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 September 30, 2007

( )

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

For the transition period

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [

]

Accelerated filer [

]

Non-accelerated filer [ X ]

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 October 16, 2007
Common Stock, $0.15 par value per share		8,421,850

MEDTOX SCIENTIFIC, INC.

INDEX

Page

Part I

Financial Information:

Item 1:

Financial Statements (Unaudited)

Consolidated Statements of Income – Three and

Nine Months Ended September 30, 2007 and 2006

Consolidated Balance Sheets – September 30, 2007

and December 31, 2006

Consolidated Statements of Cash Flows – Nine

Months Ended September 30, 2007 and 2006

Notes to Consolidated Financial Statements

Item 2:

Management's Discussion and Analysis of

Financial Condition and Results of Operations

Item 3:

Quantitative and Qualitative Disclosures

About Market Risk

Item 4:

Controls and Procedures

Unregistered Sales of Equity Securities and Use of

Proceeds

Item 3:

Defaults upon Senior Securities

Item 4:

Submission of Matters to a Vote of Securities Holders

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				Nine Months Ended
	September 30,				September 30,
	2007		2006		2007		2006

REVENUES:
Laboratory services	$ 15,723		$ 14,725		$ 46,499		$ 40,540
Product sales	5,036		3,995		14,062		11,929
	20,759		18,720		60,561		52,469

COST OF REVENUES:
Cost of services	9,322		8,555		27,431		24,364
Cost of sales	1,936		1,525		5,310		4,585
	11,258		10,080		32,741		28,949
GROSS PROFIT	9,501		8,640		27,820		23,520

OPERATING EXPENSES:
Selling, general and administrative	5,852		5,415		17,726		15,429
Research and development	599		579		1,964		1,570
	6,451		5,994		19,690		16,999
INCOME FROM OPERATIONS	3,050		2,646		8,130		6,521

OTHER EXPENSE:
Interest expense	(42	)	(99	)	(139	)	(372)
Other expense, net	(136	)	(143	)	(280	)	(429)
	(178	)	(242	)	(419	)	(801)
INCOME BEFORE INCOME TAX EXPENSE	2,872		2,404		7,711		5,720

INCOME TAX EXPENSE	(933	)	(928	)	(2,456	)	(2,208)

NET INCOME	$ 1,939		$ 1,476		$ 5,255		$ 3,512

BASIC EARNINGS PER COMMON SHARE	$ 0.23		$ 0.18		$ 0.63		$ 0.43

DILUTED EARNINGS PER COMMON SHARE	$ 0.22		$ 0.17		$ 0.59		$ 0.40

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic	8,397,882		8,178,489		8,286,551		8,161,176
Diluted	9,010,490		8,802,279		8,891,581		8,775,285

See Notes to Consolidated Financial Statements (Unaudited).

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

	September 30, 2007			December 31, 2006
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	2,003		$	1,261
Accounts receivable:
Trade, less allowance for doubtful accounts ($318 in 2007 and $280 in 2006)		15,191			10,797
Other		159			270
Total accounts receivable		15,350			11,067
Inventories		3,518			3,538
Prepaid expenses and other		739			1,314
Deferred income taxes		1,527			1,527
Total current assets		23,137			18,707
BUILDING, EQUIPMENT AND IMPROVEMENTS, net		24,106			19,572
GOODWILL		15,967			15,967
OTHER INTANGIBLE ASSETS, net		660			873
DEFERRED INCOME TAXES, net		2,237			4,351
OTHER ASSETS		702			404
TOTAL ASSETS	$	66,809		$	59,874

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	3,211		$	2,164
Accrued expenses		7,880			6,037
Current portion of long-term debt		677			677
Current portion of capital leases		6			14
Total current liabilities		11,774			8,892
LONG-TERM DEBT, net of current portion		1,148			2,055
OTHER LONG-TERM LIABILITIES		1,668			981
LONG-TERM PORTION OF CAPITAL LEASES, net of current portion		-			2

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, 8,514,281 in
2007 and 8,213,842 in 2006		1,276			1,232
Additional paid-in capital		85,783			85,683
Accumulated deficit		(31,229	)		(36,484	)
Common stock held in trust, at cost, 244,127 shares in 2007 and 177,424 shares in 2006		(2,611	)		(1,487	)
Treasury stock, at cost, 103,431 shares in 2007 and 2006		(1,000	)		(1,000	)
Total stockholders' equity		52,219			47,944
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	66,809		$	59,874

See Notes to Consolidated Financial Statements (Unaudited).

MEDTOX SCIENTIFIC, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended
	September 30, 2007			September 30, 2006
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income	$	5,255		$	3,512
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization		2,910			2,533
Provision for losses on accounts receivable		193			291
Loss on sale of equipment		40			36
Deferred and stock-based compensation		685			678
Deferred income taxes		2,114			1,869
Changes in operating assets and liabilities:
Accounts receivable		(4,476	)		(3,264	)
Inventories		20			135
Prepaid expenses and other current assets		575			450
Other assets		(303	)		36
Accounts payable and accrued expenses		2,056			447
Net cash provided by operating activities		9,069			6,723

CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of building, equipment and improvements		(6,380	)		(3,133	)
Proceeds from sale of equipment		-			21
Purchase of customer list		-			(11	)
Net cash used in investing activities		(6,380	)		(3,123	)

CASH FLOWS USED IN FINANCING ACTIVITIES:
Net proceeds on revolving credit facility		-			500
Proceeds from long-term debt		-			3,383
Principal payments on long-term debt		(907	)		(6,351	)
Principal payments on capital leases		(10	)		(12	)
Purchase of common stock for incentive plan		(1,124	)		(799	)
Purchase of treasury stock		-			(870	)
Net proceeds from sale of common stock		320			271
Payment of taxes from traded shares		(226	)		(192	)
Net cash used in financing activities		(1,947	)		(4,070	)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		742			(470	)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		1,261			1,312

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	2,003		$	842

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest	$	145		$	347
Income taxes, net of refunds received		470			140

Supplemental noncash activities:
Asset additions and related obligations		886			275

See Notes to Consolidated Financial Statements (Unaudited).

MEDTOX SCIENTIFIC, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2007

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 nine-month periods ended September 30, 2007 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, 2006.

New Accounting Standards:

In February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159). SFAS No. 159 permits entities to choose, at specified election dates, to measure eligible financial instruments at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for the Company as of January 1, 2008. The Company has not yet evaluated the impact of adopting SFAS No. 159 on its financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurement. Where applicable, SFAS No. 157 simplifies and codifies fair value related guidance previously issued within generally accepted accounting principles. Although this Statement does not require any new fair value measurements, its application may, for some entities, change current practice. SFAS No. 157 is effective for the Company as of January 1, 2008. The Company is currently in the process of evaluating the impact of the adoption of SFAS No. 157.

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. Services provided include forensic toxicology (primarily workplace drugs-of-abuse testing) and Specialty Laboratory Services, which include clinical toxicology, clinical testing for the pharmaceutical industry, pediatric lead testing, heavy metals analyses, courier delivery, and specimen collection services. 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, PROFILE-II ER^®, PROFILE^®-III ER, MEDTOXScan^®, VERDICT^®-II and SURE-SCREEN^®, in addition to a variety of agricultural testing products and other diagnostic tests for the detection of alcohol. MEDTOX Diagnostics, Inc. also provides contract manufacturing services in its Food and Drug Administration (FDA) registered/ISO 13845 certified facility.

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 September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Laboratory Services:
Revenues	$	15,723	$	14,725	$	46,499	$	40,540
Depreciation and amortization		826		728		2,484		2,153
Income from operations		1,973		2,220		5,599		5,019
Segment assets		54,391		47,348		54,391		47,348
Capital expenditures for segment assets		2,276		1,390		5,681		2,906

Product Sales:
Revenues	$	5,036	$	3,995	$	14,062	$	11,929
Depreciation and amortization		151		122		426		380
Income from operations		1,077		426		2,531		1,502
Segment assets		8,655		6,640		8,655		6,640
Capital expenditures for segment assets		309		100		699		225

Corporate (unallocated):
Other expense	$	(178)	$	(242)	$	(419)	$	(801)
Deferred tax assets, net		3,764		6,242		3,764		6,242

Company:
Revenues	$	20,759	$	18,720	$	60,561	$	52,469
Depreciation and amortization		977		850		2,910		2,533
Income from operations		3,050		2,646		8,130		6,521
Other expense		(178)		(242)		(419)		(801)
Income before income tax expense		2,872		2,404		7,711		5,720
Total assets		66,809		60,230		66,809		60,230
Capital expenditures for assets		2,585		1,490		6,380		3,131

The following is a summary of revenues from external customers for each group of services provided within the Laboratory Services segment:

(In thousands)	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006

Workplace drugs-of-abuse	$	10,430	$	9,250	$	30,400	$	26,192
Specialty Laboratory Services		5,293		5,475		16,099		14,348
	$	15,723	$	14,725	$	46,499	$	40,540

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 September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006

POC on site testing products	$	4,404	$	3,450	$	12,249	$	10,048
Contract manufacturing services		389		380		1,146		1,403
Other diagnostic products		243		165		667		478
	$	5,036	$	3,995	$	14,062	$	11,929

INVENTORIES

Inventories consisted of the following:

(In thousands)	September 30, 2007		December 31, 2006

Raw materials	$	733	$	871
Work in process		337		270
Finished goods		441		539
Supplies, including off-site inventory		2,007		1,858
	$	3,518	$	3,538

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 September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006

Net income (A)	$	1,939	$	1,476	$	5,255	$	3,512
Weighted average number of basic common shares outstanding (B)		8,397,882		8,178,489		8,286,551		8,161,176
Dilutive effect of stock options computed based on the treasury stock method		612,608		623,790		605,030		614,109
Weighted average number of diluted common shares outstanding (C)		9,010,490		8,802,279		8,891,581		8,775,285
Basic earnings per common share (A/B)	$	0.23	$	0.18	$	0.63	$	0.43
Diluted earnings per common share (A/C)	$	0.22	$	0.17	$	0.59	$	0.40

5. INCOME TAXES

The Company recorded a $110,000 and $120,000 tax benefit in the second and third quarters of 2007, respectively, due to permanent book to tax differences related to the disqualifying disposition upon the exercise of incentive stock options. In the first quarter of 2007, the Company recorded a $141,000 tax benefit from additional net operating loss carryforwards determined to be available to the Company.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109,” (FIN 48) which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The Company adopted FIN 48 effective January 1, 2007. The cumulative effect of applying this Interpretation did not result in any adjustment to retained earnings as of January 1, 2007. At September 30, 2007 and January 1, 2007, the Company had $331,000 of unrecognized tax benefits, all of which would affect the effective tax rate if recognized. It is not possible to reasonably estimate any possible change in the unrecognized tax benefits within the next 12 months. The tax years 2001-2006 remain open to examination by the major taxing jurisdictions to which the Company is subject.

In conjunction with the adoption of FIN 48, the Company began recording income tax related interest expense and interest income in income tax expense in its Consolidated Statements of Income. In prior periods, such interest expense or income was recorded in interest expense or interest income. Penalties, if any, will be recorded as a component of income tax expense. At September 30, 2007 and January 1, 2007, the Company had approximately $73,000 and $53,000, respectively, of accrued interest related to uncertain tax positions included in the Consolidated Balance Sheets.

At December 31, 2006, the Company had federal and state net operating loss carryforwards (NOLs) of approximately $16.1 million and $15.7 million, respectively, which are available to offset future taxable income. The Company's federal and state NOLs expire in varying amounts each year from 2007 through 2025 in accordance with applicable federal and state tax regulations and the timing of when the NOLs were incurred.

For financial reporting purposes, a state valuation allowance has been recorded to offset deferred tax assets that, more likely than not, will not be realized based on the Company’s filing status in certain states. 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.

CONTINGENCIES

Leases - The Company leases offices and facilities and office equipment under certain operating leases, which expire on various dates through March 2016. Under the terms of the facility leases, a pro rata share of the facility’s 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 adverse impact on the Company's consolidated financial position or results of operations.

SUBSEQUENT EVENT

On October 25, 2007, the Company entered into the Third Amendment to the Credit Agreement with Wells Fargo Bank, National Association (the “Bank”). The Third Amendment modifies certain terms and conditions of the Wells Fargo Credit Agreement as follows:

•	Extends the last day on which the Bank will make advances under the line of credit and the capital equipment note from November 1, 2007 to November 1, 2009.

•	Increases the loan limit for the purchase of capital equipment from $2.0 million to $4.9 million.

•	Removes the financial covenant requiring the maintaining of a current ratio of not less than 1.3 to 1.0 at any time.

•	Increases the financial covenant requiring a tangible net worth of not less than $22,500,000 at any time to $30,000,000 at any time.

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.

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:

•

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, 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:

other companies challenging our patents

patents issued to other companies that may harm our ability to do business

other companies designing around technologies we have developed

our inability to obtain appropriate licenses from third parties

our inability to protect our trade secrets

risk of infringement upon the proprietary rights of others

our inability to prevent others from infringing on our proprietary rights

•

our inability to obtain sufficient financing to continue to sustain or expand our operations

•

adverse results in litigation matters

•

our inability to continue to develop innovative products and services

•

an unforeseen decrease in the acceptance of current new products and services

•

flucuations in clinical trial activities

The following additional factors could cause actual results to differ materially from those indicated by the forward looking statements contained in this Form 10-Q:

•

The failure of the pace of reader installations to accelerate in 2008 after the slowing of installations in the third quarter of 2007 and the projected continued slowing of installations in the fourth quarter of 2007 due to design and software modifications to improve the reader’s performance.

•

The expected increase in sales of POCT products fails to materialize.

•

Our inability to continue the revenue growth, improved gross margins and reduced selling, general and administrative expenses attained in the first three quarters of 2007.

The above listings 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. principally engages in forensic toxicology (primarily laboratory testing for identification of drugs-of-abuse), providing these services to private and public companies, drug treatment counseling centers, occupational health clinics and hospitals, as well as third party administrators.

Our “Specialty Laboratory Services” operations consist of clinical toxicology, clinical testing for the pharmaceutical industry (e.g., central laboratory services, bioanalytical, and pharmacokinetic testing), and

analysis of heavy and trace metals. We provide these services to hospitals, clinics, HMOs and small to mid-sized biotech and pharmaceutical companies 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 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.

The Laboratory Services segment also includes New Brighton Business Center, LLC, 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. These facilities include other commercial tenants that have individual leases with terms of up to ten years.

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 point-of-collection testing (POCT) diagnostic drug screening devices, such as our PROFILE^®-II, PROFILE^®-II A, PROFILE^®-III, PROFILE-II ER^®, PROFILE^®-III ER, MEDTOXScan^® Reader, VERDICT^®-II, and SURE-SCREEN^® products, in addition to a variety of agricultural testing products and other diagnostic tests for the detection of alcohol. MEDTOX Diagnostics, Inc. also provides contract manufacturing services, such as coagulation market controls. The operations of the Product Sales segment are located in Burlington, North Carolina, where we maintain the offices, research and development laboratories, production operations, and warehouse/distribution facilities.

Key Trends Influencing Our Operating Results

Our management believes that there are several notable trends that are currently influencing, and are expected in the foreseeable future to continue to influence, our operating results. These include:

Economic Uncertainties Causing Variability in Testing Volumes in the Laboratory Services, Drugs-of-Abuse Business

In the past, we have experienced a decrease in testing volume from our existing workplace drugs-of-abuse clients, which we primarily attributed to lower new job creation and reduced employee turnover caused by economic uncertainties. In the first nine months of 2007, testing volume from our existing workplace drugs-of-abuse clients was slightly higher than the prior year period. However, 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. As the number of firms marketing diagnostic tests has grown, we have experienced increased price competition for certain diagnostic testing devices, particularly in the probation, parole and rehabilitation market.

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 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. In 2006, we expanded our number of sales representatives from 19 to 35. The increase in sales representatives has increased our business from new accounts in 2007 and helps offset risks from uncertain economic conditions that may result in 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. Our LEAN and Six-Sigma initiatives support this effort 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 introduced a number of innovative products and services.

In 2006, we developed and introduced MEDTOXScan^®, an electronic reader, which we provide to hospitals for use with our PROFILE-II ER^® and PROFILE^®-III ER POCT devices in hospital laboratories and emergency rooms. As of September 30, 2007, we had 368 readers that have been placed with clients in the hospital market for use or evaluation. As a result of our experience with a significant installed base and customer feedback, we have initiated certain device design and software modifications to improve the reader’s performance. These initiatives slowed installation of readers in the third quarter and this impact will likely continue into the fourth quarter. We anticipate the pace of installations to accelerate in 2008 after we release the enhanced version of the reader, although we cannot assure that this acceleration will materialize.

In 2005, we developed and introduced eChain^®, our web-based electronic chain-of-custody and donor tracking system. We currently have over 1,300 clinics and collection sites utilizing eChain^® throughout the country. These sites serve as the basis for our marketing campaign offering eChain^® to national clients.

In 2005, we also introduced SURE-SCREEN^®, our lower detection level POCT device targeted for the government and rehabilitation markets and our PROFILE^®-III device, an integrated cup and testing device for sale to the workplace drug testing market.

ClearCourse™, another innovative solution we offer, is a comprehensive drug testing program that combines four essential components: Drug Abuse Recognition System (DARS™) training, SURE-SCREEN^® on-site drug screening devices, laboratory based confirmation testing and WEBTOX^® online data management.

Critical Accounting Policies

We have identified the policies outlined below as critical to understanding our business and results of operations. The listing is not intended to be a comprehensive list of all accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States of America, with no need for management's judgment in their application. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements in Item 15 on Form 10-K for the year ended December 31, 2006. Note that the preparation of the interim, unaudited consolidated financial statements included in this Form 10-Q requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

Our critical accounting policies are as follows:

Accounts Receivable:

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customers' current creditworthiness, as determined by management’s review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that have been identified. While such credit losses have generally been within our historical expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that have occurred in the past. Our consolidated trade accounts receivable balance at September 30, 2007 was $15.2 million, net of allowance for doubtful accounts of $0.3 million.

Revenue Recognition:

Revenues from Laboratory Services are recognized as earned when we have performed the applicable laboratory testing services and the results have been sent to our customers or posted to our secure website.

Some of our Laboratory Services revenues for certain types of tests are billed to third-party payers including insurance companies, state Medicaid and Medicare agencies. These payers pay for such services at established amounts, which are typically lower than gross amounts billed by us. However, the tests are sometimes billed directly to patients or other parties and paid at the gross amount billed for these tests. In addition, billings for the tests are occasionally re-billed to alternative payers in situations where incorrect billing information was

submitted to us by the customer. Historically, the amounts of such incorrect billings have not been material. We estimate a discount on the billings for these tests and recognize revenues and related accounts receivable at a net amount, after discount, in order to state revenues and accounts receivable at the amount expected to be paid. While we believe that estimated discounts and the related net revenues and net accounts receivable from these testing services are materially correct, there can be differences in amounts ultimately paid compared to estimated amounts. These differences are recorded upon payment and may affect previously recorded amounts. We consider contracted rates with payers and historical discounts when estimating future discounts on a monthly basis.

Revenues from Product Sales are recognized FOB shipping point net of an allowance for estimated returns. When shipment occurs, the sales price is fixed and determinable, and collection of the resulting receivable is reasonably assured.

Off-Site Supplies Inventory:

Off-site supplies represent collection kits and forms located at collection sites throughout the United States used by Laboratory Services’ customers to submit specimens for testing services. These inventories are recorded at the lower of historical cost or market. At September 30, 2007, off-site inventory was $1.2 million. The process for valuing off-site inventory involves making significant assumptions regarding the average time that a collection site uses the inventory, as well as the amount of inventory expected to be scrapped.

Goodwill and Other Intangible Assets:

Goodwill and indefinite-lived intangible assets are reviewed for impairment at least annually and between annual test dates in certain circumstances. We perform our annual impairment test for goodwill and other intangible assets in the fourth quarter of each year. In assessing the recoverability of goodwill and other intangible assets, projections regarding estimated future cash flows and other factors are made to determine the fair value of the respective assets. If these estimates or related projections change in the future, we may be required to record impairment charges for these assets in future periods.

Accounting for Income Taxes:

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

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against net deferred tax assets. Our deferred tax assets primarily consist of certain net operating losses (NOLs) carried forward. At December 31, 2006, we had a state valuation allowance on deferred tax assets of approximately $57,000, which represents the portion of certain state NOL carryforwards that will more likely than not expire unused in future years. The valuation allowance is based on management’s estimate of future taxable income and the period over which NOLs will be recoverable. 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 our cash payments would remain unaffected until the benefit of the NOLs is completely utilized or expires unused.

We account for uncertain tax positions in accordance with FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”) an interpretation of FASB Statement No. 109 (“SFAS 109”). The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income. See Note 5 of Notes to the Consolidated Financial Statements for additional detail on our uncertain tax positions.

Results of Operations

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

To maximize our operating income, we have sought revenue growth, improved gross margins and reduced selling, general and administrative (SG&A) expense as a percentage of revenues. As discussed below, during the third quarter of 2007, we were able to achieve solid revenue growth and reduced selling, general and administrative (SG&A) expense as a percentage of revenues, but we experienced a decrease in gross margins in the quarter resulting primarily from reduced revenues from our higher-margin testing related to clinical trials. During the first nine months of this year, we made positive strides on all three fronts.

Revenues

	Three Months Ended				Quarter-over-Quarter
	September 30, 2007	% of Revenues	September 30, 2006	% of Revenues		$ Change	% Change
Revenues:

Laboratory Services	$ 15,723	75.7%	$ 14,725	78.7%		$ 998	7%

Product Sales	5,036	24.3%	3,995	21.3%		1,041	26%

	$ 20,759	100.0%	$ 18,720	100.0%		$ 2,039	11%

	Nine Months Ended				Year-over-Year
	September 30, 2007	% of Revenues	September 30, 2006	% of Revenues		$ Change	% Change
Revenues:

Laboratory Services	$ 46,499	76.8%	$ 40,540	77.3%		$ 5,959	15%

Product Sales	14,062	23.2%	11,929	22.7%		2,133	18%

	$ 60,561	100.0%	$ 52,469	100.0%		$ 8,092	15%

Our Laboratory Services segment includes revenues from workplace drugs-of-abuse testing and revenues from Specialty Laboratory Services. Our revenues from workplace drugs-of-abuse testing grew 13% and 16% for the three and nine month periods ended September 30, 2007, respectively. This growth was driven by an increase in sample volume from new client relationships, partially offset by a slight decrease in the average price per testing specimen. Pricing for our workplace drugs-of-abuse testing services tends to be fairly stable overall; however, the average price per testing specimen can vary slightly from quarter-to-quarter. Test price can vary by client based on the percentage of samples that test positive for drugs-of-abuse and the average number of samples per shipment.

Revenues from our Specialty Laboratory Services for the three months ended September 30, 2007 decreased 3% to $5.3 million due to a decline in testing for clinical trial services. For the nine months ended September 30, 2007, revenues from our Specialty Laboratory Services increased 12% to $16.1 million due to strong growth in testing for our clinical trial services business and a higher average revenue per test during the first and second quarters. Revenues from clinical trial services can fluctuate from quarter-to-quarter based on the project nature, size, and the actual timing of clinical trials. In the third quarter, our pharmaceutical company clients rescheduled over $500,000 of testing into future quarters due to slower than anticipated patient enrollment. While we continue to add new clients in clinical trial services, we are also experiencing significant repeat business from existing clients. In the first quarter of 2007, we also entered into a strategic relationship with a European laboratory which gives us access to strategically located laboratories throughout Europe, Asia, India, South America, South Africa and Australia, thus enabling us to provide laboratory clinical trial services for international trials. This relationship is non-exclusive and does not include any specified testing volumes or commitments.

In the Product Sales segment, sales of POCT products, which consists of the PROFILE^®-II, PROFILE-II ER^®, PROFILE^®-III ER, PROFILE^®-II A, PROFILE^®-III, VERDICT^®-II and SURE-SCREEN^®on-site test kits and other ancillary products for the detection of abused substances, increased 28% to $4.4 million and 22% to $12.2 million for the three and nine months ended September 30, 2007, respectively. This growth primarily reflected strong sales of PROFILE^®-III ER, SURE-SCREEN^®andPROFILE^®-III devices. Overall, pricing for our POCT devices was stable during these periods. We are also continuing our introduction of our MEDTOXScan^®reader for use with our PROFILE-II ER^®and PROFILE^®-III ERdevices in the hospital market. As of September 30, 2007, we had 368 readers that have been placed with clients in the hospital market for use or evaluation. As a result of our experience with a significant installed base and customer feedback, we have initiated certain device design and software modifications to improve the reader’s performance. These initiatives slowed installation of readers in the third quarter and this impact will likely continue into the fourth quarter. The reduction in the placement of readers did not have a negative impact on the financial performance of the Product Sales segment during the quarter.

Additionally, in the Product Sales segment, sales of contract manufacturing services were relatively flat at $0.4 million for the three months ended September 30, 2007. For the nine months ended September 30, 2007, sales of contract manufacturing services decreased 18%, or $0.3 million, to $1.1 million. During the first quarter of 2007, our largest client experienced a product recall, unrelated to the component that we provide them. The recall has caused them to experience a loss of market share and consequently lower demand for our services. After an analysis of this product category, we have concluded that it has diminishing opportunities for us, and we will exit the contract manufacturing services business over the next 12 to 18 months. Based on the expected increased sales of higher-margin POCT products, we do not anticipate a significant impact on our results of operations from exiting this business.

Gross Profit

	Three Months Ended				Quarter-over-Quarter
	September 30, 2007	% of Revenues	September 30, 2006	% of Revenues	$ Change	% Change
Cost of Revenues:

Cost of Services	$ 9,322	59.3%*	$ 8,555	58.1%*	$ 767	9%

Cost of Sales	1,936	38.4%**	1,525	38.2%**	411	27%

	$ 11,258	54.2%	$ 10,080	53.8%	$ 1,178	12%

Cost of services as a percentage of Laboratory Services revenues

Cost of sales as a percentage of Product Sales revenues

	Nine Months Ended				Year-over-Year
	September 30, 2007	% of Revenues	September 30, 2006	% of Revenues	$ Change	% Change
Cost of Revenues:

Cost of Services	$ 27,431	59.0%*	$ 24,364	60.1%*	$ 3,067	13%

Cost of Sales	5,310	37.8%**	4,585	38.4%**	725	16%

	$ 32,741	54.1%	$ 28,949	55.2%	$ 3,792	13%

Cost of services as a percentage of Laboratory Services revenues

Cost of sales as a percentage of Product Sales revenues

Consolidated gross margin was 45.8% and 45.9% of revenues for the three and nine months ended September 30, 2007, respectively, compared to 46.2% and 44.8% of revenues for the same periods in 2006.

Laboratory Services gross margin was 40.7% for the three months ended September 30, 2007, down from 41.9% in the same period of 2006. The decrease in gross margin resulted primarily from reduced revenues from our higher-margin testing related to clinical trials. For the nine months ended September 30, 2007, gross margin from Laboratory Services increased to 41.0%, up from 39.9% in the prior year period. The margin improvement was primarily attributable to increased revenues from additional testing volume through our existing infrastructure, as well as an increase in higher margin testing relating to clinical trials.

Gross margin from Product Sales was 61.6% for the three months ended September 30, 2007, down slightly from 61.8% in the same period of 2006. For the nine months ended September 30, 2007, gross margin from Product Sales increased to 62.2%, up from 61.6% in the prior year period. For the nine months ended September 30, 2007, margins were positively impacted by a shift in sales mix towards the higher-margin POCT devices and away from lower-margin contract manufacturing services, which occurred during the first quarter of 2007.

Operating Expenses

	Three Months Ended				Quarter-over-Quarter
	September 30, 2007	% of Revenues	September 30, 2006	% of Revenues	$ Change	% Change
Operating Expenses:

Selling, general and administrative	$ 5,852	28.2%	$ 5,415	28.9%	$ 437	8%

Research and development	599	2.9%	579	3.1%	20	4%

	$ 6,451	31.1%	$ 5,994	32.0%	$ 457	8%

	Nine Months Ended				Year-over-Year
	September 30, 2007	% of Revenues	September 30, 2006	% of Revenues	$ Change	% Change
Operating Expenses:

Selling, general and administrative	$ 17,726	29.3%	$ 15,429	29.4%	$ 2,297	15%

Research and development	1,964	3.2%	1,570	3.0%	394	25%

	$ 19,690	32.5%	$ 16,999	32.4%	$ 2,691	16%

Selling, General and Administrative Expenses. Selling, general and administrative (SG&A) expenses increased to $5.9 million, or 28.2% of revenues for the three months ended September 30, 2007, compared to $5.4 million, or 28.9% for the same period in 2006. For the nine months ended September 30, 2007, SG&A expenses increased to $17.7 million, or 29.3% of revenues, compared to $15.4 million, or 29.4% of revenues for the same period in 2006. The increased spending reflects an increase in sales and marketing and information technology expense.

Research and Development Expenses. Research and development expenses increased 4% and 25%, respectively, to $0.6 million and $2.0 million for the three and nine months ended September 30, 2007. The increase in the year-to-date period was primarily due to increased laboratory assay development expense in support of testing for clinical trials in our Laboratory Services segment. The increase was also driven by increased product development expense related to the introduction of the MEDTOXScan^®reader and other peripheral materials related to the reader, as well as continuing software development upgrades in our Product Sales segment.

Other Expense

Other income and expense consists primarily of interest expense and the operating results associated with our building rental activities. These expenses decreased 26% and 48%, respectively, to $178,000 and $419,000 for the three and nine months ended September 30, 2007. The improvement resulted primarily from lower interest

expense related to a reduction in average debt levels. The lower expense in the year-to-date period was also due to the resolution of a previously reserved rent receivable at the New Brighton Business Center.

Income Taxes

We recorded a tax provision for the three and nine months ended September 30, 2007 based upon an effective tax rate of 32.5% and 31.9%, respectively, compared to an effective tax rate of 38.6% for the comparable periods in 2006. The lower rate in the three and nine months ended September 30, 2007 resulted from a permanent book to tax difference related to the disqualifying disposition upon the exercise of incentive stock options. The lower rate in the nine months ended September 30, 2007 was also due to a $141,000 tax benefit from additional net operating loss carryforwards determined to be available to the Company.

At September 30, 2007, we had a valuation allowance on deferred tax assets of approximately $57,000, which represents the portion of certain state net operating loss (NOL) carryforwards that will more likely than not expire unused in future years. Should operating results in 2007 and future years differ from expectations, the valuation allowance against the NOL carryforwards and the related deferred tax asset may require adjustment in future periods.

Liquidity and Capital Resources

Our working capital requirements have been funded primarily by various combinations of operations and cash received from debt financing. Cash and cash equivalents were $2.0 million at September 30, 2007 compared to $1.3 million at December 31, 2006.

Net cash provided by operating activities was $9.1 million for the nine months ended September 30, 2007 compared to $6.7 million for the same period of 2006. This increase was primarily due to an improvement in our operating results with only a minimal corresponding cash payment of income taxes. We experienced an increase in accounts payable and accrued expenses, primarily due to the timing of scheduled payments, which was offset by a larger increase in our trade receivables from December 31, 2006 to September 30, 2007 compared to December 31, 2005 to September 30, 2006. The significant increase in accounts receivable at September 30, 2007 was primarily due to strong August and September, 2007 sales and the timing of cash receipts.

Net cash used in investing activities, consisting primarily of capital expenditures, was $6.4 million for the nine months ended September 30, 2007 compared to $3.1 million for the same period of 2006. These expenditures consisted of equipment purchased and costs incurred to continue to improve efficiencies and reduce operating costs within our Laboratory Services and Product Sales businesses. In addition, in the first nine months of 2007, we invested in instrumentation and capacity in our clinical trials services business.

Net cash used in financing activities was $1.9 million for the nine months ended September 30, 2007, compared to $4.1 million in the prior year period. The change was primarily due to the refinancing of a portion of our mortgage loan in March 2006 (see below).

In the first nine months of 2007, we repurchased 32,929 shares of our common stock in the open market and 33,774 shares of our common stock from an officer and director of our Company for a combined total cost of $1.1 million. The shares repurchased were used to fund our Long-Term Incentive Plan. In the first nine months of

2006, we repurchased a total of 115,463 shares at a cost of $1.1 million. Of the total shares repurchased, 82,550 shares were acquired in the open market at a cost of $0.8 million and contributed to our Long-Term Incentive Plan. The remaining 32,913 shares were repurchased in the open market at a cost of $0.3 million and are being held in treasury.

In March of 2006, we refinanced a portion of our mortgage loan. On March 16, 2006, we entered into a Term Note (the "Note") with the Wells Fargo Bank, National Association (the "Bank") to refinance, on March 31, 2006, a portion of the outstanding balance of $5.4 million on our mortgage loan with Principal Life Insurance Company ("Principal"). We financed the March 2001 purchase of the building complex, where our Laboratory Services segment and other commercial tenants are located, with the mortgage loan from Principal. The mortgage loan had a term of ten years and was being repaid based on a 20 year amortization schedule at a fixed interest rate of 7.23% for the first five years. In accordance with the provisions of the mortgage loan, Principal had the option to adjust the interest rate, effective March 1, 2006, or to call the loan due on March 31, 2006. We elected not to accept the interest rate adjustment and refinanced $3.4 million with the Bank over a five year term in monthly installments of approximately $56,000 plus interest, commencing May 1, 2006. Interest is calculated at either (i) a variable rate of 0.5% below the prime rate or (ii) a fixed rate of 1.9% above LIBOR in effect on the first day of the applicable fixed rate term. We paid the remaining outstanding mortgage loan balance of approximately $2.0 million using approximately $1.8 million of our Line of Credit and $0.2 million of cash.

We are party to a credit security agreement (the "Wells Fargo Credit Agreement") with the Bank. The Wells Fargo Credit Agreement, as amended through September 30, 2007, consists of:

(i) a revolving line of credit ("Line of Credit"), payable on demand, of up to $8.0 million bearing interest at either a fluctuating rate of 0.5% below the Bank’s prime rate or at a fixed rate of 1.9% above LIBOR, as defined and calculated by the Bank, in effect on the first day of the applicable fixed rate term; and

(ii) a note or notes aggregating up to $2.0 million (loan limit) for the purchase of capital equipment bearing interest at either a rate of 0.25% below the Bank’s prime rate or at a fixed rate for a period of one, two, three, or four years at a rate of 2.25% in excess of the then current yield on U.S. Treasury Securities, adjusted to a constant maturity equal to such fixed rate period.

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 0.125% 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 Agreement also requires us to comply with certain financial covenants, including maintaining, on a consolidated basis:

•	A Current Ratio not less than 1.3 to 1.0 at any time, with “Current Ratio” defined as total current assets divided by total current liabilities.

•	Tangible Net Worth not less than $22,500,000 at any time, with “Tangible Net Worth” defined as the aggregate of total stockholders’ equity plus subordinated debt less any intangible assets.

•	Total Liabilities divided by Tangible Net Worth not greater than 1.75 to 1.0 at any time, with “Total Liabilities” defined as the aggregate of current liabilities and non-current liabilities less subordinated debt, and with “Tangible Net Worth” as defined above.

•

A Debt Service Coverage Ratio not less than 1.5 to 1.0 as of each fiscal quarter end, determined on a rolling four-quarter basis, with “Debt Service Coverage Ratio” defined as the aggregate of net income before non-cash tax expense plus depreciation expense and amortization expense, divided by the aggregate of the current maturity of long-term debt for the previous four fiscal quarters plus current capital lease obligations for the previous four fiscal quarters.

On July 31, 2007, we entered into the Second Amendment to the Credit Agreement with the Bank, which modifies certain terms and conditions of the Wells Fargo Credit Agreement and removes the financial covenant limiting capital expenditures to $5.0 million in any fiscal year.

On October 25, 2007, we entered into the Third Amendment to the Credit Agreement with the Bank, which modifies certain terms and conditions of the Wells Fargo Credit Agreement as follows:

•	Extends the last day on which the Bank will make advances under the line of credit and the capital equipment note from November 1, 2007 to November 1, 2009.

•	Increases the loan limit for the purchase of capital equipment from $2.0 million to $4.9 million.

•	Removes the financial covenant requiring the maintaining of a current ratio of not less than 1.3 to 1.0 at any time.

•	Increases the financial covenant requiring a tangible net worth of not less than $22,500,000 at any time to $30,000,000 at any time.

We are relying on expected positive cash flows from operations and our Line of Credit to fund our future working capital and asset purchases. At September 30, 2007, we had total borrowing capacity of $8.0 million on our line of credit. We did not have an outstanding balance on our line of credit at September 30, 2007. The outstanding balance on our line of credit at June 30, 2007 of $0.9 million was repaid during the three month period ended September 30, 2007.

In the short term, we believe that the aforementioned resources will be sufficient to fund our planned operations through 2007. While there can be no assurance that the available capital will be sufficient to fund our future operations beyond 2007, we believe that future profitable operations, as well as access to additional capital through debt or equity financings, will be the primary means for funding our operations for the long term.

We continue to follow a plan which includes (i) aggressively monitoring and controlling costs, (ii) increasing revenues from sales of the our existing products and services, (iii) developing new products and services, as well as (iv) selectively pursuing synergistic acquisitions to increase our critical mass. However, there can be no assurance that costs can be controlled, revenues can be increased, financing may be obtained, acquisitions successfully consummated, or that we will be profitable.

Disclosures about Contractual Obligations and Commercial Commitments

The following table aggregates all contractual commitments and commercial obligations that affect the Company’s financial condition and liquidity position as of September 30, 2007:

	Payments Due by Period
(In thousands)	Total	Less than 1 year	1-3 years	4-5 years	More than 5 years

Long-term debt (1)	$ 2,021	$ 794	$ 1,227	$ -	$ -

Capital lease obligations (1)	6	6	-	-	-

Operating leases	4,699	766	1,875	996	1,062

Total contractual obligations	$ 6,726	$ 1,566	$ 3,102	$ 996	$ 1,062

(1)	Amounts include interest payments based upon contractual or prevailing interest rates.

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 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.

Impact of New Accounting Standards

at specified election dates, to measure eligible financial instruments at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for us as of January 1, 2008. We have not yet evaluated the impact of adopting SFAS No. 159 on our financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurement. Where applicable, SFAS No. 157 simplifies and codifies fair value related guidance previously issued within generally accepted accounting principles. Although this Statement does not require any new fair value measurements, its application may, for some entities, change current practice. SFAS No. 157 is effective for us as of January 1, 2008. We are currently in the process of evaluating the impact of the adoption of SFAS No. 157.

Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material changes in our market risk during the quarter ended September 30, 2007. For additional information refer to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2006.

Item 4: CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls Procedures

As of the end of the period covered by this report, we conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information that is required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms.

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.

PART II OTHER INFORMATION

ITEM 1

LEGAL PROCEEDINGS.

Inapplicable

ITEM 1A

RISK FACTORS. There have been no material changes to our risk factors during the three and nine months ended September 30, 2007. For additional information refer to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2006.

ITEM 2

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. Inapplicable

ITEM 3

DEFAULTS UPON SENIOR SECURITIES. Inapplicable

ITEM 4

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Inapplicable

ITEM 5

OTHER INFORMATION. On October 25, 2007, MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. entered into the Third Amendment to the Credit Agreement with Wells Fargo Bank, National Association (the “Bank”). The Third Amendment modifies certain terms and conditions of the Wells Fargo Credit Agreement as follows:

•

Extends the last day on which the Bank will make advances under the line of credit and the capital equipment note from November 1, 2007 to November 1, 2009.

•

Increases the loan limit for the purchase of capital equipment from $2.0 million to $4.9 million.

•

Removes the financial covenant requiring the maintaining of a current ratio of not less than 1.3 to 1.0 at any time.

•

Increases the financial covenant requiring a tangible net worth of not less than $22,500,000 at any time to $30,000,000 at any time.

The foregoing description of the Third Amendment is qualified by the provisions of the Third Amendment, which is filed herewith as Exhibit 10.30 and incorporated herein by reference.

ITEM 6

EXHIBITS. See Exhibit Index on page following signature page

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	October 30, 2007
Richard J. Braun	Chairman of the Board of Directors (Principal Executive Officer)

/s/ Kevin J. Wiersma	Vice President and Chief Financial Officer	October 30, 2007
Kevin J. Wiersma	(Principal Financial Officer)

/s/ Steven J. Schmidt	Vice President, Finance	October 30, 2007
Steven J. Schmidt	(Principal Accounting Officer)

EXHIBIT INDEX

MEDTOX SCIENTIFIC, INC.

FORM 10-Q FOR QUARTER ENDED SEPTEMBER 30, 2007

Exhibit

Number

Description

3.1

Bylaws of the Registrant, as amended. (Incorporated by reference to exhibit 3.1 filed with the Registrant’s Report on Form 10-K dated December 31, 2005).

3.2

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

3.3

Amended Certificate of Designations of Preferred Stock (Series A Convertible Preferred Stock) of the Registrant, filed with the Delaware Secretary of State on January 29, 1996 (incorporated by reference to Exhibit 3.1 filed with the Registrant’s report on Form 8-K dated January 30, 1996).

4.1

Rights Agreement dated September 18, 1998 between the Registrant and American Stock Transfer & Trust Company (incorporated by reference to Exhibit 4.1 filed with the Registrant’s Report on Form 8-K dated September 21, 1998).

10.1

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

10.2

Agreement regarding rights to “MEDTOX” name dated as of January 30, 1996 between the Registrant and Harry G. McCoy. (Incorporated by reference to Exhibit 10.38 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 1995.)**

10.3

Registrant’s Restated Equity Compensation Plan dated May 10, 2000. (Incorporated by reference to exhibit 10.46 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2000.)**

10.4

Purchase and Sale Agreement dated July 27, 2000 by and between the Registrant and NMRO, Inc. (Incorporated by reference to exhibit 10.48 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2000).

10.5

Registration Rights Agreement dated July 31, 2000 among the Registrant, certain investors, and Miller, Johnson, & Kuehn, Inc. (“MJK”). (Incorporated by reference to exhibit 10.50 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2000).**

10.6

Purchase and Sale Agreement dated December 29, 2000 by and between MEDTOX Laboratories, Inc. and PHL-OPCO, LP. (Incorporated by reference to exhibit 10.52 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2000).

10.7

Employment Agreement dated January 1, 2003, between the Registrant and Richard J. Braun. (Incorporated by reference to exhibit 10.59 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2002).**

10.8

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

10.9

Purchase and Sale Agreement dated July 1, 2003 by and between MEDTOX Laboratories, Inc. and CoxHealth. (Incorporated by reference to exhibit 10.26 filed with the Registrant’s Report on Form 10-K for the fiscal year ended December 31, 2003).

10.10

Registrant’s Supplemental Executive Retirement Plan dated December 21, 2004. (Incorporated by reference to exhibit 10.2 filed with the Registrant’s Report on Form 8-K dated December 22, 2004).**

10.11

Registrant’s Long-Term Incentive Plan as Amended dated July 27, 2005. (Incorporated by reference to exhibit 10.1 filed with the Registrant’s Report on Form 8-K dated July 28, 2005).**

10.12

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

10.13

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

10.14

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

10.15

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

10.16

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

10.17

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

10.18

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

10.19

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

10.20

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

10.21

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

10.22

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

10.23

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

10.24

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

10.25

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

10.26

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

10.27

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

10.28

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

10.29

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

10.30

Third Amendment to Credit Agreement between MEDTOX Scientific, Inc., MEDTOX Diagnostics, Inc., and MEDTOX Laboratories, Inc. and Wells Fargo Bank dated October 25, 2007. *

31.1

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

31.2

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

32.1

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

32.2

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

Filed herewith

Denotes a management contract or compensatory plan or arrangement