-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B1EhPC1otvFfgvdkQVZwSw6II8rVbAgkN8ZeYmjC1/DsR0uXXZkaqrr4fUKTYCdL haRK7pUoVQpmgOSK6aRZaw== 0000739944-99-000006.txt : 19990415 0000739944-99-000006.hdr.sgml : 19990415 ACCESSION NUMBER: 0000739944-99-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MEDTOX SCIENTIFIC INC CENTRAL INDEX KEY: 0000739944 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 953863205 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-11394 FILM NUMBER: 99593818 BUSINESS ADDRESS: STREET 1: 402 WEST COUNTY ROAD D CITY: ST PAUL STATE: MN ZIP: 55112 BUSINESS PHONE: 6126367466 MAIL ADDRESS: STREET 1: 402 WEST COUNTY ROAD D CITY: ST PAUL STATE: MN ZIP: 55112 FORMER COMPANY: FORMER CONFORMED NAME: EDITEK INC DATE OF NAME CHANGE: 19940902 FORMER COMPANY: FORMER CONFORMED NAME: ENVIRONMENTAL DIAGNOSTICS INC DATE OF NAME CHANGE: 19920703 10-K 1 1998 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] 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 Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $.15 per share (Title of Class) Securities registered pursuant to Section 12(g) of the Act: None 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-0K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of Common Stock of the Registrant, $.15 par value ("Common Stock"), held by non-affiliates of the Registrant is approximately $11,250,000, as of March 23, 1999, based upon a price of $3.875 which price is equal to the closing price for the Common Stock on the American Stock Exchange. The number of shares of Common Stock outstanding as of March 23, 1999, was 2,903,102. This document contains 67 pages and the Exhibit Index appears at page 39 hereof. MEDTOX SCIENTIFIC, INC. FORM 10-K ANNUAL REPORT FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 Table of Contents ITEM NO. PAGE Part I 1. Business. . . . . . . . . . . . . . . . . . . . . 4 2. Properties. . . . . . . . . . . . . . . . . . . . 11 3. Legal Proceedings . . . . . . . . . . . . . . . . 12 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . 12 Part II 5. Market for the Registrant's Common Equity and Related Stockholder Matters. . . . . . . . . 13 6. Selected Financial Data . . . . . . . . . . . . . . 15 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . . . . . . . . . 16 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . 24 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure . . . . . . . . . . . . . . 24 Part III 10. Directors and Executive Officers of the Registrant. . . . . . . . . . . . . . . . . . 26 11. Executive Compensation. . . . . . . . . . . . . . . . 27 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . . . 32 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . 33 Part IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. . . . . . . . . . . . . . 34 Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . 40 PART I Cautionary Statement Identifying Important Factors That Could Cause the Company's Actual Results to Differ From Those Projected in Forward Looking Statements In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, readers of this document and any document incorporated by reference herein, are advised that this document and documents incorporated by reference into this document contain both statements of historical facts and forward looking statements. Forward looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those indicated by the forward looking statements. Examples of forward looking statements include, but are not limited to (i) projections of revenues, income or loss, earning or loss per share, capital expenditures, dividends, capital structure and other financial items, (ii) statements of the plans and objectives of the Company or its management or Board of Directors, including the introduction of new products, or estimates or predictions of actions by customers, suppliers, competitors or regulatory authorities, (iii) statements of future economic performance, and (iv) statements of assumptions underlying other statements and statements about the Company or its business. This document and any documents incorporated by reference herein also identify important factors which could cause actual results to differ materially from those indicated by the forward looking statements. These risks and uncertainties include price competition, the decisions of customers, the actions of competitors, the effects of government regulation, possible delays in the introduction of new products, customer acceptance of products and services, and other factors which are described herein and/or in documents incorporated by reference herein. The cautionary statements made pursuant to the Private Litigation Securities Reform Act of 1995 above and elsewhere by the Company should not be construed as exhaustive or as any admission regarding the adequacy of disclosures made by the Company prior to the effective date of such Act. Forward looking statements are beyond the ability of the Company to control and in many cases the Company cannot predict what factors would cause results to differ materially from those indicated by the forward looking statements. ITEM 1. BUSINESS. 1. General. MEDTOX Scientific, Inc. (formerly EDITEK, Inc.), a Delaware corporation, was organized in September, 1986 to succeed the operations of a predecessor California corporation. MEDTOX Scientific, Inc. and its subsidiaries, MEDTOX Laboratories, Inc. and MEDTOX Diagnostics, Inc., are referred to herein as "the Company". MEDTOX Laboratories, Inc. is a toxicology laboratory which provides forensic toxicology, clinical toxicology, and heavy metals analyses. MEDTOX Diagnostics, Inc. develops, manufactures and markets on-site diagnostic and screening tests which are used to detect substances in humans, foodstuffs, animals, feed and the environment. The company is continuing to transition these operating units from being providers of high quality testing services and devices into a broader service organization by supporting underlying laboratory analysis and point-of-care devices with logistics management, data management and overall program management services. The Company entered the laboratory business on February 11, 1994 when it completed the acquisition of Princeton Diagnostic Laboratories of America, Inc. ("PDLA"). On January 30, 1996, the Company acquired the assets and certain liabilities of the predecessor of MEDTOX Laboratories, Inc. MEDTOX Laboratories, Inc. is now a wholly owned subsidiary. For the fiscal year ended December 31, 1998, sales from laboratory services accounted for 92% of the Company's revenues. Revenue from the sale of the Company's on-site diagnostic and screening tests and other products, including contract manufacturing services, accounted for 8% of the total revenues of the Company for the year ended December 31, 1998. 2. Principal Services, Products, and Markets. General. The Company has two reportable segments: laboratory services and products sales. Laboratory services include forensic toxicology, clinical toxicology, and heavy metal analyses as well as logistics, data, and overall program management services. Manufactured products include a variety of on-site screening products. Laboratory Services A. Employment Drug Testing Laboratory Services. The primary source of revenues of the Company is the provision of laboratory testing services for the identification of drugs of abuse. These tests are conducted using methodologies such as various immunoassays, gas liquid chromatography, and gas chromatography/mass spectrometry. MEDTOX Laboratories, Inc. was one of the charter laboratories to be certified by the federal government to perform mandated drug testing on regulated employees. It pioneered security and chain of custody procedures, including sample bar coding as well as stereospecific confirmation methods that assist in maintaining the integrity of the specimens and the confidentiality of the test results. The Company's customers for abused substance testing include public and private corporations. Among this customer base are Fortune 500 companies. In addition to public and private corporations, abused substance testing is also conducted on behalf of service firms such as drug treatment counseling centers, occupational health clinics, third party administrators and hospitals. B. Clinical Toxicology. The Company has a fully certified clinical toxicology reference laboratory specializing in esoteric therapeutic drug monitoring and emergency toxicology. The tests performed in the clinical laboratory are conducted using methodologies such as various immunoassays, gas liquid chromatography, high performance liquid chromatography, gas chromatography/mass spectrometry and tandem mass spectrometry. The Company performs the analyses of many classes of drugs including: analgesic, antianxiety, anticholinergic, anticoagulant, anticonvulsant, antidepressant, antidiabetic, antiemetic, antihistamine, antiinflammatory, antimicrobial, antipsychotic, bronchodilator, cardiovascular, stimulant, decongestant, immunosuppressant, local anesthetic, muscle relaxant, narcotic analgesic, and sedative medications. The Company's clients for this market consist of hospitals, clinics and other laboratories. Laboratory specimens are delivered to MEDTOX from clients across the country both by the Company's own couriers, contracted delivery services and commercial overnight couriers. C. Heavy metal, trace element, and solvent analyses. The Company operates a laboratory in which blood and urine are tested for heavy metals, trace elements, and solvents. The tests are performed using the methodologies such as Flame and Flameless Atomic Absorption, Inductively Coupled Plasma-Mass Spectrometry, and Gas Chromatography. The Company's clients for this market are other laboratories, occupational health clinics and companies which need to test patients or employees monitored for excess exposure to hazardous materials. D. Logistics, Data, and Program Management Services. The Company also provides services in the areas of logistics management, data management, and program management. These services support the Company's underlying business of laboratory analysis and provide added value to its clients. Value-added services include courier services for medical specimen transportation, management programs for on-site drug testing, data collection and reporting services, coordination of specimen collection sites, and medical surveillance program management. Product Sales The Company's test products are easy to use, inexpensive, point-of-care tests. The tests are capable of rapidly detecting the presence of a number of substances in human urine or blood samples, foodstuffs, animals, feed and the environment without the necessity of instruments or technical personnel. In 1998, the Company received FDA 510(k) clearance on the first of its second-generation on- site test products, PROFILE(R)-II. PROFILE(R)-II, is a five-drug lateral flow device for the detection of drugs-of-abuse in human urine. This single-step, immunoassay device has been combined with the company's Data Delivery System and laboratory confirmation capability to produce the PROFILE(R)-II Test System. This integrated on-site testing system is currently being marketed to occupational health clinics, corporate clients, third party administrators, and drug abuse counseling and treatment centers. In addition to the PROFILE(R)-II, the Company's second-generation products also include VERDICT(R)-II on-site screening devices. VERDICT(R)-II products are manufactured in one, two and three drug configurations. Target markets include criminal justice, temporary service companies, the construction industry and drug rehabilitation facilities. The Company continues to market the EZ-SCREEN(R) tests. These tests are qualitative assays utilized in agricultural diagnostics to detect mycotoxins and antibiotic residues. Mycotoxins are hazardous substances produced by fungal growth and frequently contaminate corn, wheat, rye, barley, peanuts, tree nuts, cottonseed, milk, rice, and livestock feeds. The EZ-SCREEN agridiagnostic tests are marketed to regulatory authorities and producers of foodstuffs and feeds. The Company distributes on-site tests for the detection of alcohol with the EZ-SCREEN(R) Breath Alcohol Test. The test consists of a small tube containing chemically treated crystals that change color in the presence of alcohol. The Company purchases the Breath Alcohol Test through a distribution agreement. 3. Marketing and Sales. The Company believes that the combined operations of the laboratory services and the on-site test kits manufactured by the Company have created synergy in the marketing of comprehensive, on-site and laboratory testing programs to a common customer base. The Company is in a position to offer a full line of products and services for the substance abuse testing and occupational medicine marketplace, including (1) on-site tests for the detection of substance of abuse drugs (2) on-site qualitative and quantitative determination of alcohol intoxication (both disposable and electronic instrument detection devices); (3) SAMHSA certified laboratory testing (screening and confirmation); (4) biological monitoring of occupational toxins; (5) consultation; and (6) logistic, data management and program management services. The Company currently markets these products and all laboratory services through its dedicated sales force, through independent third party administrators and through occupational health clinics. Major Customers. The Company had no single customer whose sales amounted to more than 10% of its total revenues during the year ended December 31, 1998. One customer's sales amounted to approximately 7% of the revenues of MEDTOX Laboratories, Inc. while sales to the United States government and its agencies, primarily the United States Department of Agriculture ("USDA"), amounted to approximately 4% of the revenues from MEDTOX Diagnostics, Inc. 4. New Products, Research and Development. Product Sales. Primary research and development efforts of the Company during 1998 focused on the development of tests to extend the product offerings in the single-step Profile(R)-II immunochromatographic assay product line produced by the Company. These product line extensions include Verdict(R)-II intended for the criminal justice market and Profile(R)-ER intended for the emergency room market. Verdict(R)-II consists of a line of simplified Profile(R)-II devices designed to test for the drugs that the criminal justice system is primarily concerned with today. MEDTOX has begun to market the Verdict(R)-II tests, with good acceptance, to distributors in this market. Profile(R)-ER is an expanded product which tests for additional drugs, compared to Profile(R)-II. The added drugs are especially pertinent in the rule-out diagnosis of suspected toxic drugs in emergency room settings. MEDTOX hopes to submit Profile(R)-ER for FDA-clearance at the end of the second quarter 1999. Laboratory Services. The research and development department of MEDTOX Laboratories develops new assays for new drug entities, develops new assays for existing metabolites of drugs and other toxins, and improves existing assays with the goals of improving the assays' robustness, sensitivity, accuracy, precision, specificity, and cost. Numerous new laboratory-based assays were developed during 1998 using immunochemistry, liquid chromatography (LC), gas chromatography (GC), gas chromatography with mass spectrometry (GC/MS), atomic absorption (AA), inductively coupled plasma mass spectrometry (ICP/MS), and tandem mass spectrometry (LC/MS/MS). During 1999 we plan to add gas chromatography with tandem mass spectrometry (GC/MS/MS) as well. The many new tests developed during 1998 expand our capabilities in the esoteric reference clinical toxicology market (providing sophisticated testing for hospitals and other reference laboratories), expand our capabilities and laboratory services in biological monitoring of toxins in the workplace, expand our capabilities of detecting drugs of abuse for clinical and workplace analysis, and also expand our capabilities in pharmaceutical research analysis. During 1998, MEDTOX developed a medical diagnostic laboratory to service multi-site clinical trials for the pharmaceutical industry and also provide broader services to our industrial toxicology and occupational medicine clients. Business generated by these expanded laboratory services to industrial clients is already becoming significant, while we have also received initial contracts for servicing clinical trials. Significant developmental progress was also made during 1998 for our new line of nutritional assays which include analysis of vitamins, amino acids, trace elements, measures of oxidative stress, and activities of free radical scavenging enzymes. This work allows us to assess an individual's level of oxidative stress, their ability to overcome that oxidative stress, any nutritional deficiencies, and monitor supplementation to improve their ability to overcome that stress. This area of testing is being shown to be important in the detection of susceptibility to cancers, cardiac diseases, dementias, macular degeneration, and is related to the development of serious adverse effects of drugs. 5. Raw Materials. Laboratory Services. The raw materials required by the laboratory for urine drug testing consist primarily of two types: specimen collection supplies and reagents for laboratory analysis. The collection supplies include Drug Testing Custody and Control Forms that identify the specimen and the client, as well as document the chain-of-custody. Collection supplies also consist of specimen bottles and shipping boxes. Reagents for drug testing are primarily immunoassay screening products and various chemicals used for confirmation testing. The Company believes all of these materials are available at competitive prices from other suppliers. Product Sales. The primary raw materials required for the immunoassay-based test kits produced by the Company consist of antibodies, antigens and other reagents, plastic injection-molded devices, glass fiber, nitrocellulose filter materials, and packaging materials. The Company maintains an inventory of raw materials which, to date, has been acquired primarily from third parties. Currently, most raw materials are available from several sources. The Company possesses the technical capability to produce its own antibodies and has initiated production of antibodies for certain tests. However, if the Company were to change its source of supply for raw materials used in a specific test, additional development, and the accompanying costs, may be required to adapt the alternate material to the specific diagnostic test. 6. Patents, Trademarks, Licensing and Other Proprietary Information. Product Sales. The Company has a patent pending on the system that it developed which integrates on-site scientific analysis with state-of-the-art data collection and delivery. The system is currently being utilized with the Company's PROFILE(R)-II and Verdict(R)-II products. The Company holds nine issued United States patents relating to on-site testing technology. Eight of these patents generally form the basis for the EZ-SCREEN and one-step technologies while the other patent relates to methods of utilizing whole blood as a sample medium on its immunoassay devices. Of the eight U.S. patents mentioned above which generally form the basis for the EZ-SCREEN and one-step technologies, one expires in 2000, one expires in 2004, five expire in 2007, and one expires in 2010. The patent which relates to the methods of utilizing whole blood as a sample medium expires in 2012. There can be no guarantee that there will not be a challenge to the validity of the patents. In the event of such a challenge, the Company might be required to spend significant funds to defend its patents, and there can be no assurance that the Company would be successful in any such action. Laboratory Services. The Company believes that the basic technologies requisite to the production of antibodies are in the public domain and are not patentable. The Company intends to rely upon trade secret protection of certain proprietary information, rather than patents, where it believes disclosure could cause the Company to be vulnerable to competitors who could successfully replicate the Company's production and manufacturing techniques and processes. General. The Company holds approximately 15 registered trade names and/or trademarks in reference to its products and corporate names. The trade names and/or trademarks of the Company range in duration from 10 years to 20 years with expiration dates ranging from 2001 to 2008. Applications have also been made for additional trade names. 7. Seasonality. Laboratory Services. 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 summer months, 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 flow. Product Sales. The Company does not believe that seasonality is a significant factor in sales of its on-site immunoassay tests. 8. Backlog. Laboratory Services. There exists a delay in recognition of revenues when setting up new accounts for laboratory services. The time from when an account becomes a client of the Company to the time the laboratory starts receiving specimens may be up to four months. The delay in receiving samples is primarily due to the necessity of establishing communication capabilities between the client and the laboratory, the requirement to ship out collection kits and forms, and the establishment of a collection site network. At December 31, 1998, the Company did have several accounts which were in the process of being set up where revenues are expected to be realized in 1999. Product Sales. At December 31, 1998, MEDTOX Diagnostics, Inc. did not have any significant backlog and normally does not have any significant backlog. The Company does not believe that sales backlog is a significant factor in its business. 9. Competition. Laboratory Services. Competition in the area of drugs of abuse testing is intense. Competitors and potential competitors include forensic testing units of large clinical laboratories, such as Laboratory Corporation of America Holdings, Quest Diagnostics, Inc. and SmithKline Laboratories, Inc. and other independent laboratories, specialized laboratories, and in-house testing facilities maintained by hospitals. Competitive factors include reliability and accuracy of tests, price structure, service, transportation and collection networks and the ability to establish relationships with hospitals, physicians, and users of drug abuse testing programs. It should be recognized, however, that many of the competitors and potential competitors have substantially greater financial and other resources than the Company. The industry in which the Company competes is characterized by service issues including, turn-around time of reporting results, price, the quality and reliability of results, and an absence of patent or other proprietary protection. In addition, since tests performed by the Company are not protected by patents or other proprietary rights, any of these tests could be performed by competitors. However, there are proprietary assay protocols for the more specialized testing that are unique to the Company. The Company's ability to successfully compete in the future and maintain it margins will be based on its ability to maintain its quality and customer service strength while maintaining efficiencies and low cost operations. There can be no assurance that price competitiveness will not increase in importance as a competitive factor in the laboratory testing business. Product Sales. The diagnostics market has become highly competitive with respect to the price, quality and ease of use of various tests and is characterized by rapid technological and regulatory changes. The Company has designed its on-site tests as inexpensive, on-site tests for use by unskilled personnel, and has not endeavored to compete with laboratory-based systems. Numerous large companies with greater research and development, marketing, financial, and other capabilities, as well as government-funded institutions and smaller research firms, are engaged in research, development and marketing of diagnostic assays for application in the areas for which the Company produces its products. The Company has experienced increased competition with respect to its immunoassay 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, the Company has experienced increased price competition. A further increase in competition may have a material adverse effect on the business and future financial prospects of the Company. 10. Government Regulations. The products and services of the Company are subject to the regulations of a number of governmental agencies as listed below. It is believed that the Company is currently in compliance with all regulatory authorities. The Company cannot predict whether future changes in governmental regulations might significantly increase compliance costs or adversely affect the time or cost required to develop and introduce new products. 1. Substance Abuse and Mental Health Services Administration (SAMHSA). MEDTOX Laboratories, Inc. has been certified by SAMHSA since 1988. SAMHSA certifies laboratories meeting strict standards under Subpart C of Mandatory Guidelines for Federal Workplace Drug Testing Programs. Continued certification is accomplished through periodic inspection by SAMHSA to assure compliance with applicable regulations. 2. United States Food and Drug Administration (FDA). Certain tests for human diagnostic purposes must be cleared by the FDA prior to their marketing for in vitro diagnostic use in the United States. The FDA regulated products produced by the Company are in vitro diagnostic products subject to FDA clearance through the 510(k) process which requires the submission of information and data to the FDA that demonstrates that the device to be marketed is substantially equivalent to a currently marketed device. This data is generated by performing clinical studies comparing the results obtained using the Company's device to those obtained using an existing test product. Although no maximum statutory response time has been set for review of a 510(k) submission, as a matter of policy the FDA has attempted to complete review of 510(k) submissions within 90 days. To date, the Company has received 510(k) clearance for 12 different products and the average time for clearance was 72 days with a maximum of 141 days and a minimum of 20 days. Products subject to 510(k) regulations may not be marketed for in vitro diagnostic use until the FDA issues a letter stating that a finding of substantial equivalence has been made. As a registered manufacturer of FDA regulated products, the Company is subject to a variety of FDA regulations including the Good Manufacturing Practices (GMP) regulations which define the conditions under which FDA regulated products are to be produced. These regulations are enforced by FDA and failure to comply with GMP or other FDA regulations can result in the delay of premarket product reviews, fines, civil penalties, recall, seizures, injunctions and criminal prosecution. 3. Health Care Financing Administration (HCFA). The Clinical Laboratory Improvement Act (CLIA) introduced in 1992 requires that all in vitro diagnostic products be categorized as to level of complexity. A request for CLIA categorization of any new clinical laboratory test system must be made simultaneously with FDA 510(k) submission. The EZ-SCREEN and VERDICT drugs of abuse tests currently marketed by MEDTOX Diagnostics, Inc. have been categorized as moderately complex. The complexity category to which a clinical laboratory test system is assigned may limit the number of laboratories qualified to use the test system thus impacting product sales. MEDTOX Laboratories, Inc. is a CLIA licensed laboratory. 4. Drug Enforcement Administration (DEA). The primary business of the Company involves either testing for drugs of abuse or developing test kits for the detection of drugs/drug metabolites in urine. MEDTOX Laboratories, Inc. is registered with the DEA to conduct chemical analyses with controlled substances. The MEDTOX Diagnostics, Inc. facility in Burlington, N.C. is registered by the DEA to manufacture and distribute controlled substances and to conduct research with controlled substances. Maintenance of these registrations requires that the Company comply with applicable DEA regulations. 5. Additional Laboratory Regulations. The laboratories of MEDTOX Laboratories, Inc. and certain of its laboratory personnel are licensed or otherwise regulated by certain federal agencies, states, and localities in which it conducts business. Federal, state and local laws and regulations require MEDTOX Laboratories, Inc. among other things, to meet standards governing the qualifications of laboratory owners and personnel, as well as the maintenance of proper records, facilities, equipment, test materials, and quality control programs. In addition, the laboratories are subject to a number of other federal, state, and local requirements which provide for inspection of laboratory facilities and participation in proficiency testing, as well as govern the transportation, packaging, and labeling of specimens tested by either laboratory. The laboratories are also subject to laws and regulations prohibiting the unlawful rebate of fees and limiting the manner in which business may be solicited. The laboratory receives and uses small quantities of hazardous chemicals and radioactive materials in their operations and are licensed to handle and dispose of such chemicals and materials. Any business handling or disposing of hazardous and radioactive waste is subject to potential liabilities under certain of these laws. 11. Product and Professional Liability. Laboratory Services. The Company's laboratory testing services are primarily diagnostic and expose the Company to the risk of liability claims. The Company's laboratories have maintained continuous Professional and General Liability insurance since 1984. The insurance policy covers those amounts the Company is legally obligated to pay from damages resulting from a Medical Incident, which arises out of a Failure to Render Professional Services. To date, the Company has not had any substantial product liability and no material professional service claims are currently pending. Product Sales. Manufacturing and marketing of products by the Company entail a risk of product liability claims. In August, 1993, the Company procured insurance coverage against the risk of product liability arising out of events after such date, but such insurance does not cover claims made after that date based on events that occurred prior to that date. The insurance policy covers damages that the Company is legally obligated to pay as a result from bodily injury and property damage. Consequently, for uncovered claims, the Company could be required to pay any and all costs associated with any product liability claims brought against it, the cost of defense whatever the outcome of the action, and possible settlement or damages if a court rendered a judgment in favor of any plaintiff asserting such a claim against the Company. Damages may include punitive damages, which may substantially exceed actual damages. The obligation to pay such damages could have a material adverse effect on the Company and exceed its ability to pay such damages. No product liability claims are pending. 12. Employees. As of December 31, 1998, the Company had a total of approximately 315 full time employee equivalents as compared to approximately 305 full time employee equivalents at December 31, 1997. Of the approximate 315 employees, 285 work at and for MEDTOX Laboratories, while the remaining 30 work at MEDTOX Diagnostics, Inc. The Company's employees are not covered by any collective bargaining agreements, and the Company has not experienced any work stoppages and the Company considers its relations with its employees to be good. ITEM 2. PROPERTIES. The administrative offices and laboratory operations of MEDTOX Laboratories, Inc. are located in a 45,207 square foot facility in St. Paul, Minnesota. The facility is rented under a lease which expires in March 2002. The current annual rent, excluding operating costs, for the facility is $396,000 per year. The Company leases approximately 33,000 square feet in Burlington, North Carolina, where it maintains the offices, research and development laboratories, production operations, and warehouse of MEDTOX Diagnostics, Inc. The total rent paid by the Company for this site during the fiscal year ended December 31, 1998 was approximately $122,000. These facilities are currently leased from Dr. Samuel C. Powell, a member of the Board of Directors of the Company. The Company is currently leasing the space on a month-to-month basis and intends to negotiate a new lease with Dr. Powell in the near future. The Company believes it is renting these facilities on terms as favorable as those available from third parties for equivalent premises. In the opinion of management, comparable alternative facilities could be obtained without disruption of the business if a new lease with Dr. Powell is not negotiated. See "Item 13 - Certain Relationships and Related Transactions." The Company leases administrative offices and laboratory facilities in an approximately 22,000 square foot facility in South Plainfield, New Jersey. The rent payment, excluding operating costs, is $170,345 per year. The lease runs through April, 2000. The facility is currently idle and the Company is aggressively seeking a tenant to sub-lease the facility. The costs of the facility have been considered in the Company's restructuring charge in 1996. See Note 8 to the Notes of the Consolidated Financial Statements contained herein. The Company believes that its existing facilities are adequate for the purposes being used to accommodate its product development, and manufacturing and laboratory testing requirements. ITEM 3. LEGAL PROCEEDINGS. The Company has entered a settlement agreement with United States Drug Testing Laboratories who asserted a claim of patent infringement against the Company on August 20, 1996. It was alleged that the Company infringes two patents allegedly owned by United States Drug Testing Laboratories relating to forensically acceptable determinations of gestational fetal exposure to drugs and other chemical agents. The Company while denying any infringement has reached a settlement agreement with United States Drug Testing Laboratories whereby the Company will pay United States Drug Testing Laboratories $17,500 and issue United States Drug Testing Laboratories 2,500 shares of common stock. On January 31, 1997, the Company filed suit in Federal District Court in Minnesota against Morgan Capital LLC, David Bistricer and Alex Bistricer alleging violation in Section 16b of the Securities and Exchange Act of 1934 and seeking recovery of more than $500,000 in short-swing profits. Messrs. David and Alex Bistricer are former directors of the Company. On August 4, 1997, the U.S. District Court granted Defendants' motion to dismiss the Company's complaint, ruling that the Defendants' conduct did not constitute a violation of Section 16(b). On October 29, 1997, the Company filed an appeal of that decision to the United States Court of Appeals for the Eighth Circuit. On July 21, 1998, the Eighth Circuit reversed the District Court dismissal and remanded the case to the District Court. Cross motions to dismiss and for partial summary judgment are pending. The Company is a defendant in a lawsuit brought by a previous landlord and pending in the Circuit Court of Cook County, Illinois. The landlord alleges that the Company breached the terms of a lease the Company attempted to issue in connection with an asset acquisition. Discovery is continuing in the case. In December 1998, the Court granted summary judgment against the Company on the issue of liability and the matter is set for trial in June 1999 on the issue of damages. ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS. The Annual Meeting (the "1997 Annual Meeting") of the stockholders of the Company was held on September 11, 1998. The following individuals were elected to serve on the Board of Directors of the Company for the ensuing year and until their respective successors are duly elected and qualified: Harry G. McCoy, Pharm.D., Samuel C. Powell, Ph.D., Richard A. Braun, Miles E. Efron and James W. Hansen. Also by a vote of 2,187,765 shares in favor and 261,334 shares against, at the 1997 Annual Meeting, the stockholders of the Company approved an amendment to Article FOURTH of the Company's Certificate of Incorporation to increase its number of authorized common stock from 3,000,000 shares to 3,750,000 shares. During the year ended December 31, 1998, no other matters were submitted to a vote of securities holders. The Company held a special meeting of stockholders on February 22, 1999 to adopt and approve an amendment of the Company's Certificate of Incorporation providing for a one for twenty reverse stock split of outstanding Common Stock of the Company. The amendment was approved by a vote of 2,309,935 in favor and 162,644 against. The reverse split was effective on February 23, 1999 and the stock began trading on the new basis February 24, 1999. All shares and per share amounts presented in the annual report on Form 10-K have been adjusted to reflect the reverse split. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Common Stock Since September 27, 1993, the Common Stock has been listed on the American Stock Exchange currently trading under the symbol "TOX". From September 16, 1992 to September 26, 1993 the Common Stock was traded in and quoted in the Emerging Company Marketplace of the American Stock Exchange ("ECM") under the trading symbol "EDI.EC". As of March 23, 1999, the number of holders of record of the Common Stock was 2,843. The following tables set forth, for the calendar quarters indicated, the high and low closing price per share for the Common Stock, as reported by the American Stock Exchange. The quotations shown represent inter dealer prices without adjustment for retail markups, markdowns or commissions, do not necessarily reflect actual transactions, and have been adjusted for the 1:20 reverse split which took effect on February 24, 1999. 1999: (through March 23, 1999) High Low ---- ---- ---- First Quarter............................. 4 5/8 2 1/8 1998: High Low ---- ---- ---- First Quarter........................... 7 1/2 5 Second Quarter........................ 8 3/4 5 Third Quarter........................... 8 3/4 5 Fourth Quarter......................... 7 1/2 3 3/4 1997: First Quarter........................... 12 1/2 7 1/2 Second Quarter........................ 10 7 1/2 Third Quarter........................... 10 6 1/4 Fourth Quarter......................... 7 1/2 5 On March 23, 1999, the closing price of the Common Stock as reported by the American Stock Exchange was $3 7/8. No dividends have been declared or paid by the Company since its inception and management of the Company has no plans to pay dividend in the foreseeable future. The Company's financial covenants under its debt instrument may effectively preclude the Company from paying dividends. Series A Preferred Stock To help finance the acquisition of the predecessor to MEDTOX Laboratories, Inc. and provide working capital, the Company issued 407 shares of Series A Preferred Stock in January 1996. There are currently no remaining shares of Series A Preferred Stock outstanding. The Series A Preferred Stock was convertible into shares of Common Stock, at any time from March 30, 1996, the 60th day after the shares of Series A Preferred Stock were first issued by the Company (the "Initial Conversion Date"), until January 30, 1998, the second anniversary of the Initial Preferred Issuance Date, at which time all conversion rights terminated. The Series A Preferred Stock had no voting power and had certain liquidation preference and dividend rights. The number of shares of Common Stock issuable upon conversion of a share of Series A Preferred Stock equaled the number derived by dividing (i) the purchase price of the Series A Preferred Stock ($50,000 per share) by the lesser of (i) $2.775 (based on pre-reverse split market price) or (ii) 75% of the Market Price of the Common Stock on the day the shares of Series A Preferred Stock were converted into Common Stock. "Market Price" is defined for this purpose as the daily average of the closing bid prices quoted on the American Stock Exchange or other exchange on which the Common Stock is traded for the five trading days immediately preceding the date the shares are converted. No dividends on the Series A Preferred Stock were declared or paid prior to their conversion to Common Stock. ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data are derived from financial statements of the Company and should be read in conjunction with the financial statements, related notes, and other financial information included herein. In evaluating financial performance, management focuses on net income as a segment's measure of profit or loss. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (Note 1).
SEGMENT INFORMATION (IN THOUSANDS) 1998 LAB SERVICES PRODUCT SALES TOTAL NET SALES FROM EXTERNAL CUSTOMERS 27,070 2,505 29,575 SEGMENT PROFIT (LOSS) -OPERATING INCOME (1,391) (906) (2,297) EARNINGS PER SHARE (0.79) SEGMENT ASSETS 13,981 10,619 24,600 1997 NET SALES FROM EXTERNAL CUSTOMERS 25,899 2,695 28,594 SEGMENT PROFIT (LOSS) -OPERATING INCOME 430 (405) 25 EARNINGS PER SHARE 0.01 SEGMENT ASSETS 14,269 10,612 24,881 1996 NET SALES FROM EXTERNAL CUSTOMERS 23,541 3,047 26,588 SEGMENT PROFIT (LOSS) -OPERATING INCOME (9,155) (3,653) (12,808) DEEMED DIVIDEND ON PREF STOCK (6,783) EARNINGS PER SHARE (0.59) SEGMENT ASSETS 6,643 17,437 24,080 1995 NET SALES FROM EXTERNAL CUSTOMERS 4,612 2,914 7,526 SEGMENT PROFIT (LOSS) -OPERATING INCOME (2,614) (7,283) (9,897) EARNINGS PER SHARE (0.77) SEGMENT ASSETS 1,751 2,187 3,938 1994 NET SALES FROM EXTERNAL CUSTOMERS 3,775 2,818 6,593 SEGMENT PROFIT (LOSS) -OPERATING INCOME (34) (3,512) (3,546) EARNINGS PER SHARE (0.49) SEGMENT ASSETS 4,573 2,805 7,378
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General The Company commenced operations in June 1983 and until 1986 was a development stage company. The Company became engaged in the manufacture and sale of products as a result of its acquisition of Granite Technological Enterprises, Inc. in June 1986. The Company began the manufacture and sale of its EZ-SCREEN diagnostic tests in 1985 and introduced its patented one-step assay, VERDICT and RECON, in 1993. In February 1994, the Company completed the acquisition of PDLA. In January 1996, the Company completed the acquisition of the predecessor of MEDTOX Laboratories, Inc. The results of operations for the year ended December 31, 1996 include the results of operations of MEDTOX Laboratories, Inc. for the period January 30, 1996 through December 31, 1996. Since inception, the Company has financed its working capital requirements primarily from the sale of equity securities and more recently debt financing. Year ended December 31, 1998 Compared to Year ended December 31, 1997 Laboratory Services Revenues from Laboratory Services for the year ended December 31, 1998 were $27,070,000 as compared to $25,899,000 for the year ended December 31, 1997. The increase of 4.5% was primarily attributable to increase of 16.5% in laboratory samples for employment drug testing services. This increase was due to increased sales from current clients as well as new clients. Revenue from increase in sample volume was partially offset by an 11.3% decrease in average per unit prices. The gross margin from the revenues generated from the laboratory services was 31% for the year ended December 31, 1998 as compared to a gross margin of 37.5% for the same period in 1997. The decline in gross margin was primarily due to increased costs related to implementation of new tests and a decrease in the average selling price per laboratory sample. The decrease in average realized selling price was partially offset by savings realized from cost savings and improvements in the efficiency of laboratory operations. Selling, general and administration expenses for the year ended December 31, 1998 were $7,929,000, compared to $7,780,000 for the year ended December 31, 1997. The increase of $149,000 or 2% in 1998 was the result of increased costs in several areas including; $379,000 in increased depreciation expense, $133,000 in increased group insurance costs, a $123,000 increase in computer information systems expense, and severance expenses totaling $167,000 related to staff resizing. These increases were partially offset by savings of $564,000 realized from reduced sales and marketing expenses due to a restructuring of the sales and marketing group and an overall effort to reduce and monitor costs. Research and development expenses incurred during the year ended December 31, 1998 were $522,000 as compared to $502,000 for the same period in 1997. This increase of $20,000 was primarily the result of increased in personnel costs due to scheduled salary increases. The Company periodically undertakes a review of the value of the remaining goodwill associated with the acquisition of MEDTOX Laboratories, Inc., to determine if the value is supported by the projected future undiscounted cash flows. Utilizing an undiscounted cash flow analysis, the Company determined that the carrying value of the remaining goodwill associated with the MEDTOX Laboratories, Inc. acquisition is supported by the projected cash flows at December 31, 1998. The Laboratory Services segment for the year ended December 31, 1998, incurred interest and financing costs of $615,000, compared to costs of $609,000 incurred during the year ended December 31, 1997. The Company's restructuring reserve increased by $712,000 for the year ended December 31, 1998 as compared to the period ended December 31, 1997. The increase in the reserve was due to an increase in the projected litigation and settlement expenses relating to a lawsuit brought by a previous landlord and pending in the Circuit Court of Cook County, Illinois. The landlord alleges that the Company breached the terms of a lease the Company attempted to issue in connection with an asset acquisition. Discovery is continuing in the case. In December 1998, the Court granted summary judgment against the Company on the issue of liability and the matter is set for trial in June 1999 on the issue of damages. As a result of the above, the net loss for the Laboratory Services segment of the Company for the year ended December 31, 1998 was ($1,391,000), compared to the net income of $430,000 for the year ended December 31, 1997. Product sales Revenues from Product Sales for the year ended December 31, 1998 decreased 7.1% to $2,505,000 as compared to $2,695,000 for the year ended December 31, 1997. The decrease was primarily attributable to decreased sales in substance abuse testing products and agricultural diagnostic products. Product sales include the sales generated from substance abuse testing products, which incorporates the EZ-SCREEN PROFILE and VERDICT on-site test kits and other ancillary products for the detection of abused substances. Sales from these products decreased 15.0% to $1,297,000 for the year ended December 31, 1998 compared to sales of $1,525,000 in 1997. The Company believes that the decrease in product sales is primarily due to increased competition from products perceived as more user friendly than the Company's traditional products. The Company also believes that the introduction of its new generation of on-site test kits along with its patent pending "test system" has placed the Company in strong position to compete successfully in the on-site drug screening market. The first of these next generation test kits, PROFILE(R)- II, received pre-market 510(k) clearance from the U.S. Food & Drug Administration in the fourth quarter. Product sales also include sales of agricultural diagnostic products. Sales of these products decreased 37.8% to $458,000 for the year ended December 31 1998, compared to $736,000 in 1997. The primary reason for the decrease of $278,000 was the result of decreased purchases by the USDA for the Company's products. The USDA's needs for the company's products vary from year to year and sales to the USDA are expected fluctuate accordingly. Sales of contract manufacturing services, microbiological and associated products increased 72.8% to $750,000 for the year ended December 31, 1998 compared to $434,000 in 1997. This increase was due to increased revenues from both historical customers and new customers added in late 1997. Gross margins from Product Sales for the year ended December 31, 1998 were 33.3% compared to 37% for the year ended December 31, 1997. The decrease in gross margin from product sales was due to lower overall sales of products and increased manufacturing costs related to new product development. Revenues from interest and other income for the year ended December 31, 1998 were $1,000 compared to $6,000 for the year ended December 31, 1997. Selling, general and administration expenses for products sales during the year ended December 31, 1998 were $1,045,000, compared to $946,000 for the year ended December 31, 1997. The increase of $99,000 or 10% was primarily the result of implementation costs associated with the introduction of the Company's new generation on-site products. Research and development expenses incurred during the year ended December 31, 1998 were $631,000 as compared to $463,000 for the same period in 1997. The increase of $169,000 or 36.5% was primarily the result of costs associated with the development of the Company's new generation on-site products. For the year ended December 31, 1998, the Product Sales segment incurred interest and financing costs of $59,000. There were no interest charges incurred by this segment during the year ended December 31, 1997. The interest and finance costs were the result of the funds borrowed by the Company to fund asset purchases and working capital requirements. As a result of the above, the product sales segment net loss for the year ended December 31, 1998 was ($906,000), compared to the net loss of ($405,000) for the year ended December 31, 1997. Year ended December 31, 1997 Compared to Year ended December 31, 1996 Laboratory Services Laboratory service revenues were $25,899,000 for the year ended December 31, 1997 as compared to $23,541,000 for the year ended December 31, 1996. This increase of 10% was primarily the result of the timing of the acquisition of MEDTOX whereby the Company realized revenues from MEDTOX for approximately eleven months during the year ended December 31, 1996, as compared to the complete year ended December 31, 1997. Had the acquisition of MEDTOX been effective January 1, 1996, the Company would have had revenues of $24,741,000 from laboratory services during the year ended December 31, 1996, as compared to the $25,899,000 realized from the sale of laboratory services during the year ended December 31, 1997, this would represent a pro forma increase of $1,158,000 or 5%. The 5% increase was the result of increased sales from new and existing customers. The gross margin from the revenues generated from the laboratory services was 37.5% for the year ended December 31, 1997 as compared to a gross margin of 34.8% in 1996. During the year ended December 31, 1997, the Company was able to offset declining average selling prices by reducing costs through the consolidation of laboratory operations in 1996 as well as continued improvements in efficiency of laboratory operations. Selling, general and administration expenses for laboratory services for the year ended December 31, 1997 were $7,780,000, compared to $8,584,000 for the year ended December 31, 1996. The $804,000 reduction in these expenses in 1997 was primarily the result of the consolidation of certain administrative functions into the MEDTOX facility, decreased amortization expense, and an overall effort to monitor and control costs. Research and development expenses incurred in the laboratory services segment during the year ended December 31, 1997 were $502,000 as compared to $398,000 for the same period in 1996. This increase of $104,000 was primarily the result of increased new assay development for new drug entities, new assays for existing metabolites of drugs and other toxins, and improvement in existing assays with the goals of increasing the assay's robustness, sensitivity, accuracy, precision, specificity, and cost. For the year ended December 31, 1997, the segment had interest and financing costs of $609,000, compared to costs of $469,000 incurred during the year ended December 31, 1996. This increase was the result of the funds borrowed by the Company to complete the financing for the acquisition of MEDTOX. During the year ended December 31, 1996, the Company determined that it would be beneficial to consolidate the laboratory operations of PDLA into the laboratory operations at MEDTOX as well as to down size certain administrative positions at both PDLA and MEDTOX in order to eliminate duplicative functions. As a result of these restructuring steps, the Company recorded charges of $2,424,000 during the year ended December 31, 1996, including a $101,000 write down of the goodwill associated with the PDLA acquisition, to cover certain costs of the restructuring. The Company had no such charge during the year ended December 31, 1997. During 1996 the laboratory testing industry was undergoing a period of intense competition, and MEDTOX began to experience, a declining average selling price. This trend to continued through the end of 1998. In addition, during 1996 the Company expected that alternative testing methods, including available on-site testing, or on-site testing that may become available in future years, may make the current forms of laboratory testing less competitive. While the Company expects to continue to develop and/or evaluate new testing technologies, it was believed that the current form of laboratory testing at MEDTOX could not support the carrying value of the goodwill from the sale of that laboratory to the Company. Utilizing an undiscounted cash flow analysis, the Company determined that the carrying value of the remaining goodwill associated with the MEDTOX acquisition exceeded the estimated future cash flows to be generated by that business. Accordingly, the Company recorded a write-off of $6,016,000 at December 31, 1996. The noncash write-off of the goodwill has reduced the future amortization expense of the Company by $317,000 per year. As a result of the above, the net income for the year ended December 31, 1997 for the laboratory services segment was $430,000, compared to the net loss of ($9,156,000) for the year ended December 31, 1996. Product Sales Revenues for product sales for the year ended December 31, 1997 decreased 8.9% to $2,695,000 as compared to $2,957,000 for the year ended December 31, 1996. The decrease is primarily attributable to decreased sales of the Company's agricultural diagnostic products. Product sales include the sales generated from substance abuse testing products, which incorporates the EZ-SCREEN and VERDICT on-site test kits and other ancillary products for the detection of abused substances. Sales from these products increased 3.7% to $1,525,000 for the year ended December 31, 1997 compared to $1,471,000 in 1996. Product sales also include sales of agricultural diagnostic products. Sales of these products decreased 33.7% to $736,000 for the year ended December 31 1997, compared to sales of $1,110,000 in 1996. For the year ended December 31, 1996, the Company had sales of $361,000 which were generated through the former operations of Bioman. Excluding these revenues, sales of agricultural diagnostic products were $749,000 for the year ended December 31, 1996. As such, the sales of these products on a pro forma basis declined 1.7% for the year ended December 31, 1997 as compared to the same period in 1996. The primary reason for the increase was due to increased purchases by the USDA for the Company's products. Sales of contract manufacturing services, microbiological and associated product sales were $434,000 for the year ended December 31, 1997 compared to $301,000 for the same period in 1996. This increase was due to increased revenues from contract manufacturing services. Revenues generated from the shipment of products to the U.S. Department of Defense were $75,000 for the year ended December 31, 1996. The Company had no such sales during the year ended December 31, 1997 and 1998. For the year ended December 31, 1997, the Company had no revenues from royalties and fees, compared to $90,000 for the year ended December 31, 1996. This decrease was primarily due to the absence of royalties from American Medical Laboratories, Inc. ("AML") as the agreement with AML expired in 1996. Revenues from interest and other income for the year ended December 31, 1997 were $6,000 compared to $138,000 for the year ended December 31, 1996. Gross margins from the sales of both manufactured products and products purchased for resale for the year ended December 31, 1997 were 37% compared to 27% of sales of these products during the year ended December 31, 1996. This increase in gross margin from product sales is primarily the result of the increased sales of the EZ-SCREEN PROFILE product and contract manufacturing services, as well as reduced costs as a result of certain restructuring steps taken in 1996. Selling, general and administration expenses for the year ended December 31, 1997 were $946,000, compared to $3,559,000 for the year ended December 31, 1996. The $2,613,000 reduction in these expenses in 1997 was primarily the result of the consolidation of certain administrative functions into the MEDTOX facility, decreased amortization expense, and an overall effort to monitor and control costs. Research and development expenses incurred during the year ended December 31, 1997 were $463,000 as compared to $882,000 for the same period in 1996. The reduction of $419,000 in research and development expenses is primarily the result of a reduction of personnel and a refocus of efforts in the research and development function associated with the Company's on-site products. During the year ended December 31, 1996, the Company determined that to improve the operating results of the Company, it would be necessary to sell the former operations of Bioman, close its farm facility and reduce its work force at its Burlington, North Carolina location. As a result of these restructuring steps, the Company recorded charges of $25,000 during the year ended December 31, 1996 to cover certain costs of the restructurings. The Company had no such charge during the year ended December 31, 1997. As a result of the above, the net loss for the year ended December 31, 1997 for the product sales segment was $405,000, compared to the net loss of $3,653,000 for the year ended December 31, 1996. In March 1997, the Securities and Exchange Commission Staff (the "Staff") announced its position on accounting for preferred stock which is convertible into common stock at a discount from the market rate at the date of issuance. To comply with this position, the Company recorded a deemed dividend of $6,783,000 related to the January 1996 sales of the Series A Preferred Stock. This resulted in a reported net loss applicable to common stockholders of $19,592,000 for the year ended December 31, 1996. Material Changes in Financial Condition Laboratory Services At December 31, 1998, net accounts and notes receivable for laboratory services were $5,570,000. This $415,000 increase as compared to $5,155,000 at December 31, 1997 was a result of a decrease in the allowance for bad debts and an increase in gross billings prior to pass through costs, in the fourth quarter of 1998 as compared to the same quarter in 1997. Inventories were $432,000 at December 31, 1998 compared to $457,000 at December 31, 1997. Prepaid expenses and other assets were $503,000 at December 31, 1998 as compared to $351,000 at December 31, 1997. The increase of $152,000 is primarily the result of the renewal of insurance policies, annual maintenance contracts, licenses and fees, and an increase in prepaid supplies. The balance of equipment and improvements at December 31, 1998 was $10,275,000 as compared to a balance of $9,030,000 at December 31, 1997. The increase of $1,245,000 was the result of purchases of equipment and capital improvements for the laboratory operation to improve efficiencies and reduce operating costs. As of December 31, 1998, accounts payable totaled $3,345,000 compared to $3,659,000 at December 31, 1997. The decrease of $314,000, or 8.6%, is primarily the result of more timely payment of vendors. Accrued expenses were $1,586,000 at December 31, 1998, as compared to $1,162,000 at December 31, 1997. The increase of $424,000, or 36.5%, was the result of the laboratory supplies received but not invoiced, accruals for severance expenses, and an accrual for the United States Drug Testing Laboratories litigation settlement. At December 31, 1998, the laboratory services segment had a total balance of leases payable of $702,000, compared to a balance of $414,000 at December 31, 1997. The increase in the balance of the leases payable was the result of the leases of certain equipment to improve operating efficiencies in the laboratory. At December 31, 1998, laboratory services had a total balance of restructuring accruals of $1,155,000 compared to a balance of $786,000 at December 31, 1997. The increase in the balance of the restructuring accruals of $369,000, or 47%, was the result of an increase of $712,000 in reserves for pending litigation expenses less $343,000 in restructuring expense payments made during 1998. At December 31, 1998, the Company had a total loan balance owed to its financial lender of $5,268,000, compared to a total balance of $5,016,000 owed at December 31, 1997. The net increase of $252,000, or 5%, was primarily the result of increased borrowings by the Company from its line of credit to pay operating expenses as well as fund the purchases of certain assets to improve operating efficiencies. Product Sales At December 31, 1998, net accounts receivable for product sales were $417,000. This $39,000 decrease as compared to $456,000 at December 31, 1997 was primarily due an improvement in days sales outstanding (DSO). Prepaid expenses and other assets were $21,000 at December 31, 1998 as compared to $64,000 at December 31, 1997. The decrease of $43,000 is primarily the result of the timing of the renewal of annual maintenance contracts, annual licenses and fees. The balance of equipment and improvements at December 31, 1998 was $2,787,000 as compared to a balance of $2,882,000 at December 31, 1997. The decrease of $95,000 was the result of obsolete equipment disposed of during the year. As of December 31, 1998, accounts payable totaled $186,000 compared to $109,000 at December 31, 1997. The increase of $77,000, or 70%, is primarily the result of increased purchases of supplies relating to development and production of the Company's new generation on-site products, as well as certain capital expenditures. Accrued expenses were $138,000 at December 31, 1998, as compared to $164,000 at December 31, 1997. At December 31, 1998, and December 31, 1997, the product sales segment had no leases payable. At December 31, 1998, the product services had a total loan balance owed to its financial lender of $752,000, compared to a total balance of $0 owed at December 31, 1997. The net increase of $752,000, or 100%, was the result of allocation of the portion of the Company's debt secured by the product sales segment being allocated to the segment. Funds were used for working capital as well as purchases of certain assets to improve operating efficiencies. Liquidity and Capital Resources The working capital requirements of the Company have been funded primarily by cash received from debt financing. At December 31, 1998, the Company had checks written in excess of bank balances in the amount of $142,000. Cash and cash equivalents at December 31, 1998 of $0, compared to $58,000 as of December 31, 1997. The Company is relying on expected positive cash flow from operations, its line of credit, in addition to funds received from private placements of subordinate debt (see discussion below) to fund its future working capital and asset purchases. The amount of credit on the revolving line of credit is based primarily on the receivables of the Company and, as such, varies with the accounts receivable, and to a lesser degree the inventory of the Company. As of December 31, 1998, the Company had total availability of $367,000 on the line of credit of which $115,000 was borrowed, leaving a net availability of $252,000 as of December 31, 1998. On January 14, 1998, the Company entered into a Credit Security Agreement (the "Wells Fargo Credit Agreement" f/k/a "Norwest Credit Agreement") with Wells Fargo Business Credit (Wells Fargo), f/k/a Norwest Business Credit. The Wells Fargo Credit Agreement consists of (i) a term loan of $2,125,000 which matures on January 15, 1999, (ii) a term loan of $700,000 which matures on January 15, 1999, (iii) a revolving line of credit based upon the balance of the Company's trade accounts receivable, and (iv) a note of up to $1,200,000 for the purchase of capital equipment for 1998. The term loan of $2,125,000 carries an interest rate equal to 1.25% above the publicly announced rate of interest by Wells Fargo Bank Minnesota, N.A. (the "Base Rate"). The $700,000 term loan has an interest rate equal to 3.00% above the Base Rate as does the line of credit. The note for the capital expenditures carries an interest rate equal to 1.25% above the Base Rate. The Company utilized $4.5 million of the proceeds received from Wells Fargo to pay off the outstanding loan balance owed to its former lender. On November 24, 1998 the Company and Wells Fargo Business Credit amended the Credit Agreement. The amended Wells Fargo Credit Agreement consists of (i) an increase in the remaining balance on the term loan to the original amount of $2,125,000 and extension of the maturity to November 25, 2001, (ii) an increase in the remaining balance on the $700,000 term loan to $417,000 and an extension of its maturity to June 1, 1999, and (iii) a note of up to $1,000,000 for the purchase of capital equipment for 1999. As of December 31, 1998, the Company was not in compliance with the provisions of the minimum debt service coverage ratio, minimum net income, and minimum book net worth covenants of the Norwest Credit Agreement. However, on April 12, 1999, the Company amended the Wells Fargo Credit Agreement (the Third Amendment). The Third Amendment waived the Company's noncompliance with these covenants at December 31, 1998 and also modified the terms of the financial covenants for 1999. Management is of the opinion the Company can achieve the modified financial covenants throughout the course of 1999. At December 31, 1998, the Company received $175,000 from private placements of subordinated debt, with a maturity date of December 31, 2001. The debt carries an interest rate of 12% and has accompanying warrants to purchase a number of shares of common stock equal in exercise price to 25% of the notes purchased. As of March 23, 1999, the Company had received an additional $400,000 from this debt offering. The Company is continuing to sell these securities and may sell up to $1,500,000 in the private placement. The funds received from the amendment to the Norwest Business Credit Agreement and the private placements of subordinated debt were used to fund the working capital needs of the company. In the short term, the Company believes that the aforementioned capital along with additional funds received from the subordinated debt offering will be sufficient to fund the Company's planned operations through 1999. While there can be no assurance that the available capital will be sufficient to fund the future operations of the Company beyond 1999, the Company believes that consistent profitable earnings, as well as access to capital, will be the primary basis for funding the operations of the Company for the long term. The Company continues to follow a plan which includes (i) continuing to aggressively monitor and control costs, (ii) increasing revenue from sales of the Company's products, services, and research and development contracts, as well as (iii) continue to selectively pursue synergistic acquisitions to increase the Company's critical mass. There can be no assurance that costs can be controlled, revenues can be increased, financing may be obtained, acquisitions successfully consummated, or that the Company will be profitable. Impact of Year 2000 The "Year 2000" issue arises from the fact that many computer systems rely on a two-digit date code to identify the year (e.g. 98 to represent 1998) and thus may not be able to differentiate between the year 2000 and the year 1900. If not corrected, systems processing date-dependent information may fail or create erroneous results, causing disruptions of operations, including, but not limited to, a temporary inability to process transactions, report results, send invoices, or engage in similar normal business activity. The Company has completed its assessment of its internal computer systems and has determined that modification to some portion of its software is required so that its computer systems function properly with respect to dates in the year 2000 and beyond. The Company presently believes that with modification to existing software and conversion to new software, the Year 2000 issue will not pose significant operational problems for its computer systems. The Company has initiated formal communication with all of its significant suppliers to determine the extent to which the company is vulnerable to those third parties ability to resolve their own Year 2000 issues. There can be no guarantee that the systems of other companies on which the Company relies will be timely converted or that a failure to convert or a conversion that is incompatible with the Company's system would not have an adverse effect on the Company's systems. Supplier response is not yet complete and the Company is continuing to work to conclude this area of its Year 2000 assessment. The Company anticipates completing the Year 2000 project prior to any adverse impact on its computer operating system, however, if such modifications and conversions are not made, or completed timely, the Year 2000 issue could have a material impact on the operations of the Company. The Company continues to assess its readiness relative to Year 2000 issues and will develop a contingency plan for all items not resolved at the end of the first quarter. The cost of the Year 2000 project is not expected to be material. Changes required to internally supported software are minor compared to the modifications performed in the normal course of business and the Company plans to use internal resources and delay other projects to complete these Year 2000 modifications. Updates to externally supported software are covered under existing service contracts or are not anticipated to have costs material in nature. The assessment of the impact, cost, and completion of the Year 2000 project is based on management's best estimates. Actual results could differ materially from those anticipated by factors including, but not limited to, the continued availability of certain resources, third party modification plans, and the ability to locate and correct all relevant computer codes. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Reference is made to the financial statements, financial statement schedule and notes thereto included later in this report under Item 14. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Effective May 27, 1998, the Registrant terminated Ernst & Young LLP as its independent accounting firm. The termination of Ernst & Young LLP was approved by the Audit Committee of the Board of Directors of the Registrant. There were no disagreements with Ernst & Young LLP during the last two fiscal years ending December 31, 1997. Accordingly, Ernst & Young LLP has not advised the Registrant of (i) the absence of the internal controls necessary for the Registrant to develop reliable financial statements, (ii) any information which would cause Ernst & Young LLP to no longer rely on management's representations, or that Ernst & Young LLP was unwilling to be associated with the financial statements prepared by management, (iii) any need to expand significantly the scope of its audit, or any information that if further investigated may (a) materially impact the fairness or reliability of either a previously issued audit report or the underlying financial statements or any financial statements for any fiscal period subsequent to the date of the most recent financial statements covered by an audit report or (b) cause it to be unwilling to rely on management's representations or be associated with the Registrant's financial statements, or (iv) any information that has come to the attention of Ernst & Young LLP that it concluded materially impacts the fairness or reliability of either (a) a previously issued audit report or the underlying financial statements or (b) any financial statements issued or to be issued covering any fiscal period subsequent to the date of the most recent financial statements covered by an audit report. Effective June 3, 1998, the Registrant engaged Deloitte & Touche LLP as its independent accounting firm. Neither the Registrant or any of its subsidiaries has had any prior relationships with Deloitte & Touche LLP. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS Initial Name Age Position with the Company Effective Date Harry G. McCoy 47 Chairman of the Board of Directors, 1996 President and Director Richard J. Braun 54 Chief Executive Officer and Director 1996 Samuel C. Powell, Ph.D. 46 Director 1987 James W. Hansen 43 Director 1996 Miles E. Efron 72 Director 1997 Kevin J. Wiersma 37 Vice President, Controller 1998 and Secretary Harry G. McCoy, Pharm.D., was elected Chairman of the Board of Directors and President in July 1996 and has served as a Director since January, 1996. Dr. McCoy founded MEDTOX in 1984, and served as both Clinical Director and member of the MEDTOX Board of Directors until its acquisition by the Company in January, 1996. Dr. McCoy continued as President of MEDTOX following its acquisition by the Company. Dr. McCoy also has academic appointments with the University of Minnesota and the University of North Dakota, and is Chairman and CEO of the Nova Jazz Corporation, a Minnesota non-profit company. Richard J. Braun, MBA, JD, CPA was named as a Director and elected as Chief Executive Officer in July, 1996. From 1994 until joining the Company, Mr. Braun acted as a private investor and provided management consulting services to the health care and technology industries. From 1992 until 1994, Mr. Braun served as Chief Operating Officer and as a Director of EBP, Inc., a NYSE company engaged in managed care. From 1989 through 1991, Mr. Braun served as Executive Vice President, Chief Operating Officer and Director of Reich and Tang L.P., a NYSE investment advisory and broker dealer firm. Mr. Braun currently is a Director of Enstar, Inc., a public company with investments in health care, and computer connectivity and networking. Samuel C. Powell, Ph.D., served as Chairman of the Board of Directors from November 1987 to June 1994 and has served as a Director of the Company since September, 1986. Dr. Powell served as Chairman of the Board and Chief Executive Officer of Granite Technological Enterprises, from January, 1984 until its acquisition by the Company in June 1986. Since 1987, he has been President of Powell Enterprises, Burlington, North Carolina, offering financial and management services to a variety of businesses and real estate ventures. Additionally, Dr. Powell has been involved in local politics since 1985 as Councilman for the City of Burlington, N.C. Dr. Powell has also been appointed to serve on the North Carolina Board of Science and Technology from 1989 to 1995, and as a Board Member and Chairman of the N.C. State Alcoholism Research Authority. James W. Hansen was named as a Director in September, 1996. Mr. Hansen has, since November, 1996, been Chairman, CEO and Treasurer of Videolabs, Inc., a NASDAQ traded, technology company and is CEO of Prevention First, a development stage medical services provider. From 1986 to 1992, Mr. Hansen was Senior Vice President and General Manager of the Pension Division of Washington Square Capital, a Reliastar company which is a NYSE traded financial services company. Since 1992, Mr. Hansen has served as an Investor, Director, President or Vice President of several private companies in medical services and technology. He also serves as a Director of UBIQ, Inc., Videolabs, Inc. and Prevention First and has taught in the MBA program at the University of St. Thomas since 1984. Miles E. Efron was named as a Director in January, 1997. From 1988 to 1993, Mr. Efron served as Chief Executive Officer of North Star Universal, a holding company with interests in health care, food products and computer connectivity and networking. Since 1993, Mr. Efron has served as Chairman of North Star Universal. Mr. Efron currently serves on the Board of Directors of several companies, none of which are related to the Company. Kevin J. Wiersma was named as Secretary, Vice President and Controller on July 20, 1998. Mr. Wiersma joined MEDTOX Laboratories in 1982 and continued with the MEDTOX following its acquisition by the Company. Mr. Wiersma has served in various positions with the Company relating to finance and operations management. ITEM 11. EXECUTIVE COMPENSATION The following table and the narrative text discuss the compensation paid during 1998 and the two prior fiscal years to the Company's President and Chief Executive Officer and to the other executive officers whose annual salary and bonuses exceeded $100,000 during 1998.
Summary Compensation Table Long Term Compensation -------------------------------------------------- Annual Compensation Awards Payouts Other Annual Restricted Options/ LTIP All Other Name and Principal Compensation Stock SAR's Payouts Compensation Position Year Salary Bonus (1) Awards (2) (#) (2) - -------------------------- ------- --------- ------------ ---------- ----------- --------- --------- ------------- Harry G. McCoy 1998 $209,615 -- -- -- 50,000 -- -- Chairman of the Board 1997 $199,489 -- -- -- -- -- -- and President (3) 1996 $166,648 -- -- -- -- -- -- Richard J. Braun 1998 $209,615 -- -- -- 50,000 -- $9,060(5) Chief Executive 1997 $193,479 -- -- -- -- -- $3,195(5) Officer(4) 1996 $ 72,696 -- -- -- -- -- -- Kevin J. Wiersma 1998 $ 92,144 $11,700 -- -- 5,000 -- -- Vice President, Controller and Secretary (6) Peter J. Heath 1998 $ 91,868 -- -- -- 12,500 -- $46,154 Vice President of Finance 1997 $119,235 -- -- -- -- -- $ 3,000 and Chief Financial 1996 $113,677 $30,000 -- -- 3,750 -- $ 1,400 Officer(7)
(1) Other Annual Compensation for executive officers is not reported as it is less than the required reporting threshold of the Securities and Exchange Commission. (2) Not applicable. No compensation of this type received. (3) Dr. McCoy was appointed Chairman of the Board and President on July 3, 1996. (4) Mr. Braun was appointed Chief Executive Officer on July 25, 1996. (5) Includes $9,060 of premiums paid for by the Company for a disability insurance policy on Mr. Braun for 1998 and $3,195 for 1997. (6) Mr. Wiersma was appointed Vice President and Secretary on July 20, 1998. (7) Mr. Heath resigned as Vice President of Finance and CFO on July 31, 1998. As part of Mr. Heath's separation agreement, he is to receive $90,000 payable over nine months. During 1998, Mr. Heath received $46,154 pursuant to the separation agreement. Stock Options Granted During Fiscal Year The following table sets forth information about the stock options granted to the named executive officers of the Company during 1998.
Option Grants In Last Fiscal Year Potential Realized Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term % of Total Options Number Granted to of Employees Exercise Options in Fiscal Price Expiration 5% ($) 10%( $) Name Granted Year ($/Sh) Date (2) (2) - ------------------------------------------------------------------------------------------------------------------ Harry G. McCoy 50,000 25% $8.75 03/01/08 $275,141 $697,262 Richard J. Braun 50,000 25% $8.75 03/01/08 $275,141 $697,262 Kevin J Wiersma 5,000 2% $8.75 03/01/08 $ 27,514 $ 69,726 Peter J. Heath (1) 10,000 5% $8.75 03/01/08 $ 55,028 $139,452 2,500 1% $8.75 07/31/03 $ 7,440 $ 37,659
(1) Mr. Heath resigned as Vice President of Finance and Chief Financial Officer on 7/31/98. 10,000 options to acquire shares were canceled effective 7/31/98. The remaining 2,500 options to acquire shares were fully vested at 12/31/98. (2) The potential realizable value of the options reported above was calculated by assuming 5% and 10% annual rates of appreciation of the Common Stock of the Company from the date of grant of the options until the expiration of the options. These assumed annual rates of appreciation were used in compliance with the rules of the Securities and Exchange Commission and are not intended to forecast future price appreciation of the Common Stock of the Company. The Company chose not to report the present value of the options, which is an alternative under Securities and Exchange Commission rules, because the Company does not believe any formula will determine with reasonable accuracy a present value based on unknown or volatile factors. The actual value realized from the options could be substantially higher or lower than the values reported above, depending upon the future appreciation or depreciation of the Common Stock during the option period and the timing of exercise of the options. Stock Options Exercised During Fiscal Year and Year-End Values of Unexercised Options The following table sets forth information about the stock options held by the named executive officers of the Company at December 31, 1998.
Number of Shares Number of Unexercised Value of Unexercised In-the Acquired Value Options at FY-End Money Options at FY-End Name on Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable (1) Harry G. McCoy - - 31,894/18,105 $0/$0 Richard J. Braun - - 31,894/18,105 $0/$0 Peter J. Heath - - 2,500/ - $0/$0 Kevin J. Wiersma - - 1,521/3,478 $0/$0
- ---------------------------- (1) The closing price of the Common Stock of the Company at December 31, 1998 as $5.00 per share. (Share price adjusted to reflect reverse split.) Long-Term Incentive Plans and Pension Plans The Company does not contribute to any Long-Term Incentive Plan or Pension Plan for its executive officers as those terms are defined in the rules of the Securities and Exchange Commission. The Company relies on its stock option plans to provide long-term incentives for executive officers. The Company has three stock option plans, a 1983 Stock Option Plan for employees which expired on June 23, 1993, the Equity Compensation Plan which was adopted by the shareholders of the annual meeting in 1993 to replace the 1983 Incentive Stock Option Plan, and a 1991 Non-Employee Director's Plan for members of the Board of Directors who are not employees of the Company. Compensation of Directors All directors who are not employees of the Company receive $500 per month for their service as a director. All directors are also reimbursed for expenses incurred in attending board of directors' meetings and participating in other activities. Employment Contracts Harry G. McCoy, Chairman of the Board of Directors and President of the Company, has an employment agreement with the Company covering the period ending December 31, 1999, which by its term is extended thereafter in one-year increments unless Dr. McCoy provides written notice of termination to the Company at least sixty (60) days prior to the date of termination. The agreement may also be terminated by mutual consent or due to death or for "cause," or as described below. The employment agreement provides for an annual salary of at least $199,650 and certain fringe benefits. If Dr. McCoy's employment is terminated by the Company other than for cause, or if Dr. McCoy chooses to terminate the agreement voluntarily, following (i) a change in control; (ii) any relocation to which Dr. McCoy has not agreed to of greater than fifty (50) miles; or (iii) any material reduction in the level of Dr. McCoy's responsibility, position, authorities or duties; or (iv) the Company breaches any of its obligations under the Agreement, Dr. McCoy will be entitled to a Severance Award. The Severance Award consists of Dr. McCoy's base salary, health insurance and bonus plan payments for the greater of twelve (12) months or the then remaining term of employment under the Agreement. The employment agreement contains a Covenant Not to Compete whereby for a period of twelve (12) months after the termination of employment with the Company, Dr. McCoy agrees that he will not, directly or indirectly, either (a) have any interest in (b) enter the employment of, (c) act as agent, broker, or distributor for or advisor or consultant to, or (d) provide information useful in conducting the business of the Company to solicit customers or employees on behalf of the Company to any person, firm, corporation or business entity which is engaged, or which Dr. McCoy reasonably knows is undertaking to become engaged, in the United States in the business of the Company. Richard J. Braun, Chief Executive Officer, has an employment agreement with the Company with the same terms as Dr. McCoy. Kevin Wiersma, Vice President and Controller has a severance agreement with the Company covering the period December 31, 1999, which by its term is extended thereafter in one-year increments unless either the Company or Mr. Wiersma provides written notice to the other party at least six (6) months prior to the end of the original term or each renewal period or unless the agreement is otherwise terminated due to death, permanent disability, or for "cause." The employment agreement provides for an annual salary of at least $95,000 and certain fringe benefits. If Mr. Wiersma's employment with the Company terminates during the term of the agreement involuntarily, other than an involuntary termination on account of misconduct, he will be entitled to a Severance Award. The Severance Award consists of payment of an amount equal to Mr. Wiersma's then current annual salary plus certain health benefits over the course of the twelve (12) month period following Mr. Wieresma's termination. Three other key employees of the Company have severance agreements similar to Mr. Wiersma's agreement. Compensation Committee and Decision Making The compensation of executive officers of the Company for 1998 was determined by the Compensation Committee which is currently comprised of James W. Hansen, Miles E. Efron, and Samuel C. Powell. Stock options are awarded under the Company's Equity Compensation Plan and Non-Employee Director Plan by the Compensation Committee. All non-employee directors were eligible to receive stock options under the Company's 1991 Non-Employee Director Plan, which is a formula plan in accordance with the requirements of Rule 16b-3 under the Securities Act of 1934, as amended. Report of the Compensation Committee on Executive Compensation In General The Committee has three primary goals for executive compensation at the Company. o Retaining good performers, o Rewarding executives appropriately for performance, and o Aligning executives' interests with those of stockholders. Currently, executive pay consists of three elements that are designed to meet those objectives: o Base salary is paid based primarily on job responsibilities and industry job comparison. The Committee believes that base salaries at approximately industry averages are essential to retaining good performers. o Stock options, which allow executives to benefit when the market price of the Company's stock increases. o Bonuses to be paid upon the attainment of certain financial objectives and individual circumstances when warranted. Following is additional information regarding each of the above elements. Base Salary Base salary increases for executive officers have been modest and consistent with job performance and increases in responsibility. Bonus Kevin Wiersma received a bonus in 1998 as part of incentive compensation for meeting certain performance-related goals. Stock Options In 1998, certain executive officers received incentive stock options to purchase a total of 117,500 shares. The number of options granted to the executive officers represented 59% of the total options granted in 1998 to all employees. Summary Currently, the Company's executive compensation program rewards the following elements of performance. o Individual performance is rewarded through continued employment with the Company. o Stock price performance is rewarded through increases in the value of stock options. o Financial performance of the Company is rewarded through payments of bonuses upon the attainment of certain financial goals The Committee believes that the current program has been effective in rewarding executives appropriately for performance, retaining good performers, and aligning executives' interests with those of stockholders. While the Committee is satisfied with the current compensation system, it reserves the right to make changes to the program as are necessary to continue to meet its stated goals in future years. Benefits also are offered to officers that are not based on performance. Such benefits provide a safety net of protection in the event of illness, disability, death, retirement, etc. Such a safety net is provided to all full time employees of the Company. Chief Executive Officer Pay Amounts earned during 1998 by the Chief Executive Officer, Richard J. Braun, are shown in the Summary Compensation Table. Achievements by the Company which were deemed material to the Chief Executive Officer's compensation include the attainment of profitability for 1997 for the first time in the Company's history. For the year ended December 31, 1997, the Compensation Committee used, in its deliberations on executive compensation, these criteria and other accomplishments. Submitted by the Compensation Committee of the Company's Board of Directors James W. Hansen Miles E. Efron Samuel C. Powell ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information available to the Company as of March 22, 1998 regarding the beneficial ownership of the Common Stock by (i) each person known by the Company to beneficially own more than Five Percent (5%) of the outstanding Common Stock, (ii) each of the Directors, (iii) the Chief Executive Officer and all executive officers whose compensation was $100,000 or greater during 1998, and (iv) all executive officers and Directors of the Company as a group: Number of Shares Percent of Common Name Beneficially Owned Stock Outstanding Executive Officers and Directors: Harry G. McCoy, Pharm. D. Chairman and President 187,920 (1) 6.32% Richard J. Braun Chief Executive Officer and Director 35,822 (2) 1.20% Samuel C. Powell, Ph.D., Director 72,274 (3) 2.43% Louis Perlman, Director 51,500 (4) 1.73% James W. Hansen, Director 4,722 (5) * Miles E. Efron, Director 4,444 (6) * Kevin J. Wiersma Vice President, Controller and Secretary 2,045 (7) * Peter J. Heath Vice President-Finance, CFO and Secretary 3,060 (8) * All Directors and Executive Officers As a Group (8 in number) 361,787 (9) 12.16% - ---------- * Less than one percent (1%) (1) Includes 29,572 shares of Common Stock issuable under options which are or which will become exercisable within the next 60 days. (2) Includes 29,572 shares of Common Stock issuable under options which are or which will become exercisable within the next 60 days. (3) Includes 4,027 shares of Common Stock issuable under stock options which are or will become exercisable within the next 60 days. (4) Mr. Perlman did not stand for reelection to the Board of Directors at the Company's Annual Meeting of Stockholders held on September 11, 1998. 51,500 shares was the latest information provided to the Company at September 11, 1998. (5) Includes 2,222 shares of Common Stock issuable under options which are or which will become exercisable within the next 60 days. (6) Includes 1,944 shares of Common Stock issuable under options which are or which will become exercisable within the next 60 days. (7) Includes 1,845 shares of Common Stock issuable under options which are or which will become exercisable within the next 60 days. (8) Includes 2,500 shares of Common Stock issuable under options which are or which will become exercisable within the next 60 days. (9) Includes 71,682 shares of Common Stock issuable under options which are or will become exercisable within the next 60 days. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Lease Agreement with Dr. Samuel C. Powell In July 1986, the Company executed a lease agreement with Dr. Powell providing for a lease to the Company of approximately 16,743 square feet of space at 1238 Anthony Road, Burlington, North Carolina. Since 1986, the Company has expanded the space rented under the lease to approximately 33,000 square feet. Upon the expiration of the original lease, the Company entered into a new lease with Dr. Powell for the same space and at the same base rental rate for a term of one year ending on May 31, 1990. Effective June 1, 1990, the Company has been leasing the space on a month-to-month basis. The Company is currently leasing space at a rate of approximately $10,000 per month. The Company intends to negotiate a new lease with Dr. Powell in the near future. The Company holds certain rights of first refusal to lease additional space in the building if it becomes available (the building contains a total of 42,900 square feet). The total rent paid by the Company to Dr. Powell during the fiscal year ended December 31, 1998 was approximately $122,000. The Company believes the rent amount paid to Dr. Powell is consistent with market rates. ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, REPORTS ON FORM 8-K. a. (i) Financial Statements Page Report of Independent Auditors................... 42 Consolidated Balance Sheets at December 31, 1998 and 1997.............................. 44 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996............................ 45 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996.................................. 46 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996........... 47 Notes to Consolidated Financial Statements...................................... 48 (ii) Consolidated Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts ............................ 61 All other financial statement schedules normally required under Regulation S-X are omitted as the required information is inapplicable. (iii) Exhibits 3.1 Bylaws of the Registrant (incorporated by reference to Exhibit 4.2 filed with the Registrant's Report on Form 10-Q for the quarter ended December 31, 1986). 3.2 Restated Certificate of Incorporation of the Registrant filed with the Delaware Secretary of State on July 29, 1994 (incorporated by reference to Exhibit 3.8 filed with the Registrant's Form 10-K for fiscal year ended December 31, 1994). 3.3 Certificate of Amendment of Certificate of Incorporation of the Registrant, filed with the Delaware Secretary of State on November 27, 1995. 3.4 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.) 10.2 Registrant's Stock Option Plan (as amended and restated) (incorporated by reference to Exhibit 10.2 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 30, 1990). 10.3 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). 10.5 Non-Qualified Stock Option Agreement between the Registrant and James D. Skinner dated as of July 1, 1987 (incorporated by reference to Exhibit 10.26 filed with the Registrant's Registration Statement on Form S-1 dated August 26, 1987, Commission File No. 33-15543). 10.6 Non-Qualified Stock Option Agreement between the Registrant and James D. Skinner (incorporated by reference to Exhibit 10.17 filed with the Registrant's Form 10-K for the fiscal year ended December 31, 1988). 10.7 Non-Qualified Stock Option Agreement between the Registrant and James D. Skinner dated as of August 10, 1988 (incorporated by reference to Exhibit 10.18 filed with the Registrant's Form 10-K for the fiscal year ended December 31, 1987). 10.8 Lease Agreement, dated as of June 1, 1989 between Samuel C. Powell, as lessor, and EDITEK, as lessee relating to premises located at 1238 Anthony Road, Burlington, North Carolina (incorporated by reference as filed with the Registrant's report on Form 10-Q for the quarter ended June 30, 1989). 10.12 Stock Option Agreement dated May 4, 1990 between the Registrant and Samuel C. Powell amending and restating the Non-Qualified Stock Option Agreement between the Registrant and Samuel C. Powell dated as of May 23, 1988. (Incorporated by reference to Exhibit 10.34 filed with the Registrant's Form 10-K for the fiscal year ended December 31, 1990). 10.13 Loan Modification Agreement dated May 3, 1990 between the Registrant and James D. Skinner regarding the Promissory Note dated as of September 10, 1988 by James D. Skinner to the Registrant. (Incorporated by reference to Exhibit 10.36 filed with the Registrant's Form 10-K for the fiscal year ended December 31, 1990). 10.14 Stock Purchase Agreements dated as of July 19, 1991 between the Registrant and Walter O. Fredericks, Peter J. Heath, Samuel C. Powell, and James D. Skinner. (Incorporated by reference to Exhibit (a) filed with the Registrant's Form 10-Q for the quarter ended June 30, 1991). 10.15 Form of Stock Purchase Agreement dated as of September 3, 1992 between the Registrant and Purchasers of EDITEK's common stock in a private placement on September 3, 1992. (Incorporated by reference in Exhibit 10.46 filed with the Registrant's Form 10-K for the fiscal year ended December 31, 1992). 10.16 Agreement and Plan of Merger between the Registrant, PDLA Acquisition Corporation, and Princeton Diagnostic Laboratories of America, Inc. dated October 12, 1993. (Incorporated by reference to Exhibit (a) filed with the Registrant's Form 10-Q for the quarter ended December 31, 1993.) 10.17 Registrant's Amended and Restated Stock Option Plan for non-employee directors (incorporated by reference to Exhibit 4 filed with the Registrant's Registration Statement on Form S-8 dated February 21, 1995, Commission File No. 33-89646). 10.18 Registrant's Equity Compensation Plan (incorporated by reference to Exhibit 4 filed with the Registrant's Registration Statement on Form S-8 dated November 11, 1993, Commission File No. 33-71490). 10.19 Registrant's Amended and Restated Qualified Employee Stock Purchase Plan (incorporated by reference to Exhibit 4 filed with the Registrant's Registration Statement on Form S-8 dated November 11, 1993, Commission File No. 33-71596). 10.20 Non-Qualified Stock Option Agreement between the Registrant an Mark D. Dibner dated January 14, 1993 (incorporated by reference to Exhibit 4.2 filed with the Registrant's Registration Statement on Form S-8 dated February 21, 1995, Commission File No. 33-89646). 10.22 Asset Purchase Agreement dated as of July 1, 1995 between the Registrant and MEDTOX Laboratories, Inc. (incorporated by reference to Exhibit 10.1 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.23 Amendment Agreement dated as of January 2, 1996 between the Registrant and MEDTOX Laboratories, Inc. (incorporated by reference to Exhibit 10.2 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.24 Assignment Agreement dated as of January 10, 1996 between and among the Registrant, MEDTOX Laboratories, Inc. and Psychiatric Diagnostic Laboratories of America, Inc. (incorporated by reference to Exhibit 10.3 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.25 Amendment Agreement dated as of January 30, 1996 among the Registrant, MEDTOX Laboratories, Inc. and Psychiatric Diagnostic Laboratories of America, Inc. (incorporated by reference to Exhibit 10.25 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1996.) 10.26 Loan and Security Agreement (together with the Exhibits and Schedules thereto) by and between the Registrant, Psychiatric Diagnostic Laboratories of America, Inc., diAGnostix, inc. and Heller Financial, Inc. dated January 30, 1996 (incorporated by reference to Exhibit 10.4 filed with the Registrant's Report on form 8-K dated January 30, 1996). 10.27 Term Note A executed by the Registrant, Psychiatric Diagnostic Laboratories of America, Inc. and diAGnostix in favor of Heller Financial, Inc. dated January 30, 1996 (incorporated by reference to Exhibit 10.5 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.28 Term Note B executed by the Registrant, Psychiatric Diagnostic Laboratories of America, Inc. and diAGnostix in favor of Heller Financial, Inc., dated January 30, 1996 (incorporated by reference to Exhibit 10.6 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.29 Assignment for Security (Patents) executed by the Registrant in favor of Heller Financial, Inc., dated January 30, 1996 (incorporated by reference to Exhibit 10.7 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.30 Assignment for Security - EDITEK (Trademarks) executed by the Registrant in favor of Heller Financial, Inc., dated January 30, 1996 (incorporated by reference to Exhibit 10.8 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.31 Assignment for Security - Princeton (Trademarks) executed by Princeton Diagnostic Laboratories of America, Inc. in favor of Heller Financial, Inc., dated January 30, 1996 (incorporated by reference to Exhibit 10.9 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.32 Lease Agreement between MEDTOX Laboratories, Inc. and Phoenix Home Life Mutual Ins. Co. dated April 1, 1992, and amendments thereto (incorporated by reference to Exhibit 10.10 filed with the Registrant's Report on Form 8-K dated January 30, 1996). 10.33 Employment Agreement between the Registrant and Harry G. McCoy dated January 30, 1996. (Incorporated by reference to Exhibit 10.33 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1995.) 10.34 Registrant's Amended and Restated Equity Compensation Plan (increasing shares to 3,000,000). (Incorporated by reference to Exhibit 10.34 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1995.) 10.35 Asset Purchase Agreement dated as of May 31, 1995 between the Registrant, Bioman Products, Inc. and NOVAMANN International, Inc. (Incorporated by reference to Exhibit 10.35 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1995.) 10.36 Securities Purchase Agreement dated January 31, 1996 between the Registrant and Harry G. McCoy. (Incorporated by reference to Exhibit 10.36 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1995.) 10.37 Registration Rights Agreement dated February 1, 1996 between the Registrant and Harry G. McCoy. (Incorporated by reference to Exhibit 10.37 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1995.) 10.38 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.) 10.39 Warrant Agreement dated as of December 18, 1995 between Samuel C. Powell and the Registrant. (Incorporated by reference to Exhibit 10.39 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1995.) 10.40 Termination and Settlement Agreement dated as of July 3, 1996 between the Registrant and James D. Skinner. (Incorporated by reference to Exhibit 10.40 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1996.) 10.41 Agreement dated as of March 17, 1997 between the Registrant and Harry G. McCoy whereby Dr. McCoy assigns his rights to the name "MEDTOX" to the Registrant. (Incorporated by reference to Exhibit 10.41 filed with the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1996.) 10.42 Employment Agreement dated January 1, 1997 between the Registrant and Harry G. McCoy. (Incorporated by reference to Exhibit 10.42 filed with the Registrant's Report on form 10-K for the fiscal year ended December 31, 1997.) 10.43 Employment Agreement dated January 1, 1997 between the Registrant and Richard J. Braun. (Incorporated by reference to Exhibit 10.43 filed with the Registrant's Report on form 10-K for the fiscal year ended December 31, 1997.) b. Reports on Form 8-K On June 3, 1998, the Company reported a change in its independent accountants. The Company terminated its relationship with Ernst & Young LLP and appointed Deloitte & Touche LLP as its independent auditors. On September 18, 1998, the Company declared a dividend distribution of one Preferred Share Purchase Right on each outstanding share of the Registrant's common stock, payable to stockholder of record on September 30, 1998. The Rights are distributed pursuant to a Rights Agreement, dated September 18, 1998, between the Registrant and American Stock Transfer & Trust Company. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 MEDTOX SCIENTIFIC, INC. Report on Form 10-K For year ended December 31, 1998 INDEX TO EXHIBITS FILED SEPARATELY WITH FORM 10-K EXHIBIT # DESCRIPTION OF EXHIBIT 3.5 Certificate of Amendment of Certificate of Incorporation of MEDTOX Scientific, Inc. 21 List of Subsidiaries 24.1 Consent of Deloitte & Touche LLP 24.2 Consent of Ernst & Young LLP SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 14th day of April 1999. MEDTOX Scientific, Inc. Registrant By:/s/ Harry G. McCoy, Pharm.D. Harry G. McCoy, Pharm.D. President and Chairman of the Board Pursuant to the requirements of the Securities Act of 1934, this Registration Statement has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. Signature Title Date /s/ Harry G. McCoy, Pharm.D. President, April 14, 1999 Harry G. McCoy and Chairman of the Board /s/ Richard J. Braun Chief Executive Officer April 14, 1999 Richard J. Braun Director /s/ Kevin J. Wiersma Vice President, April 14, 1999 Kevin J. Wiersma Controller and Secretary /s/ Samuel C. Powell Director April 14, 1999 Samuel C. Powell, Ph.D. /s/ James W. Hansen Director April 14, 1999 James W. Hansen /s/ Miles E. Efron Director April 14, 1999 Miles E. Efron MEDTOX SCIENTIFIC, INC. Consolidated Financial Statements for the Years Ended December 31, 1998, 1997, and 1996 and Independent Auditors' Report INDEPENDENT AUDITORS' REPORT The Shareholders and Board of Directors Medtox Scientific, Inc. We have audited the accompanying consolidated balance sheet of Medtox Scientific, Inc. (formerly EDITEK, Inc.) and Subsidiaries (the Company) as of December 31, 1998 and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the index as Item 14.a.2. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 1998 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Medtox Scientific, Inc. and Subsidiaries as of December 31, 1998 and the results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Deloitte & Touche LLP Minneapolis, Minnesota March 26, 1999 (April 12, 1999 as to the sixth paragraph of Note 5) Report of Independent Auditors Board of Directors and Shareholders Medtox Scientific, Inc. (formerly EDITEK, Inc.) We have audited the accompanying consolidated balance sheets of Medtox Scientific, Inc. (formerly EDITEK, Inc.) as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Medtox Scientific, Inc. (formerly EDITEK, Inc.) at December 31, 1997, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Minneapolis, Minnesota February 6, 1998 MEDTOX SCIENTIFIC, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 (In thousands, except for number of shares)
1998 1997 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 58 Accounts receivable: Trade, less allowance for doubtful accounts ($245 in 1998 and $514 in 1997) $ 5,957 5,443 Other 30 110 --------- --------- 5,987 5,553 INVENTORIES: Raw materials 444 414 Work in process 151 134 Finished goods 80 137 Supplies 432 457 --------- --------- 1,107 1,142 Prepaid expenses and other 524 415 --------- --------- Total current assets 7,618 7,168 EQUIPMENT AND IMPROVEMENTS: Furniture and equipment 11,779 10,669 Leasehold improvements 1,283 1,243 --------- --------- 13,062 11,912 Less accumulated depreciation and amortization (10,087) (8,946) --------- --------- 2,975 2,966 GOODWILL, net of accumulated amortization of $3,086 in 1998 and $2,245 in 1997 14,007 14,747 --------- --------- $ 24,600 $ 24,881 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Checks written in excess of bank balances $ 142 Line of credit 3,095 $ 3,572 Accounts payable 3,531 3,768 Accrued expenses 1,724 1,326 Current portion of restructuring accrual 1,079 521 Current portion of long-term debt 1,140 1,444 Current portion of capital leases 186 119 --------- --------- Total current liabilities 10,897 10,750 LONG-TERM PORTION OF RESTRUCTURING ACCRUAL 76 265 LONG-TERM DEBT 1,785 LONG-TERM PORTION OF CAPITAL LEASES 516 295 COMMITMENTS AND CONTINGENCIES (Notes 8 and 12) STOCKHOLDERS' EQUITY: Preferred stock, $1.00 par value; authorized shares, 1,000,000; issued and outstanding shares, none in 1998 and 4 in 1997 Common stock, $0.15 par value; authorized shares, 3,750,000; issued and outstanding shares, 2,899,669 in 1998 and 2,841,409 in 1997 435 426 Additional paid-in capital 59,815 59,772 Accumulated deficit (48,748) (46,451) Treasury Stock (176) (176) --------- --------- Total stockholders' equity 11,326 13,571 --------- --------- $ 24,600 $ 24,881 ========= =========
See notes to consolidated financial statements. MEDTOX SCIENTIFIC, INC. CONSOLIDATED STATEMENTS OF operations YEARS ENDED december 31, 1998, 1997, AND 1996 (In thousands, except share and per share data)
1998 1997 1996 REVENUES: Laboratory service revenues $ 27,070 $ 25,899 $ 23,541 Product sales 2,505 2,695 2,957 Royalties and fees 90 Interest and other income 1 6 138 ----------- ---------- ----------- 29,576 28,600 26,726 COSTS AND EXPENSES: Cost of services 18,689 16,191 15,344 Cost of sales 1,671 1,697 2,151 Selling, general, and administrative 8,974 9,510 11,725 Research and development 1,153 965 1,280 Interest and financing costs 674 609 469 Restructuring costs 712 (397) 2,449 Goodwill write-off 6,117 ----------- ---------- ----------- 31,873 28,575 39,535 ----------- ---------- ----------- NET (LOSS) INCOME (2,297) 25 (12,809) LESS PREFERRED STOCK DEEMED DIVIDEND (6,783) ----------- ---------- ----------- NET (LOSS) INCOME APPLICABLE TO COMMON STOCKHOLDERS $ (2,297) $ 25 $ (19,592) =========== ========== =========== (LOSS) INCOME PER SHARE APPLICABLE TO COMMON STOCKHOLDERS - BASIC AND DILUTED $ (0.79) $ 0.01 $ (11.71) =========== ========== ========== WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING 2,893,399 2,566,966 1,672,793 =========== ========= ===========
See notes to consolidated financial statements. MEDTOX SCIENTIFIC, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except for number of shares)
Note Additional Receivable Preferred Stock Common Stock Paid-in Accumulated from Treasury Shares Par Value Shares Par Value Capital Deficit Stockholder Stock Total BALANCE AT DECEMBER 31, 1995 521,989 $ 78 $ 35,461 $(33,667) $ (100) $(76) $ 1,696 Exercise of stock options and warrants 5,021 1 45 46 Stock issued for MEDTOX Laboratories, Inc. acquisition 125,865 19 4,806 4,825 Sale of preferred stock 407 19,126 19,126 Cancellation of note receivable from officer in exchange for common stock 100 (100) Sale of common stock 3,824 1 63 64 Conversion of preferred stock to common stock (169) 609,326 91 (91) Private placement of common stock 11,765 2 598 600 Net loss (12,809) (12,809) ------ ------ -------- ------ ------- -------- ------ ------ ------- BALANCE AT DECEMBER 31, 1996 238 1,277,790 192 60,008 (46,476) (176) 13,548 Stock issued for MEDTOX Laboratories, Inc. acquisition 417,292 62 (62) Sale of common stock 10,524 2 73 75 Conversion of preferred stock to common stock (234) 1,135,803 170 (247) (77) Net income 25 25 ------ ------ --------- ----- -------- -------- ------- ------ ------- BALANCE AT DECEMBER 31, 1997 4 2,841,409 426 59,772 (46,451) (176) 13,571 Sale of common stock 4,927 1 24 25 Conversion of preferred stock to common stock (4) 53,333 8 (8) Value of warrants issued 27 27 Net loss (2,297) (2,297) ------ ----- --------- ------ -------- -------- ------ ------ ------ BALANCE AT DECEMBER 31, 1998 - $ - 2,899,669 $ 435 $ 59,815 $(48,748) $ $(176) $11,326 ====== ===== ========= ======= ======== ========= ====== ====== ========
See notes to consolidated financial statements. MEDTOX SCIENTIFIC, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (In thousands)
1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $ (2,297) $ 25 $ (12,809) Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization 2,094 2,083 2,265 Goodwill write-off 6,117 PDLA write-off 284 Provision for losses on accounts receivable 42 156 128 Gain on sale of equipment (4) (42) Changes in operating assets and liabilities, net of acquisition: Accounts receivable (476) (1,156) (749) Inventories 35 148 10 Prepaid expenses and other (109) (275) 365 Accounts payable and accrued expenses 161 627 1,025 Deferred revenues (97) Restructuring accruals 369 (1,017) 1,072 ---------- -------- ---------- Net cash (used in) provided by operating activities (185) 591 (2,431) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of equipment and improvements (949) (1,315) (1,118) Proceeds from sale of equipment 4 45 Acquisitions, net of cash acquired (19,630) ---------- -------- ---------- Net cash used in investing activities (945) (1,315) (20,703) CASH FLOWS FROM FINANCING ACTIVITIES: Increase in checks in excess of bank balances 142 Net proceeds from sale of preferred stock 19,126 Net proceeds from sale of common stock 25 (2) 710 Proceeds from line of credit and long-term debt 36,669 2,135 5,437 Principal payments on capital leases (118) (87) Principal payments on line of credit and long-term debt (35,646) (1,346) (2,315) ---------- -------- ---------- Net cash provided by financing activities 1,072 700 22,958 ---------- -------- ---------- DECREASE IN CASH AND CASH EQUIVALENTS (58) (24) (176) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 58 82 258 ---------- -------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ - $ 58 $ 82 ========== ======== ==========
SUPPLEMENTAL NONCASH ACTIVITIES: During 1998 and 1997, the Company entered into capital lease agreements totaling $414,000 and $468,000, respectively. During 1996, the Company canceled the note receivable from an officer of $100,000 in exchange for 667 shares of common stock. In January 1996, the Company acquired MEDTOX Laboratories, Inc. The purchase price was $24 million, which included $19 million cash and the issuance of $5,000,000 in common stock (125,865 shares). See notes to consolidated financial statements. MEDTOX SCIENTIFIC, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1998 AND 1997 1. Summary of significant accounting policies The Company - In May 1997, the Company changed its corporate name from EDITEK, Inc. to MEDTOX Scientific, Inc. (MEDTOX). The consolidated financial statements include the accounts of MEDTOX and its wholly owned subsidiaries, MEDTOX Laboratories, Inc. (MEDTOX Laboratories) and MEDTOX Diagnostics, Inc. (MEDTOX Diagnostics) (collectively referred to as the Company). MEDTOX Laboratories provides laboratory analyses, logistics management, data management, and program management services. Laboratory analyses including clinical testing services for the detection of substances of abuse and other toxins in biological fluids and tissues. Logistics, data and program management services include courier services for medical specimen transportation, management programs for on-site drug testing, data collection and reporting services, coordination of specimen collection sites, and medical surveillance program management. MEDTOX Diagnostics is engaged in the research, development, and sale of products based upon enzyme immunoassay technology for the detection of antibiotic residues, mycotoxins, drugs of abuse and other hazardous substances as well as distribution of agridiagnostic and food safety testing products. All significant intercompany transactions and balances have been eliminated. Cash and Cash Equivalents - Cash and cash equivalents include cash and highly liquid investment maturing within three months when purchased. Trade Accounts Receivable - Sales are made to local and national customers including corporations, clinical laboratories, government agencies, medical professionals, law enforcement agencies, and health care facilities. Concentration of credit risk is limited due to the large number of customers to which the Company sells its products and services. The Company extends credit based on an evaluation of the customer's financial condition, and receivables are generally unsecured. The Company provides an allowance for doubtful accounts equal to the estimated losses expected to be incurred in the collection of accounts receivable. Inventories - Inventories are valued at the lower of cost (first-in, first-out method) or market at December 31, 1998 and 1997. Equipment and Improvements - Equipment and improvements are stated at cost. Provisions for depreciation have been computed using the straight-line method to amortize the cost of depreciable assets over their estimated useful lives. Leasehold improvements are amortized over the lesser of the lease term or the economic useful lives of the improvements. Revenue Recognition - Sales are recognized in the statement of operations when products are shipped or services are rendered. Research and Development - Research and development expenditures are charged to expense as incurred. Income Taxes - The Company uses the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Income (Loss) per Share of Common Stock - Income (loss) per share of common stock amounts are based on the weighted average number of shares of common stock outstanding, as well as shares of common stock that would have been issued and outstanding in certain transactions had the Company had the necessary number of authorized shares of common stock. All other common stock equivalents were anti-dilutive and therefore were not included in the computation of income (loss) per share for all periods presented. Goodwill - Goodwill is amortized on a straight-line basis over 20 years. The carrying value of goodwill is reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the undiscounted cash flows of the entity acquired over the remaining amortization period, the Company's carrying value of the goodwill is reduced by the estimated shortfall of cash flows. In 1996, the Company recorded goodwill write-offs totaling $6,117,000 (see Note 4). Impairment of Long-Lived Assets - The Company periodically evaluates the carrying value of long-lived assets and long-lived assets to be disposed of for potential impairment. The Company considers projected future operating results, cash flows, trends and other circumstances in making such estimates and evaluations. When the carrying value of any long-lived asset exceeds its projected undiscounted cash flows, an impairment is recognized to reduce the carrying value to its fair market value. Losses on long-lived assets to be disposed of are determined in a similar manner, except that the fair market values are reduced for the costs to sell. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Reclassifications - Certain reclassifications have been made to the 1997 and 1996 consolidated financial statements to conform with the 1998 presentation. These reclassifications had no effect on net income (loss) or total stockholders' equity as previously reported. Stock-Based Compensation - SFAS No. 123, Accounting for Stock-Based Compensation, requires companies to measure employee stock compensation plans based on the fair value method of accounting. However, the statement allows the alternative of continued use of Accounting Principles Board Opinion (APBO) No. 25, Accounting for Stock Issued to Employees, with pro forma disclosure of net income and earnings per share determined as if the fair value method had been applied in measuring compensation cost. The Company elected the continued use of APBO No. 25. Comprehensive Earnings - Comprehensive earnings is a measure of all nonowner changes in shareholders' equity and includes such items as net earnings, certain foreign currency translation items, minimum pension liability adjustments, and changes in the value of available-for-sale securities. In 1998, 1997, and 1996, comprehensive earnings for the Company were equivalent to net earnings as reported. Derivative Instruments and Hedging Activities - SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued in June 1998 and establishes accounting and reporting standards for derivative instruments. The statement requires recognition of all derivatives as either assets or liabilities in the statement of financial position measured at fair value and will be effective in fiscal year 2000. The Company has not yet completed its analysis of the impact SFAS No. 133 will have on its consolidated financial statements. 2. SEGMENTS The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, in 1998, which changes the way the Company reports information about its operating segments. The information for 1997 and 1996 has been restated to conform to the 1998 presentation. The Company has two reportable segments: Product Sales and Lab Services. The Product Sales segment is made up entirely of MEDTOX Diagnostics. Products manufactured include easy to use, inexpensive, on-site drug tests such as PROFILE II, EX-SCREEN, EX-QUANT, and VERDICT. The Lab Services segment includes MEDTOX Laboratories and CMS. Services provided include forensic toxicology, clinical toxicology, heavy metals analyses, courier delivery, and medical surveillance. In evaluating financial performance, management focuses on net income as a segment's measure of profit or loss. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 1).
Segment Information (In thousands) Lab Services Product Sales Total 1998: Net Sales $ 27,070 $ 2,505 $ 29,575 Segment Loss (1,391) (906) (2,297) Segment Assets 13,981 10,619 24,600 1997: Net Sales 25,899 2,695 28,594 Segment Profit (Loss) 430 (405) 25 Segment Assets 14,269 10,612 24,881 1996: Net Sales 23,541 3,047 26,588 Segment Loss (15,939) (3,653) (19,592) Segment Assets 6,643 17,436 24,079
3. ACQUISITIONS In January 1996, the Company acquired MEDTOX Laboratories, a toxicology laboratory located in Saint Paul, Minnesota. The purchase price was $24 million, which included $19 million cash and the issuance of 125,865 shares of common stock. The acquisition was accounted for under the purchase method of accounting under which the Company recorded approximately $22 million of goodwill. The goodwill is being amortized over a period of 20 years (see Note 4). The Company financed the acquisition by issuing $19 million of convertible preferred stock and borrowing $4 million under two $2 million term loans. In connection with the acquisition, the Company entered into a revolving line of credit of up to $7 million for working capital purposes. 4. GOODWILL WRITE-OFF In 1996, the Company reviewed the value of the goodwill associated with the acquisition of MEDTOX Laboratories. The purpose of the review was to determine if the value of the goodwill, generated as a result of the price paid by the Company for MEDTOX Laboratories, was in fact supported by the projected future benefit to the Company as measured by projected cash flows. Given the highly competitive nature of the testing marketplace, the industry and MEDTOX Laboratories had begun to experience a declining average selling price. In addition the Company believed that alternative testing methods, including on-site testing, would become available in future years that may make the then existing forms of laboratory testing less competitive. While the Company expected to continue to develop and/or evaluate new testing technologies, the then existing form of laboratory testing at MEDTOX Laboratories was unable to support the carrying value of the goodwill generated from the sale of that laboratory to the Company. Utilizing an undiscounted cash flow analysis, the Company concluded that the carrying value of the remaining goodwill associated with the MEDTOX Laboratories acquisition exceeded the estimated future cash flows. Accordingly, the Company recorded a write-off of $6,016,000 in December 1996. In September 1996, upon the sale of Bioman, the Company recorded a $101,000 write-off of the goodwill associated with the original acquisition of Bioman. 5. DEBT Long-term debt consisted of the following at December 31:
1998 1997 Term loan, due November 2001, 9% at December 31, 1998 $ 2,066 Overadvance term loan, due June 1999, 10.75% at December 31, 1998 358 Capex note, due November 2001, 9% at December 31, 1998 347 Subordinated notes, due December 2001, 12% at December 31, 1998 148 Note payable to bank, due September 2000, 10% at December 31, 1998 6 Term loan, paid in 1998 $ 1,444 -------- 2,925 1,444 Less current portion 1,140 1,444 --------- --------- $ 1,785 $ - ========================== Long-term debt maturities at December 31, 1998 were as follows: 1999 $ 1,140 2000 784 2001 1,001 --------- $ 2,925
On January 14, 1998, the Company entered into a Credit Security Agreement (the Norwest Credit Agreement) with Norwest Business Credit (Norwest). The Company utilized $4.5 million of the proceeds from the Norwest Credit Agreement to repay the outstanding second term loan owed to its former lender, Heller Financial, Inc. (Heller). The Norwest Credit Agreement consists of (i) a term loan of $2,125,000 bearing interest at prime + 1.25% due January 15, 2001; (ii) an overadvance term loan of $700,000 bearing interest at prime + 3% due January 15, 1999; (iii) a revolving line of credit of not more than $6,000,000 or 80% of the Company's eligible trade accounts receivable bearing interest at prime + 1% due January 15, 2001; and (iv) a capex note of up to $1,200,000 for the purchase of capital equipment for 1998 bearing interest at prime + 1.25% due January 15, 2001. At December 31, 1998, $3,095,000 was outstanding under the revolving line of credit, and $252,000 was available to be advanced under the borrowing base formula. The Norwest Credit Agreement requires the Company to comply with certain covenants and maintain certain quarterly financial ratios as to minimum debt service coverage and maximum debt to book net worth. It also sets minimum quarterly net income and book net worth levels which restrict the payment of dividends. The Norwest Credit Agreement is secured by virtually all of the Company's assets, including equipment, general intangibles, inventories, and receivables. On May 22, 1998, the Company and Norwest amended the Norwest Credit Agreement (the First Amendment). The First Amendment waived the Company's noncompliance with the minimum book net worth covenant for the first quarter of 1998. It also set new minimum book net worth requirements for each fiscal quarter through January 31, 1999. On November 24, 1998, the Company and Norwest again amended the Credit Agreement (the Second Amendment). The Second Amendment consisted of (i) additional borrowings of up to the original $2,125,000 term loan and extension of the due date to November 25, 2001; (ii) an additional $300,000 borrowing under the original overadvance term loan of $700,000 and an extension of the due date to June 1, 1999; (iii) a capex note of up to $1,000,000 for the purchase of capital equipment for 1999 and extension of the due date to November 25, 2001; (iv) the quarterly financial ratios as to minimum debt service coverage and maximum debt to book net worth ratios were modified; (v) the quarterly minimum net income and book net worth levels were adjusted; (vi) a waiver permitting the creation of CMS; (vii) a waiver permitting the mergers of Precision Drug Testing Laboratories of America, Inc., Princeton Drug Testing Laboratories of America, Inc., and MEDTOX Diagnostics into the Company; (viii) a waiver of the Company's noncompliance with the minimum net income and minimum book net worth requirements for the quarter ended June 30, 1998; and (ix) a waiver of the Company's noncompliance with the minimum net income, minimum book net worth, and minimum debt service coverage ratio requirements for the quarter ended September 30, 1998. As of December 31, 1998, the Company was not in compliance with the provisions of the minimum debt service coverage ratio, minimum net income, and minimum book net worth covenants of the Norwest Credit Agreement. However, on April 12, 1999, the Company amended the Norwest Credit Agreement effective April 1, 1999 (the Third Amendment). The Third Amendment waived the Company's noncompliance with these covenants at December 31, 1998 and also modified the terms of the financial covenants for 1999. Management is of the opinion the Company can achieve the modified financial covenants throughout the course of 1999. Accordingly, long-term debt under the Norwest Credit Agreement has not been reclassified as current. On December 31, 1998, the Company received $175,000 from private placements of subordinated debt. The notes require payment of the principal amount on December 31, 2001. Interest at 12% per annum is paid semiannually on June 30 and December 31. In connection with the issuance of the subordinated notes, the Company issued warrants to purchase 8,750 shares of common stock, exercisable from December 15, 1999 to December 31, 2001, at an exercise price of $5.00 per share. The Company has determined the value of the warrants at the date of grant to be $27,000. The value of the warrants has been accounted for as additional paid-in capital and deducted from the principal of the subordinated notes as discount on debt issued. During the first quarter of 1999, the Company received an additional $400,000 from private placements of subordinated debt under the same terms as the December 1998 debt issuances. In connection with the issuance of the subordinated notes, the Company issued warrants to purchase 20,000 shares of common stock at an exercise price of $5.00 per share. Interest paid for all outstanding debt was $599,000, $576,000, and $424,000 for the years ended December 31, 1998, 1997, and 1996, respectively. 6. STOCKHOLDERS' EQUITY The Board of Directors declared a one-for-twenty reverse stock split effective February 20, 1999. Accordingly, all stock option, warrant, share, and per share data included in this report have been restated to reflect the reverse split. The Company has sold its common stock in various private transactions as follows: Number Price of Per Net Shares Share Proceeds 1996 11,765 $51.00 $ 600,000 In January 1996, the Company sold 407 shares of Series A Preferred Stock at a price of $50,000 per share. Each share of Series A Preferred Stock was convertible into shares of common stock. The amount of common shares to be issued upon the exercise of the conversion right is derived by dividing (i) the purchase price of one share of Series A Preferred Stock, $50,000 by (ii) the lower of (x) $2.775 or (y) 75% of the market price of the common stock on the date the conversion right is exercised. The market price is defined as the daily average of the closing bid prices quoted on the American Stock Exchange for the five trading days immediately preceding the date the conversion right is exercised. At December 31, 1998, all 407 shares of Series A Preferred Stock had been converted into 1,798,462 shares of common stock. The market price of the Company's common stock was $70.00 on the date of issuance of the Series A Preferred Stock. The reduction in the conversion price of the Series A Preferred Stock from $70.00 to $52.50 per share was valued at $6,783,333 and recorded as a preferred stock dividend to arrive at the 1996 net loss available to holders of common stock in the calculation of net loss per share in 1996. As part of the purchase price paid by the Company for the acquisition of MEDTOX Laboratories, the Company issued 125,865 shares of common stock. In connection with the issuance of the common shares, the Company agreed that if, after the closing date of the MEDTOX Laboratories acquisition, the market value of the Company's common stock declined below approximately $39.60 per share, the Company would issue additional shares of common stock (Additional Shares) to shareholders of MEDTOX Laboratories who retain their shares of common stock at specified dates through November 19, 1997 (the Repricing Dates). The following is a summary of the price resets, the market price per share used for purposes of calculating the reset quantity of shares, and the quantity of additional shares that were issued in 1997:
Market Price Related Shares Repricing Date to Repricing Date Issued May 23, 1996 $31.20 55,953 November 22, 1996 $19.00 64,673 March 27, 1997 $8.25 257,898 November 19, 1997 $7.50 38,768 ----------- 417,292
At December 31, 1998, shares of common stock reserved for future issuance upon exercise of outstanding common stock warrants are as follows:
Number of Exercise Price Period Shares Per Share Exercisable Reserved Series N $ 59.20 Expired March 17, 1999 1,634 Series O 55.40 Expired January 30, 1999 29,333 Subordinated notes 12% 5.00 December 15, 1999 to December 31, 2001 8,750 ----------- 39,717
In addition, at December 31, 1998, 416,770 shares of common stock were reserved for future issuances under the stock option plans discussed in Note 7. On September 18, 1998, the Company's Board of Directors authorized and declared a dividend of one preferred share purchase right for each common share then outstanding. Subsequent to that date the Company maintains a plan in which one preferred share purchase right (Right) exists for each common share of the Company. Each Right entitles its holder to purchase one one-hundredth of a share of a new series of junior participating preferred stock at an exercise price of $29.80, subject to adjustment. The Rights are exercisable only if a person or group acquires beneficial ownership of 20 percent or more of the Company's outstanding common stock. 7. STOCK OPTION AND PURCHASE PLANS The Company has stock option plans to provide incentives to eligible employees, officers, and directors in the form of incentive stock options, nonqualified stock options, stock appreciation rights, restricted and unrestricted stock awards, performance shares, and other stock-based awards. The Compensation Committee of the Board of Directors determines the exercise price (not to be less than the fair market value of the underlying stock) at the date of grant. Options generally become exercisable in installments over a period of one to five years and expire ten years from the date of grant. The following table summarizes information about stock options outstanding at December 31, 1998:
Plan Options Outstanding Weighted Non- Average Shares employee Exercise Available 1983 ISO 1993 Director Price for Grant Plan Plan Plan Share Balance at December 31, 1995 167,297 22,470 36,052 2,393 $66.80 Additional shares reserved for issuance 45,047 Granted (11,915) 11,250 665 56.60 Canceled 24,231 (7,699) (21,984) (2,247) 64.80 Exercised (4,460) (561) 9.20 -------- ------- -------- ------- Balance at December 31, 1996 224,660 10,311 25,318 250 69.40 Additional shares reserved for issuance 93,817 Granted (11,500) 11,500 8.75 Canceled 14,250 (2,601) (14,250) 63.80 Exercised -------- ------- -------- ------- Balance at December 31, 1997 321,227 7,710 11,068 11,750 49.80 Additional shares reserved for issuance 3,496 Granted (145,750) 145,750 10.01 Canceled 38,690 (2,274) (35,307) (3,333) 55.63 Exercised -------- ------- -------- ------- Balance at December 31, 1998 217,613 5,436 121,511 8,417 $14.43 ======== ======= ======== =======
Plan Options Outstanding Options Exercisable Weighted Weighted Average Weighted Average Remaining Average Range of Number Exercise Contractual Number Exercise Exercise Prices Outstanding Price Life Exercisable Price $8.75 125,348 $ 8.75 9 59,758 $ 8.75 $30.00 - $59.99 1,376 53.53 3 1,376 53.99 $60.00 - $89.99 5,786 71.92 6 5,780 71.92 $90.00 - $119.99 625 102.24 5 625 102.24 $120.00 - $149.99 1,729 130.88 2 1,729 130.88 $153.80 500 153.80 3 500 153.80 --------- ------- 135,364 $ 14.43 69,768 $ 19.77
Options Outstanding Options Exercisable Weighted Weighted Range of Average Average Exercise Number Exercise Number Exercise Option Plan Prices Outstanding Price Exercisable Price 1983 Incentive Stock Option Plan $48.80 - $143.80 5,436 $99.70 5,430 $ 99.73 1993 Equity Compensation Plan $8.75 - $153.80 121,511 10.48 57,185 12.41 Nonemployee Director Plan $8.75 - $ 92.60 8,417 16.49 7,153 17.86 --------- ------- 135,364 $14.43 69,768 $ 19.77
Nonqualified Stock Options - The shares of common stock covered by nonqualified options are restricted as to transfer under applicable securities laws. Qualified Employee Stock Purchase Plan - The Company has a Qualified Employee Stock Purchase Plan (the Purchase Plan) under which all employees meeting certain criteria may subscribe to and purchase shares of common stock. The number of shares of common stock authorized to be issued under the Purchase Plan is 25,000. The subscription price of the shares is 85% of the fair market value of the common stock on the day the executed subscription form is received by the Company. The purchase price for the shares is the lesser of the subscription price or 85% of the fair market value of the shares on the day the right to purchase is exercised. Payment for common stock is made through a payroll deduction plan. The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for its stock-based compensation plan. Accordingly, no compensation expense has been recognized for its stock option awards, because the exercise price of all options equals the market price of the stock on the grant date. Had compensation expense for the Company's stock option awards been determined based upon their grant date fair value consistent with the methodology prescribed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, the Company's net loss applicable to common stockholders and basic and diluted loss per share applicable to common stockholders would have been $2,746,000 and ($0.95 per share), $87,000 and ($.03 per share), and $20,027,000 and ($11.97 per share) for 1998, 1997, and 1996, respectively. The fair value of the options at the grant date was estimated using the Black-Scholes model with the following weighted average assumptions: 1998 1997 1996 Expected life (years) 5 5 5 Interest rate 4.25% 6.0% 6.0% Volatility 90.5% 103.0% 119.5% Dividend yield 0% 0% 0% The weighted average fair value of options granted in 1998 was $5.22 per share. 8. LEASES The Company leases office and research facilities from a director under a month-to-month operating lease. Rental payments to the director were approximately $122,000, $121,000, and $122,000 for the years ended December 31, 1998, 1997, and 1996, respectively. The Company leases other offices and facilities and office equipment under certain operating leases which expire on various dates through March 2002. Under the terms of the facility leases, a pro rata share of operating expenses and real estate taxes are charged as additional rent. See also Note 9 regarding restructuring costs relative to certain facility leases. The Company subleases one of its facilities to another party whereby that party makes payments directly to the lessor. As of December 31, 1998, the Company is obligated for future minimum lease payments (excluding payments under the leases vacated as part of the 1996 restructuring discussed in Note 9) without regard for sublease payments under noncancelable leases as follows (in thousands): Capital Operating Leases Leases 1999 $257 $ 804 2000 221 633 2001 143 556 2002 91 139 2003 and thereafter 122 ----- ------ 834 $2,132 Amount representing interest 132 ----- Present value of net minimum lease payments 702 Less current portion 186 ----- Long-term capital lease obligations $ 516 ===== Rent expense (including amounts for the facilities leased from the director) amounted to $751,000, $582,000, and $638,000 for the years ended December 31, 1998, 1997, and 1996, respectively. 9. RESTRUCTURING COSTS During 1996, the Company recorded restructuring costs of $2,449,000 as a result of the consolidation of the laboratory operations of PDLA into the laboratory operations at Medtox Laboratories, the sale of the former operations of Bioman, and the reduction of its work force at certain of its facilities. In fiscal 1996, payments of $646,000 were made against the restructuring reserves. In fiscal 1997, restructuring reserves decreased by $1,017,000 to $786,000 at December 31, 1997, due to payments of $620,000 and a decrease in the estimate of the required reserve of $397,000 in December 1997. In fiscal 1998, restructuring reserves increased by $369,000 to $1,155,000 at December 31, 1998, due to payments of $342,000 and an increase in the estimate of the required reserve of $711,000 in the fourth quarter of 1998 resulting from preliminary unfavorable court rulings relative to certain contingencies originally accrued for in 1996. 10. INCOME TAXES Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets are as follows (in thousands):
1998 1997 Deferred tax liability - Excess fixed asset basis $ (194) Deferred tax assets: Excess fixed asset basis $ 169 Excess goodwill basis 1,421 1,897 Medical reserve 104 - Net operating loss carryforwards 13,523 13,487 Research and experimental credit carryforwards 65 41 Restructuring costs 439 298 Legal reserve 68 76 Other 284 413 ------------ ----------- Total net deferred tax assets 15,710 16,381 Valuation allowance for deferred tax assets (15,710) (16,381) ------------ ----------- Net deferred tax asset $ - $ - ============ ===========
At December 31, 1998, the Company had net operating loss carryforwards (NOLs) of approximately $35,600,000 which are available to offset taxable income through 2013 and begin to expire in 1999. For financial reporting purposes, a valuation allowance has been recorded to offset deferred tax assets that might not be realized. Section 382 of the Internal Revenue Code restricts the annual utilization of the NOLs incurred prior to a change in ownership. Such a change in ownership may have occurred in connection with stock transactions in 1996, and another change in ownership may have occurred in connection with the conversion of Series A Preferred Stock in 1997 and 1998. As a result of these changes in ownership, the future availability of the NOL to offset taxable income is likely substantially curtailed. 11. BENEFIT PLANS The Company has a defined contribution benefit plan that cover substantially all employees who meet certain age and length of service requirements. Contributions to the plans are at the discretion of the Board of Directors. The 401(k) expense for the years ended December 31, 1998, 1997, and 1996 was $98,000, $152,000, and $80,000, respectively. 12. COMMITMENTS AND CONTINGENCIES The Company is a defendant in a suit in Circuit Court of Cook County, Illinois to a claim of unpaid rent obligations associated with an idle facility in Illinois. The Company answered the complaint denying responsibility for the obligation. In December 1998, the Court granted summary judgment against the Company on certain issues relative to this matter. While the Company intends to vigorously defend this action, in December 1998, following the summary judgment, an additional accrual, as discussed in Note 9, was established. The Company has entered a settlement agreement with United States Drug Testing Laboratories who asserted a claim of patent infringement against the Company on August 20, 1996. It was alleged that the Company infringes two patents allegedly owned by United States Drug Testing Laboratories relating to forensically acceptable determinations of gestational fetal exposure to drugs and other chemical agents. The Company while denying any infringement has reached a settlement agreement with United States Drug Testing Laboratories whereby the Company will pay United States Drug Testing Laboratories $17,500 and issue United States Drug Testing Laboratories 2,500 shares of common stock. The Company believes that the probable outcome of the above contingencies will not materially affect the financial position or results of operations of the Company. On January 31, 1997, the Company filed suit in Federal District Court in Minnesota against a majority shareholder and two former outside directors of the Company alleging violation of Section 16b of the Securities Exchange Act of 1934 and seeking recovery of more than $500,000 in short-swing profits. On August 4, 1997, the U.S. District Court granted the defendants' Motion to Dismiss the Company's complaint, ruling that the defendants' conduct did not constitute a violation of Section 16(b). On October 29, 1997, the Company filed an appeal of that decision to the United States Court of Appeals for the Eighth Circuit (Court of Appeals). On July 21, 1998, the Court of Appeals reversed the U.S. District Court's dismissal and remanded the case back to the U.S. District Court. Under the MEDTOX Laboratories acquisition agreements, the Company may be contingently liable for certain tax liabilities incurred by the former MEDTOX Laboratories shareholders. At the present time, the possible liability under this agreement is not reasonably ascertainable because the agreement, as written, is ambiguous and its intent is not clear. Under the agreement, the obligation, if any, on the part of the Company can be deferred under certain circumstances and at the present time the Company believes this deferral will be available to the Company for the foreseeable future. SCHEDULE II - VALUATION & QUALIFYING ACCOUNTS
Balance at Charged to Costs Charged to Other Deductions Balance at Beginning of and Expenses Accounts the End of Period Period Year Ended December 31, 1998: Deducted from Asset Accounts: Allowance for Doubtful Accounts $ 515,000 $ 22,000 $ 292,000(3) $ 245,000 Restructuring Accrual $ 786,000 $ 711,111(5) $ - $ 341,000(5) $ 1,155,000 Year Ended December 31, 1997: Deducted from Asset Accounts: Allowance for Doubtful Accounts $ 358,000 $ 157,000 $ - $ - $ 515,000 Restructuring Accrual $1,803,000 $ - $ - $ 1,017,000(4) $ 786,000 Year Ended December 31, 1996: Deducted from Asset Accounts: Allowance for Doubtful Accounts $ 130,000 $ 241,000 $ 100,000(2) $ 113,000(3) $ 358,000 Restructuring Accrual $ - $ 2,449,000 $ 646,000(1) $ 1,803,000
(1) Represents severance payments and payments on lease obligations. (2) $100,000 charged to Other Accounts represents the amount acquired through MEDTOX acquisition. (3) Uncollectible accounts written off, net of recoveries (4) Includes reduction of $397,000 of Lease Liability deemed to no longer be an obligation of the Company. The remainder is due in payments toward the liability. (5) Represents payments of lease obligations and an increase of estimate on future lease payments. EX-3.5 2 EXHIBIT 3.5 Exhibit 3.5 CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF MEDTOX SCIENTIFIC, INC. MEDTOX Scientific, Inc., a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), does hereby certify that: The amendment to the Corporation's Certificate of Incorporation set forth in the following resolution approved by the Corporation's Board of Directors and stockholders was duly adopted in accordance with the provisions of section 242 of the General Corporation Laws of the State of Delaware: "RESOLVED, that the Certificate of Incorporation of the corporation be amended by striking Article FOURTH in its entirety and replacing therefor: 'FOURTH: The total number of shares of stock which the Corporation shall have authority to issue is FOUR MILLION SEVEN HUNDRED FIFTY THOUSAND (4,750,000) shares, THREE MILLION SEVEN HUNDRED FIFTY THOUSAND (3,750,000) of which shall be of a class designated as Common Stock with a par value of FIFTEEN CENTS ($0.15) per share and ONE MILLION of which shall be a class designated as Preferred Stock with a par value of ONE DOLLAR ($1.00) per share. All or any part of the authorized capital stock of the Corporation may be issued and sold, from time to time by the corporation, without further action by stockholders, for such consideration (but not less than the par value thereof) and to such persons and on such terms and conditions as may, from time to time, be fixed or determined by the Board of Directors. The voting powers, designations, preferences, and relative, participating, optional or other special rights and the qualifications, limitations or restrictions thereof, of the classes of stock of the corporation which are fixed by this Certificate of Incorporation, and the authority vested in the Board of Directors to fix by resolution or resolution providing for the issue of Preferred Stock the voting powers, designations, preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof, of the shares of Preferred Stock which are not fixed by the Certificate of Incorporation, are as follows: 1. The Preferred Stock may be issued from time to time in one or more series, each such series to have such distinctive designation or title as may be fixed by the Board of Directors prior to the issuance of any shares thereof. Each such series may differ from every other series already outstanding as may be determined from time to time by the Board of Directors prior to the issuance of any shares thereof, in any or all of the following, but in other, respects: (a) The rate of dividend which the Preferred Stock of any such series shall be entitled to receive, whether the dividends of such series shall be cumulative or non-cumulative and, if such dividends shall be cumulative, the date from which they shall be cumulative. (b) The right or obligation, if any, of the corporation to redeem shares of Preferred Stock of any series and the amount per share which the Preferred Stock of any such series shall be entitled to receive in case of the redemption thereof, and the right of the corporation, if any, to reissue any such shares after the same shall have been redeemed. (c) The amount per share which the Preferred Stock of any such series shall be entitled to receive in case of the voluntary liquidation, distribution or sale of assets, dissolution or winding up of the corporation, or in case of the involuntary liquidation, distribution or sale of assets, dissolution or winding up of the corporation. (d) The right, if any, of the holders of Preferred Stock of any such series to convert the same into other classes of stock and the terms and conditions of such conversion. (e) The voting power, if any, of the holders of Preferred Stock of any such series, and the terms and conditions under which they may exercise such voting power. (f) The terms of the sinking fund or fund of similar nature, if any, to be provided for the Preferred Stock of any such series. The description of terms of the Preferred Stock of each series in respect of the foregoing particulars shall be fixed and determined by the Board of Directors by appropriate resolution at or prior to the time of the authorization of the issue of the original shares of each such series. 2. In case the stated dividends and the amounts payable on liquidation, distribution or sale of assets, dissolution or winding up of the corporation are not paid in full, the stockholders of all series of the Preferred Stock shall share ratably in the payment of dividends, including accumulations, if any, in accordance with the same which would be payable on such shares if all dividends were declared and paid in full and in any distribution of assets other than by way of dividends, in accordance with the sums which would be payable on such distribution if all sums payable were discharged and paid in full. 3. The holders of the Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors, out of funds legally available therefor, preferential dividends in cash at, but not exceeding the annual rate fixed for each particular series. The holders of the Preferred Stock shall not be entitled to receive any dividends thereon other than dividends referred to in this Subdivision 3. 4. So long as any of the Preferred Stock remains outstanding, in no event shall any dividend whatever, whether in cash or other property (other than shares of Common Stock), be paid or declared or any distribution be made on the Common Stock, nor shall any shares of the Common Stock be purchased, retired or otherwise acquired for a consideration by the corporation unless (a) the full dividends of the Preferred Stock for all past dividend periods from the respective date or then current quarter-yearly dividend period shall have been paid or declared and a sum set apart sufficient for the payment thereof, and (b) if at any time he corporation is obligated to retire shares of any series of the Preferred Stock pursuant to a sinking fund or a fund of a similar nature, all arrears, if any, in respect of the retirement of the Preferred Stock of all such series shall have been made good. Subject to the foregoing provisions and not otherwise, such dividends (payable in cash, stock or otherwise) as may be determined by the Board of Directors may be declared and paid on the Common Stock from time to time out of the remaining funds of the corporation legally available therefor, and the Preferred Stock shall not be entitled to participate in any such dividend, whether payable in cash, stock or otherwise. 5. In the event of any liquidation, distribution or sale of assets, dissolution or winding up of the corporation, whether voluntary or involuntary, before any distribution or payment shall be made to the holders of Common Stock, the holders of the Preferred Stock of each series shall be entitled to be paid in cash the applicable liquidation price per share fixed at the time of the original authorization of issuance of shares of such respective series, together with a sum in the case of each share of the Preferred Stock, computed at the annual dividend on such share because cumulative to the date fixed for such distribution or payment date paid thereon. If such payment shall have been made in full to the holders of the Preferred Stock, the remaining assets and funds of the corporation shall be distributed among the holders of the Common Stock according to their respective shares. 6. Subject to the powers, preferences and rights and the qualification, limitations and restrictions thereof, with respect to each class of capital stock of the corporation having any preference or priority over the Common Stock, the holders of the Common Stock shall have and possess all rights appertaining to capital stock of the corporation. Holders of Common Stock may not act by written consent without a meeting.'" IN WITNESS WHEREOF, MEDTOX Scientific, Inc. has caused this Certificate to be signed and attested by its duly authorized officers this 22nd of February, 1999. MEDTOX Scientific, Inc. By: /s/ Harry G. McCoy Harry G. McCoy President ATTEST: /s/ Kevin Wiersma Kevin Wiersma EX-21 3 EXHIBIT 21 Exhibit 21 List of Subsidiaries of the Registrant Listed below are the subsidiaries of MEDTOX Scientific, Inc., all of which are wholly owned. MEDTOX Laboratories, Inc. MEDTOX Diagnostics, Inc. EX-24.1 4 EXHIBIT 24.1 Exhibit 24.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 333-45057 on Form S-3 dated February 4, 1988, No. 333-28783 on Form S-3 dated October 8, 1997, No. 333-24371 on Form S-8 dated April 2, 1997, No. 333-18547 on Form S-3 dated February 14, 1997, No. 333-827 on Form S-3 dated May 15, 1996, No. 33-89646 on Form S-8 dated February 21, 1995, No. 33-91840 on Form S-3 dated July 21, 1995, No. 33-86744 on Form S-3 dated December 13, 1994, No. 33-78590 on Form S-3 dated June 20, 1994, No. 33-74078 on Form S-3 dated February 2, 1994, No. 33-71490 on Form S-8 dated November 11, 1993, No. 33-71596 on Form S-8 dated November 11, 1993, No. 33-49474 on Form S-8 dated July 10, 1992, No. 33-48566 on Form S-3 dated June 25, 1992, No. 33-15025 on Form S-8 dated June 29, 1987, and No. 33-10393 on Form S-8 dated December 16, 1986 of our report dated March 26, 1999 (April 12, 1999 as to the sixth paragraph of Note 5), with respect to the consolidated financial statements and schedule of MEDTOX Scientific, Inc. (formerly EDITEK, Inc.) as of and for the year ended December 31, 1998 included in this Annual Report (Form 10-K) for the year ended December 31, 1998. /s/ Deloitte & Touche Minneapolis, Minnesota April 13, 1999 EX-24.1 5 EXHIBIT 24.1 Exhibit 24.2 Consent of Independent Auditors We consent to the incorporation by reference in Registration Statements No. 333-45057 on Form S-3 dated February 4, 1998, No. 333-28783 on Form S-3 dated October 8, 1997, No. 333-24371 on Form S-8 dated April 2, 1997, No. 333-18547 on Form S-3 dated February 14, 1997, No. 333-827 on Form S-3 dated May 15, 1996, No. 33-89646 on Form S-8 dated February 21, 1995, No. 33-91840 on Form S-3 dated July 21, 1995, No. 33-86744 on Form S-3 dated December 13, 1994, No. 33-78590 on Form S-3 dated June 20, 1994, No. 33-74078 on Form S-3 dated February 2, 1994, No. 33-71490 on Form S-8 dated November 11, 1993, No. 33-71596 on Form S-8 dated November 11, 1993, No. 33-49474 on Form S-8 dated July 10, 1992, No. 33-48566 on Form S-3 dated June 25, 1992, No. 33-15025 on Form S-8 dated June 29, 1987 and No 33-10393 on Form S-8 dated December 16, 1986 of our report dated February 6, 1998, with respect to the consolidated financial statements and schedule of Medtox Scientific, Inc. (formerly EDITEK, Inc.) included in the Annual Report (Form 10-K) for the year ended December 31, 1998. /s/ Ernst & Young LLP Minneapolis, Minnesota April 12, 1999 EX-27 6 EXHIBIT 27 (FDS)
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 0 0 6,232 245 1,107 7,618 13,062 10,087 24,600 10,897 0 0 0 435 10,892 24,600 29,575 29,576 20,360 31,873 0 0 674 (2,297) 0 (2,297) 0 0 0 (2,297) (0.79) (0.79)
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