Item 1. Business
General
Psychemedics Corporation ("the Company") is a Delaware corporation organized on September 24, 1986 to provide testing services for the detection of abused substances through the analysis of hair samples. The Company's testing methods utilize a patented technology for performing immunoassays on enzymatically dissolved hair samples with confirmation testing by gas chromatography/mass spectrometry ("GC/MS").
The Company's first application of its patented technology is a testing service which screens for the presence of certain drugs of abuse in hair. The application of radioimmunoassay procedures using hair differs from the more widely used application of radioimmunoassay procedures using urine samples. The Company's tests provide quantitative information which indicates the approximate amount of drug ingested as well as historical data which can show a pattern of individual drug use over a period of time. This information is useful to employers in both applicant and employee testing, to physicians, treatment professionals, law enforcement agencies, to the insurance industry, to other individuals and entities engaged in any business where drug use is an issue, and to parents concerned about drug use by their children. The Company provides commercial testing and confirmation by GC/MS using industry accepted practices for cocaine, marijuana, PCP, methamphetamine, and opiates. In addition, the Company has developed a test for methadone for use in the treatment industry.
Testing services are currently performed at the Company's laboratory at 5832 Uplander Way, Culver City, California. The Company's services are marketed under the name RIAH, (Radioimmunoassay of Hair), a registered service mark.
Development of Radioimmunoassay of Hair
The application of special radioimmunoassay procedures to the analysis of hair was initially developed in 1978 by the founders of the Company, Annette Baumgartner and Werner A. Baumgartner, Ph.D. The Baumgartners demonstrated that when certain chemical substances enter the bloodstream, the blood carries them to the hair where they become "entrapped" in the protein matrix in amounts roughly proportional to the amount ingested. The Company's drugs of abuse testing procedure involves washing the hair sample to clean it of surface contaminants and then subjecting the cleaned hair sample to the Company's unique proprietary process which involves the direct analysis of liquefied hair samples by radioimmunoassay procedures utilizing special reagents and antibodies. The antibodies detect the presence of a specific drug or metabolite in the liquefied hair sample by reacting with the drug present in the sample solution and an added radioactive analog of the drug. The resulting antibody-drug complex is precipitated and analyzed. The amount of drug present in the sample is inversely proportional to the amount of radioactive analog in the precipitate. Depending upon both the length of hair and the hair growth rate (hair grows approximately 1.3 centimeters per month), the Company is able to provide historical information on drug use by the person from whom the sample was obtained. Another testing option involves sectional analysis of the hair sample. In this procedure, the hair is sectioned lengthwise to approximately correspond to certain time periods. The sections are
then labeled by time period, which allows the Company to provide trend information on drug use. When quantitative results of this test are reported and compared to dose correlation graphs, information is provided about the individual's approximate drug usage during the period being tested.
Validation of the Company's Proprietary Testing Method
The process of analyzing human hair for the presence of drugs using the Company's patented method has been the subject of over fifty scientific field studies. Results from the studies that have been published or accepted for publication in scientific journals are generally favorable to the Company's technology. These studies were performed with the following organizations: Citizens for a Better Community Court, Columbia University, Koba Associates-DC Initiative, Harvard Cocaine Recovery Project, Hutzel Hospital, ISA Associates (Interscience America)-NIDA Workplace Study, University of California-Sleep State Organization, Maternal/Child Substance Abuse Project, Matrix Center, National Public Services Research Institute, Narcotic and Drug Research Institute, San Diego State University-Chemical Dependency Center, Spectrum Inc., Stapleford Centre (London), Task Force on Violent Crime (Cleveland, Ohio); University of Miami-Department of Psychiatry, University of Miami-Division of Neonatology, University of South Florida-Operation Par Inc., University of Washington, VA Medical Center-Georgia, U.S. Probation Parole-Santa Ana. The above studies include research in the following areas: prenatal, treatment evaluation, workplace drug use, the criminal justice system and epidemiology. Many of the studies have been funded by the National Institute of Justice or the National Institute on Drug Abuse ("NIDA"). Over 300 research articles written by independent researchers have been published supporting the general validity and usefulness of hair analysis.
An additional independent evaluation of the technology, favorable to the Company's services, has been performed by submission of blind samples by Dr. Robert DuPont, President of the Institute of Behavior and Health, Inc., the first Director of the National Institute on Drug Abuse and presently Chairman of the Company's Scientific Advisory Board. Some of the Company's customers have also completed their own testing to validate the Company's proprietary hair testing method as a prelude to utilizing the Company's services. These studies have consistently confirmed the Company's superior detection rate. When the results from utilizing the Company's patented hair testing method were compared to urine results in side-by-side evaluations, 5 to 10 times as many drug abusers were accurately identified with the Company's proprietary method. In addition to these studies, the Company is now performing testing for over 750 clients.
During 1996, the Company's patented method was utilized in a number of important research application studies. In a study funded by the White House Office of National Drug Control Policy (the Drug Czar's office) in 1996, hair analysis was used to assess levels of drug use in hard-core drug abusers. The National Institute of Justice sponsored an investigation using hair analysis to determine the extent of drug use among prison inmates. Additional research studies were conducted at Texas Christian University, Texas A & M, UCLA, University of Pennsylvania and the University of South Florida. These studies investigated drug abuse among juvenile delinquents, homeless individuals, HIV patients and pregnant women.
Advantages of Using the Company's Patented Method
The Company asserts that hair testing using its patented method confers substantive advantages relative to existing means of drug detection through urinalysis. Although urinalysis testing can provide accurate drug use information, the scope of the information is short-term and is generally limited to the type of drug ingested within a few days of the test. Studies published in many scientific publications including NIDA Research Monograph and the Journal of Forensic Sciences have indicated that cocaine, PCP, opiates, and methamphetamine disappear from urine within 72 to 96 hours of use, although marijuana may take a week or more.
In contrast to urinalysis testing, hair testing using the Company's patented method provides long-term historical drug use information resulting in a significantly wider "window of detection." This "window" may be three months or longer depending on the length of the hair sample. The Company's standard test offering, however, uses a 3.9 centimeter length cut close to the scalp; therefore, it measures use for approximately the previous 90 days.
This wider window of detection enhances the detection efficiency of hair analysis making it particularly useful in pre-employment testing. Hair testing not only identifies more drug users, but also uncovers patterns and severity of drug use, information most helpful in determining the scope of an individual's involvement with drugs and serves as a deterrent against the use of drugs. Hair testing using the Company's patented method greatly reduces the incidence of "false negatives" associated with evasive measures typically encountered with urinalysis testing. Urinalysis test results are impacted adversely by excessive fluid intake prior to testing as well as adulteration of the sample. Moreover, a drug user who abstains from use for a few days prior to urinalysis testing can usually escape detection. Hair testing is effectively free of these problems as it cannot be thwarted by evasive measures typically encountered with urinalysis testing. It is also attractive to customers since sample collection is typically performed under close supervision yet is less intrusive and embarrassing for test subjects.
Hair testing using the Company's patented method (with GC/MS confirmation) further reduces the prospects of error in conducting drug detection tests. Urinalysis testing is more susceptible to problems such as "evidentiary false positives" resulting from passive drug exposure (e.g. poppy seeds.) In the event a positive urinalysis test result is challenged based on passive exposure, the only remedy is a newly collected sample. Depending on the drug usage of the forewarned individual prior to the date of the newly collected sample, a re-test may yield a negative result when using urinalysis testing because of temporary abstention. In contrast, when the Company's hair testing method is offered on a repeat hair sample the individual suspected of drug use cannot as easily affect the results because historical drug use data remain locked in the hair fiber.
Disadvantages of Hair Testing
There are some disadvantages of hair testing as compared to drug detection through urinalysis. Because hair starts growing below the skin surface, drug ingestion evidence does not appear in hair above the scalp until five to seven days after use.
Thus, hair testing is not suitable for use in "for cause" testing such as is done in connection with an accident investigation. It does, however, provide a drug history which can complement urinalysis information in "for cause" testing.
Currently, radioimmunoassay testing using hair samples under the Company's patented method is only practiced by Psychemedics Corporation. The absence of widespread familiarity and use of hair testing may adversely impact the Company's revenue growth.
The Company's prices for its tests are generally somewhat higher than prices for comparable tests using urinalysis, but the Company believes that its superior detection rates provide more value to the customer. This pricing policy could, however, adversely impact the growth of the Company's sales volume.
Patents
In December 1987, Dr. Werner A. Baumgartner, the Company's founder and Director of Research and Development, with the assistance of the Company's patent counsel, filed the first in a series of patent applications in the U.S. Patent and Trademark Office on his inventions relating to radioimmunoassay using hair. In 1994, U.S. Patent No. 5,324,642 (the "642 Patent") was issued to the Company. This patent pertains to the universal drug extraction procedure and immunoassay technology for the detection of drugs in hair specimens. In 1995, the Company was granted an additional patent covering Dr. Baumgartner's inventions pertaining to the immuno chemical screening assay for marijuana, which is the most difficult drug to detect. Dr. Baumgartner has continued his research, and the Company has pending two additional patent applications in the U.S. Patent and Trademark Office with respect to his inventions relating to procedures using hair. The Company believes that additional patents will be granted as a result of Dr. Baumgartner's pending patent applications although there can be no assurance that any such additional patents will be granted.
Pursuant to an agreement dated January 1987, Werner A. Baumgartner and Annette Baumgartner granted to the Company an exclusive royalty-free worldwide license of all of their rights in and to their inventions relating to radioimmunoassay using hair.
Most of Dr. Baumgartner's research on the inventions covered by the 642 Patent was conducted while he was employed by the Veteran's Administration Hospital ("VA"). Dr. Baumgartner has, therefore, also granted to the U.S. government, for all Governmental purposes, a nonexclusive, irrevocable, royalty-free license to use the basic invention during the term of the patent with respect to such invention.
Certain aspects of the Company's hair analysis method are based on trade secrets owned by the Company. The Company's ability to protect the confidentiality of these trade secrets is dependent upon the Company's internal safeguards and upon the laws protecting trade secrets and unfair competition. In the event that patent protection or protection under the laws of trade secrets were not sufficient and the Company's competitors succeeded in duplicating the Company's products, the Company's business could be materially adversely affected.
Target Markets
1. Industry
The Company has focused its primary marketing efforts on the private sector. The Company believes that the market for job applicant and employee testing will yield the most immediate beneficial impact to the business of the Company and assist in establishing a regular client base.
The number of businesses using drug testing to screen job applicants and employees has increased significantly in the last nine years. The 1996 American Management Association (AMA) survey indicated that 81% of surveyed firms were engaged in some form of drug testing, a 277% increase since the initial AMA survey in 1987. The prevalence of drug screening programs reflects a growing concern that drug use contributes to employee health problems and costs (increased absenteeism, reduced productivity, etc.) and in certain industries, safety hazards. It has been estimated that the cost to industry in terms of health care costs and lost productivity is at least $60 billion annually.
The principal criticism of employee drug screening programs centers on the effectiveness of the testing program. Most private sector screening programs use urinalysis. Such programs are susceptible to evasive maneuvers and the inability to obtain identical repeat samples in the event of a challenged result.
Moreover, many employers, to accommodate concerns of their employees and to avoid infringement of employee privacy rights, conduct their programs on a pre-announced schedule, thereby providing an opportunity for many drug users to abstain in order to escape detection.
The Company presents its patented hair analysis method to potential clients as a better technology well suited to employer needs. Field studies and actual client results support the accuracy and effectiveness of the Company's patented technology and its ability to detect even casual drug use. The historical aspect of the Company's patented method as well as the Company's ability to provide correlation of the measured drug with approximate amount of ingestion, furnish an employer with greater flexibility in assessing the scope of an applicant's or an employee's drug problem.
The Company provides clients confirmation of positive results through GC/MS. The use of GC/MS is an industry accepted practice used to confirm positive drug test results of an initial screen. In an employment setting, GC/MS confirmation is typically used prior to the taking of any disciplinary action against an employee. The Company offers its clients a five-drug screen with GC/MS confirmation of cocaine, PCP, marijuana, methamphetamine, and opiates.
2. Home Use
In 1995, the Company began marketing "PDT-90",, its hair testing service to parents concerned about drug use by their children. It allows parents to collect a small sample from their child in the privacy of the home and have it tested for drugs of abuse by the Company. The PDT-90 testing service uses the same patented method that is used with the Company's workplace testing service. The Company commenced a marketing campaign in the third quarter of 1995 for the new service.
3. Medical
The Company has developed a medical market for its proprietary hair testing method consisting mostly of testing services for use by treatment professionals for drug recovery programs and prenatal care.
In the drug treatment area, the Company's patented method can be used by treatment professionals to obtain background information on drug use, information most critical in structuring an individual's recovery program. Under traditional drug detection tests, this information is obtained from self-reporting, an approach generally deemed unreliable for various reasons, including reluctance to discuss the nature of one's drug habit, memory failure, and unknown substance purity. As a follow-up to a rehabilitation process, the Company's patented method provides additional support by generating feedback to individual physicians, psychiatrists and therapists on the success of their methods. The utility of the Company's technology in monitoring recovery after discharge from employee assistance programs has been validated by the Company's customers. The Company's recently developed methadone test can also assist treatment professionals in their treatment efforts.
The Company has engaged in, and continues to engage in, studies supporting the utility of its patented hair analysis method in the evaluation of drug use during pregnancy and the corresponding treatment of newborns. Studies are under way at University of Pennsylvania, Hutzel Hospital, University of Washington, Columbia University, University of Miami, National Public Services Research Institute, University of California-Sleep State Organization and Maternal/Child Substance Abuse Project. The Company expects that these cost-benefit and application studies will demonstrate the utility of its proprietary screen in the prenatal market.
Sales and Marketing
The Company markets its corporate drug testing services primarily through its own direct sales force. The Company's in-house efforts are supplemented by a limited network of independent sales representatives who are thoroughly trained by the Company. The Company markets PDT-90, its home testing drug service, through a toll-free number. For both its business-to-business and consumer direct services, the Company has undertaken an integrated marketing campaign to enhance the market presence within each respective segment.
Competition
The Company competes directly with numerous commercial laboratories which test for drugs through urinalysis testing. Most of these laboratories, such as Laboratory Corporation of America, SmithKline Beecham Clinical Laboratories and Corning Clinical Laboratories, Inc. have substantially greater financial resources, market identity, marketing organizations, facilities, and numbers of personnel than the Company. The Company has been steadily increasing its base of corporate customers and believes that future success with new customers is dependent on the Company's ability to communicate the advantages of implementing a drug program utilizing the Company's patented hair analysis method.
The Company's ability to compete is also a function of pricing. The Company's prices for its tests are generally somewhat higher than prices for comparable tests using urinalysis. However, the Company believes that its superior detection rates,
coupled with the customer's ability to test less frequently due to hair testing's wider window of detection (approximately 90 days verses approximately three days with urinalysis) provide more value to the customer. This pricing policy could, however, lead to slower sales growth for the Company.
The Company is not aware of any other laboratories with a hair analysis technology that is comparable in effectiveness to the Company's proprietary procedures. The Company is aware of two laboratories which operate in certain limited employment testing markets and which purport to test hair samples using a method, which the Company presumes, includes the use of a form of immunoassay procedures. The Company, however, does not believe that effective immunoassay testing of hair samples is currently feasible on a commercial basis without using the Company's unique patented method.
Government Regulation
The Company is licensed as a Clinical Laboratory by the State of California as well as certain other states. All tests are performed according to the standards established by the Clinical Laboratories Improvement Act and the College of American Pathologists. Presently there are no other regulations required for the operation of a clinical laboratory in the State of California.
A substantial number of states regulate drug testing. The scope and nature of such regulation varies greatly from state to state. In some states, a clinical laboratory such as the Company is required to satisfy certain requirements as a precondition to the laboratory's certification or right to perform drug testing services with respect to specimens obtained in such state. The laws or regulations in other states, in some instances, limit testing to certain matrixes ("matrix" refers to the substance, blood, urine, hair, etc., which is tested for the presence of drugs) which in two states excludes hair. The Company seeks, through participation in the legislative and regulatory process, to educate the legislative and regulatory agencies of those few states whose statutes have been interpreted to not include the testing of hair.
In August 1995, the United States Food and Drug Administration ("FDA") issued a Warning Letter to the Company pertaining to PDT-90, the drug testing service which the Company introduced in July 1995 as a testing service for parents concerned about drug use by their children. The FDA claimed that the collection envelope the Company distributed as part of the PDT-90 testing service constituted a "medical device" under the Federal Food Drug and Cosmetic Act, as amended (the "FDC Act"), and that, because the Company did not seek the approval or permission of the FDA to market the envelope, it was therefore adulterated and misbranded under the FDC Act.
In its response, the Company stated its position that the collection envelope is not a medical device under the FDC Act. However, in order to expeditiously resolve the matter with the FDA, the Company submitted a 510(k) premarket notification to the FDA on September 27, 1995 seeking a determination from the FDA that the collection envelope is substantially equivalent to collection envelopes which previously received 510(k) premarket clearance and were currently being commercially marketed. In November 1995, the FDA issued a "Not Substantially Equivalent" ("NSE") determination in response to the Company's 510(k) submission and classified PDT-90 as a Class III device under the FDC Act.
In December 1995, the Company filed suit against the FDA in the United States Court of Appeals for the First Circuit seeking to overturn the FDA's NSE determination. In March 1996, the FDA agreed to withdraw the Warning Letter and the NSE determination in exchange for the Company's dismissal of its suit against the FDA. The FDA also confirmed its decision not to actively regulate PDT-90 and not to pursue enforcement action on any of the grounds contemplated in the Warning Letter.
On February 6, 1997, the FDA announced a new agency proposal to companies that make "drugs of abuse test systems". Under the proposal, companies engaged in the business of testing for drugs of abuse using immunoassay testing procedures previously recognized by the FDA would be able to market their test systems without pre-market approval or clearance by the FDA so long as the tests are conducted at certain approved laboratories and certain labeling and product information procedures are followed. To date, the FDA has recognized immunoassay testing procedures which involve the use of urine and sweat as the test sample in certain applications. Under the FDA proposal, companies engaged in the business of testing for drugs of abuse using samples other than those previously recognized would effectively be prohibited from operating without FDA approval or clearance. Such companies would be required to submit their test to the FDA for recognition. The FDA's February 1997 announcement states that it intends to implement the proposed new policy through notice and comment rulemaking. The proposal includes a transitional period of approximately two years in order for companies not currently in compliance with the proposed requirements to obtain the necessary data they need for submission to the FDA. The Company believes that its proprietary method of detecting drugs of abuse using hair samples is accurate and reliable and should, therefore, be recognized if necessary. However, the Company maintains that the FDA lacks statutory authority to regulate its drug testing service. There is a risk that, under regulations which may hereafter be adopted in light of the FDA's proposal, an application by the Company for recognition of the Company's proprietary hair testing technology could be denied, in which event, if upheld on appeal, the Company's business would be materially adversely affected.
Scientific Advisory Board
The Company has established a Scientific Advisory Board which consults with management of the Company to examine and evaluate the progress of the Company's research and development activities, to promote independent validation studies of the Company's patented hair analysis method technology, and to assist in accelerating acceptance of the technology in both the public and private sectors. Members of the Scientific Advisory Board are compensated at the rate of $1,000 per day for each meeting attended plus reimbursement for out-of-pocket expenses. The Chairman of the Scientific Advisory Board is Dr. Robert DuPont. Dr. DuPont's career has included numerous positions in the psychiatric and substance abuse field, including Director, Special Action Office for Drug Abuse Prevention - The White House; the first Director, National Institute on Drug Abuse; President, American Council for Drug Education; and President, Phobia Society of America. Dr. DuPont has received several national awards and presently serves as President: Institute for
Behavior and Health, Inc.; Vice President, Bensinger, DuPont and Associates, a national drug and alcohol abuse consulting firm; and he maintains a private practice in psychiatry. Dr. DuPont has also been granted options to acquire shares of the Company's common stock. Other members of the Scientific Advisory Board are Edward C. Senay, M.D., a Professor in the Department of Psychiatry at the University of Chicago, and Arthur McBay, Ph.D., a Forensic Toxicologist and former Professor of Pharmacy at the University of North Carolina.
Research and Development
The Company is continuously engaged in research and development activities. During the years ended December 31, 1996, 1995 and 1994, $413,693, $436,385 and $406,345, respectively, were expended for research and development. The Company continues to perform research activities to develop new products and services utilizing the Company's proprietary technology. Additional research using the Company's proprietary technology is being conducted by outside research organizations through government-funded studies.
The Company's research includes "controlled studies" to determine the advantages of hair testing in the medical, forensic and criminal justice markets. The Company has also furnished technical assistance to several distinguished independent researchers whose studies have been funded through government grants. Many such studies are currently in progress. The Company continues to conduct its own research toward the development of new inventions, services and products derived from the Company's patented technology.
Sources and Availability of Raw Materials
Since its inception, the Company has purchased raw materials for its laboratory services from outside suppliers. The most critical of these raw materials are the radio-labeled drugs which the Company purchases from a single supplier, although other supplies of radio-labeled drugs exist. If suitable radio-labeled drugs were to become unavailable, or available only at prohibitive cost, the Company would be required to produce its own radio-chemical supplies, although other suppliers of radio-labeled drugs exist. The Company estimates that it would have to expend approximately $400,000 for capital additions to produce its own supply. Thereafter, direct costs for such raw materials would likely decrease.
Principal Customer
The Company's major customer, Blockbuster Entertainment Group ("Blockbuster"), a division of Viacom, Inc., accounted for approximately 19% of the Company's drug testing sample volume and approximately 15% of the Company's revenue during the year ended December 31, 1996. The Company's agreement with Blockbuster is terminable at will by either party and the loss of Blockbuster as a customer could have a material adverse effect on the Company. However, the Company believes that its relations with Blockbuster are satisfactory.
Employees
As of December 31, 1996, the Company had 71 full-time equivalent employees, of which four full-time employees were in research and development. None of the Company's employees is subject to a collective bargaining agreement.
Item 2.
Item 2. Properties.
The Company maintains its corporate office and northeast sales office at 1280 Massachusetts Avenue, Cambridge, Massachusetts; the office is leased through September 1998.
The Company leases 18,000 square feet of space in Culver City, California, for sales, customer service and laboratory purposes. This facility is leased through December 31, 1997 with an option to renew for an additional five years.
Item 3.
Item 3. Legal Proceedings.
The Company's recent dispute with the Food and Drug Administration is described above under Business Government Regulation. The Company is involved in various other suits and claims in the ordinary course of business. The Company does not believe that the disposition of any such other suits or claims will have a material adverse effect on the continuing operations or financial position of the Company.
Item 4.
Item 4. Submission of Matters To Vote of Security Holders.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.
The Company's common stock has been traded on the American Stock Exchange under the symbol "PMD" since April 27, 1995. Prior to such date, the stock was traded on the NASDAQ Small-Cap Market under the symbol "PCMC". The following table sets forth for the periods indicated the range of prices for the Company's common stock as reported by the National Quotation Bureau, Inc. (through April 26, 1995) and as reported by the American Stock Exchange thereafter. As of March 14, 1997, there were 526 recordholders of the Company's common stock.
Calendar Period High Low - --------------- -------- ------ - ---- First Quarter 6 1/2 5 1/8 Second Quarter 8 6 1/16 Third Quarter 7 11/16 6 Fourth Quarter 6 3/4 5 3/4
- ---- First Quarter 3 7/16 2 1/2 Second Quarter 3 3/8 2 5/8 Third Quarter 9 3 3/8 Fourth Quarter 6 4 3/4
On July 3, 1996, the Company distributed a 3% stock dividend to shareholders of record on June 21, 1996. The share price information set forth above has not been adjusted to reflect the stock dividend. On December 19, 1996, the Company declared a cash dividend of $0.02 a share payable on January 30, 1997 to holders of record at the close of business on January 15, 1997. Subsequently, on March 4, 1997, the Company declared a cash dividend of $0.02 per share payable on April 9, 1997 to shareholders of record at the close of business on March 20, 1997. Future dividends may be made at the discretion of the Board of Directors.
Item 6.
Item 6. Selected Financial Data
The following Selected Financial Data for the years ended December 31, 1996, 1995 and 1994 have been derived from the financial statements of the Company as audited by Arthur Andersen LLP, the Company's independent public accountants. This Selected Financial Data should be read in conjunction with, and is qualified in its entirety by reference to, the financial statements and related notes thereto included elsewhere in this Report. The Selected Financial Data for the years ended December 31, 1993 and 1992 were also derived from the audited financial statements of the Company, although reference to these financial statements and related notes thereto is not included in this report.
Item 7.
Item 7. Management's Discussions and Analysis of Financial Condition and Results of Operations.
REVENUE
The year ended December 31, 1996 was another record year for revenue. Revenue was $12,214,198 in 1996 as compared to $10,110,934 in 1995 and $8,734,156 in 1994, representing an increase of 21% in 1996 and 16% in 1995. These increases were due primarily to the addition of new clients and expanded volume from existing clients in targeted industries such as manufacturing, service, retail, mining, and law enforcement. Revenue included $1,886,000 $1,822,000 and $2,059,000 from Blockbuster in 1996, 1995 and 1994, respectively. There can be no assurance that Blockbuster's testing volume and the Company's resulting revenue derived from Blockbuster will reach the same levels in 1997 as in 1996.
DIRECT COSTS AND EXPENSES
The following table sets forth the direct costs of revenue as a percentage of revenue and general and administrative expenses, marketing and selling expenses and research and development expenses as a percentage of revenue for the years ended December 31:
1996 1995 1994 ---- ---- ---- Direct costs 41% 46% 42% General and administrative expenses 19% 19% 15% Marketing and selling expenses 17% 17% 18% Research and development expenses 3% 4% 5%
Direct Costs
Direct costs for the year ended December 31, 1996 were $4,981,221 as compared to $4,689,227 in 1995 and $3,696,944 in 1994. The increases of $291,994 and $992,283 in 1996 and 1995, respectively, are due primarily to increases in the volume of samples tested in each such period. The decrease in direct costs as a percentage of revenue in 1996 as compared to 1995 is primarily the result of increased efficiencies resulting from increased sales volume.
General and Administrative Expenses
General and Administrative Expenses were $2,362,074, $1,946,648 and $1,342,653 for the years ended December 31, 1996, 1995 and 1994, respectively. The $415,426 increase in 1996 was due primarily to the higher costs incurred by the Company as a result of its continued revenue growth, principally salaries, legal, regulatory and bad debt expenses. The $603,995 increase in 1995 was also due primarily to the higher costs incurred by the Company as a result of its revenue growth.
Marketing and Selling Expenses
Marketing and Selling Expenses for the year ended December 31, 1996 were $2,048,477 as compared to $1,737,543 in 1995 and $1,546,084 in 1994. The increase in 1996 of $310,934 was due primarily to increased marketing expenses related to an expanded sales staff and increased marketing activities. The $191,459 increase in 1995 as compared to 1994 was due primarily to increased marketing expenses.
Research and Development Expenses
Research and Development Expenses remained virtually unchanged at $413,693 in 1996 as compared to $436,385 in 1995 and $406,345 in 1994. As a percentage of revenues, Research & Development Expenses decreased due to increases in revenues in the periods.
OTHER INCOME (EXPENSE)
Interest income in 1996, 1995 and 1994 resulted primarily from temporary investments of cash derived from operations, and from the exercise of stock options and warrants. The decrease in interest expense in 1996 and 1995 results from the repayment of capital lease obligations attributable to the financing of certain equipment purchases in 1993 through capital lease arrangements.
NET INCOME
Net income for December 31, 1996, 1995 and 1994 was $2,491,981, $1,558,686 and $1,831,230 respectively. The increase in 1996 was primarily due to increased revenues, and related efficiencies in direct costs derived from increased sales volume. The decrease in 1995 was primarily due to increases in direct costs and increased general and administrative expenses which exceeded increases in revenues in such year. The provision for income taxes in 1996 and 1995 represents the alternative minimum tax due, and provision for state corporate income taxes as required by the Internal Revenue Code. The Company had total net operating loss carryforwards at December 31, 1996 of approximately $3,586,000 available to offset future federal taxable income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and investment balances at December 31, 1996 amounted to $9,833,405. Cash generated from operations in 1996 was $2,352,557. The Company also received $2,756,667 of net proceeds from the exercise of warrants and stock options in 1996.
Working capital at December 31, 1996 amounted to $11,402,723 as compared to $6,788,513 at December 31, 1995. The increase of $4,614,210 during 1996 resulted primarily from increased sales and the exercise of stock options and warrants during the year.
Management believes that cash on hand, coupled with future operating profits and the proceeds from the exercise of outstanding options, should be adequate to fund anticipated working capital requirements. Depending upon the Company's results of operations, its future capital needs and available marketing opportunities, the Company may use various financing sources to raise additional equity capital. Such sources could include joint ventures or additional private equity placements.
The Company's capital expenditures were $736,432 in 1996, $1,269,118 in 1995 and $528,819 in 1994. The expenditures in 1996 were primarily a result of expansion of the Company's laboratory facilities. Capital expenditures for 1997 are expected to be approximately $600,000 and are expected to be funded through cash generated from operations and from existing cash reserves.
In December 1994, the Company's Board of Directors authorized the repurchase of up to 1 million shares of the Company's common stock. During 1995, the Company purchased a total of 699,387 shares of Common Stock for $2,676,793. This program is a direct result of the Company's solid financial condition and cash-generating capability, and it was authorized after evaluating various alternatives to enhance long-term share owner value.
On July 3, 1996, the Company distributed a 3% stock dividend to shareholders of record on June 21, 1996. The shares issued in the stock dividend represented shares which the Company acquired in the stock repurchase program. This transaction resulted in an increase of $4,667,516 in the accumulated deficit (633,006 shares distributed at a fair market value of $7.375 per share on June 31, 1996, the record date). Treasury stock was reduced by $2,422,730 as a result of this distribution. Average shares outstanding and all per share amounts included in the accompanying financial statements and Notes are based on the increased number of shares giving retroactive effect to the stock dividend.
On December 19, 1996, the Company declared a cash dividend of $0.02 a share payable on January 30, 1997 to holders of record at the close of business on January 15, 1997. This cash dividend resulted in an increase of $437,221 in the accumulated deficit and accrued dividends payable at December 31, 1996
On March 4, 1997, the Company declared a cash dividend of $0.02 per share payable on April 9, 1997 to shareholders of record at the close of business on March 20, 1997.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and financial statement schedules are incorporated by reference in this report on pages through.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
Following is a list that sets forth as of March 31, 1997 the names, ages and positions within the Company of all of the Executive Officers of the Company and the Directors of the Company. Each such director has been nominated for reelection at the Company's 1997 Annual Meeting, to be held on May 8, 1997.
NAME AGE POSITION - ---- --- -------- Raymond C. Kubacki, Jr. 52 Chief Executive Officer, President, Director
Werner A. Baumgartner, Ph.D. 61 Chairman of the Board, Director
A. Clinton Allen 53 Vice Chairman of the Board, Director
Bruce M. Stillwell 35 Vice President, Treasurer, Controller
Donald J. Kippenberger, Ph.D. 50 Vice President- Laboratory Operations
Thomas Cairns, Ph.D., D.Sc. 56 Vice President- Technology Research & Development
William Thistle, Esq. 47 Vice President, General Counsel
Donald F. Flynn 57 Director
John J. Melk 60 Director
Fred J. Weinert 49 Director
All Directors hold office until the next annual meeting of stockholders or until their successors are elected. Officers serve at the discretion of the Board of Directors.
Mr. Kubacki joined the Company in July 1991 as Director and as President and Chief Executive Officer. During the five years prior to joining the Company, he served as Vice President-National Accounts and Director of Sales and Marketing for Reliance COMM/TEC Corporation, a subsidiary of Reliance Electric Co.
Dr. Baumgartner, a founder of the Company, has served as Chairman of the Board and a Director of the Company since its organization in September 1986. Dr. Baumgartner has served as the Company's Director of Scientific and Regulatory
Affairs since May 1989. Dr. Baumgartner received his Ph.D. in physical chemistry in 1963 from the University of New South Wales, Sydney, Australia, and has been engaged in physical and biophysical chemistry research since 1960, holding research and teaching positions at University of New South Wales; Long Beach State University; Jet Propulsion Laboratory at California Institute of Technology; University of California, Los Angeles; and University of Southern California. Dr. Baumgartner has been the director of the Radioimmunoassay and In Vitro Laboratory of the Nuclear Medicine Service, Veterans Administration Hospital, Wadsworth, Los Angeles, California, since 1976, serving in such capacity on a part-time basis since February 1987.
Mr. Allen is Chairman and Chief Executive Officer of A.C. Allen & Company, Inc., an investment banking consulting firm located in Cambridge, Massachusetts. Mr. Allen currently serves as a director of Swiss Army Brands, Inc. and is a member of its Executive Committee; and as a director of SweetWater, Inc. He also serves as a director and Vice Chairman of The DeWolfe Companies, Inc. Mr. Allen has been a director of the Company since 1989.
Dr. Kippenberger joined the Company in January 1994 as Vice President of Laboratory Operations. From 1987 to 1990, he was the Technical Director of the Wiesbaden Forensic Toxicology Drug Testing Laboratory, one of the U.S. Army's largest drug testing laboratories. From 1990 to 1993 he served as the Forensic Toxicology Consultant to the U.S. Army Surgeon General, where he directed policy, technical operations and inspection oversight of the four U.S. Army toxicology drug testing laboratories. Dr. Kippenberger is a National Institute on Drug Abuse (NIDA) inspector, and a College of American Pathologists inspector.
Dr. Cairns joined the Company in July 1995 as Vice President of Technology Research & Development. An authority in the field of mass spectrometry, Dr. Cairns served as a Senior Research Scientist with the Food and Drug Administration during his 21-year tenure with that agency. He also served on the FDA Senior Science Counsel from 1991 to 1995 and served as Chairman of the FDA Science Forum from 1992 to 1995. In addition, Dr. Cairns holds an academic appointment with the University of Southern California as Adjunct Professor of Pharmaceutical Science, School of Pharmacy, and was recently appointed Science Advisor to the FDA.
Mr. Thistle joined the Company in September 1995 as Vice President and General Counsel. Prior to joining the Company, he served as Associate General Counsel for MGM Grand in Las Vegas from 1993 to 1995. From 1989 to 1993, Mr. Thistle was Associate General Counsel for Harrah's Casino Resorts.
Mr. Stillwell joined the Company in September 1995 as Vice President, Controller. In January 1996, he was elected Treasurer. Prior to joining the Company, he served in various positions including Controller for Organogenesis Inc. from 1988 to 1995. From 1983 to 1988, Mr. Stillwell was an auditor for Arthur Andersen LLP.
Mr. Flynn has been the sole stockholder and Chairman of the Board of Flynn Enterprises, Inc., a financial advisory and venture capital firm, since February 1988. Mr. Flynn also was Chairman of the Board from July 1992 until February 1996 and Chief Executive Officer from July 1992 until May 1995 of Discovery Zone, Inc., an operator of indoor entertainment and fitness facilities for children. On March 25,
1996, Discovery Zone, Inc. filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. From 1972 to December 1990, Mr. Flynn served in various positions with WMX Technologies, Inc. (formerly Waste Management, Inc.) including Senior Vice President and Chief Financial Officer. Mr. Flynn currently serves as a director of WMX Technologies, Inc. and its affiliated entities, Waste Management International plc and Wheelabrator Technologies, Inc. Mr. Flynn also serves as a director of Extended Stay America, Inc.; an owner and operator of Extended-Stay lodging facilities. Mr. Flynn has been a director of the Company since 1989.
Mr. Melk currently serves as Chairman of H20 Plus, L.P., which develops and manufactures health and beauty products and distributes them through a company-owned chain of specialty retail stores, as well as over 300 wholesale/department stores. He also serves as Chairman of MW Partners, an investor in commercial and residential real estate investments. From 1987 to 1989, Mr. Melk was Vice Chairman of the Board of Blockbuster Entertainment Corporation. From 1971 to 1975, Mr. Melk was Vice President of Corporate Development for WMX Technologies and from 1975 to 1984 held the position of President of W.M.I. International, Ltd. based in London, England. He is a director of Republic Industries, Inc., and Extended Stay America, Inc. Mr. Melk has been a director of the Company since 1991.
Mr. Weinert serves as President of San Telmo, Inc. (investment group), Barrington Services Group (a business advisory firm and commercial real estate developer), Here's Hollywood, Inc. (a Blockbuster Video franchisee) and Vice President of H20 Plus, S.A. (a distributor of cosmetics, bath products and fragrances in Argentina, Chile and Uruguay). From June 1989 to February 1995 he was President of H20 Plus L.P., MW Partners, and Century Entertainment Ltd. Previous to that he was President of Waste Management International, Inc. from December 1983 to June 1989. For over 10 years he has served on the Business Advisory Council for the University of Dayton. Mr. Weinert has been a director of the Company since 1991.
Item 11.
Item 11. Executive Compensation.
The information required by this item will be set forth in the Proxy Statement of the Company relating to the 1997 Annual Meeting of Stockholders to be held on May 8, 1997 and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item will be set forth in the Proxy Statement of the Company relating to the 1997 Annual Meeting of Stockholders to be held on May 8,1997 and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information required by this item will be set forth in the Proxy Statement of the Company relating to the 1997 Annual Meeting of Stockholders to be held on May 8, 1997 and is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) (1) Financial Statements: Page ---- Report of Independent Public Accountants
Balance Sheets as of December 31, 1996 and 1995
Statements of Income for the Years Ended December 31, 1996, 1995 and 1994
Statements of Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994
Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994
Notes to Financial Statements
(2) Financial Statements Schedules
(3) Exhibits - (See the Index to Exhibits included elsewhere in this report)
(b) Reports on Form 8-K
None
PSYCHEMEDICS CORPORATION 10-K Index to Exhibits
Exhibit Page or Number Description Reference - ------ ----------- --------- 3 Articles of Incorporation and By-Laws
3.1 Certificate of Incorporation filed September 24, 1986 - (Incorporated by reference from the Registrant's Registration Statement on Form S-18, File No. 33-10186 LA).
3.2 Amendment to Certificate of Incorporation filed October 29, 1986 - (Incorporated by reference from the Registrant's Registration Statement on Form S-18, File No. 33-10186 LA).
3.3 Amendment to Certificate of Incorporation filed July 12, 1989 - (Incorporated by reference from the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989.)
3.4 Amendment to Certificate of Incorporation filed August 7, 1990 - (Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the Quarter ended September 30, 1990 as amended by a First Amendment on Form 8 filed December 15, 1990.)
3.5 Amendment to Certificate of Incorporation filed May 9, 1991 - (Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991.)
3.6 By-Laws of the Company - (Incorporated by reference from the Registrant's Registration Statement on Form S-18, File No. 33-10186 LA).
4 Instruments Defining the Rights of Security Holders
4.1 Specimen Stock Certificate - (Incorporated by reference from the Registrant's Registration Statement on Form S-18, File No. 33-10186 LA).
10 Material Contracts
10.1 License Agreement with Werner Page or Baumgartner, Ph.D. and Annette Baumgartner Reference dated January 17, 1987 - (Incorporated by reference --------- from the Registrant's Registration Statement on Form S-18, File No. 33-10186 LA).
10.2 License Agreement with Home Office Reference Laboratory dated November 17, 1988 - (Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1988.)
10.3 License Agreement with Lifecodes Corporation dated February 24, 1989 - (Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989.)
10.4 Employment Agreement with Werner A. Baumgartner, Ph.D. dated May 15, 1994 (Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.)
10.5 Securities Purchase Agreement re: sale of 3,500,000 shares of Common Stock and 4,200,000 Common Stock Purchase Warrants dated May 15, 1989 - (Incorporated by reference from the Registrant's Current Report on Form 8-K filed May 30, 1989.)
10.6 Amendment dated as of June 30, 1990 to Securities Purchase Agreement dated May 15, 1989 - (Incorporated by reference from the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.)
10.7* 1989 Employee Stock Option Plan, as amended - (Incorporated by reference from the Registrant's 1997 Annual Proxy Statement.)
10.8* 1989 Non-Qualified Stock Option Plan, as amended Filed herewith
10.9* 1991 Non-Qualified Stock Option Plan - (Incorporated by reference from the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.)
10.10* Employment Agreement with Raymond C. Kubacki, Jr. effective July 16, 1991 (Incorporated by reference from the Registrant's Annual Report on From 10-K for the fiscal year ended December 31, 1991.)
10.11 Lease dated October 6, 1992 with Mitchell H. Page or Hersch, et. al with respect to premises in Reference Culver City, California - (Incorporated by reference --------- from the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992.)
10.12 Security Agreement dated October 6, 1992 with Mitchell H. Hersch et. al - (Incorporated by reference from the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992.) 10.13 Lease Agreement dated December 30, 1992 with General Electric Capital Corporation - (Incorporated by reference from the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992.)
10.14 Letter of Credit Agreement dated December 29, 1992 with General Electric Capital Corporation - (Incorporated by reference from the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992.)
10.15 Standby Letter of Credit dated December 29, 1992 with Brown Brothers Harriman & Co. - (Incorporated by reference from the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992.)
10.16* Employment Agreement with Donald J. Kippenberger, Ph.D. dated January 1, 1994 - (Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.)
10.17* Employment Agreement with Thomas Cairns Ph.D., D.Sc. dated July 1, 1995 - (Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.)
11 Statement re: Computation of Per Share Earnings Filed herewith
23 Consents of Experts and Counsel
23.1 Consent of Arthur Andersen LLP Filed herewith
- ---------- * Represents a management contract or compensatory plan in which a director or named executive office of the Registrant participates.
SIGNATURES
Pursuant to the requirements of Sections 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
PSYCHEMEDICS CORPORATION
By: /s/ Raymond C. Kubacki, Jr. ----------------------------------- Raymond C. Kubacki, Jr. President and Chief Executive Officer
Date: March 28, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Raymond C. Kubacki, Jr. March 28, 1997 - ---------------------------------------- Raymond C. Kubacki, Jr. President and Chief Executive Officer, Director (Principal Executive Officer)
/s/ Bruce M. Stillwell March 28, 1997 - ---------------------------------------- Vice President, Treasurer, & Controller (Principal Financial Officer)
/s/ Werner A. Baumgartner, Ph.D. March 28, 1997 - --------------------------------------- Werner A. Baumgartner, Ph.D. Director
/s/ A. Clinton Allen March 28, 1997 - ---------------------------------------- A. Clinton Allen Director
/s/ Donald F. Flynn March 28, 1997 - ---------------------------------------- Donald F. Flynn Director
/s/ John J. Melk March 28, 1997 - ---------------------------------------- John J. Melk Director
/s/ Fred J. Weinert March 28, 1997 - ---------------------------------------- Fred J. Weinert Director
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Psychemedics Corporation:
We have audited the accompanying balance sheets of PSYCHEMEDICS CORPORATION (a Delaware corporation) as of December 31, 1996 and 1995, and the related statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 financial position of Psychemedics Corporation as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts February 25, 1997 (except with respect to the matter discussed in Note 8, as to which the date is March 4, 1997)
PSYCHEMEDICS CORPORATION BALANCE SHEETS
December 31, ------------------------------ 1996 1995 ------------ ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,462,678 $ 193,787 Short-term investments 8,370,727 5,279,596 Receivables 2,657,416 1,722,770 Laboratory supplies 230,777 253,216 Prepaid expenses and other current assets 129,828 72,247 ------------ ------------ Total current assets 12,851,426 7,521,616 ------------ ------------ EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Capitalized software 602,521 296,460 Office furniture and equipment 782,511 585,411 Laboratory equipment and leasehold improvements 3,458,380 3,225,109 ------------ ------------ 4,843,412 4,106,980 Less: Accumulated depreciation and amortization 2,399,919 1,864,398 ------------ ------------ 2,443,493 2,242,582 ------------ ------------ OTHER ASSETS - NET 449,601 453,295 ------------ ------------ $ 15,744,520 $ 10,217,493 ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of obligations under capital leases $ -- $ 16,459 Accounts payable 395,434 466,412 Accrued dividend payable 437,217 -- Accrued expenses 332,244 194,665 Accrued income taxes 283,808 55,567 ------------ ------------ Total current liabilities 1,448,703 733,103 ------------ ------------ COMMITMENTS (Note 5) SHAREHOLDERS' EQUITY: Preferred stock, $.005 par value; authorized 1,000,000 shares; none outstanding -- -- Common stock, $.005 par value; authorized 50,000,000 shares; issued 21,758,087 and 20,288,280 shares in 1996 and 1995, respectively 108,790 101,441 Paid-in capital 20,722,137 15,728,033 Accumulated deficit (6,281,047) (3,668,291) Treasury stock, at cost; 66,381 shares in 1996 and 699,387 shares in 1995 (254,063) (2,676,793) ------------ ------------ Total shareholders' equity 14,295,817 9,484,390 ------------ ------------ $ 15,744,520 $ 10,217,493 ============ ============
The accompanying notes are an integral part of these financial statements.
PSYCHEMEDICS CORPORATION STATEMENTS OF INCOME
Years Ended December 31, ------------------------------------------ 1996 1995 1994 ----------- ----------- -------------
REVENUE $12,214,198 $10,110,934 $ 8,734,156 DIRECT COSTS 4,981,221 4,689,227 3,696,944 ----------- ----------- ------------ Gross profit 7,232,977 5,421,707 5,037,212 ----------- ----------- ------------ EXPENSES: General and administrative 2,362,074 1,946,648 1,342,653 Marketing and selling 2,048,477 1,737,543 1,546,084 Research and development 413,693 436,385 406,345 ----------- ----------- ------------ 4,824,244 4,120,576 3,295,082 ----------- ----------- ------------ Income from operations 2,408,733 1,301,131 1,742,130 ----------- ----------- ------------ INTEREST INCOME, net 360,248 344,755 155,200 ----------- ----------- ------------ INCOME BEFORE PROVISION FOR INCOME TAXES 2,768,981 1,645,886 1,897,330 PROVISION FOR INCOME TAXES 277,000 87,200 66,100 ----------- ----------- ------------ NET INCOME $ 2,491,981 $ 1,558,686 $ 1,831,230 =========== =========== ============ NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE $ 0.11 $ 0.07 $ 0.09 =========== =========== ============ WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 22,164,226 23,404,058 19,921,614 =========== =========== ============
The accompanying notes are an integral part of these financial statements.
PSYCHEMEDICS CORPORATION STATEMENTS OF SHAREHOLDERS' EQUITY
The accompanying notes are an integral part of these financial statements.
PSYCHEMEDICS CORPORATION STATEMENTS OF CASH FLOWS
Supplemental Cash Flow Information
Cash paid for interest during the years ended December 31, 1996, 1995 and 1994 was $578, $9,178 and $23,630, respectively. Cash paid for income taxes during the years ended December 31, 1996, 1995 and 1994 was $119,000, $67,490 and $16,411, respectively. At December 19, 1996, a $0.02 per share dividend was declared to shareholders of record on January 15, 1997. An accrued dividend payable in the amount of $437,217 has been reflected in the financial statements for this transaction.
The accompanying notes are an integral part of these financial statements.
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Psychemedics Corporation (the Company) was incorporated in 1986. The Company utilizes a patented hair analysis method involving radioimmunoassay technology to analyze human hair to detect abused substances. The founder of the Company has granted to the Company an exclusive license to all his rights in this hair analysis technology, including his rights to the drug extraction method (see Note 2).
Cash and Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with maturities of three months or less at the time of acquisition to be cash equivalents, which consist of money market accounts at December 31, 1996. Short-term investments have maturities of greater than three months and less than one year and consist of securities issued by the U.S. Government at December 31, 1996 and 1995.
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities , effective January 1, 1994. Under SFAS No. 115, investments that the Company has the positive intent and ability to hold to maturity are reported at amortized cost, which approximates fair market value, and are classified as held-to-maturity. These amounts include all short-term investments.
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost. Depreciation and amortization are provided over the estimated useful lives of the assets, using the straight-line method. The estimated useful lives of the assets are as follows:
Capitalized software 5 years Office furniture and equipment 5 to 7 years Laboratory equipment 5 to 7 years Leasehold improvements 5 years or life of lease
Other Assets
Included in other assets are patent application costs of approximately $450,000 and $504,000 as of December 31, 1996 and 1995, respectively, which relate to the drug extraction method. The Company is amortizing the cost of these patents over 10 years from the date of grant. The Company recorded amortization of $60,000 and $36,000 during 1996 and 1995, respectively. The Company evaluates the realizability of its patents based on estimated cash flows to be generated from such assets as compared to the original estimates used in measuring the assets. To the extent impairment is identified, the Company will recognize a write-down of the related assets. To date, no impairment has been identified.
Revenue Recognition
Revenues are recognized upon reporting drug test results to the customer.
Research and Development Expenses
The Company charges research and development expenses to operations as incurred.
Significant Customers
One customer had amounts due to the Company of approximately $457,000 and $330,000 at December 31, 1996 and 1995, respectively. This customer accounted for 15%, 18% and 24% of revenues during 1996, 1995 and 1994, respectively.
Management Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Net Income per Common and Common Equivalent Share
Net income per common and common equivalent share for 1996, 1995, and 1994 is based on the weighted average number of common and common equivalent shares outstanding as computed using the treasury-stock method. Fully dilutive net income per share has not been presented as the difference from primary net income per share is not significant.
Reclassifications
Certain amounts in the prior years financial statements have been reclassified to conform to current year presentation.
New Accounting Standard
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128 Earnings Per Share. SFAS No. 128 establishes standards for computing and presenting earnings per share and applies to entities with publicly held common stock or potential common stock. This statement is effective for fiscal years ending after December 15, 1997 and early adoption is not permitted. When adopted, the statement will require restatement of prior years' earnings per share. The Company will adopt this statement for its fiscal year ended December 31, 1997.
Pro forma calculations of basic and diluted earnings per share as required by SFAS No. 128 are as follows:
1996 1995 1994 ---- ---- ---- Basic EPS
Net income available to common shareholders $ 2,491,981 $1,558,686 $1,831,230
Weighted average common shares outstanding net of treasury shares 21,145,699 21,304,967 18,441,390 ----------- ---------- ---------- Basic EPS $ 0.12 $ 0.07 $ 0.10 =========== ========= ==========
Diluted EPS
Net income available to common shareholders $ 2,491,981 $1,558,686 $1,831,230 Weighted average common and common equivalent shares outstanding 22,164,226 23,404,058 19,921,614 ---------- ---------- ---------- Diluted EPS $ 0.11 $ 0.07 $ 0.09 =========== =========== ==========
2. LICENSE AGREEMENTS
The Company has a royalty-free license from the founder for the proprietary rights to the patented hair analysis technology used by the Company in its drug testing services. The Company has two agreements to sublicense its technology, which have not generated significant royalties to date.
3. INCOME TAXES
The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes.
The Company has total net operating loss carryforwards at December 31, 1996 of approximately $3,586,000 available to offset future federal taxable income, if any. Approximately $785,000 of these loss carryforwards expire in 2005, $2,223,000 in 2006, and $578,000 in 2007. The net operating loss carryforward is comprised of approximately $938,000 of losses from operations, and approximately $2,648,000 from the exercise of certain options and warrants which will increase paid-in capital when previously unrealized stock option benefits are recognized. These net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service. In addition, existing tax regulations contain provisions that may limit the net operating loss carryforward that the Company may utilize in any given year in the event of certain significant changes in ownership interest.
The provision for income taxes in the accompanying 1996, 1995 and 1994 statements of income represents the alternative minimum tax due and provision for state corporate income taxes, as required under the Internal Revenue Code.
The components of the net deferred tax amount are as follows:
December 31, ------------------------------------- 1996 1995 ---------------- ---------------- Deferred tax assets $ 1,113,000 $ 1,860,000 Valuation allowance (1,113,000) (1,860,000) ---------------- ---------------- $ - $ - ================ ================
The approximate income tax effect of each type of temporary difference and carryforward before allocation of the valuation allowance is approximately as follows:
December 31, ------------------------------------- 1996 1995 ---------------- ---------------- Operating loss and credit carryforwards $ 1,272,000 $ 1,723,000 Temporary differences (159,000) 137,000 ---------------- ---------------- $ 1,113,000 $ 1,860,000 ================ ================
A valuation allowance is provided as it is more likely than not that some portion of the deferred tax asset will not be realized. The decrease in the valuation allowance in 1996 is primarily the result of the realization of tax benefits for the current year's taxable income.
4. STOCK OPTIONS AND WARRANTS
Employee Stock Option Plan
Under the Company's 1989 Employee Stock Option Plan, as amended (the Plan), 3,399,000 shares of the Company's common stock have been reserved for issuance to key employees and officers of the Company. The Plan is administered by a committee of outside directors. Under the terms of the Plan, the Company may grant employees either incentive stock options or non qualified stock options to purchase shares of the Company's common stock at prices not less than fair market value at the date of grant, as defined in the Plan. Options are exercisable on terms to be established by the committee at its discretion. Options are generally exercisable on a cumulative basis over the four-year period following the date of grant and expire no later than ten years from the date of grant.
Nonqualified Stock Options
Under the Company's 1989 Non-Qualified Stock Option Plan, as amended, 309,000 shares of the Company's common stock have been reserved for issuance to outside (non-employee) directors. Options to purchase 25,750 shares of common stock of the Company are automatically granted under this plan to each outside director of the Company upon appointment to the Board of Directors ("initial options"). Initial options are exercisable on a cumulative basis over the two-year period following the date of grant and expire no later than ten years from the date of grant. In addition, as of March 15 of each year, options to acquire 20,600 shares are automatically granted to each person then serving as an outside director ("annual options").
Annual options become exercisable in full one year following the date of grant and expire no later than ten years from date of grant. Initial options and annual options have exercise prices equal to the fair market value on the date of grant.
Under the Company's 1991 Non-Qualified Stock Option Plan, as amended, 309,000 shares of the Company's common stock have been reserved for issuance to key employees and consultants. The plan is administered by a committee of the Board of Directors. Under the terms of the plan, the Company may grant non-qualified stock options at option prices and terms to be determined by the committee at its discretion and expire no later than ten years from the date of grant.
Warrants
In connection with private placements in 1990 and 1991, the Company issued warrants that entitled the holders to purchase an aggregate of 1,633,530 shares of the Company's common stock at exercise prices that ranged from $0.94 to $1.94 per share. In 1995, 490,230 warrants were exercised at $0.94 per share, and 23,690 warrants were exercised at $1.94 per share. In 1996, 987,787 warrants were exercised at $2.00 per share. No additional warrants remained outstanding at December 31, 1996.
Dividends
On July 3, 1996, the Company distributed a 3% stock dividend to shareholders of record on June 21, 1996. The shares issued in the stock dividend represented shares which the Company acquired in the stock repurchase program. This transaction resulted in an increase of $4,667,516 in the accumulated deficit (633,006 shares distributed at a fair market value of $7.375 per share on June 31, 1996, the record date). Treasury stock was reduced by $2,422,730 as a result of this distribution. Average shares outstanding and all per share amounts included in the accompanying financial statements and Notes are based on the increased number of shares giving retroactive effect to the stock dividend.
On December 19, 1996, the Company declared a cash dividend of $0.02 a share payable on January 30, 1997 to holders of record at the close of business on January 15, 1997. This cash dividend resulted in an increase of $437,221 in the accumulated deficit and accrued dividend payable at December 31, 1996 in the accompanying financial statements.
Accounting for Stock-Based Compensation
The Company accounts for its stock-based compensation under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation, which is effective for fiscal years beginning after December 15, 1995. SFAS No. 123 establishes a fair-value-based method of accounting for stock-based compensation plans. The Company has adopted the disclosure-only alternative under SFAS No. 123, which requires the disclosure of the pro forma effects on earnings and earnings per share as if SFAS No. 123 had been adopted, as well as certain other information.
The Company has computed the pro forma disclosures required under SFAS No. 123 for all stock options granted as of December 31, 1996 using the Black-Scholes option pricing model prescribed by SFAS No. 123.
The assumptions used and the weighted average information for the years ended December 31, 1996 and 1995 are as follows:
Years ended December 31, ------------------------ 1996 1995 ---- ----
Risk-free interest rates 5.36% - 6.07% 5.51% - 6.86% Expected dividend yield 1% 1% Expected lives 5 years 5 years Expected volatility 84.01% 32.91%
Weighted average grant-date fair value of options granted during the period $5.92 $3.97 Weighted-average exercise price $5.92 $3.97 Weighted-average remaining contractual life of options outstanding 7.23 years 7.04 years Weighted average exercise price of 1,187,616 and 2,520,436 options exercisable at December 31, 1996 and 1995, respectively $2.45 $2.11
The total value of the options granted during 1996 and 1995 was computed as approximately $435,000 and $774,000, respectively. Of these amounts, approximately $210,000 and $99,000 would be charged to operations for the years ended December 31, 1996 and 1995, respectively. The remaining amount, approximately $900,000 would be amortized over the related vesting periods. The pro-forma effect of SFAS No. 123 for the years ended December 31, 1996 and 1995 is as follows:
Years ended December 31, ------------------------ 1996 1995 ---- ----
Net income as reported $2,491,981 $1,558,686 Pro forma net income $2,281,761 $1,459,216
EPS as reported .11 .07 Pro forma net income per share .10 .06
Because the method prescribed by SFAS No. 123 has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years.
A summary of all stock option and warrant transactions for the years ended December 31, 1996, 1995 and 1994 is as follows (in thousands, except per share amounts):
1996 1995 1994 ------ ------ ------
Options and warrants at beginning of period 3,259 3,531 8,142
Granted 265 535 136
Exercised (1,509) (800) (4,600)
Canceled (108) (7) (147) ------ ------ ------
Options and warrants outstanding at end of period 1,907 3,259 3,531 ====== ====== ======
Price range of options and warrants $ 1.85 $ 1.33 $ 0.94 outstanding at end of period to $6.22 to $6.22 to $3.64
Vested options and warrants at end of period 1,188 2,520 2,582
5. COMMITMENTS
Lease Agreements
The Company leases certain of its facilities and equipment under operating lease arrangements expiring on various dates through September 1998. Total minimum lease payments, including scheduled increases, are charged to operations on a straight-line basis over the life of the lease. Rent expense for the years ended December 31, 1996, 1995 and 1994 was approximately $450,000, $445,000 and $313,000, respectively.
At December 31, 1996, minimum commitments remaining under lease agreements were as follows:
Operating Leases --------- Years ending December 31:
1997 $ 299,000 1998 86,000 --------- $ 385,000
Employment Agreement
In May 1994, the Company entered into a three-year employment agreement with an officer of the Company requiring a minimum annual salary of approximately $116,000, subject to certain adjustments.
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
December 31, ----------------------- 1996 1995 ---- ---- Accrued payroll & employee benefits $ 147,615 $ 134,159 Accrued other $ 184,629 $ 60,506 --------- --------- $ 332,244 $ 194,665 ========= =========
7. SELECTED QUARTERLY FINANCIAL DATA (Unaudited)
The following is an analysis of certain items in the accompanying statements of income by quarter for the years ended December 31, 1996 and 1995:
8. SUBSEQUENT EVENT
On March 4, 1997, the Company declared a cash dividend of $0.02 per share payable on April 9,1997 to shareholders of record at the close of business on March 20, 1997.