MEDTOX Scientific, Inc. Q2 2008 Earnings Call Transcript

Jul.17.08 | About: Medtox Scientific, (MTOX)

MEDTOX Scientific, Inc. (NASDAQ:MTOX)

Q2 2008 Earnings Conference Call

July 16, 2008 10:30 a.m. ET

Executives

Kevin Wiersma – Chief Operating Officer, Laboratory Services Division and Chief Financial Officer

Dick Braun - Chief Executive Officer

Jim Schoonover - Chief Marketing Officer

Analysts

Steve Crowley - Craig-Hallum Capital Group

Geoff Smith – Sidoti & Co.

Balaji Gandhi - Oppenheimer & Co.

Ruthanne Roussel – The Robins Group

Robert Cvengros – Next Generation Equity Research

Operator

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

Kevin Wiersma

Welcome to our second 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 Security and Exchange Commission.

Our call today is in listen-only-mode and we would like to also 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 and at this time I am pleased to introduce Dick Braun, CEO of MEDTOX.

Dick Braun

It was a challenging quarter for MEDTOX but generally not inconsistent with our expectations. In our laboratory segment, sample volume overall increased in the second quarter and our pricing structure remained stable.

Our lab based drugs-of-abuse business again showed growth in new sales. That growth was negatively impacted by 4.5% lower revenues from existing clients with the economic conditions. This compares with a 4.7% increase from existing clients in the second quarter of last year.

Within the clinical laboratory services, clinical trial services were up 28% compared with the second quarter of 2007. We set in our year-end call that 2008 again with a $5.5 million in signed protocols. New signed protocols plus other awarded business has now approximately doubled that number and we have a growing number of proposals outstanding.

While we expect to continue experiencing variability for quarter-to-quarter the trend is very positive. Our contracts with the two existing pharmaceutical clients, which have designated MEDTOX as a preferred provider, are contributing factors to the growing backlog.

Additionally we have been awarded new business because of our expanded clinical testing capabilities. We will also continue to pursue additional preferred relationships. We incurred over $300,000 of incremental expenses in the quarter due to our clinical laboratory expansion to service the position office market on a regional basis.

While this effort produced modest revenues in the first half of 2008, we continue to believe that there will be a higher revenue contribution in the second half of the year. Our early experience in the market continues to be positive. We remain optimistic regarding our diversification efforts within the Laboratory Segments.

In the Diagnostic Segment we are experiencing growth in diagnostic device sales notwithstanding a reduction in device sales to existing workplace DAU clients, similar to our experience in laboratory DAU testing. Sales of devices sold into the hospital market increased quarter-over-quarter but the lower growth rate impacted by our reader recall.

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 were used with the readers and which are properly cleared for sale by the FDA, can be read visually without the reader. As a result of the recall we have now sought prescription use clearance for the reader. We filed a 510-K application on March 5, 2008.

In response to a question in our last conference call about whether the data requested by the FDA was “at all owners” we indicated that we thought that it was reasonable and we could supply it in the short time frame. Shortly after the call we received a request for a lengthy list of additional studies and data. It took approximately one month to refine the request and agree on the studies, data and certain product modifications. We have now completed that work and submitted the full documentation to the FDA last week.

Sales of devices into the government market have been extremely strong this year. In fact, year to date they are up 55% over the same time frame last year. Our SURE-SCREEN device in DARS programs continue to contribute to this growth.

While the increase in diagnostic device sales was lower in Q2 compared to Q1 margins continue to improve. Operating margins in the Diagnostic Segment increased to 24.8% from 16.4%. Operating income increased 56% quarter over quarter.

We are expanding and diversifying our core competency. As we scale our organization in meeting more opportunities, we remain committed to our performance-based environment. Controlling cost with an efficient, low risks, high reward approach. Despite of a challenging economic environment and investing in new service offering we were able to increase operating income by 17.3%. Operating expenses as a percentage of revenues to 29.2% compared to the prior year’s 33.3% and increased overall operating margins to 14.3% from 12.8%.

Based on strong margins and financial performance in the Diagnostic Segment, successful emphasis on expense control, the growing number of science protocols and awarded business in CTS and new service offerings in our clinical laboratory we remain well positioned for the rest of 2008 and 2009. Kevin?

Kevin Wiersma

Here are some details regarding the quarter.

We experienced top line growth of 5% for the quarter. In our lab business, second quarter revenue was $16.8 up 6% from the second quarter of last year. Revenues from workplace drugs-of-abuse testing increased 5%. The solid revenue growth from new clients was offset by a 4.5% decline in our existing business.

Revenues in our specialty laboratory services were up 8% due to continued strong growth in testing for clinical trial services. In our POC Diagnostic Business second quarter revenues was $5.1 million up 3% from last year.

Revenues from our point-of-collection testing products (POTC) were $4.7 million up 12% from last year. Growth was driven primarily by strong sales of our SURE-SCREEN devices in the government market as well as continued but slow growth our PROFILE-ER devices in the hospital market. The gain in sales in the government and hospital market were partly offset by a decrease in revenues from device sales in the workplace market.

Contract manufacturing revenues were $0.3 million in the quarter down 44% from last year but consistent with our expectations. Other product revenues were $0.1 million in the quarter down from $0.2 million last year.

Our overall gross margin was 43.4% in the second quarter compared to 46.1% last year. Our lab business operated at a 38.5% margin in the second quarter down from 41.1% in the second quarter of last year.

Lab gross margins were impacted by higher cost and limited incremental revenue associated with the clinical laboratory expansion. Margins in our POC diagnostic division were 59.6% in the quarter compared to 62.1% last year. Diagnostic products gross margins were impacted by product mix were slowed growth of higher margin PROFILE-ER products and an increased in sales of lower margin SURE-SCREEN devices sold into the government market.

Our selling, general and administration expenses were $5.9 million in the quarter down 4% from $6.1 million last year. SG&A expense decreased to 26.9% of revenues compared to 29.6% of revenues last year.

Research and development expenses were $501,000 in the quarter compared to $786,000 in the second quarter last year. Second quarter of last year, we incurred increased product development expenses in our Diagnostic Division.

Other expenses were 221,000 in the quarter compared to 47,000 in the prior year. It consists primarily of interest expense and the net operating result in the New Brighton Business Center. The second quarter of last quarter, the lower expense resulted primarily from the resolution of a previously reserved rent receivable at the New Brighton Business Center.

Our income before tax was $2.9 million up 10.9% from last year. Effective income tax rate for the quarter was 33.5% compared 32.6% in the second quarter of last year. We anticipate an effective rate of 36.5% for the remainder of the year. Terms of the balance sheet are trade receivables are up on their year-end levels due to strong May and June sales and the timing of cash receipts.

Our day sales outstanding are at 58 days for the quarter compared to 60 days last year. Capital expenditures were $1.5 million for the quarter and $4 million year to date. Depreciation and amortization expense was $1.2 million for the quarter and $2.3 million year to date.

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

Dick Braun

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 Steve Crowley - Craig-Hallum.

Steve Crowley - Craig-Hallum Capital Group

Could I ask you just for a rehash on the growth profitability of each one of your key segments?

Kevin Wiersma

The overall gross margin Steve was 43.4% in the quarter compared to 46.1% last year. The lab was at 38.5% of gross margin and the POC Diagnostic Division was at 59.6%.

Steve Crowley - Craig-Hallum Capital Group

Can I have just have the year ago comps for both the lab and the products?

Kevin Wiersma

Yes the labs were 21.1% and the products was 62.1

Steve Crowley with Craig-Hallum Capital Group

So for products it was 59.6 versus 62.1.

Kevin Wiersma

Yes.

Steve Crowley - Craig-Hallum Capital Group

We will start with government because it is one of the areas we have a real robust growth. Can you give us a little bit of a flavor for whether or not this is penetration of an existing geography where you have had a lot of success with or whether part of the success story here are new States or new municipalities or new geographies?

Jim Schoonover

It is a combination of both. The growth is primarily being driven through 3 States, one of which is California, which we have had quite a bit of success with in the past and then there are two other, States that we are making new inroads in, State of Texas and the State of Kentucky.

Steve Crowley - Craig-Hallum Capital Group

I trust the success that can happen with LA County has proven to be real bullish reference ability and I guess some duplication of that success on other municipalities.

Jim Schoonover

Yes the success with that program has certainly helped us garner additional business. We are also doing work with beyond just probation, parole and the prison population. We have expanded into child and family services-type organizations and some other offshoots within the States so we are getting a much stronger foothold in those three but there is nothing special per se about the three. We certainly can expand this program beyond where we have gone with it so far.

Steve Crowley - Craig-Hallum Capital Group

Great, as I mentioned the clinical trials business, from what I read in your press release, Dick’s comments and then Kevin’s granularity on the performance, looks to be doing really well. You mentioned being real pleased, I think with the preferred provider arrangements that you guys were able to garner. Have they been the number one driver to the success here and how did that affect your strategy going forward?

Jim Schoonover

I do not know if I can call that the number one driver but they are certainly a big contribution because there is more consistency, because we are getting to see almost all of their trials that are coming up. Steve the second question was related to other opportunities within…, well, could you repeat the second part of the question?

Steve Crowley - Craig-Hallum Capital Group

Coming into this year we had expectations that these preferred provider deals would be a very positive developments for that business and the Company. It appears that they are. So I guess my question is-can you have a similar phenomenon, like in government, where success in the early stages of, with a couple of other major customers can be duplicated across the broader set.

Jim Schoonover

In general sense, yes but I think the markets are distinctively different. The government market tends to more price-sensitive and they are going to be periodically logged to be at the end of their contracts with the preferred provider relationship with the pharma. I think we feel a little more comfortable and predictable about the long-term relationship and not having it disrupted by those same occurrences.

Steve Crowley - Craig-Hallum Capital Group

On a regional, clinical laboratory, it seems like there is, if I read between the lines, what you are telling us is that there is a steady deliberate ramp underway in the business and that the prospects for greater noticeability of that business in the second half or they are because some of the customer cultivation you have been doing but maybe you could give us a little more color there.

Jim Schoonover

I think that is an accurate assessment, Steve. We really started our sales and marketing effort in the first quarter of this year. Obviously, the prospects that we are talking where there are people that had pre-existing relationships with either hospital-based labs or national reference labs, I think we have become more successful at pointing out our advantages being a local laboratory.

So, this is mostly in the Twin Cities market but I think even beyond the Twin Cities, the combination of our turnaround time which is excellent, our customer service which we also think is industry leading and some of the expansion of the test menu that we done creates a pretty compelling story for this local customers.

We do have a growing backlog of business. Some of the new contracts that we have received are with clients that have yet begun testing with us but will shortly. So, I do think that Dick’s comment about feeling much more positive towards the second half of the year is right on.

Operator

Your next question comes from Geoff Smith - Sidoti & Co.

Geoff Smith – Sidoti & Co.

I just want to quickly just clarify the clinical trial services backlog. You said it doubled from the 5.5 or to the 5.5.

Kevin Wiersma

It approximately doubled from the 5.5.

Geoff Smith – Sidoti & Co.

I just have a quick question on just what you are seeing with regards to the reader recall, just in the market, are you seeing maybe just some deferred decisions from some of your clients, based on when this approval is going to come through?

Kevin Wiersma

Yes, we are, I do think most customers that we deal with are not knowledgeable about the FDA process so they do understand that it can get somewhat complicated. They have been very patient and they are by and large satisfied with working with us on the visual read process that goes along with our devices but obviously, longer term we are going to make furthering roads into that market with the reader. So, it has been a very positive response from our customer base but it has mitigated some of the growth that we were expecting from clients that were interested in the reader due to the recall.

Geoff Smith – Sidoti & Co.

Do you think they are still at the table?

Jim Schoonover

If I might just expand on the reader for a second, certainly, we had hoped that the approval would come more quickly but what we are finding is that the FDA has sort of substantially raised their standards on providing this type of pools and it is not particularly us. It is just in general and well, to some extent that is bad news because it is taking longer. On the other hand, in the future that barrier to entry and having these kinds of readers is going to be significantly more difficult.

Geoff Smith – Sidoti & Co.

I think originally when you mentioned the initial recall; you said there was about a 75-day expectation for approval. Now, there is a resubmission, are you kind of in that same timeframe?

Jim Schoonover

Typically, there is a 90-day approval period for just starting variety to 510-Ks but the way it works with the FDA, when they ask you a question and you have to supply additional information, they total the counting of those days and then they start them again when you resubmit. So, right now based upon that explanation, with no further questions which we cannot guarantee but we are hopeful that there will not be any is there is an approximately a 60-day period left on that 90 days.

Operator

Your next question comes from Balaji Gandhi - Oppenheimer & Co.

Balaji Gandhi – Oppenheimer & Co.

I just want to make sure I understood the growth in the specialty lab business a little bit better. Could you maybe give us some color on the mix in that business in terms of what contributed to the growth?

Dick Braun

We do not breakout the mix on it separately but really the strongest driver in the growth on that was the clinical trial services.

Balaji Gandhi – Oppenheimer & Co.

In terms of margin contribution, is that higher than the rest of the business?

Dick Braun

Clinical trial services tend to be a higher margin piece of the business.

Balaji Gandhi – Oppenheimer & Co.

On SG&A, obviously is trying to get some operating leverage there. I mean how should we be thinking about that going forward, continue to get leverage or are we hitting some kind of flexion point?

Dick Braun

Our objective is to continue to get leverage off the operating line to produce SG&A expenses as percentage of sales year-over-year.

Balaji Gandhi – Oppenheimer & Co.

That will be in the ‘09 as well.

Dick Braun

Yes.

Operator

Your next question comes from Ruthanne Roussel - The Robins Group.

Ruthanne Roussel – The Robins Group

As far as the government sales are going, how many agencies do this represent, how many customers?

Dick Braun

Ruthanne, it is approximately 8 to 10 within those three states. This tends to be larger entities within the State versus groups that are more local in nature. They tend to be statewide organizations.

Ruthanne Roussel – The Robins Group

And that is a deliberate strategy?

Dick Braun

Yes, it is a way to leverage our sales efforts and obviously we like higher volume customers.

Ruthanne Roussel – The Robins Group

As far as the expansion into the regional lab provider market, I would like to better understand the stickiness you were talking about, that the customers seem to feel. You mentioned that because they start out with an existing relationship with a national competitor or with the hospital reference lab that means that it takes a while for them to make the switch to MEDTOX if they are going to do that. Can you explain to me a little bit better, are this for instance perhaps yearlong contracts or some of them are locked into with their existing providers or how stuck are they to the existing provider?

Kevin Wiersma

Generally speaking it is not a contractual issue. Many of these organizations, we have been focusing on family practice, OBGYN, Urology and also smaller and regional hospital send-out groups and some of them certainly have contracts but many of them do not. I think the issue is that MEDTOX historically has been known as a very high quality toxicology laboratory and now, we are coming to them with a much broader menu of services and some of them have been with their existing laboratory for quite some time but in many cases what we are finding is there has been a degradation of service and of turnaround time from the existing provider so it is a multi-step type process.

Number one, you introduce what you are all about at this point in time from the MEDTOX point of view. Number two, you talk to them specifically about what their test menu is and your ability to provide turnaround time in the time they are looking for. And then number three, you start to talk about pricing and other issues related to closing the deal. So, it is not that we are meeting tremendous resistance per se, it is that the timeframe on closing of sale is somewhat elongated.

Ruthanne Roussel – The Robins Group

Are we talking here of sales cycle of one month, three months, six months?

Kevin Wiersma

Probably more in the three-month timeframe that is more normal, three to four.

Ruthanne Roussel – The Robins Group

I was hoping that we might have a breakout of the actual amounts for the various components of the laboratory services. We got growth rates on them that somehow I have missed what the actual figures were.

Kevin Wiersma

Ruthanne, the workplace drugs-of-abuse in the lab was about $10.8 million and the specialty laboratory was $6 million.

Operator

Your next question comes from Robert Cvengros - Next Generation Equity Research.

Robert Cvengros – Next Generation Equity Research

Last month, I had the opportunity to revisit newly built out lab and I appreciate you let me do that. During my visit, I found personnel very busy with the cytology screening of reflex HPV. I also heard word that Quest Diagnostics recently closed a lab in the Minneapolis area and now will be forwarding cytology screening to Chicago, which may add an additional day to the receipt of results by physicians. Could you give me some color on the cytology screening margins, growth opportunities and your value proposition to the Minneapolis market right now as a result of providing services locally? I am just interested in garnering a little color on this is a really first opportunity for the pathology to really launch out.

Kevin Wiersma

Robert, all of what you have mentioned, I think, is accurate and I do believe that it will make a difference in terms of the sending out of specimens versus those being performed locally. Without getting into a lot of detail, there are certainly a number of groups that we have been talking with who were waiting for some more tangible services due to occur in order to get more serious about working with us going forward and I think we are certainly revisiting those discussions and trying to suggest that the turnaround time on these tests is critical and keeping them local is a benefit to their practice. So, we are pretty excited about that opportunity but again we are looking at this in a fairly broad manner that is one area that is a positive for us but we believe that the overall service and turnaround time that we offer is viable for any customer in the local market and the regional market.

Robert Cvengros – Next Generation Equity Research

I just raised a smile on my face because I know you have got some personnel that used to work for Quest and cytology screening are very, very qualified.

Kevin Wiersma

We are trying not to get into a lot of that detail.

Robert Cvengros – Next Generation Equity Research

Your CTS has gone from a backlog of $5.5 million to roughly around $11 million which is very, very impressive and I was just wondering how significant has it then to MEDTOX’s value proposition obtaining additional contracts for clinical testing services and molecular Flow Cytometry, pathology online now and is this only really the beginning of leveraging that value proposition.

Kevin Wiersma

We actually have recently begun performing a trial for a Pharma in Flow Cytometry and it looks like we maybe able to garner more of that business and also because of the molecular lab and the Flow Cytometry, it opens up the opportunity for us to be looking at some Pharma that maybe developing oncology drugs which we have not been able to do before. So, the whole pathology lab and the underpinnings of it offer opportunities not only in the clinical market but in CTS and market so that is exactly right.

Robert Cvengros – Next Generation Equity Research

Some of this Flow Cytometry and other molecular tests have just very, very high margins roughly would it be appropriate for me to think roughly 80% to 90% margins?

Kevin Wiersma

They are pretty high and the tests are fairly expensive. There is also an interpretation in electoral component that there is a value added.

Robert Cvengros – Next Generation Equity Research

Charges.

Kevin Wiersma

The equipment itself.

Robert Cvengros – Next Generation Equity Research

Last quarter, I believe there was a 7% increase year over year on volume due to new customers coming online. Was there a sequential increase in the customer base in Q2?

Kevin Wiersma

There was.

Robert Cvengros – Next Generation Equity Research

Any color on that as far as numbers?

Kevin Wiersma

Bob, I think we can get, we do not have the specific number. We can certainly get that to you but the opportunity to sell new account has not really been an issue for us. We continue to do that. Obviously we had a tail wind behind us a year ago, this quarter and are facing some head winds currently so I think that has been some of the swing but the new account activity is strong and really in all areas that were involved in.

Operator

Your next question is a follow-up from Steve Crowley – Craig-Hallum Capital Group.

Steve Crowley - Craig-Hallum Capital Group

I have a follow up to the question about new customers in the workplace drugs-of-abuse business. Obviously, things were more challenging from the existing customers for same stores. What can you tell us in terms of flavour for that minus, did you say 4.5% in the quarter? Was a pretty homogenous at that level or was there some variability that either should concern us or encourage us?

Kevin Wiersma

Steve, it seemed, to look at it throughout the quarter it was that the year-over-year comparisons in the first part of the quarter were better. They got a bit worse in the middle of the quarter and then they got somewhat better at the end of the quarter. So, it is a little early to tell whether or not the improvement throughout the quarter is a trend that we can look forward to going forward. We just do not know yet.

Steve Crowley - Craig-Hallum Capital Group

As I was checking your website for new stuff recently, it seems like you are highlighting your pain management initiative as new and significant and I do not know if this is the appropriate forum for a lot of information but maybe you could tell us a little bit about what you are doing there and what it could mean to you?

Kevin Wiersma

We, just to go back a little bit in history, we have been involved in the pain management. I guess we did not it call it that initially but we have done toxicology testing for entities that are involved in the management of pain for many years and we started to look at both the margins and the growth of that. We started to look at the market in a broader sense and recognized that this was an opportunity for us to create a product line, put specific management and sales people into that product line and drive it more aggressively than we had in the past and that is really what we have been doing.

The brand of the program that we offer is called ToxASSURE and it is a consultative and customized type of program that we can work with physicians in their patients on compliance issues as well as data management and overall, working with them on adverse drug reaction potential and things of that nature so we probably can talk more about that in the future because it is still fairly new in terms of its own focus but so far the early returns have been very favorable.

Steve Crowley - Craig-Hallum Capital Group

Do you think this can be a significant new silo of business for you?

Dick Braun

Absolutely.

Operator

There are no further questions at this time.

Dick Braun

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

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