable relief to enjoin consummation of the merger, rescission of the merger and/or awarding rescissory damages, damages and fees and costs, among other relief. The Company believes the lawsuit is without merit.

 
- 11 -
 
On June 21, 2012, a putative class action lawsuit was commenced against us, our directors, LabCorp and Merger Sub in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota. The lawsuit is captioned Louis Perlman v. Medtox Scientific, Inc. et al. In the lawsuit, plaintiff alleges generally that our directors breached their fiduciary duties in connection with the transaction by, among other things, agreeing to a transaction that was unfair to our stockholders, that provisions of the merger agreement unlawfully preclude our directors from further soliciting potential buyers and that the Company, LabCorp and Merger Sub aided and abetted our directors’ breach of fiduciary duties. Plaintiff purports to bring the lawsuit on behalf of the public stockholders of the Company and seeks equitable relief to enjoin consummation of the merger, rescission of the merger and/or awarding rescissory damages, damages and fees and costs, among other relief. The Plaintiff was a director of the Company from July 1996 through September 1998. The Company believes the lawsuit is without merit.

On June 26, 2012, each of the plaintiffs in the foregoing actions filed a joint motion in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota to (i) consolidate the three foregoing actions and all later-filed actions filed in the same court arising out of the same facts and circumstances, (ii) appoint plaintiffs Perlman, Siciliano and Kiel as lead plaintiffs in the consolidated action and (iii) appoint plaintiffs’ counsel in the initial actions in various capacities as lead counsel, members of an executive committee and as liaison counsel in the consolidated action. The court has not yet ruled on the motion.

On July 19, 2012, counsel for the parties in the foregoing actions (the “Minnesota Litigation”) entered into a Memorandum of Understanding (“MOU”) in which they agreed on the terms of a settlement of the Minnesota Litigation, which includes supplementation of the Definitive Proxy Statement and the dismissal with prejudice of all claims against all of the defendants in the Minnesota Litigation. The proposed settlement is conditioned upon, among other things, the execution of an appropriate stipulation of settlement and final approval of the proposed settlement by the Ramsey County Court.  Counsel for the named plaintiffs in all of these actions have agreed to stay the actions pending consideration of final approval of the settlement in the Ramsey County Court. Assuming such approval, the named plaintiffs in all actions would dismiss their respective lawsuits with prejudice against all defendants. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the Ramsey County Court will approve the settlement as stipulated by the parties. In such event, the proposed settlement as contemplated by the MOU may be terminated.

 
- 12 -
 

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

This Form 10-Q contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by such acts.  For this purpose, any statements that are not statements of historical fact may be deemed to be forward looking statements, including the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding our strategy, future operations, future expectations and future estimates, future financial position or results, and future plans and objectives of management.  Those statements in this Form 10-Q containing the words “believes”, “anticipates”, “plans”, “expects”, and similar expressions constitute forward looking statements, although not all forward looking statements contain such identifying words.  Examples of forward looking statements include, but are not limited to (i) projections of, or statements regarding, future revenues, income or loss, earnings or loss per share, capital expenditures, capital structure, pricing, income tax payments and usage of NOLs, margins and other financial items, (ii) statements regarding our plans and objectives and the impacts thereof, including planned introductions of new products and services, estimates or predictions of actions by customers, suppliers, competitors or regulatory authorities, controlling costs, and pursuing synergistic acquisitions, (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, (vi) statements regarding the stockholder meeting, expected closing, legal proceedings, and other Merger-related matters, and (vii) statements of assumptions underlying other statements and statements about our business.

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

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

·  
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

 
- 13 -
 

·  
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

·  
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

 
- 14 -
 

·  
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

·  
failure to receive stockholder approval for the Merger

·  
failure to close the Merger within the expected timeframe or at all

·  
failure of the Merger to achieve the anticipated strategic benefits

·  
adverse reactions to the Merger by customers, suppliers, employees or strategic partners

·  
other factors, including those set forth in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011

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

Executive Overview

Our Business

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

Laboratory Services

Our “Laboratory Services” business segment includes the activities of our wholly-owned subsidiary, MEDTOX Laboratories, Inc.  MEDTOX Laboratories, Inc. engages in drugs-of-abuse testing services, providing these services to private and public companies, drug treatment counseling centers, criminal justice facilities, occupational health clinics and hospitals, as well as third party administrators.


 
- 15 -
 

MEDTOX Laboratories, Inc. also provides clinical and other laboratory services which consist of clinical toxicology, clinical testing for occupational health clinics, and heavy metal, trace element and solvent analyses.  We provide these services to hospitals, clinics, HMOs and other laboratories.  Testing is conducted using methodologies that include various immunoassays, gas liquid chromatography, gas chromatography/mass spectrometry, and high performance liquid chromatography with tandem mass spectrometry.  We recently expanded our clinical & other laboratory services to include laboratory tests used by physicians and other healthcare providers for the purpose of diagnosing or treating disease or illness or the assessment of health in humans.  Testing is performed on blood, body fluids or tissues.  Our comprehensive clinical laboratory services include clinical chemistry, hematology, coagulation, urinalysis, immunology/serology (viruses, infectious diseases, immune system), immunohematology (blood typing, antibody screens), microbiology (bacteria, parasites), anatomical pathology/cytology (tissue biopsies, cancer), molecular diagnostics (infectious diseases, genetic disorders) and sub-specialties of these categories.  We also provide services in the areas of logistics management, data management and program management.  These services support our underlying business of laboratory analysis and provide added value to our clients.

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

The 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.


 
- 16 -
 

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 the first and second quarters of 2012, testing volume from our existing workplace drugs-of-abuse clients was lower than in the prior year periods, which we primarily attributed to lower new job creation and reduced employment levels and corresponding drops in hiring caused by economic uncertainties.  We feel economic uncertainties may continue to cause variability in our workplace drugs-of-abuse testing volume in the foreseeable future.

Increased POCT Diagnostic Device Test Competition

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

Our Strategy

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

Building Market Share

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

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.

 
- 17 -
 

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.

We have also continued the expansion of our prescription management business.  We offer a comprehensive testing program serving this market under the name ToxAssure ® .

Merger Agreement with Laboratory Corporation of America Holdings

On June 3, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Laboratory Corporation of America Holdings (“Parent” or “LabCorp”) and Mercer Acquisition Corp., a wholly owned subsidiary of Parent (“Merger Sub”).  See Note 6 of Notes to Consolidated Financial Statements (unaudited).

Critical Accounting Policies
 
There were no significant changes to our critical accounting policies during the three and six-month periods ended June 30, 2012 from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

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

To maximize our operating income, we have sought revenue growth, improved gross margin and reduced selling, general and administrative (SG&A) expense as a percentage of revenues.  As discussed below, during the second quarter of 2012 and the first six months of this year, we were able to achieve revenue growth and improved gross margin.


 
- 18 -
 

Revenues

 
Three Months Ended
 
Six Months Ended
(In thousands, except percentages)
June 30,
2012
June 30,
2011
$
Change
%
Change
 
June 30,
2012
June 30,
2011
$
Change
%
Change
Revenues:
                 
                   
Laboratory Services
                 
   Drugs-of abuse testing  services
$  11,709  
$  10,806  
$     903  
8%  
 
$ 22,287
$ 20,446
$   1,841 
9%  
   Clinical & other laboratory services
9,584  
8,143  
1,441  
18%  
 
18,769
15,479
3,290 
21%  
   Clinical trial services
2,148  
2,323  
(175)  
(8)%  
 
4,522
4,859
(337) 
(7)%  
                   
Product Sales
6,536  
5,659  
877  
16%  
 
12,979
11,244
1,735
15%  
                   
 
$ 29,977  
$ 26,931  
$   3,046
11%  
 
$ 58,557
$ 52,028
$   6,529
13%  

Our Laboratory Services segment includes revenues from drugs-of-abuse testing services, clinical & other laboratory services and clinical trial services.  Revenues for the three and six month periods  ended June 30, 2011 reflect the adjustment of $1.0 million and $1.6 million, respectively, for the adoption of new accounting guidance for patient service bad debt.  See Note 1 of Notes to Consolidated Financial Statements (unaudited).

Our revenues from drugs-of-abuse testing increased 8% to $11.7 million and 9% to $22.3 million for the three and six month periods ended June 30, 2012, respectively.  The increase in both periods was primarily a result of an increase in new account revenues, which increased 15% and 14% for the three and six month periods ended June 30, 2012, respectively.  The increase in both periods was mitigated by a 7% and 5% decrease in revenue from our existing client base for the three and six month periods ended June 30, 2012, respectively, primarily due to continued reduced hiring levels due to 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.  Pricing for our workplace drugs-of-abuse testing services tends to be fairly stable overall; however, the average price per testing specimen can vary slightly from quarter-to-quarter.  Test price can vary by client based on the percentage of samples that test positive for drugs-of-abuse and the average number of samples per shipment.

Revenues in our clinical and other laboratory services increased 18% to $9.6 million and 21% to $18.8 million for the three and six month periods ended June 30, 2012, respectively.  The improvement in both periods was due to continued strong growth generated by our expanded clinical laboratory capabilities and diversification initiatives, including testing for prescription management.

Revenues in clinical trial services decreased 8% to $2.1 million and 7% to $4.5 million for the three and six month periods ended June 30, 2012, respectively.  Revenues from clinical trial services can fluctuate from quarter-to-quarter based on the project nature, size, and the actual timing of clinical trials.

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

 
- 19 -
 

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 19% to $6.3 million and 17% to $11.9 million for the three and six month periods ended June 30, 2012, respectively.  The increase in both periods was due primarily to an increase in revenues in the workplace drugs-of-abuse and government markets with our newly introduced EZ-SCREEN® cup device and increased sales of Profile®-V sold into the hospital market with our MEDTOXScan® Reader.  Overall, pricing for our POCT devices was fairly stable with the prior year periods.

Sales of contract manufacturing services decreased 80% to $43,000 and 9% to $0.7 million for the three and six month periods ended June 30, 2012, respectively, as we have been phasing out of this business and completely exited this business in April 2012.

Cost of Revenues and Gross Margin

 
Three Months Ended
 
Quarter-over-Quarter
(In thousands, except percentages)
June 30,
2012
% of
Revenues
June 30,
2011
% of
Revenues
 
$
Change
%
Change
Cost of Revenues:
             
               
Cost of Services
$   14,843
63.3%*
$   13,623
64.0%*
 
$  1,220
9%
               
Cost of Sales
2,503
38.3%**
2,222
39.3%**
 
281
13%
               
 
$   17,346
57.9%
$   15,845
58.8%
 
$  1,501
10%

 
Six Months Ended
 
Year-over-Year
(In thousands, except percentages)
June 30,
2012
% of
Revenues
June 30,
2011
% of
Revenues
 
$
Change
%
Change
Cost of Revenues:
             
               
Cost of Services
$    28,893
63.4%*
$   26,575
65.2%*
 
$  2,318
9%
               
Cost of Sales
5,177
39.9%**
4,555
40.5%**
 
622
14%
               
 
$    34,070
58.2%
$   31,130
59.8%
 
$  2,940
9%

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

Consolidated gross margin was 42.1% and 41.8% of revenues for the three and six months ended June 30, 2012, respectively, compared to 41.2% and 40.2% of revenues for the same periods in 2011.

Laboratory Services gross margin was 36.7% and 36.6% for the three and six months ended June 30, 2012, respectively, up from 36.0% and 34.8% for the same periods of 2011.  The increase in both periods in 2012 was primarily due to a change in test mix and an increase in volume.

 
- 20 -
 

Gross margin from Product Sales was 61.7% and 60.1% for the three and six months ended June 30, 2012, respectively, compared to 60.7% and 59.5% for the same periods of 2011.

Operating Expenses

 
Three Months Ended
 
Quarter-over-Quarter
(In thousands, except percentages)
June 30,
2012
% of
Revenues
June 30,
2011
% of
Revenues
 
$
Change
%
Change
Operating Expenses:
             
               
Selling, general and
   administrative
$   9,993
33.3%
$   8,291
30.8%
 
$       1,702
21%
               
Research and
   development
755
2.5%
622
2.2%
 
133
21%
               
 
$  10,748
35.9%
$   8,913
33.1%
 
$       1,835
21%

 
Six Months Ended
 
Year-over-Year
(In thousands, except percentages)
June 30,
2012
% of
Revenues
June 30,
2011
% of
Revenues
 
$
Change
%
Change
Operating Expenses:
             
               
Selling, general and
   administrative
$   18,800
32.1%
$  16,276
31.3%
 
$        2,524
16%
               
Research and
   development
1,444
2.5%
1,216
2.3%
 
228
19%
               
 
$   20,244
34.6%
$  17,492
33.6%
 
$       2,752
16%

    Selling, General and Administrative Expenses .  Selling, general and administrative (SG&A) expenses increased to $10.0 million, or 33.3% of revenues for the three months ended June 30, 2012, compared to $8.3 million, or 30.8% of revenues for the same period in 2011.  For the six months ended June 30, 2012, SG&A expenses increased to $18.8 million, or 32.1% of revenues, compared to $16.3 million, or 31.3% of revenues for the same period in 2011.  The increase in both periods was primarily due to increased sales and marketing expenses and increased incentive-based compensation.  SG&A expenses for the three and six month periods ended June 30, 2012 also include approximately $0.5 million of expenses attributable to the planned merger with Laboratory Corporation of America Holdings.  See Note 6 of Notes to Consolidated Financial Statements (unaudited).  SG&A expenses for the three and six month periods ended June 30, 2011 reflect the adjustment of $1.0 million and $1.6 million, respectively, for the adoption of new accounting guidance for patient service bad debt.  See Note 1 of Notes to Consolidated Financial Statements (unaudited).

Research and Development Expenses .   Research and development expenses increased 21% to $0.8 million and 19% to $1.4 million for the three and six months ended June 30, 2012, respectively.  The increase in both periods was primarily due to increased spending for on-going projects in our Product Sales segment.

 
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Liquidity and Capital Resources

Our working capital requirements have been funded primarily by various combinations of profitable operations and cash received from our revolving credit facility.  Cash and cash equivalents at June 30, 2012 were $6.8 million, compared to $5.3 million at December 31, 2011.

Net cash provided by operating activities was $6.2 million for the six months ended June 30, 2012, compared to $5.2 million for the six months ended June 30, 2011.  The increase 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.

Net cash used in investing activities, consisting of capital expenditures, was $3.1 million for the six months ended June 30, 2012, compared to $2.6 million for the same period of 2011.   In both periods, these expenditures included equipment purchased and costs incurred to upgrade equipment, improve efficiencies and increase service levels to our clients.

We anticipate fully utilizing our net operating loss carryforwards and expect an increase in income tax payments in 2012.

Net cash used in financing activities was $1.5 million for the six months ended June 30, 2012 compared to $2.6 million in the prior year period.  In the first six months of 2012, we paid payroll taxes of $1.6 million related to shares of our common stock surrendered by employees to satisfy payroll tax withholding requirements related to a distribution from our Long-Term Incentive Plan (LTIP).  The surrendered shares were placed in treasury.  In the first six months of 2012, 119,953 shares of treasury stock were placed into trust to fund a $2.1 million contribution of common stock for our LTIP and Supplemental Executive Retirement Plan (SERP).  In the first six months of 2011, we repurchased 108,963 shares of our common stock in the open market for a cost of $1.7 million.   The shares repurchased were placed in trust to fund our LTIP and SERP.  In the first six months of 2011, we also made net payments on our line of credit of $0.8 million.

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.

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.

 
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·  
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 June 30, 2012.

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 June 30, 2012, 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 June 30, 2012.

In connection with the Merger, the Wells Fargo Credit Agreement is expected to be terminated and any outstanding borrowings thereunder to be repaid upon closing of the Merger.

Off-Balance Sheet Transactions

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

Impact of Inflation and Changing Prices

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

Seasonality

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


 
- 23 -
 

Item 3:                        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material changes in our market risk during the quarter ended June 30, 2012.  For additional information refer to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2011.

Item 4:                        CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and 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.

 
- 24 -
 

PART II                    OTHER INFORMATION

ITEM 1                      LEGAL PROCEEDINGS.

We are party to several legal proceedings relating to the proposed transaction with Laboratory Corporation of America Holdings (“LabCorp”), as follows:

On June 6, 2012, a putative class action lawsuit was commenced against us and our directors in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota. The lawsuit is captioned John Siciliano v. MEDTOX Scientific, Inc. et al. In the lawsuit, plaintiff alleges generally that our directors breached their fiduciary duties in connection with the transaction by, among other things, carrying out an unfair process and agreeing to a transaction that was unfair to our stockholders and that the Company aided and abetted our directors’ breach of fiduciary duty. Plaintiff purports to bring the lawsuit on behalf of the public stockholders of the Company and seeks equitable relief to enjoin consummation of the merger, rescission of the merger and fees and costs, among other relief. The Company believes the lawsuit is without merit.

On June 12, 2012, a putative class action lawsuit was commenced against us, our directors, LabCorp and Merger Sub in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota. The lawsuit is captioned Carol A. Kiel v. Richard Braun et al. In the lawsuit, plaintiff alleges generally that our directors breached their fiduciary duties in connection with the transaction by, among other things, agreeing to a transaction that was unfair to our stockholders, that provisions of the merger agreement unlawfully preclude our directors from further soliciting potential buyers and that the Company, LabCorp and Merger Sub aided and abetted our directors’ breach of fiduciary duties. Plaintiff purports to bring the lawsuit on behalf of the public stockholders of the Company and seeks equitable relief to enjoin consummation of the merger, rescission of the merger and/or awarding rescissory damages, damages and fees and costs, among other relief. The Company believes the lawsuit is without merit.

On June 21, 2012, a putative class action lawsuit was commenced against us, our directors, LabCorp and Merger Sub in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota. The lawsuit is captioned Louis Perlman v. Medtox Scientific, Inc. et al. In the lawsuit, plaintiff alleges generally that our directors breached their fiduciary duties in connection with the transaction by, among other things, agreeing to a transaction that was unfair to our stockholders, that provisions of the merger agreement unlawfully preclude our directors from further soliciting potential buyers and that the Company, LabCorp and Merger Sub aided and abetted our directors’ breach of fiduciary duties. Plaintiff purports to bring the lawsuit on behalf of the public stockholders of the Company and seeks equitable relief to enjoin consummation of the merger, rescission of the merger and/or awarding rescissory damages, damages and fees and costs, among other relief. The Plaintiff was a director of the Company from July 1996 through September 1998. The Company believes the lawsuit is without merit.

On June 26, 2012, each of the plaintiffs in the foregoing actions filed a joint motion in the District Court, Second Judicial District, Ramsey County, of the State of Minnesota to (i) consolidate the three foregoing actions and all later-filed actions filed in the same court arising out of the same facts and circumstances, (ii) appoint plaintiffs Perlman, Siciliano and Kiel as lead plaintiffs in the consolidated action and (iii) appoint plaintiffs’ counsel in the initial actions in various capacities as lead counsel, members of an executive committee and as liaison counsel in the consolidated action. The court has not yet ruled on the motion.

 
- 25 -
 

On July 19, 2012, counsel for the parties in the foregoing actions (the “Minnesota Litigation”) entered into a Memorandum of Understanding (“MOU”) in which they agreed on the terms of a settlement of the Minnesota Litigation, which includes supplementation of the Definitive Proxy Statement and the dismissal with prejudice of all claims against all of the defendants in the Minnesota Litigation. The proposed settlement is conditioned upon, among other things, the execution of an appropriate stipulation of settlement and final approval of the proposed settlement by the Ramsey County Court.  Counsel for the named plaintiffs in all of these actions have agreed to stay the actions pending consideration of final approval of the settlement in the Ramsey County Court. Assuming such approval, the named plaintiffs in all actions would dismiss their respective lawsuits with prejudice against all defendants. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the Ramsey County Court will approve the settlement as stipulated by the parties. In such event, the proposed settlement as contemplated by the MOU may be terminated.

ITEM 1A                        RISK FACTORS.   Other than as provided below, there have been no material changes to our risk factors during the three and six months ended June 30, 2012.  For additional information refer to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011.

There are risks and uncertainties associated with our proposed merger with Laboratory Corporation of America Holdings and Mercer Acquisition Corp.

On June 3, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Laboratory Corporation of America Holdings (“Parent” or “LabCorp”) and Mercer Acquisition Corp., a wholly owned subsidiary of Parent (“Merger Sub”). The Merger Agreement provides for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Parent.

There are a number of risks and uncertainties relating to the Merger.  For example, the Merger may not be consummated or may not be consummated in the timeframe or manner currently anticipated, as a result of several factors, including, among other things, the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement, including a termination under circumstances that would require us to pay a termination fee of $8.2 million. In addition, there can be no assurance that approval of our stockholders will be obtained, that the other conditions to closing of the Merger will be satisfied or waived or that other events will not intervene to delay or result in the termination of the Merger. If the Merger is not completed, the price of our common stock may decrease to the extent that the current market price of our common stock may reflect an assumption that the Merger will be consummated.

Pending the closing of the Merger, the Merger Agreement also restricts us from engaging in certain actions without Parent’s consent, which could prevent us from pursuing opportunities that may arise prior to the closing of the Merger. Any delay in closing or a failure to close could have a negative impact on our business and stock price as well as our relationships with our customers, vendors or employees, as well as a negative impact on our ability to pursue alternative strategic transactions and/or our ability to implement alternative business plans.

 
- 26 -
 

Our business could be adversely impacted as a result of uncertainty related to the proposed merger.

The proposed Merger could cause disruptions to our business or business relationships, which could have an adverse impact on our financial condition, results of operations and cash flows. For example:

·  
the attention of our management may be directed to transaction-related considerations and may be diverted from the day-to-day operations of our business;

·  
our employees may experience uncertainty about their future roles with us, which might adversely affect our ability to retain and hire key personnel and other employees; and

·  
customers, suppliers or other parties with which we maintain business relationships may experience uncertainty about our future and seek alternative relationships with third parties or seek to alter their business relationships with us.

In addition, we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the Merger, and many of these fees and costs are payable by us regardless of whether or not the Merger is consummated.

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

Issuer Purchases of Equity Securities

Period
 
Total Number of Shares Purchased (a)
 
Average Price Paid per Share
 
Total Number of Shares Purchased as part of Publicly Announced Plans or Programs
 
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
                 
April 1 - 30
 
93,813
 
$16.86
 
-
 
-
May 1 - 31
 
-
 
  -
 
-
 
-
June 1 - 30
 
-
 
  -
 
-
 
-
    Total
 
93,813
 
$16.86
 
-
 
-
                 

(a)  Represents the shares of the Company’s common stock surrendered by employees to satisfy payroll tax withholding requirements related to a distribution from our Long-Term Incentive Plan.

ITEM 6                        EXHIBITS .  See Exhibit Index on page following signature page.

 
 
- 27 -
 

SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

MEDTOX SCIENTIFIC, INC.

Signature
Title
Date
/s/ Richard J. Braun
President, Chief Executive Officer, and
July 26, 2012
Richard J. Braun
Chairman of the Board of Directors (Principal Executive Officer)
 
     
/s/ Kevin J. Wiersma
Vice President and Chief Financial Officer
July 26, 2012
Kevin J. Wiersma
(Principal Financial Officer)
 
     
/s/ Angela M. Lacis
Corporate Controller
July 26, 2012
Angela M. Lacis
(Principal Accounting Officer)
 
     






 
- 28 -
 

EXHIBIT INDEX
MEDTOX SCIENTIFIC, INC.
FORM 10-Q FOR QUARTER ENDED JUNE 30, 2012
 
 
Exhibit
Number                     Description


 
2.1
Agreement and Plan of Merger, dated as of June 3, 2012, by and among Laboratory Corporation of America Holdings, Mercer Acquisition Corp. and MEDTOX Scientific, Inc. (Incorporated by reference to exhibit 2.1 filed with the Registrant’s Report on Form 8-K dated June 4, 2012).

 
10.1
280G Waiver Agreement of Susan E. Puskas (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated June 4, 2012).

 
10.2
280G Waiver Agreement of Bud M. Owens (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated June 4, 2012).
 
 
31.1
Certification
 
 
31.2
Certification
 
 
32.1
Section 906 Certification of Chief Executive Officer pursuant to the Sarbanes-Oxley Act of 2002.

 
32.2
Section 906 Certification of Chief Financial Officer pursuant to the Sarbanes-Oxley Act of 2002.
 
 
 
101
Financial statements from the quarterly report on Form 10-Q of the Company for the quarter ended June 30, 2012, formatted in XBRL: (i) the Consolidated Statements of Income, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Cash Flows and (iv) the Notes to Consolidated Financial Statements.

 
 
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