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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
FOR THE YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-19371
PHARMCHEM LABORATORIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 77-0187280
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1505-A O'BRIEN DRIVE
MENLO PARK, CALIFORNIA 94025
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (415) 328-6200
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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COMMON STOCK NASDAQ NATIONAL MARKET
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-K 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.
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The aggregate market value of the voting stock held by non-affiliates of
the Registrant (based on the closing price of $4 9/16 as reported on the
Nasdaq/NMS on January 31, 1997) was approximately $26,059,000. Shares of voting
stock held by each executive officer and director and by each holder of 5% or
more of the outstanding voting stock have been treated as shares held by
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. The number of outstanding shares of
the Registrant's Common Stock as of January 31, 1997 was 5,711,648.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the PharmChem Laboratories, Inc. Proxy Statement for the 1997
Annual Meeting of Shareholders to be filed with the Commission on or before
April 30, 1997 are incorporated by reference into Part III of this Annual Report
on Form 10-K. With the exception of those portions which are specifically
incorporated by reference in this Annual Report on Form 10-K, such Proxy
Statement shall not be deemed filed as part of this Report.
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PHARMCHEM LABORATORIES, INC.
ANNUAL REPORT ON FORM 10-K
INDEX
PAGE
----
PART I.
Item 1. Business................................................................. 3
Item 2. Properties............................................................... 8
Item 3. Legal Proceedings........................................................ 8
Item 4. Submission of Matters to a Vote of Security Holders...................... 9
PART II.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.... 10
Item 6. Selected Consolidated Financial Data..................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 11
Item 8. Financial Statements and Supplementary Data.............................. 16
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................... 32
PART III.
Item 10. Directors and Executive Officers of the Registrant....................... 32
Item 11. Executive Compensation................................................... 32
Item 12. Security Ownership of Certain Beneficial Owners and Management........... 32
Item 13. Certain Relationships and Related Transactions........................... 32
PART IV.
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K........... 32
Signatures ......................................................................... 36
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PART I
ITEM 1. BUSINESS
Unless the context indicates otherwise, all references herein to
"PharmChem" or the "Company" include PharmChem Laboratories, Inc. and its
wholly-owned subsidiary, Medscreen Limited ("Medscreen").
GENERAL
PharmChem Laboratories, Inc. is a leading independent laboratory providing
integrated drug testing services to corporate and governmental customers seeking
to detect and deter the use of illegal drugs and alcohol. PharmChem is certified
by the U.S. Department of Health and Human Services, including Clinical
Laboratory Improvement Amendments (CLIA) and Substance Abuse and Mental Health
Service Administration (SAMHSA), formerly the National Institute on Drug Abuse,
the College of American Pathologists (CAP) and a number of states to conduct
drug testing using forensic procedures. These forensic procedures provide
accurate and reliable test results and a chain-of-custody for each specimen from
its collection to the reporting of its test result. PharmChem tests for a number
of drugs of abuse, including cocaine, methamphetamine, heroin, phencyclidine
(PCP), marijuana (THC) and alcohol, primarily by urinalysis but also with the
PharmChek(TM) sweat testing system and the PharmScreen(TM) on-site screening
device. In addition to forensic drug testing, PharmChem offers a range of
services which are customized to assist customers in implementing cost-effective
drug testing programs.
PharmChem was incorporated in California in 1987 to acquire PharmChem
Laboratories Operations, Inc., a California corporation which was founded in
1971. In 1991, the Company completed its initial public offering. In 1992,
PharmChem expanded its operations through the acquisitions of London-based
Medscreen (a provider of international drug testing services) and of a certified
laboratory in Fort Worth, Texas. The Company's customers include private and
public employers, criminal justice agencies and drug treatment programs,
primarily in the United States and the United Kingdom.
INDUSTRY BACKGROUND
Historically, the drug testing market has been served by national clinical
laboratory chains, independent national drug testing laboratories, such as
PharmChem, and numerous regional and local laboratories. Thousands of general
clinical laboratories nationwide can conduct forensic and and non-forensic drug
testing, and are increasingly bidding on local contracts. Over the past several
years, however, many corporate and governmental organizations are requiring drug
testing laboratories to be certified to conduct forensic drug tests and to offer
integrated cost-effective testing services. Also, many large organizations,
particularly those in the public sector, use a competitive bidding procedure to
select their drug testing laboratories. The bidding process for these
competitive contracts is often limited to qualified bidders and certified drug
testing laboratories, which can demonstrate the ability to meet the service and
volume levels specified by the customer.
DRUG TESTING OPERATIONS
The essential elements of forensic drug testing are a secure
chain-of-custody for each specimen from its collection to the reporting of its
test result and accurate and reliable testing in which a second independent test
is performed to confirm each positive test result. PharmChem carefully controls
each step of the testing process with detailed written procedures and using the
specific forensic testing methods required for legal defensibility of results.
The Company performs the largest portion of its testing at its laboratory in
Menlo Park, California, which operates six days per week, 24 hours a day. The
Company also provides complete testing services at its Texas Division in Fort
Worth and its London-based subsidiary, Medscreen. The steps in the Company's
forensic drug testing process by urinalysis are as follows:
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Specimen Collection and Transportation. Forensic drug testing begins with
specimen collection conducted under carefully controlled conditions. Once a
donor has provided a specimen, it is assigned a unique specimen identification
number. Information pertinent to the specimen is then recorded on a
chain-of-custody form numbered to match the specimen bottle. Specimens, together
with chain-of-custody forms, are delivered to the Company by courier or U.S.
mail.
Receiving and Accessioning. PharmChem receives specimens in its restricted
accessioning rooms, where they are inspected for tampering and checked for
proper chain-of-custody documentation. Specimens are identified and monitored
using unique bar-coded laboratory accessioning numbers.
Screening. Each specimen submitted to PharmChem is screened for the
presence of the drugs specified by the customer. The Company performs in excess
of 1,200,000 screening tests on more than 250,000 specimens per month to
determine the presence of drugs. The screening methods used by the Company
include enzyme-multiplied immunoassay technique (EMIT)(1), radioimmunoassay
(RIA) and thin layer chromatography (TLC).
Confirmation Testing. Specimens that screen negative are reported to the
customer without further testing. Specimens that screen positive are confirmed
by testing a separate aliquot using a different and independent technology from
that used for the initial screening. Confirmation technologies employed by
PharmChem include gas chromatography/mass spectrometry (GC/MS) and gas
chromatography (GC). GC/MS confirmation is required for federally-regulated drug
testing and most other workplace drug testing and its use has been cited with
approval in numerous legal proceedings.
Quality Assurance/Quality Control (QA/QC). PharmChem carefully monitors
the accuracy and reliability of its test results by internal and external QA/QC
programs. The Company's staff evaluates laboratory performance with open and
blind quality control samples. In addition, the Company is subject to frequent
proficiency testing by various certifying bodies which send their own open and
blind samples to the laboratory. Further, the Company is subject to frequent
inspections by certifying agencies.
Data Review. Each test result undergoes several independent levels of
review before being reported by a certifying scientist.
Reporting of Results. PharmChem transmits most of its test results
electronically using secure communications networks and more recently, through
automated voice reporting systems. Upon release by a certifying scientist, each
test result is made available by the Company's information systems to the
customer's computer, secure facsimile machine or by telephonic inquiry. The
Company routinely reports results for specimens that screen negative within 24
hours of receipt in the laboratory and within 48 hours for specimens that
require confirmation.
CUSTOMER SERVICES AND TECHNICAL SUPPORT
PharmChem provides a variety of drug testing services which are customized
to each customer's specific needs. The Company employs a customer service and
technical support staff specializing in one or more of the following areas of
service.
Specimen Collection. PharmChem manages specimen collection services for a
number of its customers. The Company maintains a list of more than 4,000 clinics
and other organizations throughout the country that offer specimen collection
services that comply with forensic drug testing procedures. PharmChem's customer
service staff identifies collectors conveniently located to customer sites,
prepares customized specimen collection procedures, conducts training of
collection personnel and monitors their performance. In 1996, PharmChem managed
more than 500,000 collections in the U.S., while Medscreen managed approximately
20,000 collections throughout the U.K. and at over 150 shipping ports throughout
the world.
- ---------------
(1)EMIT is a registered trademark of Behring Diagnostics, Inc.
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Transportation. Most specimens are transported to PharmChem by overnight
or same-day courier, or by U.S. mail. The Company offers special specimen
transportation services for selected areas throughout the country which provide
for pickup of specimens before the close of each business day.
Technical Consultation. The technical specialists on PharmChem's staff are
experienced in drug metabolism and other technical aspects of drug testing.
These specialists respond to requests from customers to interpret test results.
In addition, the Company is often called upon to assemble the complete chain-of-
custody and testing data package for specimen results which have been challenged
and to provide expert witness testimony in legal proceedings. The technical
consultation group also provides comprehensive in-service training for customers
on topics such as substance abuse trends, toxicology and drug pharmacology,
breath alcohol testing and technical information on the Company's testing
procedures.
Program Analysis. PharmChem collects and analyzes data on test results in
order to provide comprehensive monthly statistical reports to meet customers'
regulatory requirements and to assist with drug program management.
RESEARCH AND DEVELOPMENT
Research and development activities are performed by PharmChem's most
experienced scientists and technicians. The Company's research and development
efforts continually focus upon improving laboratory procedures and processes.
The Company believes it has engineered a number of efficiencies to improve the
accuracy and reliability of its drug tests.
PHARMCHEK(TM) SWEAT PATCH
Since 1992, the Company has been investing in PharmChek(TM), a system which
uses sweat to detect the use of illegal drugs. PharmChek(TM) may offer several
advantages over drug detection systems which are currently available. It does
not require the handling of urine or blood, which may be objectionable to some
people. The use of sweat as a testing medium may lengthen the drug use detection
period and decrease testing costs by reducing the need for specialized specimen
collection facilities and staff. While the primary use of PharmChek(TM) has been
to detect illegal drugs, the ability of this system to detect alcohol may also
be explored.
During 1995 and 1996, the Company conducted pilot programs using
PharmChek(TM) with the Michigan Department of Corrections (Michigan DOC) and the
Administrative Office of the United States Courts (Federal Probation). Although
certain issues have arisen in such pilot testing relating to the adhesive
qualities of the product, the Company is working toward improving the product.
In 1995, the U.S. Food and Drug Administration (FDA) cleared PharmChek(TM) for
detecting the use of cocaine, opiates (including heroin), and amphetamines
(including methamphetamine) and, in 1996, clearance was obtained for detecting
the use of phencyclidine (PCP) and marijuana (THC).
The Company has incurred significant costs in connection with the
commercialization of PharmChek(TM) and expects to continue to do so in the
future. To date, sales of PharmChek(TM) by the Company have not been material
and there can be no assurance that it will be commercially accepted by existing
or new customers or generate significant revenues in the future. Refer to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
PHARMSCREEN(TM) ON-SITE SCREENING DEVICE
In recent years there has been a growing trend toward the use of on-site
screening for drugs of abuse by a number of agencies, including some of the
Company's customers. On-site screening relies upon portable diagnostic devices
which may be used at the point of specimen collection to identify drugs of abuse
in urine specimens. This technology is advantageous in that it provides
virtually immediate test results at a lower cost than a laboratory-based testing
program.
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The Company now offers a line of on-site screening devices to supplement
the laboratory-based testing services it has traditionally offered. In 1996,
PharmChem acquired exclusive marketing rights in non-clinical markets for
PharmScreen(TM), a portable, hand-held device used for on-site screening of
drugs of abuse. In 1996, the FDA cleared PharmScreen(TM) for detecting the use
of cocaine, opiates (including heroin), amphetamines (including methamphetamine)
and PCP. PharmScreen(TM) is currently being used on a trial basis by certain
government agencies, including Michigan DOC and Federal Probation.
PharmScreen(TM) provides only a preliminary analytical result, and a more
specific alternative chemical method, such as GC/MS, is necessary to obtain a
confirmed analytical result. To date, sales of PharmScreen(TM) by the Company
have not been material and there can be no assurance that it will be
commercially accepted by existing or new customers or generate significant
revenues in the future.
SALES AND MARKETING
PharmChem sells its integrated drug testing services to corporate and
governmental customers. The sales force uses a consultative selling approach
emphasizing the scope of integrated services offered by the Company and
customizing these services to meet customers' particular needs.
CUSTOMERS
PharmChem provides integrated drug testing services to three primary
customer groups:
Public and Private Employers. Public and private employers use drug
testing as part of their hiring decisions in order to increase safety and reduce
costs associated with drug abuse in the workplace. In addition, an increasing
number of public and private employers test employees in certain positions on a
periodic or random basis and test other employees upon reasonable suspicion of
drug use. Sales to public and private employers accounted for 50%, 49%, and 48%
of the Company's total net sales in 1996, 1995 and 1994, respectively. Sales to
Sears Roebuck & Co. accounted for approximately 10% of the Company's total net
sales in 1996, 1995 and 1994.
Criminal Justice Agencies. Criminal justice agencies use drug testing
results in criminal proceedings and to assist with making parole, drug treatment
and probation decisions. In addition, these agencies use drug testing to monitor
drug treatment of individuals under supervision and to track drug use trends
within the United States. Sales to criminal justice agencies accounted for 37%,
34%, and 38% of the Company's total net sales in 1996, 1995 and 1994,
respectively. Sales to Federal Probation accounted for approximately 19%, 17%
and 19% of the Company's total net sales in 1996, 1995 and 1994, respectively.
Drug Treatment Programs. Drug treatment programs use drug testing to
monitor the treatment and rehabilitation of drug users in their care. Sales to
drug treatment programs accounted for less than 6% of the Company's total net
sales in 1996, 1995 and 1994.
Medscreen. This London-based subsidiary accounted for 8%, 11%, and 9% of
the Company's total net sales in 1996, 1995 and 1994, respectively. At the end
of 1995, Medscreen lost its largest customer, which represented approximately
20% of its revenues, due to the privatization of the British Rail Occupational
Health and Safety unit.
SUPPLIERS
PharmChem is not dependent upon any single supplier for its raw materials.
CONTRACTING
Most of PharmChem's large potential customers, including the majority of
public employers and criminal justice agencies, use a formal competitive bid
process in which the potential customer provides a detailed specification of the
drug testing services it requires. Because many of the Company's customers use a
competitive bidding process, there is no assurance that the Company will be the
successful bidder when such contracts are up for renewal. While price is an
important factor, in most cases these organizations are not
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required to accept the lowest bid, but rather may choose the winning bidders on
the basis of technical superiority and customer service.
The failure to renew a significant contract, if not replaced by comparable
contracts, could result in lower sales, lower profit margins, negative cash
flows and losses. PharmChem's contracts generally provide for no minimum amounts
or payments, and allow termination at the customer's discretion on short notice
with little or no penalty. In particular, many contracts with governmental
agencies, including criminal justice agencies, provide for termination for
convenience. Although the Company's experience has been that its customers
generally do not exercise these early termination rights, there can be no
assurance that this will continue in the future. For some customers, the Company
performs drug testing services under a standard services contract. With other
customers, the Company has no formal contract. In these cases, the Company
typically accepts and tests specimens for an agreed upon price which is
generally renegotiated every twelve months. Backlog is not a significant
statistic for the Company.
COMPETITION
The market for drug testing services became increasingly competitive in the
early 1990's, and continues to be competitive. Drug testing laboratories compete
primarily on the basis of technical capability, customer service and price. The
Company believes it competes favorably in each of these categories. PharmChem
has significantly expanded its scope of services while its average total price
per specimen has remained relatively unchanged. PharmChem's competitors include
national clinical laboratory companies, such as Smith-Kline Beecham Clinical
Laboratories, Laboratory Corporation of America (National Health
Laboratories/Roche Biomedical Laboratories) and Quest Diagnostics (formerly
Corning Clinical Laboratories); independent national drug testing laboratories;
third party administrators; medical review officers; manufacturers and
distributors of on-site screening devices and equipment; and numerous regional
and local laboratories. Consolidation in the national clinical laboratory
industry has continued in recent years and the national clinical laboratories
have greater financial, marketing, laboratory and related resources than the
Company. In addition, some customers and potential customers of the Company
operate their own drug testing facilities or may develop such facilities in the
future. A majority of the Company's sales are derived from competitive bids, and
the Company believes that competitive pressure with respect to these bids,
particularly large multi-year contracts, has intensified.
CERTIFICATION AND GOVERNMENT REGULATION
Laboratories which compete in the forensic drug testing market generally
must be certified by SAMHSA. In addition, some state and local jurisdictions
require their own certification for testing of specimens involving their
residents. Such state and local certifications are essential to the Company's
business in each such respective jurisdiction. The Company's laboratory is
currently certified by SAMHSA, CLIA, CAP and certain state and local
jurisdictions. The Company believes it is certified in all jurisdictions in
which it operates.
The Company is subject to frequent inspection by certifying bodies,
including annual CAP and semi-annual SAMHSA inspections. Inspections generally
result in reports describing areas for improvement or suggesting changes in
procedures. The Company may be required to take actions with respect to the
items noted in the inspection report in order to remain certified. Failure to
meet certification requirements could result in suspension or loss of
certification. The Company has never been decertified as the result of an
inspection. Certification is essential to the Company's business because some of
its customers are required to use a certified laboratory, and many of its
customers look to certification as an indication of reliability and accuracy of
results.
Employee drug testing by federal agencies and certain private employers is
regulated by certain federal agencies. Court precedent currently exists in a
number of states regarding the circumstances under which employers may test
employees and the procedures under which such tests must be conducted. The
circumstances under which drug testing can legally be required by employers is
subject to judicial review, and
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is challenged from time to time by employees, unions and other groups on
constitutional, privacy and other grounds.
DOMESTIC AND FOREIGN OPERATIONS
Refer to Note 10 to the Consolidated Financial Statements for net sales,
income (loss) from operations and identifiable assets by geographic location.
ENVIRONMENTAL MATTERS
A small portion of the Company's business involves testing procedures
requiring the use of chloroform and radioactive reagents, which are considered
to be hazardous materials. Failure to comply with current or future federal,
state or local environmental laws or regulations regarding these hazardous
materials could have a material adverse effect on the Company. The Company
believes that it has adequately notified employees of potential risks associated
with working at the Company and has provided a workplace safe from hazard, as
required by the Occupational Safety and Health Administration and certain state
laws. The Company believes it is in compliance with all applicable environmental
laws and regulations.
EMPLOYEES
As of December 31, 1996, the Company had approximately 350 full-time
employees. PharmChem's employees are not represented by labor organizations. The
Company considers relations with its employees to be good.
SEASONAL OPERATING FACTORS
PharmChem's operations are affected by seasonal trends to which drug
testing laboratories are generally subject. In the past, testing volume tends to
be higher in the second and third calendar quarters and lower in the fourth and
first calendar quarters, primarily due to the hiring patterns of the Company's
public and private employer customer group which affect pre-employment drug
testing. Further, demand for the Company's services is dependent on general
economic conditions.
ITEM 2. PROPERTIES
LOCATION USE SQUARE FOOTAGE REMAINING LEASE TERM
- ---------------------- ----------------- -------------- ------------------------------
1505-A O'Brien Drive Headquarters and 35,719 4 years
Menlo Park, CA 94025 Laboratory
1275 Hamilton Court Warehouse 11,925 2 years
Menlo Park, CA 94025
7606 Pebble Drive Texas Division 15,000 4 years with a 5 year option
Fort Worth, TX 76118
1A Harbour Quay 100 Medscreen 13,350 6 years with a 10 year option
Preston's Road London, Headquarters and
E14 9QZ England Laboratory
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, PharmChem is sued by individuals,
primarily those in the criminal justice system, who have tested positive for
drugs of abuse. In addition, the Company frequently testifies in administrative
and court proceedings involving the results of its tests. To date, the Company
has not experienced any material liability related to these claims, although
there can be no assurance that the Company will not at some time in the future
experience significant liability in connection with such claims. There are no
pending legal proceedings, other than ordinary routine litigation incidental to
the Company's business, to which PharmChem is a party or to which any of its
property is subject and management does not
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believe the outcome of any of the proceedings will have a material impact on its
financial position or results of operations. The Company believes that its
liability insurance coverage is adequate for its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1996.
EXECUTIVE OFFICERS OF PHARMCHEM
NAME AGE POSITION WITH THE COMPANY
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Joseph W. Halligan................ 52 President, Chief Executive Officer and Director
David A. Lattanzio................ 54 Vice President, Finance and Administration and
Chief Financial Officer
Edward V. Collom, Jr.............. 50 Vice President, Business Development
Robert S. Fogerson, Jr............ 44 Vice President, Laboratory Technical Director
Neil A. Fortner................... 42 Vice President, Laboratory Operations
Elizabeth M. Lison................ 39 Vice President, Customer Service
Mr. Halligan has been President, Chief Executive Officer and Director since
November 1995. From 1988 to 1995, Mr. Halligan was President and CEO of E.S.I.
Consulting Group, a private consulting practice, specializing in advising and
operating high growth, consumer and service oriented companies. Before forming
his consulting practice, Mr. Halligan served from 1983 to 1987 as President and
CEO of a privately-held company, Laura Scudder's, Inc. From 1969 to 1983, Mr.
Halligan served as Senior Vice President of Fotomat Corporation and President of
its subsidiary, Video Services of America. He holds a B.S. in Management and
Business Administration from Columbia Pacific University.
Mr. Lattanzio has been Vice President, Finance and Administration, and
Chief Financial Officer since April 1996. He is responsible for all business
aspects of the Company's operations, including accounting, corporate finance,
treasury, logistics, human resources and risk management. From 1995 to March
1996, Mr. Lattanzio performed private consulting for several companies,
including the Company. He served as Vice President, Finance and Chief Financial
Officer of Mission Foods from 1991 to 1995. Mr. Lattanzio holds a B.B.A. in
Accounting from the University of Notre Dame. He is a certified public
accountant and a member of the Employment Training Panel, State of California.
Mr. Collom has been Vice President, Business Development since March 1996.
He is responsible for sales, marketing and commercial development of PharmChem's
reference laboratory services and the PharmChek(TM) and PharmScreen(TM) product
lines. From 1993 to February 1996, Mr. Collom was the Business Unit Director for
Microgenics/Boehringer Mannheim's Immunoassay Unit. From 1990 to 1993, Mr.
Collom served as Director of Sales and Marketing for Specialty Laboratories,
Inc. He has also served in a variety of sales and marketing management positions
at Johnson & Johnson/Ortho Diagnostics and DuPont Medical Products. He holds a
B.S. from the University of California, Los Angeles, and holds a M.S. from
California State University and a M.B.A. from Claremont College.
Mr. Fogerson has been Vice President, Laboratory Technical Director since
July 1991. He is responsible for all technical aspects of laboratory operations.
From October 1993 through August 1994, he served as Managing Director of the
Company's Medscreen subsidiary. He served as Director, Laboratory Operations
from April 1989 to July 1991. Mr. Fogerson joined PharmChem in 1975 as a
laboratory analyst and has served in a number of capacities since that time,
including Laboratory Supervisor and Laboratory Manager. He is a laboratory
inspector for Navy drug testing laboratories. He holds a B.A. in Physiological
Psychology from Stanford University. Mr. Fogerson is a member of the American
Association of Clinical Chemistry, Society of Forensic Toxicologists, The
International Association of Forensic Toxicologists, and a member and past
president of the California Association of Toxicologists.
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Mr. Fortner has been Vice President, Laboratory Operations, since February
1992. Mr. Fortner joined the Company as Director, Laboratory Operations in July
1991. He is the Scientific Director and is responsible for all production
aspects of laboratory operations. From 1985 to 1991, he served as Director of
Toxicology at Southgate Medical Services. Mr. Fortner has more than 15 years
experience in forensic toxicology and he is a qualified SAMHSA and CAP
laboratory inspector. He is a member of the American Association of Clinical
Chemistry and a full member of the Society of Forensic Toxicologists, the
American Academy of Forensic Sciences and the American Board of Forensic
Examiners. Mr. Fortner holds a B.A. in Biology from Hiram College and a M.S. in
Biochemistry from Western Kentucky University.
Ms. Lison has been Vice President, Customer Service, since March 1997. Ms.
Lison joined the Company's Medscreen subsidiary in 1993, where she held various
management positions in sales and customer service. In June 1996, she relocated
to the Corporate office to serve as Director, Customer Service. From 1979 to
1993, Ms. Lison worked in various aspects of the design and delivery of
workplace drug testing programs for companies based in the U.K. Ms. Lison holds
a B. Tech (Hons) in Medical Science from the University of Bradford, U.K.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS
The Company's Common Stock trades on The Nasdaq Stock Market under the
symbol PCHM.
STOCK PRICES
The following table summarizes the high and low closing bid prices for the
Company's Common Stock by quarter for years 1996 and 1995, as reported by the
Automated Quotation System of the National Association of Securities Dealers
(Nasdaq). The prices shown represent quotations among securities dealers, do not
include retail markups, markdowns or commissions and may not represent actual
transactions.
CALENDAR CALENDAR
QUARTER HIGH LOW QUARTER HIGH LOW
- -------- ----- ---- -------- ----- ----
Q1 1996 $ 5 $3 1/2 Q1 1995 $ 3 1/8 $1 3/4
Q2 1996 $ 4 $2 7/8 Q2 1995 $ 5 3/8 $1 7/8
Q3 1996 $ 3 7/8 $3 Q3 1995 $ 6 3/4 $4 1/4
Q4 1996 $ 5 3/8 $3 3/8 Q4 1995 $ 5 7/8 $3 5/8
As of March 14, 1997, there were approximately 220 holders of record of
PharmChem's Common Stock. A large number of shares were held in nominee name.
Based upon information furnished by the Company's proxy solicitor, Skinner &
Co., the Company believes it had approximately 2,000 shareholders as of the same
date.
DIVIDENDS
PharmChem has never paid cash dividends on its Common Stock. The Company
plans to retain all earnings to further the operation and expansion of its
business and therefore does not expect to pay dividends in the foreseeable
future. The Company's current term and revolver credit agreement prohibits the
declaration or payment of dividends.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
FOR YEARS ENDED DECEMBER 31,
-----------------------------------------------
1996 1995 1994 1993 1992
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENTS OF OPERATIONS DATA:
Net sales...................................... $41,255 $39,111 $33,640 $29,032 $27,351
Cost of sales.................................. 31,757 29,771 25,777 22,110 17,657
------- ------- ------- ------- -------
Gross profit................................... 9,498 9,340 7,863 6,922 9,694
------- ------- ------- ------- -------
Selling, general and administrative expenses... 7,339 6,966 6,213 5,927 5,009
Marketing rights and research costs............ 1,455 1,039 854 1,002 854
Amortization of goodwill....................... 185 247 246 287 151
Provision for doubtful accounts................ 101 575 72 90 75
Restructuring and unusual charges(1)........... -- 8,775 -- 3,502 --
------- ------- ------- ------- -------
Total operating expenses....................... 9,080 17,602 7,385 10,808 6,089
------- ------- ------- ------- -------
Income (loss) from operations.................. 418 (8,262) 478 (3,886) 3,605
Other income (expense), net.................... (372) (368) (279) (311) 92
------- ------- ------- ------- -------
Income (loss) before income taxes.............. 46 (8,630) 199 (4,197) 3,697
Provision for (benefit from) income taxes...... -- (1,819) 148 (340) 1,437
------- ------- ------- ------- -------
Net income (loss).............................. $ 46 $(6,811) $ 51 $(3,857) $ 2,260
======= ======= ======= ======= =======
Net income (loss) per share.................... $ 0.01 $ (1.23) $ 0.01 $ (0.70) $ 0.39
======= ======= ======= ======= =======
Cash dividends per share....................... -- -- -- -- --
======= ======= ======= ======= =======
Weighted average shares outstanding............ 5,710 5,542 5,560 5,507 5,860
======= ======= ======= ======= =======
BALANCE SHEET DATA:
Working capital................................ $ 1,707 $ 4,283 $ 4,243 $ 3,979 $ 7,856
Total assets................................... 21,468 22,183 28,306 29,049 31,510
Long-term debt, net of current portion......... 1,205 3,401 1,972 1,690 2,931
Shareholders' equity........................... $11,287 $11,029 $17,767 $17,716 $21,568
- ---------------
(1) As more fully discussed in Note 8 to the Consolidated Financial Statements,
in 1995, the Company recorded a provision for restructuring and unusual
charges of $8.8 million related to the marketing rights and development of
PharmChek(TM), computer and peripheral equipment, Medscreen goodwill and
other unusual charges. The 1993 charges principally reflect a $2.4 million
write-down of Medscreen goodwill and other unusual charges.
Selected quarterly financial data is included in Note 11 to the
Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act
of 1933, which are subject to the "safe harbor" created by these Sections. The
Company's actual future results could differ materially from those projected in
the forward-looking statements. Some factors which could cause future actual
results to differ materially from the Company's recent results and those
projected in the forward-looking statements are described in this section. Refer
to
11
12
"Factors Affecting Operating Results." The Company assumes no obligation to
update the forward-looking statements or such factors.
RESULTS OF OPERATIONS
1996 Compared to 1995. Net sales increased 5.5% to $41,255,000 in 1996
from $39,111,000 in 1995. This increase is attributed to sales increases of 7%
to public and private employers and 17% to criminal and justice agencies, which
more than offset sales decreases of 23% to drug treatment programs and 22% at
Medscreen. Medscreen's sales decrease was primarily due to the 1995 loss of its
largest customer and certain one-time equipment sales, which more than offset
new business acquired in 1996. The Company's total volume increased 6% to
3,143,000 from 1995 levels.
Cost of sales increased 6.7% to $31,757,000 in 1996 from $29,771,000 in
1995. The increase was due primarily to increased specimen volume, especially
volume associated with providing non-laboratory related services, such as
specimen collection and transportation. Cost of sales as a percentage of net
sales increased to 77.0% in 1996 from 76.1% in 1995. Gross profit as a
percentage of net sales decreased to 23.0% in 1996 from 23.9% in 1995.
Selling, general and administrative (SG&A) expenses increased 5.4% to
$7,339,000 in 1996 from $6,966,000 in 1995. This increase reflects the Company's
continued rebuilding of the marketing, information systems and administrative
infrastructure. The percent of SG&A expenses to net sales was unchanged at 17.8%
for both years.
Marketing rights and research costs increased 40.0% to $1,455,000 in 1996
from $1,039,000 in 1995. These expenses include the cost associated with the
development and commercialization of new laboratory methods and other drug
testing systems. This increase was due primarily to the expensing in 1996 of
certain costs related to PharmChek(TM) and PharmScreen(TM). Such expenses as a
percentage of net sales increased to 3.5% in 1996 from 2.7% in 1995.
Income from operations increased to $418,000 in 1996 from a loss of
$8,262,000 in 1995. The increase is primarily related to restructuring and
unusual charges in the fourth quarter of 1995 (refer to Note 8 to the
Consolidated Financial Statements). Other expense, which includes interest
expense and interest income, increased slightly to $372,000 in 1996 from
$368,000 in 1995.
The Company had no provision for income taxes in 1996. In 1995, the benefit
from income taxes of $1,819,000 primarily related to the restructuring and
unusual charges recorded in 1995. The Company has recorded a valuation allowance
to reflect the amount of deferred tax assets which may not be realized.
Net income increased to $46,000 in 1996 from a loss of $6,811,000 in 1995,
due primarily to the restructuring and unusual charges in 1995.
1995 Compared to 1994. Net sales increased 16.3% to $39,111,000 in 1995
from $33,640,000 in 1994. Compared to 1994, the Company recorded net sales
increases of 21% to public and private employers, 3% to criminal justice
agencies, 18% to drug treatment programs and 50% at Medscreen. These increases
were attributed principally to a higher volume of specimens than in the prior
year.
Cost of sales increased 15.5% to $29,771,000 in 1995 from $25,777,000 in
1994. The increase was due primarily to increased volume, as well as direct
costs associated with the Company's managed collection services. Increasingly,
public and private employer customers are requesting these services as a part of
their drug testing programs. Cost of sales as a percentage of net sales
decreased to 76.1% in 1995 from 76.6% in 1994.
Selling, general and administrative (SG&A) expenses increased 12.1% to
$6,966,000 in 1995 from $6,213,000 in 1994. The percent of SG&A expenses to net
sales decreased to 17.8% from 18.5%. This reflects the effects of certain cost
reduction steps implemented by management in 1995.
Marketing rights and research costs increased 21.7% to $1,039,000 in 1995
from $854,000 in 1994. This increase was due primarily to an increase in the
number of staff assigned to research functions in 1995.
12
13
Marketing rights and research costs as a percentage of net sales also increased
to 2.7% in 1995 from 2.5% in 1994.
During the fourth quarter of 1995, the Company recorded a provision for
restructuring and unusual charges of $8.8 million to (1) write-off $4.0 million
of marketing rights and other expenditures related to the PharmChek(TM) sweat
patch; (2) write-down goodwill of $2.0 million related to the purchase in 1992
of Medscreen; (3) write-down certain computer and peripheral equipment of
approximately $1.9 million; and (4) provide for severance and related costs.
Additionally, during the fourth quarter of 1995, the Company increased the
allowance for doubtful accounts and other accruals by $675,000. Together, these
charges reduced 1995 after tax earnings by $7.3 million, or $1.32 per share.
Income from operations decreased to a loss of $8,262,000 in 1995 from
income of $478,000 in 1994. The decrease is primarily related to the
restructuring and unusual charges discussed above. Other expense, which includes
interest expense and interest and other income, increased to $368,000 in 1995
from $279,000 in 1994. This change was due primarily to other income realized in
1994 from a renegotiation and settlement of certain liabilities associated with
the acquisition of Medscreen, offset by lower interest expense in 1995 due to
lower interest rates and a reduction of average debt outstanding.
The benefit from income taxes for 1995 was $1,819,000 and includes a
current provision for federal and state income taxes of $131,000 and a deferred
benefit of $1,950,000 primarily relating to the restructuring and unusual
charges recorded in 1995. The Company recorded a valuation allowance in 1995 to
reflect the amount of deferred tax assets which may not be realized. The
provision for taxes in 1994 amounted to $148,000 and principally reflected
amounts currently due for federal taxes.
Net income decreased to a loss of $6,811,000 in 1995 from income of $51,000
in 1994 due to the restructuring and unusual charges. Excluding these charges,
net income for the year would have been $515,000 versus $51,000 reported in
1994.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations during the years ended December 31, 1996, 1995 and
1994 provided cash of approximately $2,758,000, $4,626,000 and $1,932,000,
respectively. The decrease in cash flow from operations between 1996 and 1995,
and the increase in cash flow from operations between 1995 and 1994 principally
reflects the non-cash restructuring and unusual charges recorded in 1995.
As of December 31, 1996 and 1995, PharmChem had $240,000 and $647,000 in
cash or cash equivalents, respectively. During 1996, the Company used
approximately $2,731,000 in cash to acquire property and equipment and
approximately $2,295,000 in cash to reduce short and long term debt. During
1995, the Company used approximately $2,732,000 in cash to acquire property and
equipment and approximately $2,648,000 in cash to reduce short and long term
debt. During the third quarter of 1995, the Company agreed to acquire
testing/analysis equipment at a cost of approximately $1,400,000; physical
delivery and financing was completed in December 1995 and in the first quarter
of 1996.
In February 1997, PharmChem amended its revolver and term loan credit
agreement ("Credit Agreement") with a bank with respect to certain financial
covenants. In March 1996, the Company amended the Credit Agreement to provide
for additional credit availability, an extended revolver loan maturity date and
greater covenant flexibility. The revolver was increased from $3,500,000 to
$5,000,000, of which $1,002,000 was outstanding at the end of 1996. The Credit
Agreement provides for borrowings under the revolver limited to 75% of qualified
account receivables. The revolver maturity date was extended from May 1996 until
November 1997. The revolver bears interest at the bank reference rate plus 0.5%
(8.75% at December 31, 1996). As of December 31, 1996, approximately $611,000
was outstanding under the term loan, which expires in November 1997. The term
loan bears interest at the bank reference rate plus 1.0% (9.25% at December 31,
1996). All borrowings are secured by a lien on all assets of the Company.
The Company anticipates that existing cash balances, amounts available
under the Credit Agreement and funds to be generated from future operations will
be sufficient to fund operations and budgeted capital expenditures through 1997.
13
14
FACTORS AFFECTING OPERATING RESULTS
PharmChem is subject to a number of risks which could affect operating
results and liquidity, which risks include, among others, the following:
Competition and Customer Contracts. The drug testing industry in which
PharmChem competes is often characterized by competitive bidding which results
in the award of contracts based on technical superiority, customer service and
price. The Company competes for customer contracts against firms that may have
greater financial, marketing, laboratory and related resources. The market for
drug testing services became increasingly competitive in the 1990's, and
continues to be competitive. A majority of the Company's sales arise out of
competitively bid contracts. The Company has in the past failed to renew
significant contracts, including the 1996 loss of the contract with the U.S.
Army which represented 4% and 7% of the Company's total sales in 1996 and 1995,
respectively. While many of the Company's contracts have multi-year terms, most
contracts are subject to discretionary termination on short notice by the
Company's customers. In addition, relatively few of the Company's contracts call
for minimum contract amounts or payments. Although the Company's historical
experience has been that customers generally use its services for the entire
length of the contract term, early termination of a substantial contract, if not
replaced by comparable contracts, could have a material adverse effect on the
Company.
PharmChek(TM). Since 1992, the Company has been investing in
PharmChek(TM), a system which uses sweat to detect the use of illegal drugs. The
process of bringing PharmChek(TM) to market has been subject to technical and
regulatory delays and there is no assurance that there will not be similar
delays in the future. Additional testing of PharmChek(TM) by customers is
required before commercial release can occur. To date, sales of PharmChek(TM)
have not been material and there is no assurance that it will be commercially
accepted by existing or new customers or generate significant revenues in the
future. While the company that developed PharmChek(TM) has obtained patents
relating to its technology, there is no assurance as to the validity of such
patents, that the products marketed by the Company will be covered by such
patents, or that competitors will not infringe upon such patents or successfully
design similar or competing products that do not infringe upon such patents. The
Company has incurred significant costs in connection with the commercialization
of PharmChek(TM) and expects to continue to do so in the future. The Company's
investment in PharmChek(TM) marketing rights was approximately $704,000,
$805,000 and $284,000 during 1996, 1995 and 1994, respectively.
Customer Concentration. The Company's two largest customers accounted for
approximately a combined 29% and 27% of the Company's sales in 1996 and 1995,
respectively. The loss of these contracts, if not replaced by comparable
contracts, would result in lower sales, lower profit margins, and in negative
cash flows and losses. The Company has in the past failed to renew significant
contracts which have had adverse effects on the Company. See "Competition and
Customer Contracts" above.
Certification. The Company's laboratory is currently certified by SAMHSA,
CLIA, CAP and a number of states to conduct drug testing using forensic
procedures. Certification is essential to the Company's business because some of
its customers are required to use certified laboratories, and many of its
customers look to certification as an indication of accuracy and reliability of
results. In order to remain certified, the Company is subject to frequent
inspections and proficiency tests. Failure to meet any of the numerous
certification requirements to which the Company is subject could result in
suspension or loss of certification. Such suspension or loss of certification
could have a material adverse effect on the Company.
Fluctuations in Operating Results. Along with competition and customer
contracts, PharmChem's operations are affected by seasonal trends to which drug
testing laboratories are generally subject. In the past, testing volume tends to
be higher in the second and third calendar quarters and lower in the fourth and
first calendar quarters, primarily due to the hiring patterns of the Company's
public and private employer customer group which affect pre-employment drug
testing. Further, demand for the Company's services is dependent on general
economic conditions. Recessionary periods generally result in fewer new hires,
and therefore may lead to fewer pre-employment drug tests for public and private
employer customers. Budget cuts at the federal, state, or local level could
reduce business from the Company's public employer, criminal justice agency and
government funded drug treatment program customers. Because expenses associated
with maintaining the
14
15
Company's testing work force are relatively fixed over the short term, the
Company's profit margins tend to increase in periods of higher testing volume
and decrease in periods of lower testing volume.
Judicial Decisions and Government Policy. State and federal courts have
generally permitted the use of drug testing under certain circumstances and
using certain procedures. However, challenges to drug testing programs are
raised from time to time by employees, unions and other groups in litigation on
constitutional, privacy and other grounds. In addition, legal precedent in a
number of states governs the circumstances under which employers may test
employees and the procedures under which such tests must be conducted. Although
the Company believes that, to date, no such litigation or law has had a material
adverse impact upon its business, new decisions, legislation or policies which
restrict the use of drug testing could have a material adverse effect on the
Company.
Credit Availability. PharmChem maintains a term and revolver loan credit
agreement with a bank. All borrowings are secured by a lien on all assets of the
Company. The credit agreement contains certain financial covenants, with which
it anticipates that it will be able to comply throughout 1997, although there
can be no assurance that such compliance will be maintained. Management expects
to enter into a new credit agreement with comparable terms prior to the
expiration date of the existing Credit Agreement.
Legal Proceedings. In the ordinary course of its business, PharmChem is
sued by individuals, primarily those in the criminal justice system, who have
tested positive for drugs of abuse. In addition, the Company frequently
testifies in administrative and court proceedings involving the results of its
tests. To date, the Company has not experienced any material liability related
to these claims, although there can be no assurance that the Company will not at
some time in the future experience significant liability in connection with such
claims. There are no pending legal proceedings, other than ordinary routine
litigation incidental to the Company's business, to which PharmChem is a party
or to which any of its property is subject and management does not believe the
outcome of any of the proceedings will have a material impact on its financial
position or results of operations. The Company believes that its liability
insurance coverage is adequate for its business.
Environmental Matters. A small portion of the Company's business involves
testing procedures requiring the use of chloroform and radioactive reagents,
which are considered to be hazardous materials. Failure to comply with current
or future federal, state or local environmental laws or regulations regarding
these hazardous materials could have a material adverse effect on the Company.
The Company believes it is in compliance with all applicable environmental laws
and regulations.
Dependence on Key Personnel. The success of PharmChem is dependent in part
on its key management and technical personnel, the loss of one or more of whom
could have a material adverse effect on the Company. None of the Company's key
employees has an employment contract with the Company. The Company believes that
its future success will depend in part upon its continued ability to attract,
retain and motivate additional highly skilled personnel.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based
Compensation." This pronouncement encourages recognition of stock-based awards
based on their fair value on the date of grant and requires additional footnote
disclosures. As permitted by this pronouncement, the Company continues to
account for stock-based compensation under the Accounting Pronouncement Board's
Opinion No. 25 "Accounting for Stock Issued to Employees." SFAS No. 123 will not
affect the Company's financial position or results of operations.
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed of." This
pronouncement requires that long-lived assets and certain intangible assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an
15
16
asset may not be recoverable. An impairment loss is to be recognized when the
sum of undiscounted cash flows is less than the carrying amount of the asset.
Although this pronouncement did not have a material impact on the Company's
financial condition or results of operations at adoption, its provisions are
applicable to any future assessments of its long-lived assets. SFAS No. 121 was
adopted effective January 1, 1996.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index at page 32, Item 14.(a)(1).
16
17
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of PharmChem Laboratories, Inc.:
We have audited the accompanying consolidated balance sheets of PharmChem
Laboratories, Inc. (a California corporation) and its subsidiary as of December
31, 1996 and 1995, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 financial position of PharmChem Laboratories, Inc.
and its subsidiary as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
San Jose, California
February 13, 1997
17
18
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------
1996 1995
------- -------
(IN THOUSANDS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.............................................. $ 240 $ 647
------- -------
Accounts receivable.................................................... 8,778 9,463
Less -- allowance for doubtful accounts............................. (610) (462)
------- -------
Accounts receivable, net....................................... 8,168 9,001
------- -------
Inventory.............................................................. 1,014 1,688
Other current assets................................................... 1,122 700
------- -------
TOTAL CURRENT ASSETS........................................... 10,544 12,036
------- -------
PROPERTY AND EQUIPMENT, at cost.......................................... 15,190 12,534
Less -- accumulated depreciation and amortization...................... (8,612) (7,134)
------- -------
Property and equipment, net......................................... 6,578 5,400
------- -------
OTHER ASSETS............................................................. 986 1,202
------- -------
GOODWILL................................................................. 10,181 10,181
Less -- accumulated amortization and write-downs.................... (6,821) (6,636)
------- -------
Goodwill, net.................................................. 3,360 3,545
------- -------
TOTAL ASSETS................................................... $21,468 $22,183
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt...................................... $ 2,335 $ 1,197
Accounts payable....................................................... 3,238 3,773
Accrued compensation................................................... 998 1,187
Accrued collectors and other liabilities............................... 2,266 1,596
------- -------
TOTAL CURRENT LIABILITIES...................................... 8,837 7,753
------- -------
LONG TERM DEBT, net of current portion................................... 1,205 3,401
DEFERRED CREDITS......................................................... 139 --
SHAREHOLDERS' EQUITY:
Common stock, no par value, 10,000 shares authorized, 5,695 and 5,587
shares issued and outstanding at December 31, 1996 and 1995,
respectively........................................................ 18,915 18,703
Accumulated deficit.................................................... (7,628) (7,674)
------- -------
TOTAL SHAREHOLDERS' EQUITY..................................... 11,287 11,029
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..................... $21,468 $22,183
======= =======
The accompanying notes are an integral part of these Consolidated Financial
Statements.
18
19
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
NET SALES..................................................... $41,255 $39,111 $33,640
COST OF SALES................................................. 31,757 29,771 25,777
------- ------- -------
GROSS PROFIT.................................................. 9,498 9,340 7,863
OPERATING EXPENSES:
Selling, general and administrative......................... 7,339 6,966 6,213
Marketing rights and research costs......................... 1,455 1,039 854
Amortization of goodwill.................................... 185 247 246
Provision for doubtful accounts............................. 101 575 72
Restructuring and unusual charges........................... -- 8,775 --
------- ------- -------
Total operating expenses............................ 9,080 17,602 7,385
------- ------- -------
INCOME (LOSS) FROM OPERATIONS................................. 418 (8,262) 478
------- ------- -------
OTHER INCOME (EXPENSE):
Interest income............................................. 63 93 92
Interest expense............................................ (435) (457) (553)
Other....................................................... -- (4) 182
------- ------- -------
Other expense, net.................................. (372) (368) (279)
------- ------- -------
INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME
TAXES....................................................... 46 (8,630) 199
PROVISION FOR (BENEFIT FROM) INCOME TAXES..................... -- (1,819) 148
------- ------- -------
NET INCOME (LOSS)............................................. $ 46 $(6,811) $ 51
======= ======= =======
NET INCOME (LOSS) PER SHARE................................... $ 0.01 $ (1.23) $ 0.01
======= ======= =======
Weighted average number of common
and common equivalent shares................................ 5,710 5,542 5,560
======= ======= =======
The accompanying notes are an integral part of these Consolidated Financial
Statements.
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20
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK TOTAL
------------------ ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT DEFICIT EQUITY
------ ------- ----------- -------------
(IN THOUSANDS)
BALANCE AT DECEMBER 31, 1993........................ 5,509 $18,630 $ (914) $17,716
----- ------- ------- -------
Exercise of stock options......................... 2 -- -- --
Net income........................................ -- -- 51 51
----- ------- ------- -------
BALANCE AT DECEMBER 31, 1994........................ 5,511 18,630 (863) 17,767
----- ------- ------- -------
Exercise of stock options......................... 76 73 -- 73
Net loss.......................................... -- -- (6,811) (6,811)
----- ------- ------- -------
BALANCE AT DECEMBER 31, 1995........................ 5,587 18,703 (7,674) 11,029
----- ------- ------- -------
Exercise of stock options......................... 108 212 -- 212
Net income........................................ -- -- 46 46
----- ------- ------- -------
BALANCE AT DECEMBER 31, 1996........................ 5,695 $18,915 $(7,628) $11,287
===== ======= ======= =======
The accompanying notes are an integral part of these Consolidated Financial
Statements.
20
21
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 46 $(6,811) $ 51
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization............................ 1,979 2,626 2,558
Restructuring and unusual charges, net of tax benefit.... -- 7,527 --
Gain on sale of equipment................................ (51) -- --
Change in operating assets and liabilities:
Accounts receivable...................................... 833 (516) (2,228)
Inventory................................................ 674 (15) (89)
Income tax refund receivable............................. (351) -- 1,118
Other current assets..................................... (71) (19) (215)
Accounts payable and other accrued liabilities........... (440) 1,834 737
Deferred credits......................................... 139 -- --
------- ------- -------
Change in operating assets and liabilities.......... 784 1,284 (677)
------- ------- -------
Net cash provided by operating activities........... 2,758 4,626 1,932
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for property and equipment........................ (2,731) (2,732) (1,810)
Payments for marketing rights............................... -- (805) (284)
Proceeds from sale of equipment............................. 230 -- --
Decrease (increase) in other assets......................... 216 (284) (135)
------- ------- -------
Net cash used in investing activities............... (2,285) (3,821) (2,229)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.................... 1,203 1,428 404
Principal payments on long-term debt........................ (2,295) (2,648) (1,935)
Proceeds from exercise of stock options..................... 212 73 --
------- ------- -------
Net cash used in financing activities............... (880) (1,147) (1,531)
------- ------- -------
NET DECREASE IN CASH AND CASH EQUIVALENTS..................... (407) (342) (1,828)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR................ 647 989 2,817
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR...................... $ 240 $ 647 $ 989
======= ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest...................................... $ 548 $ 479 $ 447
======= ======= =======
Cash paid for taxes......................................... $ -- $ 123 $ --
======= ======= =======
The accompanying notes are an integral part of these Consolidated Financial
Statements.
21
22
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. THE COMPANY
PharmChem Laboratories, Inc. is a leading independent laboratory providing
integrated drug testing services. PharmChem tests for a number of drugs of
abuse, primarily by urinalysis. In addition to forensic drug testing, PharmChem
offers a range of services which are customized to assist customers in
implementing cost-effective drug testing programs. The Company's customers
include private and public employers, criminal justice agencies and drug
treatment programs primarily in the United States and the United Kingdom (U.K.).
The consolidated financial statements include the accounts of PharmChem
Laboratories, Inc. and its wholly-owned subsidiary, Medscreen Limited
("Medscreen"), a U.K. company (collectively referred to as the "Company").
The Company is subject to a number of risks which include, among others,
competition related to customer contracts, development and marketing of
PharmChek(TM) and PharmScreen(TM), customer concentration and laboratory
certification.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of the Company
after elimination of significant intercompany accounts and transactions. The
functional currency of Medscreen is the local currency. The foreign currency
translation adjustment is not material.
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 reported amount 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.
CASH EQUIVALENTS
Cash and cash equivalents include cash balances and all highly liquid
investments with original maturities of three months or less at the date of the
purchase. At December 31, 1996 and 1995, cash and cash equivalents consist of
demand deposits maintained at established commercial banks. Such cash deposits
periodically exceed the Federal Deposit Insurance Corporation insured limit of
$100,000 for each account.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash investments and trade
receivables. The Company has cash investment policies that limit investments to
short-term, low risk instruments. Although two customers accounted for
approximately 29% of the Company's sales for the year ended December 31, 1996,
concentrations of credit risk with respect to trade receivables is mitigated by
the fact that one of the customers is a federal government agency and the
remaining customer base is diversified among many corporate industries and other
government agencies.
INVENTORY
Inventory represents laboratory and shipping items and is stated at the
lower of cost or market. Cost is determined using standard costs that
approximate actual costs on a first-in, first-out basis.
22
23
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation and amortization
are provided using the straight-line method over the estimated useful lives of
up to 10 years. Leasehold improvements and equipment held under capital leases
are amortized over the estimated useful life. At December 31, property and
equipment consisted of the following:
1996 1995
-------- --------
(IN THOUSANDS)
Lab equipment.......................................... $ 7,441 $ 6,783
Computer hardware and software......................... 2,552 1,000
Office equipment....................................... 366 513
Furniture and fixtures................................. 688 668
Leasehold improvements................................. 3,659 3,535
Construction in progress............................... 484 35
-------- --------
15,190 12,534
Less: accumulated depreciation and amortization........ (8,612) (7,134)
-------- --------
Property and equipment, net............................ $ 6,578 $ 5,400
======== ========
Expenditures for maintenance and repairs are expensed as incurred. Costs of
major replacements and betterments are capitalized. When property is retired or
otherwise disposed of, the cost and accumulated depreciation and amortization
are removed from the appropriate accounts and any gain or loss is included in
current income.
GOODWILL
Goodwill consists of the excess of cost over the fair value of the net
assets of businesses acquired and is being amortized on a straight-line basis
over periods not exceeding 40 years.
REVENUE
Revenue is recognized upon completion of laboratory analyses of specimens
submitted by customers. As a percentage of gross revenues, the Company had sales
to major customers as follows:
1996 1995 1994
---- ---- ----
Customer A............................................. 18.7% 17.2% 18.6%
Customer B............................................. 10.3% 9.7% 9.9%
INCOME TAXES
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 109, "Accounting for Income Taxes," effective January 1, 1993 which requires
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Under this method, deferred tax assets and liabilities are
determined based on the differences between the financial statement and tax
bases of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse.
23
24
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NET INCOME (LOSS) PER SHARE
Net income per share data has been computed using the weighted average
number of shares of common stock and dilutive common equivalent shares from
stock options outstanding (using the treasury stock method). Loss per share was
computed based only on the weighted average number of common shares outstanding
during the period. Common equivalent shares, which represent shares issuable
upon the exercise of outstanding options, were excluded from the calculation of
the loss per share because the effect of including such shares in the
computation would be anti-dilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About
Fair Value of Financial Instruments," requires certain disclosures regarding the
fair value of financial instruments. Cash, accounts receivable, accounts payable
and accrued liabilities are reflected in the financial statements at fair value
because of the short-term maturity of these instruments. The fair value of
long-term debt does not materially differ from its carrying amount since the
majority of such debt bears interest at variable rates and the fixed rate
obligations generally have near-term maturities.
DEFERRED CREDITS
Deferred credits represent unrealized rent abatements granted by the lessor
of the facility occupied by Medscreen, and is being amortized on a straight-line
basis as a reduction to rent expense over the remaining lease term.
INCENTIVE STOCK PLANS
The Company has two stock option plans which reserve shares of common stock
for issuance to executives, key employees, consultants and directors. The
Company accounts for stock-based compensation under the Accounting Pronouncement
Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25). The
exercise price of options granted under these plans is equal to the market price
of the Company's stock on the date of grant, and accordingly, no compensation
cost is recorded under APB 25. The Company has adopted the disclosure only
provisions of Statement of Financial Accounting Standards No. 123 "Accounting
for Stock-Based Compensation," effective January 1, 1996.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform
to current year presentation.
24
25
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. DEBT
Notes payable to bank, long-term debt and capitalized lease obligations at
December 31, consist of the following:
1996 1995
------- -------
(IN THOUSANDS)
Notes payable to a bank pursuant to the term and revolver loan agreement,
expiring November 1997, secured by a lien on all assets, interest at
bank reference rate plus 0.5% (8.75% at December 31, 1996)............. $ 1,002 $ 1,850
Notes payable to a bank pursuant to the term and revolver loan agreement,
due in monthly installments of approximately $55 plus interest, due
November 1997, secured by a lien on all assets, interest at bank
reference rate plus 1.0% (9.25% at December 31, 1996).................. 611 1,278
Obligations under capitalized leases, due in monthly installments through
2001, secured by laboratory and office equipment, interest ranging from
6% to 11%.............................................................. 1,821 1,350
Other.................................................................... 106 120
------- -------
3,540 4,598
Less: current portion.................................................... (2,335) (1,197)
------- -------
Long-term portion........................................................ $ 1,205 $ 3,401
======= =======
In February 1997, the Company amended its revolver and term loan credit
agreement ("Credit Agreement") with a bank to modify certain financial
covenants. In March 1996, the Company amended the Credit Agreement whereby the
revolver loan was increased from $3,500,000 to $5,000,000, the advance rate on
qualified accounts receivable was increased from 70% to 75%, and the maturity
date was extended until November 1997. Management expects to enter into a new
credit agreement with comparable terms prior to the expiration of the existing
Credit Agreement.
The Credit Agreement contains certain financial covenants which, among
others, require the Company to maintain certain levels of net worth, cash flow
and profitability and restricts the payment of dividends. As of December 31,
1996, the Company was in compliance with all covenants related to the Credit
Agreement.
The Company has leased certain laboratory and office equipment with an
original cost of approximately $2,724,000 under capital lease agreements. At
December 31, 1996, the future minimum lease payments, together with the present
value of the net minimum lease payments under these agreements, were as follows
(in thousands):
1997................................................................ $ 789
1998................................................................ 553
1999................................................................ 365
2000................................................................ 348
2001................................................................ 44
------
Total minimum lease payments.............................. 2,099
Less: amount representing interest........................ (278)
------
Present value of net minimum lease payments............... $1,821
======
25
26
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES
The provision for (benefit from) income taxes consisted of the following:
1996 1995 1994
---- ------- ----
(IN THOUSANDS)
Current:
Federal.................................................. $ -- $ 114 $159
State.................................................... -- 17 --
---- ------- ----
Total current.................................... -- 131 159
---- ------- ----
Deferred:
Federal.................................................. -- (1,654) 1
State.................................................... -- (296) (12)
---- ------- ----
Total deferred................................... -- (1,950) (11)
---- ------- ----
Provision for (Benefit from) income taxes........ $ -- $(1,819) $148
==== ======= ====
The federal and state tax provisions (benefits) represent the alternative
minimum tax ("AMT") on operations for 1995 while the provision recorded in 1994
reflects the tax on operations at regular rates. No provision has been recorded
on foreign income because of the utilization of tax loss carryforwards.
Undistributed earnings of the Company's foreign subsidiary are not significant.
The provision for (benefit from) income taxes is reconciled with the federal
statutory rate as follows:
1996 1995 1994
---- ------- ----
(IN THOUSANDS)
Tax provision (benefit) computed at the federal statutory
tax rate................................................. $ 16 $(3,021) $ 68
State taxes, net of federal tax benefit.................... 3 (526) --
Effects of foreign operations.............................. -- (121) 35
Amortization and write-down of goodwill.................... 66 724 44
Increase (decrease) in valuation allowance................. (83) 1,470 --
Other...................................................... (2) (345) 1
---- ------- ----
Total tax (benefit from) provision............... $ -- $(1,819) $148
==== ======= ====
26
27
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The major components of temporary differences which give rise to the
deferred tax accounts at December 31, 1996 and 1995, are as follows:
1996 1995
------ -------
(IN THOUSANDS)
Current deferred tax assets:
Reserves and accruals........................................... $ 753 $ 560
Other........................................................... -- 154
------ -------
Total gross current assets.............................. 753 714
Deferred tax valuation allowance................................ (318) (270)
------ -------
Net current asset....................................... $ 435 $ 444
====== =======
Non-current deferred tax assets:
Net operating loss carryforward................................. $ 243 $ 81
Book depreciation less than tax depreciation.................... (283) (92)
Restructuring and unusual charges............................... 876 2,183
Other........................................................... 512 --
------ -------
Total gross non-current asset........................... 1,348 2,172
Deferred tax asset valuation allowance.......................... (718) (1,200)
------ -------
Net non-current asset................................... $ 630 $ 972
====== =======
The deferred tax asset accounts are classified with "Other current assets"
and "Other assets" on the accompanying Consolidated Balance Sheets. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting and income
tax purposes. Although realization is not assured, the Company believes it is
more probable than not that the net deferred tax asset will be realized in the
future primarily from the generation, in subsequent years, of U.S. source
taxable income. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term if estimates of future taxable income
during the carryforward period are lower.
As of December 31, 1996, the Company has net operating loss carryforwards
for federal and state income tax reporting purposes of approximately $368,000
and $1,273,000, respectively. These carryforwards expire on various dates
through 2011. The Company also has net operating loss carryforwards available
for U.K. tax reporting purposes, which are restricted to the U.K. of
approximately $470,000. The Tax Reform Act of 1986 contains provisions which may
limit the net operating loss carryforwards to be used in any given year upon the
occurrence of certain events, including a significant change of ownership.
In February 1997, the Company received a refund of federal income taxes
totaling $351,000. This amount is classified in "Other current assets" on the
accompanying Consolidated Balance Sheets.
The Company's federal income tax returns for 1992 and 1993 are currently
under review by the Internal Revenue Service. In the opinion of management, any
proposed adjustments will not be significant.
27
28
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INCENTIVE STOCK PLANS
1988 INCENTIVE STOCK PLAN
In November 1988, the Company adopted the 1988 Incentive Stock Plan ("the
Plan"). Under this Plan, nonstatutory options and stock purchase rights may be
granted to employees and consultants, while incentive stock options may only be
granted to employees, for up to a total of 1,280,000 shares of common stock. The
Plan, which expires in 1998, is administered by the Officers Compensation
Committee of the Board of Directors (the "Administrator") with the term and
exercise price of the options and rights being generally at the discretion of
the Administrator. Incentive stock options must be granted at a price of at
least fair market value, while nonstatutory options and stock purchase rights
must be granted at a price of at least 85% of the fair market value, based on
the trading price of the common stock on Nasdaq, as of the date of grant. Common
shares purchased pursuant to stock purchase rights issued under the Plan are
subject to repurchase at the original issuance price by the Company upon
termination of employment. The repurchase right lapses at such rate as
determined by the Administrator. Options granted under the Plan vest generally
over a 48 month period and expire ten years after date of grant. As of December
31, 1996, only incentive stock options were outstanding.
Options to purchase approximately 206,000 shares of common stock were
exercisable at December 31, 1996. Effective January 1, 1995 the Company engaged
in a stock option exchange program that effectively repriced all then
outstanding options having an exercise price above the then current market price
of $2.00 ("Repriced grants/canceled" in the following table). The repriced
options began vesting effective January 1, 1995 over a 48 month period. The
exercise price for all options exchanged was $2.00. Option information for the
periods presented is as follows:
OPTIONS OUTSTANDING
-----------------------------------------------------
OPTIONS
AVAILABLE NUMBER WEIGHTED
FOR GRANT OF SHARES RANGE AVERAGE
--------- --------- ------------ --------
Balance at December 31, 1993.......... 554,252 432,505 $0.25 - 7.25 $ 4.89
--------- --------- ------------ -----
Granted............................. -- -- -- --
Canceled............................ 215,999 (215,999) 4.50 - 7.25 4.87
Exercised........................... -- (2,251) 0.25 0.25
--------- --------- ------------ -----
Balance at December 31, 1994.......... 770,251 214,255 0.25 - 7.25 4.96
--------- --------- ------------ -----
Granted............................. (687,480) 687,480 2.00 - 4.75 2.95
Canceled............................ 55,711 (55,711) 2.00 - 7.25 2.47
Exercised........................... -- (66,493) 0.25 - 2.00 0.74
Repriced grants..................... (157,171) 157,171 2.00 2.00
Repriced canceled................... 157,171 (157,171) 4.50 - 7.25 6.84
--------- --------- ------------ -----
Balance at December 31, 1995.......... 138,482 779,531 0.25 - 4.75 2.82
--------- --------- ------------ -----
Granted............................. (191,000) 191,000 3.25 - 4.63 3.69
Canceled............................ 165,565 (165,565) 0.25 - 4.00 2.29
Exercised........................... -- (108,145) 0.25 - 2.00 1.94
--------- --------- ------------ -----
Balance at December 31, 1996.......... 113,047 696,821 $0.25 - 4.75 $ 3.32
========= ========= ============ =====
28
29
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1992 DIRECTOR OPTION PLAN
In May 1992, the Company adopted the 1992 Director Option Plan ("the
Director Plan") and reserved 250,000 shares of common stock for issuance under
this plan. The options vest over a 48-month period and expire five years from
the date of grant. Options are granted at fair market value and the plan expires
in 2002. As of December 31, 1996, options to purchase 130,000 shares were
outstanding at exercise prices of $2.00 to $8.75 per share, 120,000 options were
available for future grants and 98,000 options were exerciseable. In 1995, 9,374
options were exercised at a weighted average share price of $2.61.
SFAS NO. 123
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recorded in the
consolidated statements of operations for the stock option plans. If the
consolidated statements of operations included compensation cost for 1996 and
1995 grants as set forth in SFAS No. 123, the Company's proforma net income
(loss) and net income (loss) per share would have been as follows:
1996 1995
------ -------
(IN THOUSANDS,
EXCEPT PER SHARE
AMOUNTS)
Net income(loss), as reported............................. $ 46 $(6,811)
Net income(loss), pro forma............................... (203) (7,119)
Net income(loss), per share, as reported.................. 0.01 (1.23)
Net income(loss), per share, pro forma.................... (0.04) (1.28)
The fair value of each grant is estimated on the date of grant using the
Binomial option pricing model with the following assumptions: risk-free interest
rate of 6%, corresponding to government securities with original maturities
similar to the estimated option life; option lives ranging from 3 to 5 years;
annual volatility of the Company's stock price of 80%; and a dividend yield of
0.0%. The effects of applying the provisions of SFAS No. 123 are not likely to
be representative of the effects on pro forma net income (loss) in future years.
The weighted average of fair values of options granted during 1996 and 1995
were $2.09 and $1.53, respectively. The options outstanding and exerciseable are
as follows:
OPTIONS EXERCISEABLE AT DECEMBER 31, 1996
OPTIONS OUTSTANDING AT DECEMBER 31, 1996 -------------------------------------------------
------------------------------------------------- WEIGHTED
NUMBER WEIGHTED AVERAGE WEIGHTED
RANGE OF OF SHARES AVERAGE REMAINING NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING EXERCISE PRICE CONTRACT LIFE EXERCISEABLE EXERCISE PRICE
-------------- ----------- -------------- ------------- ------------ --------------
$ 0.25 - $2.00 252,341 $ 1.97 7.2 Years 117,335 $ 1.94
2.88 - 4.75 544,480 3.95 6.4 Years 156,846 4.02
- 8.75 30,000 8.75 0.3 Years 30,000 8.75
-------- ------ - ----- -------- - ------ -
-----
$ 0.25 - $8.75 826,821 $ 3.52 6.1 Years 304,181 $ 3.68
============= ======= ===== ========= =======
6. PROFIT SHARING PLAN
The Company has a 401(k) plan (the "Plan") which is available to all
employees who have reached age 18 and have completed at least one year of
service. The Plan provides that each participant may contribute a portion of his
or her salary, within certain limits set forth in the U.S. Tax Code. The Company
will make a matching contribution of 10% of the amount contributed by each
participant and may make additional matching or discretionary profit sharing
contributions. The Company's contributions vest after three years of service.
Total contribution expense recorded by the Company for 1996, 1995 and 1994 was
$20,000, $52,000, and $60,000, respectively.
29
30
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS
Future minimum lease payments for the Company's office, laboratory and
warehouse space at December 31, 1996 were as follows (in thousands):
AMOUNT
------
1997................................................................ $ 800
1998................................................................ 812
1999................................................................ 816
2000................................................................ 796
2001................................................................ 361
2002 and thereafter................................................. 278
------
Total commitments......................................... $3,863
======
Rental expense for operating leases amounted to approximately $825,000,
$789,000 and $614,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.
8. PRIOR YEAR RESTRUCTURING AND UNUSUAL CHARGES
During the fourth quarter of 1995, the Company recorded a provision for
restructuring and unusual charges as follows (in thousands):
1995
------
Write-off of marketing rights and other expenditures................ $4,073
Write-down of goodwill applicable to Medscreen...................... 2,000
Write-down of certain computer and peripheral equipment............. 1,881
Other one-time costs -- principally severance....................... 821
------
$8,775
======
The write-off of marketing rights and other expenditures is related to
costs incurred in connection with the acquisition of marketing rights to
PharmChek(TM). The Company believed it prudent to write-off these costs given
the delays in obtaining necessary FDA approvals and commencing pilot tests, both
of which hampered the scheduled commercial launch of PharmChek(TM). The
Company's investment in PharmChek(TM) marketing rights was approximately
$704,000, $805,000 and $284,000 during 1996, 1995 and 1994, respectively. The
Company expects to continue its investment in PharmChek(TM). To date, there have
been no material revenues generated from PharmChek(TM).
During the fourth quarter of 1995, Medscreen lost a customer which
accounted for approximately 20% of its revenues. As a result, the Company
revised its assessment of the realization of the carrying value of its
investment and an additional write-down of $2,000,000 was recognized in the
fourth quarter of 1995. The write-down was determined based on the projected
discounted cash flows of Medscreen compared with the carrying value of the
Company's investment in Medscreen, including goodwill, at the date of the
write-down.
The write-down of computer and peripheral equipment is consistent with the
Company's plan to begin replacing certain existing systems to enhance service to
its customers and provide the infrastructure to better monitor and control
expenses.
9. LITIGATION
The Company is the defendant in certain legal matters which are normal for
the industry in which the Company operates. Management believes that these
matters, both individually and in the aggregate, will not have a material
adverse impact on the Company's financial position or results of operations.
30
31
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. GEOGRAPHICAL DATA
Information about the Company's operations in geographic areas where it
operates is as follows:
DOMESTIC FOREIGN TOTAL
-------- ------- --------
(IN THOUSANDS)
Net sales:
1996................................................ $ 37,781 $ 3,474 $ 41,255
1995................................................ 34,679 4,432 39,111
1994................................................ 30,677 2,963 33,640
Income (loss) from operations:
1996................................................ 242 176 418
1995(1)............................................. (6,590) (1,672) (8,262)
1994................................................ 725 (247) 478
Identifiable assets at year end:
1996................................................ 16,623 4,845 21,468
1995................................................ 17,298 4,885 22,183
1994................................................ 21,555 6,751 28,306
- ---------------
(1) Refer to Note 8 for discussion of restructuring and unusual charges recorded
in the fourth quarter.
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized selected quarterly financial data is as follows:
QUARTER ENDED
------------------------------------------
3/31 6/30 9/30 12/31
------ ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1996
Net sales.................................... $9,867 $10,771 $10,631 $ 9,986
Gross profit................................. 2,241 2,531 2,625 2,101
Net income (loss)............................ (178) 82 155 (13)
Net income (loss) per share.................. $(0.03) $ 0.01 $ 0.03 $ 0.00
Weighted average shares outstanding.......... 5,594 5,791 5,763 5,682
1995
Net Sales.................................... $8,792 $ 9,722 $10,307 $10,290
Gross profit................................. 2,270 2,460 2,480 2,130
Net income (loss)(1)......................... 101 174 180 (7,266)
Net income (loss) per share.................. $ 0.02 $ 0.03 $ 0.03 $ (1.31)
Weighted average shares outstanding.......... 5,561 5,751 5,870 5,574
- ---------------
(1) Refer to Note 8 for discussion of restructuring and unusual charges recorded
in the fourth quarter.
31
32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEMS 10 TO 13 INCLUSIVE.
These items have been omitted in accordance with the General Instructions
to Form 10-K and are answered by reference to those portions of the Registrant's
definitive proxy statement with respect to the 1997 Annual Meeting of
Shareholders which contain the information required by these items. The
Registrant will file with the Commission not later than 120 days after the end
of the fiscal year covered by this report such definitive proxy statement
pursuant to Regulation 14A. Information regarding executive officers of the
Company is contained in Part I of this Annual Report on Form 10-K under caption
"Executive Officers of PharmChem."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS.
PAGE
NUMBER
IN
THIS
REPORT
------
Report of Independent Public Accountants, Arthur Andersen LLP. ................ 17
Consolidated Balance Sheets at December 31, 1996 and 1995...................... 18
Consolidated Statements of Operations for the years ended December 31, 1996,
1995 and 1994................................................................. 19
Consolidated Statements of Shareholders' Equity for the years ended December
31, 1996, 1995 and 1994....................................................... 20
Consolidated Statements of Cash Flows for the years ended December 31, 1996,
1995
and 1994..................................................................... 21
Notes to Consolidated Financial Statements..................................... 22
(A)(2) FINANCIAL STATEMENT SCHEDULE
Schedule II -- Valuation and Qualifying Accounts............................... 35
All other schedules are omitted because they are not applicable, not
required, or the required information is shown in the Consolidated Financial
Statements or notes thereto.
32
33
(A)(3) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ --------------------------------------------------------------------------------
3.01(1) Amended and Restated Articles of Incorporation dated August 21, 1991.
3.02(2) Bylaws, as amended May 19, 1992.
4.01(1) Restated Modification Agreement dated August 14, 1989.
10.01(1) 1988 Incentive Stock Plan, as amended.
10.02(1) Form of Stock Option Agreement.
10.03(1) Form of Stock Option Agreement (providing for accelerated vesting upon death or
disability).
10.04(3) Form of Stock Option Agreement (January 1, 1995).
10.05(1) Form of Stock Purchase Agreement.
10.06(4) 1992 Director Option Plan.
10.07(4) Form of Director Option Agreement.
10.08 Amendment to 1992 Director Option Plan dated February 28, 1996.
10.09 Amendment to 1992 Director Option Plan dated March 4, 1997.
10.10(1) 401(k) Plan.
10.11 Amendment to 401(k) Plan dated August 25, 1996.
10.12(1) Lease Agreements for the Company's offices in Menlo Park, California dated
October 21, 1988 and September 11, 1990, respectively.
10.13(5) Lease Amendment for the Company's offices in Menlo Park, California dated
November 30, 1995.
10.14 Lease Amendment for the Company's offices in Menlo Park, California dated March
6, 1996.
10.15(6) Harbour Quay (London) Lease Documents.
10.16 Lease Agreement for the Company's offices in Fort Worth, Texas dated October 24,
1991.
10.17 Lease Amendment for the Company's offices in Fort Worth, Texas dated December 8,
1992.
10.18 Lease Amendment for the Company's offices in Fort Worth, Texas dated February 9,
1996.
10.19(1) Form of Indemnification Agreement.
10.20(3) Loan and Security Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated November 17, 1994.
10.21(7) Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated March 6, 1995.
10.22(5) Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated September 1, 1995.
10.23(5) Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated March 26, 1996.
10.24 Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated June 19, 1996.
10.25 Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated February 14, 1997.
10.26(4)(8) License and Supply Agreement with Sudormed, Inc. dated March 10, 1992.
10.27(6)(8) License and Supply Agreement with Sudormed, Inc. dated October 25, 1993.
10.28(6)(8) Supply Agreement with SolarCare Technologies Corporation dated August 1, 1993.
33
34
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ --------------------------------------------------------------------------------
10.29(5)(8) First Amendment to Supply Agreement dated December 1, 1995.
10.30(4)(8) Probation Division of the Administration Office of The U.S. Courts Contract
dated October 1, 1992.
10.31(6)(8) Sears Merchandise Group Service Agreement dated September 22, 1992.
10.32 Master Lease Purchase Agreement dated December 18, 1995 with Fidelity Leasing
Corporation and Lease Purchase Addenda in connection therewith.
10.33 Master Equipment Lease dated March 17, 1996 with Olympus Commercial Credit.
21.01 List of Subsidiaries.
23.01 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
- ---------------
(1) Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 33-41363), effective August 8, 1991.
(2) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1992.
(3) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1994.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1992.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1993.
(7) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1995.
(8) Confidential treatment requested as to certain portions of this exhibit.
(9) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1991.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1996.
(C) EXHIBITS
See (a) (3) above.
(D) FINANCIAL STATEMENT SCHEDULE
See (a) (2) above.
34
35
PHARMCHEM LABORATORIES, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER DEDUCTIONS END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS (WRITE-OFFS) OF PERIOD
- ------------------------------------------- ---------- ---------- ---------- ------------ ----------
Allowance for Doubtful Accounts
Period ended:
December 31, 1994..................... $123 $ 72 $-- $ 56 $139
==== ==== == ==== ====
December 31, 1995..................... $139 $955 $-- $632 $462
==== ==== == ==== ====
December 31, 1996..................... $462 $206 $-- $ 58 $610
==== ==== == ==== ====
35
36
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 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, IN THE CITY OF MENLO
PARK, STATE OF CALIFORNIA, ON THIS 17TH DAY OF MARCH, 1997.
PHARMCHEM LABORATORIES, INC.
By: /s/ JOSEPH HALLIGAN
------------------------------------
Joseph Halligan
President, Chief Executive Officer
and Director
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Joseph W. Halligan, acting individually,
as such person's true and lawful attorney-in-fact and agent, with full power of
substitution, for such person, in any and all capacities, to sign any and all
amendments (including post-effective amendments) to this report on Form 10-K,
and to file with same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact and agent, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as such person might or could do
in person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitutes, may do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT ON FORM 10-K HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:
SIGNATURE TITLE DATE
- ------------------------------------------ --------------------------------- ---------------
/s/ JOSEPH HALLIGAN President, Chief Executive March 17, 1997
- ------------------------------------------ Officer and Director (Principal
Joseph Halligan Executive Officer)
/s/ DAVID A. LATTANZIO Chief Financial Officer, Vice March 17, 1997
- ------------------------------------------ President, Finance and
David A. Lattanzio Administration (Principal
Accounting and Financial Officer)
/s/ RICHARD IRWIN Chairman of the Board and March 17, 1997
- ------------------------------------------ Director
Richard Irwin
/s/ THOMAS VOLPE Director March 17, 1997
- ------------------------------------------
Thomas Volpe
36
37
INDEX TO EXHIBITS
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBITS PAGE
- ------------ ---------------------------------------------------------------------------
3.01(1) Amended and Restated Articles of Incorporation dated August 21, 1991.
3.02(2) Bylaws, as amended May 19, 1992.
4.01(1) Restated Modification Agreement dated August 14, 1989.
10.01(1) 1988 Incentive Stock Plan, as amended.
10.02(1) Form of Stock Option Agreement.
10.03(1) Form of Stock Option Agreement (providing for accelerated vesting upon
death or disability).
10.04(3) Form of Stock Option Agreement (January 1, 1995).
10.05(1) Form of Stock Purchase Agreement.
10.06(4) 1992 Director Option Plan.
10.07(4) Form of Director Option Agreement.
10.08 Amendment to 1992 Director Option Plan dated February 28, 1996.
10.09 Amendment to 1992 Director Option Plan dated March 4, 1997.
10.10(1) 401(k) Plan.
10.11 Amendment to 401(k) Plan dated August 25, 1996.
10.12(1) Lease Agreements for the Company's offices in Menlo Park, California dated
October 21, 1988 and September 11, 1990, respectively.
10.13(5) Lease Amendment for the Company's offices in Menlo Park, California dated
November 30, 1995.
10.14 Lease Amendment for the Company's offices in Menlo Park, California dated
March 6, 1996.
10.15(6) Harbour Quay (London) Lease Documents.
10.16 Lease Agreement for the Company's offices in Fort Worth, Texas dated
October 24, 1991.
10.17 Lease Amendment for the Company's offices in Fort Worth, Texas dated
December 8, 1992.
10.18 Lease Amendment for the Company's offices in Fort Worth, Texas dated
February 9, 1996.
10.19(1) Form of Indemnification Agreement.
10.20(3) Loan and Security Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated November 17, 1994.
10.21(7) Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated March 6, 1995.
10.22(5) Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated September 1, 1995.
10.23(5) Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated March 26, 1996.
10.24 Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated June 19, 1996.
10.25 Loan Modification Agreement between Silicon Valley Bank and PharmChem
Laboratories, Inc. dated February 14, 1997.
10.26(4)(8) License and Supply Agreement with Sudormed, Inc. dated March 10, 1992.
10.27(6)(8) License and Supply Agreement with Sudormed, Inc. dated October 25, 1993.
10.28(6)(8) Supply Agreement with SolarCare Technologies Corporation dated August 1,
1993.
10.29(5)(8) First Amendment to Supply Agreement dated December 1, 1995.
10.30(4)(8) Probation Division of the Administration Office of The U.S. Courts Contract
dated October 1, 1992.
38
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBITS PAGE
10.31(6)(8) Sears Merchandise Group Service Agreement dated September 22, 1992.
10.32 Master Lease Purchase Agreement dated December 18, 1995 with Fidelity
Leasing Corporation and Lease Purchase Addenda in connection therewith.
10.33 Master Equipment Lease dated March 17, 1996 with Olympus Commercial Credit.
21.01 List of Subsidiaries.
23.01 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
- ---------------
(1) Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 33-41363), effective August 8, 1991.
(2) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1992.
(3) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1994.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1992.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1993.
(7) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1995.
(8) Confidential treatment requested as to certain portions of this exhibit.
(9) Incorporated by reference from the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1991.