<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-19371
PHARMCHEM LABORATORIES, INC.
(Exact name of registrant as specified in its charter)
CALIFORNIA 77-0187280
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
1505-A O'BRIEN DRIVE
MENLO PARK, CALIFORNIA 94025
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (650) 328-6200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Name of each exchange
Title of each class on which registered
- ------------------- -------------------
COMMON STOCK NASDAQ NATIONAL MARKET
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant (based on the closing price of $3.75 as reported on the
Nasdaq/NMS on January 31, 2000) was approximately $9,524,000. Shares of voting
stock held by each executive officer and director and by each holder of 5% or
more of the outstanding voting stock have been treated as shares held by
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. The number of outstanding shares of
the Registrant's Common Stock as of January 31, 2000 was 5,805,729.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the PharmChem Laboratories, Inc. Proxy Statement for the
2000 Annual Meeting of Shareholders to be filed with the Commission on or before
April 28, 2000 are incorporated by reference into Part III of this Annual Report
on Form 10-K. With the exception of those portions which are specifically
incorporated by reference in this Annual Report on Form 10-K, such Proxy
Statement shall not be deemed filed as part of this Report.
================================================================================
<PAGE> 2
PHARMCHEM LABORATORIES, INC.
ANNUAL REPORT ON FORM 10-K
INDEX
<TABLE>
<CAPTION>
PAGE
----
PART I
<S> <C> <C>
Item 1. Business....................................................................................... 3
Item 2. Properties..................................................................................... 11
Item 3. Legal Proceedings.............................................................................. 11
Item 4. Submission of Matters to a Vote of Security Holders............................................ 12
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.......................... 13
Item 6. Selected Consolidated Financial Data........................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ......... 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .................................... 21
Item 8. Financial Statements and Supplementary Data.................................................... 21
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure..................................................................................... 43
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 43
Item 11. Executive Compensation......................................................................... 43
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 43
Item 13. Certain Relationships and Related Transactions................................................. 43
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K................................. 43
Signatures............................................................................................... 48
</TABLE>
2
<PAGE> 3
PART I
ITEM 1. BUSINESS
GENERAL OVERVIEW
PharmChem is a leading independent laboratory that provides integrated
drug testing services. Our customers include private and public employers,
criminal justice agencies and drug treatment programs primarily in the United
States and Europe who seek to detect and deter the use of illegal drugs and
alcohol. We are certified by a number of states agencies, as well as by the
following organizations to conduct drug testing using forensic procedures:
- Substance Abuse and Mental Health Service Administration (SAMHSA) of the
US Department of Health and Human Services
- College of American Pathologists (CAP)
Our domestic laboratories are certified under the Clinical Laboratory
Improvement Amendments (CLIA) or have "deemed status" under CLIA as a result of
state certification. Our forensic procedures provide accurate and reliable test
results and a chain of custody for each specimen from its collection to the
reporting of its test result.
We test for a number of drugs of abuse, including:
- cocaine
- methamphetamine
- heroin
- phencyclidine (PCP)
- marijuana (THC)
- alcohol
We test primarily by urinalysis but also with the PharmChek(R) Drugs of
Abuse Patch (for testing with sweat) and the PharmScreen(R) on-site screening
devices. Under our Premium Comprehensive Management Program(TM), we offer a
comprehensive set of services customized to assist customers in implementing
cost-effective drug testing programs.
CORPORATE BACKGROUND
PharmChem was incorporated in California in 1987 to acquire PharmChem
Laboratories Operations, Inc., a California corporation founded in 1971. In
1991, we completed our initial public offering. In 1992, we expanded our
operations through the acquisition of London-based Medscreen Limited
(Medscreen), a certified laboratory providing international drug testing
services In 1992 we also acquired a certified laboratory in Fort Worth, Texas.
Our worldwide headquarters are located at 1505-A O'Brien Drive, Menlo Park,
California 94025 and our telephone number is (650) 328-6200. When we refer to
"we", "our" or "PharmChem" in this Form 10-K, we mean the current California
corporation (PharmChem Laboratories, Inc.) as well as Medscreen.
INDUSTRY BACKGROUND
National clinical laboratory chains, independent national drug testing
laboratories, like ourselves, and numerous regional and local laboratories have
historically served the drug testing market. Thousands of general clinical
laboratories nationwide can conduct forensic and non-forensic drug testing, and
are increasingly bidding on local contracts. Over the past several years,
through consolidations, restructurings and bankruptcies, there has been a
decline in the number of independent laboratories whose sole business is
conducting forensic drug testing. Many corporate and governmental organizations
require drug testing laboratories to be certified to conduct forensic drug tests
and to offer integrated cost-effective testing services. Many large
organizations, particularly those in the public sector, use a competitive
bidding procedure to select their drug testing laboratories. These organizations
often limit the bidding to certified drug testing laboratories that can
demonstrate the ability to meet their specified service and volume levels.
3
<PAGE> 4
FORENSIC DRUG TESTING
The essential elements of forensic drug testing are:
- a secure chain of custody for each specimen from its collection to the
reporting of its test result;
- accurate and reliable testing in which a second independent test is
performed to confirm each positive test result.
We carefully control each step of the testing process with detailed
written procedures and by using the specific forensic testing methods required
for legal defensibility of results. We perform most of our testing at our
laboratory in Menlo Park, California, which operates six days per week, 24 hours
a day. We also provide complete testing services at our Texas Division in Fort
Worth and at Medscreen.
URINALYSIS
The steps in PharmChem's forensic drug testing process by urinalysis,
our primary drug testing method, are as follows:
Specimen Collection and Transportation
- Forensic drug testing begins with specimen collection conducted under
carefully controlled conditions. Once a donor has provided a specimen,
we assign a unique specimen identification number.
- We then record information pertinent to the specimen on a chain of
custody form numbered to match the specimen bottle.
- Specimens, together with chain of custody forms, are delivered to
PharmChem by courier or mail.
Receiving and Accessioning
- We receive specimens in our restricted accessioning rooms, where we
inspect them for tampering and check for proper chain of custody
documentation.
- We identify and track the specimens using unique bar-coded laboratory
accessioning numbers.
Screening Analyses
- We screen each specimen submitted for the presence of the drugs
specified by the customer.
- We perform approximately 1,660,000 screening tests on more than
235,000 specimens per month to determine the presence of drugs.
- The screening methods we use include:
* enzyme immunoassay
* radioimmunoassay
* thin layer chromatography
Results/Confirmation Testing
- We report negative screening results to the customer.
- If the specimen tests positive, we confirm the results by testing a
separate aliquot using a different and independent technology from
that used for the initial screening.
- Confirmation technologies we use include:
* gas chromatography/mass spectrometry (GC/MS)
* gas chromatography
GC/MS confirmation is required for federally-regulated drug testing and
most other workplace drug testing. Its use has been cited with approval in
numerous legal proceedings.
4
<PAGE> 5
Quality Control
We carefully monitor the accuracy and reliability of our test results by
internal and external quality assurance and quality control programs. Our staff
evaluates laboratory performance with open and blind quality control samples. We
are subject to frequent proficiency testing by various certifying bodies, which
send their own open and blind samples to the laboratory. We are also subject to
frequent inspections by certifying agencies. We put each test result through
several independent levels of review before a certified scientist reports the
results to our customer.
Reporting of Results
We transmit most of our test results electronically. We use various
secure communication networks and automated voice reporting systems. Our
information systems make each test result available to the customer's computer
or secure facsimile machine, by telephonic inquiry or by mail delivery. We
routinely report results for specimens that screen negative within 24 hours of
receipt in the laboratory and within 48 hours for specimens that require
confirmation.
PHARMSCREEN(R) ON-SITE SCREENING DEVICE
In recent years there has been a growing trend toward the use of on-site
screening for drugs of abuse by a number of agencies, including some of our
customers. On-site screening relies upon portable diagnostic devices that the
customer may use at the point of specimen collection to readily identify drugs
of abuse in urine specimens. This technology is advantageous because it provides
virtually immediate test results.
We offer a line of on-site screening devices to supplement our laboratory-based
testing services. PharmScreen(R) is a portable, hand-held device used for
on-site screening of drugs of abuse and is available in single, dual, four and
five test configurations. We recently launched the Comprehensive Drug Test Kit
to help businesses implement a drug free workplace program. The Comprehensive
Drug Test Kit includes 25 PharmScreen(R) five-drug test devices, training
videos, a substance abuse policy, chain of custody forms and other materials
packaged in one transportable box. PharmScreen(R) is currently being used by
certain government agencies, including the Michigan Department of Corrections
(Michigan DOC) and the Administrative Office of the United States Courts
(Federal Probation), and by certain private employers, including Sears Roebuck &
Co. PharmScreen(R) provides only a preliminary analytical result, and a more
specific alternative chemical method, such as GC/MS, is necessary to obtain a
confirmed analytical result.
Although our sales of PharmScreen(R) have steadily increased, there can
be no assurance that it will be commercially accepted by existing or new
customers or generate significant revenues in the future.
PHARMCHEK(R) DRUGS OF ABUSE PATCH
PharmChek(R) is a system that uses sweat to detect the presence of
illegal drugs and has been under development by us since 1992. It consists of a
transparent polyurethane outer covering, a small absorbent pad and a release
liner. A unique number is printed on the underside of the polyurethane layer for
identification and anti-counterfeiting purposes. Unlike urinalysis, flushing or
employing a diuretic to rid the body of drugs of abuse does not affect
PharmChek(R) test results, since the drugs in the sweat simply collect on the
absorption pad until the pad is removed for analysis.
PharmChek(R) may offer other advantages over other drug detection
systems currently available. First, it does not require the handling of urine or
blood, which may be objectionable to some people. Second, the use of sweat as a
testing medium may lengthen the drug use detection period and decrease testing
costs by reducing the need for specialized specimen collection facilities and
staff.
Recent state and federal court cases in California and Nevada have
affirmed the validity of PharmChek(R) for detecting the use of illegal drugs.
The FDA has cleared PharmChek(R) for detecting the use of:
5
<PAGE> 6
- cocaine
- opiates (including heroin)
- amphetamines (including methamphetamine)
- phencyclidine (PCP)
- marijuana (THC)
Our sales of PharmChek(R) have not been significant and there can be no
assurance that it will be commercially accepted by existing or new customers or
generate significant revenues in the future.
SUPPLIERS
We are dependent upon a single supplier for the PharmChek(R) product. We
are not dependent upon any other single supplier for our raw materials.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
We provide a variety of drug testing services which are customized to
each customer's specific needs. We employ a customer service and technical
support staff specializing in one or more of the following areas of service.
- SPECIMEN COLLECTION. We manage specimen collection services for
a number of our customers. We maintain a list of more than 5,000
clinics and other organizations throughout the United States
(US) and Puerto Rico that offer specimen collection services
that comply with forensic drug-testing procedures. Our customer
service staff identifies collectors conveniently located to
customer sites, prepares customized specimen collection
procedures, conducts training of collection personnel and
monitors their performance. In 1999, PharmChem managed
approximately 500,000 collections in the US, while Medscreen
managed approximately 30,000 collections throughout the United
Kingdom (UK) and at over 300 shipping ports throughout the
world.
- TRANSPORTATION. Most specimens are transported to PharmChem by
overnight or same-day courier, or by mail. We offer special
specimen transportation services for selected areas that provide
for pickup of specimens before the close of each business day.
- TECHNICAL CONSULTATION. The technical specialists on our staff
are experienced in drug metabolism and other technical aspects
of drug testing. These specialists respond to requests from
customers to interpret test results. In addition, we are often
called upon to assemble the complete chain of custody and
testing data package for specimen results that have been
challenged and to provide expert witness testimony in legal
proceedings. The technical consultation group also provides
comprehensive in-service training for customers on topics such
as substance abuse trends, toxicology and drug pharmacology,
breath alcohol testing and technical information on PharmChem's
testing procedures.
- PROGRAM ANALYSIS. We collect and analyze data on test results in
order to provide comprehensive monthly statistical reports to
meet customers' regulatory requirements and to assist with drug
program management.
SALES AND MARKETING
We sell our integrated drug testing services to corporate and
governmental customers. Our sales force uses a consultative selling approach -
Premium Comprehensive Management(TM) (PCM). PCM emphasizes the full scope of
integrated services we offer and customizes these services to meet customers'
particular needs. PCM provides customized services including:
- a worldwide database of collection sites and on-call collections
for rapid response
- alternatives to laboratory urine testing including on-site
screening devices such as PharmScreen(R), sweat testing with
PharmChek(R) and hair testing
- statistical reporting
6
<PAGE> 7
- centralized billing and other services
CUSTOMERS
PharmChem provides integrated drug testing services to three primary
customer groups in the United States and provides these services internationally
through Medscreen:
PUBLIC AND PRIVATE WORKPLACE EMPLOYERS
Public and private workplace employers use drug testing as part of their
hiring decisions in order to increase safety and reduce costs associated with
drug abuse in the workplace. In addition, an increasing number of public and
private workplace employers test employees in certain positions on a periodic or
random basis and test other employees upon reasonable suspicion of drug use.
Sales of laboratory services and products to public and private
workplace employers accounted for 38%, 42% and 45% of our total net sales in
1999, 1998 and 1997, respectively. Sales to Sears, Roebuck & Co. accounted for
approximately 10%, 11% and 10% of our total net sales in 1999, 1998 and 1997,
respectively.
CRIMINAL JUSTICE AGENCIES
Criminal justice agencies use drug testing results in criminal
proceedings and to assist with making parole, drug treatment and probation
decisions. These agencies also use drug testing to monitor drug treatment of
individuals under supervision and to track drug use trends within the United
States.
Sales of laboratory services and products to criminal justice agencies
accounted for 43%, 39% and 41% of our total net sales in 1999, 1998 and 1997,
respectively. Sales to Federal Probation accounted for approximately 19%, 18%
and 17% of our total net sales in 1999, 1998 and 1997, respectively.
DRUG TREATMENT PROGRAMS
Drug treatment programs use drug testing to monitor the treatment and
rehabilitation of drug users in their care. Sales of laboratory services and
products to drug treatment programs accounted for less than 5% of the our total
net sales in 1999, 1998 and 1997.
MEDSCREEN'S CUSTOMER BASE
PharmChem's London-based subsidiary accounted for 16%, 15% and 11% of
our total net sales in 1999, 1998 and 1997, respectively. Medscreen's primary
customers operate in the maritime, criminal justice, oil, chemical, utilities
and transportation industries. Medscreen has customers in 35 countries.
Approximately 61% of 1999 sales were from UK-based customers with the balance
from customers in other countries in Europe, Asia, Middle East, Far East and
South America.
CONTRACTING
Customers engage us to provide services through the following:
- the formal competitive bid process
- standard service contracts
- without a formal contract, but by accepting test specimens for
an agreed upon price renegotiated every twelve months
A majority of our sales are derived from competitive bids, and we
believe that competitive pressure with respect to these bids, particularly for
large multi-year contracts, has intensified. Many of our large potential
customers, including the majority of public employers and criminal justice
agencies, use a formal competitive bid process in which the potential customer
provides a detailed specification of the drug testing services it requires.
There is no assurance
7
<PAGE> 8
that we will be the successful bidder when these contracts are up for renewal.
While price is an important factor, in most cases these organizations are not
required to accept the lowest bid, but rather may choose the winning bidders
based on technical superiority and customer service.
The failure to renew a significant contract, if not replaced by
comparable contracts, could result in lower sales, lower profit margins,
decreased cash flows and losses. Our contracts generally allow termination at
the customer's discretion on short notice with little or no penalty. Many
contracts provide for termination for convenience. Although in the past our
customers generally have not exercised these early termination rights, there can
be no assurance that this will continue in the future.
Backlog is not a significant statistic for PharmChem due to the short
turnaround time for processing specimens.
COMPETITION
The market for drug testing services became increasingly competitive in
the early 1990's, and continues to be competitive. Drug testing laboratories
compete primarily on the basis of:
- customer service
- technical capability
- price
We believe that PharmChem competes favorably in each of these
categories. We have significantly expanded our scope of services and the
average total price per specimen has remained relatively unchanged.
8
<PAGE> 9
Our competitors include:
- national clinical laboratory companies, such as Laboratory
Corporation of America and Quest Diagnostics
- independent national drug testing laboratories, such as
Psychemedics Corporation and Medtox Scientific, Inc.
- regional and local laboratories
- third party administrators
- medical review officers
- manufacturers and distributors of on-site screening devices and
equipment
The national clinical laboratories have greater financial, marketing,
laboratory and related resources than PharmChem. In addition, some of our
customers and our potential customers operate their own drug testing facilities
or may develop such facilities in the future.
CERTIFICATION AND GOVERNMENT REGULATION
Laboratories which compete in the U.S. forensic drug testing market
generally must be certified by SAMHSA. In addition, some state and local
jurisdictions require their own certification for testing of specimens of their
residents. Such state and local certifications are essential to our business in
each such respective jurisdiction. Our laboratories are currently certified by
SAMHSA, CAP and certain state and local jurisdictions. Our Texas laboratory is
certified by CLIA and our California laboratory has received "deemed status"
under CLIA as a result of its State of California certification. We believe we
are certified in all jurisdictions in which we operate.
We are subject to frequent inspection by certifying bodies, including
annual CAP and semi-annual SAMHSA inspections. Inspections sometimes result in
reports describing areas for improvement or suggesting changes in procedures. We
may be required to take actions on the items noted in the inspection report in
order to remain certified. Failure to meet certification requirements could
result in suspension or loss of certification.
We have never been decertified as the result of an inspection.
Certification is essential to our business because some of our customers are
required to use a certified laboratory, and many of our customers look to
certification as an indication of reliability and accuracy of results.
Certain federal agencies regulate employee drug testing by other federal
agencies and certain private employers. Court precedent currently exists in a
number of states regarding the circumstances under which employers may test
employees and the procedures under which such tests must be conducted. The
circumstances under which drug testing can legally be required by employers is
subject to judicial review, and is challenged from time to time by employees,
unions and other groups on constitutional, privacy and other grounds.
ENVIRONMENTAL MATTERS
A small portion of our business involves testing procedures requiring
the use of chloroform and radioactive reagents, which are considered to be
hazardous materials. Failure to comply with current or future federal, state or
local environmental laws or regulations regarding these hazardous materials
could have a material adverse effect on us. We believe that we have adequately
notified employees of potential risks associated with working at PharmChem and
have provided a workplace safe from hazard, as required by the Occupational
Safety and Health Administration and certain state laws. We believe we are in
compliance with all applicable environmental laws and regulations.
EMPLOYEES
As of December 31, 1999, we had approximately 300 full-time employees.
Our employees are not represented by labor organizations, and we consider
relations with our employees to be good.
9
<PAGE> 10
YEAR 2000
The Year 2000 (Y2K) issue is the result of date-sensitive devices,
systems and computer applications that were deployed using two digits rather
than four digits to define the applicable year. Therefore, these technologies
may improperly recognize a year containing "00" as 1900 rather than the year
2000. This may result in a system failure or miscalculations causing disruptions
of operations. We are subject to various risks associated with the Y2K impact on
information systems software and hardware. We have assessed our exposure to
Y2K-related problems focusing on three potential areas of exposure: laboratory
information systems (LIS), electronic transmission of test results and the
readiness of significant third parties with whom we have a material business
relationship, such as transportation systems. To date, we have not experienced
any material Y2K problems with our systems, our transmission of test results or
our outside suppliers. However, we cannot assure that our systems or our
suppliers do not have undetected Y2K problems that could result in significant
operating difficulties for PharmChem.
For the period January 1, 1996 through December 31, 1999, PharmChem has
invested over $6.0 million in new information systems which have been designed
to enhance our operational capabilities as well as meet Y2K requirements. We
completed all Y2K projects at various dates through the end of the fourth
quarter of 1999. We have funded all investments in information systems and other
Y2K projects with internally generated cash, leases or bank financing. We
estimate approximately $200,000 was expensed for Y2K activities, including
consulting costs and payroll for employees dedicated to Y2K projects.
SEASONAL OPERATING FACTORS
PharmChem's operations are affected by both seasonal trends to which
drug testing laboratories are generally subject and general economic conditions.
In the past, testing volume tends to be higher in the second and third calendar
quarters and lower in the fourth and first calendar quarters, primarily due to
the hiring patterns of our public and private employer customer group which
affect pre-employment drug testing.
RESEARCH AND DEVELOPMENT
Our most experienced scientists and technicians perform research and
development activities. Our research and development efforts continually focus
upon improving laboratory procedures and processes. We believe we have
engineered a number of efficiencies to improve the accuracy and reliability of
our drug tests.
10
<PAGE> 11
DOMESTIC AND FOREIGN OPERATIONS
Refer to Note 10 to the Consolidated Financial Statements for reportable
segment information and financial information about geographic areas.
ITEM 2. PROPERTIES
<TABLE>
<CAPTION>
LOCATION USE SQUARE FOOTAGE REMAINING LEASE TERM
- ----------------------- ------------------- ------------- ---------------------------
<S> <C> <C> <C>
1505-A O'Brien Drive World Headquarters 35,719 1 year 5 months(1)
Menlo Park, CA 94025 and Laboratory
1275 Hamilton Court Distribution Center 11,925 6 years(2)
Menlo Park, CA 94025
7606 Pebble Drive Texas Division and 15,000 1 year with a 5 year option
Fort Worth, TX 76118 Laboratory
1A Harbour Quay Medscreen 13,350 3 years with a 10 year
100 Preston's Road Headquarters and option
London, E14 9PH Laboratory
England
</TABLE>
- ---------
(1) We are presently seeking to either renegotiate this lease or seek
alternative facilities.
(2) The lease contains an option for early termination in 2001.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of our business, we are sued by individuals,
primarily those in the criminal justice system, who have tested positive for
drugs of abuse. In addition, we frequently testify in administrative and court
proceedings involving the results of our tests. To date, we have not experienced
any material liability related to these claims, although there can be no
assurance that we will not at some time in the future experience significant
liability in connection with such claims. There are no pending legal
proceedings, other than ordinary routine litigation incidental to our business,
to which we are a party or to which any of our property is subject and our
management does not believe the outcome of any of the proceedings will have a
material impact on our financial position or results of operations.
We believe that our liability insurance coverage is adequate for our
business.
11
<PAGE> 12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 1999.
EXECUTIVE OFFICERS OF PHARMCHEM
<TABLE>
<CAPTION>
NAME AGE POSITION WITH PHARMCHEM
---- --- --------------------------------------------------
<S> <C> <C>
Joseph W. Halligan 55 President, Chief Executive Officer and Director
David A. Lattanzio 57 Vice President, Finance and Administration,
Chief Financial Officer and Secretary
Neil A. Fortner 45 Vice President, Laboratory Operations
Elizabeth M. Lison 42 Vice President, Customer Service
Joseph L. Kurta 48 Vice President, Sales and Marketing
</TABLE>
Mr. Halligan has been PharmChem's President, Chief Executive Officer and
Director since November 1995. From 1988 to 1995, he was President and CEO of
E.S.I. Consulting Group, a private consulting practice, specializing in advising
and operating high growth, consumer and service oriented companies. Before
forming his consulting practice, Mr. Halligan served from 1983 to 1987 as
President and CEO of a privately-held company, Laura Scudder's, Inc. From 1969
to 1983, he served as Senior Vice President of Fotomat Corporation and President
of its subsidiary, Video Services of America. He holds a B.S. in Management and
Business Administration from Columbia Pacific University.
Mr. Lattanzio has been PharmChem's Vice President, Finance and
Administration, and Chief Financial Officer since April 1996 and Secretary since
January 1997. He is responsible for all business aspects of our operations,
including accounting, corporate finance, treasury, logistics, human resources
and risk management. From 1995 to March 1996, Mr. Lattanzio performed private
consulting for several companies, including PharmChem. He served as Vice
President, Finance and Chief Financial Officer of Mission Foods from 1991 to
1995. Mr. Lattanzio holds a B.B.A. in Accounting from the University of Notre
Dame and is a certified public accountant.
Mr. Fortner has served as Vice President, Laboratory Operations of
PharmChem since February 1992. He joined PharmChem as Director, Laboratory
Operations in July 1991. He is the Scientific Director and is responsible for
all production aspects of laboratory operations. From 1985 to 1991, he served as
Director of Toxicology at Southgate Medical Services. Mr. Fortner has more than
15 years experience in forensic toxicology and he is a qualified SAMHSA and CAP
laboratory inspector. He is a member of the American Association of Clinical
Chemistry and a full member of the Society of Forensic Toxicologists, the
American Academy of Forensic Sciences and the American Board of Forensic
Examiners. Mr. Fortner holds a B.A. in Biology from Hiram College and a M.S. in
Biochemistry from Western Kentucky University.
Ms. Lison became Vice President, Customer Service of PharmChem in March
1997. She joined Medscreen in 1993, where she held various management positions
in sales and customer service. Ms. Lison is responsible for all customer service
functions. In June 1996, she relocated to our corporate office to serve as
Director, Customer Service. From 1979 to 1993, Ms. Lison worked in various
aspects of the design and delivery of workplace drug testing programs for
companies based in the UK. Ms. Lison holds a B. Tech (Hons) in Medical Science
from the University of Bradford, UK.
Mr. Kurta has served as Vice President, Sales and Marketing since
joining PharmChem in March 1998. He is responsible for sales, marketing and the
commercial development of our laboratory services and the PharmScreen(R) and
PharmChek(R) product lines. Prior to joining PharmChem, Mr. Kurta served as
Director of Business Development and Director of Sales and Marketing for the
Unilab Corporation and served in various capacities at Damon Laboratories and
Corning/Metpath Laboratories. From 1979 to 1986, Mr. Kurta owned and operated
Spectrum Helicopters, Inc., Copter Quik Delivery Systems and Geriatric
HealthCare Group. Mr. Kurta holds B.A. and M.S. degrees from Alfred University
in New York.
12
<PAGE> 13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Our common stock trades on the Nasdaq National Market under the symbol
"PCHM".
STOCK PRICES
The following table sets forth for the periods indicated the high and
low closing bid prices for the our common stock by quarter for years 1999 and
1998, as reported by the Automated Quotation System of the National Association
of Securities Dealers (Nasdaq). The prices shown represent quotations among
securities dealers, do not include retail markups, markdowns or commissions and
may not represent actual transactions.
<TABLE>
<CAPTION>
CALENDAR CALENDAR
QUARTER HIGH LOW QUARTER HIGH LOW
-------- ---- --- -------- ---- ---
<S> <C> <C> <C> <C> <C> <C>
Q1 1999 $ 4.750 $ 1.750 Q1 1998 $ 2.750 $ 2.188
Q2 1999 $ 3.438 $ 2.125 Q2 1998 $ 2.875 $ 2.125
Q3 1999 $ 3.000 $ 1.938 Q3 1998 $ 3.500 $ 2.250
Q4 1999 $ 4.000 $ 1.750 Q4 1998 $ 4.750 $ 2.375
</TABLE>
As of March 1, 2000, there were approximately 150 holders of record of
our common stock. A large number of shares were held in nominee name. Based upon
information furnished by our proxy solicitor, Skinner & Co, we believe we have
approximately 1,500 shareholders as of March 1, 2000.
DIVIDENDS
We have never paid cash dividends on our common stock. We currently
anticipate that we will retain all future earnings for use in the operation and
expansion of our business and do not anticipate paying any dividends in the
foreseeable future. In addition, our current revolving credit agreement
prohibits the declaration or payment of dividends.
13
<PAGE> 14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
1999 1998 1997 1996 1995
-------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
(In thousands, except per share data)
Consolidated Statements of Operations Data:
Net sales ........................................... $ 44,487 $ 43,172 $ 39,233 $41,255 $ 39,111
Cost of sales ....................................... 31,374 31,653 31,311 31,757 29,771
-------- -------- -------- ------- --------
Gross profit ........................................ 13,113 11,519 7,922 9,498 9,340
-------- -------- -------- ------- --------
Selling, general and administrative expenses ........ 10,033 9,800 8,234 8,689 8,005
Amortization of goodwill ............................ 185 185 185 185 247
Provision for doubtful accounts ..................... 141 325 350 206 575
Restructuring and unusual charges(1) ................ - - - - 8,775
-------- -------- -------- ------- --------
Total operating expenses .................... 10,359 10,310 8,769 9,080 17,602
-------- -------- -------- ------- --------
Income (loss) from operations .................. 2,754 1,209 (847) 418 (8,262)
Other expenses, net ................................. 248 288 389 372 368
-------- -------- -------- ------- --------
Income (loss) before income taxes .............. 2,506 921 (1,236) 46 (8,630)
Provision for (benefit from) income taxes ........... (294) 286 34 - (1,819)
-------- -------- -------- ------- --------
Net income (loss) .............................. $ 2,800 $ 635 $ (1,270) $ 46 $ (6,811)
======== ======== ======== ======= ========
Basic earnings (loss) per share ..................... $ 0.48 $ 0.11 $ (0.22) $ 0.01 $ (1.23)
======== ======== ======== ======= ========
Diluted earnings (loss) per share ................... $ 0.47 $ 0.10 $ (0.22) $ 0.01 $ (1.23)
======== ======== ======== ======= ========
Basic weighted average shares outstanding ........... 5,786 5,764 5,734 5,622 5,542
======== ======== ======== ======= ========
Diluted weighted average shares outstanding ......... 5,954 6,238 5,734 5,710 5,542
======== ======== ======== ======= ========
Cash dividends per share ............................ - - - - -
======== ======== ======== ======= ========
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficiency) ........................ $ 3,040 $ (319) $ (1,147) $ 1,707 $ 4,283
Total assets ........................................ 25,046 22,063 22,246 21,647 22,236
Long-term debt, net of current portion .............. 2,593 656 696 1,205 3,401
Shareholders' equity ................................ 13,697 10,910 10,211 11,431 11,026
</TABLE>
- ----------
(1) In 1995, we recorded a provision for restructuring and unusual
charges of $8.8 million related to the marketing rights and
development of PharmChek(R), computer and peripheral equipment,
Medscreen goodwill and other unusual charges.
Selected quarterly financial data is included in Note 11 to the Consolidated
Financial Statements.
14
<PAGE> 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD-LOOKING STATEMENTS
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act
of 1933 ("Forward-looking Statements"), which are subject to the "safe harbor"
created by these Sections. Forward-looking statements are statements about
future financial results, future products or services and other events that have
not yet occurred. For example, statements like we "expect," we "anticipate" or
we "believe" are forward-looking statements. Investors should be aware that
actual results may differ materially from our expressed expectations because of
risks and uncertainties about the future. We will not necessarily update the
information in this Form 10-K if any forward-looking statement later turns out
to be inaccurate. Details about risks affecting various aspects of our business
are discussed throughout this Form 10-K and include the risks identified in
"Factors Affecting Operating Results".
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial data
(dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED DECEMBER 31, TWELVE MONTHS ENDED DECEMBER 31,
-------------------------------------------- -------------------------------------------
1999 1998 1999 1998 1999 1998 1999 1998
--------- --------- --------- --------- --------- --------- --------- ---------
(As a % of net sales) (As a % of net sales)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NET SALES:
Workplace employers $ 4,051 $ 4,328 35.9% 39.8% $ 15,742 $ 17,440 35.4% 40.4%
Criminal justice agencies 4,412 4,010 39.1 36.8 17,492 15,214 39.3 35.2
Drug rehab programs 377 407 3.3 3.8 1,538 1,581 3.5 3.7
Domestic products & other 620 600 5.5 5.5 2,639 2,528 5.9 5.9
Medscreen 1,834 1,537 16.2 14.1 7,076 6,409 15.9 14.8
--------- --------- --------- -------- --------- --------- --------- ---------
Total net sales 11,294 10,882 100.0 100.0 44,487 43,172 100.0 100.0
COST OF SALES 8,116 7,955 71.9 73.1 31,374 31,653 70.5 73.3
--------- --------- --------- -------- --------- --------- --------- ---------
GROSS PROFIT 3,178 2,927 28.1 26.9 13,113 11,519 29.5 26.7
--------- --------- --------- -------- --------- --------- --------- ---------
OPERATING EXPENSES:
Selling, general & administrative 2,594 2,401 23.0 22.0 10,033 9,800 22.6 22.7
Amortization of goodwill 46 46 0.4 0.4 185 185 0.4 0.4
Provision for doubtful accounts 8 103 0.0 1.0 141 325 0.3 0.7
--------- --------- --------- -------- --------- --------- --------- ---------
Total operating expenses 2,648 2,550 23.4 23.4 10,359 10,310 23.3 23.8
--------- --------- --------- -------- --------- --------- --------- ---------
INCOME FROM OPERATIONS 530 377 4.7 3.5 2,754 1,209 6.2 2.9
--------- --------- --------- -------- --------- --------- --------- ---------
OTHER EXPENSES, net 75 32 0.7 0.3 248 288 0.6 0.7
PROVISION FOR (BENEFIT
FROM) INCOME TAXES (627) 108 (5.6) 1.0 (294) 286 (0.7) 0.7
--------- --------- --------- -------- --------- --------- --------- ---------
NET INCOME $ 1,082 $ 237 9.6% 2.2% $ 2,800 $ 635 6.3% 1.5%
========= ========= ========= ======== ========= ========= ========= =========
</TABLE>
15
<PAGE> 16
1999 COMPARED TO 1998
Net Sales
Annual net sales increased 3.0% to $44,487,000 in 1999 from
$43,172,000 in 1998. This increase mostly reflects the continued growth of our
international drug testing operations. Medscreen's sales increased 10% on the
strength of a 15.9% increase in specimen volume. Current year sales in the US
increased 1.8% and reflect a $2.3 million (15.0%) increase in criminal justice
sales that more than offset a $1.7 million (9.7%) decrease in workplace sales.
Domestic specimen volume increased 1.9% compared to 1998 levels. Our
consolidated specimen volume increased 2.7% to 2,850,000 and average selling
prices for laboratory analysis were flat compared to 1998 levels. Net sales for
the fourth quarter of 1999 increased 3.8% and average selling prices increased
3.7% from the comparable 1998 periods. In December, as part of our Premium
Comprehensive Management(TM) program of fully integrated drug testing
services, we launched our e-commerce system which provides for order processing,
forms printing, collection scheduling, specimen tracking and results
reporting--all through secure internet transmission.
Cost of Sales
Although our annual specimen volume was higher in 1999, our cost of
sales for the year decreased 0.9% to $31,374,000 in 1999 from $31,653,000 in
1998. Cost of sales as a percentage of net sales decreased to 70.5% in 1999 from
73.3% in 1998 and reflects improved operating efficiencies and continued
favorable results from our cost containment program initiated in 1997,
principally in the areas of direct labor and distribution. Gross profit as a
percentage of net sales increased to 29.5% in 1999 from 26.7% in 1998 reflecting
improved profit margins. Cost of sales for the 1999 fourth quarter of $8,116,000
increased slightly from the same prior year period due to higher specimen
collection costs.
Selling, General and Administrative Expense
Selling, general and administrative (SG&A) expenses for the year
increased 2.4% to $10,033,000 in 1999 from $9,800,000 in 1998 due to higher
depreciation expenses from our implementation of the Unified Database (UDB)
software project in the third quarter of 1999. The percent of SG&A expenses to
net sales decreased slightly to 22.6% in 1999 from 22.7% in 1998. SG&A expenses
for the 1999 fourth quarter increased 8.0% to $2,594,000 from $2,401,000 in the
prior year period and reflects higher depreciation expenses associated with the
UDB project. We are also continuing to invest heavily in information systems and
sales and marketing.
Income From Operations
Income from operations for the year was $2,754,000 in 1999 compared
to $1,209,000 in 1998, while income from operations for the fourth quarter was
$530,000 in 1999 compared to $377,000 in 1998.
Provision for (Benefit from) Income Taxes
The 1999 provision for current income taxes of $482,000 for the year
was more than offset by a reversal of $336,000 of tax accruals no longer
required due to a favorable settlement of an IRS review (recorded in the first
quarter of 1999) and the recognition of an income tax benefit of approximately
$440,000 from reducing the valuation allowance against net deferred tax assets
(recorded in the fourth quarter of 1999). In addition, we offset approximately
$347,000 of federal and state taxes with utilization of net operating loss
carryforwards. During 1998, we recorded a provision for taxes of $286,000 for
the year and $108,000 for the fourth quarter.
Net Income
Net income for the year was $2,800,000 in 1999 compared to net
income of $635,000 in 1998. We reported net income of $1,082,000 in the 1999
fourth quarter compared to net income of $237,000 in 1998.
16
<PAGE> 17
1998 COMPARED TO 1997
Net Sales
Annual net sales increased 10.0% to $43,172,000 in 1998 from
$39,233,000 in 1997. This increase mostly reflects 49% higher sales at Medscreen
and a 37% increase in products. Medscreen's 1998 results reflect a full year of
the HM Prisons contract, which started in late 1997. Sales of our PharmScreen(R)
Onsite Screening Device increased 73% and reflects the increased popularity of
the single, dual, four and five test configurations. Our total urinalysis volume
increased 3.5% to almost 2,800,000 specimens and average selling prices
increased 4.7% from 1997 levels. Net sales for the 1998 fourth quarter of
$10,882,000 increased 7.4% from the 1997 fourth quarter and reflects the higher
Medscreen sales.
Cost of Sales
Cost of sales for the year increased 1.1% to $31,653,000 in 1998
from $31,311,000 in 1997. Cost of sales as a percentage of net sales decreased
to 73.3% in 1998 from 79.8% in 1997 and reflects our improved operating
efficiencies and favorable results from the our cost containment program that
was initiated in 1997. Cost reductions were successful in the areas of direct
labor and results transmissions. Gross profit as a percentage of net sales
increased to 26.7% in 1998 from 20.2% in 1997 reflecting improved profit
margins. Cost of sales for the 1998 fourth quarter of $7,955,000 increased
slightly from the 1997 fourth quarter due to increased specimen volume.
Selling, General and Administrative Expense
Selling, general and administrative (SG&A) expenses for the year
increased 19.0% to $9,800,000 in 1998 from $8,234,000 in 1997. The percent of
SG&A expenses to net sales increased to 22.5% in 1998 from 21.0% in 1997. SG&A
expenses for the 1998 fourth quarter increased 25.1% to $2,364,000. These
increases reflect our continued rebuilding of the sales, marketing, information
systems and administrative infrastructure and higher depreciation expenses.
Income From Operations
Income from operations for the year was $1,209,000 in 1998 compared
to a loss from operations of $847,000 in 1997. Other expense, which includes
interest expense and interest income, decreased to $288,000 in 1998 from
$389,000 in 1997 due to lower average debt levels in 1998. We recorded a
provision for income taxes of $286,000 in 1998.
Net Income
Net income for the year was $635,000 in 1998 compared to a net loss
of $1,270,000 in 1997. We reported net income of $237,000 in the 1998 fourth
quarter compared to net income of $37,000 in 1997.
LIQUIDITY AND CAPITAL RESOURCES
Our operations during the years ending December 31, 1999, 1998 and
1997 provided cash of approximately $3,437,000, $4,596,000 and $1,140,000,
respectively. The decrease in cash flow from operations between 1999 and 1998
reflects higher accounts receivable, a buildup of inventory to mitigate
potential Y2K problems at our key suppliers and the reversal of the deferred tax
valuation reserves, all of which more than offset the increase in net income.
The increase in cash flow from operations between 1998 and 1997 reflects our
improved operations and our better working capital management, principally in
accounts receivables.
As of December 31, 1999 and 1998, we had $1,804,000 and $802,000 in
cash and cash equivalents, respectively. During 1999, we completed three
financing transactions totaling $3,782,000 and a significant portion of the
proceeds were used for repayment of existing debt. We had net repayments of the
revolving line of credit totaling $2,379,000 and repayments on term debt and
capital leases totaled $835,000. We also used $3,007,000 to acquire property and
equipment, mostly related to computer software and laboratory analyzers. During
1998, we had net
17
<PAGE> 18
repayments on the revolving line of credit of $1,702,000, we acquired $2,889,000
of property and equipment and we repaid term debt and capital lease obligations
of $513,000.
On December 5, 1997, we entered into a new revolving credit
agreement (Credit Agreement) whereby the maximum line of credit was increased to
$6,000,000. We used proceeds from the Credit Agreement to immediately repay the
revolver balance outstanding under our previous credit agreement. The Credit
Agreement permits borrowings of 85% of qualified accounts receivable, bears
interest at the bank base rate plus 1.0% (9.50% at December 31, 1999), is
secured by a lien on substantially all of our assets (excluding computer
software) and carries a commitment fee equal to 0.5% of the maximum line of
credit . The mark-up of 1.0% over the base rate and the commitment fee of 0.5%
can, under certain conditions, be reduced to 0.5% and 0.25%, respectively. At
December 31, 1999, the available maximum that could be borrowed under the Credit
Agreement was $4,615,000.
On August 10, 1998, the Credit Agreement was amended to provide for
$500,000 of additional borrowing capacity (which was never used) through
September 1998 and to provide for greater flexibility with respect to certain
financial covenants. On November 5, 1999, the Credit Agreement was modified to
permit up to $2,000,000 of the revolving line of credit to be used to repurchase
our common stock under our common stock repurchase program and to permit the
declaration and distribution of a dividend in connection with our shareholder
rights plan. As of December 31, 1999, we were in compliance with all covenants
except that we exceeded the limitation on annual capital expenditures, for which
we obtained a waiver.
On April 20, 1999, we entered into a $1,500,000 variable rate
installment note (Installment Note) with our bank. The proceeds from the
Installment Note were immediately used to reduce the amount outstanding under
the revolving line of credit. The Installment Note is subject to the same terms
and conditions as the Credit Agreement, bears interest at the bank's base rate
plus 1.0% (9.50% at December 31, 1999) and is payable over 60 months.
On April 30, 1999, we entered into a $1,082,000 financing lease agreement
with a lessor to refinance certain modules of our Unified Database software
project. The lease agreement bears interest at 8.5% and is payable over 36
months. The proceeds from the lease were used to reduce amounts outstanding
under the revolving line of credit. On November 23, 1999, we entered into a
$1,200,000 financing lease agreement with a lessor to refinance certain other
modules of our Unified Database software project. The lease agreement bears
interest at 9.5% and is payable over 36 months. The proceeds from the lease were
used to reduce amounts outstanding under the revolving line of credit and for
capital expenditures. These leases have been accounted for as capital leases.
Effective January 1, 2000, the Credit Agreement markup and
commitment fee were reduced to 0.5% and 0.25%, respectively, as a result of our
meeting the specified conditions.
We anticipate that existing cash balances, amounts available under
the Credit Agreement and funds to be generated from future operations will be
sufficient to fund operations and budgeted capital expenditures through 2000.
In November, 1999, our Board of Directors approved a common stock
repurchase program whereby we are able to purchase up to 300,000 shares
(approximately 5%) of our common stock from time to time on the open market or
in privately negotiated sales. In connection with this program, our bank has
authorized up to $2.0 million from our existing Credit Agreement to be used
toward repurchase of our common stock under this program. The repurchase program
contains certain restrictions, including limitations on the quantity, bid price
and timing of stock purchases. As of December 31, 1999, no shares have been
repurchased.
18
<PAGE> 19
FACTORS AFFECTING OPERATING RESULTS
We are subject to a number of risks which could affect operating
results and liquidity, including, among others, the following:
COMPETITION AND CUSTOMER CONTRACTS
The market for drug testing services became increasingly competitive
in the 1990's, and continues to be competitive. Drug testing laboratories
compete primarily on the basis of:
- customer service
- technical capability
- price
We compete for customer contracts against firms that may have
greater financial, marketing, laboratory and related resources.
A majority of our sales arise out of competitively bid contracts,
which are awarded based on technical superiority, customer service and price.
The failure to renew a significant contract, if not replaced by comparable
contracts, could result in lower sales, lower profit margins, decreased cash
flows and losses. Our contracts generally allow termination at the customer's
discretion on short notice with little or no penalty. Many contracts provide for
termination for convenience. In addition, relatively few of our contracts call
for minimum contract amounts or payments. Although in the past our customers
generally have not exercised these early termination rights, there can be no
assurance that this will continue in the future. Early termination of a
substantial contract, if not replaced by comparable contracts, could have a
material adverse effect on PharmChem.
PHARMCHEK(R) DRUGS OF ABUSE PATCH
Since 1992, we have been investing in PharmChek(R), a system which
uses sweat to detect the use of illegal drugs. To date, our sales of
PharmChek(R) have not been material and there is no assurance that it will be
commercially accepted by existing or new customers or generate significant
revenues in the future. While the company that developed PharmChek(R) has
obtained patents relating to its technology, there are various risks associated
with the technology. There is no assurance:
- as to the validity of such patents
- that the products we market will be covered by such
patents
- that competitors will not infringe upon such patents or
successfully design similar or competing products that
do not infringe upon such patents that the company
- that obtained the PharmChek(R) patents will continue to
be able to deliver products to the PharmChem.
CUSTOMER CONCENTRATION
Our two largest customers combined accounted for approximately 29%,
29% and 27% of our sales in 1999, 1998 and 1997, respectively. The loss of these
contracts, if not replaced by comparable contracts, could result in lower sales,
lower profit margins, decreased cash flows and losses. We have in the past
failed to renew significant contracts which has had adverse effects on
PharmChem. See "Competition and Customer Contracts" above.
CERTIFICATION
We are certified by SAMHSA, CAP and a number of states to conduct
drug testing using forensic procedures. In addition, our Texas and California
laboratories are certified as discussed earlier in Part I on Certification and
Government Regulation. Certification is essential to our business because some
of our customers are required to use certified laboratories, and many of our
customers look to certification as an indication of accuracy and reliability of
results. In order to remain certified, we are subject to frequent inspections
and proficiency tests. Failure to meet any of
19
<PAGE> 20
the numerous certification requirements to which we are subject could result in
suspension or loss of certification. Such suspension or loss of certification
could have a material adverse effect on PharmChem.
SEASONAL TRENDS AND ECONOMIC CONDITIONS
Seasonal trends to which drug testing laboratories are generally
subject affect our operations. In the past, testing volume tends to be higher in
the second and third calendar quarters and lower in the fourth and first
calendar quarters, primarily due to the hiring patterns of our public and
private employer customer group which affect pre-employment drug testing. Demand
for our services is also dependent on general economic conditions. Recessionary
periods generally result in fewer new hires, and therefore may lead to fewer
pre-employment drug tests for public and private employer customers. Budget cuts
at the federal, state or local level could reduce business from our public
employer, criminal justice agency and government funded drug treatment program
customers. Because expenses associated with maintaining our testing work force
are relatively fixed over the short term, our profit margins tend to increase in
periods of higher testing volume and decrease in periods of lower testing
volume.
JUDICIAL DECISIONS AND GOVERNMENT POLICY
State and federal courts have generally permitted the use of drug
testing under certain circumstances and using certain procedures. However,
challenges to drug testing programs are raised from time to time by employees,
unions and other groups in litigation on constitutional, privacy and other
grounds. In addition, legal precedent in a number of states governs the
circumstances under which employers may test employees and the procedures under
which such tests must be conducted. Although we believe that, to date, no such
litigation or law has had a material adverse impact upon our business, new
decisions, legislation or policies which restrict the use of drug testing could
have a material adverse effect on PharmChem.
CREDIT AVAILABILITY
We maintain a revolving credit agreement with a bank. All borrowings
are secured by a lien on all of our assets (excluding computer software). The
Credit Agreement contains certain financial covenants, which we anticipate being
able to comply with throughout 2000, although there can be no assurance that
such compliance will be maintained.
LEGAL PROCEEDINGS
In the ordinary course of our business, we are sued by individuals,
primarily those in the criminal justice system, who have tested positive for
drugs of abuse. In addition, we frequently testify in administrative and court
proceedings involving the results of our tests. To date, we have not experienced
any material liability related to these claims, although there can be no
assurance that we will not at some time in the future experience significant
liability in connection with such claims.
ENVIRONMENTAL MATTERS
A small portion of our business involves testing procedures
requiring the use of chloroform and radioactive reagents, which are considered
to be hazardous materials. Failure to comply with current or future federal,
state or local environmental laws or regulations regarding these hazardous
materials could have a material adverse effect on PharmChem. We believe we are
in compliance with all applicable environmental laws and regulations.
DEPENDENCE ON KEY PERSONNEL
Our success is dependent in part on our key management and technical
personnel, the loss of one or more of whom could have a material adverse effect
on PharmChem. None of our key employees has an employment contract with us. We
believe that our future success will depend in part upon our continued ability
to attract, retain and motivate additional highly skilled personnel.
YEAR 2000
20
<PAGE> 21
The Year 2000 (Y2K) issue is the result of date-sensitive devices,
systems and computer applications that were deployed using two digits rather
than four digits to define the applicable year. Therefore, these technologies
may improperly recognize a year containing "00" as 1900 rather than the year
2000. This may result in a system failure or miscalculations causing disruptions
of operations. We are subject to various risks associated with the Y2K impact on
information systems software and hardware. We have assessed our exposure to
Y2K-related problems focusing on three potential areas of exposure: laboratory
information systems (LIS), electronic transmission of test results and the
readiness of significant third parties with whom we have a material business
relationship, such as transportation systems. To date, we have not experienced
any material Y2K problems with our systems, our transmission of test results or
our outside suppliers. However, we cannot assure that our systems or our
suppliers do not have undetected Y2K problems that could result in significant
operating difficulties for PharmChem.
For the period January 1, 1996 through December 31, 1999, PharmChem
has invested over $6.0 million in new information systems which have been
designed to enhance our operational capabilities as well as meet Y2K
requirements. We completed all Y2K projects at various dates through the end of
the fourth quarter of 1999. We have funded all investments in information
systems and other Y2K projects with internally generated cash, leases or bank
financing. We estimate approximately $200,000 was expensed for Y2K activities,
including consulting costs and payroll for employees dedicated to Y2K projects.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to market risk with respect to our debt outstanding
and foreign currency transactions. Our revolving line of credit and bank term
debt carry interest at the prime rate plus 1.0%, and under certain circumstances
can be reduced to prime plus 0.5%. As the prime rate increases, we will incur
higher relative interest expense and a decrease in the prime rate will reduce
relative interest expense. In recent years, there have not been significant
fluctuations in the prime rate. Assuming levels of debt consistent with
historical amounts, a 1.0% change in the prime rate would not materially change
interest expense.
Due to our international operations, certain transactions are
conducted in foreign currencies. Medscreen's transactions are denominated
approximately 84% in pound sterling and 16% in US currency. During 1999 and
1998, Medscreen's net sales represented 16% and 15%, respectively, of our total
net sales and, as a result, we do not consider the impact of market risk on
foreign currency transactions material. For that reason, we do not intend to
engage in hedging transactions.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index at page 44, Item 14. (a) (1).
21
<PAGE> 22
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
of PharmChem Laboratories, Inc.:
We have audited the accompanying consolidated balance sheets of PharmChem
Laboratories, Inc. and subsidiary (the Company) as of December 31, 1999 and
1998, and the related consolidated statements of operations, comprehensive
income (loss), shareholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1999. In connection with our audits of the
consolidated financial statements, we also have audited the financial statement
schedule as listed in the accompanying index in Item 14(a)(2). These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.
We 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PharmChem
Laboratories, Inc. and subsidiary as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999 in conformity with generally accepted
accounting principles. Also in our opinion, the related consolidated financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
KPMG LLP
San Francisco, California
February 11, 2000
22
<PAGE> 23
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
-------- --------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ...................................... $ 1,804 $ 802
Accounts receivable, net of allowance for doubtful
accounts of $545 and $562, respectively .................... 6,716 6,522
Inventory ...................................................... 1,934 1,525
Deferred tax asset ............................................. 608 315
Prepaids and other current assets .............................. 537 404
-------- --------
TOTAL CURRENT ASSETS ................................... 11,599 9,568
-------- --------
PROPERTY AND EQUIPMENT, net ........................................ 9,555 8,508
OTHER ASSETS ....................................................... 1,087 997
GOODWILL, net of accumulated amortization
of $6,426 and $6,241, respectively ............................ 2,805 2,990
-------- --------
$ 25,046 $ 22,063
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving line of credit ....................................... $ - $ 2,379
Current portion of long-term debt .............................. 1,475 465
Accounts payable ............................................... 2,903 3,123
Accrued compensation ........................................... 1,259 1,155
Accrued collectors and other liabilities ....................... 2,922 2,765
-------- --------
TOTAL CURRENT LIABILITIES .............................. 8,559 9,887
-------- --------
LONG TERM DEBT, net of current portion ............................. 2,593 656
OTHER NONCURRENT LIABILITIES ....................................... 197 610
-------- --------
TOTAL LIABILITIES ...................................... 11,349 11,153
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, no par value, 10,000 shares authorized, 5,805
and 5,782 shares issued and outstanding at December 31,
1999 and 1998, respectively ................................ 19,139 19,090
Accumulated other comprehensive income ......................... 21 83
Accumulated deficit ............................................ (5,463) (8,263)
-------- --------
TOTAL SHAREHOLDERS' EQUITY ............................. 13,697 10,910
-------- --------
$ 25,046 $ 22,063
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 24
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
NET SALES ........................................ $ 44,487 $ 43,172 $ 39,233
COST OF SALES .................................... 31,374 31,653 31,311
-------- -------- --------
GROSS PROFIT ..................................... 13,113 11,519 7,922
-------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative ...... 10,033 9,800 8,234
Amortization of goodwill ................. 185 185 185
Provision for doubtful accounts .......... 141 325 350
-------- -------- --------
Total operating expenses ..... 10,359 10,310 8,769
-------- -------- --------
INCOME (LOSS) FROM OPERATIONS .................... 2,754 1,209 (847)
-------- -------- --------
OTHER EXPENSE, net:
Interest expense ......................... 284 293 397
Interest income .......................... (21) (3) (8)
Other .................................... (15) (2) -
-------- -------- --------
Other expense, net ........... 248 288 389
-------- -------- --------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES .. 2,506 921 (1,236)
PROVISION FOR (BENEFIT FROM) INCOME TAXES ........ (294) 286 34
-------- -------- --------
NET INCOME (LOSS) ................................ $ 2,800 $ 635 $ (1,270)
======== ======== ========
EARNINGS (LOSS) PER SHARE:
Basic .................................... $ 0.48 $ 0.11 $ (0.22)
======== ======== ========
Diluted .................................. $ 0.47 $ 0.10 $ (0.22)
======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic .................................... 5,786 5,764 5,734
======== ======== ========
Diluted .................................. 5,954 6,238 5,734
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 25
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
NET INCOME (LOSS) ....................... $ 2,800 $ 635 $(1,270)
OTHER COMPREHENSIVE INCOME (LOSS):
Foreign currency translation .... (62) 1 (62)
------- ------- -------
COMPREHENSIVE INCOME (LOSS) ............. $ 2,738 $ 636 $(1,332)
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 26
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK OTHER TOTAL
-------------------- COMPREHENSIVE ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT INCOME DEFICIT EQUITY
------- -------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 ......... 5,695 $ 18,915 $ 144 $ (7,628) $ 11,431
Exercise of stock options .... 55 112 - - 112
Other comprehensive loss ..... - (62) - (62)
--------
Net loss ..................... - - - (1,270) (1,270)
-------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 1997 ......... 5,750 19,027 82 (8,898) 10,211
Exercise of stock options .... 32 63 - - 63
Other comprehensive income ... - 1 - 1
Net income ................... - - - 635 635
-------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 1998 ......... 5,782 19,090 83 (8,263) 10,910
EXERCISE OF STOCK OPTIONS .... 23 49 - - 49
OTHER COMPREHENSIVE LOSS ..... - - (62) - (62)
NET INCOME ................... - - - 2,800 2,800
-------- -------- -------- -------- --------
BALANCE AT DECEMBER 31, 1999 ......... 5,805 $ 19,139 $ 21 $ (5,463) $ 13,697
======== ======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE> 27
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ..................................................... $ 2,800 $ 635 $(1,270)
Adjustments to reconcile net income (loss) to net
Cash provided by operating activities:
Depreciation and amortization .................................... 2,057 1,999 1,917
Provision for doubtful accounts .................................. 141 325 350
Deferred income taxes ............................................ (440) 152 34
Loss (gain) on dispositions and sales of equipment ............... 95 (2) 6
Deferred gain on sale of equipment ............................... (24) (82) -
Change in operating assets and liabilities:
Accounts receivable .............................................. (335) 761 210
Inventory ........................................................ (409) 84 (595)
Income tax refund receivable ..................................... - - 351
Prepaids and other current assets ................................ (136) (99) 34
Other noncurrent assets .......................................... 60 (75) (5)
Accounts payable and other accrued liabilities ................... 41 435 100
Other noncurrent liabilities ..................................... (413) 463 8
------- ------- -------
Net cash provided by operating activities ................... 3,437 4,596 1,140
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ................................... (3,007) (2,889) (2,798)
Proceeds from sales of equipment ...................................... 17 439 -
------- ------- -------
Net cash used in investing activities ....................... (2,990) (2,450) (2,798)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) on revolving lines of credit, net ............. (2,379) (1,702) 3,079
Proceeds from financing leases and long term debt ..................... 3,782 435 -
Principal payments on long-term debt and capital leases ............... (835) (513) (1,339)
Proceeds from exercise of stock options ............................... 49 63 112
------- ------- -------
Net cash provided by (used in) financing activities ......... 617 (1,717) 1,852
------- ------- -------
Foreign currency translation .......................................... (62) 1 (62)
------- ------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS ................................ 1,002 430 132
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ........................... 802 372 240
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR ................................. $ 1,804 $ 802 $ 372
======= ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest, net of $138, $153 and $46 capitalized in 1999,
1998 and 1997, respectively ....................................... $ 434 $ 305 $ 376
======= ======= =======
Cash paid for taxes .................................................. $ 246 $ 1 $ 3
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE> 28
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
1. THE COMPANY
PharmChem is a leading independent laboratory providing integrated drug
testing services. We test for a number of drugs of abuse, primarily by
urinalysis. In addition to forensic drug testing, we offer a range of services
which are customized to assist customers in implementing cost-effective drug
testing programs. Our customers include private and public employers, criminal
justice agencies and drug treatment programs primarily in the United States (US)
and Europe.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of PharmChem
and our wholly-owned subsidiary, Medscreen, a United Kingdom (UK) company, after
elimination of all intercompany accounts and transactions. The functional
currency of Medscreen is the local currency. When we refer to "we" or
"PharmChem" in these Notes, we mean the current California corporation
(PharmChem Laboratories, Inc.) as well as our wholly-owned subsidiary Medscreen.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires our management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash balances and all highly liquid
investments with original maturities of three months or less at the date of
purchase. At December 31, 1999 and 1998, cash and cash equivalents consist of
demand deposits maintained at established commercial banks. Such cash deposits
periodically exceed the Federal Deposit Insurance Corporation insured limit of
$100,000 for each account.
CONCENTRATIONS OF CREDIT RISK
We are subject to a number of risks which include, among others,
competition related to customer contracts, development and marketing of
PharmChek(R) and PharmScreen(R), customer concentration and laboratory
certification. Financial instruments which potentially subject PharmChem to
concentrations of credit risk consist principally of cash investments, trade
receivables and debt. We have cash investment policies that limit investments to
short-term, low risk instruments. Although two customers accounted for
approximately 29%, 29% and 27% of our sales for the years ended December 31,
1999, 1998 and 1997, respectively, we believe the risk associated with
concentrations of credit for trade receivables is mitigated because (i) one of
the customers is a federal government agency; (ii) the remaining customer base
is diversified among many corporate industries and other government agencies;
(iii) we have an ongoing credit evaluation process; and (iv) we maintain an
allowance for doubtful accounts.
28
<PAGE> 29
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INVENTORY
We state inventory at the lower of cost or market. We determine cost
using standard costs, including freight, that approximate actual costs on a
first-in, first-out basis. At December 31, our inventory consisted of the
following:
<TABLE>
<CAPTION>
1999 1998
----- ------
(In thousands)
<S> <C> <C>
Laboratory materials ...................... $ 801 $ 529
Collection materials ...................... 649 801
Products .................................. 484 195
------ ------
$1,934 $1,525
====== ======
</TABLE>
PROPERTY AND EQUIPMENT
We record property and equipment at cost. We provide for depreciation and
amortization using the straight-line method over the estimated useful lives. We
amortize leasehold improvements and equipment held under capital leases over the
shorter of the lease term or useful lives. At December 31, our property and
equipment consisted of the following:
<TABLE>
<CAPTION>
USEFUL LIVES
IN YEARS 1999 1998
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Lab equipment ...................................................... 5 to 10 $ 5,881 $ 6,920
Computer hardware and software ..................................... 3 to 10 7,698 5,107
Office equipment ................................................... 3 to 7 395 500
Furniture, fixtures and other ...................................... 3 to 10 974 785
Leasehold improvements ............................................. - 3,579 3,942
Construction in progress ........................................... - 1,559 2,113
-------- --------
20,086 19,367
Less: accumulated depreciation and amortization .................... (10,531) (10,859)
-------- --------
Property and equipment, net ........................................ $ 9,555 $ 8,508
======== ========
</TABLE>
We capitalize software development costs for internal use in accordance
with Statement of Position (SOP) 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use." Capitalization of software
development costs begins in the application development stage and ends when the
asset is placed into service. We amortize such costs using the straight-line
basis over estimated useful lives. Under SOP 98-1, we capitalized $850,000 and
$1,590,000 of software development costs in 1999 and 1998, respectively, related
to our information systems capital expenditure program.
Expenditures for maintenance and repairs are expensed as incurred. We
capitalize costs of major replacements and betterments. When we retire or
otherwise dispose of property, we remove the cost and accumulated depreciation
and amortization from the appropriate accounts and we include any gain or loss
in the statement of operations.
29
<PAGE> 30
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
LONG-LIVED ASSETS, INCLUDING GOODWILL
In accordance with Statement of Financial Accounting Standards (SFAS) No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," we review, as circumstances dictate, the carrying
amount of our long-lived assets. The purpose of these reviews is to determine
whether the carrying amounts are recoverable. We determine recoverability by
comparing the projected undiscounted net cash flows of the long-lived assets
against their respective carrying amounts. We measure the amount of impairment,
if any, based on the excess of the carrying value over the fair value. Our
management believes that no impairment of long-lived assets has occurred during
the three years ended December 31, 1999.
Goodwill consists of the excess of cost over the fair value of the net
assets of businesses acquired and we amortize goodwill on a straight-line basis
over periods ranging from 20 to 40 years.
REVENUE AND OTHER DEFERRED CREDITS
We recognize revenue (i) upon completion of laboratory analyses of
specimens submitted by customers, and (ii) at the time of shipment for products.
Deferred credits include deferred rent and deferred service revenues. Deferred
rent represents unrealized rent abatements granted by the lessor of the facility
occupied by Medscreen, and we amortize deferred rent on a straight-line basis as
a reduction to rent expense over the remaining lease term. Deferred service
revenues represents amounts billed in advance of laboratory analysis performed.
We classify deferred revenues expected to be realized beyond one year as other
noncurrent liabilities.
INCOME TAXES
We account for income taxes in accordance with SFAS No. 109, "Accounting
for Income Taxes," which requires recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method, we
determine deferred tax assets and liabilities based on temporary differences
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse.
STOCK BASED-COMPENSATION
We account for our stock-based compensation in accordance with SFAS No.
123, "Accounting for Stock-Based Compensation." As allowed by SFAS No. 123, we
continue to measure compensation expense for awards granted to employees and
directors under the provisions of Accounting Principles Board Opinion (APB) No.
25, "Accounting for Stock Issued to Employees," and related interpretations. The
exercise price of options granted under our stock option plans is equal to the
market price of our stock on the date of grant. Therefore, we have not recorded
compensation cost under APB No. 25.
30
<PAGE> 31
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
EARNINGS (LOSS) PER SHARE
We compute and disclose our earnings (loss) per share in accordance with
SFAS No. 128, "Earnings Per Share," which requires the presentation of basic and
diluted earnings (loss) per share. We calculate basic earnings (loss) per share
using the weighted average number of common shares outstanding during the
period. We calculate diluted earnings (loss) per share using the weighted
average number of common shares and dilutive potential common shares outstanding
during the period. Dilutive potential common shares represent shares issuable
upon the exercise of outstanding options. We calculate dilutive potential common
shares using the treasury stock method.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About
Fair Value of Financial Instruments," requires certain disclosures regarding the
fair value of financial instruments. The carrying amounts of accounts
receivable, accounts payable and accrued liabilities approximate fair value
because of the short-term maturity of these instruments. The fair values of
revolving credit agreements, long-term debt and notes payable do not materially
differ from their carrying amounts since the majority of such debt bears
interest at variable rates and the fixed rate obligations generally have
near-term maturities or have matured.
RECLASSIFICATIONS
We have made certain reclassifications to prior year amounts to conform to
current year presentation.
3. DEBT
Our revolving credit agreement and capitalized lease obligations at
December 31 consist of the following:
<TABLE>
<CAPTION>
1999 1998
-------- --------
(In thousands)
<S> <C> <C>
Revolving credit agreement pursuant to a revolving loan agreement ...................... $ -- $ 2,379
Term note .............................................................................. 1,369 --
Obligations under capitalized leases, due in monthly installments through 2002,
secured by laboratory equipment, office equipment and computer software,
interest rates ranging from 6% to 10% .............................................. 2,699 1,121
-------- --------
4,068 3,500
Less: current portion and revolving line of credit ..................................... (1,475) (2,844)
-------- --------
Long-term portion ...................................................................... $ 2,593 $ 656
======== ========
</TABLE>
31
<PAGE> 32
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Future principal payments at December 31, 1999 are as follows (in
thousands):
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
2000..................................................................... $1,475
2001..................................................................... 1,228
2002..................................................................... 944
2003..................................................................... 316
2004..................................................................... 105
------
Total Debt............................................................... $4,068
======
</TABLE>
On December 5, 1997, we entered into a new revolving credit agreement
(Credit Agreement) whereby the maximum line of credit was increased to
$6,000,000. We used proceeds from the Credit Agreement to immediately repay the
revolver balance outstanding under our previous credit agreement. The Credit
Agreement permits borrowings of 85% of qualified accounts receivable, bears
interest at the bank base rate plus 1.0% (9.50% at December 31, 1999), is
secured by a lien on substantially all of our assets (excluding computer
software) and carries a commitment fee equal to 0.5% of the maximum line of
credit . The mark-up of 1.0% over the base rate and the commitment fee of 0.5%
can, under certain conditions, be reduced to 0.5% and 0.25%, respectively. At
December 31, 1999, the available maximum that could be borrowed under the Credit
Agreement was $4,615,000.
The Credit Agreement contains certain financial covenants, which among
others, require PharmChem to maintain certain ratios of working capital and net
worth and restricts the payment of dividends. On August 10, 1998, the Credit
Agreement was amended to provide for $500,000 of additional borrowing capacity
(which was never used) through September 1998 and to provide for greater
flexibility with respect to certain financial covenants. On November 5, 1999,
the Credit Agreement was modified to permit up to $2,000,000 of the revolving
line of credit to be used to repurchase our common stock under our common stock
repurchase program and to permit the declaration and distribution of a dividend
in connection with our shareholder rights plan. As of December 31, 1999, we were
in compliance with all covenants except that we exceeded the limitation on
annual capital expenditures, for which we obtained a waiver.
On April 20, 1999, we entered into a $1,500,000 variable rate installment
note (Installment Note) with our bank. The proceeds from the Installment Note
were immediately used to reduce the amount outstanding under the revolving line
of credit. The Installment Note is subject to the same terms and conditions as
the Credit Agreement, bears interest at the bank's base rate plus 1.0% (9.50% at
December 31, 1999) and is payable over 60 months.
On April 30, 1999, we entered into a $1,082,000 financing lease agreement
with a lessor to refinance certain modules of our Unified Database software
project. The lease agreement bears interest at 8.5% and is payable over 36
months. The proceeds from the lease were used to reduce amounts outstanding
under the revolving line of credit. On November 23, 1999, we entered into a
$1,200,000 financing lease agreement with a lessor to refinance certain other
modules of our Unified Database software project. The lease agreement bears
interest at 9.5% and is payable over 36 months. The proceeds from the lease were
used to reduce amounts outstanding under the revolving line of credit and for
capital expenditures. These leases have been accounted for as capital leases.
Effective January 1, 2000, the Credit Agreement markup and commitment fee
were reduced to 0.5% and 0.25%, respectively, as a result of our meeting the
specified conditions. The weighted average interest rate for 1999 and 1998 was
10.6% and 9.8%, respectively.
32
<PAGE> 33
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
We have leased certain laboratory equipment, office equipment and computer
software with an original cost of approximately $4,422,000 and $2,139,000 under
capital lease agreements at December 31, 1999 and 1998, respectively. The
accumulated depreciation of such leased equipment was approximately $1,159,000
and $691,000 at December 31, 1999 and 1998, respectively. At December 31, 1999,
the future minimum lease payments, together with the present value of the net
minimum lease payments under these agreements, were as follows (in thousands):
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
2000.................................................................. $1,360
2001.................................................................. 1,014
2002.................................................................. 653
------
Total minimum lease payments.................................... 3,027
Less: amount representing interest ............................. (328)
------
Present value of net minimum lease payments..................... $2,699
======
</TABLE>
4. INCOME TAXES
The income (loss) before income taxes based upon the geographic locations
of our operations consisted of the following for the year ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------ ---- -------
(In thousands)
<S> <C> <C> <C>
Pre-tax income (loss):
Domestic ...................... $1,232 $148 $(1,552)
Foreign ....................... 1,274 773 316
------ ---- -------
Consolidated .................. $2,506 $921 $(1,236)
====== ==== =======
</TABLE>
The provision for (benefit from) income taxes consisted of the following
for the year ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
----- ---- ----
(In thousands)
<S> <C> <C> <C>
Current:
Federal ............................................... $(326) $ -- $--
State ................................................. 5 5 --
Foreign ............................................... 467 129 --
----- ---- ---
Total current ................................... 146 134 --
----- ---- ---
Deferred:
Federal ............................................... (170) 83 --
State ................................................. (224) 27 --
Foreign ............................................... (46) 42 34
----- ---- ---
Total deferred .................................. (440) 152 34
----- ---- ---
Provision for (benefit from) income taxes ....... $(294) $286 $34
===== ==== ===
</TABLE>
Undistributed earnings at our foreign subsidiary are not significant. We
reconciled the provision for income taxes with the federal statutory rate for
the year ended December 31 as follows:
33
<PAGE> 34
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Tax provision (benefit) computed at the federal statutory tax rate .......... $ 852 $ 313 $ (420)
State taxes, net of federal tax benefit ..................................... 47 13 (30)
Utilization of net operating loss carryforwards ............................. (277) (146) --
Effects of foreign operations ............................................... (40) (1) (27)
Amortization of goodwill and other permanent differences .................... 377 131 44
Change in the beginning of the year valuation allowance .......... (975) (24) 438
Reversal of accrual no longer required ........................... (336) -- --
Other ....................................................................... 58 -- 29
------ ------ ------
Provision for income taxes ........................... $ (294) $ 286 $ 34
====== ====== ======
</TABLE>
The major components of temporary differences which give rise to the
deferred tax accounts at December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998
-------- --------
(In thousands)
<S> <C> <C>
Current deferred tax assets:
Reserves and accruals ................................ $ 516 $ 653
Net operating loss carryforwards ..................... 195 188
-------- --------
Total gross current asset ...................... 711 841
Deferred tax valuation allowance ..................... (103) (523)
-------- --------
Net current asset .............................. $ 608 $ 318
======== ========
Non-current deferred tax assets:
Net operating loss carryforwards ..................... $ 179 $ 657
Difference between book and tax depreciation ......... 424 396
Capital loss carryforwards ........................... 198 171
Research tax credit carryforwards and other .......... 172 281
-------- --------
Total gross non-current asset .................. 973 1,505
Deferred tax asset valuation allowance ............... (255) (927)
-------- --------
Net non-current asset .......................... $ 718 $ 578
======== ========
Total deferred tax asset ........................................... $ 1,326 $ 896
======== ========
</TABLE>
In the fourth quarter of 1999, we recognized an income tax benefit of
approximately $440,000 from reducing the valuation allowance primarily as a
result of the continued improvement in our operating results and prospects. In
addition, we offset approximately $347,000 of federal and state taxes with
utilization of net operating loss carryforwards. The recognition of the net
deferred tax asset is based upon the expected utilization of net operating loss
carryforwards that we believe will more likely than not be realized. The net
change in the valuation allowance was an increase (decrease) of $(1,252,000),
$(24,000) and $438,000 in 1999, 1998 and 1997, respectively.
We have classified the long-term deferred tax asset with "Other assets" on
the accompanying Consolidated Balance Sheets. Deferred income taxes reflect the
net tax effects of temporary differences between the carrying amounts of assets
and liabilities for financial reporting and income tax purposes. Although
realization is not assured, we believe more likely than not that the net
deferred tax asset will be realized in the future primarily from the
34
<PAGE> 35
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
generation of US source taxable income. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if estimates
of future taxable income during the carryforward periods are lowered or are
lower than currently estimated.
As of December 31, 1999, we have net operating loss carryforwards for
federal and state income tax reporting purposes of approximately $1,213,000 and
$1,140,000, respectively. The federal loss carryforwards expire at various dates
through 2012 and the state loss carryforwards expire at various dates through
2002. The Tax Reform Act of 1986 contains provisions which may limit the net
operating loss carryforwards to be used in any given year upon the occurrence of
certain events, including a significant change of ownership.
In the first quarter of 1999, we successfully appealed a Notice of
Deficiency issued by the Internal Revenue Service (IRS) during its examination
of our income tax returns for years 1990 to 1995. The IRS had challenged the
deductibility of research expenses related to the development of the
PharmChek(R) sweat patch device. As a result of this favorable ruling, we
reversed a $336,000 reserve that was no longer required.
5. INCENTIVE STOCK PLANS AND STOCK REPURCHASE PROGRAM
1997 AND 1988 INCENTIVE STOCK PLANS
In May 1997, our shareholders approved the 1997 Incentive Stock Plan
whereby stock options, including incentive stock options, non-qualified options,
restricted shares, performance shares, bonus shares and stock appreciation
rights may be granted to employees, consultants and directors, for up to 500,000
shares of common stock. This 1997 Plan, which expires in 2007, is administered
by the Officers Compensation Committee of the Board of Directors. That Committee
determines the term of each stock option (up to a maximum of ten years). The
exercise price cannot be less than 100% of the fair market value of the common
stock on the date the option is granted. Unless that Committee determines
otherwise, options will be exercisable with respect to 6.25% of the granted
shares on the first day of each of the first sixteen calendar quarters after the
grant date. As of December 31, 1999, options granted under the 1997 Plan totaled
240,059 and no options have been canceled or exercised.
In November 1988, we adopted the 1988 Incentive Stock Plan. The 1988 Plan
expired in 1998. Under the 1988 Plan, nonstatutory options and stock purchase
rights could be granted to employees and consultants, while incentive stock
options could only be granted to employees, for up to a total of 1,280,000
shares of common stock. Options granted under the 1988 Plan vest generally over
a 48-month period and expire ten years after the grant date.
Effective March 24, 1998 we engaged in a stock option exchange program
that effectively repriced all then outstanding options having an exercise price
above the then current market price of $2.375. See "Repriced granted/canceled"
in the following table. The repriced options began vesting effective April 24,
1998 over a 48-month period. The exercise price for all options exchanged was
$2.375.
Options to purchase approximately 453,790, 244,081 and 309,753 shares of
common stock under both plans were exercisable at December 31, 1999, 1998 and
1997 respectively. Option information for the periods presented is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------
OPTIONS WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR GRANT OF SHARES PRICE
--------- --------- --------
<S> <C> <C> <C>
Balance at December 31, 1996 ................... 113,047 696,821 $ 3.32
-------- -------- ------
Additional shares approved ........... 500,000 -- --
</TABLE>
35
<PAGE> 36
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<S> <C> <C> <C>
Granted .............................. (40,000) 40,000 3.56
Canceled ............................. 52,631 (52,631) 2.04
Exercised ............................ -- (55,286) 2.06
-------- -------- ------
Balance at December 31, 1997 ................... 625,678 628,904 3.55
-------- -------- ------
1988 Plan expiration ................. (7,739) -- --
Granted .............................. (370,250) 370,250 2.45
Canceled ............................. 42,252 (42,252) 3.31
Exercised ............................ -- (18,394) 2.02
Repriced granted ..................... (463,480) 463,480 2.38
Repriced canceled .................... 463,480 (463,480) 3.95
-------- -------- ------
Balance at December 31, 1998 ................... 289,941 938,508 2.95
-------- -------- ------
GRANTED .............................. (30,000) 30,000 3.38
CANCELED ............................. -- (33,377) 2.38
EXERCISED ............................ -- (8,123) 2.38
-------- -------- ------
BALANCE AT DECEMBER 31, 1999 ................... 259,941 927,008 $ 2.41
======== ======== ======
</TABLE>
1992 DIRECTOR OPTION PLAN
In May 1992, we adopted the 1992 Director Option Plan ("the Director
Plan") and reserved 250,000 shares of common stock for issuance under this plan.
On March 22, 1997, we changed the Director Plan to provide for grants to outside
directors only. The options vest over a 48-month period and are granted at fair
market value. Options granted prior to 2000 expire five years from the original
grant date. On November 30, 1999, the Director Plan was amended to change the
date of automatic grants from January 1 to March 1. Options to purchase
approximately 15,204, 37,601 and 88,332 shares of common stock were exercisable
at December 31, 1999, 1998 and 1997, respectively.
36
<PAGE> 37
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Option information for the periods presented is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-----------------------
OPTIONS WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR GRANT OF SHARES PRICE
--------- --------- --------
<S> <C> <C> <C>
Balance at December 31, 1996 .......... 110,626 130,000 $ 3.32
-------- -------- ------
Granted ..................... (10,000) 10,000 5.25
Canceled .................... 30,000 (30,000) 8.75
Exercised ................... -- -- --
-------- -------- ------
Balance at December 31, 1997 .......... 130,626 110,000 3.52
-------- -------- ------
Granted ..................... (15,000) 15,000 2.58
Canceled .................... 62,187 (62,187) 4.05
Exercised ................... -- (12,813) 2.00
-------- -------- ------
Balance at December 31, 1998 .......... 177,813 50,000 2.38
-------- -------- ------
GRANTED ..................... (10,000) 10,000 4.63
CANCELED .................... 15,000 (15,000) 2.88
EXERCISED ................... -- (15,000) 2.00
-------- -------- ------
BALANCE AT DECEMBER 31, 1999 .......... 182,813 30,000 $ 4.02
======== ======== ======
</TABLE>
The following summarizes information about all stock option plans at
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- -------------------------
WEIGHTED WEIGHTED AVG. WEIGHTED
AVERAGE REMAINING AVERAGE
RANGE OF OPTIONS EXERCISE CONTRACTUAL OPTIONS EXERCISE
EXERCISE PRICE OUTSTANDING PRICE LIFE EXERCISABLE PRICE
-------------- ----------- -------- ------------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$2.00 93,278 $2.000 5.0 Years 93,278 $2.000
2.375 740,230 2.375 8.3 Years 333,943 2.375
2.50 - 5.25 123,500 3.338 7.3 Years 41,773 3.447
------------- ------- ------ --------- ------- ------
$2.00 - $5.25 957,008 $2.463 7.8 Years 468,994 $2.396
============= ======= ====== ========= ======= ======
</TABLE>
37
<PAGE> 38
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PROFORMA INFORMATION
We continue to apply APB No. 25 in accounting for our stock based
compensation plans. Accordingly, no compensation cost has been recorded in the
consolidated statements of operations for the stock option plans. If we had
determined compensation cost for our stock based compensation plans in
accordance with the fair value method prescribed by SFAS No. 123, our proforma
net income (loss) and earnings (loss) per share for the years ended December 31
would have been as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ --------
(In thousands, except
per share amounts)
<S> <C> <C> <C>
Net income (loss), as reported ..................... $2,800 $ 635 $ (1,270)
Net income (loss), pro forma ....................... 2,580 278 (1,737)
Basic earnings (loss) per share, as reported ....... $ 0.48 $ 0.11 $ (0.22)
Basic earnings (loss) per share, pro forma ......... 0.45 0.05 (0.30)
Diluted earnings (loss) per share, as reported ..... 0.47 0.10 (0.22)
Diluted loss per share, pro forma .................. 0.44 0.05 (0.30)
</TABLE>
The weighted average fair values of options granted during 1999, 1998 and
1997 were $2.26, $1.44 and $2.31, respectively. We estimate the fair value of
each grant on the date of grant using the Binomial option pricing model with the
following weighted average assumptions:
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Risk free rate of return................................. 5% 5% 6%
Option lives in years.................................... 3 to 5 3 to 5 3 to 5
Annual volatility of stock price......................... 89% 89% 80%
Dividend yield........................................... 0.0% 0.0% 0.0%
</TABLE>
The above proforma amounts include compensation expense for options
granted since January 1, 1995, and may not be representative of that to be
expected in future years.
COMMON STOCK REPURCHASE PROGRAM
In November, 1999, our Board of Directors approved a common stock
repurchase program whereby we are able to purchase up to 300,000 shares
(approximately 5%) of our common stock from time to time on the open market or
in privately negotiated sales. In connection with this program, our bank has
authorized up to $2.0 million from our existing Credit Agreement to be used
toward repurchase of our common stock under this program. The repurchase program
contains certain restrictions, including limitations on the quantity of, bid
price and timing of stock purchases. As of December 31, 1999, no shares have
been repurchased.
38
<PAGE> 39
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. EARNINGS PER SHARE
The calculations of basic and diluted earnings (loss) per share are as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ --------
(In thousands, except
per share amounts)
<S> <C> <C> <C>
Net income (loss) ...................................................... $2,800 $ 635 $ (1,270)
====== ====== ========
Denominator for basic earnings (loss) per share - weighted
average common shares ............................................... 5,786 5,764 5,734
Dilutive stock options ................................................. 168 474 --
------ ------ --------
Denominator for diluted earnings (loss) per share ...................... 5,954 6,238 5,734
====== ====== ========
Basic earnings (loss) per share ........................................ $ 0.48 $ 0.11 $ (0.22)
====== ====== ========
Diluted earnings (loss) per share ...................................... $ 0.47 $ 0.10 $ (0.22)
====== ====== ========
</TABLE>
We did not include options to purchase 113,500 and 5,000 shares of our
common stock at December 31, 1999 and 1998, respectively, in the computation of
diluted earnings per share because their exercise prices were greater than the
average market share price of our common stock of $2.92 and $4.63, respectively.
All options to purchase shares of our common stock at December 31, 1997 were not
included in the computation of diluted loss per share for the same reason.
7. PROFIT SHARING PLAN
We have a 401(k) plan which is available to all employees who have reached
age 18 and have completed at least one year of service. The 401(k) Plan provides
that each participant may contribute a portion of his or her salary, within
certain limits prescribed by U.S. tax laws. We will make a matching contribution
of 10% of the amount contributed by each participant. We may make additional
matching or discretionary profit sharing contributions. Our contributions vest
after three years of service. The total contribution expenses we recorded were
$73,000, $46,000 and $41,000 for 1999, 1998 and 1997, respectively.
8. SHAREHOLDER RIGHTS PLAN
On November 30, 1999 our Board of Directors adopted a shareholder rights
plan designed to protect the long-term value of PharmChem for its shareholders
if there were a future unsolicited acquisition attempt. In connection with the
plan, our Board declared a dividend of one preferred share purchase right for
each share of PharmChem's Common Stock on the November 30, 1999 record date and
further directed the issuance of one such right with respect to each share of
our Common Stock that we issue after the record date, except in certain
circumstances. Each right will entitle a shareholder to buy 1/100 of a share of
preferred stock at an exercise price of $35.00 which will be subject to
adjustment in certain circumstances. Subject to certain exceptions, if a person
or group acquires 15% or more of our outstanding Common Stock, commences, or
announces an intention to make, a tender offer, consummation of which would
result in the ownership of 15% or more of our outstanding Common Stock, each
right will entitle its holder (other than such person or members of such group)
to purchase, at the right's then-current exercise price, a number of our common
shares having a market value of twice the right's exercise price. Such person or
group will not include a 15% shareholder holding more than 15% of the
outstanding common shares at the time of adoption of the plan who may accumulate
up to 25% of our common shares before triggering the rights. In addition, if at
any time after a person or group (other than certain exempt persons) acquires
15% or more of our common shares or we are acquired in a merger or other
business combination transaction, each right will entitle its holder to
purchase, at a right's then-current exercise
39
<PAGE> 40
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
price, a number of the acquiring company's common shares having a market value
at the time of twice the right's exercise price. The rights will expire on
November 30, 2009. Our bank modified the Credit Agreement to permit the
declaration and distribution of a dividend in connection with this shareholder
rights plan.
9. COMMITMENTS AND CONTINGENCIES
Future minimum lease payments under noncancellable leases for our office,
laboratory and warehouse space at December 31, 1999 were as follows (in
thousands):
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
2000................................................ $785
2001................................................ 789
2002................................................ 464
2003................................................ 212
2004................................................ 98
2005 & thereafter................................... 152
------
Total commitments $2,500
======
</TABLE>
Rental expense for operating leases amounted to approximately $1,251,000,
$1,199,000 and $944,000 for the years ended December 31, 1999, 1998 and 1997,
respectively.
In connection with the original employment and relocation of one employee,
we have committed to participate in the purchase of the employee's residence.
Pursuant to this commitment, we have an outstanding loan from the employee of
$109,000 at December 31, 1999 and 1998. We included this loan in "Other assets"
in the accompanying consolidated balance sheets. The loan is due in 2001 unless
employment terminates or certain other maturity events occur. The loan is
secured by a deed of trust on the residence and earns contingent interest on the
net proceeds from the sale of the employee's residence. In certain
circumstances, we are contingently liable for a portion of the mortgage
payments, insurance costs and property taxes, until such time as the property is
sold.
We are the defendant in certain legal matters which are normal for the
industry in which we operate. Our management believes that these matters, both
individually and in the aggregate, will not have a material adverse impact on
PharmChem's financial position or results of operations.
40
<PAGE> 41
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. REPORTABLE SEGMENTS
We have two reportable segments, Domestic and International, providing
integrated drug testing services. The Domestic segment serves the United States
and the International segment serves primarily the United Kingdom (61% of
international sales in 1999) and also includes the European, Asian, Middle
Eastern and South American markets. PharmChem's California and Texas operations
service the Domestic segment and Medscreen services the International segment.
The accounting policies of the segments are the same as those described in the
Summary of Significant Accounting Policies in the accompanying notes to the
consolidated financial statements. We evaluate segment profit based on income or
loss from operations before intercompany interest, other income or expense and
income taxes and excluding goodwill amortization. Intersegment sales and
transfers are not material. Information about our segments as of and for the
years ended December 31 is as follows:
<TABLE>
<CAPTION>
DOMESTIC INTERNATIONAL TOTAL
-------- ------------- --------
(In thousands)
<S> <C> <C> <C>
1999: Net sales from external customers ............ $ 37,411 $7,076 $ 44,487
Depreciation and amortization ................ 1,783 274 2,057
Segment profit ............................... 1,665 1,274 2,939
Segment assets ............................... 18,410 6,636 25,046
Expenditures for segment assets .............. 2,812 195 3,007
1998: Net sales from external customers ............ $ 36,764 $6,408 $ 43,172
Depreciation and amortization ................ 1,731 268 1,999
Segment profit ............................... 584 810 1,394
Segment assets ............................... 16,324 5,739 22,063
Expenditures for segment assets .............. 2,550 339 2,889
1997: Net sales from external customers ............ $ 34,970 $4,263 $ 39,233
Depreciation and amortization ................ 1,669 248 1,917
Segment profit (loss) ........................ (1,031) 369 (662)
Segment assets ............................... 17,158 5,088 22,246
Expenditures for segment assets .............. 2,715 83 2,798
</TABLE>
Two customers of the Domestic segment accounted for the following as a
percentage of our consolidated net sales for the year ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Customer A ........................ 18.9% 18.3% 17.1%
Customer B ........................ 10.3% 11.1% 10.1%
</TABLE>
41
<PAGE> 42
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized selected quarterly financial data is as follows:
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------
3/31 6/30 9/30 12/31
-------- -------- -------- --------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
1999:
Net sales ....................................... $ 10,174 $ 11,149 $ 11,870 $ 11,294
Gross profit .................................... 2,950 3,284 3,701 3,178
Net income ...................................... 583 361 774 1,082
Basic earnings per share ........................ $ 0.10 $ 0.06 $ 0.13 $ 0.19
Diluted earnings per share ...................... $ 0.10 $ 0.06 $ 0.13 $ 0.18
Basic weighted average shares outstanding ....... 5,782 5,784 5,784 5,794
Diluted weighted average shares outstanding ..... 6,096 5,903 5,857 5,960
1998:
Net sales ....................................... $ 9,528 $ 11,451 $ 11,311 $ 10,882
Gross profit .................................... 2,220 3,236 3,136 2,927
Net income (loss) ............................... (192) 246 344 237
Basic earnings (loss) per share ................. $ (0.03) $ 0.04 $ 0.06 $ 0.04
Diluted earnings (loss) per share ............... $ (0.03) $ 0.04 $ 0.06 $ 0.04
Basic weighted average shares outstanding ....... 5,751 5,758 5,771 5,780
Diluted weighted average shares outstanding ..... 5,751 5,826 5,903 6,254
</TABLE>
42
<PAGE> 43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEMS 10 TO 13 INCLUSIVE
We have omitted these items in accordance with the General Instructions to
Form 10-K. Information regarding our Directors is incorporated by reference to
PharmChem's Proxy Statement to be filed with the Securities and Exchange
Commission in connection with our 1999 annual meeting.
Information regarding our Executive officers can be found in Part I this
Annual Report on Form 10-K on page 12.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
PAGE
NUMBER
IN THIS
REPORT
--------
<S> <C>
Independent Auditors' Report...................................................................... 22
Consolidated Balance Sheets at December 31, 1999 and 1998......................................... 23
Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997 24
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 1999, 1998 and 1997.......................................................... 25
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1999,
1998 and 1997............................................................................. 26
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997........ 27
Notes to Consolidated Financial Statements........................................................ 28
(a)(2) FINANCIAL STATEMENT SCHEDULE
Schedule II Valuation and Qualifying Accounts.......................................... 47
</TABLE>
All other schedules are omitted because they are not applicable, not
required, or the required information is shown in the Consolidated Financial
Statements or notes thereto.
43
<PAGE> 44
(a) (3) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
---------- -----------------------
<S> <C>
3.01(1) Amended and Restated Articles of Incorporation dated August 21, 1991.
3.02(2,13) Bylaws, as amended through October 21, 1998.
4.01(1) Restated Modification Agreement dated August 14, 1989.
10.01(1) 1988 Incentive Stock Plan, as amended.
10.02(6) Form of Stock Option Agreement.
10.03(1) Form of Stock Option Agreement (providing for accelerated vesting upon death or disability).
10.04(6) Form of Stock Option Agreement (January 1, 1995).
10.05(1) Form of Stock Purchase Agreement.
10.06(4) 1992 Director Option Plan.
10.07(4) Form of Director Option Agreement.
10.08(9) Amendment Number 1 to 1992 Director Option Plan dated February 28, 1996.
10.09(9) Amendment Number 2 to 1992 Director Option Plan dated March 4, 1997.
10.10 Amendment Number 3 to 1992 Director Option Plan dated November 30, 1999.
10.11(10) 1997 Equity Incentive Plan.
10.12(10) Form of Stock Option Agreement (Nonstatutory Stock Option) in connection with the 1997 Equity
Incentive Plan.
10.13(10) Stock Option Agreement (Incentive Stock Option) in connection with the 1997 Equity Incentive Plan.
10.14(1) 401(k) Plan.
10.15(9) Amendment to 401(k) Plan dated August 25, 1996.
10.16(14) Amendment to 401(k) Plan dated September 15, 1998.
10.17(15) Rights Agreement dated November 30, 1999.
10.18(1) Lease Agreements for the Company's offices in Menlo Park, California dated October 21, 1988 and
September 11, 1990, respectively.
10.19(8) Lease Amendment for the Company's offices in Menlo Park, California dated November 30, 1995.
10.20(9) Lease Amendment for the Company's offices in Menlo Park, California dated March 6, 1996.
10.21(16) Lease Amendment for the Company's distribution center in Menlo Park, California dated May 7, 1999.
10.22(5) Harbour Quay (London) Lease Documents.
10.23(9) Lease Agreement for the Company's offices in Fort Worth, Texas dated October 24, 1991.
10.24(9) Lease Amendment for the Company's offices in Fort Worth, Texas dated December 8, 1992.
10.25(9) Lease Amendment for the Company's offices in Fort Worth, Texas dated February 9, 1996.
10.26(13) Form of Indemnification Agreement.
10.27(12) Loan and Security Agreement between Comerica Bank of California and PharmChem Laboratories, Inc.
dated December 5, 1997.
10.28(12) Security Agreement (all assets) between Comerica Bank of California and PharmChem Laboratories, Inc.
dated December 5, 1997.
10.29(13) Amendment to Loan and Security Agreement between Comerica Bank of California and
</TABLE>
44
<PAGE> 45
<TABLE>
<S> <C>
PharmChem Laboratories, Inc. dated August 10, 1998.
10.30 Amendment to Loan and Security Agreement between Comerica Bank of California and PharmChem
Laboratories, Inc. dated November 5, 1999.
10.31(16) Variable Rate Installment Note between Comerica Bank of California and PharmChem
Laboratories, Inc. dated April 14, 1999.
10.32(16) Lease Agreement for computer software between American Technologies Credit, Inc. and
PharmChem Laboratories, Inc. dated March 29, 1999.
10.33 Lease Agreement for computer software between Jules and Associates, Inc. and PharmChem
Laboratories, Inc. dated November 23, 1999.
10.34(4,11) License and Supply Agreement with Sudormed, Inc. dated March 10, 1992.
10.35(5,11) License and Supply Agreement with Sudormed, Inc. dated October 25, 1993.
10.36(5,11) Supply Agreement with SolarCare Technologies Corporation dated August 1, 1993.
10.37(8,11) First Amendment to Supply Agreement dated December 1, 1995.
10.38(10) Master Lease Purchase Agreement dated December 18, 1995 with Fidelity Leasing Corporation and
Lease Purchase Addenda in connection therewith.
10.39(10) Master Equipment Lease dated March 17, 1996 with Olympus Commercial Credit.
21.01 List of Subsidiaries.
23.01 Consent of KPMG LLP, Independent Certified Public Accountants.
27.1 Financial Data Schedule.
</TABLE>
(1) Incorporated by reference from the Company's Registration Statement on
Form S-1 (File No. 33-41363), effective August 8, 1991.
(2) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1991.
(3) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1992.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1992.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994.
(7) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1995.
(8) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995.
(9) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996.
(10) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1997.
(11) Confidential treatment requested as to certain portions of this exhibit.
(12) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997.
(13) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1998.
(14) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998.
(15) Incorporated by reference from the Company's Current Report on Form 8-K
dated December 6, 1999.
(16) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1999.
45
<PAGE> 46
(b) REPORTS ON FORM 8-K
Report on Form 8-K filed on December 6, 1999.
(c) EXHIBITS
See (a)(3) above.
(d) FINANCIAL STATEMENT SCHEDULE
See (a)(2) above.
46
<PAGE> 47
PHARMCHEM LABORATORIES, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND DEDUCTIONS END
DESCRIPTION OF PERIOD EXPENSES (WRITE-OFFS) OF PERIOD
----------- ---------- ---------- ------------ ----------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts
Year ended:
December 31, 1997................. $610 $350 $492 $468
==== ==== ==== ====
December 31, 1998................. $468 $325 $231 $562
==== ==== ==== ====
DECEMBER 31, 1999................. $562 $141 $158 $545
==== ==== ==== ====
</TABLE>
47
<PAGE> 48
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF MENLO
PARK, STATE OF CALIFORNIA, ON THIS 7TH DAY OF MARCH, 2000.
PHARMCHEM LABORATORIES, INC.
BY: /s/ Joseph W. Halligan
-------------------------------------
JOSEPH W. HALLIGAN
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Joseph W. Halligan, acting individually,
as such person's true and lawful attorney-in-fact and agent, with full power of
substitution, for such person, in any and all capacities, to sign any and all
amendments (including post-effective amendments) to this report on Form 10-K,
and to file the same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact and agent, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as such person might or could do
in person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitutes, may do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT ON FORM 10-K HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Joseph W. Halligan President, Chief Executive Officer and Director March 7, 2000
------------------------------------- (Principal Executive Officer)
Joseph W. Halligan
/s/ David A. Lattanzio Chief Financial Officer, Vice President, March 7, 2000
------------------------------------- Finance and Administration
David A. Lattanzio (Principal Accounting and Financial Officer)
and Secretary
/s/ Richard D. Irwin Chairman of the Board and Director March 7, 2000
-------------------------------------
Richard D. Irwin
/s/ Donald R. Stroben
-------------------------------------
Donald R. Stroben Director March 7, 2000
</TABLE>
48
<PAGE> 49
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
---------- -----------------------
<S> <C>
3.01(1) Amended and Restated Articles of Incorporation dated August 21, 1991.
3.02(2,13) Bylaws, as amended through October 21, 1998.
4.01(1) Restated Modification Agreement dated August 14, 1989.
10.01(1) 1988 Incentive Stock Plan, as amended.
10.02(6) Form of Stock Option Agreement.
10.03(1) Form of Stock Option Agreement (providing for accelerated vesting upon death or disability).
10.04(6) Form of Stock Option Agreement (January 1, 1995).
10.05(1) Form of Stock Purchase Agreement.
10.06(4) 1992 Director Option Plan.
10.07(4) Form of Director Option Agreement.
10.08(9) Amendment Number 1 to 1992 Director Option Plan dated February 28, 1996.
10.09(9) Amendment Number 2 to 1992 Director Option Plan dated March 4, 1997.
10.10 Amendment Number 3 to 1992 Director Option Plan dated November 30, 1999.
10.11(10) 1997 Equity Incentive Plan.
10.12(10) Form of Stock Option Agreement (Nonstatutory Stock Option) in connection with the 1997 Equity
Incentive Plan.
10.13(10) Stock Option Agreement (Incentive Stock Option) in connection with the 1997 Equity Incentive Plan.
10.14(1) 401(k) Plan.
10.15(9) Amendment to 401(k) Plan dated August 25, 1996.
10.16(14) Amendment to 401(k) Plan dated September 15, 1998.
10.17(15) Rights Agreement dated November 30, 1999.
10.18(1) Lease Agreements for the Company's offices in Menlo Park, California dated October 21, 1988 and
September 11, 1990, respectively.
10.19(8) Lease Amendment for the Company's offices in Menlo Park, California dated
November 30, 1995.
10.20(9) Lease Amendment for the Company's offices in Menlo Park, California dated
March 6, 1996.
10.21(16) Lease Amendment for the Company's distribution center in
Menlo Park, California dated May 7, 1999.
10.22(5) Harbour Quay (London) Lease Documents.
10.23(9) Lease Agreement for the Company's offices in Fort Worth, Texas dated
October 24, 1991.
10.24(9) Lease Amendment for the Company's offices in Fort Worth, Texas dated
December 8, 1992.
10.25(9) Lease Amendment for the Company's offices in Fort Worth, Texas dated
February 9, 1996.
10.26(13) Form of Indemnification Agreement.
10.27(12) Loan and Security Agreement between Comerica Bank of California and PharmChem Laboratories,
Inc. dated December 5, 1997.
10.28(12) Security Agreement (all assets) between Comerica Bank of California and PharmChem
Laboratories, Inc. dated December 5, 1997.
10.29(13) Amendment to Loan and Security Agreement between Comerica Bank of California and
</TABLE>
<PAGE> 50
<TABLE>
<S> <C>
PharmChem Laboratories, Inc. dated August 10, 1998.
10.30 Amendment to Loan and Security Agreement between Comerica Bank of California and PharmChem
Laboratories, Inc. dated November 5, 1999.
10.31(16) Variable Rate Installment Note between Comerica Bank of California and PharmChem
Laboratories, Inc. dated April 14, 1999.
10.32(16) Lease Agreement for computer software between American Technologies Credit, Inc. and
PharmChem Laboratories, Inc. dated March 29, 1999.
10.33 Lease Agreement for computer software between Jules and Associates, Inc. and PharmChem
Laboratories, Inc. dated November 23, 1999.
10.34(4,11) License and Supply Agreement with Sudormed, Inc. dated March 10, 1992.
10.35(5,11) License and Supply Agreement with Sudormed, Inc. dated October 25, 1993.
10.36(5,11) Supply Agreement with SolarCare Technologies Corporation dated August 1, 1993.
10.37(8,11) First Amendment to Supply Agreement dated December 1, 1995.
10.38(10) Master Lease Purchase Agreement dated December 18, 1995 with Fidelity Leasing Corporation and
Lease Purchase Addenda in connection therewith.
10.39(10) Master Equipment Lease dated March 17, 1996 with Olympus Commercial Credit.
21.01 List of Subsidiaries.
23.01 Consent of KPMG LLP, Independent Certified Public Accountants.
27.1 Financial Data Schedule.
</TABLE>
(1) Incorporated by reference from the Company's Registration Statement on
Form S-1 (File No. 33-41363), effective August 8, 1991.
(2) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1991.
(3) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1992.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1992.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994.
(7) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1995.
(8) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995.
(9) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996.
(10) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1997.
(11) Confidential treatment requested as to certain portions of this exhibit.
(12) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997.
(13) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1998.
(14) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998.
(15) Incorporated by reference from the Company's Current Report on Form 8-K
dated December 6, 1999.
(16) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1999.
<PAGE> 51
(b) REPORTS ON FORM 8-K
Report on Form 8-K filed on December 6, 1999.
(c) EXHIBITS
See (a) (3) above.
(d) FINANCIAL STATEMENT SCHEDULE
See (a) (2) above.
<PAGE> 1
Exhibit 10.10
AMENDMENT NO. 3
TO PHARMCHEM LABORATORIES, INC.
1992 DIRECTOR OPTION PLAN
This Amendment No. 3 (the "Amendment") to the PharmChem Laboratories,
Inc. 1992 Director Option Plan, as heretofore amended (the "Plan"), is made
effective as of the 30th day of November, 1999 by the Administrator of the Plan
pursuant to Section 11(a) of the Plan. All capitalized terms used herein and not
otherwise defined herein shall have the meanings given them in the Plan.
AMENDMENT
The Plan is hereby amended as follows:
1. The date "January 1" in Section 4(b)(iii) of the Plan is hereby changed
to "March 31."
IN WITNESS WHEREOF, this Amendment is executed effective as of the date
first set forth above by the Administrator of the Plan, which Administrator
consists of the Outside Directors of the Company.
/s/ Richard D. Irwin
------------------------------------
Richard D. Irwin
/s/ Donald R. Stroben
------------------------------------
Donald R. Stroben
<PAGE> 1
Exhibit 10.30
November 5, 1999
David A. Lattanzio
Vice President and Chief Financial Officer
PharmChem Laboratories, Inc.
1505A O'Brien Drive
Menlo Park, CA 94025
Dear Dave:
With regard to the Loan & Security Agreement ("Agreement") between Comerica
Bank-California ("Bank") and PharmChem Laboratories, Inc. ("Borrower") dated
November 18, 1997, and the First Modification to the Agreement dated August 10,
1998, Borrower has requested, and Bank has agreed, to modify the Agreement as
set forth below.
1.) Up to $2,000,000 of the Borrower's $6,000,000 Revolving Line of Credit
can be used to repurchase outstanding stock of the Borrower.
2.) Borrower shall be permitted to declare and distribute any dividends in
the form of rights which allow shareholders to purchase shares of a new
series of preferred stock. This shall include a shareholders rights
offering or other actions that are now currently contemplated by the
company.
All other Terms and Conditions of the Agreement shall be in full force and
effect.
Sincerely,
/s/ James L. Weber
- ----------------------------------
James L. Weber
Vice President
<PAGE> 1
Exhibit 10.33
LESSOR: MASTER EQUIPMENT
JULES AND ASSOCIATES, INC. LEASE AGREEMENT
515 SOUTH FIGUEROA STREET
SUITE 1950
LOS ANGELES, CA 90071
MASTER LEASE AGREEMENT NO. A10161999
Lease Agreement made this 23rd day of November, 1999 between JULES AND
ASSOCIATES, INC. ("Lessor") with a place of business located at 515 South
Figueroa Street, Suite 1950, Los Angeles, California 90071 and PharmChem
Laboratories, Inc. ("Lessee") having its principal place of business located at
1505-A O'Brien Drive, Menlo Park, California 94025-1435.
1. LEASE AGREEMENT. Lessor hereby leases to Lessee and Lessee hereby leases
from Lessor all of the personal property ("Equipment") described in Equipment
Lease Schedule(s), which are or may from time to time be executed by Lessor and
Lessee and attached hereto or incorporated herein by reference ("Schedules"),
upon the terms and conditions set forth in this Lease, as supplemented by the
terms and conditions set forth in the appropriate Schedule(s) identifying such
items of Equipment. All terms and conditions of this Lease shall govern the
rights and obligations of Lessor and Lessee except as specifically modified in
writing. Whenever reference is made herein to the "Lease", it shall be deemed to
include each of the various Schedules identifying all items of Equipment, all of
which constitute one undivided Lease of the Equipment and the terms and
conditions of which are incorporated herein by reference. Lessee's liability for
Lessee's obligations under this Lease will survive the expiration or earlier
termination of this Lease.
2. SELECTION OF EQUIPMENT; ACCEPTANCE. Lessee will select the type, quantity
and supplier of each item of Equipment designated in the appropriate Schedule,
and in reliance thereon such Equipment will then be ordered by Lessor from such
supplier or Lessor will accept an assignment of any existing purchase order
therefore. Lessor will have no liability for any delivery or failure by the
supplier to fill the purchase order or to meet the conditions thereof. Lessee
acknowledges that Lessor has not participated and will not participate in any
way in Lessee's selection of the Equipment or of the supplier. Lessee agrees to
inspect the Equipment and to execute an Acknowledgment and Acceptance of
Equipment by Lessee notice, as provided by Lessor, after the Equipment has been
delivered and after Lessee is satisfied that the Equipment is satisfactory in
every respect. Lessee hereby authorizes Lessor to insert in this Lease serial
numbers or other identifying data with respect to the Equipment.
3. DISCLAIMER OF WARRANTIES AND CLAIMS; LIMITATION OF REMEDIES. LESSOR, NOT
BEING THE MANUFACTURER OF THE EQUIPMENT NOR THE MANUFACTURER'S AGENT, MAKES NO
EXPRESS OR IMPLIED WARRANTY OF ANY KIND WHATSOEVER WITH RESPECT TO THE
EQUIPMENT, INCLUDING, BUT NOT LIMITED TO, THE MERCHANTIBILITY OF THE EQUIPMENT
OR ITS FITNESS FOR ANY PARTICULAR PURPOSE; THE DESIGN OR CONDITION OF THE
EQUIPMENT; THE QUALITY OR CAPACITY OF THE EQUIPMENT; THE WORKMANSHIP IN THE
EQUIPMENT; COMPLIANCE OF THE EQUIPMENT WITH THE REQUIREMENT OF ANY LAW, RULE,
SPECIFICATION OR CONTRACT PERTAINING THERETO; PATENT INFRINGEMENT; OR LATENT
DEFECTS. LESSEE LEASES THE EQUIPMENT "AS IS" AND WITH ALL FAULTS. LESSEE
ACCORDINGLY AGREES NOT TO ASSERT ANY CLAIM WHATSOEVER AGAINST LESSOR FOR LOSS OF
ANTICIPATORY PROFITS OR CONSEQUENTIAL DAMAGES. LESSOR SHALL HAVE NO OBLIGATION
TO INSTALL, ERECT, TEST, SERVICE, OR MAINTAIN THE EQUIPMENT. LESSEE SHALL LOOK
TO THE MANUFACTURER AND/OR SELLER FOR ANY CLAIMS RELATED TO THE EQUIPMENT.
IF THE EQUIPMENT IS NOT PROPERLY INSTALLED, DOES NOT OPERATE AS REPRESENTED
OR WARRANTED BY THE SUPPLIER OR MANUFACTURER, OR IS UNSATISFACTORY FOR ANY
REASON, REGARDLESS OF CAUSE OR CONSEQUENCE, LESSEE'S ONLY REMEDY, IF ANY, SHALL
BE AGAINST THE SUPPLIER OR MANUFACTURER OF THE EQUIPMENT AND NOT AGAINST LESSOR.
LESSOR HEREBY ACKNOWLEDGES THAT ANY MANUFACTURER'S AND/OR SELLER'S WARRANTIES
ARE FOR THE BENEFIT OF BOTH LESSOR AND LESSEE. NOTWITHSTANDING THE FOREGOING,
LESSEE'S OBLIGATIONS TO PAY THE RENTALS OR OTHERWISE UNDER THIS LEASE SHALL BE
AND ARE ABSOLUTE AND UNCONDITIONAL. TO THE EXTENT PERMITTED BY THE MANUFACTURER
OR SELLER, AND PROVIDED LESSEE IS NOT IN DEFAULT UNDER THIS LEASE, LESSOR SHALL
MAKE AVAILABLE TO LESSEE ALL MANUFACTURER AND/OR SELLER WARRANTIES WITH RESPECT
TO EQUIPMENT.
LESSEE SPECIFICALLY ACKNOWLEDGES THAT THE EQUIPMENT IS LEASED TO LESSEE
SOLELY FOR COMMERCIAL OR BUSINESS PURPOSES AND NOT FOR PERSONAL, FAMILY,
HOUSEHOLD, OR AGRICULTURAL PURPOSES.
THE PARTIES HAVE SPECIFICALLY NEGOTIATED AND AGREED TO THE FOREGOING PARAGRAPH:
LESSEE INITIALS: S/ DAL .
/S/ DAL
PAGE 1 OF 5
<PAGE> 2
4. STATUTORY FINANCE LEASE. Lessee agrees and acknowledges that it is the
intent of both parties to this Lease that it qualify as a statutory finance
lease under Article 2A of the Uniform Commercial Code. Lessee acknowledges and
agrees that Lessee has selected both: (1) the Equipment; and (2) the supplier
from whom Lessor is to purchase the Equipment. Lessee acknowledges that Lessor
has not participated in any way in Lessee's selection of the Equipment or of the
supplier, and Lessor has not selected, manufactured, or supplied the Equipment.
LESSEE IS ADVISED THAT IT MAY HAVE RIGHTS UNDER THE CONTRACT EVIDENCING THE
LESSOR'S PURCHASE OF THE EQUIPMENT FROM THE SUPPLIER CHOSEN BY LESSEE AND THAT
LESSEE SHOULD CONTACT THE SUPPLIER OF THE EQUIPMENT FOR A DESCRIPTION OF ANY
SUCH RIGHTS.
5. ASSIGNMENT BY LESSEE PROHIBITED. WITHOUT LESSOR'S PRIOR WRITTEN CONSENT,
LESSEE SHALL NOT ASSIGN THIS LEASE OR SUBLEASE THE EQUIPMENT OR ANY INTEREST
THEREIN, OR PLEDGE OR TRANSFER THIS LEASE, OR OTHERWISE DISPOSE OF THE EQUIPMENT
COVERED HEREBY.
6. COMMENCEMENT; RENTAL PAYMENTS; INTERIM RENTALS. This Lease shall commence
upon the written acceptance hereof by Lessor and shall end upon full performance
and observance by Lessee of each and every term, condition and covenant set
forth in this Lease, any Schedules hereto and any extensions hereof. The monthly
rental payments shall be in advance and shall be in the amounts and frequency as
set forth on the face of this Lease or any Schedules hereto. The first such
rental payment shall be made on the first day of the month following the date on
which the Equipment is accepted by the Lessee. In addition to regular rentals,
Lessee shall pay to Lessor interim rent, which shall be a pro-rata portion of
the monthly rental charges based on a daily rental charge of one-thirtieth
(1/30th) of the monthly rental calculated from the date on which the Equipment
is accepted by the Lessee to the end of the respective month, and shall be due
and payable upon Lessee's receipt of invoice from Lessor. The rental period
under the Lease shall terminate following the last day of the terms stated on
the face hereof or in any Schedule hereto unless such Lease or Schedule has been
extended or otherwise modified. Lessor shall have no obligation to Lessee under
this Lease if the Equipment, for whatever reason, is not delivered to Lessee
within ninety (90) days after Lessee signs this Lease. Lessor shall have no
obligation to Lessee under this Lease if Lessee fails to execute and deliver to
Lessor an Acknowledgment and Acceptance of Equipment by Lessee acknowledging its
acceptance of the Equipment within thirty (30) days after it is delivered to
Lessee, with respect to this Lease or any Schedule hereto.
7. SECURITY DEPOSIT. As security for the prompt and full payment of rent, and
the faithful and timely performance of all provisions of this Lease, and any
extensions or renewals thereof, Lessee shall pledge and deposit with Lessor the
security amount set forth in the section shown as "Security Deposit" on each
respective Schedule. In the event any default shall be made in the performance
of any of Lessee's obligations under this Lease, Lessor shall have the right,
but shall not be obligated, to apply said security to the curing of such
default. Within 15 days after Lessor mails notice to Lessee that Lessor has
applied any portion of the Security Deposit to the curing of any default, Lessee
shall restore said Security Deposit to the full amount set forth in the
Schedules. On the expiration or earlier termination of each Schedule to this
Lease, or any extension or renewal thereof, provided Lessee has paid all of the
rent herein called for and fully performed all other provisions of this Lease
with respect to such Schedule, Lessor will return to Lessee any then remaining
balance of the security deposit with respect to such Schedule, without interest.
Said security deposit may be commingled with Lessor's other funds.
8. LIMITED PREARRANGED AMENDMENTS. SPECIFIC POWER OF ATTORNEY; In the event
it is necessary to amend the terms of this Lease or the terms of any Schedule to
reflect a change in one or more of the following conditions:
(1) Lessor's actual cost of procuring the Equipment; or
(2) Lessor's actual cost of providing Equipment to Lessee; or
(3) A change in the Lease payments as a result of (1) and/or (2) above; or
(4) Description of the leased Equipment,
Lessee agrees that any such amendment shall be described in a letter from Lessor
to Lessee, and unless within 15 days after the date of such letter Lessee
objects thereto in a writing delivered to Lessor, this Lease and any affected
Schedules shall be deemed amended and such amendments shall be incorporated
herein/therein as if originally set forth herein/therein. Lessee grants to
Lessor a specific power of attorney for Lessor to use as follows: (1) Lessor may
sign and file on Lessee's behalf any document Lessor deems necessary to perfect
or protect Lessor's interest in the Equipment or pursuant to the Uniform
Commercial Code; and (2) Lessor may sign, endorse or negotiate for Lessor's
benefit any instrument representing proceeds from any policy of insurance
covering the Equipment.
/S/ DAL
PAGE 2 OF 5
<PAGE> 3
9. LOCATION. The Equipment shall be kept at the location specified in each
Schedule or, if none is specified, at Lessee's address as set forth above, and
shall not be removed therefrom without Lessor's prior written consent. Lessor
shall have the right to inspect the Equipment and observe its use during normal
business hours, and Lessee will ensure Lessor's ability to enter into and upon
the premises where the Equipment may be located for such purpose.
10. USE. Lessee shall use the Equipment in a careful manner, shall make all
necessary repairs at Lessee's expense, and shall comply with all laws relating
to its possession, use or maintenance, and shall not make any alterations,
additions or improvements to the Equipment without Lessor's prior written
consent. All additions, repairs or improvements made to the Equipment shall
belong to Lessor.
11. OWNERSHIP; PERSONALITY. The Equipment is, and shall remain, the property
of Lessor, and Lessee shall have no right, title or interest therein or thereto
except as expressly set forth in this Lease. Should Lessee have an end of term
purchase option and Lessee does not give proper notice as agreed upon by both
parties, then, that purchase option shall be null and void and the terms and
conditions as set forth in this Agreement shall prevail after any extension
period. The Equipment shall remain personal property even though installed in or
attached to real property.
12. SURRENDER. By this Lease, Lessee acquires no ownership rights in the
Equipment and has no option to purchase same. Upon the expiration or termination
of any Schedule or this Lease, or in the event of a default pursuant to
Paragraph 20 hereof, Lessee, at its expense, shall return the Equipment in good
repair, ordinary wear and tear resulting from proper use thereof alone excepted,
by delivering it, packed and ready for shipment, to such place or carrier as
Lessor may specify.
13. RENEWAL. At the expiration of the term set forth in each Schedule, Lessee
shall return the Equipment subject to said Schedule in accordance with Paragraph
12 hereof. At Lessor's option, this Lease, with respect to each Schedule, may be
continued on a month-to-month basis until 30 days after Lessee returns the
Equipment subject to the Schedule to Lessor. In the event that the Lease, with
respect to a Schedule, is so continued, Lessee shall pay to Lessor rentals in
the same periodic amounts as indicated under "Rental" on the Schedule.
14. LOSS AND DAMAGE. Lessee shall bear the entire risk of loss, theft, damage
or destruction of the Equipment from any cause whatsoever, and no loss, theft,
damage or destruction of the Equipment shall relieve Lessee of the obligation to
pay rent or to comply with any other obligation under this Lease.
In the event of damage to any item of Equipment, Lessee shall immediately place
the same in good repair at Lessee's expense. If Lessor determines that any item
of Equipment is lost, stolen, destroyed or damaged beyond repair, Lessee shall
at Lessee's option do one of the following:
(a) Replace the same with like Equipment in good repair, acceptable to
Lessor; or
(b) Pay Lessor in cash the following: (i) all amounts due by Lessee to Lessor
with respect to all affected Schedules up to the date of the loss; (ii)
the unpaid balance of the total rent for the remaining term of the
affected Schedules attributable to said item, reduced to present value at
a discount rate of 6% as of the date of the loss; and (iii) the Lessor's
estimate as of the time this Lease was entered into of Lessor's residual
interest in the Equipment, discounted to present value at a discount rate
of 6% as of the date of the loss. Upon Lessor's receipt of payment as set
forth above, Lessee shall be entitled to the Equipment, without any
warranties. If insurance proceeds are used to fully comply with this
subparagraph, the balance of any such proceeds shall go to Lessee to
compensate for loss of use of the Equipment for the remaining term of the
Lease.
15. INSURANCE; LIENS; TAXES. Lessee shall provide and maintain insurance
against loss, theft, damage or destruction of the Equipment in an amount not
less than the full replacement value of the Equipment, with loss payable to
Lessor. Lessee shall also provide and maintain comprehensive general all-risk
liability insurance, including but not limited to product liability coverage,
insuring Lessor and Lessee with a severability of interest endorsement or its
equivalent, against any and all loss or liability for damages either to persons
or property or otherwise, which might result from or happen in connection with
the condition, use or operation of the Equipment, with such limits and with an
insurer as are satisfactory to Lessor. Each policy shall expressly provide that
said insurance as to Lessor and its assigns shall not be invalidated by any act,
omission or neglect of Lessee and cannot be canceled without 30 days written
notice to Lessor. As to each policy, Lessee shall furnish to Lessor a
certificate of insurance from the insurer, which certificate shall evidence the
insurance coverage required by this Paragraph and shall designate Lessor as loss
payee and/or additional insured. Lessor shall have no obligation to ascertain
the existence or adequacy of insurance, or to provide any insurance coverage for
the Equipment or for Lessee's benefit.
Lessee shall keep the Equipment free and clear of all levies, liens and
encumbrances. Lessee shall pay all charges and taxes (local, state and federal)
which may now or hereafter be imposed upon the ownership, leasing, rental, sale,
purchase, possession or use of the Equipment excluding, however, all taxes on or
measured by Lessor's net income.
If Lessee fails to procure or maintain said insurance or to pay said charges
or taxes, Lessor shall have the right, but shall not be obligated, to effect
such insurance, or pay such charges or taxes. In that event, Lessor shall notify
Lessee of such payment and Lessee shall repay to Lessor the cost thereof within
15 days after such notice is mailed to Lessee.
/S/ DAL
PAGE 3 OF 5
<PAGE> 4
16. INDEMNITY. Lessee shall indemnify Lessor against any claims, actions,
damages or liabilities, including all attorney fees, arising out of or connected
with the Equipment, without limitation. Such indemnification shall survive the
expiration, cancellation or termination of this Lease. Lessee waives any
immunity Lessee may have under any industrial insurance act with regard to
indemnification of Lessor.
17. ASSIGNMENT BY LESSOR. Any assignee of Lessor shall have all of the rights
but none of the obligations of Lessor under this Lease. Lessee shall recognize
and hereby consents to any assignment of this Lease by Lessor, and Lessee shall
not assert against the assignee any defense, counterclaim or set-off that Lessee
may have against Lessor. Subject to the foregoing, this Lease inures to the
benefit of and is binding upon the heirs, devisees, personal representatives,
survivors, successors in interest and assigns of the parties hereto.
18. SERVICE CHARGES; INTEREST. If Lessee shall fail to make any payment
required by this Lease within 10 days of the due date thereof, Lessee shall pay
to Lessor a service charge of 8% of the amount due, provided, however, that not
more than one such service charge shall be made on any delinquent payment
regardless of the length of the delinquency. In addition to the foregoing
service charge, Lessee shall pay to Lessor a $100 default fee with respect to
any payment which becomes thirty (30) days past due. In addition, Lessee shall
pay to Lessor any actual additional expenses incurred by Lessor in collection
efforts, including but not limited to long-distance telephone charges and travel
expenses.
Further, Lessee shall pay to Lessor interest on any delinquent payment or
amount due under this Lease from the due date thereof until paid, at the lesser
of the maximum rate of interest allowed by law or 18% per annum.
19. TIME OF ESSENCE. Time is of the essence of this Lease, and this provision
shall not be impliedly waived by the acceptance on occasion of late or defective
performance.
20. DEFAULT. Lessee shall be in default of this Lease if:
(a) Lessee shall fail to make any payment due under the terms of this Lease
for a period of 10 days from the due date thereof; or
(b) Lessee shall fail to observe, keep or perform any other provision of this
Lease, and such failure shall continue for a period of 10 days; or
(c) Lessee has made any misleading or false statement in connection with
application for or performance of this Lease; or
(d) The Equipment or any part thereof shall be subject to any lien, levy,
seizure, assignment, transfer, bulk transfer, encumbrance, application,
attachment, execution, sublease, or sale without prior written consent of
Lessor, or if Lessee shall abandon the Equipment or permit any other entity or
person to use the Equipment without prior written consent of Lessor; or
(e) Lessee dies or ceases to exist or ceases business activities; or
(f) Lessee defaults on any other agreement it has with Lessor; or
(g) Lessee or any guarantor of this Lease defaults on any obligation to
Lessor, or any to the above-listed events of default occur with respect to
Lessee or any guarantor, or Lessee or any such guarantor files or has filed
against it a petition under the bankruptcy laws; or
(h) Lessee undergoes a sale, buyout, change of control, or change in
ownership of any type, form or manner which, as judged solely by Lessor, results
in deterioration in Lessee's credit worthiness.
21. REMEDIES. If Lessee is in default, Lessor, with or without notice to
Lessee, shall have the right to exercise any one or more of the following
remedies, concurrently or separately and without any election of remedies being
deemed to have been made:
(a) Lessor may enter upon Lessee's premises and without any court order or
other process of law may repossess and remove the Equipment, or render the
Equipment unusable without removal, either with or without notice to Lessee.
Lessee hereby waives any trespass or right of action for damages by reason of
such entry, removal or disabling. Any such repossession shall not constitute a
termination of this Lease;
(b) Lessor may require Lessee, at its expense, to return the Equipment in
good repair, ordinary wear and tear resulting from proper use thereof alone
excepted, by delivering it, packed and ready for shipment, to such place or
carrier as Lessor may specify;
(c) Lessor may cancel or terminate this Lease and may retain any and all
prior payments paid by Lessee;
(d) Lessor may declare all sums due and to become due under this Lease
immediately due and payable, including as to any or all items of Equipment,
without notice or demand to Lessee;
(e) Lessor may re-release the Equipment to any third party, without notice to
Lessee, upon such terms and conditions as Lessor alone shall determine, or may
sell the Equipment without notice to Lessee, at private or public sale, at which
sale Lessor may be the purchaser;
(f) Lessor may sue for and recover from Lessee the sum of all unpaid rents
and other payments due under this Lease then accrued, plus all accelerated
future payments due under this Lease, reduced to their present value using a
discount rate of 6%, as of the date of default, plus Lessor's estimate at the
time this Lease was entered into of Lessor's residual interest in
the Equipment, reduced to present value at a discount rate of 6%, as of the
date of default, less the net proceeds of disposition, if any, of the Equipment;
/S/ DAL
PAGE 4 OF 5
<PAGE> 5
(g) To pursue any other remedy available at law, by statute or in equity.
No right or remedy conferred upon or reserved to Lessor is exclusive of any
other right or remedy herein, or by law or by equity provided or permitted, but
each shall be cumulative of every other right or remedy given herein or now or
hereafter existing by law or equity or by statute or otherwise, and may be
enforced concurrently therewith or from time to time. No single or partial
exercise by Lessor of any right or remedy hereunder shall preclude any other or
further exercise of any other right or remedy.
22. MULTIPLE LESSEES. Lessee and each of them are jointly and severally
responsible and liable to Lessor under this Lease. Lessor may, with the consent
of any one of the Lessees hereunder, modify, extend or change any of the terms
hereof without consent or knowledge of the others, without in any way releasing,
waiving or impairing any right granted to Lessor against the others.
23. EXPENSE OF ENFORCEMENT. In the event of any legal action with respect to
this Lease, the prevailing party in any such action shall be entitled to
reasonable attorney fees, including attorney fees incurred at the trial level,
including action in bankruptcy court, on appeal or review, or incurred without
action, suits or proceedings, together with all costs and expenses incurred in
pursuit thereof.
24. MISCELLANEOUS.
(1) LESSEE HEREBY ACKNOWLEDGES THAT THIS LEASE IS NONCANCELABLE FOR THE ORIGINAL
RENTAL TERM SET FORTH IN EACH SCHEDULE.
(2) LESSEE UNDERSTANDS AND ACKNOWLEDGES THAT NO BROKER OR SUPPLIER NOR ANY
SALESMAN, BROKER OR AGENT OF ANY BROKER OR SUPPLIER IS AN AGENT OF LESSOR. NO
BROKER OR SUPPLIER, NOR ANY SALESMAN, BROKER OR AGENT OF ANY BROKER OR SUPPLIER
IS AUTHORIZED TO WAIVE OR ALTER ANY TERM OR CONDITION OF THIS LEASE, AND NO
REPRESENTATION AS TO THE EQUIPMENT OR ANY OTHER MATTER BY A BROKER OR SUPPLIER
OR ANY SALESMAN, BROKER OR AGENT OF ANY BROKER OR SUPPLIER SHALL IN ANY WAY
AFFECT LESSEE'S DUTY TO PAY THE RENTALS AND TO PERFORM LESSEE'S OBLIGATIONS SET
FORTH IN THIS LEASE. LESSEE AUTHORIZES LESSOR TO INSERT ANY APPLICABLE DATES ON
THE LEASE OR ATTACHMENTS TO THE LEASE.
(3) LESSEE AGREES THAT LESSOR MAY USE LESSEE'S NAME IN ADVERTISING AND
PROMOTIONAL MATERIALS AND GENERAL TERMS OF THIS MASTER EQUIPMENT LEASE AND
SCHEDULES.
(4) LESSEE SHALL FURNISH LESSOR WITH (a) A FISCAL YEAR END FINANCIAL STATEMENT
INCLUDING BALANCE SHEET AND INCOME STATEMENT WITHIN ONE HUNDRED AND TWENTY DAYS
(120) DAYS OF THE CLOSE OF EACH FISCAL YEAR AND (b) SUCH OTHER FINANCIAL DATA OR
INFORMATION RELATIVE TO THIS LEASE AND THE EQUIPMENT AS LESSOR MAY FROM TIME TO
TIME REQUEST.
25. SEVERABILITY. This Lease is intended to constitute a valid and
enforceable legal instrument. In the event any provision hereof is declared
invalid, such provision will be deemed severable from the remaining provisions
of this Lease, all of which will remain in full force and effect.
26. ENTIRE AGREEMENT; WAIVER. This instrument and the Schedules executed by
Lessor and Lessee constitute the entire agreement between Lessor and Lessee with
respect to the Equipment and the subject matter of this Lease. Lessee certifies
and warrants that this Lease has been duly authorized, executed and delivered by
Lessee and constitutes the legal, valid and binding obligation and that the
person executing this Lease on behalf of the Lessee warrants that he or she has
been authorized to do so. No provision of this Lease shall be modified unless in
writing signed by an authorized representative of Lessor and Lessee. Waiver by
Lessor of any provision hereof in one instance shall not constitute a waiver of
any other instance. NO ORAL OR WRITTEN AGREEMENT, GUARANTY, PROMISE, CONDITION,
REPRESENTATION OR WARRANTY SHALL BE BINDING UNLESS MADE A PART OF THIS LEASE BY
DULY EXECUTED ADDENDUM.
LESSOR INITIALS: /S/ JB LESSEE INITIALS: /S/ DAL
------ --------
27. CHOICE OF LAW; JURISDICTION. THIS LEASE SHALL NOT BE EFFECTIVE UNTIL
SIGNED BY LESSOR AT ITS PRINCIPAL PLACE OF BUSINESS LISTED ABOVE. THIS LEASE
SHALL BE CONSIDERED TO HAVE BEEN MADE IN THE STATE OF LESSOR'S PRINCIPAL PLACE
OF BUSINESS AND SHALL BE INTERPRETED IN ACCORDANCE WITH THE LAWS AND REGULATIONS
OF THAT STATE.
LESSEE AGREES TO JURISDICTION IN THE STATE OF LESSOR'S PRINCIPAL PLACE OF
BUSINESS IN ANY ACTION, SUIT OR PROCEEDING ARISING OUT OF THIS LEASE, AND
CONCEDES THAT IT, AND EACH OF THEM, TRANSACTED BUSINESS IN THE SAID STATE BY
ENTERING INTO THIS LEASE. IN THE EVENT OF LEGAL ACTION TO ENFORCE THIS LEASE,
LESSEE AGREES THAT VENUE MAY BE LAID IN COUNTY OF LESSOR'S PRINCIPAL PLACE OF
BUSINESS.
LESSOR INITIALS: /S/ JB LESSEE INITIALS: /S/ DAL
------ --------
LESSEE: LESSOR: JULES AND ASSOCIATES, INC.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
/s/ David A. Lattanzio Date: 11/23/99 /s/ Jules Buenaventa Date: 11/29/99
- ---------------------- --------------------
David A. Lattanzio, CFO Jules Buenaventa, President
MLMM083199
</TABLE>
PAGE 5 OF 5
<PAGE> 6
LEASE SCHEDULE
MASTER EQUIPMENT
LEASE AGREEMENT NO. A10161999
LEASE SCHEDULE NO. 1
BETWEEN JULES AND ASSOCIATES, INC. (LESSOR)
and PharmChem Laboratories, Inc. (LESSEE)
1. DESCRIPTION OF EQUIPMENT
Quantity Item Model/Serial No.
"SEE EXHIBIT "A" ATTACHED HERETO AND MADE A PART HEREOF"
2. EQUIPMENT LOCATION
The above Equipment is to be located and delivered to Lessee's premises
at 1505A O'Brien Drive, Menlo Park, CA 94025-1435.
3. RENTAL TERM: 36 months.
4. RENTAL PAYMENT:
The rental payment amount is $38,118.38 with successive rental payments
in the same amount due on the same day monthly thereafter.
5. NUMBER AND AMOUNT OF ADVANCE RENTAL PAYMENTS:
NUMBER: 1 $38,118.38
6. SECURITY DEPOSIT: $0.00
7. THIS SCHEDULE AND ITS TERMS AND CONDITIONS ARE HEREBY INCORPORATED BY
REFERENCE IN THE ABOVE MASTER EQUIPMENT LEASE AGREEMENT. LESSEE PERMITS
LESSOR TO INSERT MODEL AND SERIAL NUMBERS OF EQUIPMENT WHEN DETERMINED
BY LESSOR.
- -------------------------------------------------------------------------------
LESSEE: PharmChem Laboratories, Inc. LESSOR: JULES AND ASSOCIATES, INC.
(Must be signed by Authorized Corporate
Officer, Partner, or Proprietor)
/s/ David A. Lattanzio /s/ Jules Buenabenta, PRESIDENT
- ----------------------------- ---------------------------------------
David A. Lattanzio, CFO JULES BUENABENTA
Accepted this 29th day of NOVEMBER 1999
at LOS ANGELES, CA
<PAGE> 7
ADDENDUM "A"
TO
MASTER EQUIPMENT LEASE AGREEMENT NO. A10161999
REFERENCE is made to the above-referenced Mater Equipment Lease Agreement
("Lease") dated the 23rd day of November, 1999, by and between PharmChem
Laboratories, Inc. as Lessee, and Jules and Associates, Inc. as Lessor.
Notwithstanding the terms and conditions contained in the Master Equipment Lease
Agreement and to the limited extent hereof, this superseding anything to the
contrary, the parties hereto agree as follows:
"AFTER THE FINAL RENTAL PAYMENT HAS BEEN MADE SPECIFIC TO THE RESPECTIVE
SCHEDULE, PLUS ALL ACCRUED BUT UNPAID LATE CHARGES, INTEREST, TAXES, PENALTIES
AND/OR ALL OR ANY OTHER SUMS DUE AND OWING UNDER THE LEASE AGREEMENT, AND NO
EVENT OF DEFAULT, AS THE SAME IS MORE FULLY DESCRIBED IN THE LEASE AGREEMENT,
HAS OCCURRED OR IS CONTINUING, AND PROVIDED LESSEE NOTIFIES LESSOR (BY CERTIFIED
MAIL) AT LEAST ONE HUNDRED AND EIGHTY (180) DAYS PRIOR TO FINAL RENTAL PAYMENT
(SPECIFIC TO THE RESPECTIVE SCHEDULE) OF LESSEE'S INTENT OF OPTION CHOICE,
LESSEE MAY EXERCISE ONE OF THE FOLLOWING OTPIONS: 1) PURCHASE ALL OF THE
EQUIPMENT OR PRODUCT FOR THE FAIR MARKET VALUE DETERMINED BY LESSEE; 2) RETURN
ALL OF THE EQUIPMENT OR PRODUCT (AND CEASE USING PRODUCT); 3) EXTEND THE LEASE
FOR AN ADDITIONAL TWELVE MONTH PERIOD AT THE RATE DELINEATED ON THE RESPECTIVE
SCHEDULE. SHOULD LESSEE NOT GIVE PROPER NOTICE AS INDICATED ABOVE, THE LEASE
SHALL BE AUTOMATICALLY EXTENDED FOR AN ADDITIONAL SIX MONTH PERIOD AT THE RATE
DELINEATED ON THE RESPECTIVE SCHEDULE."
In all other respects, the terms and conditions of the Master Equipment Lease
Agreement, as originally set forth, shall remain in full force and effect.
IN WITNESS WHEREOF, the parties hereto, by their authorized signatories, have
executed this Addendum "A" at the date set forth below their respective
signatures.
LESSEE: PHARMCHEM LABORATORIES, INC. LESSOR: JULES AND ASSOCIATES, INC.
BY /s/ David A. Lattanzio BY /s/ Jules Buenabenta
-------------------------- -------------------------
David A. Lattanzio Jules Buenabenta
TITLE Vice President & CFO TITLE President
DATE November 23, 1999 DATE 11/29/99
<PAGE> 8
ADDENDUM "B"
TO
MASTER EQUIPMENT LEASE AGREEMENT
REFERENCE is made to the above referenced Master Equipment Lease Agreement No.
A10161999, dated November 23, 1999, by and between Pharmchem Laboratories, Inc.
as Lessee and Jules and Associates, Inc., as Lessor.
Notwithstanding the terms and conditions contained in the Master Equipment Lease
Agreement and to the limited extent hereof, this superceding anything to the
contrary, the parties hereto agree as follows:
SECTION 1. LEASE AGREEMENT. Line 2, after the word "Equipment", insert "or
Product" to be consistent with this change the word "Equipment" as it appears
throughout the Master Equipment Lease Agreement is revised to read "Equipment or
Product".
SECTION 6. COMMENCEMENT; RENTAL PAYMENTS; INTERIM RENTALS. Line 5, replace "The
first such rental payment .................. which the Equipment is accepted by
the Lessee" with "The first such rental payment shall be due and payable on the
day that the Equipment is accepted by the Lessee with successive rental payments
in the same amount due on the same day monthly thereafter. Line 6, delete, "In
addition to regular rentals ................... Lessee's receipt of invoice from
Lessor.".
SECTION 12. SURRENDER. At the end of the paragraph, insert "Superceded by the
attached Addendum "A" made a part hereof".
SECTION 13. RENEWAL. At the end of the paragraph, insert "Superceded by the
attached Addendum "A" made a part hereof".
SECTION 15. INSURANCE; LIENS; TAXES. Line 15, after the word "income" insert
"or/and gross revenues".
SECTION 20: DEFAULT: Replace subsection (a) with the following "Lessee shall
fail to make any payment due under the terms of this Lease for a period of ten
(10) days after written notice of such default from Lessor or its assigns."
Replace subsection (b) with the following, "Lessee shall fail to observe, keep
or perform any other provision of this Lease not involving payment of money, and
such failure shall continue for a period of thirty (30) days after written
notice of such default from Lessor or its assigns". Subsection (h) delete "as
judged solely by Lessor".
In all other respects, the terms and conditions of the Master Equipment Lease
Agreement, as originally set forth, shall remain in full force and effect.
In witness hereof, the parties hereto, by their authorized signatories, have
executed this Addendum "B" at the date set forth below by their respective
signatures.
LESSEE: Pharmchem Laboratories, Inc. LESSOR: Jules and Associates, Inc.
By: /s/ David A. Lattanzio By: /s/ Jules Buenebenta
----------------------------- ---------------------------
Name: David A. Lattanzio Name: Jules Buenabenta
Title: CFO Title: President
Date: November 23, 1999 Date: 11/29/99
<PAGE> 1
Exhibit 21.01
LIST OF SUBSIDIARIES
Medscreen Limited
1A Harbour Quay
100 Preston's Road
London, England E149PH
<PAGE> 1
Exhibit 23.01
CONSENT OF KPMG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
PharmChem Laboratories, Inc.:
We consent to the incorporation by reference in the registration statements
(File numbers 33-45481, 33-64770 and 333-36885) on Forms S-8 of PharmChem
Laboratories, Inc. of our report dated February 11, 2000, relating to the
consolidated balance sheets of PharmChem Laboratories, Inc. and subsidiary as of
December 31, 1999 and 1998, and the related consolidated statements of
operations, comprehensive income (loss), shareholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1999, and related
schedule, which report appears in the December 31, 1999 annual report on Form
10-K of PharmChem Laboratories, Inc.
KPMG LLP
San Francisco, California
March 20, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,804
<SECURITIES> 0
<RECEIVABLES> 7,182
<ALLOWANCES> 545
<INVENTORY> 1,934
<CURRENT-ASSETS> 11,599
<PP&E> 20,086
<DEPRECIATION> 10,859
<TOTAL-ASSETS> 25,046
<CURRENT-LIABILITIES> 8,559
<BONDS> 0
0
0
<COMMON> 19,139
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 25,046
<SALES> 0
<TOTAL-REVENUES> 44,487
<CGS> 0
<TOTAL-COSTS> 31,374
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 141
<INTEREST-EXPENSE> 284
<INCOME-PRETAX> 2,506
<INCOME-TAX> (294)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,800
<EPS-BASIC> .48
<EPS-DILUTED> .47
</TABLE>
