MEDTOX Scientific, Inc. Q2 2009 Earnings Call Transcript

| About: Medtox Scientific, (MTOX)

MEDTOX Scientific, Inc. (NASDAQ:MTOX)

Q2 2009 Earnings Call

July 15, 2009 10:30 am ET

Executives

Richard J. Braun – Chief Executive Officer

Kevin J. Wiersma – Chief Financial Officer

James A. Schoonover – Chief Operating Officer

Analysts

Steven Crowley – Craig Hallum Capital

Operator

Welcome to the MEDTOX quarterly conference call. (Operator Instructions) At this time I'd like to turn the conference over to Kevin Wiersma, Chief Financial Officer.

Kevin Wiersma

Good morning everyone. I am Kevin Wiersma, Chief Operating Officer of the MEDTOX Laboratory Services Division and also CFO of the company. Welcome to our second quarter conference call. Before Dick Braun, our CEO, begins our prepared presentation, I'd like to cover one administrative item.

Forward looking statements in our conference call today are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. Such factors are described from time to time in the companies annual report on Form 10-K and other reports filed with the Securities and Exchange Commission. Our call today is in listen-only mode, and we'd also like to welcome those listeners who have accessed this morning's call on the internet.

Following our prepared remarks, we'll have a question and answer session that is accessible to our institutional investors and qualified financial analysts covering MEDTOX and our industry. We look forward to your questions. Also joining us for our call is Jim Schoonover, our Chief Marketing Officer, and at this time I am pleased to introduce Dick Braun, CEO of MEDTOX.

Richard Braun

Lab-based drugs-of-abuse business showed strong growth in new sales quarter over quarter, but due to economic conditions affecting employment, revenues from our existing client base were down 26.7%. Clinical laboratory revenues increased 15.7% in the second quarter compared to the prior year period. This increase is attributed to our clinical laboratory expansion and diversification initiatives undertaken in the last year. This includes continued growth in clinical trial services albeit at a reduced rate as a result of cancellation by the sponsor of one active trial and temporary curtailment of trial activity from one of our preferred client relationships as a result of client manufacturing and regulatory issues.

In the diagnostic segment, revenues were down quarter over quarter attributable to lower sales of devices to our workplace drugs of abuse clients. With regards to our 510(k) filing for an additional three drugs to be included on the panel for the MEDTOX scan reader, we filed the 510(k) for the three additional drugs on May 18, 2009. On July 7, 2009, we provided what we believed was the final response to FDA inquiries regarding the file. We are prepared to relaunch the reader and expand the panel as soon as we receive approval.

While we are being negatively impacted in our drugs of business because of economic conditions affecting hiring patterns, new client growth in the laboratory drugs of abuse business continues to be strong which has been the case over the last year. We remain focused on gaining market share in this recessionary period so that when employment picks up, we’re well positioned to benefit from increased business from our expanding client base.

Expansion of our clinical laboratory capabilities while having created expense and margin pressure in the short run is continuing to gain traction. We remain committed to our strategy of gaining increased market share in drugs of abuse during this downturn and aggressively diversifying into larger and higher value clinical markets as a solid, sustainable, and long-term strategy. In support of this strategy, we hired 4 new associate sales reps in the quarter and are currently recruiting for a fifth.

Kevin Wiersma

Here are some details regarding the quarter. Revenues were $21.3 million in the quarter, down 2.5% from the second quarter of last year. In our lab business, second quarter revenues were $16.6 million, down 1.2% from the second quarter of last year. Revenues from drugs-of-abuse testing decreased 10.6% to $9.6 million for the quarter, primarily as a result of a 26.7% decline in revenues from our existing drugs-of-abuse clients due to challenging economic conditions affecting hiring decisions. The decrease was mitigated by strong revenues of $1.7 million from new accounts.

Revenues in our clinical and other laboratory services were up 15.7% for the quarter, primarily due to a 17.9% growth generated by our expanded clinical laboratory capabilities. The clinical and other laboratory services growth was dampened by lower growth in testing for clinical trials services. In our diagnostic product business, second quarter revenues were $4.7 million, down 6.9% from last year, due primarily to a $28.7% decline in revenues from device sales in the workplace market, partially offset by strong sales of Sure-Screen devices in the government market.

Our overall gross margin was 35.9% in the second quarter compared to 43.4% last year. Our lab business operated at a 29.9% margin in the second quarter, down from 38.5% in the second quarter of last year. The decrease in gross margin was due to a 10.6% drop in drugs of abuse testing revenue over a highly fixed cost structure and an increased cost associated with our clinical laboratory expansion.

Gross margin in our diagnostic product division was 57.2%, down from 59.6% last year. The decrease reflects the shift in sales mix of point of collection testing devices with the decrease in higher margin PROFILE devices sold in the workplace market and an increase in sales of lower margin Sure-Screen devices sold in the government market.

Our SG&A expenses were $6.5 million, or 30.6% of revenues in the quarter, up from $5.9 million or 26.9% of revenues in the second quarter of last year. The increase was primarily associated with an increase in sales and marketing expense as well as the reclassification of $150,000 from other expenses which were determined to be more appropriately classified in SG&A in the quarter.

Research and development expenses were $589,000 in the quarter, up 17.6% from the second quarter of last year due to increased product development expense in our diagnostic product division. Other expenses were $62,000 in the quarter, compared to $198,000 in the second quarter of last year. The decrease is primarily due to the reclassification of $150,000 to SG&A in the quarter.

In terms of the balance sheet, at quarter end, we had $3.3 million in cash. Our trade receivables are up from the year-end level due to the timing of sales and cash receipts. Our days sales outstanding was 62.7 days for the quarter compared to 59.2 days last year.

The long-term portion of our debt has been paid off.

For the first six months of the year, capital expenditures were $2.1 million, and depreciation and amortization was $2.6 million. Cash flow from operations was $1.8 million for the first six months of the year.

This concludes our review of the company's financial performance.

Richard Braun

Thank you, Kevin. We would now be glad to take any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steven Crowley – Craig-Hallum Capital.

Steven Crowley – Craig Hallum Capital

I think last quarter you were able to share with us some statistics or metrics on either the number of customers versus a year ago, or number of new customers. Do you have those again?

Richard Braun

Steve, yes and no. I can tell you that we looked at it, and we realized why you’re asking this, and the master accounts are up 9%, but the whole number of master accounts and sub-accounts is not very relevant because if you remember it was up 20-30% last quarter, but the increased revenues were $1.4 million last quarter in drugs of abuse, and this quarter, they were 1.7. There isn’t a correlation because a lot of the structure of the master accounts and subaccounts and the number has to do with the way we bill clients, the way they structure information that they send us, so it isn’t really a relevant number we don’t believe. What’s relevant is the revenue number.

Steven Crowley – Craig-Hallum Capital

Clearly the story continues to be a tug of war between sluggishness out of your existing customer base and some pretty substantial success on the new customer acquisition side.

James A. Schoonover

That’s correct. It’s still a difficult hiring environment, but yet we continue to make inroads with new accounts, so you’re right. It is pretty much of a tug of war right now.

Steven Crowley – Craig-Hallum Capital

In terms of the specialty lab services segment, clinical trials you’ve advertised as being a lumpy business as it grows in an overall annual path. Is this just one of those lumps that you reminded us from time to time that we’re likely to see? What can you tell us about the kind of visibility you have longer term for the clinical trials business?

Richard Braun

Steve, that’s a fair assessment, and I thank you for reminding us and everyone that we’ve continually said that it is lumpy. Now the irony of that is that this is the first quarter in all the years we’ve been telling that that it’s really been lumpy on the downside. We don’t see anything systemic. In the one case, there was a trial cancelled. That was the NICE trial ongoing because of an adverse event with a patient. We still have that client. They’ll continue to send us business. In the other case, it was a preferred client relationship where they had manufacturing issues with the FDA, and they shut down all their manufacturing and trial activity on a temporary basis till they could resolve them, but all indications are that they’ll be back probably fall or later in the year giving us business, and our backlog, etc., is respectable, so a longwinded answer is you’re absolutely right. It’s just a function of lumpiness, but it’s not systemic.

Steven Crowley – Craig-Hallum Capital

You had mentioned I believe last quarter or the quarter before that you had added to your roster preferred partnership type customers or preferred vendor status type customers, and one was more on the contract research organization level. Have you started to see business flow there or do you have some visibility for that starting to happen?

James A. Schoonover

Steve, they’re a very large organization—multibillion in revenue—and it took us a while to get ourselves positioned properly within their system, but we have actually started to see revenue from their first trial, and they’re growing their backlog with us as well, so we feel very confident that that’s going to be a good long-term relationship.

Steven Crowley – Craig-Hallum Capital

Just a couple more on the specialty lab services, and then I’ll get back in the queue and give somebody else a chance to ask questions. The two other segments if you could give us some kind of color or update would be the clinic pain management offering that you had. We had a rash of new stories unfortunately with celebrities and personalities dying from pain management drugs and accidental or erroneous overdoses. Does that help your business in any way, shape, or form? Some of the awareness around the difficulty in managing those drugs, and how is that business doing, and then maybe you could give us an update on the regional clinical laboratory effort?

James A. Schoonover

As it relates to the pain management part of the business, obviously some of what’s been in the media recently has shined somewhat of a light on it, but the reality is that physicians I think that are involved in the business recognize that they need to be doing prescription medication monitoring in general just as a good business practice, and we have had good market penetration to date. We’ve continued to invest in that area within our sales and marketing group, and because MEDTOX’s foundation really was as a toxicology laboratory, we’re extremely well positioned in that market, and so we feel it’s going to be a very good growth market in the future. It’s done well. It’ll continue to do well, and we continue to invest in it. As it relates to the regional clinical lab market, we’re making steady progress. I think it is a situation where we need to unseat some incumbents, and sometimes that takes longer than one expects it to, but we’ve got some additions to our test menu that are very exciting to some of the physician groups we’re targeting, so we’re starting to see some traction there in specialty areas, so the pain is growing maybe a little faster than we had originally anticipated, and the clinical lab area is growing on target.

Steven Crowley – Craig-Hallum Capital

A couple of things on the financial side. There was a little bit of bump in SG&A spend from both Q1 and Q2 a year ago. Was there anything quirky in your SG&A line for Q2, and is that the right run rate for us to think about until things out there in the market place change materially?

Kevin J. Wiersma

Nothing quirky in it, Steve. There was a reclassification form other expenses into SG&A of $150,000, and you’ll see that going forward that those expenses will be classed SG&A as opposed to other expenses, but other than that nothing quirky.

Steven Crowley – Craig-Hallum Capital

In terms of the gross margin side of the equation, I trust some of the lumpiness that you experienced in the clinical trial services business likely had a dampening effect on the laboratory gross margin in the quarter.

Kevin J. Wiersma

That would be correct.

Steven Crowley – Craig-Hallum Capital

So it that business comes back more strongly down the stretch run of this year, we should expect some positive impact.

Kevin J. Wiersma

Correct.

Steven Crowley – Craig-Hallum Capital

In terms of your comments about the hospital drugs of abuse product line, it seems like you’re still waiting for FDA approval of those final three tests. I know this is always tricky to do, Dick, but in terms of characterizing your discussions or progress or have you felt like you’ve been making steady progress towards the right conclusion there, or what can you tell us about that endeavor?

Richard J. Braun

We feel very positive about it. The process went quickly, it went smoothly. We had a very informed and capable reviewer. While you know it can be unpredictable with the FDA, right now we’re just anticipating them processing this through their system, and we’re hopeful that it’ll be fairly soon, and the sales group is really geared up and pretty excited about reintroducing the product.

Steven Crowley – Craig-Hallum Capital

In this interim period where you’ve been somewhat handicapped or very handicapped for growing the business, has it remained relatively stable plus or minus a little bit? How would you characterize your revenue flows out of the hospital market place?

James A. Schoonover

Steve, it’s been stable. There are some clients that have gone to other options related to a reader that we obviously hoped wouldn’t. On the other hand, there are some that have accepted the reader with the nine drugs that are looking forward to getting the other three. So I don’t think the impact was dramatic on the existing customers as much as it sort of slowed down the growth of that area, and that’s what I think we’re excited about going forward. We continue to work with Cardinal Health on this, and once we get all 12 drugs cleared, we will have more of a formal product relaunch and gear that up through the Cardinal reps as well as with our own reps.

Steven Crowley – Craig-Hallum Capital

And the competitive landscape for that product line, has that really changed much in the last year or so?

James A. Schoonover

Basically no. There’s been change of some players in that Inverness purchased Biosite, but I don’t know that that’s made a dramatic difference at the market level or at the buyer level, so we’re confident that we’re going to be successful in competing on a broad base in that market.

Steven Crowley – Craig-Hallum Capital

The essence of that question is has your window of opportunity closed there? It doesn’t sound like it, at least from a competitive landscape standpoint.

James A. Schoonover

Absolutely not.

Steven Crowley – Craig-Hallum Capital

Kevin, you mentioned that the long-term debt that the company had was paid down. Did you pay it off completely, or did the remaining roll into current debt payable?

Kevin J. Wiersma

Yes, the remaining rolled into current, and it’s about $600,000.

Steven Crowley – Craig-Hallum Capital

Okay, so this is the scheduled payment. You didn’t accelerate any of that stuff?

Kevin J. Wiersma

That’s correct.

Steven Crowley – Craig-Hallum Capital

In terms of CapEx, is there anything on the horizon of particular significance or worthy of mention or should we think about your Capex being around a million bucks a quarter until things get materially better in terms of backdrop?

Kevin J. Wiersma

I think target will be between $4 and $5 million for the year.

Steven Crowley – Craig-Hallum Capital

In looking out to next year, I know that seems a long way away, but is that a reasonable run rate ex some real growth-related demands that would require investment?

Kevin J. Wiersma

We will provide more information on that as we finalize those plans, but right now there are no plans for heavy capital expenditure spending.

Steven Crowley – Craig-Hallum Capital

As we look at the potential profitability of a business like pain management which seems to be doing well, where would that fall on the spectrum of being higher margin or lower margin amongst your service offerings? Would it be on the higher side?

Kevin J. Wiersma

Yes, on the higher side.

Steven Crowley – Craig-Hallum Capital

The regular way clinical laboratory services business, that may be more on the lower side or is that corporate average kind of stuff?

Richard J. Braun

Yes. It is not necessarily. That business has lots of variability in terms of pricing and margin based on whether it’s a test that’s a common test versus more of a specialized test, so you really need to look at that from a broader perspective.

Kevin J. Wiersma

And some of that also is impacted by some of the fixed cost nature, and as the volume grows, the incremental margin will be better than the base margins that we are currently seeing on it.

Steven Crowley – Craig-Hallum Capital

How is your view of that market opportunity, the clinical laboratory services, since you have been in the market for a little while? Is it still the same vision?

Richard J. Braun

Yes. I think it is still the same vision. I think we never underestimated that it was going to take some time to become known both in the local twin cities market as well as on a regional basis. I think we are getting very well known now. Some of the incumbents have been in place with customers for many years and so either a service failure on their part or better service and a broader test menu on our part is starting to allow us to have meaningful discussions, and again we are going after some targeted opportunities within specialty areas that are somewhat unique in that we brought up as part of an expanded test menu, and that’s given us some opportunity to talk with people about specific testing, so I think if you’re looking at this longer term, it’s going as expected, and we are at it on a daily basis, and we’re not going away, and the market is not going to go away.

Operator

That concludes the question-and-answer session. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Kevin J. Wiersma

We would like to thank you for joining us, and we look forward to speaking with you again when we announce third quarter results. Thank you.

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