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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 0-19371
PHARMCHEM, Inc.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0187280
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
1505-A O'BRIEN DRIVE
MENLO PARK, CALIFORNIA 94025
(Address of principal executive (Zip Code)
offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (800) 446-5177
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Name of each exchange
Title of each class on which registered
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COMMON STOCK NASDAQ NATIONAL MARKET
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant (based on the closing price of $3.00 as reported on the
Nasdaq/NMS on January 31, 2001) was approximately $6,660,000. Shares of voting
stock held by each executive officer and director and by each holder of 5% or
more of the outstanding voting stock have been treated as shares held by
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. The number of outstanding shares of
the Registrant's Common Stock as of January 31, 2001 was 5,847,310.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the PharmChem, Inc. Proxy Statement for the 2001 Annual
Meeting of Stockholders to be filed with the Commission on or before April 16,
2001 are incorporated by reference into Part III of this Annual Report on Form
10-K. With the exception of those portions which are specifically incorporated
by reference in this Annual Report on Form 10-K, such Proxy Statement shall not
be deemed filed as part of this Report.
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PHARMCHEM, INC.
ANNUAL REPORT ON FORM 10-K
INDEX
PAGE
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PART I
Item 1. Business.......................................................................... 3
Item 2. Properties........................................................................ 10
Item 3. Legal Proceedings................................................................. 10
Item 4. Submission of Matters to a Vote of Security Holders............................... 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............. 12
Item 6. Selected Consolidated Financial Data.............................................. 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations ....................................................................... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ....................... 21
Item 8. Financial Statements and Supplementary Data....................................... 21
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure ....................................................................... 43
PART III
Item 10. Directors and Executive Officers of the Registrant................................ 43
Item 11. Executive Compensation............................................................ 43
Item 12. Security Ownership of Certain Beneficial Owners and Management.................... 43
Item 13. Certain Relationships and Related Transactions.................................... 43
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K.................... 43
Signatures................................................................................... 48
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PART I
ITEM 1. BUSINESS
GENERAL OVERVIEW
PharmChem, Inc. is a leading independent laboratory that provides
integrated drug testing services. Our customers include private and public
employers, criminal justice agencies and drug treatment programs primarily in
the United States and Europe who seek to detect and deter the use of illegal
drugs and alcohol. We are certified by a number of states agencies, as well as
by the following organizations to conduct drug testing using forensic
procedures:
- Substance Abuse and Mental Health Service Administration
(SAMHSA) of the US Department of Health and Human Services
- College of American Pathologists (CAP)
Our domestic laboratories are certified under the Clinical Laboratory
Improvement Amendments (CLIA) or have "deemed status" under CLIA as a result of
state certification. Our forensic procedures provide accurate and reliable test
results and a chain of custody for each specimen from its collection to the
reporting of its test result.
We test for a number of drugs of abuse, including:
- cocaine
- methamphetamine
- heroin
- phencyclidine (PCP)
- marijuana (THC)
- alcohol
We test primarily by urinalysis but also with the PharmChek(R) Drugs of
Abuse Patch (for testing with sweat) and the PharmScreen(R) on-site screening
devices. Under our Premium Comprehensive Management Program(R), we offer a
comprehensive set of services customized to assist customers in implementing
cost-effective drug testing programs.
CORPORATE BACKGROUND
In March 2000, PharmChem, Inc. was formed as a Delaware corporation and
in May 2000, PharmChem Laboratories, Inc., a California corporation was merged
into PharmChem, Inc. PharmChem Laboratories, Inc. was incorporated in 1987 to
acquire PharmChem Laboratories Operations, Inc., a California corporation
founded in 1971. In 1991, we completed our initial public offering. In 1992, we
expanded our operations through the acquisition of London-based Medscreen
Limited (Medscreen), a certified laboratory providing international drug testing
services In 1992 we also acquired a certified laboratory in Fort Worth, Texas.
Our telephone number is (800) 446-5177. When we refer to "we", "our" or
"PharmChem" in this Form 10-K, we mean the current Delaware corporation
(PharmChem, Inc.) as well as Medscreen.
INDUSTRY BACKGROUND
National clinical laboratory chains, independent national drug testing
laboratories, like ourselves, and numerous regional and local laboratories have
historically served the drug testing market. Thousands of general clinical
laboratories nationwide can conduct forensic and non-forensic drug testing, and
are increasingly bidding on local contracts. Over the past several years,
through consolidations, restructurings and bankruptcies, there has been a
decline in the number of independent laboratories whose sole business is
conducting forensic drug testing. Many corporate and governmental organizations
require drug testing laboratories to be certified to conduct forensic drug tests
and to offer integrated cost-effective testing services. Many large
organizations, particularly those in the public sector, use a competitive
bidding procedure to select their drug testing laboratories. These organizations
often limit the
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bidding to certified drug testing laboratories that can demonstrate the ability
to meet their specified service and volume levels.
FORENSIC DRUG TESTING
The essential elements of forensic drug testing are:
- a secure chain of custody for each specimen from its collection
to the reporting of its test result;
- accurate and reliable testing in which a second independent test
is performed to confirm each positive test result.
We carefully control each step of the testing process with detailed
written procedures and by using the specific forensic testing methods required
for legal defensibility of results. We perform most of our testing at our
laboratory in Menlo Park, California, which operates six days per week, 24 hours
a day. We also provide complete testing services at our Texas Division in Fort
Worth and at Medscreen.
URINALYSIS
The steps in PharmChem's forensic drug testing process by urinalysis,
our primary drug testing method, are as follows:
Specimen Collection and Transportation
- Forensic drug testing begins with specimen collection conducted
under carefully controlled conditions. Once a donor has provided
a specimen, we assign a unique specimen identification number.
- We then record information pertinent to the specimen on a chain
of custody form numbered to match the specimen bottle.
- Specimens, together with chain of custody forms, are delivered
to PharmChem by courier or mail.
Receiving and Accessioning
- We receive specimens in our restricted accessioning rooms, where
we inspect them for tampering and check for proper chain of
custody documentation.
- We identify and track the specimens using unique bar-coded
laboratory accessioning numbers.
Screening Analyses
- We screen each specimen submitted for the presence of the drugs
specified by the customer.
- We perform approximately 1,600,000 screening tests on more than
225,000 specimens per month to determine the presence of drugs.
- The screening methods we use include:
* enzyme immunoassay
* enzyme assay
* thin layer chromatography
Results/Confirmation Testing
- We report negative screening results to the customer.
- If the specimen tests positive, we confirm the results by
testing a separate aliquot using a different and independent
technology from that used for the initial screening.
- Confirmation technologies we use include:
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- gas chromatography/mass spectrometry (GC/MS)
- gas chromatography
GC/MS confirmation is required for federally-regulated drug testing and
most other workplace drug testing. Its use has been cited with approval in
numerous legal proceedings.
Quality Control
We carefully monitor the accuracy and reliability of our test results by
internal and external quality assurance and quality control programs. Our staff
evaluates laboratory performance with open and blind quality control samples. We
are subject to frequent proficiency testing by various certifying bodies, which
send their own open and blind samples to the laboratory. We are also subject to
frequent inspections by certifying agencies. We put each test result through
several independent levels of review before a certified scientist reports the
results to our customer.
Reporting of Results
We transmit most of our test results electronically. We use various
secure communication networks and automated voice reporting systems. Our
information systems make each test result available to the customer's computer
or secure facsimile machine, via the internet, by telephonic inquiry or by mail
delivery. We routinely report results for specimens that screen negative within
24 hours of receipt in the laboratory and within 48 hours for specimens that
require confirmation.
PHARMSCREEN(R) ON-SITE SCREENING DEVICE
In recent years there has been a growing trend toward the use of on-site
screening for drugs of abuse by a number of agencies, including some of our
customers. On-site screening relies upon portable diagnostic devices that the
customer may use at the point of specimen collection to readily identify drugs
of abuse in urine specimens. This technology is advantageous because it provides
virtually immediate test results.
We offer a line of on-site screening devices to supplement our
laboratory-based testing services. PharmScreen(R) is a portable, hand-held
device used for on-site screening of drugs of abuse and is available in single,
dual, four and five test configurations. PharmScreen(R) is currently being used
by certain government agencies, including the Administrative Office of the
United States Courts (Federal Probation), and by certain private employers,
including Sears Roebuck & Co. PharmScreen(R) provides only a preliminary
analytical result, and a more specific alternative chemical method, such as
GC/MS, is necessary to obtain a confirmed analytical result.
Although our sales of PharmScreen(R) have steadily increased, there can
be no assurance that it will be commercially accepted by existing or new
customers or generate significant revenues in the future.
PHARMCHEK(R) DRUGS OF ABUSE PATCH
PharmChek(R) is a system that uses sweat to detect the presence of
illegal drugs and has been under development by us since 1992. It consists of a
transparent polyurethane outer covering, a small absorbent pad and a release
liner. A unique number is printed on the underside of the polyurethane layer for
identification and anti-counterfeiting purposes. Unlike urinalysis, flushing or
employing a diuretic to rid the body of drugs of abuse does not affect
PharmChek(R) test results, since the drugs in the sweat simply collect on the
absorption pad until the pad is removed for analysis.
PharmChek(R) may offer other advantages over other drug detection
systems currently available. First, it does not require the handling of urine or
blood, which may be objectionable to some people. Second, the use of sweat as a
testing medium may lengthen the drug use detection period and decrease testing
costs by reducing the need for specialized specimen collection facilities and
staff. Court cases in California and Nevada have recognized the validity of
PharmChek(R) for detecting the use of illegal drugs.
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The FDA has cleared PharmChek(R) for detecting the use of:
- cocaine
- opiates (including heroin)
- amphetamines (including methamphetamine)
- phencyclidine (PCP)
- marijuana (THC)
Our sales of PharmChek(R) have not been significant and there can be no
assurance that it will be commercially accepted by existing or new customers or
generate significant revenues in the future.
SUPPLIERS
We are dependent upon a single supplier for the PharmChek(R) product and
we are in the process of seeking an alternative supplier. We are not dependent
upon any other single supplier for our raw materials.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
We provide a variety of drug testing services which are customized to
each customer's specific needs. We employ a customer service and technical
support staff specializing in one or more of the following areas of service.
SPECIMEN COLLECTION
We manage specimen collection services for a number of our customers. We
maintain a list of more than 5,000 clinics and other organizations throughout
the United States (US) and Puerto Rico that offer specimen collection services
that comply with forensic drug-testing procedures. Our customer service staff
identifies collectors conveniently located to customer sites, prepares
customized specimen collection procedures, conducts training of collection
personnel and monitors their performance. In 2000, PharmChem managed
approximately 530,000 collections in the US, while Medscreen managed
approximately 30,000 collections throughout the United Kingdom (UK) and at over
300 shipping ports throughout the world.
TRANSPORTATION
Most specimens are transported to PharmChem by overnight or same-day
courier, or by mail. We offer special specimen transportation services for
selected areas that provide for pickup of specimens before the close of each
business day.
TECHNICAL CONSULTATION
The technical specialists on our staff are experienced in drug
metabolism and other technical aspects of drug testing. These specialists
respond to requests from customers to interpret test results. In addition, we
are often called upon to assemble the complete chain of custody and testing data
package for specimen results that have been challenged and to provide expert
witness testimony in legal proceedings. The technical consultation group also
provides comprehensive in-service training for customers on topics such as
substance abuse trends, toxicology and drug pharmacology, breath alcohol testing
and technical information on PharmChem's testing procedures.
PROGRAM ANALYSIS
We collect and analyze data on test results in order to provide
comprehensive monthly statistical reports to meet customers' regulatory
requirements and to assist with drug program management.
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SALES AND MARKETING
We sell our integrated drug testing services to corporate and
governmental customers. Our sales force uses a consultative selling approach -
Premium Comprehensive Management(R) (PCM(R)). PCM(R) emphasizes the full scope
of integrated services we offer and customizes these services to meet customers'
particular needs. PCM(R) provides customized services including:
- a worldwide database of collection sites and on-call collections
for rapid response
- alternatives to laboratory urine testing including on-site
screening devices such as PharmScreen(R), sweat testing with
PharmChek(R) and hair testing
- PharmTrack, our secure internet-based tracking and reporting
system
- FAST, our secure internet-based collection scheduling and
management system
- statistical management reporting
- centralized billing and other services
CUSTOMERS
PharmChem provides integrated drug testing services to three primary
customer groups in the United States and provides these services internationally
through Medscreen:
PUBLIC AND PRIVATE WORKPLACE EMPLOYERS
Public and private workplace employers use drug testing as part of their
hiring decisions in order to increase safety and reduce costs associated with
drug abuse in the workplace. In addition, an increasing number of public and
private workplace employers test employees in certain positions on a periodic or
random basis and test other employees upon reasonable suspicion of drug use.
Sales of laboratory services and products to public and private
workplace employers accounted for 40%, 38% and 42% of our total net sales in
2000, 1999 and 1998, respectively. Sales to Sears, Roebuck & Co. accounted for
approximately 11%, 10% and 11% of our total net sales in 2000, 1999 and 1998,
respectively.
CRIMINAL JUSTICE AGENCIES
Criminal justice agencies use drug testing results in criminal
proceedings and to assist with making parole, drug treatment and probation
decisions. These agencies also use drug testing to monitor drug treatment of
individuals under supervision and to track drug use trends within the United
States.
Sales of laboratory services and products to criminal justice agencies
accounted for 41%, 43% and 39% of our total net sales in 2000, 1999 and 1998,
respectively. Sales to Federal Probation accounted for approximately 18%, 19%
and 18% of our total net sales in 2000, 1999 and 1998, respectively.
DRUG TREATMENT PROGRAMS
Drug treatment programs use drug testing to monitor the treatment and
rehabilitation of drug users in their care. Sales of laboratory services and
products to drug treatment programs accounted for less than 5% of our total net
sales in 2000, 1999 and 1998.
MEDSCREEN'S CUSTOMER BASE
PharmChem's London-based subsidiary accounted for 16%, 16% and 15% of
our total net sales in 2000, 1999 and 1998, respectively. Medscreen's primary
customers operate in the maritime, criminal justice, oil, chemical, utilities
and transportation industries. Medscreen has customers in 35 countries.
Approximately 60% of Medscreen's 2000
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sales were from UK-based customers with the balance from customers in other
countries in Europe, Asia and South America.
CONTRACTING
Customers engage us to provide services through the following:
- the formal competitive bid process
- standard service contracts
- without a formal contract, but by accepting test specimens for
an agreed upon price renegotiated every twelve months
A majority of our sales are derived from competitive bids, and we
believe that competitive pressure with respect to these bids, particularly for
large multi-year contracts, has intensified. Many of our large potential
customers, including the majority of public employers and criminal justice
agencies, use a formal competitive bid process in which the potential customer
provides a detailed specification of the drug testing services it requires.
There is no assurance that we will be the successful bidder when these contracts
are up for renewal. While price is an important factor, in most cases these
organizations are not required to accept the lowest bid, but rather may choose
the winning bidders based on technical superiority and customer service.
The failure to renew a significant contract, if not replaced by
comparable contracts, could result in lower sales, lower profit margins,
decreased cash flows and losses. Our contracts generally allow termination at
the customer's discretion on short notice with little or no penalty. Many
contracts provide for termination for convenience. Although in the past our
customers generally have not exercised these early termination rights, there can
be no assurance that this will continue in the future.
Backlog is not a significant statistic for PharmChem due to the short
turnaround time for processing specimens.
COMPETITION
The market for drug testing services became increasingly competitive in
the early 1990's, and continues to be competitive. Drug testing laboratories
compete primarily on the basis of:
- customer service
- technical capability
- price
We believe that PharmChem competes favorably in each of these
categories. We have significantly expanded our scope of services and invested
heavily in information technology to provide flexible, responsive and customized
drug testing programs while maintaining a competitive average total selling
price per specimen.
Our competitors include:
- national clinical laboratory companies, such as Laboratory
Corporation of America Holdings and Quest Diagnostics, Inc.
- independent national drug testing laboratories, such as
Psychemedics Corporation and Medtox Scientific, Inc.
- regional and local laboratories
- third party administrators
- medical review officers
- manufacturers and distributors of on-site screening devices and
equipment
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The national clinical laboratories have greater financial, marketing,
laboratory and related resources than PharmChem. In addition, some of our
customers and our potential customers operate their own drug testing facilities
or may develop such facilities in the future.
CERTIFICATION AND GOVERNMENT REGULATION
Laboratories which compete in the U.S. forensic drug testing market
generally must be certified by SAMHSA. In addition, some state and local
jurisdictions require their own certification for testing of specimens of their
residents. Such state and local certifications are essential to our business in
each such respective jurisdiction. Our laboratories are currently certified by
SAMHSA, CAP and certain state and local jurisdictions. Our Texas laboratory is
certified by CLIA and our California laboratory has received "deemed status"
under CLIA as a result of its State of California certification. We believe we
are certified in all jurisdictions in which we operate.
We are subject to frequent inspection by certifying bodies, including
annual CAP and semi-annual SAMHSA inspections. Inspections sometimes result in
reports describing areas for improvement or suggesting changes in procedures. We
may be required to take actions on the items noted in the inspection report in
order to remain certified. Failure to meet certification requirements could
result in suspension or loss of certification.
We have never been decertified as the result of an inspection.
Certification is essential to our business because some of our customers are
required to use a certified laboratory, and many of our customers look to
certification as an indication of reliability and accuracy of results.
Certain federal agencies regulate employee drug testing by other federal
agencies and certain private employers. Court precedent currently exists in a
number of states regarding the circumstances under which employers may test
employees and the procedures under which such tests must be conducted. The
circumstances under which drug testing can legally be required by employers is
subject to judicial review, and is challenged from time to time by employees,
unions and other groups on constitutional, privacy and other grounds.
In 2001, a revision of the Federal Register, CFR Part 40, will be
implemented. This revision will impose more stringent requirements for the
training and retraining of specimen collector service providers. This may
negatively impact the pool of available service providers and may result in
higher costs for the services they perform.
ENVIRONMENTAL MATTERS
A small portion of our business involves testing procedures requiring
the use of chloroform, which is considered to be a hazardous material. Failure
to comply with current or future federal, state or local environmental laws or
regulations regarding this hazardous material could have a material adverse
effect on us. We believe that we have adequately notified employees of potential
risks associated with working at PharmChem and have provided a workplace safe
from hazard, as required by the Occupational Safety and Health Administration
and certain state laws. We believe we are in compliance with all applicable
environmental laws and regulations.
EMPLOYEES
As of December 31, 2000, we had approximately 300 full-time employees.
Our employees are not represented by labor organizations, and we consider
relations with our employees to be good.
SEASONAL OPERATING FACTORS
PharmChem's operations are affected by both seasonal trends to which
drug testing laboratories are generally subject and general economic conditions.
Our laboratory testing volume tends to be higher in the second and third
calendar quarters and lower in the fourth and first calendar quarters, primarily
due to the hiring patterns of our public and private employer customer group
which affect pre-employment drug testing.
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RESEARCH AND DEVELOPMENT
Our most experienced scientists and technicians perform research and
development activities. Our research and development efforts continually focus
upon improving laboratory procedures and processes. We believe we have
engineered a number of efficiencies to improve the accuracy and reliability of
our drug tests.
DOMESTIC AND FOREIGN OPERATIONS
Refer to Note 10 to the Consolidated Financial Statements for reportable
segment information and financial information about geographic areas.
ITEM 2. PROPERTIES
LOCATION USE SQUARE FOOTAGE REMAINING LEASE TERM
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1505-A O'Brien Drive World Headquarters 35,719 5 months (1)
Menlo Park, CA 94025 and Laboratory
1275 Hamilton Court Distribution Center 11,925 5 years (2)
Menlo Park, CA 94025
7606 Pebble Drive Texas Division and 15,000 5 years
Fort Worth, TX 76118 Laboratory
1A Harbour Quay Medscreen 13,350 2 years with a 10 year
100 Preston's Road Headquarters and option
London, E14 9PH Laboratory
England
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(1) We are presently seeking alternative facilities.
(2) The lease contains an option for early termination in 2001.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of our business, we are sued by individuals,
primarily those in the criminal justice system, who have tested positive for
drugs of abuse. In addition, we frequently testify in administrative and court
proceedings involving the results of our tests. To date, we have not experienced
any material liability related to these claims, although there can be no
assurance that we will not at some time in the future experience significant
liability in connection with such claims. There are no pending legal
proceedings, other than ordinary routine litigation incidental to our business,
to which we are a party or to which any of our property is subject and our
management does not believe the outcome of any of the proceedings will have a
material impact on our financial position or results of operations.
We believe that our liability insurance coverage is adequate for our
business.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 2000.
EXECUTIVE OFFICERS OF PHARMCHEM
NAME AGE POSITION WITH PHARMCHEM
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Joseph W. Halligan 56 President, Chief Executive Officer and Director
David A. Lattanzio 58 Vice President, Finance and Administration, Chief
Financial Officer and Secretary
Neil A. Fortner 46 Vice President, Laboratory Operations
Elizabeth M. Lison 43 Vice President, Business Development
Joseph L. Kurta 49 Vice President, Sales and Marketing
Bryan Merryman 44 Vice President, Customer Service
Baburaj Parakkal 34 Vice President, Information Systems
Mr. Halligan has been PharmChem's President, Chief Executive Officer and
Director since November 1995. From 1988 to 1995, he was President and CEO of
E.S.I. Consulting Group, a private consulting practice, specializing in advising
and operating high growth, consumer and service-oriented companies. Before
forming his consulting practice, Mr. Halligan served from 1983 to 1987 as
President and CEO of a privately-held company, Laura Scudder's, Inc. From 1969
to 1983, he served as Senior Vice President of Fotomat Corporation and President
of its subsidiary, Video Services of America. He holds a B.S. in Management and
Business Administration from Columbia Pacific University.
Mr. Lattanzio has been PharmChem's Vice President, Finance and
Administration, and Chief Financial Officer since April 1996 and Secretary since
January 1997. He is responsible for all business aspects of our operations,
including accounting, corporate finance, treasury, purchasing, human resources
and risk management. From 1995 to March 1996, Mr. Lattanzio performed private
consulting for several companies, including PharmChem. He served as Vice
President, Finance and Chief Financial Officer of Mission Foods from 1991 to
1995. Mr. Lattanzio holds a B.B.A. in Accounting from the University of Notre
Dame and is a Certified Public Accountant.
Mr. Fortner has served as Vice President, Laboratory Operations of
PharmChem since February 1992. He joined PharmChem as Director, Laboratory
Operations in July 1991. He is the Scientific Director and is responsible for
all production aspects of laboratory operations. From 1985 to 1991, he served as
Director of Toxicology at Southgate Medical Services. Mr. Fortner has more than
20 years experience in forensic toxicology and he is a qualified SAMHSA and CAP
laboratory inspector. He is a member of the American Association of Clinical
Chemistry and a full member of the Society of Forensic Toxicologists, the
American Academy of Forensic Sciences (Fellow) and the American Board of
Forensic Examiners. Mr. Fortner holds a B.A. in Biology from Hiram College and a
M.S. in Biochemistry from Western Kentucky University. He is certified as a
Forensic Toxicology Specialist by the American Board of Forensic Toxicologists
and as a Toxicological Chemist by the National Registry of Certified Chemists.
Ms. Lison became Vice President, Business Development of PharmChem in
November 2000. Previously, she served as Vice President, Customer Service since
March 1997. She joined Medscreen in 1993, where she held various management
positions in sales and customer service. Ms. Lison is responsible for developing
new business and enhancing our relationships with existing customers. In June
1996, she relocated to our corporate office to serve as Director, Customer
Service. From 1979 to 1993, Ms. Lison worked in various aspects of the design
and delivery of workplace drug testing programs for companies based in the UK.
Ms. Lison holds a B. Tech (Hons) in Medical Science from the University of
Bradford, UK.
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Mr. Kurta has served as Vice President, Sales and Marketing since
joining PharmChem in March 1998. He is responsible for sales, marketing and the
commercial development of our laboratory services and the PharmScreen(R) and
PharmChek(R) product lines. Prior to joining PharmChem, Mr. Kurta served as
Director of Business Development and Director of Sales and Marketing for the
Unilab Corporation and served in various capacities at Damon Laboratories and
Corning/Metpath Laboratories. From 1979 to 1986, Mr. Kurta owned and operated
Spectrum Helicopters, Inc., Copter Quik Delivery Systems and Geriatric
HealthCare Group. Mr. Kurta holds B.A. and M.S. degrees from Alfred University
in New York.
Mr. Merryman has served as Vice President, Customer Service since
joining PharmChem in November 2000. He is responsible for all customer service
functions. Prior to joining PharmChem, Mr. Merryman served in various customer
service capacities at Quest Diagnostics from 1982 to 1990 and from 1996 until he
joined PharmChem. From 1990 to 1996, Mr Merryman held management positions at
Laboratory Corporation of America. Mr. Merryman holds a B.B.A. degree in
Computer Sciences from Ursinus College in Pennsylvania and is in the process of
completing his M.B.A. from the University of Phoenix.
Mr. Parakkal has served as Vice President, Information Systems since
November 2000. He is responsible for all information service functions. He has
also served as Director, Systems Development at PharmChem since 1997. Prior to
joining PharmChem, Mr. Parakkal served in project management at Transworld
Information Systems, Inc. from 1996 to 1997. He was responsible for directing
the development of cross-functional systems, software and databases. From 1987
to 1995, Mr. Parakkal worked in Information Technology in various aspects of
design, development and implementation of business applications in India. Mr.
Parakkal holds a B.S. degree in Physics from University of Madras, India and is
in the process of completing a B.S. degree in Business Management from the
University of Phoenix.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock trades on The Nasdaq National Market under the symbol
"PCHM".
STOCK PRICES
The following table sets forth for the periods indicated the high and
low closing bid prices for our common stock by quarter for years 2000 and 1999,
as reported by the Automated Quotation System of the National Association of
Securities Dealers (Nasdaq). The prices shown represent quotations among
securities dealers, do not include retail markups, markdowns or commissions and
may not represent actual transactions.
CALENDAR CALENDAR
QUARTER HIGH LOW QUARTER HIGH LOW
- ------- ------- ------- -------- ------- -------
Q1 2000 $ 5.000 $ 3.250 Q1 1999 $ 4.750 $ 1.750
Q2 2000 $ 5.000 $ 2.125 Q2 1999 $ 3.438 $ 2.125
Q3 2000 $ 4.125 $ 2.563 Q3 1999 $ 3.000 $ 1.938
Q4 2000 $ 4.000 $ 2.000 Q4 1999 $ 4.000 $ 1.750
As of March 1, 2001, there were approximately 130 holders of record of
our common stock. A large number of shares were held in nominee name. Based upon
information furnished by our proxy solicitor, Skinner & Co, we believe we have
approximately 1,000 stockholders as of March 1, 2001.
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DIVIDENDS
We have never paid cash dividends on our common stock. We currently
anticipate that we will retain all future earnings for use in the operation and
expansion of our business and do not anticipate paying any dividends in the
foreseeable future. In addition, our current revolving credit agreement
prohibits the declaration or payment of dividends except in connection with our
stockholder rights plan.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(In thousands, except per share data)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales ......................................... $ 46,832 $ 44,487 $ 43,172 $ 39,233 $ 41,255
Cost of sales ..................................... 32,915 31,374 31,653 31,311 31,757
-------- -------- -------- -------- --------
Gross profit ...................................... 13,917 13,113 11,519 7,922 9,498
-------- -------- -------- -------- --------
Selling, general and administrative ............... 11,460 10,033 9,800 8,234 8,689
Amortization of goodwill .......................... 185 185 185 185 185
Provision for (reduction of) doubtful accounts .... (119) 141 325 350 206
-------- -------- -------- -------- --------
Total operating expenses ..................... 11,526 10,359 10,310 8,769 9,080
-------- -------- -------- -------- --------
Income (loss) from operations ................ 2,391 2,754 1,209 (847) 418
Other expenses, net ............................... 258 248 288 389 372
-------- -------- -------- -------- --------
Income (loss) before income taxes ............ 2,133 2,506 921 (1,236) 46
Provision for (benefit from) income taxes ......... 772 (294) 286 34 -
-------- -------- -------- -------- --------
Net income (loss) ............................ $ 1,361 $ 2,800 $ 635 $ (1,270) $ 46
======== ======== ======== ======== ========
Basic earnings (loss) per share ................... $ 0.23 $ 0.48 $ 0.11 $ (0.22) $ 0.01
======== ======== ======== ======== ========
Diluted earnings (loss) per share ................. $ 0.22 $ 0.47 $ 0.10 $ (0.22) $ 0.01
======== ======== ======== ======== ========
Basic weighted average shares outstanding ......... 5,822 5,786 5,764 5,734 5,622
======== ======== ======== ======== ========
Diluted weighted average shares outstanding ....... 6,069 5,954 6,238 5,734 5,710
======== ======== ======== ======== ========
Cash dividends per share .......................... - - - - -
======== ======== ======== ======== ========
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficiency) ...................... $ 2,407 $ 3,040 $ (319) $ (1,147) $ 1,707
Total assets ...................................... 27,265 25,046 22,063 22,246 21,647
Long-term debt, net of current portion ............ 1,731 2,593 656 696 1,205
Stockholders' equity .............................. 14,995 13,697 10,910 10,211 11,431
Selected quarterly financial data is included in Note 12 to the Consolidated
Financial Statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD LOOKING STATEMENTS
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act
of 1933 ("Forward-looking Statements"), which are subject to the "safe harbor"
created by these Sections. Forward-looking statements are statements about
future financial results, future products or services and other events that have
not yet occurred. For example, statements like we "expect," we "anticipate" or
we "believe" are forward-looking statements. Investors should be aware that
actual results may differ materially from our expressed expectations because of
risks and uncertainties about the future. We will not necessarily update the
information in this Form 10-K if any forward-looking statement later turns out
to be inaccurate. Details about risks affecting various aspects of our business
are discussed throughout this Form 10-K and include the risks identified in
"Factors Affecting Operating Results."
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial data
(dollars in thousands):
THREE MONTHS ENDED DECEMBER 31, TWELVE MONTHS ENDED DECEMBER 31,
---------------------------------------- ------------------------------------------
2000 1999 2000 1999 2000 1999 2000 1999
-------- -------- -------- -------- -------- -------- -------- --------
(As a % of net sales) (As a % of net sales)
NET SALES:
Workplace employers ................ $ 4,014 $ 3,743 31.7% 33.1% $ 14,562 $ 15,433 31.1 34.7%
Criminal justice agencies .......... 4,381 4,412 34.5 39.1 17,678 17,492 37.7 39.3
Drug rehab programs ................ 253 377 2.0 3.3 1,125 1,538 2.4 3.5
Domestic products & other .......... 2,161 929 17.0 8.2 6,029 2,948 12.9 6.6
Medscreen .......................... 1,879 1,834 14.8 16.2 7,438 7,076 15.9 15.9
-------- -------- -------- -------- -------- -------- -------- --------
Total net sales .............. 12,688 11,294 100.0 100.0 46,832 44,487 100.0 100.0
COST OF SALES ........................ 9,204 8,116 72.5 71.9 32,915 31,374 70.3 70.5
-------- -------- -------- -------- -------- -------- -------- --------
GROSS PROFIT ......................... 3,484 3,178 27.5 28.1 13,917 13,113 29.7 29.5
-------- -------- -------- -------- -------- -------- -------- --------
OPERATING EXPENSES:
Selling general and administrative . 2,720 2,594 21.4 23.0 11,460 10,033 24.5 22.6
Amortization of goodwill ........... 46 46 0.4 0.4 185 185 0.4 0.4
Provision for (reduction of)
doubtful accounts ............... 106 8 0.8 0.0 (119) 141 (0.3) 0.3
-------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses ..... 2,872 2,648 22.6 23.4 11,526 10,359 24.6 23.3
-------- -------- -------- -------- -------- -------- -------- --------
INCOME FROM OPERATIONS ............... 612 530 4.9 4.7 2,391 2,754 5.1 6.2
-------- -------- -------- -------- -------- -------- -------- --------
OTHER EXPENSES, net .................. 91 75 0.8 0.7 258 248 0.6 0.6
PROVISION FOR (BENEFIT FROM)
INCOME TAXES .................... 219 (627) 1.7 (5.6) 772 (294) 1.6 (0.7)
-------- -------- -------- -------- -------- -------- -------- --------
NET INCOME ........................... $ 302 $ 1,082 2.4% 9.6% $ 1,361 $ 2,800 2.9% 6.3%
======== ======== ======== ======== ======== ======== ======== ========
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2000 COMPARED TO 1999
Net Sales
Annual net sales increased 5.3% to $46,832,000 in 2000 from $44,487,000
in 1999. This increase mostly reflects the continued growth of PharmScreen(R),
our line of onsite screening products, and our international drug testing
operations. Medscreen's sales increased 5.1% on the strength of a 12.9% increase
in specimen volume. Current year sales in the US increased 5.3% and reflect
increases of $1.3 million (54.0%) in product sales and $1.8 million (367.3%) in
non-laboratory sales that more than offset a $1.1 million (3.2%) decrease in
traditional laboratory sales. Our non-laboratory sales include our web-based
collection management system and related collector management services. Domestic
specimen volume decreased 5.4% compared to 1999 levels as more testing volume
was shifted to PharmScreen(R). Our consolidated laboratory specimen volume
decreased 4.2% to 2,730,000 and average selling prices for laboratory analysis
increased 2.9% compared to 1999 levels. Net sales for the fourth quarter of 2000
increased 12.3% and laboratory average selling prices increased 6.0% from the
comparable 1999 periods. As part of our Premium Comprehensive Management(R)
program of fully integrated drug testing services, in the fourth quarter of 1999
we launched our e-commerce system which provides for order processing, forms
printing, collection scheduling, specimen tracking and results reporting through
secure internet transmission. Our current year's fourth quarter reflects a full
three months of revenues from our web-based system compared to one month in
1999.
Cost of Sales
Our cost of sales for the year increased 4.9% to $32,915,000 in 2000
from $31,374,000 in 1999. Cost of sales as a percentage of net sales decreased
to 70.3% in 2000 from 70.5% in 1999 and reflects improved operating efficiencies
and continued favorable results from our cost containment program initiated in
1997, principally in direct labor. We incurred higher specimen collection costs
due to the growth in customers requiring nationwide collection services. Gross
profit as a percentage of net sales increased to 29.7% in 2000 from 29.5% in
1999 reflecting higher sales. Cost of sales for the 2000 fourth quarter of
$9,204,000 increased 13.4% from the same prior year period due to higher sales
volume and related specimen collection costs.
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses for the year
increased 14.2% to $11,460,000 in 2000 from $10,033,000 in 1999 due to our
continued investment in our sales and marketing strategy, additional staffing in
our customer service functions and higher depreciation expenses from our
implementation of the Unified Database (UDB) software project in the third
quarter of 1999. The percent of SG&A expenses to net sales increased to 24.5% in
2000 from 22.6% in 1999. SG&A expenses for the 2000 fourth quarter increased
4.9% to $2,720,000 from $2,594,000 in the prior year period and reflects higher
staffing in our sales and customer service functions.
Income From Operations
Income from operations for the year was $2,391,000 in 2000 compared to
$2,754,000 in 1999, while income from operations for the fourth quarter was
$612,000 in 2000 compared to $530,000 in 1999.
Provision for (Benefit from) Income Taxes
During 2000, we recorded a provision for taxes of $772,000 for the year
and $219,000 for the fourth quarter. The 1999 provision for current income taxes
of $482,000 for the year was more than offset by a reversal of $336,000 of tax
accruals no longer required due to a favorable settlement of an IRS review
(recorded in the first quarter of 1999) and the recognition of an income tax
benefit of approximately $440,000 from reducing the deferred tax valuation
allowance (recorded in the fourth quarter of 1999). In addition, we offset
approximately $347,000 of federal and state taxes with utilization of net
operating loss carryforwards in 1999.
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Net Income
Net income for the year was $1,361,000 in 2000 compared to net income of
$2,800,000 in 1999. Excluding the favorable impact of the 1999 tax adjustments,
net income for the year in 1999 was $1,677,000. We reported net income of
$302,000 in the 2000 fourth quarter compared to net income of $1,082,000 in
1999. Excluding the favorable impact of the 1999 tax adjustments, proforma
income in the 1999 fourth quarter would have been $295,000.
1999 COMPARED TO 1998
Net Sales
Annual net sales increased 3.0% to $44,487,000 in 1999 from $43,172,000
in 1998. This increase mostly reflects the continued growth of our international
drug testing operations. Medscreen's sales increased 10% on the strength of a
15.9% increase in specimen volume. Our 1999 sales in the US increased 1.8% and
reflected a $2.3 million (15.0%) increase in criminal justice sales that more
than offset a $2.0 million (11.5%) decrease in workplace sales. Domestic
specimen volume increased 1.9% compared to 1998 levels. Our consolidated
specimen volume increased 2.7% to 2,850,000 and average selling prices for
laboratory analysis were relatively unchanged compared to 1998 levels. Net sales
for the fourth quarter of 1999 increased 3.8% and average selling prices
increased 2.3% from the comparable 1998 periods. In December 1999, as part of
our Premium Comprehensive Management(R) program of fully integrated drug testing
services, we launched our e-commerce system which provides for order processing,
forms printing, collection scheduling, specimen tracking and results
reporting--all through secure internet transmission.
Cost of Sales
Although our annual specimen volume was higher in 1999, our cost of
sales for the year decreased 0.9% to $31,374,000 in 1999 from $31,653,000 in
1998. Cost of sales as a percentage of net sales decreased to 70.5% in 1999 from
73.3% in 1998 and reflects improved operating efficiencies and continued
favorable results from our cost containment program initiated in 1997,
principally in the areas of direct labor and distribution. Gross profit as a
percentage of net sales increased to 29.5% in 1999 from 26.7% in 1998 reflecting
improved profit margins. Cost of sales for the 1999 fourth quarter of $8,116,000
increased slightly from the same prior year period due to higher specimen
collection costs.
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses for the year
increased 2.4% to $10,033,000 in 1999 from $9,800,000 in 1998 due to higher
depreciation expenses from our implementation of the Unified Database (UDB)
software project in the third quarter of 1999. The percent of SG&A expenses to
net sales decreased slightly to 22.6% in 1999 from 22.7% in 1998. SG&A expenses
for the 1999 fourth quarter increased 8.0% to $2,594,000 from $2,401,000 in the
prior year period and reflects higher depreciation expenses associated with the
UDB project. We also continued to invest heavily in information systems and
sales and marketing.
Income From Operations
Income from operations for the year was $2,754,000 in 1999 compared to
$1,209,000 in 1998.
Provision for (Benefit from) Income Taxes
The 1999 provision for current income taxes of $482,000 for the year was
more than offset by a reversal of $336,000 of tax accruals no longer required
due to a favorable settlement of an IRS review (recorded in the first quarter of
1999) and the recognition of an income tax benefit of approximately $440,000
from reducing the deferred tax valuation allowance (recorded in the fourth
quarter of 1999). In addition, we offset approximately $347,000 of federal and
state taxes with utilization of net operating loss carryforwards. During 1998,
we recorded a provision for taxes of $286,000 for the year.
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Net Income
Net income for the year was $2,800,000 in 1999 compared to net income of
$635,000 in 1998.
LIQUIDITY AND CAPITAL RESOURCES
Our operations during the years ending December 31, 2000, 1999 and 1998
provided cash of approximately $3,753,000, $3,437,000 and $4,596,000,
respectively. The increase in cash flow from operations between 2000 and 1999
reflects improved collections on accounts receivable and higher payables due to
a higher volume of business in the current year's fourth quarter compared to
1999. The decrease in cash flow from operations between 1999 and 1998 reflects
higher accounts receivable, a buildup of inventory to mitigate potential Y2K
problems at our key suppliers and the reversal of the deferred tax valuation
reserves, all of which more than offset the increase in net income.
As of December 31, 2000 and 1999, we had $1,714,000 and $1,804,000 in
cash and cash equivalents, respectively. During 2000, we completed one financing
transaction totaling $1,674,000 and a significant portion of the proceeds were
used for repayment of existing debt. We had net borrowings of the revolving line
of credit totaling $731,000 and repayments on term debt and capital leases
totaled $2,643,000. We also used $3,546,000 to acquire property and equipment,
mostly related to computer software and laboratory analyzers. During 1999, we
had net repayments on the revolving line of credit of $2,379,000, we acquired
$3,007,000 of property and equipment and we repaid term debt and capital lease
obligations of $835,000.
On April 30, 1999, we entered into a $1,082,000 financing lease
agreement with a lessor to refinance certain modules of our Unified Database
software project. The lease agreement bears interest at 8.5% and is payable over
36 months. The proceeds from the lease were used to reduce amounts outstanding
under the revolving line of credit. On November 23, 1999, we entered into a
$1,200,000 financing lease agreement with a lessor to refinance certain other
modules of our Unified Database software project. The lease agreement bears
interest at 9.5% and is payable over 36 months. The proceeds from the lease were
used to reduce amounts outstanding under the revolving line of credit and for
capital expenditures. These leases have been accounted for as capital leases.
On May 15, 2000, we entered into an amended and restated Loan and
Security Agreement ("Credit Agreement) with our bank. The amended Credit
Agreement reflects similar terms and conditions to the predecessor agreement
covering our revolving line of credit and variable rate installment note
("Installment Note"). The amended Credit Agreement provides for borrowings under
the revolving line of credit limited to 85% of qualified accounts receivables
(up to a maximum of $6,000,000), is secured by a lien on substantially all of
our assets (excluding computer software) and carries a commitment fee equal to
0.25% of the maximum line of credit. The Credit Agreement contains certain
financial covenants, which, among others, require PharmChem to maintain certain
ratios of working capital and net worth. The Credit Agreement permits up to
$2,000,000 of the revolving line of credit to be used to repurchase our common
stock under our common stock repurchase program and permits the declaration and
distribution of a dividend in connection with our stockholder rights plan.
On September 7, 2000, we entered into a $1,674,000 Installment Note with
our bank. The majority of the proceeds from the Installment Note were
immediately used to pay off the amount outstanding under a separate $1,500,000
installment note with the same bank. The Installment Note is subject to the
terms and conditions of the amended Credit Agreement, currently bears interest
at the prime rate plus 0.5% and is payable over 43 months. At December 31, 2000,
the calculated maximum that could be borrowed and the amount outstanding under
the Credit Agreement were $5,834,000 and $731,000, respectively. Advances under
the revolving line of credit carry interest at either the prime rate plus 0.5%
(9.50% at December 31, 2000) or LIBOR plus 3.25%. As of December 31, 2000, we
were in compliance with all covenants except that we exceeded the limitation on
annual capital expenditures, for which we obtained a waiver. We anticipate that
existing cash balances, amounts available under the Credit Agreement and funds
to be generated from future operations will be sufficient to fund operations and
budgeted capital expenditures through 2001.
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In November, 1999, our Board of Directors approved a common stock
repurchase program whereby we are able to purchase up to 300,000 shares
(approximately 5%) of our common stock from time to time on the open market or
in privately negotiated sales. Our bank has authorized up to $2.0 million from
our existing Credit Agreement to be used toward repurchase of our common stock
under this program. The repurchase program contains certain restrictions,
including limitations on the quantity, bid price and timing of stock purchases.
As of December 31, 2000, no shares have been repurchased.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25. This interpretation clarifies the application of Opinion 25 for
certain issues: (a) the definition of employee for purposes of applying Opinion
No. 25, (b) the criteria for determining whether a plan qualifies as a
noncompensatory plan, (c) the accounting consequence of various modifications to
the terms of a previously fixed stock option or award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. With
certain exceptions, this Interpretation is effective July 1, 2000. The adoption
of Interpretation No. 44 did not have a material effect on our consolidated
financial position or results of operations.
In December 1999, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements, as amended by SAB 101A, which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosures related to revenue recognition policies.
In June 2000, the SEC issued SAB 101B which deferred the effective date of SAB
101 until the last quarter of fiscal years beginning after December 31, 1999. We
performed a review of our revenue recognition policies and determined they are
in compliance with SAB 101.
In September 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
for hedging activities. The statement requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The statement generally
provides for matching the timing of gain or loss recognition on the hedging
instrument with the recognition of (a) the changes in the fair value of the
hedged asset or liability that are attributable to the hedged risk or (b) the
earnings effect of the hedged forecasted transaction. SFAS No. 133 was to be
effective for all fiscal quarters of fiscal years beginning after September 15,
1999. In September 1999, the FASB issued SFAS No. 137, which defers the
implementation of SFAS No. 133. SFAS No. 133, as amended by SFAS No. 137, will
be effective for all fiscal quarters of fiscal years beginning after September
15, 2000. The adoption of SFAS Nos. 133 and 137 did not have a material effect
on our consolidated financial position or results of operations.
FACTORS AFFECTING OPERATING RESULTS
We are subject to a number of risks which could affect operating results
and liquidity, including, among others, the following:
COMPETITION AND CUSTOMER CONTRACTS
The market for drug testing services became increasingly competitive in
the 1990's, and continues to be competitive. Drug testing laboratories compete
primarily on the basis of:
- customer service
- technical capability
- price
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We compete for customer contracts against firms that may have greater
financial, marketing, laboratory and related resources.
A majority of our sales arise out of competitively bid contracts, which
are awarded based on technical superiority, customer service and price. The
failure to renew a significant contract, if not replaced by comparable
contracts, could result in lower sales, lower profit margins, decreased cash
flows and losses. Our contracts generally allow termination at the customer's
discretion on short notice with little or no penalty. Many contracts provide for
termination for convenience. In addition, relatively few of our contracts call
for minimum contract amounts or payments. Although in the past our customers
generally have not exercised these early termination rights, there can be no
assurance that this will continue in the future. Early termination of a
substantial contract, if not replaced by comparable contracts, could have a
material adverse effect on PharmChem.
PHARMCHEK(R) DRUGS OF ABUSE PATCH
Since 1992, we have been investing in PharmChek(R), a system which uses
sweat to detect the use of illegal drugs. To date, our sales of PharmChek(R)
have not been material and there is no assurance that it will continue to be
commercially accepted by existing or new customers or generate significant
revenues in the future. While the company that developed PharmChek(R) has
obtained patents relating to its technology, there are various risks associated
with the technology. There is no assurance:
- as to the validity of such patents
- that the products we market will be covered by such patents
- that competitors will not infringe upon such patents or
successfully design similar or competing products that do not
infringe upon such patents
- that the company that obtained the PharmChek(R) patents will
continue to be able to deliver products to PharmChem or that an
alternative supplier will be found
CUSTOMER CONCENTRATION
Our two largest customers combined accounted for approximately 29% of
our sales in 2000, 1999 and 1998. The loss of these contracts, if not replaced
by comparable contracts, could result in lower sales, lower profit margins,
decreased cash flows and losses. We have in the past failed to renew significant
contracts which has had adverse effects on PharmChem. See "Competition and
Customer Contracts" above.
CERTIFICATION
We are certified by SAMHSA, CAP and a number of states to conduct drug
testing using forensic procedures. In addition, our Texas and California
laboratories are certified as discussed earlier in Part I under Certification
and Government Regulation. Certification is essential to our business because
some of our customers are required to use certified laboratories, and many of
our customers look to certification as an indication of accuracy and reliability
of results. In order to remain certified, we are subject to frequent inspections
and proficiency tests. Failure to meet any of the numerous certification
requirements to which we are subject could result in suspension or loss of
certification. Such suspension or loss of certification could have a material
adverse effect on PharmChem.
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SEASONAL TRENDS AND ECONOMIC CONDITIONS
Seasonal trends to which drug testing laboratories are generally subject
affect our operations. In the past, testing volume tends to be higher in the
second and third calendar quarters and lower in the fourth and first calendar
quarters, primarily due to the hiring patterns of our public and private
employer customer group which affect pre-employment drug testing. Demand for our
services is also dependent on general economic conditions. Recessionary periods
generally result in fewer new hires, and therefore may lead to fewer
pre-employment drug tests for public and private employer customers. Similarly,
customers may scale back their drug testing program in a tight labor market.
Budget cuts at the federal, state or local level could reduce business from our
public employer, criminal justice agency and government funded drug treatment
program customers. Because expenses associated with maintaining our testing work
force are relatively fixed over the short term, our profit margins tend to
increase in periods of higher testing volume and decrease in periods of lower
testing volume.
JUDICIAL DECISIONS AND GOVERNMENT POLICY
State and federal courts have generally permitted the use of drug
testing under certain circumstances and using certain procedures. However,
challenges to drug testing programs are raised from time to time by employees,
unions and other groups in litigation on constitutional, privacy and other
grounds. In addition, legal precedent in a number of states governs the
circumstances under which employers may test employees and the procedures under
which such tests must be conducted. Although we believe that, to date, no such
litigation or law has had a material adverse impact upon our business, new
decisions, legislation or policies which restrict the use of drug testing could
have a material adverse effect on PharmChem.
CREDIT AVAILABILITY
We maintain a revolving credit agreement with a bank. All borrowings are
secured by a lien on all of our assets (excluding computer software). The Credit
Agreement contains certain financial covenants, which we anticipate being able
to comply with throughout 2001, although there can be no assurance that such
compliance will be maintained.
LEGAL PROCEEDINGS
In the ordinary course of our business, we are sued by individuals,
primarily those in the criminal justice system, who have tested positive for
drugs of abuse. In addition, we frequently testify in administrative and court
proceedings involving the results of our tests. To date, we have not experienced
any material liability related to these claims, although there can be no
assurance that we will not at some time in the future experience significant
liability in connection with such claims.
ENVIRONMENTAL MATTERS
A small portion of our business involves testing procedures requiring
the use of chloroform and radioactive reagents, which are considered to be
hazardous materials. Failure to comply with current or future federal, state or
local environmental laws or regulations regarding these hazardous materials
could have a material adverse effect on PharmChem. We believe we are in
compliance with all applicable environmental laws and regulations.
DEPENDENCE ON KEY PERSONNEL
Our success is dependent in part on our key management and technical
personnel, the loss of one or more of whom could have a material adverse effect
on PharmChem. None of our key employees has an employment contract with us. We
believe that our future success will depend in part upon our continued ability
to attract, retain and motivate additional highly skilled personnel.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to market risk with respect to our debt outstanding and
foreign currency transactions. Our revolving line of credit and bank installment
note carry interest at the prime rate plus 0.5%. As the prime rate increases, we
will incur higher relative interest expense and a decrease in the prime rate
will reduce relative interest expense. In recent years, there have not been
significant fluctuations in the prime rate. Assuming levels of debt consistent
with historical amounts, a 1.0% change in the prime rate would not materially
change interest expense.
Due to our international operations, certain transactions are conducted
in foreign currencies. Medscreen's transactions are denominated approximately
84% in pound sterling and 16% in US currency. During 2000 and 1999, Medscreen's
net sales represented 16% of our total net sales and, as a result, we do not
consider the impact of market risk on foreign currency transactions material.
For that reason, we do not intend to engage in hedging transactions.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index at page 43, Item 14. (a) (1).
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INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
of PharmChem, Inc.:
We have audited the accompanying consolidated balance sheets of PharmChem, Inc.
and its subsidiary (the Company) as of December 31, 2000 and 1999, and the
related consolidated statements of income, comprehensive income, stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 2000. In connection with our audits of the consolidated financial
statements, we also have audited the financial statement schedule as listed in
the accompanying index in Item 14(a)(2). These consolidated financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedule based on our audits. We
did not audit the financial statements of Medscreen Limited (Medscreen), the
Company's wholly-owned subsidiary, as of and for the year ended December 31,
2000, which statements reflect total assets constituting 23 percent and total
revenues constituting 16 percent of the related consolidated totals. Those
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for Medscreen, is
based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 and the report of
the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of PharmChem, Inc. and its subsidiary
as of December 31, 2000 and 1999, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
2000 in conformity with accounting principles generally accepted in the United
States of America. Also in our opinion, the related consolidated financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
KPMG LLP
San Francisco, California
February 12, 2001
22
23
PHARMCHEM, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31,
-------------------
2000 1999
-------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ......................................... $ 1,714 $ 1,804
Accounts receivable, net of allowance for doubtful
accounts of $376 and $545, respectively ....................... 8,004 6,716
Inventory ......................................................... 1,855 1,934
Deferred tax asset ................................................ 386 608
Prepaids and other current assets ................................. 834 537
-------- --------
TOTAL CURRENT ASSETS ...................................... 12,793 11,599
-------- --------
PROPERTY AND EQUIPMENT, net ............................................... 11,026 9,555
OTHER ASSETS .............................................................. 826 1,087
GOODWILL, net of accumulated amortization
of $6,611 and $6,426, respectively ............................... 2,620 2,805
-------- --------
$ 27,265 $ 25,046
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving line of credit .......................................... $ 731 $ -
Current portion of long-term debt ................................. 1,368 1,475
Accounts payable .................................................. 4,097 2,903
Accrued compensation .............................................. 1,404 1,259
Accrued collectors and other liabilities .......................... 2,786 2,922
-------- --------
TOTAL CURRENT LIABILITIES ................................. 10,386 8,559
-------- --------
LONG TERM DEBT, net of current portion .................................... 1,731 2,593
OTHER NONCURRENT LIABILITIES .............................................. 153 197
-------- --------
TOTAL LIABILITIES ......................................... 12,270 11,349
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 25,000 shares authorized, 5,847
and 5,805 shares issued and outstanding at December
31, 2000 and and 1999, respectively ............................... 6 6
Additional paid-in capital ........................................ 19,233 19,133
Accumulated other comprehensive (loss) income ..................... (142) 21
Accumulated deficit ............................................... (4,102) (5,463)
-------- --------
TOTAL STOCKHOLDERS' EQUITY ................................ 14,995 13,697
-------- --------
$ 27,265 $ 25,046
======== ========
See accompanying notes to consolidated financial statements.
23
24
PHARMCHEM, INC.
CONSOLIDATED INCOME STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
NET SALES ................................................. $ 46,832 $ 44,487 $ 43,172
COST OF SALES ............................................. 32,915 31,374 31,653
-------- -------- --------
GROSS PROFIT .............................................. 13,917 13,113 11,519
-------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative ............... 11,460 10,033 9,800
Amortization of goodwill .......................... 185 185 185
Provision for (reduction of) doubtful accounts .... (119) 141 325
-------- -------- --------
Total operating expenses .............. 11,526 10,359 10,310
-------- -------- --------
INCOME FROM OPERATIONS .................................... 2,391 2,754 1,209
-------- -------- --------
OTHER EXPENSE, net:
Interest expense .................................. 281 284 293
Interest income ................................... (11) (21) (3)
Other income ...................................... (12) (15) (2)
-------- -------- --------
Other expense, net .................... 258 248 288
-------- -------- --------
INCOME BEFORE PROVISION FOR INCOME TAXES .................. 2,133 2,506 921
PROVISION FOR (BENEFIT FROM) INCOME TAXES ................. 772 (294) 286
-------- -------- --------
NET INCOME ................................................ $ 1,361 $ 2,800 $ 635
======== ======== ========
EARNINGS PER SHARE:
Basic ............................................. $ 0.23 $ 0.48 $ 0.11
======== ======== ========
Diluted ........................................... $ 0.22 $ 0.47 $ 0.10
======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic ............................................. 5,822 5,786 5,764
======== ======== ========
Diluted ........................................... 6,069 5,954 6,238
======== ======== ========
See accompanying notes to consolidated financial statements.
24
25
PHARMCHEM, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-------------------------------
2000 1999 1998
------- ------- -------
NET INCOME ............................. $ 1,361 $ 2,800 $ 635
OTHER COMPREHENSIVE (LOSS) INCOME:
Foreign currency translation ... (163) (62) 1
------- ------- -------
COMPREHENSIVE INCOME ................... $ 1,198 $ 2,738 $ 636
======= ======= =======
See accompanying notes to consolidated financial statements.
25
26
PHARMCHEM, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS EXCEPT NUMBER OF SHARES)
ACCUMULATED
ADDITIONAL OTHER TOTAL
PAID-IN COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
SHARES PAR VALUE CAPITAL INCOME (LOSS) DEFICIT EQUITY
-------- -------- -------- ------------- ----------- ------------
BALANCE AT DECEMBER 31, 1997 .............. 5,750 $ 6 $ 19,021 $ 82 $ (8,898) $ 10,211
Exercise of stock options ......... 32 - 63 - - 63
Other comprehensive income ........ - - - 1 - 1
Net income ........................ - - - - 635 635
-------- -------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 1998 .............. 5,782 6 19,084 83 (8,263) 10,910
Exercise of stock options ......... 23 - 49 - - 49
Other comprehensive loss .......... - - - (62) - (62)
Net income ........................ - - - - 2,800 2,800
-------- -------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 1999 .............. 5,805 6 19,133 21 (5,463) 13,697
EXERCISE OF STOCK OPTIONS ......... 42 - 100 - - 100
OTHER COMPREHENSIVE LOSS .......... - - - (163) - (163)
NET INCOME ........................ - - - - 1,361 1,361
-------- -------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 2000 .............. 5,847 $ 6 $ 19,233 $ 142 $ (4,102) $ 14,995
======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
26
27
PHARMCHEM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------
2000 1999 1998
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................. $ 1,361 $ 2,800 $ 635
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization .................................. 2,252 2,057 1,999
Provision for (reduction of) doubtful accounts ................. (119) 141 325
Deferred income taxes .......................................... 250 (440) 152
Loss (gain) on dispositions and sales of equipment ............. 4 95 (2)
Deferred gain on sale of computer software ..................... (24) (24) (82)
Change in operating assets and liabilities:
Accounts receivable ............................................ (1,169) (335) 761
Inventory ...................................................... 79 (409) 84
Prepaids and other current assets .............................. (297) (136) (99)
Other noncurrent assets ........................................ 233 60 (75)
Accounts payable and other accrued liabilities ................. 1,227 41 435
Other noncurrent liabilities ................................... (44) (413) 463
------- ------- -------
Net cash provided by operating activities .............. 3,753 3,437 4,596
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .................................... (3,546) (3,007) (2,889)
Proceeds from sales of equipment ....................................... 4 17 439
------- ------- -------
Net cash used in investing activities .................. (3,542) (2,990) (2,450)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) on revolving lines of credit, net .............. 731 (2,379) (1,702)
Proceeds from financing leases and long term debt ...................... 1,674 3,782 435
Principal payments on long-term debt and capital leases ................ (2,643) (835) (513)
Proceeds from exercise of stock options ................................ 100 49 63
------- ------- -------
Net cash provided by (used in) financing activities .... (138) 617 (1,717)
------- ------- -------
Foreign currency translation ........................................... (163) (62) 1
------- ------- -------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ........................... (90) 1,002 430
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ................................. 1,804 802 372
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR ....................................... $ 1,714 $ 1,804 $ 802
======= ======= =======
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest, net of $218, $138 and $153 capitalized
in 2000, 1999 and 1998, respectively ...................................... $ 490 $ 434 $ 305
======= ======= =======
Cash paid for taxes ........................................................ $ 550 $ 246 $ 1
======= ======= =======
See accompanying notes to consolidated financial statements.
27
28
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999
1. THE COMPANY
PharmChem is a leading independent laboratory providing integrated drug
testing services. We test for a number of drugs of abuse, primarily by
urinalysis. In addition to forensic drug testing, we offer a range of services
which are customized to assist customers in implementing cost-effective drug
testing programs. Our customers include private and public workplace employers,
criminal justice agencies and drug treatment programs primarily in the United
States (US) and Europe.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of PharmChem and
our wholly-owned subsidiary, Medscreen, a United Kingdom (UK) company, after
elimination of all intercompany accounts and transactions. The functional
currency of Medscreen is the local currency.
On May 16, 2000, the stockholders of PharmChem Laboratories, Inc. approved
the merger of PharmChem Laboratories, Inc., a California corporation, into
PharmChem, Inc., a newly created Delaware corporation. In connection with this
merger, each share of PharmChem Laboratories, Inc. common stock outstanding as
of May 16, 2000, was converted into and exchanged for one share of PharmChem,
Inc. common stock with a par value of $0.001 per share. PharmChem Laboratories,
Inc. was incorporated in 1987 to acquire PharmChem Laboratories Operations,
Inc., a California corporation founded in 1971. The stockholders' equity section
of the balance sheet has been reclassified to conform prior year's amounts to
the current year presentation. PharmChem, Inc. has an authorized capital of
25,000,000 shares of common stock and 5,000,000 shares of preferred stock.
When we refer to "we" or "PharmChem" in these Notes, we mean the current
Delaware corporation (PharmChem, Inc.) as well as our wholly-owned subsidiary
Medscreen.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires our management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash balances and all highly liquid
investments with original maturities of three months or less at the date of
purchase. At December 31, 2000 and 1999, cash and cash equivalents consist of
demand deposits maintained at established commercial banks. Such cash deposits
periodically exceed the Federal Deposit Insurance Corporation insured limit of
$100,000 for each account.
28
29
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CONCENTRATIONS OF CREDIT RISK
We are subject to a number of risks which include, among others, competition
related to customer contracts, development and marketing of PharmChek(R) and
PharmScreen(R), customer concentration and laboratory certification. Financial
instruments which potentially subject PharmChem to concentrations of credit risk
consist principally of cash investments, trade receivables and debt. We have
cash investment policies that limit investments to short-term, low risk
instruments. Although two customers accounted for approximately 29% of our sales
for each of the three years ended December 31, 2000, 1999 and 1998, we believe
the risk associated with concentrations of credit for trade receivables is
mitigated because (i) one of the customers is a federal government agency; (ii)
the remaining customer base is diversified among many corporate industries and
other government agencies; (iii) we have an ongoing credit evaluation process;
and (iv) we maintain an allowance for doubtful accounts.
INVENTORY
We state inventory at the lower of cost or market. We determine cost using
standard costs, including freight, that approximate actual costs on a first-in,
first-out basis. At December 31, our inventory consisted of the following:
2000 1999
------ ------
(In thousands)
Laboratory materials ......... $ 733 $ 801
Collection materials ......... 841 649
Products ..................... 281 484
------ ------
$1,855 $1,934
====== ======
PROPERTY AND EQUIPMENT
We record property and equipment at cost. We provide for depreciation and
amortization using the straight-line method over the estimated useful lives. We
amortize leasehold improvements and equipment held under capital leases over the
lease term or useful lives. At December 31, our property and equipment consisted
of the following:
USEFUL
LIVES
IN YEARS 2000 1999
-------- -------- --------
(In thousands)
Lab equipment ......................... 5 to 10 $ 4,585 $ 5,881
Computer hardware and software ........ 3 to 10 8,429 7,698
Office equipment ...................... 3 to 7 403 395
Furniture, fixtures and other ......... 3 to 10 889 974
Leasehold improvements ................ - 2,434 3,579
Construction in progress .............. - 3,603 1,559
-------- --------
20,343 20,086
Less: accumulated depreciation and
amortization ......................... (9,317) (10,531)
-------- --------
Property and equipment, net ........... $ 11,026 $ 9,555
======== ========
We capitalize software development costs for internal use in accordance with
Statement of Position (SOP) 98-1, "Accounting for Costs of Computer Software
Developed or Obtained for Internal Use." Capitalization of software
29
30
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
development costs begins in the application development stage and ends when the
asset is placed into service. We amortize such costs using the straight-line
basis over estimated useful lives. Under SOP 98-1, we capitalized $1,492,000 and
$850,000 of software development costs in 2000 and 1999, respectively, related
to our information systems capital expenditure program.
Expenditures for maintenance and repairs are expensed as incurred. We
capitalize costs of major replacements and betterments. When we retire or
otherwise dispose of property, we remove the cost and accumulated depreciation
and amortization from the appropriate accounts and we include any gain or loss
in the income statement.
LONG-LIVED ASSETS, INCLUDING GOODWILL
In accordance with Statement of Financial Accounting Standards (SFAS) No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," we review, as circumstances dictate, the carrying
amount of our long-lived assets. The purpose of these reviews is to determine
whether the carrying amounts are recoverable. We determine recoverability by
comparing the projected undiscounted net cash flows of the long-lived assets
against their respective carrying amounts. We measure the amount of impairment,
if any, based on the excess of the carrying value over the fair value. Our
management believes that there have been no circumstances which would require us
to evaluate for impairment of long-lived assets during the three years ended
December 31, 2000.
Goodwill consists of the excess of cost over the fair value of the net
assets of businesses acquired and we amortize goodwill on a straight-line basis
over periods ranging from 20 to 40 years.
REVENUE AND OTHER DEFERRED CREDITS
We recognize revenue in accordance with Securities and Exchange Commission
(SEC) Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in
Financial Statements, as amended by SAB 101A, which provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements
filed with the SEC. We performed a review of our revenue recognition policies
and believe we are in compliance with SAB 101. Revenue is recognized (i) upon
completion of laboratory analyses of specimens submitted by customers, and (ii)
at the time of shipment for products. Deferred credits include deferred rent and
deferred service revenues. Deferred rent represents unrealized rent abatements
granted by the lessor of the facility occupied by Medscreen, and we amortize
deferred rent on a straight-line basis as a reduction to rent expense over the
remaining lease term. Deferred service revenues represents amounts billed in
advance of laboratory analysis performed. We classify deferred revenues expected
to be realized beyond one year as other noncurrent liabilities.
STOCK BASED-COMPENSATION
We account for our stock-based compensation in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation", and Interpretation No. 44,
"Accounting for Certain Transactions involving Stock Compensation." As allowed
by SFAS No. 123, we continue to measure compensation expense for awards granted
to employees and directors under the provisions of Accounting Principles Board
Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. The exercise price of options granted under our stock option
plans is equal to the market price of our stock on the date of grant. Therefore,
we have not recorded compensation cost under APB No. 25.
30
31
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INCOME TAXES
We account for income taxes in accordance with SFAS No. 109, "Accounting for
Income Taxes," which requires recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, we determine
deferred tax assets and liabilities based on temporary differences between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
EARNINGS PER SHARE
We compute and disclose our earnings per share in accordance with SFAS No.
128, "Earnings Per Share," which requires the presentation of basic and diluted
earnings per share. We calculate basic earnings per share using the weighted
average number of common shares outstanding during the period. We calculate
diluted earnings per share using the weighted average number of common shares
and dilutive potential common shares outstanding during the period. Dilutive
potential common shares represent shares issuable upon the exercise of
outstanding options. We calculate dilutive potential common shares using the
treasury stock method.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments," requires certain disclosures regarding the fair
value of financial instruments. The carrying amounts of accounts receivable,
accounts payable and accrued liabilities approximate fair value because of the
short-term maturity of these instruments. The fair values of revolving credit
agreements, long-term debt and notes payable do not materially differ from their
carrying amounts since the majority of such debt bears interest at variable
rates and the fixed rate obligations generally have near-term maturities or have
matured.
RECLASSIFICATIONS
We have made certain reclassifications to prior year amounts to conform to
current year presentation.
3. DEBT
Our revolving credit agreement and capitalized lease obligations at December
31 consist of the following:
2000 1999
------- -------
(In thousands)
Revolving credit agreement pursuant to a revolving loan agreement .... $ 731 $ -
Term installment note ................................................ 1,559 1,369
Obligations under capitalized leases, due in monthly installments
through 2002, secured by laboratory equipment, office equipment and
computer software, interest rates ranging from 6% to 10% ............ 1,540 2,699
3,830 4,068
------- -------
Less: current portion and revolving line of credit ................... (2,099) (1,475)
------- -------
Long-term portion .................................................... $ 1,731 $ 2,593
======= =======
31
32
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Future principal payments at December 31, 2000 are as follows (in thousands):
AMOUNT
------
2001 ......................... $2,099
2002 ......................... 1,086
2003 ......................... 456
2004 ......................... 190
------
Total Debt ................... $3,830
======
On May 15, 2000, we entered into an amended and restated Loan and Security
Agreement ("Credit Agreement) with our bank. The amended Credit Agreement
reflects similar terms and conditions to the predecessor agreement covering our
revolving line of credit and variable rate installment note ("Installment
Note"). The amended Credit Agreement provides for borrowings under the revolving
line of credit limited to 85% of qualified accounts receivables (up to a maximum
of $6,000,000), is secured by a lien on substantially all of our assets
(excluding computer software) and carries a commitment fee equal to 0.25% of the
maximum line of credit. The Credit Agreement contains certain financial
covenants, which, among others, require PharmChem to maintain certain ratios of
working capital and net worth. The Credit Agreement permits up to $2,000,000 of
the revolving line of credit to be used to repurchase our common stock under our
common stock repurchase program and permits the declaration and distribution of
a dividend in connection with our stockholder rights plan.
At December 31, 2000, the calculated maximum that could be borrowed and the
amount outstanding under the Credit Agreement were $5,834,000 and $731,000,
respectively. Advances under the revolving line of credit carry interest at
either the prime rate plus 0.5% or LIBOR plus 3.25%. As of December 31, 2000, we
were in compliance with all covenants except that we exceeded the limitation on
annual capital expenditures, for which we obtained a waiver.
On September 7, 2000, we entered into a $1,674,000 Installment Note with our
bank. The majority of the proceeds from the Installment Note were immediately
used to pay off the amount outstanding under a separate $1,500,000 installment
note. The Installment Note is subject to the terms and conditions of the amended
Credit Agreement, currently bears interest at the prime rate plus 0.5% and is
payable over 43 months.
On April 30, 1999, we entered into a $1,082,000 financing lease agreement
with a lessor to refinance certain modules of our Unified Database software
project. The lease agreement bears interest at 8.5% and is payable over 36
months. The proceeds from the lease were used to reduce amounts outstanding
under the revolving line of credit. On November 23, 1999, we entered into a
$1,200,000 financing lease agreement with a lessor to refinance certain other
modules of our Unified Database software project. The lease agreement bears
interest at 9.5% and is payable over 36 months. The proceeds from the lease were
used to reduce amounts outstanding under the revolving line of credit and for
capital expenditures. These leases have been accounted for as capital leases.
We have leased certain laboratory equipment, office equipment and computer
software with an original cost of approximately $4,357,000 and $4,422,000 under
capital lease agreements at December 31, 2000 and 1999, respectively. The
accumulated depreciation of such leased equipment was approximately $1,714,000
and $1,159,000 at December 31, 2000 and 1999, respectively. At December 31,
2000, the future minimum lease payments, together with the present value of the
net minimum lease payments under these agreements, were as follows (in
thousands):
32
33
AMOUNT
-------
2001 ............................................... $ 1,012
2002 ............................................... 654
-------
Total minimum lease payments ................... 1,666
Less: amount representing interest ............. (126)
-------
Present value of net minimum lease payments .... $ 1,540
=======
4. INCOME TAXES
The income before income taxes based upon the geographic locations of our
operations consisted of the following for the year ended December 31:
2000 1999 1998
-------- -------- --------
Pre-tax income: (In thousands)
Domestic ............. $ 503 $ 1,232 $ 148
Foreign .............. 1,630 1,274 773
-------- -------- --------
Consolidated ......... $ 2,133 $ 2,506 $ 921
======== ======== ========
The provision for (benefit from) income taxes consisted of the following for
the year ended December 31:
2000 1999 1998
-------- -------- --------
(In thousands)
Current:
Federal ........................................ $ - $ (326) $ -
State .......................................... 4 5 5
Foreign ........................................ 518 467 129
-------- -------- --------
Total current ................................ 522 146 134
-------- -------- --------
Deferred:
Federal ........................................ 157 (170) 83
State .......................................... 103 (224) 27
Foreign ........................................ (10) (46) 42
-------- -------- --------
Total deferred ............................... 250 (440) 152
-------- -------- --------
Provision for (benefit from) income taxes .... $ 772 $ (294) $ 286
======== ======== ========
33
34
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Undistributed earnings at our foreign subsidiary are not significant. We
reconciled the provision for income taxes with the federal statutory rate for
the year ended December 31 as follows:
2000 1999 1998
-------- -------- --------
(In thousands)
Tax provision computed at the federal statutory tax rate ... $ 725 $ 852 $ 313
State taxes, net of federal tax benefit .................... 18 47 13
Utilization of net operating loss carryforwards ............ - (277) (146)
Effects of foreign operations .............................. (65) (40) (1)
Amortization of goodwill and other permanent differences ... 106 377 131
Change in the beginning of the year valuation allowance .... 48 (975) (24)
Reversal of accrual no longer required ..................... (73) (336) -
Other ...................................................... 13 58 -
-------- -------- --------
Provision for (benefit from) income taxes ..... $ 772 $ (294) $ 286
======== ======== ========
The major components of temporary differences which give rise to the
deferred tax accounts at December 31 are as follows:
2000 1999
------- -------
(In thousands)
Current deferred tax assets:
Reserves and accruals ............................ $ 357 $ 516
Net operating loss carryforwards ................. 119 195
------- -------
Total gross current asset .................... 476 711
Deferred tax valuation allowance ................. (90) (103)
------- -------
Net current asset ............................ $ 386 $ 608
======= =======
Non-current deferred tax assets:
Net operating loss carryforwards ................. $ 430 $ 179
Difference between book and tax depreciation ..... 252 424
Capital loss carryforwards ....................... 189 198
Research tax credit carryforwards and other ...... 135 172
------- -------
Total gross non-current asset ................ 1,006 973
Deferred tax asset valuation allowance ........... (316) (255)
------- -------
Net non-current asset ........................ $ 690 $ 718
======= =======
Total net deferred tax asset ............................... $ 1,076 $ 1,326
======= =======
The increase in the deferred tax valuation allowance in 2000 principally
reflects our revised expectations for the realization of state net operating
loss carryforwards. In the fourth quarter of 1999, we recognized an income tax
benefit of approximately $440,000 from reducing the valuation allowance
primarily as a result of the continued improvement in our operating results and
prospects and, in addition, we offset approximately $347,000 of federal and
state taxes with utilization of net operating loss carryforwards. The
recognition of the net deferred tax asset is based upon the expected
34
35
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
utilization of net operating loss carryforwards that we believe will more likely
than not be realized. The net change in the valuation allowance was an increase
(decrease) of $48,000, $(1,252,000) and $(24,000) in 2000, 1999 and 1998,
respectively.
We have classified the long-term deferred tax asset with "Other assets" on
the accompanying Consolidated Balance Sheets. Deferred income taxes reflect the
net tax effects of temporary differences between the carrying amounts of assets
and liabilities for financial reporting and income tax purposes. Although
realization is not assured, we believe more likely than not that the net
deferred tax asset will be realized in the future primarily from the generation
of US source taxable income. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carryforward periods are lowered or are lower than
currently estimated.
As of December 31, 2000, we have net operating loss carryforwards for
federal and state income tax reporting purposes of approximately $1,445,000 and
$979,000, respectively. The federal loss carryforwards expire at various dates
through 2019 and the state loss carryforwards expire at various dates through
2005. The Tax Reform Act of 1986 contains provisions which may limit the net
operating loss carryforwards to be used in any given year upon the occurrence of
certain events, including a significant change of ownership.
In the first quarter of 1999, we successfully appealed a Notice of
Deficiency issued by the Internal Revenue Service (IRS) during its examination
of our income tax returns for years 1990 to 1995. The IRS had challenged the
deductibility of research expenses related to the development of the
PharmChek(R) sweat patch device. As a result of this favorable ruling, we
reversed a $336,000 reserve that was no longer required.
5. INCENTIVE STOCK PLANS AND STOCK REPURCHASE PROGRAM
1997 AND 1988 INCENTIVE STOCK PLANS
In May 1997, our stockholders approved the 1997 Incentive Stock Plan whereby
stock options, including incentive stock options, non-qualified options,
restricted shares, performance shares, bonus shares and stock appreciation
rights may be granted to employees, consultants and directors, for up to 500,000
shares of common stock. This 1997 Plan, which expires in 2007, is administered
by the Officers Compensation Committee of the Board of Directors. The Committee
determines the term of each stock option (up to a maximum of ten years). The
exercise price cannot be less than 100% of the fair market value of the common
stock on the date the option is granted. Unless the Committee determines
otherwise, options will be exercisable with respect to 6.25% of the granted
shares on the first day of each of the first sixteen calendar quarters after the
grant date. As of December 31, 2000, we had granted 328,059 options and canceled
6,000 options. No options have been exercised under the 1997 Plan.
In November 1988, we adopted the 1988 Incentive Stock Plan. The 1988 Plan
expired in 1998. Under the 1988 Plan, nonstatutory options and stock purchase
rights could be granted to employees and consultants, while incentive stock
options could only be granted to employees, for up to a total of 1,280,000
shares of common stock. Options granted under the 1988 Plan vest generally over
a 48-month period and expire ten years after the grant date. Effective March 24,
1998 we engaged in a stock option exchange program that effectively repriced all
then outstanding options having an exercise price above the then current market
price of $2.375. See "Repriced granted/canceled" in the following table. The
repriced options began vesting effective April 24, 1998 over a 48-month period.
The exercise price for all options exchanged was $2.375.
35
36
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Options to purchase approximately 604,931, 453,790 and 244,081 shares of
common stock under the 1988 and 1997 incentive stock option plans were
exercisable at December 31, 2000, 1999 and 1998 respectively. Option information
for the periods presented is as follows:
OPTIONS OUTSTANDING
------------------------
WEIGHTED
OPTIONS AVERAGE
AVAILABLE NUMBER EXERCISE
FOR GRANT OF OPTIONS PRICE
--------- ---------- --------
Balance at December 31, 1997 ........... 625,678 628,904 $ 3.55
-------- -------- --------
1988 Plan expiration ............ (7,739) - -
Granted ......................... (370,250) 370,250 2.45
Canceled ........................ 42,252 (42,252) 3.31
Exercised ....................... - (18,394) 2.02
Repriced granted ................ (463,480) 463,480 2.38
Repriced canceled ............... 463,480 (463,480) 3.95
-------- -------- --------
Balance at December 31, 1998 ........... 289,941 938,508 2.95
-------- -------- --------
Granted ......................... (30,000) 30,000 3.38
Canceled ........................ - (33,377) 2.38
Exercised ....................... - (8,123) 2.38
-------- -------- --------
Balance at December 31, 1999 ........... 259,941 927,008 2.41
-------- -------- --------
GRANTED ......................... (88,000) 88,000 4.40
CANCELED ........................ 6,000 (46,545) 2.61
EXERCISED ....................... - (42,481) 2.34
-------- -------- --------
BALANCE AT DECEMBER 31, 2000 ........... 177,941 925,982 $ 2.59
======== ======== ========
1992 DIRECTOR OPTION PLAN
In May 1992, we adopted the 1992 Director Option Plan ("the Director Plan")
and reserved 250,000 shares of common stock for issuance under this plan. On
March 22, 1997, we changed the Director Plan to provide for grants to outside
directors only. The options vest over a 48-month period and are granted at fair
market value. Options granted prior to 2000 expire five years from the original
grant date. On November 30, 1999, the Director Plan was amended to change the
date of automatic grants from January 1 to March 1. On February 18, 2000, the
Director Plan was amended to increase the number of annual option grants to each
director to 10,000 from 5,000, to increase the life of newly issued option
grants to 10 years from 5 years and to extend the expiration date of the
Director Plan to March 31, 2004. Options to purchase approximately 25,307,
15,204 and 37,601 shares of common stock under the Director Plan were
exercisable at December 31, 2000, 1999 and 1998, respectively.
36
37
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Option information for the periods presented is as follows:
OPTIONS OUTSTANDING
------------------------
OPTIONS WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR GRANT OF OPTIONS PRICE
--------- ---------- --------
Balance at December 31, 1996 ........... 110,626 130,000 $ 3.32
-------- -------- --------
Granted ......................... (10,000) 10,000 5.25
Canceled ........................ 30,000 (30,000) 8.75
-------- -------- --------
Balance at December 31, 1997 ........... 130,626 110,000 3.52
-------- -------- --------
Granted ......................... (15,000) 15,000 2.58
Canceled ........................ 62,187 (62,187) 4.05
Exercised ....................... - (12,813) 2.00
-------- -------- --------
Balance at December 31, 1998 ........... 177,813 50,000 2.38
-------- -------- --------
Granted ......................... (10,000) 10,000 4.63
Canceled ........................ 15,000 (15,000) 2.88
Exercised ....................... - (15,000) 2.00
-------- -------- --------
Balance at December 31, 1999 ........... 182,813 30,000 4.02
-------- -------- --------
GRANTED ......................... (20,000) 20,000 5.00
-------- -------- --------
BALANCE AT DECEMBER 31, 2000 ........... 162,813 50,000 $ 4.41
======== ======== ========
The following summarizes information about all stock option plans at December
31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------- -------------------------
WEIGHTED AVG. WEIGHTED
WEIGHTED REMAINING AVERAGE
RANGE OF OPTIONS AVERAGE CONTRACTUAL OPTIONS EXERCISE
EXERCISE PRICE OUTSTANDING EXERCISE PRICE LIFE EXERCISABLE PRICE
- -------------------- ----------- -------------- ------------- ----------- ---------
$ 2.00 79,052 $ 2.00 4.0 Years 79,052 $ 2.00
2.38 672,430 2.38 7.3 Years 461,706 2.38
2.50 - 5.25 224,500 3.87 7.6 Years 89,480 3.63
- -------------------- --------- --------- --------- --------- ---------
$2.00 - $5.25 975,982 $ 2.69 7.1 Years 630,238 $ 2.51
==================== ========= ========= ========= ========= =========
37
38
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PROFORMA INFORMATION
We continue to apply APB No. 25 in accounting for our stock based
compensation plans. Accordingly, no compensation cost has been recorded in the
consolidated statements of operations for the stock option plans. If we had
determined compensation cost for our stock based compensation plans in
accordance with the fair value method prescribed by SFAS No. 123, our proforma
net income and earnings per share for the years ended December 31 would have
been as follows:
2000 1999 1998
--------- --------- ---------
(In thousands, except per
share amounts)
Net income, as reported ..................... $ 1,361 $ 2,800 $ 635
Net income, pro forma ....................... 1,190 2,580 278
Basic earnings per share, as reported ....... $ 0.23 $ 0.48 $ 0.11
Basic earnings per share, pro forma ......... 0.20 0.45 0.05
Diluted earnings per share, as reported ..... 0.22 0.47 0.10
Diluted loss per share, pro forma ........... 0.20 0.44 0.05
The weighted average fair values of options granted during 2000, 1999 and
1998 were $2.92, $2.26 and $1.44, respectively. We estimate the fair value of
each grant on the date of grant using the Binomial option pricing model with the
following weighted average assumptions:
2000 1999 1998
-------- -------- --------
Risk free rate of return ............... 6% 5% 5%
Option lives in years .................. 3 TO 5 3 to 5 3 to 5
Annual volatility of stock price ....... 93% 89% 89%
Dividend yield ......................... 0.0% 0.0% 0.0%
The above proforma amounts include compensation expense for options granted
since January 1, 1995, and may not be representative of that to be expected in
future years.
COMMON STOCK REPURCHASE PROGRAM
In November, 1999, our Board of Directors approved a common stock repurchase
program whereby we are able to purchase up to 300,000 shares (approximately 5%)
of our common stock from time to time on the open market or in privately
negotiated sales. In connection with this program, our bank has authorized up to
$2.0 million from our existing Credit Agreement to be used toward repurchase of
our common stock under this program. The repurchase program contains certain
restrictions, including limitations on the quantity of, bid price and timing of
stock purchases. As of December 31, 2000, no shares have been repurchased.
38
39
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. EARNINGS PER SHARE
The calculations of basic and diluted earnings per share are as follows:
2000 1999 1998
-------- -------- --------
(In thousands, except per
share amounts)
Net income ............................................... $ 1,361 $ 2,800 $ 635
======== ======== ========
Denominator for basic earnings per share - weighted
average common shares ..................... 5,822 5,786 5,764
Dilutive stock options ................................... 247 168 474
-------- -------- --------
Denominator for diluted earnings per share ............... 6,069 5,954 6,238
======== ======== ========
Basic earnings per share ................................. $ 0.23 $ 0.48 $ 0.11
======== ======== ========
Diluted earnings per share ............................... $ 0.22 $ 0.47 $ 0.10
======== ======== ========
We did not include options to purchase 105,000, 113,500 and 5,000 shares of
our common stock at December 31, 2000, 1999 and 1998, respectively, in the
computation of diluted earnings per share because their exercise prices were
greater than the average market share price of our common stock of $3.40, $2.92
and $4.63, respectively.
7. PROFIT SHARING PLAN
We have a 401(k) plan which is available to all employees who have reached
age 18 and have completed at least three consecutive months of service. The
401(k) Plan provides that each participant may contribute a portion of his or
her salary, within certain limits prescribed by U.S. tax laws. We will make a
matching contribution of at least 10% of the amount contributed by each
participant. We may make additional matching or discretionary profit sharing
contributions. Our contributions vest after three years of service. The total
contribution expenses we recorded were $57,000, $73,000 and $46,000 for 1999,
1999 and 1998, respectively.
8. STOCKHOLDER RIGHTS PLAN
On November 30, 1999 our Board of Directors adopted a stockholder rights
plan designed to protect the long-term value of PharmChem for its stockholders
if there were a future unsolicited acquisition attempt. In connection with the
plan, our Board declared a dividend of one preferred share purchase right for
each share of PharmChem's Common Stock on the November 30, 1999 record date and
further directed the issuance of one such right with respect to each share of
our Common Stock that we issue after the record date, except in certain
circumstances. Each right will entitle a stockholder to buy 1/100 of a share of
preferred stock at an exercise price of $35.00 which will be subject to
adjustment in certain circumstances.
Subject to certain exceptions, if a person or group acquires 15% or more of
our outstanding Common Stock, commences, or announces an intention to make, a
tender offer, consummation of which would result in the ownership of 15% or more
of our outstanding Common Stock, each right will entitle its holder (other than
such person or members of such group) to purchase, at the right's then-current
exercise price, a number of our common shares having a market value of twice the
right's exercise price. Such person or group will not include a 15% stockholder
holding more than 15% of the outstanding common shares at the time of adoption
of the plan who may accumulate up to 25% of our common shares before triggering
the rights. In addition, if at any time after a person or group (other than
certain
39
40
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
exempt persons) acquires 15% or more of our common shares or we are acquired in
a merger or other business combination transaction, each right will entitle its
holder to purchase, at a right's then-current exercise price, a number of the
acquiring company's common shares having a market value at the time of twice the
right's exercise price. The rights will expire on November 30, 2009. Our bank
modified the Credit Agreement to permit the declaration and distribution of a
dividend in connection with this stockholder rights plan.
On December 19, 2000 our Board of Directors amended the stockholder rights
plan to increase the threshold for existing 15% stockholders to a 27% ownership
level from a 25% ownership level.
9. COMMITMENTS AND CONTINGENCIES
Future minimum lease payments under noncancellable operating leases for our
office, laboratory and warehouse space at December 31, 2000 were as follows (in
thousands):
AMOUNT
------
2001 ......................... $ 561
2002 ......................... 305
2003 ......................... 204
2004 ......................... 98
2005 & thereafter ............ 51
------
Total commitments .......... $1,219
======
Rental expense for operating leases amounted to approximately $1,263,000,
$1,251,000 and $1,199,000 for the years ended December 31, 2000, 1999 and 1998,
respectively.
In connection with the original employment and relocation of one employee,
we have committed to participate in the purchase of the employee's residence.
Pursuant to this commitment, we have an outstanding receivable from the employee
of $109,000 at December 31, 2000 and 1999. We included this loan in "Prepaids
and other current assets" and "Other assets" in the accompanying consolidated
balance sheets as of December 31, 2000 and 1999, respectively. The loan is due
in 2001 unless employment terminates, certain other maturity events occur or the
due date is extended. The loan is secured by a deed of trust on the residence
and earns contingent interest on the net proceeds from the sale of the
employee's residence. In certain circumstances, we are contingently liable for a
portion of the mortgage payments, insurance costs and property taxes, until such
time as the property is sold.
We are the defendant in certain legal matters which are normal for the
industry in which we operate. Our management believes that these matters, both
individually and in the aggregate, will not have a material adverse impact on
PharmChem's financial position or results of operations.
10. REPORTABLE SEGMENTS
We have two reportable segments, Domestic and International, providing
integrated drug testing services. The Domestic segment serves the United States
and the International segment serves primarily the United Kingdom (60% of
international sales in 2000) and also includes the European, Asian, Middle
Eastern and South American markets. PharmChem's California and Texas operations
service the Domestic segment and Medscreen services the International segment.
The accounting policies of the segments are the same as those described in the
Summary of Significant Accounting Policies in the accompanying notes to the
consolidated financial statements. We evaluate segment profit
40
41
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
based on income or loss from operations before intercompany interest, other
income or expense and income taxes and excluding goodwill amortization.
Intersegment sales and transfers are not material. Information about our
segments as of and for the years ended December 31 is as follows:
DOMESTIC INTERNATIONAL TOTAL
--------- ------------- ---------
(In thousands)
2000: Net sales from external
customers ....................... $ 39,394 $ 7,438 $ 46,832
Depreciation and amortization .... 1,955 297 2,252
Segment profit ................... 927 1,649 2,576
Segment assets ................... 21,016 6,249 27,265
Expenditures for segment
assets .......................... 3,470 76 3,546
1999: Net sales from external
customers ....................... $ 37,411 $ 7,076 $ 44,487
Depreciation and amortization .... 1,783 274 2,057
Segment profit ................... 1,665 1,274 2,939
Segment assets ................... 18,410 6,636 25,046
Expenditures for segment
assets .......................... 2,812 195 3,007
1998: Net sales from external
customers ....................... $ 36,764 $ 6,408 $ 43,172
Depreciation and amortization .... 1,731 268 1,999
Segment profit ................... 584 810 1,394
Segment assets ................... 16,324 5,739 22,063
Expenditures for segment
assets .......................... 2,550 339 2,889
Two customers of the Domestic segment accounted for the following as a
percentage of our consolidated net sales for the year ended December 31:
2000 1999 1998
-------- -------- --------
Customer A ......... 17.8% 18.9% 18.3%
Customer B ......... 11.4% 10.3% 11.1%
11. SUBSEQUENT EVENT
On January 3, 2001, we completed a $2,363,000 financing lease agreement with
a group of lessors to refinance certain modules of ATLAS, our new laboratory
information management system. The lease agreement bears interest at 8.9% and is
payable over 36 to 48 months. The proceeds from the lease will be used to reduce
amounts outstanding under our revolving line of credit and to fund additional
capital expenditures. This lease has been accounted for as a capital lease.
41
42
PHARMCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized selected quarterly financial data is as follows:
QUARTER ENDED
----------------------------------------------
3/31 6/30 9/30 12/31
------- ------- ------- -------
(In thousands, except per share amounts)
2000:
Net sales ......................................... $10,608 $11,580 $11,956 $12,688
Gross profit ...................................... 3,398 3,520 3,493 3,484
Net income ........................................ 282 374 403 302
Basic earnings per share .......................... $ 0.05 $ 0.06 $ 0.07 $ 0.05
Diluted earnings per share ........................ $ 0.05 $ 0.06 $ 0.07 $ 0.05
Basic weighted average shares outstanding ......... 5,809 5,823 5,824 5,833
Diluted weighted average shares outstanding ....... 6,170 5,986 6,063 6,063
1999:
Net sales ......................................... $10,174 $11,149 $11,870 $11,294
Gross profit ...................................... 2,950 3,284 3,701 3,178
Net income ........................................ 583 361 774 1,082
Basic earnings per share .......................... $ 0.10 $ 0.06 $ 0.13 $ 0.19
Diluted earnings per share ........................ $ 0.10 $ 0.06 $ 0.13 $ 0.18
Basic weighted average shares outstanding ......... 5,782 5,784 5,784 5,794
Diluted weighted average shares outstanding ....... 6,096 5,903 5,857 5,960
42
43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On May 16, 2000 our Board of Directors approved the appointment of Gallagher
& Co. to replace KPMG LLP as Medscreen's auditors for the 2000 fiscal year. The
audit reports of KPMG LLP issued for Medscreen's financial statements for either
of the past two years have not contained an adverse opinion or a disclaimer of
opinion, nor have its opinions been qualified or modified as to uncertainty,
audit scope or accounting principles. During our two most recent fiscal years
and the subsequent interim period preceding their replacement, there were no
disagreements with KPMG LLP on any matter of accounting principles or practice,
financial statement disclosure or auditing scope or procedure, which
disagreement(s), if not resolved to the satisfaction of KPMG LLP, caused it to
make a reference to the subject matter of the disagreement in connection with
its reports.
PART III
ITEMS 10 TO 13 INCLUSIVE
We have omitted these items in accordance with the General Instructions to
Form 10-K. Information regarding our Directors is incorporated by reference to
PharmChem's Proxy Statement to be filed with the Securities and Exchange
Commission in connection with our 2001 Annual Meeting of Stockholders.
Information regarding our Executive officers can be found in Part I this
Annual Report on Form 10-K on page 11.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS.
PAGE
NUMBER
IN THIS
REPORT
-------
Independent Auditors' Report ....................................................................... 22
Consolidated Balance Sheets at December 31, 2000 and 1999 .......................................... 23
Consolidated Income Statements for the years ended December 31, 2000, 1999 and 1998 ............... 24
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2000, 1999 and 1998 ................................................................. 25
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000,
1999 and 1998 .................................................................................... 26
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 ......... 27
Notes to Consolidated Financial Statements ......................................................... 28
(a) (2) FINANCIAL STATEMENT SCHEDULE
Schedule II Valuation and Qualifying Accounts ...................................................... 47
All other schedules are omitted because they are not applicable, not
required, or the required information is shown in the Consolidated Financial
Statements or notes thereto.
43
44
(a) (3) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
2.01(1) Agreement and Plan of Merger of PharmChem, Inc., a Delaware
corporation, and PharmChem Laboratories, Inc., a California
corporation
2.02(1) Certificate of Merger of PharmChem Laboratories, Inc. into
PharmChem, Inc.
3.01(1) Certificate of Incorporation of PharmChem, Inc.
3.02(1) Bylaws of PharmChem, Inc.
4.01(2) Restated Modification Agreement dated August 14, 1989.
10.01(2) 1988 Incentive Stock Plan, as amended.
10.02(5) Form of Stock Option Agreement.
10.03(2) Form of Stock Option Agreement (providing for accelerated vesting
upon death or disability).
10.04(5) Form of Stock Option Agreement (January 1, 1995).
10.05(2) Form of Stock Purchase Agreement.
10.06(3) 1992 Director Option Plan.
10.07(3) Form of Director Option Agreement.
10.08(7) Amendment Number 1 to 1992 Director Option Plan dated February
28, 1996.
10.09(7) Amendment Number 2 to 1992 Director Option Plan dated March 4,
1997.
10.10(14) Amendment Number 3 to 1992 Director Option Plan dated November
30, 1999.
10.11(15) Amendment Number 4 to 1992 Director Option Plan dated February
18, 2000.
10.12(8) 1997 Equity Incentive Plan.
10.13(8) Form of Stock Option Agreement (Nonstatutory Stock Option) in
connection with the 1997 Equity Incentive Plan.
10.14(8) Stock Option Agreement (Incentive Stock Option) in connection
with the 1997 Equity Incentive Plan.
10.15(2) 401(k) Plan.
10.16(7) Amendment to 401(k) Plan dated August 25, 1996.
10.17(10) Amendment to 401(k) Plan dated September 15, 1998.
10.18(11) Rights Agreement dated November 30, 1999.
10.19(17) Amendment to Rights Agreement dated December 18, 2000.
10.20(2) Lease Agreements for the Company's offices in Menlo Park,
California dated October 21, 1988 and September 11, 1990,
respectively.
10.21(6) Lease Amendment for the Company's offices in Menlo Park,
California dated November 30, 1995.
10.22(7) Lease Amendment for the Company's offices in Menlo Park,
California dated March 6, 1996.
10.23(13) Lease Amendment for the Company's distribution center in Menlo
Park, California dated May 7, 1999.
10.24(4) Harbour Quay (London) Lease Documents.
10.25(7) Lease Agreement for the Company's offices in Fort Worth, Texas
dated October 24, 1991.
10.26(7) Lease Amendment for the Company's offices in Fort Worth, Texas
dated December 8, 1992.
44
45
10.27(7) Lease Amendment for the Company's offices in Fort Worth, Texas
dated February 9, 1996.
10.28(1) Amended and Restated Loan and Security Agreement between Comerica
Bank of California and PharmChem Laboratories, Inc. dated May 15,
2000.
10.29(1) Intellectual Property Security Agreement between Comerica Bank of
California and PharmChem Laboratories, Inc. dated May 15, 2000.
10.30(16) Modification to Loan and Security Agreement between Comerica Bank
of California and PharmChem, Inc. dated September 7, 2000.
10.31(16) Variable Rate Installment Note between Comerica Bank of
California and PharmChem, Inc. dated September 7, 2000.
10.32(16) Form of Indemnification Agreement.
10.33(12) Lease Agreement for computer software between American
Technologies Credit, Inc. and PharmChem, Inc. dated March 29,
1999.
10.34(14) Lease Agreement for computer software between Jules and
Associates, Inc. and PharmChem, Inc. dated November 23, 1999.
10.35(3,9) License and Supply Agreement with Sudormed, Inc. dated March 10,
1992.
10.36(4,9) License and Supply Agreement with Sudormed, Inc. dated October
25, 1993.
10.37(4,9) Supply Agreement with SolarCare Technologies Corporation dated
August 1, 1993.
10.38(6,9) First Amendment to Supply Agreement dated December 1, 1995.
10.39(8) Master Lease Purchase Agreement dated December 18, 1995 with
Fidelity Leasing Corporation and Lease Purchase Addenda in
connection therewith.
10.40(8) Master Equipment Lease dated March 17, 1996 with Olympus
Commercial Credit.
21.01 List of Subsidiaries.
23.01 Consent of KPMG LLP, Independent Certified Public Accountants.
(1) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2000.
(2) Incorporated by reference from the Company's Registration Statement on
Form S-1 (File No. 33-41363), effective August 8, 1991.
(3) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1992.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995.
(7) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996.
(8) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1997.
(9) Confidential treatment requested as to certain portions of this exhibit.
(10) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998.
(11) Incorporated by reference from the Company's Current Report on Form 8-K
dated December 6, 1999.
(12) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 1999.
45
46
(13) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1999.
(14) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1999.
(15) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2000.
(16) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 2000.
(17) Incorporated by reference from the Company's Current Report on Form 8-K
dated December 19, 2000.
(b) REPORTS ON FORM 8-K
Report on Form 8-K dated December 19, 2000.
(c) EXHIBITS
See (a) (3) above.
(d) FINANCIAL STATEMENT SCHEDULE
See (a) (2) above.
46
47
PHARMCHEM, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
CHARGED TO
BALANCE AT (REDUCTION BALANCE AT
BEGINNING OF) COSTS AND END
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
---------- ------------- ---------- ----------
Allowance for Doubtful Accounts
Year ended:
December 31, 1998 ...................... $ 468 $ 325 $ 231 $ 562
======== ======== ======== ========
December 31, 1999 ...................... $ 562 $ 141 $ 158 $ 545
======== ======== ======== ========
DECEMBER 31, 2000 ...................... $ 545 $ (119) $ 50 $ 376
======== ======== ======== ========
47
48
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF MENLO
PARK, STATE OF CALIFORNIA, ON THIS 6TH DAY OF MARCH, 2001.
PHARMCHEM, INC.
BY: /S/ Joseph W. Halligan
--------------------------------------
JOSEPH W. HALLIGAN
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Joseph W. Halligan, acting
individually, as such person's true and lawful attorney-in-fact and agent, with
full power of substitution, for such person, in any and all capacities, to sign
any and all amendments (including post-effective amendments) to this report on
Form 10-K, and to file the same, with all exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorney-in-fact and agent, full power and authority to do and perform
each and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as such person might or could do
in person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitutes, may do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT ON FORM 10-K HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF
THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Joseph W. Halligan
----------------------
Joseph W. Halligan President, Chief Executive Officer March 6, 2001
and Director (Principal Executive
Officer)
/s/ David A. Lattanzio
----------------------
David A. Lattanzio Chief Financial Officer, Vice March 6, 2001
President, Finance and
Administration (Principal
Accounting and Financial
Officer) and Secretary
/s/ Richard D. Irwin
--------------------
Richard D. Irwin Chairman of the Board and Director March 6, 2001
/s/ Donald R. Stroben
---------------------
Donald R. Stroben Director March 6, 2001
48
49
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------
2.01(1) Agreement and Plan of Merger of PharmChem, Inc., a Delaware
corporation, and PharmChem Laboratories, Inc., a California
corporation
2.02(1) Certificate of Merger of PharmChem Laboratories, Inc. into
PharmChem, Inc.
3.01(1) Certificate of Incorporation of PharmChem, Inc.
3.02(1) Bylaws of PharmChem, Inc.
4.01(2) Restated Modification Agreement dated August 14, 1989.
10.01(2) 1988 Incentive Stock Plan, as amended.
10.02(5) Form of Stock Option Agreement.
10.03(2) Form of Stock Option Agreement (providing for accelerated vesting
upon death or disability).
10.04(5) Form of Stock Option Agreement (January 1, 1995).
10.05(2) Form of Stock Purchase Agreement.
10.06(3) 1992 Director Option Plan.
10.07(3) Form of Director Option Agreement.
10.08(7) Amendment Number 1 to 1992 Director Option Plan dated February
28, 1996.
10.09(7) Amendment Number 2 to 1992 Director Option Plan dated March 4,
1997.
10.10(14) Amendment Number 3 to 1992 Director Option Plan dated November
30, 1999.
10.11(15) Amendment Number 4 to 1992 Director Option Plan dated February
18, 2000.
10.12(8) 1997 Equity Incentive Plan.
10.13(8) Form of Stock Option Agreement (Nonstatutory Stock Option) in
connection with the 1997 Equity Incentive Plan.
10.14(8) Stock Option Agreement (Incentive Stock Option) in connection
with the 1997 Equity Incentive Plan.
10.15(2) 401(k) Plan.
10.16(7) Amendment to 401(k) Plan dated August 25, 1996.
10.17(10) Amendment to 401(k) Plan dated September 15, 1998.
10.18(11) Rights Agreement dated November 30, 1999.
10.19(17) Amendment to Rights Agreement dated December 18, 2000.
10.20(2) Lease Agreements for the Company's offices in Menlo Park,
California dated October 21, 1988 and September 11, 1990,
respectively.
10.21(6) Lease Amendment for the Company's offices in Menlo Park,
California dated November 30, 1995.
10.22(7) Lease Amendment for the Company's offices in Menlo Park,
California dated March 6, 1996.
10.23(13) Lease Amendment for the Company's distribution center in Menlo
Park, California dated May 7, 1999.
10.24(4) Harbour Quay (London) Lease Documents.
10.25(7) Lease Agreement for the Company's offices in Fort Worth, Texas
dated October 24, 1991.
10.26(7) Lease Amendment for the Company's offices in Fort Worth, Texas
dated December 8, 1992.
50
10.27(7) Lease Amendment for the Company's offices in Fort Worth, Texas
dated February 9, 1996.
10.28(1) Amended and Restated Loan and Security Agreement between Comerica
Bank of California and PharmChem Laboratories, Inc. dated May 15,
2000.
10.29(1) Intellectual Property Security Agreement between Comerica Bank of
California and PharmChem Laboratories, Inc. dated May 15, 2000.
10.30(16) Modification to Loan and Security Agreement between Comerica Bank
of California and PharmChem, Inc. dated September 7, 2000.
10.31(16) Variable Rate Installment Note between Comerica Bank of
California and PharmChem, Inc. dated September 7, 2000.
10.32(16) Form of Indemnification Agreement.
10.33(12) Lease Agreement for computer software between American
Technologies Credit, Inc. and PharmChem, Inc. dated March 29,
1999.
10.34(14) Lease Agreement for computer software between Jules and
Associates, Inc. and PharmChem, Inc. dated November 23, 1999.
10.35(3,9) License and Supply Agreement with Sudormed, Inc. dated March 10,
1992.
10.36(4,9) License and Supply Agreement with Sudormed, Inc. dated October
25, 1993.
10.37(4,9) Supply Agreement with SolarCare Technologies Corporation dated
August 1, 1993.
10.38(6,9) First Amendment to Supply Agreement dated December 1, 1995.
10.39(8) Master Lease Purchase Agreement dated December 18, 1995 with
Fidelity Leasing Corporation and Lease Purchase Addenda in
connection therewith.
10.40(8) Master Equipment Lease dated March 17, 1996 with Olympus
Commercial Credit.
21.01 List of Subsidiaries.
23.01 Consent of KPMG LLP, Independent Certified Public Accountants.
(1) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2000.
(2) Incorporated by reference from the Company's Registration Statement on
Form S-1 (File No. 33-41363), effective August 8, 1991.
(3) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1992.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995.
(7) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996.
(8) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1997.
(9) Confidential treatment requested as to certain portions of this exhibit.
(10) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998.
(11) Incorporated by reference from the Company's Current Report on Form 8-K
dated December 6, 1999.
(12) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 1999.
51
(13) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1999.
(14) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1999.
(15) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2000.
(16) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 2000.
(17) Incorporated by reference from the Company's Current Report on Form 8-K
dated December 19, 2000.