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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NUMBER: 1-13738
PSYCHEMEDICS CORPORATION
(exact name of registrant as specified in its charter)
Delaware 58-1701987
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1280 Massachusetts Ave., Cambridge, MA 02138
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 617-868-7455
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.005 Par Value American Stock Exchange
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(Title of class) (name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-B is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
On March 14, 1997 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $ 91,553,934 and 21,827,791 shares of
Common Stock, $.005 par value, were outstanding at such date.
DOCUMENTS INCORPORATED BY REFERENCE
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Part III - Portions of the Registrant's Proxy Statement relative to the 1997
Annual Meeting of Stockholders to be held on May 8, 1997.
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PART I
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The information provided by the Company in this Report may contain
"forward-looking" information which involves risks and uncertainties, such as
statements of the Company's plans, objectives, expectations and intentions. The
cautionary statements made in this report should be read as being applicable to
all forward-looking statements wherever they appear in this report. The
Company's actual results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include those
discussed in Item 7 below, as well as those discussed elsewhere herein.
Item 1. Business
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GENERAL
Psychemedics Corporation ("the Company") is a Delaware corporation organized on
September 24, 1986 to provide testing services for the detection of abused
substances through the analysis of hair samples. The Company's testing methods
utilize a patented technology for performing immunoassays on enzymatically
dissolved hair samples with confirmation testing by gas chromatography/mass
spectrometry ("GC/MS").
The Company's first application of its patented technology is a testing service
which screens for the presence of certain drugs of abuse in hair. The
application of radioimmunoassay procedures using hair differs from the more
widely used application of radioimmunoassay procedures using urine samples. The
Company's tests provide quantitative information which indicates the approximate
amount of drug ingested as well as historical data which can show a pattern of
individual drug use over a period of time. This information is useful to
employers in both applicant and employee testing, to physicians, treatment
professionals, law enforcement agencies, to the insurance industry, to other
individuals and entities engaged in any business where drug use is an issue, and
to parents concerned about drug use by their children. The Company provides
commercial testing and confirmation by GC/MS using industry accepted practices
for cocaine, marijuana, PCP, methamphetamine, and opiates. In addition, the
Company has developed a test for methadone for use in the treatment industry.
Testing services are currently performed at the Company's laboratory at 5832
Uplander Way, Culver City, California. The Company's services are marketed under
the name RIAH (Radioimmunoassay of Hair), a registered service mark.
DEVELOPMENT OF RADIOIMMUNOASSAY OF HAIR
The application of special radioimmunoassay procedures to the analysis of hair
was initially developed in 1978 by the founders of the Company, Annette
Baumgartner and Werner A. Baumgartner, Ph.D. The Baumgartners demonstrated that
when certain chemical substances enter the bloodstream, the blood carries them
to the hair where they become "entrapped" in the protein matrix in amounts
roughly proportional to the amount ingested. The Company's drugs of abuse
testing procedure involves washing the hair sample to clean it of surface
contaminants and then subjecting the cleaned hair sample to the Company's unique
proprietary process which involves the direct analysis of liquefied hair samples
by radioimmunoassay procedures utilizing special reagents and antibodies. The
antibodies detect the presence of a specific drug or metabolite in the liquefied
hair sample by reacting with the drug present in the sample solution and an
added radioactive analog of the drug. The resulting antibody-drug complex is
precipitated and analyzed. The amount of drug present in the sample is inversely
proportional to the amount of radioactive analog in the precipitate. Depending
upon both the length of hair and the hair growth rate (hair grows
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approximately 1.3 centimeters per month), the Company is able to provide
historical information on drug use by the person from whom the sample was
obtained. Another testing option involves sectional analysis of the hair sample.
In this procedure, the hair is sectioned lengthwise to approximately correspond
to certain time periods. The sections are then labeled by time period, which
allows the Company to provide trend information on drug use. When quantitative
results of this test are reported and compared to dose correlation graphs,
information is provided about the individual's approximate drug usage during the
period being tested.
VALIDATION OF THE COMPANY'S PROPRIETARY TESTING METHOD
The process of analyzing human hair for the presence of drugs using the
Company's patented method has been the subject of over fifty scientific field
studies. Results from the studies that have been published or accepted for
publication in scientific journals are generally favorable to the Company's
technology. These studies were performed with the following organizations:
Citizens for a Better Community Court, Columbia University, Koba Associates-DC
Initiative, Harvard Cocaine Recovery Project, Hutzel Hospital, ISA Associates
(Interscience America)-NIDA Workplace Study, University of California-Sleep
State Organization, Maternal/Child Substance Abuse Project, Matrix Center,
National Public Services Research Institute, Narcotic and Drug Research
Institute, San Diego State University-Chemical Dependency Center, Spectrum Inc.,
Stapleford Centre (London), Task Force on Violent Crime (Cleveland, Ohio);
University of Miami-Department of Psychiatry, University of Miami-Division of
Neonatology, University of South Florida-Operation Par Inc., University of
Washington, VA Medical Center-Georgia, U.S. Probation Parole-Santa Ana. The
above studies include research in the following areas: prenatal, treatment
evaluation, workplace drug use, the criminal justice system and epidemiology.
Many of the studies have been funded by the National Institute of Justice or the
National Institute on Drug Abuse ("NIDA"). Over 300 research articles written by
independent researchers have been published supporting the general validity and
usefulness of hair analysis.
An additional independent evaluation of the technology, favorable to the
Company's services, has been performed by submission of blind samples by Dr.
Robert DuPont, President of the Institute of Behavior and Health, Inc., the
first Director of the National Institute on Drug Abuse and presently Chairman of
the Company's Scientific Advisory Board. Some of the Company's customers have
also completed their own testing to validate the Company's proprietary hair
testing method as a prelude to utilizing the Company's services. These studies
have consistently confirmed the Company's superior detection rate. When the
results from utilizing the Company's patented hair testing method were compared
to urine results in side-by-side evaluations, 5 to 10 times as many drug abusers
were accurately identified with the Company's proprietary method. In addition to
these studies, the Company is now performing testing for over 750 clients.
During 1996, the Company's patented method was utilized in a number of important
research application studies. In a study funded by the White House Office of
National Drug Control Policy (the Drug Czar's office) in 1996, hair analysis was
used to assess levels of drug use in hard-core drug abusers. The National
Institute of Justice sponsored an investigation using hair analysis to determine
the extent of drug use among prison inmates. Additional research studies were
conducted at Texas Christian University, Texas A & M, UCLA, University of
Pennsylvania and the University of South Florida. These studies investigated
drug abuse among juvenile delinquents, homeless individuals, HIV patients and
pregnant women.
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ADVANTAGES OF USING THE COMPANY'S PATENTED METHOD
The Company asserts that hair testing using its patented method confers
substantive advantages relative to existing means of drug detection through
urinalysis. Although urinalysis testing can provide accurate drug use
information, the scope of the information is short-term and is generally limited
to the type of drug ingested within a few days of the test. Studies published in
many scientific publications including NIDA RESEARCH MONOGRAPH and the JOURNAL
OF FORENSIC SCIENCES have indicated that cocaine, PCP, opiates, and
methamphetamine disappear from urine within 72 to 96 hours of use, although
marijuana may take a week or more.
In contrast to urinalysis testing, hair testing using the Company's patented
method provides long-term historical drug use information resulting in a
significantly wider "window of detection." This "window" may be three months or
longer depending on the length of the hair sample. The Company's standard test
offering, however, uses a 3.9 centimeter length cut close to the scalp;
therefore, it measures use for approximately the previous 90 days.
This wider window of detection enhances the detection efficiency of hair
analysis making it particularly useful in pre-employment testing. Hair testing
not only identifies more drug users, but also uncovers patterns and severity of
drug use, information most helpful in determining the scope of an individual's
involvement with drugs and serves as a deterrent against the use of drugs. Hair
testing using the Company's patented method greatly reduces the incidence of
"false negatives" associated with evasive measures typically encountered with
urinalysis testing. Urinalysis test results are impacted adversely by excessive
fluid intake prior to testing as well as adulteration of the sample. Moreover, a
drug user who abstains from use for a few days prior to urinalysis testing can
usually escape detection. Hair testing is effectively free of these problems as
it cannot be thwarted by evasive measures typically encountered with urinalysis
testing. It is also attractive to customers since sample collection is typically
performed under close supervision yet is less intrusive and embarrassing for
test subjects.
Hair testing using the Company's patented method (with GC/MS confirmation)
further reduces the prospects of error in conducting drug detection tests.
Urinalysis testing is more susceptible to problems such as "evidentiary false
positives" resulting from passive drug exposure (e.g. poppy seeds.) In the event
a positive urinalysis test result is challenged based on passive exposure, the
only remedy is a newly collected sample. Depending on the drug usage of the
forewarned individual prior to the date of the newly collected sample, a re-test
may yield a negative result when using urinalysis testing because of temporary
abstention. In contrast, when the Company's hair testing method is offered on a
repeat hair sample the individual suspected of drug use cannot as easily affect
the results because historical drug use data remain locked in the hair fiber.
DISADVANTAGES OF HAIR TESTING
There are some disadvantages of hair testing as compared to drug detection
through urinalysis. Because hair starts growing below the skin surface, drug
ingestion evidence does not appear in hair above the scalp until five to seven
days after use.
Thus, hair testing is not suitable for use in "for cause" testing such as is
done in connection with an accident investigation. It does, however, provide a
drug history which can complement urinalysis information in "for cause" testing.
Currently, radioimmunoassay testing using hair samples under the Company's
patented method is only practiced by Psychemedics Corporation. The absence of
widespread familiarity and use of hair testing may adversely impact the
Company's revenue growth.
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The Company's prices for its tests are generally somewhat higher than prices for
comparable tests using urinalysis, but the Company believes that its superior
detection rates provide more value to the customer. This pricing policy could,
however, adversely impact the growth of the Company's sales volume.
PATENTS
In December 1987, Dr. Werner A. Baumgartner, the Company's founder and Director
of Research and Development, with the assistance of the Company's patent
counsel, filed the first in a series of patent applications in the U.S. Patent
and Trademark Office on his inventions relating to radioimmunoassay using hair.
In 1994, U.S. Patent No. 5,324,642 (the "642 Patent") was issued to the Company.
This patent pertains to the universal drug extraction procedure and immunoassay
technology for the detection of drugs in hair specimens. In 1995, the Company
was granted an additional patent covering Dr. Baumgartner's inventions
pertaining to the immuno chemical screening assay for marijuana, which is the
most difficult drug to detect.
Dr. Baumgartner has continued his research, and the Company has pending two
additional patent applications in the U.S. Patent and Trademark Office with
respect to his inventions relating to procedures using hair. The Company
believes that additional patents will be granted as a result of Dr.
Baumgartner's pending patent applications although there can be no assurance
that any such additional patents will be granted.
Pursuant to an agreement dated January 1987, Werner A. Baumgartner and Annette
Baumgartner granted to the Company an exclusive royalty-free worldwide license
of all of their rights in and to their inventions relating to radioimmunoassay
using hair.
Most of Dr. Baumgartner's research on the inventions covered by the 642 Patent
was conducted while he was employed by the Veteran's Administration Hospital
("VA"). Dr. Baumgartner has, therefore, also granted to the U.S. government, for
all Governmental purposes, a nonexclusive, irrevocable, royalty-free license to
use the basic invention during the term of the patent with respect to such
invention.
Certain aspects of the Company's hair analysis method are based on trade secrets
owned by the Company. The Company's ability to protect the confidentiality of
these trade secrets is dependent upon the Company's internal safeguards and upon
the laws protecting trade secrets and unfair competition. In the event that
patent protection or protection under the laws of trade secrets were not
sufficient and the Company's competitors succeeded in duplicating the Company's
products, the Company's business could be materially adversely affected.
TARGET MARKETS
1. Industry
The Company has focused its primary marketing efforts on the private sector. The
Company believes that the market for job applicant and employee testing will
yield the most immediate beneficial impact to the business of the Company and
assist in establishing a regular client base.
The number of businesses using drug testing to screen job applicants and
employees has increased significantly in the last nine years. The 1996 American
Management Association (AMA) survey indicated that 81% of surveyed firms were
engaged in some form of drug testing, a 277% increase since the initial AMA
survey in 1987. The prevalence of drug
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screening programs reflects a growing concern that drug use contributes to
employee health problems and costs (increased absenteeism, reduced productivity,
etc.) and in certain industries, safety hazards. It has been estimated that the
cost to industry in terms of health care costs and lost productivity is at least
$60 billion annually.
The principal criticism of employee drug screening programs centers on the
effectiveness of the testing program. Most private sector screening programs use
urinalysis. Such programs are susceptible to evasive maneuvers and the inability
to obtain identical repeat samples in the event of a challenged result.
Moreover, many employers, to accommodate concerns of their employees and to
avoid infringement of employee privacy rights, conduct their programs on a
pre-announced schedule, thereby providing an opportunity for many drug users to
abstain in order to escape detection.
The Company presents its patented hair analysis method to potential clients as a
better technology well suited to employer needs. Field studies and actual client
results support the accuracy and effectiveness of the Company's patented
technology and its ability to detect even casual drug use. The historical aspect
of the Company's patented method as well as the Company's ability to provide
correlation of the measured drug with approximate amount of ingestion, furnish
an employer with greater flexibility in assessing the scope of an applicant's or
an employee's drug problem.
The Company provides clients confirmation of positive results through GC/MS. The
use of GC/MS is an industry accepted practice used to confirm positive drug test
results of an initial screen. In an employment setting, GC/MS confirmation is
typically used prior to the taking of any disciplinary action against an
employee. The Company offers its clients a five-drug screen with GC/MS
confirmation of cocaine, PCP, marijuana, methamphetamine, and opiates.
2. Home Use
In 1995, the Company began marketing "PDT-90", its hair testing service to
parents concerned about drug use by their children. It allows parents to collect
a small sample from their child in the privacy of the home and have it tested
for drugs of abuse by the Company. The PDT-90 testing service uses the same
patented method that is used with the Company's workplace testing service. The
Company commenced a marketing campaign in the third quarter of 1995 for the new
service.
3. Medical
The Company has developed a medical market for its proprietary hair testing
method consisting mostly of testing services for use by treatment professionals
for drug recovery programs and prenatal care.
In the drug treatment area, the Company's patented method can be used by
treatment professionals to obtain background information on drug use,
information most critical in structuring an individual's recovery program. Under
traditional drug detection tests, this information is obtained from
self-reporting, an approach generally deemed unreliable for various reasons,
including reluctance to discuss the nature of one's drug habit, memory failure,
and unknown substance purity. As a follow-up to a rehabilitation process, the
Company's patented method provides additional support by generating feedback to
individual physicians, psychiatrists and therapists on the success of their
methods. The utility of the
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Company's technology in monitoring recovery after discharge from employee
assistance programs has been validated by the Company's customers. The Company's
recently developed methadone test can also assist treatment professionals in
their treatment efforts.
The Company has engaged in, and continues to engage in, studies supporting the
utility of its patented hair analysis method in the evaluation of drug use
during pregnancy and the corresponding treatment of newborns. Studies are under
way at University of Pennsylvania, Hutzel Hospital, University of Washington,
Columbia University, University of Miami, National Public Services Research
Institute, University of California-Sleep State Organization and Maternal/Child
Substance Abuse Project. The Company expects that these cost-benefit and
application studies will demonstrate the utility of its proprietary screen in
the prenatal market.
SALES AND MARKETING
The Company markets its corporate drug testing services primarily through its
own direct sales force. The Company's in-house efforts are supplemented by a
limited network of independent sales representatives who are thoroughly trained
by the Company. The Company markets PDT-90, its home testing drug service,
through a toll-free number. For both its business-to-business and consumer
direct services, the Company has undertaken an integrated marketing campaign to
enhance the market presence within each respective segment.
COMPETITION
The Company competes directly with numerous commercial laboratories which test
for drugs through urinalysis testing. Most of these laboratories, such as
Laboratory Corporation of America, SmithKline Beecham Clinical Laboratories and
Corning Clinical Laboratories, Inc. have substantially greater financial
resources, market identity, marketing organizations, facilities, and numbers of
personnel than the Company. The Company has been steadily increasing its base of
corporate customers and believes that future success with new customers is
dependent on the Company's ability to communicate the advantages of implementing
a drug program utilizing the Company's patented hair analysis method.
The Company's ability to compete is also a function of pricing. The Company's
prices for its tests are generally somewhat higher than prices for comparable
tests using urinalysis. However, the Company believes that its superior
detection rates, coupled with the customer's ability to test less frequently due
to hair testing's wider window of detection (approximately 90 days verses
approximately three days with urinalysis) provide more value to the customer.
This pricing policy could, however, lead to slower sales growth for the Company.
The Company is not aware of any other laboratories with a hair analysis
technology that is comparable in effectiveness to the Company's proprietary
procedures. The Company is aware of two laboratories which operate in certain
limited employment testing markets and which purport to test hair samples using
a method, which the Company presumes, includes the use of a form of immunoassay
procedures. The Company, however, does not believe that effective immunoassay
testing of hair samples is currently feasible on a commercial basis without
using the Company's unique patented method.
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GOVERNMENT REGULATION
The Company is licensed as a Clinical Laboratory by the State of California as
well as certain other states. All tests are performed according to the standards
established by the Clinical Laboratories Improvement Act and the College of
American Pathologists. Presently there are no other regulations required for the
operation of a clinical laboratory in the State of California.
A substantial number of states regulate drug testing. The scope and nature of
such regulation varies greatly from state to state. In some states, a clinical
laboratory such as the Company is required to satisfy certain requirements as a
precondition to the laboratory's certification or right to perform drug testing
services with respect to specimens obtained in such state. The laws or
regulations in other states, in some instances, limit testing to certain
matrixes ("matrix" refers to the substance, blood, urine, hair, etc., which is
tested for the presence of drugs) which in two states excludes hair. The Company
seeks, through participation in the legislative and regulatory process, to
educate the legislative and regulatory agencies of those few states whose
statutes have been interpreted to not include the testing of hair.
In August 1995, the United States Food and Drug Administration ("FDA") issued a
Warning Letter to the Company pertaining to PDT-90, the drug testing service
which the Company introduced in July 1995 as a testing service for parents
concerned about drug use by their children. The FDA claimed that the collection
envelope the Company distributed as part of the PDT-90 testing service
constituted a "medical device" under the Federal Food Drug and Cosmetic Act, as
amended (the "FDC Act"), and that, because the Company did not seek the approval
or permission of the FDA to market the envelope, it was therefore adulterated
and misbranded under the FDC Act.
In its response, the Company stated its position that the collection envelope is
not a medical device under the FDC Act. However, in order to expeditiously
resolve the matter with the FDA, the Company submitted a 510(k) premarket
notification to the FDA on September 27, 1995 seeking a determination from the
FDA that the collection envelope is substantially equivalent to collection
envelopes which previously received 510(k) premarket clearance and were
currently being commercially marketed. In November 1995, the FDA issued a "Not
Substantially Equivalent" ("NSE") determination in response to the Company's
510(k) submission and classified PDT-90 as a Class III device under the FDC Act.
In December 1995, the Company filed suit against the FDA in the United States
Court of Appeals for the First Circuit seeking to overturn the FDA's NSE
determination. In March 1996, the FDA agreed to withdraw the Warning Letter and
the NSE determination in exchange for the Company's dismissal of its suit
against the FDA. The FDA also confirmed its decision not to actively regulate
PDT-90 and not to pursue enforcement action on any of the grounds contemplated
in the Warning Letter.
On February 6, 1997, the FDA announced a new agency proposal to companies that
make "drugs of abuse test systems". Under the proposal, companies engaged in the
business of testing for drugs of abuse using immunoassay testing procedures
previously recognized by the FDA would be able to market their test systems
without pre-market approval or clearance by the FDA so long as the tests are
conducted at certain approved laboratories and certain labeling and product
information procedures are followed. To date, the FDA has recognized immunoassay
testing procedures which involve the use of urine and sweat as the test sample
in certain applications. Under the FDA proposal, companies engaged in the
business of testing for drugs of abuse using samples other than those previously
recognized would effectively be prohibited from operating without FDA approval
or clearance. Such companies
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would be required to submit their test to the FDA for recognition. The FDA's
February 1997 announcement states that it intends to implement the proposed new
policy through notice and comment rulemaking. The proposal includes a
transitional period of approximately two years in order for companies not
currently in compliance with the proposed requirements to obtain the necessary
data they need for submission to the FDA. The Company believes that its
proprietary method of detecting drugs of abuse using hair samples is accurate
and reliable and should, therefore, be recognized if necessary. However, the
Company maintains that the FDA lacks statutory authority to regulate its drug
testing service. There is a risk that, under regulations which may hereafter be
adopted in light of the FDA's proposal, an application by the Company for
recognition of the Company's proprietary hair testing technology could be
denied, in which event, if upheld on appeal, the Company's business would be
materially adversely affected.
SCIENTIFIC ADVISORY BOARD
The Company has established a Scientific Advisory Board which consults with
management of the Company to examine and evaluate the progress of the Company's
research and development activities, to promote independent validation studies
of the Company's patented hair analysis method technology, and to assist in
accelerating acceptance of the technology in both the public and private
sectors. Members of the Scientific Advisory Board are compensated at the rate of
$1,000 per day for each meeting attended plus reimbursement for out-of-pocket
expenses. The Chairman of the Scientific Advisory Board is Dr. Robert DuPont.
Dr. DuPont's career has included numerous positions in the psychiatric and
substance abuse field, including Director, Special Action Office for Drug Abuse
Prevention - The White House; the first Director, National Institute on Drug
Abuse; President, American Council for Drug Education; and President, Phobia
Society of America. Dr. DuPont has received several national awards and
presently serves as President: Institute for behavior and Health, Inc.; Vice
President, Bensinger, DuPont and Associates, a national drug and alcohol abuse
consulting firm; and he maintains a private practice in psychiatry. Dr. DuPont
has also been granted options to acquire shares of the Company's common stock.
Other members of the Scientific Advisory Board are Edward C. Senay, M.D., a
Professor in the Department of Psychiatry at the University of Chicago, and
Arthur McBay, Ph.D., a Forensic Toxicologist and former Professor of Pharmacy at
the University of North Carolina.
RESEARCH AND DEVELOPMENT
The Company is continuously engaged in research and development activities.
During the years ended December 31, 1996, 1995 and 1994, $413,693, $436,385 and
$406,345, respectively, were expended for research and development. The Company
continues to perform research activities to develop new products and services
and to improve existing products and services utilizing the Company's
proprietary technology. Additional research using the Company's proprietary
technology is being conducted by outside research organizations through
government-funded studies.
The Company's research includes "controlled studies" to determine the advantages
of hair testing in the medical, forensic and criminal justice markets. The
Company has also furnished technical assistance to several distinguished
independent researchers whose studies have been funded through government
grants. Many such studies are currently in progress. The Company continues to
conduct its own research toward the development of new inventions, services and
products derived from the Company's patented technology.
SOURCES AND AVAILABILITY OF RAW MATERIALS
Since its inception, the Company has purchased raw materials for its laboratory
services from outside suppliers. The most critical of these raw materials are
the radio-labeled drugs which
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the Company purchases from a single supplier, although other supplies of
radio-labeled drugs exist. If suitable radio-labeled drugs were to become
unavailable, or available only at prohibitive cost, the Company would be
required to produce its own radio-chemical supplies, although other suppliers of
radio-labeled drugs exist. The Company estimates that it would have to expend
approximately $400,000 for capital additions to produce its own supply.
Thereafter, direct costs for such raw materials would likely decrease.
PRINCIPAL CUSTOMER
The Company's largest customer in 1996, Blockbuster Entertainment Group
("Blockbuster"), a division of Viacom, Inc., accounted for approximately 21% of
the Company's drug sampling volume and approximately 18% of the Company's
revenue during the year ended December 31, 1995, and approximately 19% of drug
sampling volume and 15% of the Company's revenue in 1996.
EMPLOYEES
As of December 31, 1996, the Company had 71 full-time equivalent employees, of
which four full-time employees were in research and development. None of the
Company's employees is subject to a collective bargaining agreement.
Item 7. Management's Discussions and Analysis of Financial Condition
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and Results of Operations.
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RESULTS OF OPERATIONS
The year ended December 31, 1996 was another record year for revenue. Revenue
was $12.2 million in 1996 as compared to $10.1 million in 1995 and $8.7 million
in 1994, representing an increase of 21% in 1996 and 16% in 1995. These
increases were due primarily to increases in volume from both new and existing
clients of 24% in 1996 and 20% in 1995 offset by average price decreases of 3%
in 1996 and 4% in 1995 primarily as the result of volume discounts granted to
large customers. The number of employers utilizing the Company's drug testing
services increased 20% in 1994, 24% in 1995 and 46% in 1996. As a result, the
share of revenues derived from Blockbuster Entertainment Group has decreased
from 24% in 1994 to 15% in 1996. Blockbuster's share of drug testing revenues is
expected to decline further in subsequent years.
Gross margin was 59% of sales in 1996 compared to 54% in 1995 and 58% in 1994.
The increase in 1996 was primarily the result of increased efficiencies
resulting from increased volume. The decrease in 1995 from the 1994 level was
due to higher costs associated with expansion of the Company's laboratory
facilities in 1995.
General and administrative (G&A) expenses were held to 19% of revenues in 1996,
the same percentage as in 1995. G&A expenses represented 15% of revenues in
1994. G&A expenses increased by $415,000 to $2.36 million in 1996, and increased
by $604,000 to $1.95 million in 1995. The increase in 1996 was primarily due to
increased expenditures for payroll, legal, regulatory and bad debt provisions.
The increase in 1995 was also due primarily to higher costs incurred by the
Company for payroll, legal and regulatory expenses.
Marketing and selling expenses for the year ended December 31, 1996 remained at
17% of revenues in both 1995 and 1996, representing a decrease of 1% as a
percent of revenues from the 1994 amount which was 18% of revenues. Marketing
and selling expenses
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increased by $311,000 to $2 million in 1996, and by $191,000 to $1.7 million in
1995. The increase in 1996 was due primarily to increased marketing expenses and
additional sales staff. The increase in 1995 was due primarily to increases in
marketing expenses. The Company currently expects that marketing and selling
expenses will exceed 17% of revenues in 1997 as the Company continues its
efforts to expand its client base.
Research and development expenses remained virtually unchanged in 1996 from 1995
and 1994 amounts, but continued to decline as a percentage of revenues from 5%
in 1994 to 3% in 1996.
Net interest income increased as a result of higher levels of short-term
investments in 1996 as compared to 1995.
Net income increased 60% to $2.5 million in 1996, following a decline of 15% to
$1.6 million in 1995 . The increase in 1996 was primarily due to increased
revenues, and related efficiencies in direct costs derived from increased sales
volume. The decrease in 1995 was primarily due to increases in direct costs and
increased general and administrative expenses which exceeded increases in
revenues in such year. The provision for income taxes in 1996 and 1995
represented the alternative minimum tax due as required under the Internal
Revenue Code, and provision for state corporate income taxes. The Company had
total net operating loss carryforwards at December 31, 1996 of approximately
$3.6 million available to offset future years' cash payments for income taxes,
however, approximately $2.6 million of these loss carryforwards were comprised
of deductions from the exercise of certain options and warrants which will
increase paid-in capital when tax benefits related to these options and warrants
are recognized.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company had $9.8 million of cash, cash equivalents and
short-term investments, compared to $5.5 million at December 31, 1995. The
Company's operating activities generated net cash of $2.3 million in 1996 and
$2.0 million in 1995. Investing activities used $3.8 million in 1996 and $0.5
million in 1995 while financing activities generated $2.7 million in 1996 and
used $1.8 million in 1995.
The Company's source of funds in 1996 was derived approximately 53% from
financing activities, the major item being the receipt of proceeds from the
exercise of stock options and warrants, and approximately 47% from net cash
generated from operations. In 1995, the primary source of funds was net cash
generated from operations. Operating cash flows increased $379,000 in 1996. Net
income was higher in 1996 by $933,000 but this increase was offset by increases
in receivables and reductions in accounts payable which were only partially
offset by increases in other liability accounts. The non-cash effect of
depreciation and amortization in 1996 and 1995 was $535,000 and $600,000,
respectively.
Capital expenditures in 1996 were $736,000, a reduction of $534,000 from 1995's
expenditures of $1.27 million. The expenditures in 1996 primarily consisted of
new equipment, including a new gas chromatographer/mass spectrometer (GC/MS).
The 1995 expenditures consisted of expansion of the Company's laboratory
facilities in Culver City, California, as well as an additional GC/MS machine
and other equipment. the Company currently plans to make capital expenditures of
approximately $1,300,000 in 1997, primarily in connection with the purchase of
11
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laboratory and computer equipment. The Company believes that within the next
year it may be required to expand its existing laboratory or develop a second
laboratory, the cost of which is currently believed to range from $2 million to
$4 million.
In December 1994, the Company's Board of Directors authorized the repurchase of
up to 1 million shares of the Company's common stock. During 1995, the Company
purchased a total of 699,387 shares for an aggregate purchase price of $2.6
million. No shares were purchased in 1996.
On July 3, 1996, the Company distributed a 3% stock dividend to shareholders of
record on June 21, 1996. The shares issued in the stock dividend represented
shares which the Company acquired in the stock repurchase program. This
transaction resulted in an increase of $4.67 million in the accumulated deficit
(633,000 shares distributed at a fair market value of $7.37 per share). Treasury
stock was reduced by $2.42 million as a result of this distribution. Average
shares outstanding and all per share amounts included in the accompanying
Financial Statements and Notes are based on the increased number of shares
giving retroactive effect to the stock dividend.
Since December 31, 1996 and prior to the filing of this Amendment No. 1, the
Company has distributed an aggregate of $2,194,000 of cash dividends to its
shareholders.
At December 31, 1996, the Company's principal sources of liquidity included
$9.8 million of cash, cash equivalents and short-term investments. Management
believes that such funds, together with future operating profits, should be
adequate to fund anticipated working capital requirements and capital
expenditures in the near term. Depending upon the Company's results of
operations, its future capital needs and available marketing opportunities, the
Company may use various financing sources to raise additional funds. Such
sources could include joint ventures, issuance of common stock or debt
financing. At December 31, 1996, the Company had no long-term debt.
FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company or statements made by its
employees may contain forward-looking information which involves risks and
uncertainties. In particular, statements contained in this report which are not
historical facts (including but not limited to the Company's expectations
regarding principal customers, business strategy, anticipated operating results
and anticipated cash requirements) may be "forward-looking" statements. The
Company's actual results may differ from those stated in any forward-looking
statements. Factors that may cause such difference include, but are not limited
to, risks associated with the continued expansion of the Company's sales and
marketing network, development of markets for new products and services offered
by the Company, the economic health of principal customers of the Company,
financial and operational risks associated with possible expansion of testing
facilities used by the Company, government regulation, competition and general
economic conditions.
12
<PAGE> 13
'
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Psychemedics Corporation
Date: January 27, 1998 By: /s/ Raymond C. Kubacki, Jr.
--------------------------------------
Raymond C. Kubacki, Jr.
President and Chief Executive Officer
Date: January 27, 1998 By: /s/ Bruce M. Stillwell
--------------------------------------
Bruce M. Stillwell
Vice President, Treasurer & Controller
13
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January 27, 1998
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Psychemedics Corporation (the "Company") Form 10-K for the Fiscal
Year Ended December 31, 1996 Form 10-Q for the Quarter Ended March
31, 1997 File No. 1-13738
------------------------------------------------------------------
Dear Sir or Madam :
In response to the Staff's comment letter dated June 30, 1997 addressed to
Raymond C. Kubacki, Jr., President of the Company, the following materials are
hereby being transmitted for filing under the Securities Exchange Act of 1934,
as amended:
1. Form 10-K/A Amendment No. 1 to the Company's Annual Report on Form 10-K for
the Fiscal Year Ended December 31, 1996; and
2. Form 10-Q/A Amendment No. 1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.
The Company wishes to respond to the staff's comments as follows:
Form 10-K for FYE December 31, 1996
- -----------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------ ---------------------------------------------------------------
Results of Operations.
---------------------
Results of Operations
---------------------
1. The discussion of the results of operations is too general. Please revise
to include an analysis and quantification of the particular causes of
changes in material line item amounts from period to period. The analysis
should identify individual factors (such as change in prices, volume,
product mix,
<PAGE> 15
Securities and Exchange Commission
January 27, 1998
Page 2
etc.), discuss the reasons that these factors changed during the period,
and quantify their effects. You should discuss the reasons why management
believes reported trends are expected to continue or change. Refer to Item
303 of Regulation S-K and Release No. 34-26831 which discusses the
disclosure requirements of Item 303 in detail.
Response: The section has been revised to comply with the staff's request.
2. Expand the discussion to include percentage comparisons of each material
change in line items from year to year. Please note that while the use of
additional statistical analysis such as the common-size analysis the
Company has utilized, is encouraged, disclosure and percentage comparisons
of material changes in the line items of the financial statements from year
to year must be the starting point of the disclosure. Please revise
accordingly.
Response: The section has been revised to comply with the staff's request.
Liquidity and Capital Resources
-------------------------------
3. The statement of cash flows should be utilized to present a balanced
discussion dealing with cash flows from investing and financing activities
as well as from operations.
Response: The section has been revised to comply with the staff's request.
4. Indicate the general purpose of the capital commitments and the anticipated
source of funds needed to fulfill such commitments.
Response: The section has been revised to comply with the staff's request.
5. Identify and separately describe each internal and external source of
liquidity, disclosing the amount of any material unused sources of liquid
assets.
Response: The section has been revised to comply with the staff's request.
6. Revise the disclosure to discuss liquidity on both a short-term and
long-term basis.
Response: The section has been revised to comply with the staff's request.
7. Quantify the discussion of the Company's working capital needs.
