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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
COMMISSION FILE NUMBER: 1-13738
PSYCHEMEDICS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 58-1701987
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OR ORGANIZATION)
1280 MASSACHUSETTS AVE., CAMBRIDGE, MA 02138
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 617-868-7455
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
COMMON STOCK, $.005 PAR VALUE AMERICAN STOCK EXCHANGE
(TITLE OF CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-B 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 [ ]
On March 18, 1998 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $71,393,751 and 22,130,197 shares of Common
Stock, $.005 par value, were outstanding at such date.
DOCUMENTS INCORPORATED BY REFERENCE
Part III -- Portions of the Registrant's Proxy Statement relative to the
1998 Annual Meeting of Stockholders to be held on May 4, 1998.
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PART I
The information provided by the Company in this Report may contain
"forward-looking" information which involves risks and uncertainties, such as
statements of the Company's plans, objectives, expectations and intentions. The
cautionary statements made in this report should be read as being applicable to
all forward-looking statements wherever they appear in this report. The
Company's actual results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include those
discussed in Item 7 below, as well as those discussed elsewhere herein.
ITEM 1. BUSINESS
GENERAL
Psychemedics Corporation ("the Company") is a Delaware corporation
organized on September 24, 1986 to provide testing services for the detection of
abused substances through the analysis of hair samples. The Company's testing
methods utilize a patented technology for performing immunoassays on
enzymatically dissolved hair samples with confirmation testing by gas
chromatography/mass spectrometry ("GC/MS").
The Company's first application of its patented technology is a testing
service which screens for the presence of certain drugs of abuse in hair. The
application of radioimmunoassay procedures using hair differs from the more
widely used application of radioimmunoassay procedures using urine samples. The
Company's tests provide quantitative information which indicates the approximate
amount of drug ingested as well as historical data which can show a pattern of
individual drug use over a period of time. This information is useful to
employers in both applicant and employee testing, to physicians, treatment
professionals, law enforcement agencies, to the insurance industry; and to
parents concerned about drug use by their children and to other individuals and
entities engaged in any business where drug use is an issue. The Company
provides commercial testing and confirmation by GC/MS using industry accepted
practices for cocaine, marijuana, PCP, methamphetamine, and opiates. In
addition, the Company has developed a test for methadone for use in the
treatment industry.
Testing services are currently performed at the Company's laboratory at
5832 Uplander Way, Culver City, California. The Company's services are marketed
under the name RIAH(R) (Radioimmunoassay of Hair), a registered service mark.
DEVELOPMENT OF RADIOIMMUNOASSAY OF HAIR
The application of special radioimmunoassay procedures to the analysis of
hair was initially developed in 1978 by the founders of the Company, Annette
Baumgartner and Werner A. Baumgartner, Ph.D. The Baumgartners demonstrated that
when certain chemical substances enter the bloodstream, the blood carries them
to the hair where they become "entrapped" in the protein matrix in amounts
roughly proportional to the amount ingested. The Company's drugs of abuse
testing procedure involves washing the hair sample to clean it of surface
contaminants and then subjecting the cleaned hair sample to the Company's unique
proprietary process which involves the direct analysis of liquefied hair samples
by radioimmunoassay procedures utilizing special reagents and antibodies. The
antibodies detect the presence of a specific drug or metabolite in the liquefied
hair sample by reacting with the drug present in the sample solution and an
added radioactive analog of the drug. The resulting antibody-drug complex is
precipitated and analyzed. The amount of drug present in the sample is inversely
proportional to the amount of radioactive analog in the precipitate. Depending
upon both the length of hair and the hair growth rate (hair grows approximately
1.3 centimeters per month), the Company is able to provide historical
information on drug use by the person from whom the sample was obtained. Another
testing option involves sectional analysis of the hair sample. In this
procedure, the hair is sectioned lengthwise to approximately correspond to
certain time periods. The sections are then labeled by time period, which allows
the
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Company to provide trend information on drug use. When quantitative results of
this test are reported and compared to dose correlation graphs, information is
provided about the individual's approximate drug usage during the period being
tested.
VALIDATION OF THE COMPANY'S PROPRIETARY TESTING METHOD
The process of analyzing human hair for the presence of drugs using the
Company's patented method has been the subject of over fifty scientific field
studies. Results from the studies that have been published or accepted for
publication in scientific journals are generally favorable to the Company's
technology. These studies were performed with the following organizations:
Citizens for a Better Community Court, Columbia University, Koba Associates-DC
Initiative, Harvard Cocaine Recovery Project, Hutzel Hospital, ISA Associates
(Interscience America)-NIDA Workplace Study, University of California-Sleep
State Organization, Maternal/Child Substance Abuse Project, Matrix Center,
National Public Services Research Institute, Narcotic and Drug Research
Institute, San Diego State University-Chemical Dependency Center, Spectrum Inc.,
Stapleford Centre (London), Task Force on Violent Crime (Cleveland, Ohio);
University of Miami-Department of Psychiatry, University of Miami-Division of
Neonatology, University of South Florida-Operation Par Inc., University of
Washington, VA Medical Center-Georgia, U.S. Probation Parole-Santa Ana. The
above studies include research in the following areas: prenatal, treatment
evaluation, workplace drug use, the criminal justice system and epidemiology.
Many of the studies have been funded by the National Institute of Justice or the
National Institute on Drug Abuse ("NIDA"). Over 300 research articles written by
independent researchers have been published supporting the general validity and
usefulness of hair analysis.
An additional independent evaluation of the technology, favorable to the
Company's services, has been performed by submission of blind samples by Dr.
Robert DuPont, President of the Institute of Behavior and Health, Inc., the
first Director of the National Institute on Drug Abuse and presently Chairman of
the Company's Scientific Advisory Board. Some of the Company's customers have
also completed their own testing to validate the Company's proprietary hair
testing method as a prelude to utilizing the Company's services. These studies
have consistently confirmed the Company's superior detection rate. When the
results from utilizing the Company's patented hair testing method were compared
to urine results in side-by-side evaluations, 5 to 10 times as many drug abusers
were accurately identified with the Company's proprietary method. In addition to
these studies, the Company is now performing testing for over 1,100 clients.
In 1997, the Company completed a study of drug abuse among Vietnam veterans
in collaboration with the Washington University School of Medicine in St. Louis,
and continued to expand research projects on juvenile drug abuse in the criminal
justice system with the University of South Florida and the Medical University
of South Carolina. In addition, Jefferson Medical College in Philadelphia
initiated a program with hair analysis to evaluate drug treatment outcomes.
ADVANTAGES OF USING THE COMPANY'S PATENTED METHOD
The Company asserts that hair testing using its patented method confers
substantive advantages relative to existing means of drug detection through
urinalysis. Although urinalysis testing can provide accurate drug use
information, the scope of the information is short-term and is generally limited
to the type of drug ingested within a few days of the test. Studies published in
many scientific publications have indicated that most drugs disappear from urine
within a few days.
In contrast to urinalysis testing, hair testing using the Company's
patented method provides long-term historical drug use information resulting in
a significantly wider "window of detection." This "window" may be three months
or longer depending on the length of the hair sample. The Company's standard
test offering, however, uses a 3.9 centimeter length cut close to the scalp;
therefore, it measures use for approximately the previous 90 days.
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This wider window of detection enhances the detection efficiency of hair
analysis making it particularly useful in pre-employment testing. Hair testing
not only identifies more drug users, but also uncovers patterns and severity of
drug use, information most helpful in determining the scope of an individual's
involvement with drugs and serves as a deterrent against the use of drugs. Hair
testing using the Company's patented method greatly reduces the incidence of
"false negatives" associated with evasive measures typically encountered with
urinalysis testing. Urinalysis test results are impacted adversely by excessive
fluid intake prior to testing as well as adulteration of the sample. Moreover, a
drug user who abstains from use for a few days prior to urinalysis testing can
usually escape detection. Hair testing is effectively free of these problems as
it cannot be thwarted by evasive measures typically encountered with urinalysis
testing. It is also attractive to customers since sample collection is typically
performed under close supervision yet is less intrusive and embarrassing for
test subjects.
Hair testing using the Company's patented method (with GC/MS confirmation)
further reduces the prospects of error in conducting drug detection tests.
Urinalysis testing is more susceptible to problems such as "evidentiary false
positives" resulting from passive drug exposure (e.g. poppy seeds.) In the event
a positive urinalysis test result is challenged, the only remedy is a newly
collected sample. Depending on the drug usage of the forewarned individual prior
to the date of the newly collected sample, a re-test may yield a negative result
when using urinalysis testing because of temporary abstention. In contrast, when
the Company's hair testing method is offered on a repeat hair sample the
individual suspected of drug use cannot as easily affect the results because
historical drug use data remain locked in the hair fiber.
DISADVANTAGES OF HAIR TESTING
There are some disadvantages of hair testing as compared to drug detection
through urinalysis. Because hair starts growing below the skin surface, drug
ingestion evidence does not appear in hair above the scalp until five to seven
days after use.
Thus, hair testing is not suitable for use in "for cause" testing such as
is done in connection with an accident investigation. It does, however, provide
a drug history which can complement urinalysis information in "for cause"
testing.
Currently, radioimmunoassay testing using hair samples under the Company's
patented method is only practiced by Psychemedics Corporation. The absence of
widespread familiarity and use of hair testing may adversely impact the
Company's revenue growth.
The Company's prices for its tests are generally somewhat higher than
prices for tests using urinalysis, but the Company believes that its superior
detection rates provide more value to the customer. This pricing policy could,
however, adversely impact the growth of the Company's sales volume.
PATENTS
In December 1987, Dr. Werner A. Baumgartner, the Company's founder and
Director of Research and Development, with the assistance of the Company's
patent counsel, filed the first in a series of patent applications in the U.S.
Patent and Trademark Office on his inventions relating to radioimmunoassay using
hair. In 1994, U.S. Patent No. 5,324,642 (the "642 Patent") was issued to the
Company. This patent pertains to the universal drug extraction procedure and
immunoassay technology for the detection of drugs in hair specimens. In 1995,
the Company was granted an additional patent covering Dr. Baumgartner's
inventions pertaining to the immuno chemical screening assay for marijuana,
which is the most difficult drug to detect.
Dr. Baumgartner has continued his research, and the Company has pending two
additional patent applications in the U.S. Patent and Trademark Office with
respect to his inventions relating to procedures using hair. The Company
believes that additional patents will be granted as a result of
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Dr. Baumgartner's pending patent applications although there can be no assurance
that any such additional patents will be granted.
Pursuant to an agreement dated January 1987, Werner A. Baumgartner and
Annette Baumgartner granted to the Company an exclusive royalty-free worldwide
license of all of their rights in and to their inventions relating to
radioimmunoassay using hair.
Most of Dr. Baumgartner's research on the inventions covered by the 642
Patent was conducted while he was employed by the Veteran's Administration
Hospital ("VA"). Dr. Baumgartner has, therefore, also granted to the U.S.
government, for all Governmental purposes, a nonexclusive, irrevocable,
royalty-free license to use the basic invention during the term of the patent
with respect to such invention.
Certain aspects of the Company's hair analysis method are based on trade
secrets owned by the Company. The Company's ability to protect the
confidentiality of these trade secrets is dependent upon the Company's internal
safeguards and upon the laws protecting trade secrets and unfair competition. In
the event that patent protection or protection under the laws of trade secrets
were not sufficient and the Company's competitors succeeded in duplicating the
Company's products, the Company's business could be materially adversely
affected.
TARGET MARKETS
1. Industry
The Company has focused its primary marketing efforts on the private
sector. The Company believes that the market for job applicant and employee
testing will yield the most immediate beneficial impact to the business of the
Company and assist in establishing a regular client base.
The number of businesses using drug testing to screen job applicants and
employees has increased significantly in the last nine years. The 1996 American
Management Association (AMA) survey indicated that 81% of surveyed firms were
engaged in some form of drug testing, a 277% increase since the initial AMA
survey in 1987. The prevalence of drug screening programs reflects a growing
concern that drug use contributes to employee health problems and costs
(increased absenteeism, reduced productivity, etc.) and in certain industries,
safety hazards. It has been estimated that the cost to industry in terms of
health care costs and lost productivity is at least $60 billion annually.
The principal criticism of employee drug screening programs centers on the
effectiveness of the testing program. Most private sector screening programs use
urinalysis. Such programs are susceptible to evasive maneuvers and the inability
to obtain identical repeat samples in the event of a challenged result.
Moreover, many employers, to accommodate concerns of their employees and to
avoid infringement of employee privacy rights, conduct their programs on a
pre-announced schedule, thereby providing an opportunity for many drug users to
abstain in order to escape detection.
The Company presents its patented hair analysis method to potential clients
as a better technology well suited to employer needs. Field studies and actual
client results support the accuracy and effectiveness of the Company's patented
technology and its ability to detect even casual drug use. The historical aspect
of the Company's patented method as well as the Company's ability to provide
correlation of the measured drug with approximate amount of ingestion, furnish
an employer with greater flexibility in assessing the scope of an applicant's or
an employee's drug problem.
The Company performs a confirmation test of all positive results through
GC/MS. The use of GC/MS is an industry accepted practice used to confirm
positive drug test results of an initial screen. In an employment setting, GC/MS
confirmation is typically used prior to the taking of any
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disciplinary action against an employee. The Company offers its clients a
five-drug screen with GC/MS confirmation of cocaine, PCP, marijuana,
methamphetamine, and opiates.
2. Home Use
In 1995, the Company began marketing "PDT-90"(R), its hair testing service
to parents concerned about drug use by their children. It allows parents to
collect a small sample from their child in the privacy of the home and have it
tested for drugs of abuse by the Company. The PDT-90 testing service uses the
same patented method that is used with the Company's workplace testing service.
During the second quarter of 1997, the Company began offering its personal drug
testing service, "PDT-90" through retail drug stores.
3. Medical/Research
The Company has developed a medical market for its proprietary hair testing
method consisting mostly of testing services for use by treatment professionals
for drug recovery programs and prenatal care.
In the drug treatment area, the Company's patented method can be used by
treatment professionals to obtain background information on drug use,
information most critical in structuring an individual's recovery program. Under
traditional drug detection tests, this information is obtained from
self-reporting, an approach generally deemed unreliable for various reasons,
including reluctance to discuss the nature of one's drug habit, memory failure,
and unknown substance purity. As a follow-up to a rehabilitation process, the
Company's patented method provides additional support by generating feedback to
individual physicians, psychiatrists and therapists on the success of their
methods. The utility of the Company's technology in monitoring recovery after
discharge from employee assistance programs has been validated by the Company's
customers. The Company's recently developed methadone test can also assist
treatment professionals in their treatment efforts.
The Company has engaged in, and continues to engage in, studies supporting
the utility of its patented hair analysis method in the evaluation of drug use
during pregnancy and the corresponding treatment of newborns. Studies are under
way at University of Pennsylvania, Hutzel Hospital, University of Washington,
Columbia University, University of Miami, National Public Services Research
Institute, University of California -- Sleep State Organization and
Maternal/Child Substance Abuse Project. The Company expects that these
cost-benefit and application studies will demonstrate the utility of its
proprietary screen in the prenatal market.
SALES AND MARKETING
The Company markets its corporate drug testing services primarily through
its own direct sales force. The Company markets PDT-90, its home testing drug
service, primarily through retail drug stores. For both its business-to-business
and consumer direct services, the Company has undertaken an integrated marketing
campaign to enhance the market presence within each respective segment.
COMPETITION
The Company competes directly with numerous commercial laboratories which
test for drugs through urinalysis testing. Most of these laboratories, such as
Laboratory Corporation of America, SmithKline Beecham Clinical Laboratories and
Quest (formerly Corning Clinical Laboratories, Inc.) have substantially greater
financial resources, market identity, marketing organizations, facilities, and
numbers of personnel than the Company. The Company has been steadily increasing
its base of corporate customers and believes that future success with new
customers is dependent on the Company's ability to communicate the advantages of
implementing a drug program utilizing the Company's patented hair analysis
method.
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The Company's ability to compete is also a function of pricing. The
Company's prices for its tests are generally somewhat higher than prices for
tests using urinalysis. However, the Company believes that its superior
detection rates, coupled with the customer's ability to test less frequently due
to hair testing's wider window of detection (approximately 90 days verses
approximately three days with urinalysis) provide more value to the customer.
This pricing policy could, however, lead to slower sales growth for the Company.
The Company is not aware of any other laboratories with a hair analysis
technology that is comparable in effectiveness to the Company's proprietary
procedures. The Company is aware of two laboratories which operate in certain
limited employment testing markets and which purport to test hair samples using
a method, which the Company presumes, includes the use of a form of immunoassay
procedures. The Company, however, does not believe that effective immunoassay
testing of hair samples is currently feasible on a commercial basis without
using the Company's unique patented method.
GOVERNMENT REGULATION
The Company is licensed as a Clinical Laboratory by the State of California
as well as certain other states. All tests are performed according to the
standards established by the Clinical Laboratories Improvement Act and the
College of American Pathologists. Presently there are no other regulations
required for the operation of a clinical laboratory in the State of California.
A substantial number of states regulate drug testing. The scope and nature
of such regulation varies greatly from state to state. In some states, companies
who operate a clinical laboratory are required to satisfy certain requirements
as a precondition to the laboratory's certification or right to perform drug
testing services with respect to specimens obtained in such state. The laws or
regulations in other states, in some instances, limit testing to certain
matrixes ("matrix" refers to the substance, blood, urine, hair, etc., which is
tested for the presence of drugs) which in a couple of instances do not include
hair. The Company has participated in legislative and regulatory hearings to
educate lawmakers on the advantages of hair testing.
In August 1995, the United States Food and Drug Administration ("FDA")
issued a Warning Letter to the Company pertaining to PDT-90, the drug testing
service which the Company introduced in July 1995 as a testing service for
parents concerned about drug use by their children. The FDA claimed that the
collection envelope the Company distributed as part of the PDT-90 testing
service constituted a "medical device" under the Federal Food Drug and Cosmetic
Act, as amended (the "FDC Act"), and that, because the Company did not seek the
approval or permission of the FDA to market the envelope, it was therefore
adulterated and misbranded under the FDC Act.
In its response, the Company stated its position that the collection
envelope is not a medical device under the FDC Act. However, in order to
expeditiously resolve the matter with the FDA, the Company submitted a 510(k)
premarket notification to the FDA on September 27, 1995 seeking a determination
from the FDA that the collection envelope is substantially equivalent to
collection envelopes which previously received 510(k) premarket clearance and
were currently being commercially marketed. In November 1995, the FDA issued a
"Not Substantially Equivalent" ("NSE") determination in response to the
Company's submission and classified PDT-90 as a Class III device under the FDC
Act.
In December 1995, the Company filed suit against the FDA in the United
States Court of Appeals for the First Circuit seeking to overturn the FDA's NSE
determination. In March 1996, the FDA agreed to withdraw the Warning Letter and
the NSE determination in exchange for the Company's dismissal of its suit
against the FDA. The FDA also confirmed its decision not to actively regulate
PDT-90 and not to pursue enforcement action on any of the grounds contemplated
in the Warning Letter, and to refrain from enforcement action during the period
that any future pre-market notification application by the Company with respect
to PDT-90 is pending.
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On March 5, 1998, the FDA issued a proposed rule applicable to companies
that market "drugs of abuse test sample collection systems". Under the proposed
rule, companies engaged in the business of testing for drugs of abuse using
testing procedures previously recognized by the FDA would be able to market
their test sample collection systems without pre-market approval or clearance by
the FDA so long as the tests are conducted at laboratories that are recognized
or approved by the FDA and certain labeling and product information procedures
are followed. To date, the FDA has recognized testing procedures which involve
the use of urine, sweat and saliva as the test sample in certain applications.
Under the FDA's proposed rule, companies engaged in the business of testing for
drugs of abuse using other samples would effectively be prohibited from
operating without FDA approval or clearance. Such companies would be required to
submit their test to the FDA for recognition that the test is accurate and
reliable for laboratory use. In addition, the laboratory performing the test
would be required to satisfy certain FDA requirements. In the proposed rule, the
FDA states that it intends to implement the proposed new policy through notice
and comment rulemaking. Interested persons may submit written comments regarding
the proposal on or before July 6, 1998. The proposed rule includes a
transitional period of a minimum of two years (i.e. until one year following the
publication of a final rule, or until March 5, 2000, whichever is later) in
order for companies not currently in compliance with the proposed requirements
to obtain the necessary data they need for submission to the FDA. The Company
believes that its proprietary method of detecting drugs of abuse using hair
samples is accurate and reliable and should, therefore, be recognized if
necessary. However, the Company maintains that the FDA lacks statutory authority
to regulate its hair testing service. There is a risk that, if the rule as
proposed becomes final, the Company may be required to apply to the FDA for
recognition of the Company's proprietary hair testing technology, and if such
application were denied (and if such denial were upheld on appeal), the
Company's business would be materially adversely affected.
SCIENTIFIC ADVISORY BOARD
The Company has established a Scientific Advisory Board which consults with
management of the Company to examine and evaluate the progress of the Company's
research and development activities, to promote independent validation studies
of the Company's patented hair analysis method technology, and to assist in
accelerating acceptance of the technology in both the public and private
sectors. Members of the Scientific Advisory Board are compensated at the rate of
$1,000 per day for each meeting attended plus reimbursement for out-of-pocket
expenses. The Chairman of the Scientific Advisory Board is Dr. Robert DuPont.
Dr. DuPont's career has included numerous positions in the psychiatric and
substance abuse field, including Director, Special Action Office for Drug Abuse
Prevention -- The White House; the first Director, National Institute on Drug
Abuse; President, American Council for Drug Education; and President, Phobia
Society of America. Dr. DuPont has received several national awards and
presently serves as President: Institute for behavior and Health, Inc.; Vice
President, Bensinger, DuPont and Associates, a national drug and alcohol abuse
consulting firm; and he maintains a private practice in psychiatry. Dr. DuPont
has also been granted options to acquire shares of the Company's common stock.
Other members of the Scientific Advisory Board are Edward C. Senay, M.D., a
Professor in the Department of Psychiatry at the University of Chicago, and
Arthur McBay, Ph.D., a Forensic Toxicologist and former Professor of Pharmacy at
the University of North Carolina.
RESEARCH AND DEVELOPMENT
The Company is continuously engaged in research and development activities.
During the years ended December 31, 1997, 1996 and 1995, $437,626, $413,693 and
$436,385, respectively, were expended for research and development. The Company
continues to perform research activities to develop new products and services
and to improve existing products and services utilizing the Company's
proprietary technology. Additional research using the Company's proprietary
technology is being conducted by outside research organizations through
government-funded studies.
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The Company's research includes "controlled studies" to determine the
advantages of hair testing in the medical, forensic and criminal justice
markets. The Company has also furnished technical assistance to several
distinguished independent researchers whose studies have been funded through
government grants. Many such studies are currently in progress. The Company
continues to conduct its own research toward the development of new inventions,
services and products derived from the Company's patented technology.
SOURCES AND AVAILABILITY OF RAW MATERIALS
Since its inception, the Company has purchased raw materials for its
laboratory services from outside suppliers. The most critical of these raw
materials are the radio-labeled drugs which the Company purchases from a single
supplier, although other suppliers of radio-labeled drugs exist. If the current
supplier of radio-labeled drugs became unable to supply the Company, or supplies
were available only at prohibitive cost, the Company could produce its own
radio-chemical supplies. The Company estimates that it would have to expend
approximately $400,000 for capital additions to produce its own supply.
Thereafter, direct costs for such raw materials would likely decrease.
PRINCIPAL CUSTOMER
The Company's largest customer, General Motors Corporation, accounted for
approximately 13% of the Company's drug sampling volume and approximately 10% of
the Company's revenue during the year ended December 31, 1997.
EMPLOYEES
As of December 31, 1997, the Company had 125 full-time equivalent
employees, of which four full-time employees were in research and development.
None of the Company's employees is subject to a collective bargaining agreement.
ITEM 2. PROPERTIES.
The Company maintains its corporate office and northeast sales office at
1280 Massachusetts Avenue, Cambridge, Massachusetts; the office is leased
through September 1998.
The Company leases 18,000 square feet of space in Culver City, California,
for sales, customer service and laboratory purposes. This facility is leased
through December 31, 2005 with an option to renew for an additional two years.
ITEM 3. LEGAL PROCEEDINGS.
The Company's recent dispute with the Food and Drug Administration is
described above under Business Government Regulation. The Company is involved in
various other suits and claims in the ordinary course of business. The Company
does not believe that the disposition of any such other suits or claims will
have a material adverse effect on the continuing operations or financial
position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company's common stock is traded on the American Stock Exchange under
the symbol "PMD". As of March 18, 1998, there were 485 recordholders of the
Company's common stock. The following table sets forth for the periods indicated
the range of prices for the Company's common stock as reported by the American
Stock Exchange and dividends declared by the Company.
CALENDAR PERIOD HIGH LOW DIVIDENDS
- --------------- ---- --- ---------
1997
Fourth Quarter.............................................. $6 3/4 $5 $0.02
Third Quarter............................................... $8 11/16 $6 1/8 $0.02
Second Quarter.............................................. $8 1/4 $6 1/2 $0.02
First Quarter............................................... $8 $5 13/16 $0.02
1996
Fourth Quarter.............................................. $6 3/4 $5 3/4 $0.02
Third Quarter............................................... $7 11/16 $6 --
Second Quarter.............................................. $8 $6 1/16 --
First Quarter............................................... $6 1/2 $5 1/8 --
Future cash dividends may be declared at the discretion of the Board of
Directors. On July 3, 1996, the Company distributed a 3% stock dividend to
shareholders of record on June 21, 1996. The share price information set forth
above has not been adjusted to reflect the stock dividend.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from the financial
statements of the Company and should be read in conjunction with, and is
qualified in its entirety by reference to, the financial statements and related
notes thereto included elsewhere in this Report.
AS OF AND FOR THE YEARS ENDED
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DECEMBER 31,
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1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue.............................. $15,398 $12,214 $10,111 $ 8,734 $ 6,576
Gross profit......................... $ 9,341 $ 7,233 $ 5,422 $ 5,037 $ 3,886
Income from operations............... $ 3,056 $ 2,409 $ 1,301 $ 1,742 $ 986
Net income........................... $ 2,501 $ 2,492 $ 1,559 $ 1,831 $ 953
Basic net income per share........... $ .11 $ .12 $ .07 $ .10 $ .06
Diluted net income per share......... $ .11 $ .11 $ .07 $ .09 $ .05
Weighted average common shares
outstanding........................ 21,963 21,146 21,305 18,441 15,035
Weighted average common shares
outstanding, assuming dilution..... 22,541 22,164 23,404 20,023 19,924
Total Assets......................... $18,855 $15,745 $10,217 $10,290 $ 4,385
Working Capital...................... $13,090 $11,403 $ 6,789 $ 7,658 $ 1,935
Shareholders' Equity................. $16,733 $14,296 $ 9484 $ 9,580 $ 3,536
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS
Revenue was $15.4 million in 1997 as compared to $12.2 million in 1996 and
$10.1 million in 1995, representing increases of 26% in 1997 and 21% in 1996.
These increases were due primarily to increases in volume from both new and
existing clients of 31% in 1997 and 24% in 1996 offset by
9
11
average price decreases of 4% in 1997 and 3% in 1996 primarily as the result of
volume discounts granted to large customers. Gross margin was 61% of sales in
1997 compared to 59% in 1996 and 54% in 1995. The increase in 1997 was primarily
the result of increased efficiencies resulting from increased volume.
General and administrative (G&A) expenses represented 15% of revenue in
1997, down from 19% in both 1996 and 1995. G&A expenses decreased by $88,000 to
$2.3 million in 1997, and increased by $415,000 to $2.4 million in 1996. The
decrease in 1997 was primarily due to decreased professional fees. The increase
in 1996 was also due primarily to higher costs incurred by the Company for
payroll, professional fees and regulatory and bad debt expenses.
Marketing and selling expenses for the year ended December 31, 1997
increased to 23% of revenue versus 17% in both 1996 and 1995. Marketing and
selling expenses increased by $1,525,000 to $3.6 million in 1997, and by
$311,000 to $1.2 million in 1996. The increase in 1997 was due primarily to
increased marketing expenses related to advertising and other costs associated
with the introduction of PDT-90, as well as increased sales, field support and
customer service personnel for corporate business. The increase in 1996 was due
primarily to increased marketing expenses and additional sales staff.
Research and development expenses remained virtually unchanged in 1997 from
1996 and 1995 amounts, but continued to decrease as a percentage of revenue from
4% in 1995 to 3% in 1996 and 1997.
Net interest income increased as a result of higher average investment
balances in 1997 as compared to 1996.
Net income was $2.5 million in 1997, essentially flat with 1996 following
an increase of 60% from $1.6 million in 1995. The 1997 results were impacted by
increased revenues and related efficiencies in direct costs derived from
increased revenues, offset by increased marketing and selling costs and an
increased effective tax rate resulting from the reduction in net operating loss
carryforwards available to offset the provision for income taxes.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had $10.0 million of cash, cash
equivalents and short-term investments, compared to $9.8 million at December 31,
1996. The Company's operating activities generated net cash of $2.1 million in
1997, $2.4 million in 1996 and $2.0 million 1995. Investing activities used $2.5
million in 1997, $3.8 million in 1996 and $516,000 in 1995, while financing
activities used $501,000 in 1997, generated $2.7 million in 1996 and used $1.8
million in 1995.
Although net income in 1997 was virtually unchanged from the 1996 amount,
operating cash flows decreased $200,000 in 1997 compared to 1996, due to larger
increases in 1997 in prepaid expenses, laboratory supplies and accounts
receivable, a decrease in accrued expenses and a larger decrease in accounts
payable in 1997 than in 1996, which were offset by the increase of nearly $1.4
million in deferred revenue. The deferred revenue represents deliveries to
retail outlets of the Company's retail testing service PDT-90 which, in each
case, will be recorded as revenue after completion of the underlying test. The
non-cash effect of depreciation and amortization in 1997 and 1996 was $636,000
and $535,000, respectively.
Capital expenditures in 1997 were $1.4 million, an increase of $676,000
from 1996 expenditures of $736,000. The expenditures consisted of new equipment,
including laboratory and computer equipment. The Company currently plans to make
capital expenditures of approximately $1 million in 1998, primarily in
connection with the purchase of laboratory and computer equipment. The Company
believes that within the next year it may be required to expand its existing
laboratory or develop a second laboratory, the cost of which is currently
believed to range from $2 million to $3 million.
10
12
During 1995, the Company repurchased a total of 699,387 shares for treasury
for $2.6 million. In 1997 an additional 117,302 shares were repurchased for
$751,000.
On July 3, 1996, the Company distributed a 3% stock dividend to
shareholders of record on June 21, 1996. The shares issued in the stock dividend
were treasury shares. This transaction resulted in an increase of $4.67 million
in the accumulated deficit (633,000 shares distributed at a fair market value of
$7.37 per share). Treasury stock was reduced by $2.42 million as a result of
this distribution. All share and per share amounts have been retroactively
restated to reflect the stock dividend.
The Company commenced paying cash dividends in 1997 and distributed nearly
$2.2 million during the year. Since December 31, 1997, the Company has
distributed an aggregate of $442,604 of cash dividends to its shareholders. The
Company announced on November 17, 1997 that its Board of Directors has
established a policy of declaring regular quarterly dividends at an initial
annual rate of $0.08 per share (or $0.02 per quarter) commencing in the first
quarter of 1998.
At December 31, 1997, the Company's principal sources of liquidity included
$10.0 million of cash, cash equivalents and short-term investments. Management
currently believes that such funds, together with future operating profits,
should be adequate to fund anticipated working capital requirements and capital
expenditures in the near term. Depending upon the Company's results of
operations, its future capital needs and available marketing opportunities, the
Company may use various financing sources to raise additional funds. Such
sources could include joint ventures, issuance of common stock or debt
financing. At December 31, 1997, the Company had no long-term debt.
IMPACT OF YEAR 2000 ISSUE
The Year 2000 issue results from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
The Company is in the process of conducting an assessment of its computer
information systems and is beginning to take the necessary steps to determine
the nature and extent of the work required to make its systems Year 2000
compliant, where necessary. These steps will require the Company to modify,
upgrade or replace some of its internal financial and operational systems. The
Company continues to evaluate the estimated cost of bringing all internal
systems, equipment and operations into Year 2000 compliance, but has not yet
finished determining the total cost of these compliance efforts. While these
efforts will involve additional costs, the Company believes, based upon
currently available information, that these costs will not have a material
adverse effect on its business, financial condition or results of operations.
However, if these efforts are not completed on time, or if the cost of updating
or replacing the Company's information systems exceeds the Company's current
estimates, the Year 2000 issue could have a material adverse impact on the
Company's business, financial condition or results of operations.
The Company also intends to determine the extent to which the Company may
be vulnerable to any failures by its major suppliers, distributors and service
providers to remedy their own Year 2000 issues, and is in the process of
initiating formal communications with these parties. At this time the Company is
unable to estimate the nature or extent of any potential adverse impact
resulting from the failure of third party suppliers, distributors and service
providers to achieve Year 2000 compliance, although the Company does not
currently anticipate that it will experience any material shipment delays from
its major product suppliers or any material sales delays from its major
distributors due to Year 2000 issues. However, there can be no assurance that
these third parties will not experience Year 2000 problems or that any problems
would not have a material effect on the Company's product supply and
distribution channels. Because the cost and timing of Year 2000
11
13
compliance by third parties such as suppliers, distributors and service
providers is not within the Company's control, no assurance can be given with
respect to the cost or timing of such efforts or any potential adverse effects
on the Company of any failure by these third parties to achieve Year 2000
compliance.
FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company or statements made
by its employees may contain forward-looking information which involves risks
and uncertainties. In particular, statements contained in this report which are
not historical facts (including but not limited to the Company's expectations
regarding revenues, business strategy, anticipated operating results, cash
dividends, and anticipated cash requirements) may be "forward-looking"
statements. The Company's actual results may differ from those stated in any
forward-looking statements. Factors that may cause such difference include, but
are not limited to, risks associated with the continued expansion of the
Company's sales and marketing network, development of markets for new products
and services offered by the Company, the economic health of principal customers
of the Company, financial and operational risks associated with possible
expansion of testing facilities used by the Company, government regulation,
including, but not limited to, FDA regulations, competition and general economic
conditions.
ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA.
The financial statements and financial statement schedule are included in
this report on pages F-1 through F-16.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Following is a list that sets forth as of March 27, 1998 the names, ages
and positions within the Company of all of the Executive Officers of the Company
persons chosen to become executive officers of the Company, and the Directors of
the Company. Each such director has been nominated for reelection at the
Company's 1998 Annual Meeting, to be held on May 4, 1998.
NAME AGE POSITION
- ---- --- --------
Raymond C. Kubacki, Jr.................... 53 Chief Executive Officer, President,
Director
Werner A. Baumgartner, Ph.D............... 62 Chairman of the Board, Director
A. Clinton Allen.......................... 54 Vice Chairman of the Board, Director
Bruce M. Stillwell........................ 36 Vice President, Treasurer, Controller(1)
Peter C. Monson........................... 42 Vice President, Treasurer, Controller(1)
Donald J. Kippenberger, Ph.D.............. 51 Vice President -- Laboratory Operations
Thomas Cairns, Ph.D., D.Sc................ 57 Vice President -- Laboratory Operations
William Thistle, Esq...................... 48 Vice President, General Counsel
Michael J. Lamb........................... 48 Vice President, Sales
Donald F. Flynn........................... 58 Director
John J. Melk.............................. 61 Director
Fred J. Weinert........................... 50 Director
- ---------------
(1) Mr. Monson was elected Vice President, Treasurer and Controller effective
March 30, 1998. Mr. Stillwell resigned from such position as of that date.
12
14
All Directors hold office until the next annual meeting of stockholders or
until their successors are elected. Officers serve at the discretion of the
Board of Directors.
Mr. Kubacki joined the Company in July 1991 as Director and as President
and Chief Executive Officer. During the five years prior to joining the Company,
he served as Vice President -- National Accounts and Director of Sales and
Marketing for Reliance COMM/TEC Corporation, a subsidiary of Reliance Electric
Co.
Dr. Baumgartner, a founder of the Company, has served as Chairman of the
Board and a Director of the Company since its organization in September 1986.
Dr. Baumgartner has served as the Company's Director of Scientific and
Regulatory Affairs since May 1989. Dr. Baumgartner received his Ph.D. in
physical chemistry in 1963 from the University of New South Wales, Sydney,
Australia, and has been engaged in physical and biophysical chemistry research
since 1960, holding research and teaching positions at University of New South
Wales; Long Beach State University; Jet Propulsion Laboratory at California
Institute of Technology; University of California, Los Angeles; and University
of Southern California. Dr. Baumgartner has been the director of the
Radioimmunoassay and In Vitro Laboratory of the Nuclear Medicine Service,
Veterans Administration Hospital, Wadsworth, Los Angeles, California, since
1976, serving in such capacity on a part-time basis since February 1987.
Mr. Allen is Chairman and Chief Executive Officer of A.C. Allen & Company,
Inc., an investment banking consulting firm located in Cambridge, Massachusetts.
Mr. Allen currently serves as a director of Swiss Army Brands, Inc. and is a
member of its Executive Committee. He also serves as a director and Vice
Chairman of The DeWolfe Companies, Inc. Mr. Allen has been a director of the
Company since 1989.
Dr. Kippenberger joined the Company in January 1994 as Vice President of
Laboratory Operations. From 1987 to 1990, he was the Technical Director of the
Wiesbaden Forensic Toxicology Drug Testing Laboratory, one of the U.S. Army's
largest drug testing laboratories. From 1990 to 1993 he served as the Forensic
Toxicology Consultant to the U.S. Army Surgeon General, where he directed
policy, technical operations and inspection oversight of the four U.S. Army
toxicology drug testing laboratories. Dr. Kippenberger is a National Institute
on Drug Abuse (NIDA) inspector, and a College of American Pathologists
inspector.
Dr. Cairns joined the Company in July 1995 as Vice President of Technology
Research & Development. An authority in the field of mass spectrometry, Dr.
Cairns served as a Senior Research Scientist with the Food and Drug
Administration during his 21-year tenure with that agency. He also served on the
FDA Senior Science Counsel from 1991 to 1995 and served as Chairman of the FDA
Science Forum from 1992 to 1995. In addition, Dr. Cairns holds an academic
appointment with the University of Southern California as Adjunct Professor of
Pharmaceutical Science, School of Pharmacy, and was recently appointed Science
Advisor to the FDA. Effective March 31, 1998, for family reasons, Dr. Cairns
relinquished his position as Vice President -- Technology Research & Development
and began serving as Senior Scientist of the Company as of that date.
Mr. Thistle joined the Company in September 1995 as Vice President and
General Counsel. Prior to joining the Company, he served as Associate General
Counsel for MGM Grand in Las Vegas from 1993 to 1995. From 1989 to 1993, Mr.
Thistle was Associate General Counsel for Harrah's Casino Resorts.
Mr. Stillwell joined the Company in September 1995 as Vice President,
Controller. In January 1996, he was elected Treasurer. Prior to joining the
Company, he served in various positions including Controller for Organogenesis
Inc. from 1988 to 1995. From 1983 to 1988, Mr. Stillwell as an auditor for
Arthur Andersen LLP. Effective March 30, 1998 Mr. Stillwell resigned from his
positions as Vice President, Treasurer & Controller.
13
15
Mr. Monson joined the Company effective March 30, 1998 as Vice President,
Treasurer and Controller. From November 1996 until joining the Company, Mr.
Monson was a financial consultant to several different companies, most recently
with GTE Internetworking. From 1994 to 1996, Mr. Monson was Chief Financial
Officer of Bet Systems, Inc. From 1991 to 1994, Mr. Monson was the Corporate
Controller and Treasurer of Gamma International, Ltd., a publicly traded gaming
company.
Mr. Lamb joined the Company in June 1997 as Vice President, Sales. Prior to
joining the Company, he served as Director, Sales and Marketing for Polaroid
Corporation located in Cambridge, Massachusetts, from 1990 to 1996. From 1986 to
1990, Mr. Lamb was Director, National Accounts for Polaroid Corporation, U.S.A.
Mr. Flynn has been the sole stockholder and Chairman of the Board of Flynn
Enterprises, Inc., a financial advisory and venture capital firm, since February
1988. Since February 1997, he has also been the Vice Chairman of Blue Chip
Casino, Inc., an owner and operator of a riverboat gaming vessel in Michigan
City, Indiana. Mr. Flynn also was Chairman of the Board of Discovery Zone, Inc.
from July 1992 until February 1996 and Chief Executive Officer from July 1992
until May 1995, an operator of indoor entertainment and fitness facilities for
children. On March 25, 1996, Discovery Zone, Inc. filed a voluntary petition
under Chapter 11 of the U.S. Bankruptcy Code. Discovery Zone emerged from
bankruptcy with a Plan of Reorganization which was approved by the Bankruptcy
Court in July 1997. From 1972 to 1990, Mr. Flynn served in various positions
with Waste Management, Inc. including Senior Vice President and Chief Financial
Officer. Mr. Flynn currently serves as a Director of Waste Management, Inc. and
its affiliated entities, Waste Management International plc and Wheelabrator
Technologies, Inc. Mr. Flynn also serves as a Director of Extended Stay America,
Inc., an owner and operator of extended-stay lodging facilities. Mr. Flynn has
been a director of the Company since 1989.
Mr. Melk currently serves as Chairman of H(2)0 Plus, L.P., which develops
and manufactures health and beauty products and distributes them through a
company-owned chain of specialty retail stores. He also serves as Chairman of MW
Partners, an investor in commercial and residential real estate developments.
From 1987 to 1989, Mr. Melk was Vice Chairman of the Board of Blockbuster
Entertainment Corporation. From 1971 to 1975, Mr. Melk was Vice President of
Corporate Development for Waste Management, Inc. and from 1975 to 1984 held the
position of President of W.M.I. International, Ltd. based in London, England. He
is a director of Republic Industries, Inc., and Extended Stay America, Inc. Mr.
Melk has been a director of the Company since 1991.
Mr. Weinert serves as President of San Telmo, Inc. (investment group),
Barrington Services Group (commercial real estate developer), Here's Hollywood,
Inc. (a Blockbuster Video franchisee) and Vice President of H(2)0 Plus, S.R.L.
(a distributor of cosmetics, bath products and fragrances in Argentina, Brazil,
Chile and Uruguay). From 1989 to 1995 he was President of H(2)0 Plus L.P., MW
Partners, and Century Entertainment Ltd. Previous to that he was President of
Waste Management International, Inc. from 1983 to 1989. For over 12 years he has
served on the Business Advisory Council for the University of Dayton. Mr.
Weinert has been a director of the Company since 1991.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely on its reviews of copies of reports filed pursuant to Section
16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
or written representations from persons required to file such reports
("Reporting Persons"), the Company believes that, except as follows, all such
filings required to be made by such Reporting Persons were timely made in
accordance with the requirements of the Exchange Act. On July 31, 1997, Dr.
Kippenberger filed a Form 4 relating to the exercise of a stock option and sale
of the underlying shares in June 1997. In September 1997, Mr. Weinert filed a
Form 4 relating to the exercise of a stock option in May 1997.
14
16
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item will be set forth in the Proxy
Statement of the Company relating to the 1998 Annual Meeting of Stockholders to
be held on May 4, 1998 and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item will be set forth in the Proxy
Statement of the Company relating to the 1998 Annual Meeting of Stockholders to
be held on May 4, 1998 and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item will be set forth in the Proxy
Statement of the Company relating to the 1998 Annual Meeting of Stockholders to
be held on May 4, 1998 and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
PAGE
----
(a) (1) Financial Statements:
Report of Independent Public Accountants.................... F-1
Balance Sheets as of December 31, 1997 and 1996............. F-2
Statements of Income for the Years Ended December 31, 1997,
1996 and 1995............................................... F-3
Statements of Shareholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995............................ F-4
Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995......................................... F-5
Notes to Financial Statements............................... F-6
(2) Financial Statement Schedule................................ F-16
(3) Exhibits -- (See the Index to Exhibits included elsewhere in
this report)
(b) Reports on Form 8-K
None
15
17
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.
PSYCHEMEDICS CORPORATION
By /s/ RAYMOND C. KUBACKI, JR.
------------------------------------
Raymond C. Kubacki, Jr.
President and Chief Executive
Officer
Date: March 27, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ RAYMOND C. KUBACKI, JR. March 27, 1998
------------------------------------------------------
Raymond C. Kubacki, Jr.
President and Chief Executive Officer, Director (Principal
Executive Officer)
/s/ BRUCE M. STILLWELL March 27, 1998
------------------------------------------------------
Bruce M. Stillwell
Vice President, Treasurer, & Controller (Principal
Financial and Accounting Officer)
/s/ WERNER A. BAUMGARTNER, PH.D. March 27, 1998
------------------------------------------------------
Werner A. Baumgartner, Ph.D.
Director
/s/ A. CLINTON ALLEN March 27, 1998
------------------------------------------------------
A. Clinton Allen
Director
/s/ DONALD F. FLYNN March 27, 1998
------------------------------------------------------
Donald F. Flynn
Director
/s/ JOHN J. MELK March 27, 1998
------------------------------------------------------
John J. Melk
Director
/s/ FRED J. WEINERT March 27, 1998
------------------------------------------------------
Fred J. Weinert
Director
16
18
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Psychemedics Corporation:
We have audited the accompanying balance sheets of Psychemedics Corporation
(a Delaware corporation) as of December 31, 1997 and 1996, and the related
statements of income, shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Psychemedics Corporation as
of December 31, 1997 and 1996, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 24, 1998
F-1
19
PSYCHEMEDICS CORPORATION
BALANCE SHEETS
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 585,142 $ 1,462,678
Short-term investments.................................... 9,446,418 8,370,727
Accounts receivable, net of allowance for doubtful
accounts of $264,429 and $163,991 in 1997 and 1996,
respectively........................................... 3,784,488 2,657,416
Laboratory supplies....................................... 500,325 230,777
Deferred tax asset........................................ 380,000 --
Prepaid expenses and other current assets................. 515,874 129,828
----------- -----------
Total current assets................................... 15,212,247 12,851,426
----------- -----------
PROPERTY AND EQUIPMENT, AT COST
Computer software......................................... 871,937 602,521
Office furniture and equipment............................ 1,096,724 782,511
Laboratory equipment...................................... 3,720,750 2,954,205
Leasehold improvements.................................... 552,105 504,175
----------- -----------
6,241,516 4,843,412
Less: Accumulated depreciation and amortization........... 3,021,842 2,399,919
----------- -----------
3,219,674 2,443,493
----------- -----------
OTHER ASSETS................................................ 423,318 449,601
----------- -----------
$18,855,239 $15,744,520
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 196,259 $ 395,434
Accrued dividend payable.................................. -- 437,217
Accrued expenses.......................................... 220,820 283,719
Accrued income taxes...................................... 217,243 283,808
Deferred revenue.......................................... 1,488,010 48,525
----------- -----------
Total current liabilities.............................. 2,122,332 1,448,703
----------- -----------
COMMITMENTS (Note 6)
SHAREHOLDERS' EQUITY:
Preferred stock, $.005 par value; authorized 1,000,000
shares; none outstanding............................... -- --
Common stock, $.005 par value; authorized 50,000,000
shares; issued and outstanding 22,382,720 and
21,758,087 shares in 1997 and 1996, respectively....... 111,913 108,790
Paid-in capital........................................... 23,581,549 20,722,137
Accumulated deficit....................................... (5,537,505) (6,281,047)
Less -- Treasury stock, at cost; 183,683 shares in 1997
and 66,381 shares in 1996.............................. (1,005,439) (254,063)
Less -- Receivable from officer........................... (417,611) --
----------- -----------
Total shareholders' equity............................. 16,732,907 14,295,817
----------- -----------
$18,855,239 $15,744,520
=========== ===========
The accompanying notes are an integral part of these financial statements.
F-2
20
PSYCHEMEDICS CORPORATION
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
REVENUE......................................... $15,398,952 $12,214,198 $10,110,934
COST OF REVENUE................................. 6,057,606 4,981,221 4,689,227
----------- ----------- -----------
Gross profit.................................. 9,341,346 7,232,977 5,421,707
----------- ----------- -----------
EXPENSES:
General and administrative.................... 2,273,780 2,362,074 1,946,648
Marketing and selling......................... 3,573,920 2,048,477 1,737,543
Research and development...................... 437,626 413,693 436,385
----------- ----------- -----------
6,285,326 4,824,244 4,120,576
----------- ----------- -----------
Income from operations........................ 3,056,020 2,408,733 1,301,131
INTEREST INCOME, net............................ 517,133 360,248 344,755
----------- ----------- -----------
INCOME BEFORE PROVISION FOR INCOME TAXES........ 3,573,153 2,768,981 1,645,886
PROVISION FOR INCOME TAXES...................... 1,072,000 277,000 87,200
----------- ----------- -----------
NET INCOME...................................... $ 2,501,153 $ 2,491,981 $ 1,558,686
=========== =========== ===========
BASIC NET INCOME PER SHARE...................... $ 0.11 $ 0.12 $ 0.07
=========== =========== ===========
DILUTED NET INCOME PER SHARE.................... $ 0.11 $ 0.11 $ 0.07
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING...... 21,963,116 21,145,699 21,304,967
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING,
ASSUMING DILUTION............................. 22,540,841 22,164,226 23,404,058
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-3
21
PSYCHEMEDICS CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK TREASURY STOCK
--------------------- ----------------------
$0.005 PAID-IN ACCUMULATED RECEIVABLE
SHARES PAR VALUE CAPITAL DEFICIT SHARES COST FROM OFFICER
---------- --------- ----------- ----------- -------- ----------- ------------
BALANCE, December 31, 1994......... 19,510,879 $ 97,554 $14,709,632 $(5,226,977) -- $ -- $ --
Exercise of warrants, net of
related costs.................. 498,951 2,495 504,583 -- -- -- --
Exercise of stock options........ 278,450 1,392 513,818 -- -- -- --
Acquisition of treasury stock.... -- -- -- -- 699,387 (2,676,793) --
Net income....................... -- -- -- 1,558,686 -- -- --
---------- -------- ----------- ----------- -------- ----------- ---------
BALANCE, December 31, 1995......... 20,288,280 101,441 15,728,033 (3,668,291) 699,387 (2,676,793) --
Exercise of warrants, net of
related costs.................. 987,787 4,939 1,970,635 -- -- -- --
Exercise of stock options........ 482,020 2,410 778,683 -- -- -- --
Distribution of 3% stock
dividend....................... -- -- 2,244,786 (4,667,516) (633,006) 2,422,730 --
Cash dividend declared........... -- -- -- (437,221) -- -- --
Net income....................... -- -- -- 2,491,981 -- -- --
---------- -------- ----------- ----------- -------- ----------- ---------
BALANCE, December 31, 1996......... 21,758,087 108,790 20,722,137 (6,281,047) 66,381 (254,063) --
Exercise of stock options,
including tax benefits......... 624,633 3,123 2,859,412 -- -- -- (417,611)
Cash dividends declared.......... -- -- -- (1,757,611) -- -- --
Acquisition of treasury stock.... -- -- -- -- 117,302 (751,376) --
Net income....................... -- -- -- 2,501,153 -- -- --
---------- -------- ----------- ----------- -------- ----------- ---------
BALANCE, December 31, 1997......... 22,382,720 $111,913 $23,581,549 $(5,537,505) 183,683 $(1,005,439) $(417,611)
========== ======== =========== =========== ======== =========== =========
TOTAL
-----------
BALANCE, December 31, 1994......... $ 9,580,209
Exercise of warrants, net of
related costs.................. 507,078
Exercise of stock options........ 515,210
Acquisition of treasury stock.... (2,676,793)
Net income....................... 1,558,686
-----------
BALANCE, December 31, 1995......... 9,484,390
Exercise of warrants, net of
related costs.................. 1,975,574
Exercise of stock options........ 781,093
Distribution of 3% stock
dividend....................... --
Cash dividend declared........... (437,221)
Net income....................... 2,491,981
-----------
BALANCE, December 31, 1996......... 14,295,817
Exercise of stock options,
including tax benefits......... 2,444,924
Cash dividends declared.......... (1,757,611)
Acquisition of treasury stock.... (751,376)
Net income....................... 2,501,153
-----------
BALANCE, December 31, 1997......... $16,732,907
===========
The accompanying notes are an integral part of these financial statements.
F-4
22
PSYCHEMEDICS CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income......................................... $ 2,501,153 $ 2,491,981 $ 1,558,686
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................... 696,514 535,522 599,714
Deferred income taxes........................... (380,000) -- --
Changes in current assets and liabilities:
Accounts receivable........................... (1,127,072) (934,646) (305,069)
Laboratory supplies........................... (269,548) 22,439 (64,513)
Prepaid expenses and other current assets..... (386,046) (57,581) 7,440
Accounts payable.............................. (199,175) (70,978) 162,850
Accrued expenses.............................. (111,424) 89,054 22,971
Accrued income taxes.......................... (18,040) 228,241 (8,717)
Deferred revenue.............................. 1,439,485 48,525 --
----------- ----------- -----------
Net cash provided by operating
activities............................... 2,145,847 2,352,557 1,973,362
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (purchases) sales of short-term investments.... (1,075,691) (3,091,131) 840,857
Purchases of property and equipment................ (1,412,695) (736,432) (1,269,118)
(Increase) decrease in other assets................ (33,717) 3,689 (88,071)
----------- ----------- -----------
Net cash used in investing activities...... (2,522,103) (3,823,874) (516,332)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on obligations under capital leases....... -- (16,459) (153,514)
Proceeds from the exercise of stock options,
including tax benefits.......................... 2,444,924 2,756,667 1,022,288
Dividends paid..................................... (2,194,828) -- --
Acquisition of treasury stock...................... (751,376) -- (2,676,793)
----------- ----------- -----------
Net cash (used in) provided by financing
activities............................... (501,280) 2,740,208 (1,808,019)
----------- ----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS........................................ (877,536) 1,268,891 (350,989)
CASH AND CASH EQUIVALENTS, beginning of year......... 1,462,678 193,787 544,776
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, end of year............... $ 585,142 $ 1,462,678 $ 193,787
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest............................. $ -- $ 578 $ 9,178
Cash paid for income taxes......................... $ 156,000 $ 119,000 $ 67,490
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING
ACTIVITY:
Issuance of common stock for receivable from
officer......................................... $ 417,611 $ -- $ --
The accompanying notes are an integral part of these financial statements.
F-5
23
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Psychemedics Corporation (the Company) was incorporated in 1986. The
Company utilizes a patented hair analysis method involving radioimmunoassay
technology to analyze human hair to detect abused substances. The founder of the
Company has granted to the Company an exclusive license to all his rights in
this hair analysis technology, including his rights to the drug extraction
method (see Note 2).
Cash Equivalents in Short-Term Investments
The Company considers all highly liquid investments with original
maturities of 90 days or less to be cash equivalents. Cash equivalents consist
of money market accounts. Short-term investments have maturities of between
three months and one year and consist principally of securities issued by the
U.S. Government at December 31, 1997 and 1996.
The Company accounts for investment securities under Statement of Financial
Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt
and Equity Securities. Under SFAS No. 115, investments that the Company has the
positive intent and ability to hold to maturity are classified as
held-to-maturity and are reported as amortized cost, which approximates fair
market value. All short-term investments were classified as held-to-maturity at
December 31, 1997 and 1996.
Property and Equipment
Property and equipment is stated at cost. Depreciation and amortization are
provided over the estimated useful lives of the assets, using the straight-line
method. The estimated useful lives of the assets are as follows:
Computer software 5 years
Office furniture and equipment 5 to 7 years
Laboratory equipment 5 to 7 years
Leasehold improvements Lesser of 5 years or life of lease
Other Assets
Other assets consist primarily of capitalized legal costs relating to
patent applications on the Company's drug extraction method. The Company is
amortizing the cost of these patents over 10 years from the date of grant. The
Company recorded amortization of $60,000 in both 1997 and 1996. The Company
evaluates the realizability of its patents based on estimated cash flows to be
generated from such assets as compared to the original estimates used in
measuring the assets. To the extent impairment is identified, the Company will
recognize a write-down of the related assets. To date, no impairment has been
identified.
Dividends
On July 3, 1996, the Company distributed a 3% stock dividend to
shareholders of record on June 21, 1996. All share amounts have been
retroactively restated to reflect the 3% stock dividend. In 1996, the Company
declared a cash dividend of $0.02 per share for a total amount of $437,221,
which was paid in 1997. In 1997, the Company declared cash dividends of $0.08
per share for a total amount of $1,757,611, all of which was paid in 1997.
F-6
24
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
Revenue Recognition
Revenues for all product offerings are recognized upon reporting drug test
results to the customer. During 1997, the Company began offering its personal
drug testing service, "PDT-90," through retail drug stores. At December 31, 1997
and 1996, the Company had approximately $1,448,000 and $49,000, respectively, of
deferred revenue related to the PDT-90 service, principally due to receiving
payments prior to the performance of the related test.
Income Taxes
The Company accounts for income taxes in accordance with the provisions of
SFAS No. 109, Accounting for Income Taxes. This statement requires that the
Company recognize a current tax asset or liability for current taxes payable or
refundable, and a deferred tax asset or liability is recorded for the estimated
future tax effects of temporary differences between the financial statement and
tax reporting of assets and liabilities. Deferred tax expense (benefit) results
from the net change in deferred tax assets and liabilities during the year. A
deferred tax valuation allowance is required if it is more likely than not that
all or a portion of recorded deferred tax assets will not be realized.
Research and Development Expenses
The Company charges all research and development expenses to operations as
incurred.
Concentration of Credit Risk
SFAS No. 105, Disclosure of Information About Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance-sheet and credit risk
concentrations. Financial instruments that potentially subject the Company to
concentrations of credit risk are principally cash equivalents, short-term
investments and accounts receivable. The Company places its investments in
highly rated institutions.
Concentration of credit risk with respect to accounts receivable is limited
to certain customers to whom the Company makes substantial sales. To reduce
risk, the Company routinely assesses the financial strength of its customers
and, as a consequence, believes that its accounts receivable credit risk
exposure is limited. The Company maintains an allowance for potential credit
losses but historically has not experienced any significant losses related to
individual customers or groups of customers in any particular industry or
geographic area.
Significant Customers
The Company had one customer account for 10%, 15% and 18% of total revenues
in 1997, 1996 and 1995, respectively. As of December 31, 1997 and 1996, one
customer accounted for 16% and 17% of total accounts receivable, respectively.
Reclassifications
Certain amounts in the prior year's financial statements have been
reclassified to conform to current year's presentation.
Basic and Diluted Net Income Per Share
In March 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 128, Earnings Per Share. This statement established standards for computing
and presenting earnings
F-7
25
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
per share. Net income per share for each period presented has been retroactively
restated to conform with SFAS No. 128.
Basic net income per share was computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per share was computed by dividing net income by the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. Dilutive common equivalent shares outstanding during the period have
been determined in accordance with the treasury-stock method. Common equivalent
shares consist of common stock issuable upon the exercise of outstanding
options.
Basic and diluted weighted average common shares outstanding are as
follows:
1997 1996 1995
---------- ---------- ----------
Weighted average common shares
outstanding.............................. 21,963,116 21,145,699 21,304,967
Effect of dilutive common stock options.... 577,725 1,018,527 2,099,091
---------- ---------- ----------
Weighted average common shares outstanding,
assuming dilution........................ 22,540,841 22,164,226 23,404,058
========== ========== ==========
As of December 31, 1997, 1996 and 1995, options to purchase 113,000, 50,000
and 160,000 common shares, respectively, were outstanding but not included in
the diluted weighted average common share calculation as the effect would have
been antidilutive.
Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosure about the fair value of financial instruments. Financial
instruments consist principally of cash equivalents, short-term investments,
accounts receivable and accounts payable. The estimated fair value of these
financial instruments approximates their carrying value and, except for accounts
receivable, is based primarily on market quotes. The Company's cash equivalents
and short-term investments are generally money market accounts and obligations
of the federal government.
New Accounting Standards
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 requires disclosure of all components of comprehensive income on an
annual and interim basis. Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from nonowner sources. SFAS No. 130 is effective for
fiscal years beginning after December 15, 1997.
In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. SFAS No. 131 requires certain financial
and supplementary information to be disclosed on an annual and interim basis for
each reportable segment of an enterprise. SFAS No. 131 is effective for fiscal
years beginning after December 15, 1997. Unless impracticable, companies would
be required to restate prior information upon adoption.
Management Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-8
26
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
2. RECEIVABLE FROM OFFICER
The amount receivable from officer represents advances for the purchase of
common stock. The notes bear interest at 5.9% and are full recourse. The notes,
together with accrued interest, are payable $211,000 on November 12, 1998 and
$206,000 on January 6, 1999.
3. ROYALTY AGREEMENTS
The Company has a royalty-free license from the founder for the proprietary
rights to the patented hair analysis technology used by the Company in its drug
testing services. The Company has two agreements to sublicense its technology,
which have not generated significant royalties to date.
4. INCOME TAXES
The income tax provision for the years ended December 31, 1997, 1996 and
1995 consists of the following:
1997 1996 1995
---------- ---------- ---------
Current --
Federal................................... $1,197,400 $ 941,400 $ 559,600
State..................................... 254,600 174,400 103,700
---------- ---------- ---------
1,452,000 1,115,800 663,300
---------- ---------- ---------
Deferred --
Federal................................... (290,300) (802,500) (526,700)
State..................................... (89,700) (36,300) (49,400)
---------- ---------- ---------
(380,000) (838,800) (576,100)
---------- ---------- ---------
$1,072,000 $ 277,000 $ 87,200
========== ========== =========
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate as follows:
1997 1996 1995
----- ----- -----
Federal statutory rate..................................... 34.0% 34.0% 34.0%
Increase (decrease) resulting from --
State tax provision, net of federal benefit.............. 6.3 6.3 6.3
Utilization of net operating loss carryforwards previously
not benefitted........................................... (10.6) (30.8) (35.8)
Non-deductible expenses.................................... 3.6 0.5 0.8
Other, net................................................. (3.3) -- --
----- ----- -----
Effective tax rate......................................... 30.0% 10.0% 5.3%
===== ===== =====
F-9
27
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
The components of the net deferred tax asset included in the accompanying
balance sheets are approximately as follows:
1997 1996
--------- -----------
Deferred revenue......................................... $ 488,000 $ --
Non-deductible reserves and accruals..................... 154,000 18,000
Net operating loss carryforwards......................... 284,000 1,272,000
Property basis differences............................... (262,000) (177,000)
--------- -----------
Subtotal............................................ 664,000 $ 1,113,000
Valuation allowance...................................... (284,000) (1,113,000)
--------- -----------
Net asset........................................... $ 380,000 --
========= ===========
A valuation allowance was provided in 1997 on the net operating loss
carryforwards (NOL's) which were generated from the exercise of stock options.
These NOL's will result in an increase to paid-in capital when realized. The
reduction in the valuation allowance from 1996 is due in part to the realization
of the benefits of the NOL's from stock options. Additionally the Company
reduced the valuation allowance for $829,000 of NOL's generated from operations
as the NOL's were realized.
As of December 31, 1997, the Company had total NOL's of approximately
$700,000 available to offset future federal taxable income. The NOL's, which
expire through 2007, are subject to review and possible adjustment by the
Internal Revenue Service. In addition, existing tax regulations contain
provisions that may limit the net operating loss carryforwards that the Company
may utilize in any given year in the event of certain significant changes in
ownership.
5. STOCK OPTIONS AND WARRANTS
Employee Stock Option Plan
Under the Company's 1989 Employee Stock Option Plan, as amended (the Plan),
3,399,000 shares of the Company's common stock have been reserved for issuance
to key employees and officers of the Company. The Plan is administered by a
committee of outside directors. Under the terms of the Plan, the Company may
grant employees either incentive stock options or non qualified stock options to
purchase shares of the Company's common stock at exercise prices not less than
the fair market value at the date of grant, as defined in the Plan. Options are
exercisable on terms to be established by the committee at its discretion.
Options are generally exercisable over the four-year period following the date
of grant and expire no later than ten years from the date of grant.
Nonqualified Stock Options to Outside Directors
Under the Company's 1989 Non-Qualified Stock Option Plan, as amended,
309,000 shares of the Company's common stock have been reserved for issuance to
outside (non-employee) directors. Options to purchase 25,750 shares of common
stock of the Company are automatically granted under this plan to each outside
director of the Company upon appointment to the Board of Directors ("initial
options"). Initial options are exercisable over the two-year period following
the date of grant and expire ten years from the date of grant. In addition, as
of March 15 of each year, options to acquire 20,600 shares are automatically
granted to each person then serving as an outside director ("annual options").
Annual options become exercisable in full one year following the date of
grant and expire no later than ten years from date of grant. Initial options and
annual options have exercise prices equal to the fair market value on the date
of grant.
F-10
28
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
Under the Company's 1991 Non-Qualified Stock Option Plan, as amended,
309,000 shares of the Company's common stock have been reserved for issuance to
key employees and consultants. The plan is administered by a committee of the
Board of Directors. Under the terms of the plan, the Company may grant
non-qualified stock options at option prices and terms to be determined by the
committee at its discretion and expire no later than ten years from the date of
grant.
Warrants
In connection with private placements of capital stock in 1990 and 1991,
the Company issued warrants that entitled the holders to purchase an aggregate
of 1,633,530 shares of the Company's common stock at exercise prices that ranged
from $0.94 to $1.94 per share. All of the warrants were exercised or had expired
by December 31, 1996.
A summary of all stock option and warrant transactions for the years ended
December 31, 1997, 1996 and 1995 is as follows (in thousands, except per share
amounts):
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
--------- --------------
Outstanding, December 31, 1994............................. 3,531 $2.02
Granted.................................................. 535 3.93
Exercised................................................ (800) 1.32
Terminated............................................... (7) 2.41
------ -----
Outstanding, December 31, 1995............................. 3,259 2.50
Granted.................................................. 265 5.70
Exercised................................................ (1,509) 1.88
Terminated............................................... (108) 2.06
------ -----
Outstanding, December 31, 1996............................. 1,907 2.98
Granted.................................................. 173 6.89
Exercised................................................ (625) 2.48
Terminated............................................... (31) 4.16
------ -----
Outstanding, December 31, 1997............................. 1,424 $4.02
====== =====
Exercisable, December 31, 1995............................. 2,520 $2.11
====== =====
Exercisable, December 31, 1996............................. 1,188 $2.45
====== =====
Exercisable, December 31, 1997............................. 758 $3.04
====== =====
The following table summarizes information about stock options outstanding
at December 31, 1997 (in thousands, except per share amounts):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- -------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
EXERCISE NUMBER REMAINING AVERAGE NUMBER AVERAGE
PRICE OF CONTRACTUAL EXERCISE OF EXERCISE
RANGE OPTIONS LIFE PRICE OPTIONS PRICE
-------- ------- ----------- -------- ------- --------
$1.81 - $2.31 410,083 1.05 $2.03 389,113 $2.04
2.82 - 3.69 452,479 7.18 3.08 246,867 3.11
5.03 - 7.38 511,246 8.48 6.10 121,750 6.07
7.63 50,000 9.42 7.63 -- --
F-11
29
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
Accounting for Stock-Based Compensation
SFAS No. 123, Accounting for Stock-Based Compensation, establishes a
fair-value-based method of accounting for stock-based compensation plans. The
Company has adopted the disclosure-only alternative under SFAS No. 123, which
requires the disclosure of the pro forma effects on earnings and earnings per
share as if the fair value method as calculated under SFAS No. 123 had been used
to recorded stock options, as well as certain other information.
The assumptions used and the weighted average information for the years
ended December 31, 1997, 1996 and 1995 are as follows:
1997 1996 1995
---------- ------------- -------------
Risk-free interest rates...................... 6.32% 5.36% - 6.07% 5.51% - 6.86%
Expected dividend yield....................... 1% 1% 1%
Expected lives................................ 5 years 5 years 5 years
Expected volatility........................... 69.70% 84.01% 32.91%
Weighted average grant-date fair value of
options granted during the period........... $4.44 $2.14 $1.46
Weighted-average remaining contractual life of
options outstanding......................... 7.63 years 7.23 years 7.04 years
Had compensation cost for the Company's stock option plans been determined
consistent with SFAS No. 123, net income could have been approximately as
follows:
1997 1996 1995
---------- ---------- ----------
As reported --
Net income....................................... $2,501,153 $2,491,981 $1,558,686
Basic net income per share....................... $ 0.11 $ 0.12 $ 0.07
Diluted net income per share..................... $ 0.11 $ 0.11 $ 0.07
Pro forma --
Net income....................................... $1,892,035 $2,281,761 $1,459,216
Basic net income per share....................... $ 0.09 $ 0.11 $ 0.07
Diluted net income per share..................... $ 0.08 $ 0.10 $ 0.06
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
6. COMMITMENTS
Lease Agreements
The Company leases certain of its facilities and equipment under operating
lease arrangements expiring on various dates through December 2005. Total
minimum lease payments, including scheduled increases, are charged to operations
on a straight-line basis over the life of the lease. Rent expense for the years
ended December 31, 1997, 1996 and 1995 was approximately $475,000, $450,000 and
$445,000, respectively.
F-12
30
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
At December 31, 1997, minimum commitments remaining under lease agreements
were as follows:
AMOUNT
----------
Years ending December 31:
1998.......................................... $ 346,000
1999.......................................... $ 239,000
2000.......................................... $ 216,000
2001.......................................... $ 216,000
2002.......................................... $ 243,000
Thereafter.................................... $ 729,000
----------
$1,989,000
==========
7. EMPLOYEE BENEFIT PLAN
On November 1, 1997, the Company adopted the Psychemedics Corporation
401(k) Savings and Retirement Plan (the 401(k) Plan). The 401(k) Plan is a
qualified defined contribution plan in accordance with Section 401(k) of the
Internal Revenue Code. All employees over the age of 21 who have completed one
year of service are eligible to make pre-tax contributions up to a specified
percentage of their compensation. Under the 401(k) Plan, the Company may, but is
not obligated to, match a portion of the employees' contribution up to a defined
maximum. No matching contribution was made in 1997.
8. ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
--------------------
1997 1996
-------- --------
Accrued payroll and employee benefits....................... $187,085 $147,615
Accrued other............................................... 33,735 136,104
-------- --------
$220,820 $283,719
======== ========
F-13
31
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS --(CONTINUED)
9. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following are selected quarterly financial data for the years ended
December 31, 1997 and 1996:
QUARTER ENDED
-----------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1997 1997 1997 1997
----------- ----------- ------------- ------------
Revenues......................... $ 3,253,743 $ 4,402,203 $ 3,673,859 $ 4,069,147
Gross profit..................... 1,931,871 2,795,588 2,076,892 2,536,997
Income from operations........... 632,867 998,362 439,192 985,599
Net income....................... 637,107 745,520 374,436 744,090
Basic net income per share....... 0.03 0.03 0.02 0.03
Diluted net income per share..... $ 0.03 $ 0.03 $ 0.02 $ 0.03
Weighted average common shares
outstanding.................... 21,832,664 21,832,664 21,935,913 22,143,821
Weighted average common shares
outstanding, assuming
dilution....................... 22,755,427 22,797,637 22,826,007 22,447,186
QUARTER ENDED
-----------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1996 1996 1996 1996
----------- ----------- ------------- ------------
Revenues......................... $ 2,674,665 $ 3,141,313 $ 3,146,808 $ 3,251,412
Gross profit..................... 1,490,657 1,918,478 1,866,879 1,956,963
Income from operations........... 388,387 720,117 737,864 562,365
Net income....................... 449,284 716,465 731,999 594,233
Basic net income per share....... 0.02 0.03 0.03 0.03
Diluted net income per share..... $ 0.02 $ 0.03 $ 0.03 $ 0.03
Weighted average common shares
outstanding.................... 21,054,734 21,370,391 21,615,468 21,612,106
Weighted average common shares
outstanding, assuming
dilution....................... 22,234,593 22,514,614 22,720,866 22,533,713
10. SUBSEQUENT EVENT
On February 2, 1998, the Company declared a cash dividend of $0.02 per
share payable on March 10, 1998 to shareholders of record at the close of
business on February 20, 1998.
F-14
32
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To Psychemedics Corporation
We have audited in accordance with generally accepted auditing standards,
the financial statements of Psychemedics Corporation included in this Form 10-K,
and have issued our report thereon dated February 24, 1998. Our audit was made
for the purpose of forming an opinion on the basic financial statements taken as
a whole. The schedule listed in Item 14(a)(2) is the responsibility of the
Company's management and 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
Boston, Massachusetts
February 24, 1998
F-15
33
SCHEDULE II
PSYCHEMEDICS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
----------------------------------------------------
BALANCE, CHARGED BALANCE,
BEGINNING TO COST OR DEDUCTIONS END OF
ALLOWANCE FOR DOUBTFUL ACCOUNTS OF PERIOD EXPENSE (WRITE-OFFS) PERIOD
------------------------------- ---------- ---------- ------------ --------
Year Ended
December 31, 1995............................. 10,000 21,175 -- 31,175
December 31, 1996............................. 31,175 180,000 (47,184) 163,991
December 31, 1997............................. 163,991 162,000 (61,562) 264,429
F-16
34
PSYCHEMEDICS CORPORATION
10-K
INDEX TO EXHIBITS
EXHIBIT PAGE OR
NUMBER DESCRIPTION REFERENCE
- ------- ----------- ---------
3 Articles of Incorporation and By-Laws
3.1 Certificate of Incorporation filed September 24,
1986 -- (Incorporated by reference from the Registrant's
Registration Statement on Form S-18, File No. 33-10186 LA).
3.2 Amendment to Certificate of Incorporation filed October 29,
1986 -- (Incorporated by reference from the Registrant's
Registration Statement on Form S-18, File No. 33-10186 LA).
3.3 Amendment to Certificate of Incorporation filed July 12,
1989 -- (Incorporated by reference from the Registrant's
Annual Report on Form 10-K for the fiscal year ended June
30, 1989.)
3.4 Amendment to Certificate of Incorporation filed August 7,
1990 -- (Incorporated by reference from the Registrant's
Quarterly Report on Form 10-Q for the Quarter ended
September 30, 1990 as amended by a First Amendment on Form 8
filed December 15, 1990.)
3.5 Amendment to Certificate of Incorporation filed May 9,
1991 -- (Incorporated by reference from the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1991.)
3.6 By-Laws of the Company -- (Incorporated by reference from
the Registrant's Registration Statement on Form S-18, File
No. 33-10186 LA).
4 Instruments Defining the Rights of Security Holders
4.1 Specimen Stock Certificate -- (Incorporated by reference
from the Registrant's Registration Statement on Form S-18,
File No. 33-10186 LA).
10 Material Contracts
10.1 License Agreement with Werner Baumgartner, Ph.D. and Annette
Baumgartner dated January 17, 1987 -- (Incorporated by
reference from the Registrant's Registration Statement on
Form S-18, File No. 33-10186 LA).
10.2* Employment Agreement with Werner A. Baumgartner, Ph.D. dated
May 15, 1994 (Incorporated by reference from the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995.)
10.3* 1989 Employee Stock Option Plan, as amended -- (Incorporated
by reference from the Registrant's 1997 Annual Proxy
Statement.)
10.4* 1989 Non-Qualified Stock Option Plan, as amended
(Incorporated by reference from the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1996.
10.5* 1991 Non-Qualified Stock Option Plan -- (Incorporated by
reference from the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1991.)
35
EXHIBIT PAGE OR
NUMBER DESCRIPTION REFERENCE
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10.6* Employment Agreement with Raymond C. Kubacki, Jr. effective
July 16, 1991 (Incorporated by reference from the
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1991.)
10.7 Lease dated October 6, 1992 with Mitchell H. Hersch, et. al
with respect to premises in Culver City,
California -- (Incorporated by reference from the
Registrant's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1992.)
10.7.1 Security Agreement dated October 6, 1992 with Mitchell H.
Hersch et. al -- (Incorporated by reference from the
Registrant's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1992.)
10.7.2 First Amendment to Lease dated with Mitchell H. Hersch, et.
al. Filed herewith
10.7.3 Second Amendment to Lease dated with Mitchell H. Hersch, et.
al. Filed herewith
10.7.4 Third Amendment to Lease dated December 31, 1997 with
Mitchell H. Hersch, et. al. Filed herewith
10.8* Employment Agreement with Donald J. Kippenberger, Ph.D.
dated January 1, 1994 -- (Incorporated by reference from the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995.)
10.9* Employment Agreement with Thomas Cairns Ph.D., D.Sc. dated
July 1, 1995 -- (Incorporated by reference from the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995.)
23 Consents of Experts and Counsel
23.1 Consent of Arthur Andersen LLP Filed herewith
27 Financial Data Schedule Filed herewith
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* Represents a management contract or compensatory plan in which a director or
named executive office of the Registrant participates.