UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2019

or

for the transition period from _________ to __________

Commission file number: 1-13738

PSYCHEMEDICS CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Registrant's telephone number including area code: (978) 206-8220

Securities registered pursuant to section 12(b) of the act:

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 whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes X No___

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes___ No X

The number of shares of Common Stock of the Registrant, par value $0.005 per share, outstanding at October 20, 2019 was 5,516,931.

PSYCHEMEDICS CORPORATION

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2019

INDEX

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(in thousands, except per share amounts)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands, except per share amounts)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(UNAUDITED)

See accompanying notes to condensed consolidated financial statements

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FACTORS THAT MAY AFFECT FUTURE RESULTS

From time to time, information provided by the Company or statements made by its employees may contain "forward-looking" information which involves risks and uncertainties. In particular, statements contained in this report which are not historical facts (including, but not limited to, the Company's expectations regarding earnings, earnings per share, revenues, operating cash flows, profitability, margins, pricing, dividends, future business, growth opportunities, new accounts, customer base, test volume, sales and marketing strategy, business strategy, general and administrative expenses, marketing and selling expenses, research and development expenses, anticipated operating results, foreign drug testing laws and regulations and the enforcement of such laws and regulations, including effective dates of such laws and regulations, investments in plant, property, equipment and leasehold improvements, strategies with respect to governmental agencies and regulations, cost savings, capital expenditures, liquidity of investments, our relationship with our Brazilian distributor and market demand for drug testing services in Brazil and anticipated cash requirements) may be "forward-looking" statements. The Company's actual results may differ from those stated in any "forward-looking" statements. Factors that may cause such differences include, but are not limited to, risks associated with employee hiring practices of the Company’s principal customers, development of markets for new products and services offered by the Company, costs associated with capacity expansion, government regulation (including, but not limited to, Food and Drug Administration regulations and foreign government regulation including Brazilian commercial drivers license drug test laws and regulations), risks associated with the delay in the implementation of new regulations, risks associated with foreign currency fluctuations, R&D spending, competition (including, without limitation, competition from other companies pursuing the same growth opportunities), the Company’s ability to maintain its reputation and brand image, the ability of the Company to achieve its business plans, cost controls, leveraging of its global operating platform, risks of information technology system failures and data security breaches, the uncertain global economy, the Company’s ability to attract, develop and retain executives and other qualified employees and independent contractors, including distributors, the Company’s ability to obtain and protect intellectual property rights, litigation risks, and general economic conditions. With respect to the continued payment of cash dividends, factors include, but are not limited to, available surplus, cash flow, capital expenditure reserves required, debt service obligations, and other factors that the Board of Directors of the Company may take into account.

Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements represent the Company’s estimates and assumptions only as of the filing date of this Report. The Company expressly disclaim any duty to provide updates to forward-looking statements, and the estimates and assumptions associated with them, after the filing date of this Report, in order to reflect changes in circumstances or expectations, or the occurrence of unanticipated events, except to the extent required by applicable securities laws. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed above and under “Risk Factors” set forth in Part I Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, as well as the risks and uncertainties discussed elsewhere in this Report. The Company qualifies all of its forward-looking statements by these cautionary statements. The Company cautions you that these risks are not exhaustive. The Company operates in a continually changing business environment and new risks emerge from time to time.

OVERVIEW

Revenue for the third quarter of 2019 was $9.9 million compared to $11.0 million for the comparable period in 2018, a decrease of 11%. The Company reported net income of $0.7 million, or $0.12 per diluted share for the three months ended September 30, 2019 versus $1.3 million, or $0.23 per diluted share for the same period in 2018, a decrease of 47%. The decrease in net income was primarily a result of lower international revenue. Revenue for the nine months ended 2019 was $29.0 million compared to $32.7 million in 2018, a decrease of 12%. Net income for the nine months ended September 30, 2019 was $2.1 million, or $0.37 per diluted share versus $3.7 million, or $0.67 per diluted share for the same period in 2018, a decrease of 44%. The Company declared $0.54 per share of cash dividends to its shareholders in the nine months ended September 30, 2019 and 2018. The Company has paid 92 consecutive quarterly cash dividends.

RESULTS OF OPERATIONS

Revenue decline of 11% for the three months ended September 30, 2019 was primarily due to a 12% decrease in volume. Revenues from domestic business decreased 6%. Revenues from international business decreased 21%. Revenue for the nine months ended September 2019 was $29.0 million compared to $32.7 million for the comparable period in 2018, a decrease of 12%. This was primarily due to a 10% decrease in volume and a 2% negative impact from foreign currency exchange.

Gross profit was $4.4 million for the three months ended September 30, 2019, compared to $5.4 million for the same period in 2018, a decrease of $1.0 million, or 18%. Direct costs decreased by $0.2 million or 3% for the three months ended September 30, 2019, compared to the same period in 2018. The gross profit margin was 44% for the three months ended September 30, 2019 versus 49% for the comparable period in 2018. The decrease in margin for the three months was primarily driven by the impact from lower revenue and from an increase in Brazil sales taxes as a result of a new distributor agreement (discussed below). Gross profit was $13.0 million for the nine months ended September 30, 2019, compared to $15.9 million for the same period in 2018, a decrease of $2.9 million, or 18%. Direct costs decreased by $0.9 million or 5% for the nine months ended September 30, 2019 when compared to the same period in 2018. The gross profit margin for the nine month period ended September 30, 2019 was 45% compared to 49% for the comparable period in 2018. The decrease in margin for the nine months was primarily driven by the impact from lower revenue.

General and administrative (“G&A”) expenses decreased 11% to $1.4 million for the three months ended September 30, 2019 from $1.6 million for the same period in 2018. As a percentage of revenue, G&A expenses were 14% and 15% for the three months ended September 30, 2019 and 2018, respectively. General and administrative expenses decreased 4% to $4.7 million for the nine months ended September 30, 2019 from $4.9 million for the same period in 2018. As a percentage of revenue, G&A expenses were 16% and 15% for the nine months ended September 30, 2019 and 2018, respectively.

Marketing and selling expenses decreased 2% to $1.2 million for the three months ended September 30, 2019 compared to $1.3 million for the same period in 2018. As a percentage of revenue, marketing and selling expenses were 13% and 12% for the three months ended September 30, 2019 and 2018, respectively. Marketing and selling expenses decreased 9% to $3.5 million for the nine months ended September 30, 2019 from $3.8 million for the same period in 2018. As a percentage of revenue, marketing and selling expenses were 12% for the nine months ended September 30, 2019 and 2018.

Research and development (“R&D”) expenses were $0.4 million for the three months ended September 30, 2019 and 2018. As a percentage of revenue, R&D expenses were 4% and 3% for the three months ended September 30, 2019 and 2018, respectively. R&D expenses increased 11% to $1.2 million for the nine months ended September 30, 2019 compared to $1.1 million for the comparable period of 2018. As a percentage of revenue, R&D expenses were 4% and 3% for the nine months ended September 30, 2019 and 2018, respectively.

Provision for income taxes consists primarily of federal and state income taxes in the United Sates and income taxes in Brazil. We estimate income taxes in each of the jurisdictions in which we operate. During the three months ended September 30, 2019 and 2018, the Company recorded tax provisions of $0.7 million and $0.8 million, respectively. These provisions represented effective tax rates of 49% for the three months ended September 30, 2019 and 40% for the comparable period of 2018. During the nine months ended September 30, 2019 and 2018, the Company recorded tax provisions of $1.6 and $2.4 million, respectively. These provisions represented effective tax rates of 43% for the nine months ended September 30, 2019 and 40% for the comparable period of 2018. The Company currently expects the year-end tax rate to be approximately 43%. This rate can fluctuate significantly based on the mix of business and pre-tax income, as Brazil taxes are based on revenue.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2019, the Company had approximately $6.5 million of cash and cash equivalents and $8.8 million of working capital. The Company's operating activities generated net cash of $3.4 million for the nine months ended September 30, 2019. Investing activities provided $2.6 million of cash while financing activities used $3.3 million of cash during the first nine months of 2019.

Cash provided by operating activities of $3.4 million reflected net income of $2.1 million adjusted for depreciation and amortization of $2.2 million, stock-based compensation of $0.5 million and a decrease of deferred income taxes of $0.1 million. This was affected by an increase in current assets of $0.8 million and a decrease in current liabilities of $0.6 million.

Cash provided by investing activities of $2.6 million reflected the sale of marketable securities of $3.8 million, purchases of equipment and leasehold improvements of $0.9 million and cost of internally developed software of $0.2 million. We anticipate spending approximately $0.5 million in additional equipment purchases for the remainder of 2019. Additionally, approximately $2.2 to $2.7 million will be spent on leasehold improvements. These improvements relate to a transition the Company is making from one facility in Culver City to a new facility in Culver City.

Cash used by financing activities of $3.3 million included cash dividends to shareholders of $3.0 million and $0.3 million from long-term debt payments.

Contractual obligations and other commercial commitments as of September 30, 2019 include operating lease commitments and outstanding debt, described in Notes 8 and 9, respectively of the Notes to Condensed Consolidated Financial Statements.

At September 30, 2019, the Company's principal sources of liquidity included an aggregate of approximately $6.5 million of cash and cash equivalents. The Company had $8.8 million and $9.8 million of working capital as of September 30, 2019 and December 31, 2018, respectively. The new lease accounting standard negatively impacted the working capital amount by $1.2 million. Management currently believes that such funds should be adequate to fund anticipated working capital and capital equipment requirements for the next 12 months.   Depending upon the Company's results of operations and capital needs, the Company may use various financing sources to raise additional funds.

New Brazilian Distributor Agreement

In September 2019, the Company entered into a new distribution agreement in Brazil with its existing independent distributor in Brazil and a related entity. As previously disclosed, in 2018, a majority interest in Psychemedics Brasil was acquired by Instituto Hermes Pardini S.A. (IHP). Under the new agreement, the Company’s existing distributor was appointed as a non-exclusive distributor to sell, promote and distribute Psychemedics’ hair drug testing services for an indefinite term. The agreement may be terminated for any reason by either Psychemedics or the distributor following 90 days’ written notice. IHP and its controlled companies are restricted to distributing only Psychemedics’ hair drug tests and the hair drug tests of one other IHP Company. The agreement provides for Psychemedics’ hair drug tests to be marketed, sold, and reported in Brazil under the Psychemedics Corporation brand name, with all related materials so identified. This agreement also allows the Company to pursue other distribution opportunities in Brazil.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report (the “evaluation date”) the Company’s management under the supervision and with the participation of the Company’s Chief Executive Officer and Vice President of Finance, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act. Based upon that evaluation, the Chief Executive Officer and Vice President - Finance concluded as of the evaluation date, that the Company’s disclosure controls and procedures were effective for ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that its disclosure controls and procedures were also effective to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the Company’s principal executive and principal financial officers, to allow timely decisions regarding required disclosure.

There has been no significant change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

PART II OTHER INFORMATION

Item 1A. Risk Factors

We are subject to numerous political, legal, operational and other risks as a result of our international operations which could impact our business in many ways.

Although we conduct a majority of our business in the United States, a significant portion of our business is derived from Brazil. Our international operations increase our exposure to the inherent risks of doing business in international markets. Depending on the market, these risks include without limitation:

As the Company has previously disclosed, there are greater challenges and uncertainties in a new, large and developing market, such as Brazil.

Under the Company’s new distribution agreement with its Brazilian distributor (see Part I, Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – New Brazilian Distributor Agreement), the distribution agreement may be terminated for any reason by either the Company or its distributor following 90 days’ written notice. Although the agreement permits Psychemedics to pursue other distribution policies in Brazil, any significant decrease in our sales to our distributor in Brazil absent a suitable replacement would have a materially adverse impact on our business.

International operations also require us to devote significant management resources to implement our controls and systems in new markets, to comply with the U.S. Foreign Corrupt Practices Act and similar anti-corruption laws in non-U.S. jurisdictions and to overcome challenges based on differing languages and cultures.

Except as noted above, there have been no material changes in our risk factors from those disclosed in our 2018 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no purchases of treasury stock in the first nine months of 2019.

Item 6. Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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