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MEDTOX Scientific Inc. (NASDAQ:MTOX)

Q4 2007 Earnings Call

February 20, 2008 10:30 am ET

Executives

Dick Braun - CEO

Kevin Wiersma - CFO of MEDTOX Scientific, Inc. and COO of Laboratory Division

Jim Schoonover - CMO

Analysts

Steven Crowley - Craig-Hallum Capital Group

Geoff Smith - Sidoti & Co.

Ruthanne Roussel - Robins Group

Operator

Good day and welcome to the MEDTOX quarterly conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Mr. Kevin Wiersma. Please go ahead sir.

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 fourth quarter conference call. Before Dick Braun, our CEO, begins our prepared presentation, I would 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 company's 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 would also like to welcome those listeners who have accessed this morning's call on the Internet. Following our prepared remarks we will have a question-and-answer session that is accessible to 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. At this time I am pleased to introduce Dick Braun, CEO of MEDTOX.

Dick Braun

Thank you Kevin we're pleased with our results in 2007. Revenues, gross margin, operating income and net income before taxes were at record levels for both the quarter and the year. While drive increases both in the top and bottom lines we improved our gross margin and operating margin for the year and further strengthened our balance sheet.

In our Laboratory segment sample volume overall increased in 2007 and our pricing structure remained stable. We continue to be encouraged regarding the future of both our Laboratory and our Diagnostic segments. Our lab based drugs-of-abuse business again showed solid growth in 2007.

Within clinical laboratory services, clinical trial services clients generated approximately $5 million in revenues in 2007 up from $4.5 million in 2006. This is below our expectations, but as we have pointed out since this business is project oriented we may experience lumpiness in revenue generation.

In the third quarter we disclosed that over $500,000 in contracts had been moved forward into future quarters. We are committed to the market and continue to add new clients. In late 2007 we signed contracts with two existing pharma clients, one being the US arm of a global top pharmaceutical company that have designated MEDTOX as a preferred provider.

This is an opportunity to gain an increasing share of those clients laboratory business. We hope that over time, these types of relationships will help mitigate the lumpiness in revenue realization.

In addition to the two preferred provider contracts, we also entered the New Year with signed contracts for $5.5 million. As we noted in our press release this morning, in 2007 and early 2008 we completed expansion of our clinical laboratory capabilities.

In early 2006 we initiated a study to determine if there was an opportunity for MEDTOX laboratories to compete in the physician office and patient testing market on a regional basis. We looked at the market, our capabilities and our potential to compete against national laboratories and hospital out reach programs in the Upper Midwest.

Consistent with our strategy of operating in markets that are large relative to our size, regional clinical market is estimated to be in excess of $200 million with over $100 million in Minnesota. With regards to health care coverage and payer information where associated populations in the target, the data appears to be favorable. Rate of uninsured is 7%, which is below the national average.

The examination of the insurance products for the leading payers in the market shows that the market is primarily PPO, Preferred Provider Organization, for that product-driven as opposed to a higher incidence of HMO, Health Maintenance Organization, products. Generally, the reimbursement levels and the opportunity to participate are better in the PPO market as opposed to those with heavy HMO concentration, and this would only allow is non-profit HMOs.

In Minnesota, out of the top-ten health plans three payers account for 77% of the coverage. We are currently contracted with all three. We assessed our capabilities both in terms of closing the gap to be a full service clinical lab, and looking at how other successful regional labs have competed.

Visits to a number of regional labs convinced us that we could compete especially since our market has many favorable characteristics for entry. One of the most favorable is there are no other independent full service clinical labs in Minnesota or Western Wisconsin.

We have a local presence along with our own extensive career network, which we developed over the last 20 years. The last issue to address was further development of our laboratory capabilities. Over the past five years we have been expanding our clinical capabilities in servicing our occupational health clinic clients and for clinical trial services.

In the second half of 2007, and continuing into the first quarter of 2008, we added to our test menu in neurology, diagnostic immunology, allergy, [austeric] chemical chemistry and hematology. We added staffing state-of-the-art instrumentation and laboratory build-out for full service pathology and microbiology, which includes surgical pathology, histology, cytology, molecular pathology and microbiology.

Based on our local presence company owned courier network and advanced instrumentation of technology. We believe we'll able to offer superior turnaround times for its physicians and patients. In IT we've added hardware and software to ensure connectivity to the client in terms of interfaces, ordering and reporting.

With regard to revenue cycle management we've expanded our capabilities in pricing contract management billing and account receivables management. Expanded clinical testing capabilities will also benefit our clinical trials services offering, since there have been trials for which we did not compete as of limitation in menu, staff expertise or instrumentation that may now be accessible to us.

In summary this new market is large and favorable from a demographic, geographic and payer status and we have expanded our instrumentation, staffing and infrastructure to successfully compete going forward. While we're optimistic about the long-term prospects, we recognize that it may take a while to gain traction and therefore have not planned for revenue contribution until later in 2008.

In the Diagnostic segment, we continue to see strong growth and significantly improving margins. Year-over-year and for the fourth quarter revenues increased 20% and 28% respectively. The revenue increased growth diagnostics [2000] operating income to $3.6 million from $2.1 million in the previous year a 71% increase. Operating margin was 19.1% compared to 13.1% in the previous year. Diagnostic segment, also achieved 62% gross margins.

On January 30, 2008 we disclosed that we were voluntarily recalling approximately 400 MEDTOXScan electronic readers because of misbranding. At that time we explained that the PROFILE-III ER devices sold for the use with the readers and which are properly cleared for sale by the FDA can be read visually without the reader, which is provided at no cost.

We also disclosed that the estimated cost for the recall would be approximately $10,000. It had been our original attention to replace these readers with a new generation of reader having OTC or over the counter approval 2008. As a result of the recall we will now also be seeking prescription use clearance for the new reader, which we believe can be achieved in a shorter time frame compared to OTC.

As of this morning we have contracted 305 hospitals regarding the recall. In all but four instances the clients have indicated that they will continue to order and use our devices without a reader until our next generation of FDA cleared reader is available to them.

We have completed the clinical studies for the prescription use FDA filing and we're in the process of the electromagnetic compatibility and emissions testing. FDA 510(k) filing for prescription use is planned to be completed before the end of the first quarter. Based on these facts at this time we do not believe the recall will have a material impact on our financials on a year-over-year basis.

Overall we are expanding and diversifying our core competencies. We will continue to scale our organization to meet new opportunities, but we continue to remain committed to a performance based environment controlling costs with an efficient low risk high reward approach. The significant amount of our revenue is built around recurring revenue model from existing clients.

In 2007 revenue increased 15% largely from new clients, which exceeds the prior three year average year-over-year growth rate of 10.7%. This adds to our momentum in entering 2008. We are also building on that momentum by the fact that at the end of 2005 we employed 23 sales associates and at the end of 2007 the number increased to 36. We look forward to another successful year in 2008. Kevin?

Kevin Wiersma

Thank you, Dick. Here are some details regarding the quarter and the year. We experienced top line growth of 14% for the fourth quarter, and 15% for the year. In our lab business, fourth quarter revenues were $14.8 million, up 10% from the fourth quarter of last year.

For the full year, revenues in our lab business grew 13% to $61.3 million. Revenues from drugs-of-abuse testing increased 8% for the fourth quarter, driven by strong sample volume from new business. Drugs-of-abuse testing revenues increased 14% for the year due to increased sample volume. Revenues for specialty laboratory services were up 12% for the quarter and 12% for the year due to higher average price per test and an increase in overall sample volume.

In our POC diagnostic business, fourth quarter revenues were $4.9 million, up 28% from last year, for the full year, POC diagnostic revenues grew by 20% to $19 million. This growth was driven primarily by strong sales of our PROFILE-III A, PROFILE-III ER and SURE-SCREEN devices. Our overall gross margin was 43.3% in the fourth quarter, up from 43.2% last year, for the full year our overall gross margin was 45.3% up 90 basis points from 44.4% last year.

Our lab business operated at a 37.2% margin in the fourth quarter, down 70 basis points from 37.9% in the fourth quarter of last year. Lab gross margins were impacted in the quarter by higher costs associated with the expansion of the clinical laboratory. For the year gross margins in our lab business was 40.1%, up from 39.4% last year. Improvement in gross margin resulted from additional volume through our current infrastructure.

Margins in our diagnostic division were 61.6% in the fourth quarter compared to 61.7% last year. For the year gross margins in our diagnostic division were 62.1% compared to 61.6% last year. For the quarter our selling, general and administration expenses were $6 million up from $5.2 million in the fourth quarter last year. But the continued increased investment in sales and marketing, and increased accounting and audit expenses associated with Sarbanes-Oxley.

For the full year our selling, general and administration expenses increased to $23.7 million compared to $20.6 million last year, but remained consistent as a percentage of sales at 29.6%. Our increased spending was primarily associated with increased sales and marketing expense and spending on information technology. For 2008 we anticipate selling, general and administration expenses to decrease as a percentage of sales.

Research and development expenses were $639,000 in the quarter up $53,000 from the fourth quarter of last year. For the year research and development expenses were $2.6 million or 3.2% of sales compared to $2.2 million or 3.1% of sales last year. We expect R&D expenses to remain at a similar as a percentage of sales in 2008.

Other expenses increased $83,000 to $288,000 in the quarter. For the year other expenses were $707,000 compared to $1 million last year primarily due to lower interest expense related to reductions in our average debt levels.

We recorded $2.6 million in income tax expense for 2007 based upon an effective tax rate of approximately 28.1% compared to an effective tax rate of 36.8% in 2006. The lower rate in 2007 was primarily due to a tax benefit from the favorable resolution of an examination by the North Carolina Department of Revenue. We expect our effective tax rate for 2008 to be around 36.5%.

Net income for the quarter was $1,435,000 up 39% from $1,036,000 last year. For the year net income was $6,690,000 up 47% from $4,548,000 by last year.

Diluted earnings per share were $0.16 in the quarter up 33% from $0.12 per share in the fourth quarter last year. For the year diluted earnings per share were $0.75 up 44% from $0.52 per share last year.

In terms of the balance sheet, trade receivables are up from their previous year end levels due to strong November and December sales and timing of cash receipts. Our day sales outstanding was 54.5 days for the year compared to 53.6 days last year. Our bad debt expense for the year was 0.5% of revenues. Our long-term liabilities are $2.7 million.

For the year capital expenditures were $9 million and reflect an increased investment in our clinical laboratory. We anticipate capital expenditures for 2008 to be approximately $6.5 million to $7.5 million. Depreciation and amortization was $4 million for the year.

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

Kevin Wiersma

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

Question-and-Answer Session

Operator

(Operator Instructions). We'll go first to Steven Crowley, Craig-Hallum Capital Group.

Steven Crowley - Craig-Hallum Capital Group

Good morning, gentlemen.

Dick Braun

Good morning, Steve.

Steven Crowley - Craig-Hallum Capital Group

Not a stuff to talk about, maybe I could hit a couple of things and then I'll hop back in the queue. First of all, Dick, you mentioned having had some success down the stretch end of the year in terms of renewing some contracts with major customers in CTS and landing some new ones.

You referenced, I believe $5.5 million of signed contracts in the business going into 2008. Can you give us some feel for where you were a year ago, so we have some frame of reference on that $5.5 million, it sounds pretty good, but maybe you could give us where you were 12 months ago?

Dick Braun

I don't have a precise number in front of me, but as I recall, it was $3.5 million.

Steven Crowley - Craig-Hallum Capital Group

Okay, so rather significant jump there, which should bode well for that business. Now your ability to garner these preferred partner or provider relationships. Maybe if Jim is on the call, maybe you could provide us with a little bit of color as to why you are able to do that and what that really means. It sounds good, but maybe you could populate that for us.

Jim Schoonover

Well, just very briefly, these generally are companies that we've had a successful relationship with over the last two to three years. They are looking for a laboratory of our size where they can get a bit more service and more collaborative partnership type activity versus just simply having a project based relationship with some of the larger labs.

So in both cases this was something that was sort of a natural fit over a period of time as their needs became more obvious to them they approached us and we were certainly extremely happy to enter into that type of partnership relationship and we hope we can do this with other companies also.

Steven Crowley - Craig-Hallum Capital Group

And is the nature of the signed contracts you have this year very similar type business or is it more run rate business less project business what can you talk about composition?

Jim Schoonover

The only thing I would say that's different from a year ago is it's probably a little bit more balanced between our project oriented business and what we call clinic or ongoing central lab services business. The central lab services is more basic chemistry work done for individuals enrolled in trials versus the R&D type business, which was very heavy in 2007 is probably a little bit more above a reasonable relationship between the two going into 2008.

Steven Crowley - Craig-Hallum Capital Group

Excellent, well looks like you've got pretty good visibility for that business. Now the new business you've disclosed today the regional clinical laboratory service offering, it seems like it's a pretty significant opportunity. You're planning conservative with us in terms of the kind of contribution that could have year one. The investment that you've made seems substantial in terms of incremental capital equipment or capital expenditures could you talk to us a little bit about where it hit your income statement sounds like it was up in the cost of goods sold for the lab business but maybe the magnitude of the drag it had during 2007?

Kevin Wiersma

Sure expenses in 2007 in the fourth quarter were probably a little over $100,000 maybe $110,000 it actually hit the P&L and you're right that's primarily above the line and cost of services for the laboratory.

Steven Crowley - Craig-Hallum Capital Group

And Kevin while you are on maybe you could just run through the typically breakdown of your revenues. I think you gave a split between work place drugs-of-abuse, services and specialty lab services. But within the product category this and contract manufacturing and other stuff do you have those numbers?

Kevin Wiersma

It do Steve. When the collection testing products in 2007 was $16.6 million, our contract manufacturing revenue was $1.4 million and then other diagnostic products were at $1 million.

Steven Crowley - Craig-Hallum Capital Group

Do you have those numbers Q4, I can do the math but if you have them there you saved me a little bit of work?

Steven Schmidt

Q4 POCT products were $4.4 million, contract manufacturing came in at $300,000 and other diagnostic products at $200,000.

Steven Crowley - Craig-Hallum Capital Group

Okay, and one follow up and I'll jump in the queue. Talk about contract manufacturing trailing off over an extended period of time, what kind of update do you have there?

Dick Braun

I think we initially had disclosed that we felt that would be gone in early 2009. We are actually in the process of some negotiations with one of the larger clients, we only had a small number of clients in this category they would like us to extend that in to or later 2010. And the quick recall for that would be that we would probably increase the price to them. So there may be a slight extension of that termination date and when that becomes certain we'll certainly apprise you of it.

Steven Crowley - Craig-Hallum Capital Group

I'll get back in the queue thanks gentlemen.

Operator

We'll go next to [Geoff Smith], Sidoti & Co.

Geoff Smith - Sidoti & Co.

Good morning, guys. Thanks for taking my questions. Can I just start with the corporate exposure you guys have to the job market. Can you break that up between the lab and point of collection businesses?

Kevin Wiersma

Sure, Jeff. This is Kevin. On the lab business, the drugs-of-abuse testing was about 65% of the revenue. In 2007 of that 65% is probably about 5% that relates to testing for government entities, prison, probation, parole and other government sources.

Geoff Smith - Sidoti & Co.

Okay.

Kevin Wiersma

In the diagnostic segment, it's about 40%, 41% is workplace related. The rest is primarily hospital and government related as well.

Geoff Smith - Sidoti & Co.

So the remainder is still about 60% of the lab revenue is corporate exposure?

Kevin Wiersma

Right.

Geoff Smith - Sidoti & Co.

Okay. And have you seen any downticks in the Q1 volume with slowing of the job market?

Kevin Wiersma

In January, our drugs-of-abuse testing from our base clients was consistent with the previous year. Though it's pretty flat at this point.

Geoff Smith - Sidoti & Co.

Okay. What percent of the $5.5 million of CTS backlog is from your preferred providers?

Jim Schoonover

Jeff, this is Jim Schoonover. That actually is above and beyond the preferred providers.

Geoff Smith - Sidoti & Co.

Okay. Great and then just my final question would be any traction you're seeing in the new physician market and if you guys have any assumptions for top line contributions. I know you said it's going to hit till late in '08, but can you give us some color on what you would be expecting for the year?

Dick Braun

I can't do that, because we've sort of tried to be consistent disciplined about not giving guidance. But Jim might be able to give you as you all would say a little color because he been out personally making calls.

Jim Schoonover

Jeff I think the issue is, a number of the customers that we've gone to see clearly have had relationships with other providers for quite sometime. So sort of Phase I of this is an introduction of MEDTOX what are we doing? What are our capabilities? And the fact that we're a local laboratory, which gives us we believe some strong service advantages over some of the laboratories being used by a lot of these prospect companies. We think that we are a very legitimate alternative for them, but this is a process and so we will take it a step at a time and mind those opportunities as they come up.

Obviously in this business there is some immediate disenchantment with existing providers that we could take advantage of and then in other cases we have to spend some time explaining the advantages of being local and being very responsive and service oriented. We're in it for the long run, we're going to take it daily in terms of activity and we've got very good sales people on that part of the business and we're going to hit it pretty hard.

Dick Braun

I might just add something to that, you may know we have been in Minnesota and we've been here for over 20 years. We're not particularly well branded, because historically our clinical laboratory business we were a reference lab especially in [austeric] toxicology where we provided in effect business-to-business. We got samples from other laboratories and perhaps some specialized clinics and so we're now entering into a slightly different realm where we have to be out sort of one-on-one with physicians in clinics. So it's slightly different for us and we're going to have to work at it.

Geoff Smith - Sidoti & Co.

Okay, great thanks guys.

Operator

(Operator Instructions) We will go next to Ruthanne Roussel of Robins Group.

Ruthanne Roussel - Robins Group

Good morning gentlemen thanks very much for taking our questions. I wanted to see if we could get more color on the ClearCourse program that was discussed on the last conference call. At that time it was well underway for the Los Angeles County probation department and there was talk of other large county agencies in California that might signup for it. Has there been progress on that front?

Jim Schoonover

Yes Ruthanne, this is Jim Schoonover there has been or we continue to believe that the ClearCourse model that includes our drugs-of-abuse recognition system as well as SURE-SCREEN device has a lot of attraction not only to other counties in California, but frankly through out the United States. The government part of our business was very strong in 2007, they had a year that we hope will meet again in 2008 and this model, which combines training with lower detection level testing devices as well as electronic results reporting has been very, very well received by that market which historically has not been presented with a lot of training opportunities. So we've made progress we tend to not disclose individual accounts that have been signed up but the activity is strong and looks good going forward.

Ruthanne Roussel - Robins Group

Okay thank you. That's some of the things I wanted to know about has already been answered, but I did want to follow up and just confirm. Looking at the balance sheet I don't see where this could possibly be, but you haven't capitalized any of the cost from the move into the new market have you?

Kevin Wiersma

The equipment is capital expenditure the other costs have been expensed as incurred.

Ruthanne Roussel - Robins Group

And about how does that breakdown? Which is to say the total amount that was spent is the amount that was put through the income statement plus whatever has been capitalized?

Kevin Wiersma

The expense relative to the regional clinical lab in the fourth quarter was about $110,000.

Ruthanne Roussel - Robins Group

Okay, thanks. That's clear. That's it's from me. Thanks very much.

Kevin Wiersma

Okay.

Operator

We'll take a follow-up from Steven Crowley, Craig-Hallum Capital Group.

Steven Crowley - Craig-Hallum Capital Group

Jim, picking up on a comment you just made, I want to make sure I understand what you are telling us. The government business in 2007 seemed to have a very strong year. Best guess was maybe up 50%, certainly 40%, maybe you could comment on that, but your comment was that you hope that business can have another strong year. But the word meet was in there. Meet that performance, again, I trust this continues to be a robust growth opportunity for you guys or am I out of my field?

Jim Schoonover

No, no. I think you might have misinterpreted the syntax. We did grow very nicely in government last year, and we expect that percentage growth over 2007 to be met again or exceeded in 2008.

Dick Braun

And that would be keeping in mind that the recurring revenue model is that the assumption there is that we will keep the incremental clients and business that we got in 2007, and Jim's expectation is that group can do it over again and add to it at the same level.

Jim Schoonover

Right.

Steven Crowley - Craig-Hallum Capital Group

And the key to that or your recent success, has it been the reference ability of large accounts like LA, has it been new product and what's the recipe for the future there?

Jim Schoonover

Well, I think it's a combination of a number of things. The ClearCourse model and especially the DAR's training continues to be very well received in the market, but I think and this is not surprising that the SURE-SCREEN device with the lower detection levels for that market has taken a while for it to gain traction and it has now gained traction and there is I believe an overview by that market that if we can get more 'zero tolerance type testing' with one device meaning SURE-SCREEN why would we want to use more standard corporate cutoff levels that are offered by our competitors. So I think it's a combination of a number of things and as well very good sales capabilities by the government group in MEDTOX. So it's a lot of different things but I would say SURE-SCREEN is a major driver to that.

Steven Crowley - Craig-Hallum Capital Group

Excellent now back in the workplace drugs-of-abuse business. Part of the thesis has been that I have had and that you guys are emerging as a legitimate national supplier of relative to a couple of the big boys and that eChain in some of your capabilities position you well to win some larger national accounts. Where are you if at all in that mix and what can you tell us about your sales and marketing efforts in the core business?

Jim Schoonover

Well couple of things number one we have been a national player in that market for a number of years so taking on national customers is not new to us nor is it particularly difficult. eChain has been in the market for about two years now and has been time tested, I think customers are very comfortable with its functionality. And we split our corporate, what we call our workplace sales group into one group that will focus on hospital sales and another larger group that will focus on corporate sales, those efforts will be tied very closely to eChain, but they will not necessarily be totally focused on large national customers.

We believe that there is a market for them, what we would call the middle market, may be 1,000 to 10,000 employees that would be very interested and excited by this opportunity. And we have a lot of the program management capabilities to handle those accounts very effectively. So, we are going to be much more aggressive at pushing the eChain concept out. We’ve about 1500 collection facilities now that are on the eChain system and we intend to expand that as the year goes on.

Steven Crowley - Craig-Hallum Capital Group

So, part of the recipe for combating whatever kind of weakness we see in the macro economy. It seems like you recipes you’ve added sales resources, you’ve a capabilities to go after more in new accounts. Is that just blocking and tacking in those two areas the recipe you're going to use in core business?

Dick Braun

Yes. The one thing I would add to that is we’ve made an effort from last three to four years to really concentrate on the occupational health clinic market and we're going to continue to push hard in that markets. The clinical labs that we’ve expanded also gives us some additional capabilities for those occupational health clinical customers and we would like to sell them not only drug testing services, but also clinical services on more of a national basis. But that’s a bit of a sub-market.

So the answer to your question is we believe we can have a very strong year for new account acquisition. And then we will wait and see what kind of economic issues before the country as a whole.

Steven Crowley - Craig-Hallum Capital Group

Okay. And one final question for maybe for Kevin on the expense front. We've obviously seen a step-up in expenses because of your investment in these new market new business line opportunities. Are you at a level kind of a run-rate level here where there maybe some increments, but there won't be another step function?

Kevin Wiersma

Yeah. There will be some incremental expenses and certainly those costs weren't fully in the fourth quarters, as there will be more of them in the first quarter, but it won't be a significant amount.

Steven Crowley - Craig-Hallum Capital Group

Okay. Great. Thanks very much gentlemen.

Operator

(Operator instructions). And it appears there are no further questions at this time. I'll like to turn the conference back over to management for any additional or closing remarks.

Dick Braun

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

Operator

And this concludes today's conference. Thank you for your participation. You may disconnect at this time.

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