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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER: 1-13738
PSYCHEMEDICS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 58-1701987
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1280 MASSACHUSETTS AVE., CAMBRIDGE, MA 02138
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 617-868-7455
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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COMMON STOCK, $.005 PAR VALUE AMERICAN STOCK EXCHANGE
(TITLE OF CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
</TABLE>
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. [X]
On March 15, 1999 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $53,108,138 and 22,038,626 shares of Common
Stock, $.005 par value, were outstanding at such date.
DOCUMENTS INCORPORATED BY REFERENCE
Part III -- Portions of the Registrant's Proxy Statement relative to the
1999 Annual Meeting of Stockholders to be held on May 6, 1999.
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PART I
The information provided by the Company in this Report may contain
"forward-looking" information which involves risks and uncertainties, such as
statements of the Company's plans, objectives, expectations and intentions. The
cautionary statements made in this report should be read as being applicable to
all forward-looking statements wherever they appear in this report. The
Company's actual results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include those
discussed in Item 7 below, as well as those discussed elsewhere herein.
ITEM 1. BUSINESS
GENERAL
Psychemedics Corporation ("the Company") is a Delaware corporation
organized on September 24, 1986 to provide testing services for the detection of
abused substances through the analysis of hair samples. The Company's testing
methods utilize a patented technology for performing immunoassays on
enzymatically dissolved hair samples with confirmation testing by mass
spectrometry.
The Company's first application of its patented technology is a testing
service that screens for the presence of certain drugs of abuse in hair. The
application of radioimmunoassay procedures using hair differs from the more
widely used application of radioimmunoassay procedures using urine samples. The
Company's tests provide quantitative information which indicates the approximate
amount of drug ingested as well as historical data which can show a pattern of
individual drug use over a period of time. This information is useful to
employers in both applicant and employee testing, to physicians, treatment
professionals, law enforcement agencies, to the insurance industry; and to
parents concerned about drug use by their children and to other individuals and
entities engaged in any business where drug use is an issue. The Company
provides commercial testing and confirmation by mass spectrometry 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 drug
treatment industry.
Testing services are currently performed at the Company's laboratory at
5832 Uplander Way, Culver City, California. The Company's services are marketed
under the name RIAH (Radioimmunoassay of Hair), a registered service mark.
DEVELOPMENT OF RADIOIMMUNOASSAY OF HAIR
The application of special radioimmunoassay procedures to the analysis of
hair was initially developed in 1978 by the founders of the Company, Annette
Baumgartner and Werner A. Baumgartner, Ph.D. The Baumgartners demonstrated that
when certain chemical substances enter the bloodstream, the blood carries them
to the hair where they become "entrapped" in the protein matrix in amounts
roughly proportional to the amount ingested. The Company's drugs of abuse
testing procedure involves washing the hair sample to clean it of surface
contaminants and then subjecting the cleaned hair sample to the Company's unique
proprietary process which involves the direct analysis of liquefied hair samples
by radioimmunoassay procedures utilizing special reagents and antibodies. The
antibodies detect the presence of a specific drug or metabolite in the liquefied
hair sample by reacting with the drug present in the sample solution and an
added radioactive analog of the drug. The resulting antibody-drug complex is
precipitated and analyzed. The amount of drug present in the sample is inversely
proportional to the amount of radioactive analog in the precipitate. Depending
upon both the length of hair and the hair growth rate (hair grows approximately
1.3 centimeters per month), the Company is able to provide historical
information on drug use by the person from whom the sample was obtained. Another
testing option involves sectional analysis of the hair sample. In this
procedure, the hair is sectioned lengthwise to approximately correspond to
certain time periods. The sections are then labeled by time period,
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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 has over 1,500 clients for whom it performs testing.
In 1998, the National Institute of Justice, utilizing Psychemedics hair
testing, completed a Pennsylvania Prison study where hair analysis revealed an
average prison use level in 1996 of approximately 7.9%. Comparatively,
urinalysis revealed virtually no positives. After measures to curtail drug use
were instituted, drug sniffing dogs, searches and scanners, the use level fell
to approximately 2% according to the results of hair analysis in 1998. Again,
the urine tests had virtually no positives. The study illustrated the usefulness
of hair analysis to monitor populations and the weakness of urinalysis.
ADVANTAGES OF USING THE COMPANY'S PATENTED METHOD
The Company asserts that hair testing using its patented method confers
substantive advantages relative to existing means of drug detection through
urinalysis. Although urinalysis testing can provide accurate drug use
information, the scope of the information is short-term and is generally limited
to the type of drug ingested within a few days of the test. Studies published in
many scientific publications have indicated that most drugs disappear from urine
within a few days.
In contrast to urinalysis testing, hair testing using the Company's
patented method provides long-term historical drug use information resulting in
a significantly wider "window of detection." This "window" may be three months
or longer depending on the length of the hair sample. The
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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 can also uncover 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 less embarrassing for test subjects.
Hair testing using the Company's patented method (with mass spectrometry
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). To combat this problem, in federally mandated testing the opiate cutoff
levels for urine testing were raised 667% on December 1, 1998 and the presence
of a heroin metabolite, 6-AM, was required in order to call a result a positive.
These new results, however, effectively reduced the detection time frame for
heroin in urine down to several hours post-use. In contrast, the metabolite 6-AM
is stable in hair and can be detected for months. In the event a positive
urinalysis test result is challenged, the only remedy is a newly collected
sample. Depending on the drug usage of the forewarned individual prior to the
date of the newly collected sample, a re-test may yield a negative result when
using urinalysis testing because of temporary abstention. In contrast, when the
Company's hair testing method is offered on a repeat hair sample the individual
suspected of drug use cannot as easily affect the results because historical
drug use data remain locked in the hair fiber.
DISADVANTAGES OF HAIR TESTING
There are some disadvantages of hair testing as compared to drug detection
through urinalysis. Because hair starts growing below the skin surface, drug
ingestion evidence does not appear in hair above the scalp until five to seven
days after use.
Thus, hair testing is not suitable for use in "for cause" testing such as
is done in connection with an accident investigation. It does, however, provide
a drug history which can complement urinalysis information in "for cause"
testing.
Currently, radioimmunoassay testing using hair samples under the Company's
patented method is only practiced by Psychemedics Corporation. The absence of
widespread familiarity and use of hair testing may adversely impact the
Company's revenue growth.
The Company's prices for its tests are generally somewhat higher than
prices for tests using urinalysis, but the Company believes that its superior
detection rates provide more value to the customer. This pricing policy could,
however, adversely impact the growth of the Company's sales volume.
PATENTS
In December 1987, Dr. Werner A. Baumgartner, the Company's founder and
Director of Research and Development, with the assistance of the Company's
patent counsel, filed the first in a series of patent applications in the U.S.
Patent and Trademark Office on his inventions relating to radioimmunoassay using
hair. In 1994, U.S. Patent No. 5,324,642 (the "642 Patent") was issued to
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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.
In October 1998 the Company was informed by the Japanese Patent Office that
it had allowed the pending Japanese patent application containing broad claims
to the Company's proprietary hair test for drugs of abuse. The Japanese patent,
combined with others in place in the United States and Europe, affords the
Company the opportunity to eventually expand drugs of abuse hair testing
technology throughout the world.
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 several years. The 1996
American Management Association (AMA) survey indicated that 81% of surveyed
firms were engaged in some form of drug testing, a 277% increase since the
initial AMA survey in 1987. The prevalence of drug screening programs reflects a
growing concern that drug use contributes to employee health problems and costs
(increased absenteeism, reduced productivity, etc.) and in certain industries,
safety hazards. It has been estimated that the cost to industry in terms of
health care costs and lost productivity is at least $60 billion annually.
The principal criticism of employee drug screening programs centers on the
effectiveness of the testing program. Most private sector screening programs use
urinalysis. Such programs are susceptible to evasive maneuvers and the inability
to obtain identical repeat samples in the event of a challenged result.
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Moreover, many employers, to accommodate concerns of their employees and to
avoid infringement of employee privacy rights, conduct their programs on a
pre-announced schedule, thereby providing an opportunity for many drug users to
abstain in order to escape detection.
The Company presents its patented hair analysis method to potential clients
as a better technology well suited to employer needs. Field studies and actual
client results support the accuracy and effectiveness of the Company's patented
technology and its ability to detect even casual drug use. The historical aspect
of the Company's patented method as well as the Company's ability to provide
correlation of the measured drug with approximate amount of ingestion, furnish
an employer with greater flexibility in assessing the scope of an applicant's or
an employee's drug problem.
The Company performs a confirmation test of all positive results through
mass spectrometry. The use of mass spectrometry is an industry accepted practice
used to confirm positive drug test results of an initial screen. In an
employment setting, mass spectrometry 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 mass spectrometry confirmation of cocaine,
PCP, marijuana, methamphetamine, and opiates.
2. Home Use
In 1995, the Company began marketing "PDT-90"(R), its hair testing service
to parents concerned about drug use by their children. It allows parents to
collect a small sample from their child in the privacy of the home and have it
tested for drugs of abuse by the Company. The PDT-90 testing service uses the
same patented method that is used with the Company's workplace testing service.
During the second quarter of 1997, the Company began offering its personal drug
testing service, "PDT-90" through retail drug stores.
3. Research
The Company's technology has been used in, and continues to be used by
independent researchers in studies supporting the utility of its patented hair
analysis method in the evaluation of drug use during pregnancy, in newborns and
in other at-risk populations (e.g.: prisons, probation programs). Studies have
been performed 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.
SALES AND MARKETING
The Company markets its corporate drug testing services primarily through
its own direct sales force. The Company markets PDT-90, its home testing drug
service, primarily through retail drug stores. For both its business-to-business
and consumer direct services, the Company has undertaken an integrated marketing
campaign to enhance the market presence within each respective segment. In 1998,
the Company began marketing its testing services over the Internet at several
websites.
COMPETITION
The Company competes directly with numerous commercial laboratories that
test for drugs through urinalysis testing. Most of these laboratories, such as
Laboratory Corporation of America, SmithKline Beecham Clinical Laboratories and
Quest (formerly Corning Clinical Laboratories, Inc.) have substantially greater
financial resources, market identity, marketing organizations, facilities, and
numbers of personnel than the Company. The Company has been steadily increasing
its base of corporate customers and believes that future success with new
customers is dependent on the
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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
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 versus
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 several laboratories which operate in
certain limited employment testing markets and which purport to test hair
samples using a method, which the Company presumes, includes the use of a form
of immunoassay procedures. The Company, however, does not believe that effective
immunoassay testing of hair samples is currently feasible on a commercial basis
without using the Company's unique patented method.
GOVERNMENT REGULATION
The Company is licensed as a Clinical Laboratory by the State of California
as well as certain other states. All tests are performed according to the
standards established by the Clinical Laboratories Improvement Act and the
College of American Pathologists. Presently there are no other regulations
required for the operation of a clinical laboratory in the State of California.
A substantial number of states regulate drug testing. The scope and nature
of such regulation varies greatly from state to state and is subject to change
from time to time. The Company addresses state law issues on an ongoing basis.
Shortly after the introduction of the Company's PDT-90 drug testing
service, the United States Food and Drug Administration ("FDA") attempted to
assert jurisdiction over the Company's PDT-90 service by claiming that the
collection envelope distributed as part of the service was a medical device.
This ultimately led to the Company filing suit against the FDA contesting the
FDA's position. In March 1996, the FDA agreed to withdraw its claims against the
Company in exchange for the Company's agreement to discontinue its lawsuit. On
March 5, 1998, the FDA issued a proposed rule applicable to companies that
market "drugs of abuse test sample collection systems". Under the proposed rule,
companies engaged in the business of testing for drugs of abuse using a test
(screening assay) previously recognized by the FDA would be able to market their
test sample collection systems without pre-market approval or clearance by the
FDA so long as the test is conducted at a laboratory that is recognized by
laboratory certification agencies designated by the FDA and certain labeling and
product information procedures are followed. To date, the FDA has recognized
urine-screening assays that existed prior to the 1976 Medical Device Amendments
to the Federal Food, Drug and Cosmetic Act, as well as subsequent assays which
have demonstrated substantial equivalence to such previously existing assays.
Under the FDA's proposed rule, companies engaged in the business of testing for
drugs of abuse using assays not yet recognized by the FDA would be required to
submit their assay to the FDA for recognition prior to marketing. In addition,
the laboratory performing the tests would be required to be certified by a
recognized agency. In the proposed rule, the FDA states that it intends to
implement the proposed new policy through notice and comment rulemaking. The
proposed rule includes a transitional period of one year following the
publication of a final rule in order for companies not currently in compliance
with the proposed requirements to obtain the necessary data they need for
submission to the FDA. As of March 15, 1999, a final rule had not yet been
published. There is a risk that, if the rule as proposed becomes final, the
Company may be required to apply to the FDA for recognition of the Company's
screening assays, and if such application were denied (and if such denial were
upheld on appeal), the Company's business would be materially adversely
affected. The Company believes that its
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proprietary method of detecting drugs of abuse using hair samples includes
accurate and reliable screening assays and should, therefore, be recognized by
the FDA if necessary. However, the Company maintains that the FDA lacks
statutory authority to regulate its hair testing service as a medical device.
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 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, 1998, 1997 and 1996, $499,895, $437,626, and
$413,693, 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 forensic and criminal justice markets. The
Company has also furnished technical assistance to several distinguished
independent researchers whose studies have been funded through government
grants. Many such studies are currently in progress. The Company continues to
conduct its own research toward the development of new inventions, services and
products derived from the Company's patented technology.
SOURCES AND AVAILABILITY OF RAW MATERIALS
Since its inception, the Company has purchased raw materials for its
laboratory services from outside suppliers. The most critical of these raw
materials are the radio-labeled drugs which the Company purchases from a single
supplier, although other suppliers of radio-labeled drugs exist. The Company has
entered into an agreement with its principal supplier to purchase certain
proprietary information regarding the manufacture of such radio-labeled drugs
owned by the supplier in the event that the supplier ceases to be able to supply
such radio-labeled drugs to the Company.
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EMPLOYEES
As of December 31, 1998, the Company had 127 full-time equivalent
employees, of whom four full-time employees were in research and development.
None of the Company's employees is subject to a collective bargaining agreement.
ITEM 2. PROPERTIES.
The Company maintains its corporate office and northeast sales office at
1280 Massachusetts Avenue, Cambridge, Massachusetts; the office is leased
through September 2003.
The Company leases 18,000 square feet of space in Culver City, California,
for sales, customer service and laboratory purposes. This facility is leased
through December 31, 2005 with an option to renew for an additional two years.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in various suits and claims in the ordinary course
of business. The Company does not believe that the disposition of any such suits
or claims will have a material adverse effect on the continuing operations or
financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company's common stock is traded on the American Stock Exchange under
the symbol "PMD". As of March 15, 1999, there were 444 record holders of the
Company's common stock. The following table sets forth for the periods indicated
the range of prices for the Company's common stock as reported by the American
Stock Exchange and dividends declared by the Company.
<TABLE>
<CAPTION>
CALENDAR PERIOD HIGH LOW DIVIDENDS
--------------- ---- --- ---------
<S> <C> <C> <C>
1998
Fourth Quarter........................................ $5 1/8 $4 1/16 $0.03
Third Quarter......................................... $5 5/16 $4 1/8 $0.03
Second Quarter........................................ $5 7/8 $4 3/4 $0.03
First Quarter......................................... $6 $5 5/16 $0.02
1997
Fourth Quarter........................................ $6 3/4 $5 $0.02
Third Quarter......................................... $8 11/16 $6 1/8 $0.02
Second Quarter........................................ $8 1/4 $6 1/2 $0.02
First Quarter......................................... $8 $5 13/16 $0.02
</TABLE>
Future cash dividends may be declared at the discretion of the Board of
Directors.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from the financial
statements of the Company and should be read in conjunction with, and is
qualified in its entirety by reference to, the financial statements and related
notes thereto.
<TABLE>
<CAPTION>
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------------ ------- -------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenue........................... $17,670 $15,398 $12,214 $10,111 $ 8,734
Gross profit...................... $10,201 $ 9,341 $ 7,233 $ 5,422 $ 5,037
Income from operations............ $ 3,307 $ 3,056 $ 2,409 $ 1,301 $ 1,742
Net income........................ $ 2,397 $ 2,501 $ 2,492 $ 1,559 $ 1,831
Basic net income per share........ $ 0.11 $ 0.11 $ 0.12 $ 0.07 $ 0.10
Diluted net income per share...... $ 0.11 $ 0.11 $ 0.11 $ 0.07 $ 0.09
Total Assets............ $18,739 $18,855 $15,745 $10,217 $10,290
Working Capital................... $11,119 $13,090 $11,403 $ 6,789 $ 7,658
Shareholders' Equity.............. $15,737 $16,733 $14,296 $ 9,484 $ 9,580
Cash dividends declared per common
share........................... $ 0.11 $ 0.08 $ 0.02 -- --
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company or statements made
by its employees may contain "forward-looking" information which involves risks
and uncertainties. In particular, statements contained in this report which are
not historical facts (including but not limited to the Company's expectations
regarding revenues, business strategy, anticipated operating results, cash
dividends and anticipated cash requirements) may be "forward looking"
statements. The Company's actual results may differ from those stated in any
"forward looking" statements. Factors that may cause such differences include,
but are not limited to, risks associated with the continued expansion of the
Company's sales and marketing network, development of markets for new products
and services offered by the Company, the economic health of principal customers
of the Company, financial and operational risks associated with possible
expansion of testing facilities used by the Company, government regulation
(including, but not limited to, Food and Drug Administration regulations),
competition and general economic conditions.
RESULTS OF OPERATIONS
Revenue was $17.7 million in 1998 as compared to $15.4 million in 1997 and
$12.2 million in 1996, representing increases of 15% in 1998 and 26% in 1997
above prior year levels. These increases were due primarily to increases in
volume from both new and existing clients of 17% in 1998 and 31% in 1997, more
than offsetting average price decreases of 2% in 1998 and 4% in 1997 primarily
as the result of volume discounts granted to large customers. Gross margin was
58% of sales in 1998 compared to 61% in 1997 and 59% in 1996. The decrease in
1998 was due primarily to the addition of production capacity during the latter
part of 1998, in anticipation of future sample volume increases. The increase in
1997 was primarily the result of increased efficiencies resulting from increased
volume.
General and administrative ("G&A") expenses represented 16% of revenue in
1998 as compared to 15% of revenue in 1997 and 19% of revenue in 1996. G&A
expenses increased by $634,000 to $2.9 million from 1997 to 1998 and decreased
by $88,000 to $2.3 million from 1996 to 1997. Approximately half of the 1998
increase was personnel related and consisted primarily of
9
<PAGE> 11
three additions to staff and costs pertaining to the introduction of a 401(k)
retirement plan. Greater professional fees for legal and accounting services in
1998 also contributed to the increase. The decrease in 1997 was primarily due to
decreased professional fees.
Marketing and selling expenses for the year ended December 31, 1998
decreased to 20% of revenue versus 23% in 1997 and 17% in 1996. Marketing and
selling expenses decreased by $87,000 to $3.5 million from 1997 to 1998, and
increased by $1,525,000 to $3.6 million from 1996 to 1997. Although the Company
continued to expand marketing activities related to the corporate market in
1998, total marketing and selling expenses decreased from 1997 levels because a
significant amount of expenditures made in the second quarter of 1997 to
initially penetrate the retail home testing market were non-recurring. The
increase in 1997 was due primarily to increased marketing expenses related to
advertising and other costs associated with the introduction of PDT-90, as well
as increased sales, field support and customer service personnel for corporate
business.
Research and development expenses increased by $62,000 from 1997 to 1998,
but remained constant as a percentage of revenue at 3% in 1998, 1997 and 1996.
Net interest income increased by $43,000 in 1998 as compared to 1997, due
to slightly higher average investment balances in 1998 as compared to 1997 and
improved cash management procedures that were put in place during 1998. Net
interest income increased by $157,000 in 1997 as compared to 1996, due to higher
average investment balances in 1997 as compared to 1996.
During the year ended December 31, 1998, the Company recorded a tax
provision of $1.5 million reflecting an effective tax rate of 38.0%. During the
year ended December 31, 1997, the Company recorded a tax provision of $1.1
million reflecting an effective tax rate of 30.0%. The increase in the effective
tax rate resulted from the reduction in net operating loss carryforwards
available to offset the provision for income taxes, partially offset by tax
credits generated in 1998.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had $9.8 million of cash, cash
equivalents and short-term investments, compared to $10.0 million at December
31, 1997. The Company's operating activities generated net cash of $5.0 million
in 1998, $2.1 million in 1997, and $2.4 million in 1996. Investing activities
used $1.6 million in 1998, $2.5 million in 1997, and $3.8 million in 1996, while
financing activities used $3.3 million in 1998, $501,000 in 1997, and generated
$2.7 million in 1996.
Although net income in 1998 was $100,000 less than the 1997 amount,
operating cash flows increased by $2.9 million in 1998 as compared to 1997, due
primarily to a significant decrease in accounts receivable and increases in
accounts payable and accrued expenses. The non-cash effect of depreciation and
amortization in 1998, 1997 and 1996 was $991,000, $696,000 and $535,000,
respectively.
Capital expenditures in 1998 were $1.9 million, an increase of $477,000
from 1997 expenditures of $1.4 million. The expenditures related principally to
new equipment, including laboratory and computer equipment, and computer
software. The Company currently plans to make capital expenditures of
approximately $1 million in 1999, primarily in connection with the purchase of
additional laboratory and computer equipment. The Company believes that within
the next two years 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.
During 1998, the Company repurchased a total of 349,981 shares for treasury
at an aggregate cost of $1.6 million. In 1997, 117,302 shares were repurchased
for treasury at an aggregate cost of $751,000.
On July 3, 1996, the Company distributed a 3% stock dividend to
shareholders of record on June 21, 1996. The shares issued in the stock dividend
were treasury shares. This transaction resulted in an increase of $4.7 million
in the accumulated deficit (633,000 shares distributed at a fair
10
<PAGE> 12
market value of $7.37 per share). Treasury stock was reduced by $2.4 million as
a result of this distribution. All share and per share amounts have been
retroactively restated to reflect the stock dividend.
The Company commenced paying cash dividends in 1997 and distributed nearly
$2.2 million during the year. In 1998, the Company distributed $2,444,957 of
cash dividends to its shareholders.
At December 31, 1998, the Company's principal sources of liquidity included
$9.8 million of cash, cash equivalents and short-term investments. Management
currently believes that such funds, together with future operating profits,
should be adequate to fund anticipated working capital requirements and capital
expenditures in the near term. Depending upon the Company's results of
operations, its future capital needs and available marketing opportunities, the
Company may use various financing sources to raise additional funds. Such
sources could include joint ventures, issuance of common stock or debt
financing. At December 31, 1998, the Company had no debt.
IMPACT OF YEAR 2000 ISSUE
The Year 2000 issue results from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs or hardware and equipment that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
Over the past two years, the Company has made substantial modifications and
improvements to all of its operational and financial software. An integral part
of this process has been to ensure that all newly purchased and internally
developed software is Year 2000 compliant. The Company has completed a
preliminary evaluation all of the existing software used in its internal systems
and operations and expects that it will be Year 2000 compliant by the end of the
second quarter of 1999, and that the cost to bring such software into compliance
will not exceed $20,000. The Company is still evaluating various hardware and
equipment components used in its laboratory operations and also expects to be
Year 2000 compliant in this area by the end of the second quarter of 1999, at an
estimated additional cost of less than $100,000. The Company believes that
although these costs are not material to its business, if these efforts are not
completed on time, or if the cost of updating or replacing the Company's
information systems greatly exceeds the Company's current estimates, the Year
2000 issue could have a material adverse impact on the Company's business,
financial condition or results of operations.
The Company also intends to determine the extent to which the Company may
be vulnerable to any failures by its major suppliers, customers and service
providers to remedy their own Year 2000 issues, and is in the process of
initiating formal communications with these parties. At this time the Company is
unable to estimate the nature or extent of any potential adverse impact
resulting from the failure of third party suppliers, customers and service
providers to achieve Year 2000 compliance, although the Company does not
currently anticipate that it will experience any material shipment delays from
its major product suppliers or any material payment delays from its major
customers due to Year 2000 issues. However, there can be no assurance that these
third parties will not experience Year 2000 problems or that any problems would
not have a material effect on the Company's business. Because the cost and
timing of Year 2000 compliance by third parties such as suppliers, customers and
service providers is not within the Company's control, no assurance can be given
with respect to the cost or timing of such efforts or any potential adverse
effects on the Company of any failure by these third parties to achieve Year
2000 compliance.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ materially from
those projected in the forward-looking
11
<PAGE> 13
statements. The Company is exposed to market risk related to changes in interest
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
Interest Rate Sensitivity. The Company maintains a short-term investment
portfolio consisting principally of securities issued by the U.S. Government
with an average maturity of less than six months. These held-to-maturity
securities are subject to interest rate risk and will fall in value if market
rates increase. If market interest rates were to increase immediately and
uniformly by 10 percent from levels at December 31, 1998, the fair value of the
portfolio would decline by an immaterial amount. The Company has the ability to
hold its fixed income investments until maturity, and therefore the Company
would not expect its operating results or cash flows to be affected to any
significant degree by the effect of a sudden change in market interest rates on
its securities portfolio.
ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA
The financial statements and financial statement schedule are included in
this report on pages F-1 through F-16.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Following is a list that sets forth as of March 15, 1999 the names, ages
and positions within the Company of all of the Executive Officers of the Company
persons chosen to become executive officers of the Company, and the Directors of
the Company. Each such director has been nominated for reelection at the
Company's 1999 Annual Meeting, to be held on May 6, 1999 at 3:30 P.M. at The
Boston Harbor Hotel, 70 Rowes Wharf, Boston, Massachusetts.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Raymond C. Kubacki, Jr................. 54 Chief Executive Officer, President, Director
Werner A. Baumgartner, Ph.D............ 63 Chairman of the Board, Director
A. Clinton Allen....................... 55 Vice Chairman of the Board, Director
Peter C. Monson........................ 43 Vice President, Treasurer, Controller
William Thistle, Esq................... 49 Vice President, General Counsel
Michael J. Lamb........................ 49 Vice President, Sales
Donald F. Flynn........................ 59 Director, Audit Committee member, Options Committee
member
John J. Melk........................... 62 Director, Audit Committee member, Options Committee
member
Fred J. Weinert........................ 51 Director, Audit Committee member, Options Committee
member
</TABLE>
All Directors hold office until the next annual meeting of stockholders or
until their successors are elected. Officers serve at the discretion of the
Board of Directors.
Mr. Kubacki has served as President and Chief Executive Officer and as a
Director of the Company since July 1991. Prior to joining the Company, he served
as Vice President-National Accounts and Director of Sales and Marketing for
Reliance COMM/TEC Corporation, a subsidiary of Reliance Electric Co.
12
<PAGE> 14
Dr. Baumgartner, a founder of the Company, has served as Chairman of the
Board and a Director of the Company since its organization in September 1986.
Dr. Baumgartner has served as the Company's Director of Scientific and
Regulatory Affairs since May 1989. Dr. Baumgartner received his Ph.D. in
physical chemistry in 1963 from the University of New South Wales, Sydney,
Australia, and has been engaged in physical and biophysical chemistry research
since 1960, holding research and teaching positions at University of New South
Wales; Long Beach State University; Jet Propulsion Laboratory at California
Institute of Technology; University of California, Los Angeles; and University
of Southern California. Dr. Baumgartner has been the director of the
Radioimmunoassay and In Vitro Laboratory of the Nuclear Medicine Service,
Veterans Administration Hospital, Wadsworth, Los Angeles, California, since
1976, serving in such capacity on a part-time basis since February 1987.
Mr. Allen has served as Vice Chairman and as a Director of the Company
since 1989. He is also Chairman and Chief Executive Officer of A.C. Allen &
Company, Inc., an investment banking consulting firm located in Cambridge,
Massachusetts. He is a director of Response USA, Inc., Legal Club of America,
Image Guided Technologies, Inc., Diversified Corporate Resources, Inc., Swiss
Army Brands, Inc., and The DeWolfe Companies, Inc., where he serves as Vice
Chairman.
Mr. Thistle joined the Company in September 1995 as Vice President and
General Counsel. Prior to joining the Company, he served as Associate General
Counsel for MGM Grand in Las Vegas from 1993 to 1995. From 1989 to 1993, Mr.
Thistle was Associate General Counsel for Harrah's Casino Resorts.
Mr. Monson joined the Company effective March 30, 1998 as Vice President,
Treasurer and Controller. From November 1996 until joining the Company, Mr.
Monson was a financial consultant to several different companies, most recently
with GTE Internetworking. From 1994 to 1996, Mr. Monson was Chief Financial
Officer of Bet Systems, Inc. From 1991 to 1994, Mr. Monson was the Corporate
Controller and Treasurer of Gamma International, Ltd., a publicly traded gaming
company.
Mr. Lamb joined the Company in June 1997 as Vice President, Sales. Prior to
joining the Company, he served as Director, Sales and Marketing for Polaroid
Corporation located in Cambridge, Massachusetts, from 1990 to 1996. From 1986 to
1990, Mr. Lamb was Director, National Accounts for Polaroid Corporation, U.S.A.
Mr. Flynn has been the sole stockholder and Chairman of the Board of Flynn
Enterprises, Inc., since March 1992 and Flynn Financial Corp. since November
1988, financial advisory and venture capital firms. Since February 1997, he has
also been the Vice Chairman of the Blue Chip Casino, Inc., an owner and operator
of a riverboat gaming vessel in Michigan City, Indiana. Mr. Flynn also was
Chairman of the Board from July 1992 until February 1996 and Chief Executive
Officer from July 1992 until May 1995 of Discovery Zone, Inc., an operator of
indoor entertainment and fitness facilities for children. On March 25, 1996,
Discovery Zone, Inc. filed a voluntary petition under Chapter 11 of the U.S.
Bankruptcy Code. Discovery Zone emerged from bankruptcy with a Plan of
Reorganization that was approved by the Bankruptcy Court in July 1997. From 1972
to 1990, Mr. Flynn served in various positions with Waste Management, Inc.
including Senior Vice President and Chief Financial Officer. Mr. Flynn serves as
a Director of Extended Stay America, Inc., an owner and operator of
extended-stay lodging facilities. Mr. Flynn has been a director of the Company
since 1989.
Mr. Melk currently serves as Chairman of H(2)0 Plus, L.P., which develops
and manufactures health and beauty products and distributes them through a
company-owned chain of specialty retail stores. He also serves as Chairman of MW
Partners, an investor in commercial and residential real estate developments.
From 1987 to 1989, Mr. Melk was Vice Chairman of the Board of Blockbuster
Entertainment Corporation. From 1971 to 1975, Mr. Melk was Vice President of
Corporate
13
<PAGE> 15
Development for Waste Management, Inc. and from 1975 to 1984 held the position
of President of W.M.I. International, Ltd. based in London, England. He is a
director of Republic Industries, Inc., and Extended Stay America, Inc. In August
1998, he assumed the position of Chairman of Fisher Island Holdings, LLC, of
Miami, Florida. Mr. Melk has been a director of the Company since 1991.
Mr. Weinert is the majority shareholder and serves as CEO of San Telmo,
Inc. (investment group), Barrington Services Group (commercial real estate
developer), San Telmo L.L.C (a distributor of fragrances and cosmetics) and H20
Plus, S.R.L. (a distributor and retailer of cosmetics, bath products and
fragrances in Argentina, Brazil, Chile and Uruguay). From 1989 to 1995 he was
President of H20 Plus L.P., MW Partners, and Century Entertainment Ltd. Previous
to that, he was President of Waste Management International, Inc. from 1983 to
1989. For over 13 years he has served on the Business Advisory Council for the
University of Dayton. Mr. Weinert has been a director of the Company since 1991.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely on its reviews of copies of reports filed pursuant to Section
16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
or written representations from persons required to file such reports
("Reporting Persons"), the Company believes that all such filings required to be
made by such Reporting Persons were timely made in accordance with the
requirements of the Exchange Act.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be set forth in the Proxy
Statement of the Company relating to the 1999 Annual Meeting of Stockholders to
be held on May 6, 1999 and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be set forth in the Proxy
Statement of the Company relating to the 1999 Annual Meeting of Stockholders to
be held on May 6, 1999 and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be set forth in the Proxy
Statement of the Company relating to the 1999 Annual Meeting of Stockholders to
be held on May 6, 1999 and is incorporated herein by reference.
14
<PAGE> 16
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
(a)(1) Financial Statements:
Report of Independent Public Accountants.................... F-1
Balance Sheets as of December 31, 1998 and 1997............. F-2
Statements of Income for the Years Ended December 31, 1998,
1997 and 1996............................................... F-3
Statements of Shareholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996............................ F-4
Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996......................................... F-5
Notes to Financial Statements............................... F-6
(2) Schedules
None
Exhibits (see the Index to Exhibits included elsewhere in
(3) this Report)
(b) Reports on Form 8-K
None
</TABLE>
15
<PAGE> 17
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Psychemedics Corporation:
We have audited the accompanying balance sheets of Psychemedics Corporation
(a Delaware corporation) as of December 31, 1998 and 1997, and the related
statements of income, shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Psychemedics Corporation as
of December 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 9, 1999 (except with respect to
the matter discussed in Note 11, as to
which the date is February 23, 1999)
F-1
<PAGE> 18
PSYCHEMEDICS CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 724,738 $ 585,142
Short-term investments.................................... 9,088,436 9,446,418
Accounts receivable, net of allowance for doubtful
accounts of $377,000 and $264,429 in 1998 and 1997,
respectively........................................... 3,075,619 3,784,488
Laboratory supplies....................................... 510,016 500,325
Deferred tax asset........................................ 241,000 380,000
Prepaid expenses and other current assets................. 482,388 515,874
----------- -----------
Total current assets................................. 14,122,197 15,212,247
----------- -----------
PROPERTY AND EQUIPMENT, AT COST
Computer software......................................... 1,205,840 871,937
Office furniture and equipment............................ 1,277,519 1,096,724
Laboratory equipment...................................... 4,968,196 3,720,750
Leasehold improvements.................................... 679,810 552,105
----------- -----------
8,131,365 6,241,516
Less -- Accumulated depreciation and amortization......... 3,949,128 3,021,842
----------- -----------
4,182,237 3,219,674
----------- -----------
OTHER ASSETS................................................ 434,925 423,318
----------- -----------
$18,739,359 $18,855,239
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 675,072 $ 196,259
Accrued expenses.......................................... 582,754 220,820
Accrued income taxes...................................... 162,357 217,243
Deferred revenue.......................................... 1,436,667 1,488,010
----------- -----------
Total current liabilities............................ 2,856,850 2,122,332
----------- -----------
COMMITMENTS (Note 6)
SHAREHOLDERS' EQUITY:
Preferred stock, $.005 par value; authorized 1,000,000
shares; none outstanding............................... -- --
Common stock, $.005 par value; authorized 50,000,000
shares; issued and outstanding 22,607,290 and
22,382,720 shares in 1998 and 1997, respectively....... 113,036 111,913
Paid-in capital........................................... 24,403,949 23,581,549
Accumulated deficit....................................... (5,585,453) (5,537,505)
Less -- Treasury stock, at cost; 533,664 shares in 1998
and 183,683 shares in 1997............................. (2,645,232) (1,005,439)
Less -- Receivable from officer........................... (403,791) (417,611)
----------- -----------
Total shareholders' equity........................... 15,882,509 16,732,907
----------- -----------
$18,739,359 $18,855,239
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE> 19
PSYCHEMEDICS CORPORATION
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
REVENUE................................................ $17,669,975 $15,398,952 $12,214,198
COST OF REVENUE........................................ 7,468,574 6,057,606 4,981,221
----------- ----------- -----------
Gross profit......................................... 10,201,401 9,341,346 7,232,977
----------- ----------- -----------
EXPENSES:
General and administrative........................... 2,907,803 2,273,780 2,362,074
Marketing and selling................................ 3,486,929 3,573,920 2,048,477
Research and development............................. 499,895 437,626 413,693
----------- ----------- -----------
6,894,627 6,285,326 4,824,244
----------- ----------- -----------
Income from operations............................... 3,306,774 3,056,020 2,408,733
INTEREST INCOME, net................................... 560,235 517,133 360,248
----------- ----------- -----------
INCOME BEFORE PROVISION FOR INCOME TAXES............... 3,867,009 3,573,153 2,768,981
PROVISION FOR INCOME TAXES............................. 1,470,000 1,072,000 277,000
----------- ----------- -----------
NET INCOME............................................. $ 2,397,009 $ 2,501,153 $ 2,491,981
=========== =========== ===========
BASIC NET INCOME PER SHARE............................. $ 0.11 $ 0.11 $ 0.12
=========== =========== ===========
DILUTED NET INCOME PER SHARE........................... $ 0.11 $ 0.11 $ 0.11
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING............. 22,205,626 21,963,116 21,145,699
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, ASSUMING
DILUTION............................................. 22,586,705 22,540,841 22,164,226
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 20
PSYCHEMEDICS CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
---------------------- TREASURY STOCK
$ 0.005 PAID-IN ACCUMULATED ---------------------- RECEIVABLE
SHARES PAR VALUE CAPITAL DEFICIT SHARES COST FROM OFFICER
---------- --------- ----------- ----------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995.... 20,288,280 $101,441 $15,728,033 $(3,668,291) 699,387 $(2,676,793) $ --
Exercise of warrants, net of
related costs............. 987,787 4,939 1,970,635 -- -- -- --
Exercise of stock options... 482,020 2,410 778,683 -- -- -- --
Distribution of 3% stock
dividend.................. -- -- 2,244,786 (4,667,516) (633,006) 2,422,730 --
Cash dividend declared
($0.02 per share)......... -- -- -- (437,221) -- -- --
Net income.................. -- -- -- 2,491,981 -- -- --
---------- -------- ----------- ----------- -------- ----------- ---------
BALANCE, December 31, 1996.... 21,758,087 108,790 20,722,137 (6,281,047) 66,381 (254,063) --
Exercise of stock options,
including tax benefits.... 624,633 3,123 2,859,412 -- -- -- (417,611)
Cash dividends declared
($0.08 per share)......... -- -- -- (1,757,611) -- -- --
Acquisition of treasury
stock..................... -- -- -- -- 117,302 (751,376) --
Net income.................. -- -- -- 2,501,153 -- -- --
---------- -------- ----------- ----------- -------- ----------- ---------
BALANCE, December 31, 1997.... 22,382,720 111,913 23,581,549 (5,537,505) 183,683 (1,005,439) (417,611)
Exercise of stock options,
including tax benefits.... 224,570 1,123 822,400 -- -- -- --
Payments on receivable from
officer................... -- -- -- -- -- -- 13,820
Cash dividends declared
($0.11 per share)......... -- -- -- (2,444,957) -- -- --
Acquisition of treasury
stock..................... -- -- -- -- 349,981 (1,639,793) --
Net income.................. -- -- -- 2,397,009 -- -- --
---------- -------- ----------- ----------- -------- ----------- ---------
BALANCE, December 31, 1998.... 22,607,290 $113,036 $24,403,949 $(5,585,453) 533,664 $(2,645,232) $(403,791)
========== ======== =========== =========== ======== =========== =========
<CAPTION>
TOTAL
-----------
<S> <C>
BALANCE, December 31, 1995.... $ 9,484,390
Exercise of warrants, net of
related costs............. 1,975,574
Exercise of stock options... 781,093
Distribution of 3% stock
dividend.................. --
Cash dividend declared
($0.02 per share)......... (437,221)
Net income.................. 2,491,981
-----------
BALANCE, December 31, 1996.... 14,295,817
Exercise of stock options,
including tax benefits.... 2,444,924
Cash dividends declared
($0.08 per share)......... (1,757,611)
Acquisition of treasury
stock..................... (751,376)
Net income.................. 2,501,153
-----------
BALANCE, December 31, 1997.... 16,732,907
Exercise of stock options,
including tax benefits.... 823,523
Payments on receivable from
officer................... 13,820
Cash dividends declared
($0.11 per share)......... (2,444,957)
Acquisition of treasury
stock..................... (1,639,793)
Net income.................. 2,397,009
-----------
BALANCE, December 31, 1998.... $15,882,509
===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 21
PSYCHEMEDICS CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $2,397,009 $2,501,153 $2,491,981
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 990,807 696,514 535,522
Deferred income taxes................................... 139,000 (380,000) --
Changes in current assets and liabilities:
Accounts receivable................................... 722,689 (1,127,072) (934,646)
Laboratory supplies................................... (9,691) (269,548) 22,439
Prepaid expenses and other current assets............. 33,486 (386,046) (57,581)
Accounts payable...................................... 478,813 (199,175) (70,978)
Accrued expenses...................................... 361,934 (111,424) 89,054
Accrued income taxes.................................. (54,886) (18,040) 228,241
Deferred revenue...................................... (51,343) 1,439,485 48,525
---------- ---------- ----------
Net cash provided by operating activities.......... 5,007,818 2,145,847 2,352,557
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net sales (purchases) of short-term investments........... 357,982 (1,075,691) (3,091,131)
Purchases of property and equipment....................... (1,889,849) (1,412,695) (736,432)
(Increase) decrease in other assets....................... (75,128) (33,717) 3,689
---------- ---------- ----------
Net cash used in investing activities.............. (1,606,995) (2,522,103) (3,823,874)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on obligations under capital leases.............. -- -- (16,459)
Proceeds from the exercise of stock options, including tax
benefits................................................ 823,523 2,444,924 2,756,667
Dividends paid............................................ (2,444,957) (2,194,828) --
Acquisition of treasury stock............................. (1,639,793) (751,376) --
---------- ---------- ----------
Net cash (used in) provided by financing
activities....................................... (3,261,227) (501,280) 2,740,208
---------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 139,596 (877,536) 1,268,891
CASH AND CASH EQUIVALENTS, beginning of year................ 585,142 1,462,678 193,787
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of year...................... $ 724,738 $ 585,142 $1,462,678
========== ========== ==========
Supplemental Disclosure of Cash Flow Information
Cash paid for interest............................. $ -- $ -- $ 578
========== ========== ==========
Cash paid for income taxes......................... $1,073,000 $ 156,000 $ 119,000
========== ========== ==========
Supplemental Disclosure of Non-Cash Financing Activity
Issuance of common stock for receivable from
officer.......................................... $ -- $ 417,611 $ --
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 22
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Psychemedics Corporation (the Company) was incorporated in 1986. The
Company utilizes a patented hair analysis method involving radioimmunoassay
technology to analyze human hair to detect abused substances. The founder of the
Company has granted to the Company an exclusive license to all his rights in
this hair analysis technology, including his rights to the drug extraction
method (see Note 3).
Management Estimates and Uncertainties
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The Company is subject to a number of risks and uncertainties similar to
those of other companies, such as those associated with the continued expansion
of the Company's sales and marketing network, development of markets for new
products and services offered by the Company, the economic health of principal
customers of the Company, financial and operational risks associated with
possible expansion of testing facilities used by the Company, government
regulation (including, but not limited to, Food and Drug Administration
regulations), competition and general economic conditions.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with original
maturities of 90 days or less from the date of purchase to be cash equivalents.
Cash equivalents consist principally of money market accounts at December 31,
1998 and 1997.
The Company accounts for investment securities in accordance with Statement
of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Under SFAS No. 115, investments that
the Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity and are reported at amortized cost, which
approximates fair market value. All short-term investments were classified as
held-to-maturity as December 31, 1998 and 1997. Short-term investments have
maturities between three months and one year and consist principally of
securities issued by the U.S. Government at December 31, 1998 and 1997.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization
are provided over the estimated useful lives of the assets, using the
straight-line method. The estimated useful lives of the assets are as follows:
<TABLE>
<S> <C>
Computer software 5 years
Office furniture and equipment 5 to 7 years
Laboratory equipment 5 to 7 years
</TABLE>
F-6
<PAGE> 23
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
Other Assets
Other assets consist primarily of capitalized legal costs relating to
patent applications on the Company's drug extraction method. The Company is
amortizing the cost of these patents over 10 years from the date of grant. The
Company recorded amortization of $63,521 and $60,000 in 1998 and 1997,
respectively. In accordance with SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of, the Company
evaluates the realizability of its patents based on estimated cash flows to be
generated from such assets as compared to the original estimates. To the extent
an impairment is identified, the Company will recognize a write-down of the
related assets. To date, no impairment has been identified.
Revenue Recognition
Except as provided below, revenues from the Company's services are
recognized upon reporting of drug test results to the customer. Revenues related
to sample collection kits not returned for processing by customers are
recognized when the likelihood of the Company performing any service obligation
is deemed remote. At December 31, 1998 and 1997, the Company had deferred
revenue balances of approximately $1,437,000 and $1,488,000, respectively,
reflecting payments for its personal drug testing service received prior to the
performance of the related test.
Income Taxes
The Company accounts for income taxes in accordance with the provisions of
SFAS No. 109, Accounting for Income Taxes. This statement requires the Company
to recognize a current tax liability or asset for current taxes payable or
refundable, and a deferred tax liability or asset for the estimated future tax
effects of temporary differences between the financial statement and tax
reporting of assets and liabilities to the extent that they are realizable.
Deferred tax expense (benefit) results from the net change in deferred tax
assets and liabilities during the year. A deferred tax valuation allowance is
required if it is more likely than not that all or a portion of the recorded
deferred tax assets will not be realized.
Research and Development Expenses
The Company charges all research and development expenses to operations as
incurred.
Concentration of Credit Risk
SFAS No. 105, Disclosure of Information About Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance-sheet and credit risk
concentrations. The Company has no significant off-balance-sheet or
concentration of credit risk. Financial instruments that potentially subject the
Company to concentrations of credit risk are principally cash equivalents,
short-term investments and accounts receivable. The Company places its
investments in highly rated institutions. Concentration of credit risk with
respect to accounts receivable is limited to certain customers to whom the
Company makes substantial sales. To reduce risk, the Company routinely assesses
the financial strength of its customers and, as a consequence, believes that its
accounts receivable credit risk exposure is limited. The Company maintains an
allowance for potential credit losses but historically has not experienced any
significant losses related to individual customers or groups of customers in any
particular industry or geographic area.
F-7
<PAGE> 24
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
Significant Customers
No single customer accounted for greater than 10% of revenues in 1998. One
of the Company's customers accounted for 10% and 15% of total revenues in 1997
and 1996, respectively. As of December 31, 1998 and 1997, the same customer
accounted for 10% and 16% of total accounts receivable, respectively.
Basic and Diluted Net Income Per Share
In accordance with SFAS No. 128, Earnings Per Share, basic net income per
share is computed by dividing net income by the weighted average number of
common shares outstanding during the period. Diluted net income per share was
computed by dividing net income by the weighted average number of common and
dilutive common equivalent shares outstanding during the period. The number of
dilutive common equivalent shares outstanding during the period has been
determined in accordance with the treasury-stock method. Common equivalent
shares consist of common stock issuable upon the exercise of outstanding
options.
Basic and diluted weighted average common shares outstanding are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Weighted average common shares outstanding..... 22,205,626 21,963,116 21,145,699
Dilutive common equivalent shares.............. 381,079 577,725 1,018,527
---------- ---------- ----------
Weighted average common shares outstanding,
assuming dilution............................ 22,586,705 22,540,841 22,164,226
========== ========== ==========
</TABLE>
As of December 31, 1998, 1997 and 1996, options to purchase 553,666,
113,000 and 50,000 common shares, respectively, were outstanding but not
included in the dilutive common equivalent share calculation as their effect
would have been antidilutive.
Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosure about the fair value of financial instruments. Financial
instruments consist principally of cash equivalents, short-term investments,
accounts receivable and accounts payable. The estimated fair value of these
financial instruments approximates their carrying value and, except for accounts
receivable, is based primarily on market quotes. The Company's cash equivalents
and short-term investments are generally money market accounts and securities
issued by the U.S. Government.
Comprehensive Income
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, Reporting Comprehensive Income. SFAS No. 130 requires disclosure of all
components of comprehensive income on an annual and interim basis. Comprehensive
income is defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances from nonowner
sources. The Company's total comprehensive income was the same as reported net
income for all periods presented.
Segment Reporting
The Company adopted SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information, in the fiscal year ended December 31, 1998.
SFAS No. 131 establishes standards for
F-8
<PAGE> 25
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS No. 131 also
establishes standards for related disclosures about products and services and
geographic areas. To date, the Company has managed its operations as one
segment, drug testing services. As a result, the financial information disclosed
herein materially represents all of the financial information related to the
Company's principal operating segment. Substantially all of the Company's
revenues are generated in the United States. All of the Company's assets are
located in the United States.
Software Development Costs
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires
computer software costs associated with internal use software to be charged to
operations as incurred until certain capitalization criteria have been met. The
Company adopted SOP 98-1 beginning January 1, 1998. SOP 98-1 had no effect upon
adoption. As of December 31, 1998 and 1997, $1,205,540 and $871,937 of software
development costs, respectively, have been capitalized. During the years ended
December 31, 1998 and 1997, $43,930 and $20,848 of related amortization was
charged to operations, respectively.
Start-Up Costs
In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of
Start-Up Activities, which requires that all nongovernmental entities charge to
operations the costs of start-up activities, including organizational costs, as
those costs are incurred. The Company has historically recorded all such costs
as expenses in the period incurred.
Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
133 is effective for all periods beginning after June 15, 1999 and establishes
methods of accounting for derivative financial instruments and hedging
activities related to those instruments as well as other hedging activities.
Adoption of SFAS No. 133 is not expected to have a material impact on the
Company's financial position or results of operations.
2. RECEIVABLE FROM OFFICER
The amounts receivable from officer represent advances for the purchase of
common stock. The notes bear interest at 4.82% and are full recourse. The notes,
together with accrued interest, are payable approximately $200,000 on November
12, 1999 and approximately $204,000 on January 6, 2000.
3. ROYALTY AGREEMENTS
The Company has a royalty-free license from the founder for the proprietary
rights to the patented hair analysis technology used by the Company in its drug
testing services. The Company has two agreements to sublicense its technology,
which have not generated significant royalties to date.
F-9
<PAGE> 26
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
4. INCOME TAXES
The income tax provisions for the years ended December 31, 1998, 1997 and
1996 consist of the following:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Current--
Federal...................................... $ 998,000 $1,197,400 $ 941,400
State........................................ 333,000 254,600 174,400
---------- ---------- ----------
1,331,000 1,452,000 1,115,800
---------- ---------- ----------
Deferred--
Federal...................................... 104,000 (290,300) (802,500)
State........................................ 35,000 (89,700) (36,300)
---------- ---------- ----------
139,000 (380,000) (838,800)
---------- ---------- ----------
$1,470,000 $1,072,000 $ 277,000
========== ========== ==========
</TABLE>
The provisions for income taxes differ from the amount computed by applying
the statutory federal income tax rate as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----- ------ ------
<S> <C> <C> <C>
Federal statutory rate............................... 34.0% 34.0% 34.0%
Increase (decrease) resulting from--
State tax provision, net of federal benefit........ 5.9 6.3 6.3
Utilization of net operating loss carryforwards
previously not benefitted....................... -- (10.6) (30.8)
Utilization of tax credits......................... (5.7) -- --
Non-deductible expenses............................ 3.8 3.6 0.5
Other, net......................................... -- (3.3) --
----- ------ ------
Effective tax rate................................... 38.0% 30.0% 10.0%
===== ====== ======
</TABLE>
The components of the net deferred tax assets included in the accompanying
balance sheets are approximately as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Deferred revenue............................................ $ 442,000 $ 488,000
Nondeductible reserves and accruals......................... 143,000 154,000
Net operating loss carryforwards............................ -- 284,000
Property basis differences.................................. (344,000) (262,000)
--------- ---------
Subtotal............................................... 241,000 664,000
Valuation allowance......................................... -- (284,000)
--------- ---------
Net asset.............................................. $ 241,000 $ 380,000
========= =========
</TABLE>
F-10
<PAGE> 27
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
A valuation allowance was provided in 1997 on the net operating loss
carryforwards (NOLs) which were generated from the exercise of stock options.
These NOLs resulted in an increase to paid-in capital when realized in 1998.
5. STOCK OPTIONS
Employee Stock Option Plan
The Company's 1989 Employee Stock Option Plan, as amended (the Plan),
provides for the issuance of incentive stock options (ISOs) and nonqualified
stock options (NSOs) to key employees and officers of the Company to purchase up
to 3,399,000 shares of the Company's common stock. The Plan is administered by a
committee of non-employee directors. Under the terms of the Plan, the Company
may grant employees either incentive stock options or non-qualified stock
options to purchase shares of the Company's common stock at exercise prices not
less than the fair market value at the date of grant, as defined in the Plan.
Options are exercisable on terms to be established by the committee at its
discretion. Options are generally exercisable over the four-year period
following the date of grant and expire no later than ten years from the date of
grant.
Nonqualified Stock Options to Non-Employee Directors
The Company's 1989 Non-Qualified Stock Option Plan, as amended, provides
for the issuance of NSOs to non-employee directors to purchase up to 309,000
shares of the Company's common stock. Options to purchase 25,750 shares of
common stock of the Company are automatically granted under this plan to each
non-employee director of the Company upon appointment to the Board of Directors
(Initial Options). Initial Options are exercisable over the two-year period
following the date of grant and expire ten years from the date of grant. In
addition, as of March 15 of each year, options to acquire 20,600 shares are
automatically granted to each person then serving as an outside director (Annual
Options).
Annual Options become exercisable, in full, one year following the date of
grant and expire no later than ten years from date of grant. Initial Options and
Annual Options have exercise prices equal to the fair market value on the date
of grant.
The Company's 1991 Non-Qualified Stock Option Plan, as amended, provides
for the issuance of NSOs to key employees and consultants to purchase up to
309,000 shares of the Company's common stock. The plan is administered by a
committee of the Board of Directors. Under the terms of the plan, the Company
may grant non-qualified stock options at option prices and terms to be
determined by the committee at its discretion and expire no later than ten years
from the date of grant.
F-11
<PAGE> 28
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
A summary of all stock option transactions for the years ended December 31,
1998, 1997 and 1996 is as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
--------- --------------
<S> <C> <C>
Outstanding, December 31,1995............................... 3,259 $2.50
Granted................................................... 265 5.70
Exercised................................................. (1,509) 1.88
Terminated................................................ (108) 2.06
------ -----
Outstanding, December 31,1996............................... 1,907 2.98
Granted................................................... 173 6.89
Exercised................................................. (625) 2.48
Terminated................................................ (31) 4.16
------ -----
Outstanding, December 31,1997............................... 1,424 4.02
Granted................................................... 337 5.17
Exercised................................................. (225) 2.27
Terminated................................................ (70) 5.14
------ -----
Outstanding, December 31,1998............................... 1,466 $4.43
====== =====
Exercisable, December 31,1998............................... 903 $3.93
====== =====
Exercisable, December 31,1997............................... 758 $3.04
====== =====
Exercisable, December 31,1996............................... 1,188 $2.45
====== =====
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1998 (in thousands, except per share amounts):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- -------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
EXERCISE REMAINING AVERAGE NUMBER AVERAGE
PRICE NUMBER OF CONTRACTUAL EXERCISE OF EXERCISE
RANGE OPTIONS LIFE PRICE OPTIONS PRICE
- --------------------- ---------- ------------ --------- -------- --------
<S> <C> <C> <C> <C> <C>
$1.85 221 4.93 $1.85 221 $1.85
2.82 - 3.63 403 6.10 2.99 324 3.03
5.03 - 7.06 792 8.20 5.68 346 5.96
7.69 50 8.44 7.69 12 7.69
</TABLE>
The weighted average remaining contractual life of options outstanding at
December 31, 1998, 1997 and 1996 was 7.14 years, 7.63 years, and 7.23 years,
respectively.
Accounting for Stock-Based Compensation
SFAS No. 123, Accounting for Stock-Based Compensation, requires the
measurement of the fair value of stock options or warrants to be included in the
statement of income or disclosed in the notes to financial statements. The
Company has determined that it will continue to account for stock-based
compensation for employees under Accounting Principles Board Opinion No. 25 and
elect the disclosure-only alternative under SFAS No. 123. The Company has
computed the value of options using the Black-Scholes option pricing model
prescribed by SFAS No. 123.
F-12
<PAGE> 29
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
The assumptions used and the weighted average information for the years
ended December 31, 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- -------------
<S> <C> <C> <C>
Risk-free interest rates........................ 5.15% 6.32% 5.36% - 6.07%
Expected dividend yield......................... 2% 1% 1%
Expected lives.................................. 5 years 5 years 5 years
Expected volatility............................. 42.68% 69.70% 84.01%
Weighted average grant-date fair value of
options granted during the period............. $ 2.14 $ 4.44 $ 2.14
</TABLE>
Had compensation cost for the Company's stock option plans been determined
consistent with SFAS No. 123, net income and basic and diluted net income per
share would have been approximately as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
As reported --
Net income................................ $2,397,009 $2,501,153 $2,491,981
Basic net income per share................ $ 0.11 $ 0.11 $ 0.12
Diluted net income per share.............. $ 0.11 $ 0.11 $ 0.11
Pro forma --
Net income................................ $1,713,342 $1,892,035 $2,281,761
Basic net income per share................ $ 0.08 $ 0.09 $ 0.11
Diluted net income per share.............. $ 0.08 $ 0.08 $ 0.10
</TABLE>
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
6. COMMITMENTS
Lease Agreements
The Company leases certain of its facilities and equipment under operating
lease agreements expiring on various dates through December 2005. Total minimum
lease payments, including scheduled increases, are charged to operations on the
straight-line basis over the life of the respective lease. Rent expense for the
years ended December 31, 1998, 1997 and 1996 was approximately $441,000,
$475,000, and $450,000, respectively.
At December 31, 1998, minimum commitments remaining under lease agreements
were as follows:
<TABLE>
<CAPTION>
AMOUNT
----------
<S> <C>
Years ending December 31:
1999................................................... $ 444,000
2000................................................... $ 403,000
2001................................................... $ 377,000
2002................................................... $ 373,000
2003................................................... $ 342,000
Thereafter............................................. $ 479,000
----------
$2,418,000
==========
</TABLE>
F-13
<PAGE> 30
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
7. EMPLOYEE BENEFIT PLAN
On November 1, 1997, the Company adopted the Psychemedics Corporation
401(k) Savings and Retirement Plan (the 401(k) Plan). The 401(k) Plan is a
qualified defined contribution plan in accordance with Section 401(k) of the
Internal Revenue Code. All employees over the age of 21 who have completed one
year of service are eligible to make pre-tax contributions up to a specified
percentage of their compensation. Under the 401(k) Plan, the Company may, but is
not obligated to, match a portion of the employees' contribution up to a defined
maximum. A matching contribution of $94,111 was made in 1998 while no
contribution was made in 1997.
8. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Accrued payroll and employee benefits...................... $246,277 $187,085
Other accrued expenses..................................... 336,477 33,735
-------- --------
$582,754 $220,820
======== ========
</TABLE>
9. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following are selected quarterly financial data for the years ended
December 31, 1998 and 1997:
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1998 1998 1998 1998
---------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
Revenues.................................. $4,121,903 $4,834,720 $4,571,820 $4,141,532
Gross profit.............................. 2,427,015 2,924,394 2,623,795 2,226,197
Income from operations.................... 944,034 1,175,911 826,078 360,751
Net income................................ 641,278 782,186 575,409 398,136
Basic net income per share................ 0.03 0.04 0.03 0.02
Diluted net income per share.............. 0.03 0.03 0.03 0.02
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1997 1997 1997 1997
---------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
Revenues.................................. $3,253,743 $4,402,203 $3,673,859 $4,069,147
Gross profit.............................. 1,931,871 2,795,588 2,076,892 2,536,997
Income from operations.................... 632,867 998,362 439,192 985,599
Net income................................ 637,107 745,520 374,436 744,090
Basic net income per share................ 0.03 0.03 0.02 0.03
Diluted net income per share.............. 0.03 0.03 0.02 0.03
</TABLE>
F-14
<PAGE> 31
PSYCHEMEDICS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
10. ALLOWANCE FOR DOUBTFUL ACCOUNTS
A summary of the allowance for doubtful accounts is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance, beginning of period........................ $264,429 $163,991 $ 31,175
Provision for doubtful accounts..................... 165,000 162,000 180,000
Write-offs.......................................... (52,429) (61,562) (47,184)
-------- -------- --------
Balance, end of period.............................. $377,000 $264,429 $163,991
======== ======== ========
</TABLE>
11. SUBSEQUENT EVENT
On February 23, 1999, the Company declared a cash dividend of $.04 per
share payable on March 22, 1999 to shareholders of record at the close of
business on March 5, 1999.
F-15
<PAGE> 32
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PSYCHEMEDICS CORPORATION
By: /s/
RAYMOND C. KUBACKI, JR.
----------------------------------
RAYMOND C. KUBACKI, JR.
PRESIDENT AND CHIEF EXECUTIVE
OFFICER
Date: March 24, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<C> <S> <C>
/s/ RAYMOND C. KUBACKI, JR. President and Chief March 24, 1999
- --------------------------------------------------- Executive Officer, Director
RAYMOND C. KUBACKI, JR. (Principal Executive
Officer)
/s/ PETER C. MONSON Vice President, Treasurer & March 24, 1999
- --------------------------------------------------- Controller (Principal
PETER C. MONSON Financial and Accounting
Officer)
/s/ WERNER A. BAUMGARTNER, PH.D. Director March 24, 1999
- ---------------------------------------------------
WERNER A. BAUMGARTNER, PH.D.
/s/ A. CLINTON ALLEN Director March 24, 1999
- ---------------------------------------------------
A. CLINTON ALLEN
/s/ DONALD F. FLYNN Director March 24, 1999
- ---------------------------------------------------
DONALD F. FLYNN
/s/ JOHN J. MELK Director March 24, 1999
- ---------------------------------------------------
JOHN J. MELK
/s/ FRED J. WEINERT Director March 24, 1999
- ---------------------------------------------------
FRED J. WEINERT
</TABLE>
<PAGE> 33
PSYCHEMEDICS CORPORATION
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT PAGE OR
NUMBER DESCRIPTION REFERENCE
- ------- ----------- ---------
<S> <C> <C>
3 Articles of Incorporation and By-Laws
3.1 Certificate of Incorporation filed September 24,
1986 -- (Incorporated by reference from the Registrant's
Registration Statement on Form S-18, File No. 33-10186 LA).
3.2 Amendment to Certificate of Incorporation filed October 29,
1986 -- (Incorporated by reference from the Registrant's
Registration Statement on Form S-18, File No. 33-10186 LA).
3.3 Amendment to Certificate of Incorporation filed July 12,
1989 -- (Incorporated by reference from the Registrant's
Annual Report on Form 10-K for the fiscal year ended June
30, 1989.)
3.4 Amendment to Certificate of Incorporation filed August 7,
1990 -- (Incorporated by reference from the Registrant's
Quarterly Report on Form 10-Q for the Quarter ended
September 30, 1990 as amended by a First Amendment on Form 8
filed December 15, 1990.)
3.5 Amendment to Certificate of Incorporation filed May 9,
1991 -- (Incorporated by reference from the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1991.)
3.6 By-Laws of the Company -- (Incorporated by reference from
the Registrant's Registration Statement on Form S-18, File
No. 33-10186 LA).
4 Instruments Defining the Rights of Security Holders
4.1 Specimen Stock Certificate -- (Incorporated by reference
from the Registrant's Registration Statement on Form S-18,
File No. 33-10186 LA).
10 Material Contracts
10.1 License Agreement with Werner Baumgartner, Ph.D. and Annette
Baumgartner dated January 17, 1987 -- (Incorporated by
reference from the Registrant's Registration Statement on
Form S-18, File No. 33-10186 LA).
10.2* 1989 Employee Stock Option Plan, as amended -- (Incorporated
by reference from the Registrant's 1997 Annual Proxy
Statement.)
10.3* 1989 Non-Qualified Stock Option Plan, as amended
(Incorporated by reference from the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1996.
10.4* 1991 Non-Qualified Stock Option Plan -(Incorporated by reference from
the Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1991.)
10.5 Lease dated October 6, 1992 with Mitchell H. Hersch, et. al
with respect to premises in Culver City,
California -- (Incorporated by reference from the
Registrant's Annual Report on Form 10-KSB for for the fiscal
year ended December 31, 1992.)
10.5.1 Security Agreement dated October 6, 1992 with Mitchell H.
Hersch et. al (Incorporated by reference from the
Registrant's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1992.)
10.5.2 First Amendment to Lease dated with Mitchell H. Hersch,
et.al -- (Incorporated by reference from the Registrant's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1997.)
</TABLE>
<PAGE> 34
<TABLE>
<CAPTION>
EXHIBIT PAGE OR
NUMBER DESCRIPTION REFERENCE
- ------- ----------- ---------
<S> <C> <C>
10.5.3 Second Amendment to Lease dated with Mitchell H. Hersch,
et.al. (Incorporated by reference from the Registrant's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1997.)
10.5.4 Third Amendment to Lease dated December 31, 1997 with
Mitchell H. Hersch, et.al. (Incorporated by reference from
the Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997.)
23 Consents of Experts and Counsel
23.1 Consent of Arthur Andersen LLP Filed herewith
27 Financial Data Schedule Filed herewith
</TABLE>
- ---------------
* Represents a management contract or compensatory plan in which a director or
named executive officer of the Registrant participates.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated February 9, 1999, included in this Form 10-K, into Psychemedics
Corporation's previously filed Registration Statements File Nos.
33-41787, 33-50712, 33-45332, 33-66942, 33-58970 and 333-12403.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
March 24, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 724,738
<SECURITIES> 9,088,436
<RECEIVABLES> 3,075,619
<ALLOWANCES> 377,000
<INVENTORY> 510,016
<CURRENT-ASSETS> 14,122,197
<PP&E> 8,131,365
<DEPRECIATION> 3,949,128
<TOTAL-ASSETS> 18,739,359
<CURRENT-LIABILITIES> 2,856,850
<BONDS> 0
0
0
<COMMON> 113,036
<OTHER-SE> 15,769,473
<TOTAL-LIABILITY-AND-EQUITY> 18,739,359
<SALES> 17,669,975
<TOTAL-REVENUES> 17,669,975
<CGS> 7,468,574
<TOTAL-COSTS> 7,468,574
<OTHER-EXPENSES> 6,894,627
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 3,867,009
<INCOME-TAX> 1,470,000
<INCOME-CONTINUING> 2,397,009
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,397,009
<EPS-PRIMARY> 0.11
<EPS-DILUTED> 0.11
</TABLE>
