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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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, 1997
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 7-0187280
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1505-A O'BRIEN DRIVE 94025
MENLO PARK, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant (based on the closing price of $2 9/16 as reported on the Nasdaq/NMS
on January 30, 1998) was approximately $14,736,000. 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 30, 1998 was 5,750,499.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the PharmChem Laboratories, Inc. Proxy Statement for the 1997
Annual Meeting of Shareholders to be filed with the Commission on or before
April 30, 1998 are incorporated by reference into Part III of this Annual Report
on Form 10-K. With the exception of those portions which are specifically
incorporated by reference in this Annual Report on Form 10-K, such Proxy
Statement shall not be deemed filed as part of this Report.
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PHARMCHEM LABORATORIES, INC.
ANNUAL REPORT ON FORM 10-K
INDEX
PAGE
----
PART I.
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 6
Item 3. Legal Proceedings........................................... 6
Item 4. Submission of Matters to a Vote of Security Holders......... 7
PART II
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters......................................... 8
Item 6. Selected Consolidated Financial Data........................ 9
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
Item 8. Financial Statements and Supplementary Data................. 14
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 32
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 33
Item 11. Executive Compensation...................................... 33
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 33
Item 13. Certain Relationships and Related Transactions.............. 33
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form
8-K......................................................... 33
Signatures.............................................................. 37
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PART I
ITEM 1. BUSINESS
Unless the context indicates otherwise, all references herein to
"PharmChem" or the "Company" include PharmChem Laboratories, Inc. and its
wholly-owned subsidiary, Medscreen Limited ("Medscreen").
GENERAL
PharmChem Laboratories, Inc. is a leading independent laboratory providing
integrated drug testing services to corporate and governmental customers seeking
to detect and deter the use of illegal drugs and alcohol. PharmChem is certified
by the Substance Abuse and Mental Health Service Administration (SAMHSA) of the
U.S. Department of Health and Human Services, the College of American
Pathologists (CAP) and a number of states to conduct drug testing using forensic
procedures. The Company also has "deemed status" under the Clinical Laboratory
Improvement Amendments (CLIA) as a result of its CAP certification. The 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. PharmChem
tests for a number of drugs of abuse, including cocaine, methamphetamine,
heroin, phencyclidine (PCP), marijuana (THC) and alcohol, primarily by
urinalysis but also with the PharmChek(R) Drugs of Abuse Patch (for testing with
sweat). PharmChem also offers PharmScreen(TM) on-site screening devices and a
comprehensive set of services that are customized to assist customers in
implementing cost-effective drug testing programs.
PharmChem was incorporated in California in 1987 to acquire PharmChem
Laboratories Operations, Inc., a California corporation, which was founded in
1971. In 1991, the Company completed its initial public offering. In 1992,
PharmChem expanded its operations through the acquisitions of London-based
Medscreen (a certified laboratory providing international drug testing services)
and of a certified laboratory in Fort Worth, Texas. The Company's customers
include private and public employers, criminal justice agencies and drug
treatment programs, primarily in the United States and the United Kingdom.
INDUSTRY BACKGROUND
Historically, the drug testing market has been served by national clinical
laboratory chains, independent national drug testing laboratories, such as
PharmChem, and numerous regional and local laboratories. 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, however, many corporate and governmental organizations are requiring drug
testing laboratories to be certified to conduct forensic drug tests and to offer
integrated cost-effective testing services. Also, many large organizations,
particularly those in the public sector, use a competitive bidding procedure to
select their drug testing laboratories. The bidding process for these
competitive contracts is often limited to qualified bidders and certified drug
testing laboratories, which can demonstrate the ability to meet the service and
volume levels specified by the customer.
DRUG TESTING OPERATIONS
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 and accurate and reliable testing in which a second independent test is
performed to confirm each positive test result. PharmChem carefully controls
each step of the testing process with detailed written procedures and using the
specific forensic testing methods required for legal defensibility of results.
The Company performs the largest portion of its testing at its laboratory in
Menlo Park, California, which operates six days per week, 24 hours a day. The
Company also provides complete testing services at its Texas Division in Fort
Worth and its London-based subsidiary, Medscreen. The steps in the Company's
forensic drug testing process by urinalysis 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, it is assigned a unique specimen identification
number. Information pertinent to the specimen is then recorded on a chain of
custody
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form numbered to match the specimen bottle. Specimens, together with chain of
custody forms, are delivered to the Company by courier or U.S. mail.
Receiving and Accessioning. PharmChem receives specimens in its restricted
accessioning rooms, where they are inspected for tampering and checked for
proper chain of custody documentation. Specimens are identified and tracked
using unique bar-coded laboratory accessioning numbers.
Screening. Each specimen submitted to PharmChem is screened for the
presence of the drugs specified by the customer. The Company performs in excess
of 1,300,000 screening tests on more than 220,000 specimens per month to
determine the presence of drugs. The screening methods used by the Company
include enzyme immunoassay, radioimmunoassay (RIA) and thin layer chromatography
(TLC).
Confirmation Testing. Results of specimens that screen negative are
reported to the customer. Specimens that screen positive are confirmed by
testing a separate aliquot using a different and independent technology from
that used for the initial screening. Confirmation technologies employed by
PharmChem include gas chromatography/mass spectrometry (GC/MS) and gas
chromatography (GC). GC/MS confirmation is required for federally-regulated drug
testing and most other workplace drug testing and its use has been cited with
approval in numerous legal proceedings.
Quality Assurance/Quality Control (QA/QC). PharmChem carefully monitors the
accuracy and reliability of its test results by internal and external QA/QC
programs. The Company's staff evaluates laboratory performance with open and
blind quality control samples. In addition, the Company is subject to frequent
proficiency testing by various certifying bodies, which send their own open and
blind samples to the laboratory. Further, the Company is subject to frequent
inspections by certifying agencies.
Data Review. Each test result undergoes several independent levels of
review before being reported by a certifying scientist.
Reporting of Results. PharmChem transmits most of its test results
electronically using various secure communication networks and through automated
voice reporting systems. Upon release by a certifying scientist, each test
result is made available by the Company's information systems to the customer's
computer, secure facsimile machine or by telephonic inquiry. The Company
routinely reports results for specimens that screen negative within 24 hours of
receipt in the laboratory and within 48 hours for specimens that require
confirmation.
CUSTOMER SERVICES AND TECHNICAL SUPPORT
PharmChem provides a variety of drug testing services which are customized
to each customer's specific needs. The Company employs a customer service and
technical support staff specializing in one or more of the following areas of
service.
Specimen Collection. PharmChem manages specimen collection services for a
number of its customers. The Company maintains a list of more than 5,000 clinics
and other organizations throughout the country that offer specimen collection
services that comply with forensic drug-testing procedures. PharmChem's 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 1997, PharmChem managed
more than 500,000 collections in the U.S., while Medscreen managed approximately
25,000 collections throughout the UK and at over 150 shipping ports throughout
the world.
Transportation. Most specimens are transported to PharmChem by overnight or
same-day courier, or by U.S. mail. The Company offers special specimen
transportation services for selected areas throughout the country, which provide
for pickup of specimens before the close of each business day.
Technical Consultation. The technical specialists on PharmChem's 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, the Company is 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
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training for customers on topics such as substance abuse trends, toxicology and
drug pharmacology, breath alcohol testing and technical information on the
Company's testing procedures.
Program Analysis. PharmChem collects and analyzes data on test results in
order to provide comprehensive monthly statistical reports to meet customers'
regulatory requirements and to assist with drug program management.
RESEARCH AND DEVELOPMENT
PharmChem's most experienced scientists and technicians perform research
and development activities. The Company's research and development efforts
continually focus upon improving laboratory procedures and processes. The
Company believes it has engineered a number of efficiencies to improve the
accuracy and reliability of its drug tests.
PHARMSCREEN(TM) 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 the
Company's customers. On-site screening relies upon portable diagnostic devices
that may be used at the point of specimen collection to identify drugs of abuse
in urine specimens. This technology is advantageous in that it provides
virtually immediate test results at a lower cost than a laboratory-based testing
program.
The Company now offers an expanded line of on-site screening devices to
supplement the laboratory-based testing services it has traditionally offered.
In 1996, PharmChem acquired exclusive marketing rights in non-clinical markets
for PharmScreen(TM), a portable, hand-held device used for on-site screening of
drugs of abuse. In 1996, the U.S. Food and Drug Administration (FDA) cleared
PharmScreen(TM) for detecting the use of cocaine, opiates (including heroin),
amphetamines and methamphetamine. In 1997, the FDA cleared PharmScreen(TM) for
detecting PCP, benzodiazepines, barbiturates and methadone. PharmScreen(TM) is
available in single, dual, four and five test configurations and 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). PharmScreen(TM) 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. To date, sales of
PharmScreen(TM) by the Company have not been material and 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
Since 1992, the Company has been investing in and developing PharmChek(R),
a system that uses sweat to detect the use of illegal drugs. PharmChek(R) may
offer several advantages over other drug detection systems currently available.
It does not require the handling of urine or blood, which may be objectionable
to some people. 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. In 1995,
the FDA cleared PharmChek(R) for detecting the use of cocaine, opiates
(including heroin), and amphetamines (including methamphetamine) and, in 1996,
clearance was obtained for detecting the use of phencyclidine (PCP) and
marijuana (THC). The Company previously conducted pilot programs using
PharmChek(R) with the Michigan DOC and the Federal Probation. Although certain
issues had arisen with respect to the adhesive qualities of the product, the
Company believes these issues have been resolved.
The Company has incurred significant costs in connection with the
commercialization of PharmChek(R) and expects to continue to do so in the
future. To date, sales of PharmChek(R) by the Company have not been material and
there can be no assurance that it will be commercially accepted by existing or
new customers or
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generate significant revenues in the future. Refer to "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
SALES AND MARKETING
PharmChem sells its integrated drug testing services to corporate and
governmental customers. The sales force uses a consultative selling approach
emphasizing the scope of integrated services offered by the Company and
customizing these services to meet customers' particular needs.
CUSTOMERS
PharmChem provides integrated drug testing services to three primary
customer groups:
Public and Private Employers. Public and private 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 employers test employees in certain
positions on a periodic or random basis and test other employees upon
reasonable suspicion of drug use. Sales to public and private employers
accounted for 45%, 50% and 49% of the Company's total net sales in 1997,
1996 and 1995, respectively. Sales to Sears, Roebuck and Co. accounted for
approximately 10% of the Company's total net sales in 1997, 1996 and 1995.
Criminal Justice Agencies. Criminal justice agencies use drug testing
results in criminal proceedings and to assist with making parole, drug
treatment and probation decisions. In addition, these agencies use drug
testing to monitor drug treatment of individuals under supervision and to
track drug use trends within the United States. Sales to criminal justice
agencies accounted for 41%, 37%, and 34% of the Company's total net sales
in 1997, 1996 and 1995, respectively. Sales to Federal Probation accounted
for approximately 17%, 19% and 17% of the Company's total net sales in
1997, 1996 and 1995, respectively.
Drug Treatment Programs. Drug treatment programs use drug testing to
monitor the treatment and rehabilitation of drug users in their care. Sales
to drug treatment programs accounted for less than 6% of the Company's
total net sales in 1997, 1996 and 1995.
Medscreen. This London-based subsidiary accounted for 11%, 8%, and 11%
of the Company's total net sales in 1997, 1996 and 1995, respectively.
Medscreen's primary customers operate in the maritime, oil and
transportation industries. During 1997, Medscreen sales were generated 55%
in the UK and 45% in various other countries in Europe, Asia and South
America.
SUPPLIERS
PharmChem is not dependent upon any single supplier for its raw materials.
CONTRACTING
Most of PharmChem's 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. Because many of the Company's customers use a
competitive bidding process, there is no assurance that the Company will be the
successful bidder when such 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 on the basis of
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, negative cash
flows and losses. PharmChem's contracts generally provide for no minimum amounts
or payments, and allow termination at the customer's discretion on short notice
with little or no penalty. In particular, many contracts with governmental
agencies, including criminal justice agencies, provide for termination for
convenience. Although the Company's experience has been that its customers
generally do not exercise these early termination rights, there can be no
assurance that this will continue in the
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future. For some customers, the Company performs drug testing services under a
standard service contract. With other customers, the Company has no formal
contract. In these cases, the Company typically accepts and tests specimens for
an agreed upon price which is generally renegotiated every twelve months.
Backlog is not a significant statistic for the Company.
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 technical capability, customer service and price. The
Company believes it competes favorably in each of these categories. PharmChem
has significantly expanded its scope of services while its average total price
per specimen has remained relatively unchanged. PharmChem's competitors include
national clinical laboratory companies, such as Smith-Kline Beecham Clinical
Laboratories, Laboratory Corporation of America (National Health
Laboratories/Roche Biomedical Laboratories) and Quest Diagnostics (formerly
Corning Clinical Laboratories); independent national drug testing laboratories;
third party administrators; medical review officers; manufacturers and
distributors of on-site screening devices and equipment; and numerous regional
and local laboratories. The national clinical laboratories have greater
financial, marketing, laboratory and related resources than the Company. In
addition, some customers and potential customers of the Company operate their
own drug testing facilities or may develop such facilities in the future. A
majority of the Company's sales are derived from competitive bids, and the
Company believes that competitive pressure with respect to these bids,
particularly large multi-year contracts, has intensified.
CERTIFICATION AND GOVERNMENT REGULATION
Laboratories which compete in the 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 involving their
residents. Such state and local certifications are essential to the Company's
business in each such respective jurisdiction. The Company's laboratory is
currently certified by SAMHSA, CAP, certain state and local jurisdictions and
has received "deemed status" under CLIA as a result of its CAP certification.
The Company believes it is certified in all jurisdictions in which it operates.
The Company is subject to frequent inspection by certifying bodies,
including annual CAP and semi-annual SAMHSA inspections. Inspections generally
result in reports describing areas for improvement or suggesting changes in
procedures. The Company may be required to take actions with respect to 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. The Company has never been decertified as the result of an
inspection. Certification is essential to the Company's business because some of
its customers are required to use a certified laboratory, and many of its
customers look to certification as an indication of reliability and accuracy of
results.
Employee drug testing by federal agencies and certain private employers is
regulated by certain federal agencies. 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.
DOMESTIC AND FOREIGN OPERATIONS
Refer to Note 10 to the Consolidated Financial Statements for net sales,
income (loss) from operations and identifiable assets by geographic location.
ENVIRONMENTAL MATTERS
A small portion of the Company's 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
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future federal, state or local environmental laws or regulations regarding these
hazardous materials could have a material adverse effect on the Company. The
Company believes that it has adequately notified employees of potential risks
associated with working at the Company and has provided a workplace safe from
hazard, as required by the Occupational Safety and Health Administration and
certain state laws. The Company believes it is in compliance with all applicable
environmental laws and regulations.
EMPLOYEES
As of December 31, 1997, the Company had approximately 300 full-time
employees. PharmChem's employees are not represented by labor organizations. The
Company considers relations with its employees to be good.
SEASONAL OPERATING FACTORS
PharmChem's operations are affected by seasonal trends to which drug
testing laboratories are generally subject. 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 the Company's
public and private employer customer group which affect pre-employment drug
testing. Further, demand for the Company's services is dependent on general
economic conditions.
YEAR 2000 ISSUES
The Company is subject to various risks associated with the year 2000
impact on information systems. External risk factors are principally related to
the ability of the Company's customers and suppliers to address year 2000 issues
that may adversely impact the Company's operations if not corrected. The Company
has performed a preliminary assessment of the year 2000 impact on internal
information systems. The assessment identified year 2000 issues with respect to
the Company's laboratory information system which may require either an
investment in programming changes because of the existence of a legacy flat file
system or in the replacement of the existing system. The Company is presently in
the process of compiling a more comprehensive assessment of the year 2000
issues, evaluating enhanced capabilities of new laboratory information systems
offering a more current technological architecture and related costs. The
Company expects to arrive at a decision on the laboratory information system in
mid-1998.
ITEM 2. PROPERTIES
LOCATION USE SQUARE FOOTAGE REMAINING LEASE TERM
-------- --- -------------- --------------------
1505-A O'Brien Drive World Headquarters 35,719 3 years
Menlo Park, CA 94025 and Laboratory
1275 Hamilton Court Distribution Center 11,925 1 year
Menlo Park, CA 94025
7606 Pebble Drive Texas Division and 15,000 3 years with a 5 year
Fort Worth, TX 76118 Laboratory option
1A Harbour Quay Medscreen 13,350 5 years with a 10 year
100 Preston's Road Headquarters and option
London, E14 9QZ Laboratory
England
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, PharmChem is sued by individuals,
primarily those in the criminal justice system, who have tested positive for
drugs of abuse. In addition, the Company frequently testifies in administrative
and court proceedings involving the results of its tests. To date, the Company
has not experienced any material liability related to these claims, although
there can be no assurance that the Company 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
the Company's
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business, to which PharmChem is a party or to which any of its property is
subject and management does not believe the outcome of any of the proceedings
will have a material impact on its financial position or results of operations.
The Company believes that its liability insurance coverage is adequate for its
business.
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 1997.
EXECUTIVE OFFICERS OF PHARMCHEM
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
53 President, Chief Executive Officer and
Joseph W. Halligan Director
55 Vice President, Finance and
David A. Lattanzio Administration,
Chief Financial Officer and Secretary
Edward V. Collom (1) 51 Vice President, Business Development
44 Vice President, Laboratory Technical
Robert S. Fogerson, Jr.(2) Director
Neil A. Fortner 43 Vice President, Laboratory Operations
Elizabeth M. Lison 40 Vice President, Customer Service
Joseph L. Kurta 46 Vice President, Sales and Marketing
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(1) Effective December 31, 1997, Edward V. Collom resigned.
(2) Effective January 18, 1998, Robert S. Fogerson, Jr. resigned.
Mr. Halligan has been President, Chief Executive Officer and Director since
November 1995. From 1988 to 1995, Mr. Halligan 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, Mr.
Halligan 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 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 the Company's 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 the Company. 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. He is
a certified public accountant and a member of the Employment Training Panel,
State of California.
Mr. Fortner has been Vice President, Laboratory Operations, since February
1992. Mr. Fortner joined the Company 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 has been Vice President, Customer Service, since March 1997. Ms.
Lison joined the Company's Medscreen subsidiary in 1993, where she held various
management positions in sales and customer service. In June 1996, she relocated
to the Corporate office to serve as Director, Customer Service. From 1979 to
1993, Ms. Lison worked in various aspects of the design and delivery of
workplace drug testing programs for companies based in the UK. Ms. Lison holds a
B. Tech (Hons) in Medical Science from the University of Bradford, UK.
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Mr. Kurta has been Vice President, Sales and Marketing since joining the
Company in March 1998. Mr. Kurta is responsible for sales, marketing and the
commercial development of the Company's laboratory services and the
PharmScreen(TM) and PharmChek(R) product lines. Prior to joining the Company,
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.
PART II
ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock trades on The Nasdaq Stock Market under the
symbol PCHM.
STOCK PRICES
The following table summarizes the high and low closing bid prices for the
Company's Common Stock by quarter for years 1997 and 1996, as reported by the
Automated Quotation System of the National Association of Securities Dealers
(Nasdaq). The prices shown represent quotations among securities dealers, do not
include retail markups, markdowns or commissions and may not represent actual
transactions.
CALENDAR CALENDAR
QUARTER HIGH LOW QUARTER HIGH LOW
- --------------------- ---- ---- -------- ---- ----
Q1 1997 $5 5/16 $3 7/8 Q1 1996 $5 $3 1/2
Q2 1997 4 3/ 3 1/ Q2 1996 4 2 7/
Q3 1997 4 1/ 2 5/ Q3 1996 3 7/ 3
Q4 1997 3 1/ 2 Q4 1996 5 3/ 3 3/
As of March 1, 1998, there were approximately 170 holders of record of
PharmChem's Common Stock. A large number of shares were held in nominee name.
Based upon information furnished by the Company's proxy solicitor, Skinner &
Co., the Company believes it had approximately 1,500 shareholders as of the same
date.
DIVIDENDS
PharmChem has never paid cash dividends on its Common Stock. The Company
plans to retain all earnings to further the operation and expansion of its
business and therefore does not expect to pay dividends in the foreseeable
future. The Company's current revolving credit agreement prohibits the
declaration or payment of dividends.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995 1994 1993
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales.................................. $39,233 $41,255 $39,111 $33,640 $29,032
Cost of sales.............................. 31,311 31,757 29,771 25,777 22,110
------- ------- ------- ------- -------
Gross profit....................... 7,922 9,498 9,340 7,863 6,922
------- ------- ------- ------- -------
Selling, general and administrative
expenses................................ 8,053 7,234 6,966 6,213 5,927
Marketing rights and research costs........ 181 1,455 1,039 854 1,002
Amortization of goodwill................... 185 185 247 246 287
Provision for doubtful accounts............ 350 206 575 72 90
Restructuring and unusual charges(1)....... -- -- 8,775 -- 3,502
------- ------- ------- ------- -------
Total operating expenses........... 8,769 9,080 17,602 7,385 10,808
------- ------- ------- ------- -------
Income (loss) from operations...... (847) 418 (8,262) 478 (3,886)
Other expense, net......................... (389) (372) (368) (279) (311)
------- ------- ------- ------- -------
Income (loss) before income
taxes............................ (1,236) 46 (8,630) 199 (4,197)
Provision for (benefit from) income
taxes................................... 34 -- (1,819) 148 (340)
------- ------- ------- ------- -------
Net income (loss).................. $(1,270) $ 46 $(6,811) $ 51 $(3,857)
======= ======= ======= ======= =======
Basic earnings (loss) per share............ $ (0.22) $ 0.01 $ (1.23) $ 0.01 $ (0.70)
======= ======= ======= ======= =======
Diluted earnings (loss) per share.......... $ (0.22) $ 0.01 $ (1.23) $ 0.01 $ (0.70)
======= ======= ======= ======= =======
Basic weighted average shares
outstanding............................. 5,734 5,622 5,542 5,510 5,507
======= ======= ======= ======= =======
Diluted weighted average shares
outstanding............................. 5,734 5,710 5,542 5,560 5,507
======= ======= ======= ======= =======
Cash dividends per share................... -- -- -- -- --
======= ======= ======= ======= =======
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficiency)............... $(1,079) $ 1,707 $ 4,283 $ 4,243 $ 3,979
Total assets............................... 22,096 21,468 22,183 28,306 29,049
Long-term debt, net of current portion..... 696 1,205 3,401 1,972 1,690
Shareholders' equity....................... 10,129 11,287 11,029 17,767 17,716
- ---------------
(1) As more fully discussed in Note 8 to the Consolidated Financial Statements,
in 1995, the Company 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. The 1993 charges principally reflect a $2.4 million
write-down of Medscreen goodwill and other unusual charges.
Selected quarterly financial data is included in Note 11 to the
Consolidated Financial Statements.
9
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ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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, which are subject to the "safe harbor" created by these Sections. The
Company's actual future results could differ materially from those projected in
the forward-looking statements. Some factors which could cause future actual
results to differ materially from the Company's recent results and those
projected in the forward-looking statements are described in this section. Refer
to "Factors Affecting Operating Results." The Company assumes no obligation to
update the forward-looking statements or such factors.
RESULTS OF OPERATIONS
1997 Compared to 1996. Net sales decreased 4.9% to $39,233,000 in 1997 from
$41,255,000 in 1996. This decrease is attributed to urinalysis sales decreases
of 13% to criminal justice agencies and the August 1996 awarding of the US Army
contract to another laboratory, which more than offset sales increases of 23% at
Medscreen and higher PharmScreen(TM) and PharmChek(R) product sales. The
Company's total urinalysis volume decreased 15% to 2,681,000 specimens from 1996
levels. Net sales for the 1997 fourth quarter of $10,135,000 increased slightly
from the prior year, reflecting higher product sales and Medscreen sales
partially offset by lower criminal justice sales.
Cost of sales for the year decreased 1.4% to $31,311,000 in 1997 from
$31,757,000 in 1996. The decrease was due primarily to decreased specimen
volume. Cost of sales as a percentage of net sales increased to 79.8% in 1997
from 77.0% in 1996. Gross profit as a percentage of net sales decreased to 20.2%
in 1997 from 23.0% in 1996. Cost of sales for the 1997 fourth quarter of
$7,739,000 decreased slightly from the prior year due to decreased specimen
volume partially offset by higher product cost of sales.
Selling, general and administrative (SG&A) expenses for the year increased
11.3% to $8,053,000 in 1997 from $7,234,000 in 1996. The percent of SG&A
expenses to net sales increased to 20.5% in 1997 from 17.5% in 1996. SG&A
expenses for the 1997 fourth quarter increased 19% to $1,819,000. These
increases reflect the Company's continued rebuilding of the sales, marketing,
information systems and administrative infrastructure.
Marketing rights and research costs for the year decreased to $181,000 in
1997 from $1,455,000 in 1996. Marketing rights and research costs for the 1997
fourth quarter decreased substantially from 1996. These 1997 expenses include
the costs associated with the development and commercialization of new
laboratory methods and other drug testing systems. The decreases were due to
significant expenses in 1996 associated with the commercialization of
PharmChek(R). For the year, the percent of marketing rights and research costs
to net sales decreased to 0.5% in 1997 from 3.5% in 1996.
Loss from operations for the year was $847,000 in 1997 compared to income
from operations of $418,000 in 1996. Other expense, which includes interest
expense and interest income, increased slightly to $389,000 in 1997 from
$372,000 in 1996. The Company recorded a provision for deferred income taxes of
$34,000 in the 1997 fourth quarter related to the operations of Medscreen. The
Company had no provision for income taxes in 1996.
Net loss for the year was $1,270,000 in 1997 compared to net income of
$46,000 in 1996. The Company reported net income of $37,000 in the 1997 fourth
quarter compared to a net loss of $13,000 in 1996.
1996 Compared to 1995. Net sales increased 5.5% to $41,255,000 in 1996 from
$39,111,000 in 1995. This increase is attributed to sales increases of 7% to
public and private employers and 17% to criminal and justice agencies, which
more than offset sales decreases of 23% to drug treatment programs and 22% at
Medscreen. Medscreen's sales decrease was primarily due to the 1995 loss of its
largest customer and certain one-time equipment sales, which more than offset
new business acquired in 1996. The Company's total urinalysis volume increased
6% to 3,141,000 specimens from 1995 levels.
10
13
Cost of sales increased 6.7% to $31,757,000 in 1996 from $29,771,000 in
1995. The increase was due primarily to increased specimen volume, especially
volume associated with providing non-laboratory related services, such as
specimen collection and transportation. Cost of sales as a percentage of net
sales increased to 77.0% in 1996 from 76.1% in 1995. Gross profit as a
percentage of net sales decreased to 23.0% in 1996 from 23.9% in 1995.
Selling, general and administrative (SG&A) expenses increased 3.8% to
$7,234,000 in 1996 from $6,966,000 in 1995. This increase reflects the Company's
continued rebuilding of the sales, marketing, information systems and
administrative infrastructure. The percent of SG&A expenses to net sales was
unchanged at 18% for both years.
Marketing rights and research costs increased 40.0% to $1,455,000 in 1996
from $1,039,000 in 1995. These expenses include the cost associated with the
development and commercialization of new laboratory methods and other drug
testing systems. This increase was due primarily to the expensing in 1996 of
certain costs related to the commercialization of PharmChek(R) and
PharmScreen(TM). Such expenses as a percentage of net sales increased to 3.5% in
1996 from 2.7% in 1995.
Income from operations increased to $418,000 in 1996 from a loss of
$8,262,000 in 1995. The increase is primarily related to restructuring and
unusual charges in the fourth quarter of 1995 (refer to Note 8 to the
Consolidated Financial Statements). Other expense, net, which includes interest
expense and interest income, increased slightly to $372,000 in 1996 from
$368,000 in 1995.
The Company had no provision for income taxes in 1996. In 1995, the benefit
from income taxes of $1,819,000 primarily related to the restructuring and
unusual charges recorded in 1995. The Company recorded a valuation allowance in
1995 to reflect the amount of deferred tax assets which may not be realized.
Net income increased to $46,000 in 1996 from a loss of $6,811,000 in 1995,
due primarily to the restructuring and unusual charges in 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations during the years ended December 31, 1997, 1996 and
1995 provided cash of approximately $1,330,000, $2,758,000 and $4,626,000,
respectively. The decrease in cash flow from operations between 1997 and 1996
reflects the 1997 loss reported by the Company. The decrease in cash flow from
operations between 1996 and 1995 reflects the non-cash restructuring and unusual
charges recorded in 1995.
As of December 31, 1997 and 1996, PharmChem had $372,000 and $240,000 in
cash or cash equivalents, respectively. During 1997, the Company had net
borrowings on the revolving line of credit of $3,079,000 which were used to
acquire $2,798,000 of property and equipment and to reduce term debt and capital
lease obligations by $1,339,000. During 1996, the Company used approximately
$2,731,000 in cash to acquire property and equipment and approximately
$2,295,000 in cash to reduce short and long term debt.
On December 5, 1997, PharmChem entered into a new revolving credit
agreement ("Credit Agreement") whereby the maximum line of credit was increased
to $6,000,000. The Credit Agreement permits borrowings of 85% of qualified
accounts receivable, bears interest at the bank reference rate plus 1.0% (9.5%
at December 31, 1997) and is secured by a lien on all assets of the Company. The
mark-up of 1.0% over the reference rate can, under certain conditions, be
reduced to 0.5%. At December 31, 1997, the maximum that could be borrowed under
the Credit Agreement was $5,007,000. The Credit Agreement contains certain
financial covenants, which among others, require the Company to maintain certain
levels of working capital, liabilities and net worth and restricts the payment
of dividends. Proceeds from the Credit Agreement were used to repay the revolver
balance outstanding under the Company's previous credit agreement which was
amended several times during 1997 and, most recently, on October 18, 1997. At
that time, the revolver maturity date was extended from November 17, 1997 to
December 5, 1997, the interest rate was increased to the bank reference rate
plus 2.0% and more flexible financial covenants were established.
11
14
The Company anticipates 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 1998.
FACTORS AFFECTING OPERATING RESULTS
PharmChem is subject to a number of risks which could affect operating
results and liquidity, which risks include, among others, the following:
Competition and Customer Contracts. The drug testing industry in which
PharmChem competes is often characterized by competitive bidding which results
in the award of contracts based on technical superiority, customer service and
price. The Company competes for customer contracts against firms that may have
greater financial, marketing, laboratory and related resources. The market for
drug testing services became increasingly competitive in the 1990's, and
continues to be competitive. A majority of the Company's sales arise out of
competitively bid contracts. The Company has in the past failed to renew
significant contracts, including the 1996 awarding of the US Army contract to
another laboratory which represented 4% and 7% of the Company's total sales in
1996 and 1995, respectively. While many of the Company's contracts have
multi-year terms, most contracts are subject to discretionary termination on
short notice by the Company's customers. In addition, relatively few of the
Company's contracts call for minimum contract amounts or payments. Although the
Company's historical experience has been that customers generally use its
services for the entire length of the contract term, early termination of a
substantial contract, if not replaced by comparable contracts, could have a
material adverse effect on the Company.
PharmChek(R) Drugs of Abuse Patch. Since 1992, the Company has been
investing in and developing PharmChek(R), a system which uses sweat to detect
the use of illegal drugs. The process of bringing PharmChek(R) to market has
been subject to technical and regulatory delays and there is no assurance that
there will not be similar delays in the future. To date, 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 is no assurance as to the validity of such
patents, that the products marketed by the Company will be covered by such
patents, or that competitors will not infringe upon such patents or successfully
design similar or competing products that do not infringe upon such patents. The
Company has incurred significant costs in connection with the commercialization
of PharmChek(R) and expects to continue to do so in the future. The Company's
cumulative investment in PharmChek(R) marketing rights was approximately
$1,509,000 during the past three years.
Customer Concentration. The Company's two largest customers accounted for
approximately a combined 27% and 29% of the Company's sales in 1997 and 1996,
respectively. The loss of these contracts, if not replaced by comparable
contracts, would result in lower sales, lower profit margins and in negative
cash flows and losses. The Company has in the past failed to renew significant
contracts which have had adverse effects on the Company. See "Competition and
Customer Contracts" above.
Certification. The Company is certified SAMHSA, CAP and a number of states
to conduct drug testing using forensic procedures. The Company also has "deemed
status" under the Clinical Laboratory Improvement Amendments as a result of its
CAP certification. Certification is essential to the Company's business because
some of its customers are required to use certified laboratories, and many of
its customers look to certification as an indication of accuracy and reliability
of results. In order to remain certified, the Company is subject to frequent
inspections and proficiency tests. Failure to meet any of the numerous
certification requirements to which the Company is subject could result in
suspension or loss of certification. Such suspension or loss of certification
could have a material adverse effect on the Company.
Fluctuations in Operating Results. Along with competition and customer
contracts, PharmChem's operations are affected by seasonal trends to which drug
testing laboratories are generally subject. 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 the Company's
public and private employer customer group which affect pre-employment drug
testing. Further, demand for the Company's services is dependent on
12
15
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 the Company's public employer, criminal justice
agency and government funded drug treatment program customers. Because expenses
associated with maintaining the Company's testing work force are relatively
fixed over the short term, the Company's 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
the Company believes that, to date, no such litigation or law has had a material
adverse impact upon its business, new decisions, legislation or policies which
restrict the use of drug testing could have a material adverse effect on the
Company.
Credit Availability. PharmChem maintains a revolving credit agreement with
a bank. All borrowings are secured by a lien on all assets of the Company. The
credit agreement contains certain financial covenants, with which the Company
anticipates that it will be able to comply with throughout 1998, although there
can be no assurance that such compliance will be maintained.
Legal Proceedings. In the ordinary course of its business, PharmChem is
sued by individuals, primarily those in the criminal justice system, who have
tested positive for drugs of abuse. In addition, the Company frequently
testifies in administrative and court proceedings involving the results of its
tests. To date, the Company has not experienced any material liability related
to these claims, although there can be no assurance that the Company 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 the Company's business, to which PharmChem is a party
or to which any of its property is subject and management does not believe the
outcome of any of the proceedings will have a material impact on its financial
position or results of operations. The Company believes that its liability
insurance coverage is adequate for its business.
Environmental Matters. A small portion of the Company's 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 the Company.
The Company believes it is in compliance with all applicable environmental laws
and regulations.
Dependence on Key Personnel. The success of PharmChem is dependent in part
on its key management and technical personnel, the loss of one or more of whom
could have a material adverse effect on the Company. None of the Company's key
employees has an employment contract with the Company. The Company believes that
its future success will depend in part upon its continued ability to attract,
retain and motivate additional highly skilled personnel.
Year 2000 Issues. The Company is subject to various risks associated with
the year 2000 impact on information systems. External risk factors are
principally related to the ability of the Company's customers and suppliers to
address year 2000 issues that may adversely impact the Company's operations if
not corrected. The Company has performed a preliminary assessment of the year
2000 impact on internal information systems. The assessment identified year 2000
issues with respect to the Company's laboratory information system which may
require either an investment in programming changes because of the existence of
a legacy flat file system or in the replacement of the existing system. The
Company is presently in the process of compiling a more comprehensive assessment
of the year 2000 issues, evaluating enhanced capabilities of new laboratory
information systems offering a more current technological architecture and
related costs. The Company expects to arrive at a decision on the laboratory
information system in mid-1998.
13
16
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 131 "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for disclosures about segments of an enterprise and is effective for
annual periods beginning after December 15, 1997. The Company expects to include
the SFAS No. 131 disclosures in its consolidated financial statements for the
year ended December 31, 1998.
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and displaying
comprehensive income and its components in general-purpose financial statements
and is effective for fiscal years beginning after December 15, 1997.
Comprehensive income includes net income and several other items that current
accounting standards require to be recognized outside of net income. The Company
expects to include the SFAS No. 130 disclosures in its 1998 consolidated
financial statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index at page 33, Item 14.(a)(1).
14
17
REPORT OF KPMG PEAT MARWICK LLP, INDEPENDENT AUDITORS
To the Board of Directors and Shareholders
of PharmChem Laboratories, Inc.:
We have audited the accompanying consolidated balance sheet of PharmChem
Laboratories, Inc. and subsidiary (the Company) as of December 31, 1997, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the year then ended. In connection with our audit of the consolidated
financial statements, we also have audited the financial statement schedule as
listed in the accompanying index. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the 1997 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, 1997, and the
results of their operations and their cash flows for the year then ended 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 PEAT MARWICK LLP
San Francisco, California
February 13, 1998
15
18
REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS
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, 1996, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the two years in the period ended December 31, 1996. These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and 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 financial statements referred to above present fairly,
in all material respects, the financial position of PharmChem Laboratories, Inc.
and its subsidiary as of December 31, 1996, and the results of their operations
and their cash flows for each of the two years in the period ended December 31,
1996 in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
San Jose, California
February 13, 1997
16
19
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
DECEMBER 31,
------------------
1997 1996
------- -------
CURRENT ASSETS:
Cash and cash equivalents................................. $ 372 $ 240
Accounts receivable, net of allowance for doubtful
accounts of $468 and $610, respectively................ 7,608 8,168
Inventory................................................. 1,609 1,014
Prepaids and other current assets......................... 456 1,122
------- -------
TOTAL CURRENT ASSETS.............................. 10,045 10,544
------- -------
PROPERTY AND EQUIPMENT, net................................. 7,638 6,578
OTHER ASSETS................................................ 1,238 986
GOODWILL, net of accumulated amortization and write-downs of
$6,214 and $6,029, respectively........................... 3,175 3,360
------- -------
$22,096 $21,468
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving line of credit.................................. $ 4,081 $ 1,002
Current portion of long-term debt......................... 503 1,333
Accounts payable.......................................... 3,322 3,238
Accrued compensation...................................... 990 998
Accrued collectors and other liabilities.................. 2,228 2,266
------- -------
TOTAL CURRENT LIABILITIES......................... 11,124 8,837
------- -------
LONG TERM DEBT, net of current portion...................... 696 1,205
DEFERRED RENT............................................... 147 139
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, no par value, 10,000 shares authorized,
5,750 and 5,695 shares issued and outstanding at
December 31, 1997 and 1996, respectively............... 19,027 18,915
Accumulated deficit....................................... (8,898) (7,628)
------- -------
TOTAL SHAREHOLDERS' EQUITY........................ 10,129 11,287
------- -------
$22,096 $21,468
======= =======
See accompanying notes to consolidated financial statements.
17
20
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
NET SALES................................................... $39,233 $41,255 $39,111
COST OF SALES............................................... 31,311 31,757 29,771
------- ------- -------
GROSS PROFIT................................................ 7,922 9,498 9,340
------- ------- -------
OPERATING EXPENSES:
Selling, general and administrative....................... 8,053 7,234 6,966
Marketing rights and research costs....................... 181 1,455 1,039
Amortization of goodwill.................................. 185 185 247
Provision for doubtful accounts........................... 350 206 575
Restructuring and unusual charges......................... -- -- 8,775
------- ------- -------
Total operating expenses.......................... 8,769 9,080 17,602
------- ------- -------
INCOME (LOSS) FROM OPERATIONS............................... (847) 418 (8,262)
------- ------- -------
OTHER INCOME (EXPENSE):
Interest income........................................... 8 63 93
Interest expense.......................................... (397) (435) (457)
Other..................................................... -- -- (4)
------- ------- -------
Other expense, net................................ (389) (372) (368)
------- ------- -------
INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME
TAXES..................................................... (1,236) 46 (8,630)
PROVISION FOR (BENEFIT FROM) INCOME TAXES................... 34 -- (1,819)
------- ------- -------
NET INCOME (LOSS)........................................... $(1,270) $ 46 $(6,811)
======= ======= =======
EARNINGS (LOSS) PER SHARE:
Basic..................................................... $ (0.22) $ 0.01 $ (1.23)
======= ======= =======
Diluted................................................... $ (0.22) $ 0.01 $ (1.23)
======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic..................................................... 5,734 5,622 5,542
======= ======= =======
Diluted................................................... 5,734 5,710 5,542
======= ======= =======
See accompanying notes to consolidated financial statements.
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PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK TOTAL
---------------- ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT DEFICIT EQUITY
------ ------- ----------- -------------
(IN THOUSANDS)
BALANCE AT DECEMBER 31, 1994....................... 5,511 $18,630 $ (863) $17,767
Exercise of stock options........................ 76 73 -- 73
Net loss......................................... -- -- (6,811) (6,811)
----- ------- ------- -------
BALANCE AT DECEMBER 31, 1995....................... 5,587 18,703 (7,674) 11,029
Exercise of stock options........................ 108 212 -- 212
Net income....................................... -- -- 46 46
----- ------- ------- -------
BALANCE AT DECEMBER 31, 1996....................... 5,695 18,915 (7,628) 11,287
Exercise of stock options........................ 55 112 -- 112
Net loss......................................... -- -- (1,270) (1,270)
----- ------- ------- -------
BALANCE AT DECEMBER 31, 1997....................... 5,750 $19,027 $(8,898) $10,129
===== ======= ======= =======
See accompanying notes to consolidated financial statements.
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22
PHARMCHEM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR YEARS ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $(1,270) $ 46 $(6,811)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................... 1,917 1,979 2,626
Provision for doubtful accounts........................ 350 206 575
Restructuring and unusual charges, net of tax
benefit............................................... -- -- 7,527
Loss (gain) on dispositions and sales of equipment..... 6 (51) --
Change in operating assets and liabilities:
Accounts receivable.................................... 210 627 (1,091)
Inventory.............................................. (595) 674 (15)
Income tax refund receivable........................... 351 (351) --
Prepaids and other current assets...................... 315 (71) (19)
Accounts payable and other accrued liabilities......... 38 (440) 1,834
Deferred rent.......................................... 8 139 --
------- ------- -------
Net cash provided by operating activities......... 1,330 2,758 4,626
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (2,798) (2,731) (2,732)
Payments for marketing rights............................. -- -- (805)
Proceeds from sale of equipment........................... -- 230 --
Decrease (increase) in other assets....................... (252) 216 (284)
------- ------- -------
Net cash used in investing activities............. (3,050) (2,285) (3,821)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) on revolving lines of credit,
net.................................................... 3,079 (848) (750)
Proceeds from issuance of long-term debt.................. -- 1,203 910
Principal payments on long-term debt...................... (1,339) (1,447) (1,380)
Proceeds from exercise of stock options................... 112 212 73
------- ------- -------
Net cash provided by (used in) financing
activities...................................... 1,852 (880) (1,147)
------- ------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 132 (407) (342)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 240 647 989
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 372 $ 240 $ 647
======= ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest, net of $46 capitalized in 1997.... $ 376 $ 548 $ 479
======= ======= =======
Cash paid for taxes....................................... $ 3 $ -- $ 123
======= ======= =======
See accompanying notes to consolidated financial statements.
20
23
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
1. THE COMPANY
PharmChem Laboratories, Inc. is a leading independent laboratory providing
integrated drug testing services. PharmChem tests for a number of drugs of
abuse, primarily by urinalysis. In addition to forensic drug testing, PharmChem
offers a range of services which are customized to assist customers in
implementing cost-effective drug testing programs. The Company's customers
include private and public employers, criminal justice agencies and drug
treatment programs primarily in the United States and the United Kingdom (UK).
The consolidated financial statements include the accounts of PharmChem
Laboratories, Inc. and its wholly-owned subsidiary, Medscreen Limited
("Medscreen"), a UK company (collectively referred to as the "Company").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The consolidated financial statements include the accounts of the Company
after elimination of all intercompany accounts and transactions. The functional
currency of Medscreen is the local currency. The foreign currency translation
adjustment is not material for any periods presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires 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, 1997 and 1996, 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
The Company is subject to a number of risks which include, among others,
competition related to customer contracts, development and marketing of
PharmChek(R) and PharmScreen(TM), customer concentration and laboratory
certification.
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash investments and trade
receivables. The Company has cash investment policies that limit investments to
short-term, low risk instruments. Two customers accounted for approximately 27%
of the Company's sales for the year ended December 31, 1997, and one customer
accounted for approximately 24% of accounts receivable at December 31, 1997.
Concentrations of credit risk with respect to trade receivables are mitigated by
the fact that the largest customer is a federal government agency, the remaining
customer base is diversified among many corporate industries and other
government agencies, the Company's ongoing credit evaluation process and the
allowance for doubtful accounts.
21
24
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
Inventory
Inventory is stated at the lower of cost or market. Cost is determined
using standard costs, including freight, that approximate actual costs on a
first-in, first-out basis. At December 31, inventory consisted of the following:
1997 1996
------ ------
(IN THOUSANDS)
Laboratory materials....................................... $ 412 $ 396
Collection materials....................................... 1,072 469
Products................................................... 125 149
------ ------
$1,609 $1,014
====== ======
Property and Equipment
Property and equipment is recorded at cost. Depreciation and amortization
are provided using the straight-line method over the estimated useful lives of
up to 10 years. Leasehold improvements and equipment held under capital leases
are amortized over the estimated useful life. At December 31, property and
equipment consisted of the following:
1997 1996
------ ------
(IN THOUSANDS)
Lab equipment.............................................. $7,047 $7,441
Computer hardware and software............................. 3,806 2,552
Office equipment........................................... 469 366
Furniture, fixtures and other.............................. 765 688
Leasehold improvements..................................... 3,691 3,659
Construction in progress................................... 1,692 484
------ ------
17,470 15,190
Less: accumulated depreciation and amortization............ (9,832) (8,612)
------ ------
Property and equipment, net................................ $7,638 $6,578
====== ======
Expenditures for maintenance and repairs are expensed as incurred. Costs of
major replacements and betterments are capitalized. When property is retired or
otherwise disposed of, the cost and accumulated depreciation and amortization
are removed from the appropriate accounts and any gain or loss is included in
the statement of operations.
Long-Lived Assets, Including Goodwill
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company
reviews, as circumstances dictate, the carrying amount of its intangible assets.
The purpose of these reviews is to determine whether the carrying amounts are
recoverable. Recoverability is determined by comparing the projected discounted
net cash flows of the long-lived assets against their respective carrying
amounts. The amount of impairment, if any, is measured based on the excess of
the carrying value over the fair value. Management believes that no impairment
of long-lived assets has occurred.
Goodwill consists of the excess of cost over the fair value of the net
assets of businesses acquired and is being amortized on a straight-line basis
over periods ranging from 20 to 40 years. Amortization expense, including
write-downs of goodwill, for the years ended December 31, 1997, 1996 and 1995
was $185,000,
22
25
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
$185,000 and $2,247,000, respectively. Refer to Note 8 for further discussion of
1995 restructuring and unusual charges.
Revenue
Revenue is recognized upon completion of laboratory analyses of specimens
submitted by customers and at the time of shipment for products. As a percentage
of gross revenues, the Company had sales to major customers as follows:
1997 1996 1995
----- ----- -----
Customer A......................................... 17.1% 18.7% 17.2%
Customer B......................................... 10.1% 10.3% 9.7%
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("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, deferred tax assets and
liabilities are determined 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.
Accounting for Stock-Based Compensation
The Company has adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," effective January 1, 1996. This statement establishes financial
accounting and reporting standards for stock-based compensation, including
employee stock purchase plans and stock option plans. As allowed by SFAS No.
123, the Company continues to measure compensation expense for awards granted to
employees under the provisions of Accounting Pronouncement Board Opinion (APB)
No. 25 "Accounting for Stock Issued to Employees." The exercise price of options
granted under these plans is equal to the market price of the Company's stock on
the date of grant, and accordingly, no compensation cost is recorded under APB
No. 25.
Earnings (Loss) Per Share
The Company has adopted SFAS No. 128, "Earnings Per Share," as of December
31, 1997, which requires the presentation of basic and diluted earnings (loss)
per share. Basic earnings (loss) per share is calculated using the weighted
average number of common shares outstanding during the period. Diluted earnings
(loss) per share is calculated 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 and are calculated using the treasury stock method. Earnings
23
26
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
(loss) per share amounts for all previously reported periods have been restated
to conform with SFAS No. 128. The calculations of basic and diluted earnings
(loss) per share are as follows:
1997 1996 1995
----------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net income (loss).................................... $(1,270) $ 46 $(6,811)
Denominator for basic earnings (loss) per
share -- weighted
average common shares.............................. 5,734 5,622 5,542
Dilutive stock options............................... -- 88 --
------- ------ -------
Denominator for diluted earnings (loss) per share.... 5,734 5,710 5,542
======= ====== =======
Basic earnings (loss) per share...................... $ (0.22) $ 0.01 $ (1.23)
======= ====== =======
Diluted earnings (loss) per share.................... $ (0.22) $ 0.01 $ (1.23)
======= ====== =======
Options to purchase 379,480 shares of the Company's common stock at
December 31, 1996, were not included in the computation of diluted earnings per
share because their exercise prices were greater than the average market price
of the Company's common stock of $3.96 per share. All options to purchase shares
of the Company's common stock at December 31, 1997 and 1995, respectively, were
not included in the computation of diluted loss per share as their effect would
have been antidilutive.
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 approximates fair value
because of the short-term maturity of these instruments. The fair values of
revolving credit agreements, long-term debt and notes payable to a bank 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.
Deferred Rent
Deferred rent represent unrealized rent abatements granted by the lessor of
the facility occupied by Medscreen, and is being amortized on a straight-line
basis as a reduction to rent expense over the remaining lease term.
Reclassifications
Certain reclassifications have been made to prior year amounts to conform
to current year presentation.
24
27
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
3. DEBT
Revolving credit agreement, notes payable to bank, long-term debt and
capitalized lease obligations at December 31 consist of the following:
1997 1996
------- -------
(IN THOUSANDS)
Revolving credit agreement pursuant to revolver loan
agreement, secured by a lien on all assets, renewable
monthly, interest at bank reference rate plus 1.0 % (9.50%
at December 31, 1997)..................................... $ 4,081 $ --
Notes payable to a bank pursuant to the term and revolver
loan agreement, secured by a lien on all assets, paid in
full in December 1997..................................... -- 1,002
Notes payable to a bank pursuant to the term and revolver
loan agreement, due in monthly installments of
approximately $55 plus interest, secured by a lien on all
assets, paid in full in November 1997..................... -- 611
Obligations under capitalized leases, due in monthly
installments through 2001, secured by laboratory and
office equipment, interest rates ranging from 6% to 11%... 1,164 1,821
Other....................................................... 35 106
------- -------
5,280 3,540
Less: current portion and revolving line of credit.......... (4,584) (2,335)
------- -------
Long-term portion........................................... $ 696 $ 1,205
======= =======
On December 5, 1997, PharmChem entered into a new revolving credit
agreement ("Credit Agreement") whereby the maximum line of credit was increased
to $6,000,000. The Credit Agreement permits borrowings of 85% of qualified
accounts receivable, bears interest at the bank reference rate plus 1.0% (9.5%
at December 31, 1997) and is secured by a lien on all assets of the Company. The
mark-up of 1.0% over the reference rate can, under certain conditions, be
reduced to 0.5%. At December 31, 1997, the maximum that could be borrowed under
the Credit Agreement was $5,007,000. The Credit Agreement contains certain
financial covenants, which among others, require the Company to maintain certain
levels of working capital, liabilities and net worth and restricts the payment
of dividends.
Proceeds from the Credit Agreement were used to repay the revolver balance
outstanding under the Company's previous credit agreement which was amended
several times during 1997 and, most recently, on October 18, 1997. At that time,
the revolver maturity date was extended from November 17, 1997 to December 5,
1997, the interest rate was increased to the bank reference rate plus 2.0% and
more flexible financial covenants were established.
The Company has leased certain laboratory and office equipment with an
original cost of approximately $2,724,000 under capital lease agreements. At
December 31, 1997, the future minimum lease payments, together with the present
value of the net minimum lease payments under these agreements, were as follows
(in thousands):
1998................................................ $ 553
1999................................................ 365
2000................................................ 347
2001................................................ 44
------
Total minimum lease payments.............. 1,309
Less: amount representing interest........ (145)
------
Present value of net minimum lease
payments................................ $1,164
======
25
28
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
4. INCOME TAXES
The provision for (benefit from) income taxes consisted of the following:
1997 1996 1995
---- ------ -------
(IN THOUSANDS)
Current:
Federal......................................... $-- $ -- $ 114
State........................................... -- -- 17
Foreign......................................... -- -- --
--- ------ -------
Total current........................... -- -- 131
--- ------ -------
Deferred:
Federal......................................... -- -- (1,654)
State........................................... -- -- (296)
Foreign......................................... 34 -- --
--- ------ -------
Total deferred.......................... 34 -- (1,950)
--- ------ -------
Provision for (benefit from) income
taxes................................. $34 $ -- $(1,819)
=== ====== =======
The deferred tax provision in 1997 represents the partial utilization of UK
net operating losses previously recorded as a deferred tax asset at the
statutory rate. As a result, the deferred tax asset decreased by $34,000.
The current federal and state tax provisions represent the alternative
minimum tax ("AMT") on operations for 1995. Undistributed earnings of the
Company's foreign subsidiary are not significant. The provision for (benefit
from) income taxes is reconciled with the federal statutory rate as follows:
1997 1996 1995
----- ----- -------
(IN THOUSANDS)
Tax provision (benefit) computed at the federal
statutory tax rate............................. $(420) $ 16 $(3,021)
State taxes, net of federal tax benefit.......... (30) 3 (526)
Effects of foreign operations.................... (27) -- (121)
Amortization and write-down of goodwill.......... 44 66 724
Increase (decrease) in valuation allowance....... 438 (83) 1,470
Other............................................ 29 (2) (345)
----- ----- -------
Total tax (benefit from) provision..... $ 34 $ -- $(1,819)
===== ===== =======
26
29
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
The major components of temporary differences which give rise to the
deferred tax accounts at December 31, 1997 and 1996, are as follows:
1997 1996
------- ------
(IN THOUSANDS)
Current deferred tax assets:
Reserves and accruals................................... $ 373 $ 753
------- ------
Total gross current asset....................... 373 753
Deferred tax valuation allowance........................ (219) (318)
------- ------
Net current asset............................... $ 154 $ 435
======= ======
Non-current deferred tax assets:
Net operating loss carryforward......................... $ 1,064 $ 243
Difference between book and tax depreciation............ 93 (283)
Restructuring and unusual charges....................... 526 876
Research tax credit carryforwards and other............. 449 512
------- ------
Total gross non-current asset................... 2,132 1,348
Deferred tax asset valuation allowance.................. (1,255) (718)
------- ------
Net non-current asset........................... $ 877 $ 630
======= ======
The deferred tax asset accounts are classified with "Other current assets"
and "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, the Company believes it is
more likely than not that the net deferred tax asset will be realized in the
future primarily from the generation, in subsequent years, 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 period are lower.
As of December 31, 1997, the Company has net operating loss carryforwards
for federal and state income tax reporting purposes of approximately $2,756,000
and $1,806,000, respectively. The federal loss carryforwards expire between 2004
and 2012 and the state loss carryforwards expire between 1998 and 2002. The
Company also has net operating loss carryforwards available for UK tax reporting
purposes, which are restricted to the UK, of approximately $102,000. 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 February 1997, the Company received a refund of federal income taxes
totaling $351,000. This amount was classified in "Other current assets" on the
accompanying Consolidated Balance Sheets at December 31, 1996.
The Internal Revenue Service ("IRS") is currently examining the Company's
income tax returns for 1992, 1993 and 1994, and has issued a Notice of
Deficiency resulting from the IRS challenging the deductibility of research
expenses related to the development of the PharmChek sweat patch device. The
Company believes the Notice of Deficiency is incorrect and has requested a
hearing with an IRS Appeals Officer. The Company does not believe the ultimate
outcome of this matter will have a material impact on the Company's consolidated
results of operations or financial position.
27
30
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
5. INCENTIVE STOCK PLANS
1997 and 1988 Incentive Stock Plans
In May 1997, the Company's shareholders approved the 1997 Incentive Stock
Plan ("the 1997 Plan") whereby stock options, including incentive stock options,
non-qualified options, restricted shares, performance shares, bonus shares and
stock appreciation rights may be granted to employees, consultants and
directors, for up to 500,000 shares of common stock. This 1997 Plan, which
expires in 2007, is administered by the Officers Compensation Committee of the
Board of Directors ("the Committee"). The Committee shall determine the term of
each stock option (up to a maximum of ten years) and the exercise price cannot
be less than 100% of the fair market value of the common stock on the date the
option is granted. Except as otherwise provided, options will be exercisable
with respect to 6.25% of the shares corresponding to the grant on the first day
of each of the first sixteen calendar quarters after the grant date. As of
December 31, 1997, no options have been granted under the 1997 Plan.
In November 1988, the Company adopted the 1988 Incentive Stock Plan ("the
1988 Plan"). Under this 1988 Plan, nonstatutory options and stock purchase
rights may be granted to employees and consultants, while incentive stock
options may only be granted to employees, for up to a total of 1,280,000 shares
of common stock. The 1988 Plan, which expires in 1998, is also administered by
the Committee. The Committee shall determine the term and exercise price of the
options and rights. Incentive stock options must be granted at a price of at
least fair market value, while nonstatutory options and stock purchase rights
must be granted at a price of at least 85% of the fair market value, based on
the trading price of the common stock on Nasdaq, as of the date of grant. Common
shares purchased pursuant to stock purchase rights issued under the 1988 Plan
are subject to repurchase at the original issuance price by the Company upon
termination of employment. The repurchase right lapses at such rate as
determined by the Committee. Options granted under the 1988 Plan vest generally
over a 48-month period and expire ten years after date of grant.
Effective January 1, 1995 the Company 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 $2.00 ("Repriced
grants/canceled" in the following table). The repriced options began vesting
effective January 1, 1995 over a 48-month period. The exercise price for all
options exchanged was $2.00.
28
31
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
Options to purchase approximately 309,753, 206,000 and 122,000 shares of
common stock were exercisable at December 31, 1997, 1996 and 1995 respectively.
As of December 31, 1997, only incentive stock options were outstanding. Option
information for the periods presented is as follows:
OPTIONS OUTSTANDING
OPTIONS -----------------------------------
AVAILABLE NUMBER WEIGHTED
FOR GRANT OF SHARES RANGE AVERAGE
--------- --------- ---------- --------
Balance at December 31, 1994........... 770,251 214,255 0.25-7.25 4.96
-------- -------- ---------- -----
Granted.............................. (687,480) 687,480 2.00-4.75 2.95
Canceled............................. 55,711 (55,711) 2.00-7.25 2.47
Exercised............................ -- (66,493) 0.25-2.00 0.74
Repriced grants...................... (157,171) 157,171 2.00 2.00
Repriced canceled.................... 157,171 (157,171) 4.50-7.25 6.84
-------- -------- ---------- -----
Balance at December 31, 1995........... 138,482 779,531 0.25-4.75 2.82
-------- -------- ---------- -----
Granted.............................. (191,000) 191,000 3.25-4.63 3.69
Canceled............................. 165,565 (165,565) 0.25-4.00 2.29
Exercised............................ -- (108,145) 0.25-2.00 1.94
-------- -------- ---------- -----
Balance at December 31, 1996........... 113,047 696,821 0.25-4.75 3.32
-------- -------- ---------- -----
Additional shares approved........... 500,000 -- -- --
Granted.............................. (40,000) 40,000 3.00-4.38 3.56
Canceled............................. 52,631 (52,631) 0.25-3.25 2.04
Exercised............................ -- (55,286) 2.00-3.25 2.06
-------- -------- ---------- -----
Balance at December 31, 1997........... 625,678 628,904 $2.00-4.75 $3.55
======== ======== ========== =====
1992 Director Option Plan
In May 1992, the Company 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, the Director Plan was amended to provide for
grants to outside directors only. The options vest over a 48-month period and
expire five years from the date of grant. Options are granted at fair market
value and the plan expires in 2002. As of December 31, 1997, options to purchase
110,000 shares were outstanding at a weighted average share price of $3.52,
130,626 options were available for future grants, 88,332 options were
exercisable at a weighted average share price of $3.20 and 30,000 options
expired at a weighted average share price of $8.75. During 1997 and 1996, 10,000
options were granted each year at weighted average share prices of $5.38 and
$4.50, respectively. No options were exercised or canceled in 1997 or 1996. In
1995, 9,374 options were exercised at a weighted average share price of $2.61
and 45,000 options were granted at a weighted average share price of $2.00.
The following summarizes information about all stock option plans at
December 31, 1997:
OPTIONS OUTSTANDING
- -------------------------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED WEIGHTED ----------------------------
AVERAGE AVERAGE WEIGHTED
RANGE OF OPTIONS EXERCISE REMAINING OPTIONS AVERAGE
EXERCISE PRICE OUTSTANDING PRICE CONTRACT LIFE EXERCISABLE EXERCISE PRICE
-------------- ----------- ----------- ------------- ----------- --------------
$2.00 154,424 $2.00 6.0 Years 109,691 $2.00
2.88 - 3.63 205,000 3.40 5.9 Years 88,230 3.33
4.13 - 5.38 379,480 4.27 6.4 Years 200,164 4.28
------------- ------- ----- --------- ------- -----
$2.00 - $5.38 738,904 $3.55 6.1 Years 398,085 $3.44
============= ======= ===== ========= ======= =====
29
32
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
Proforma Information
The Company continues to apply APB No. 125 in accounting for its stock
based compensation. Accordingly, no compensation cost has been recorded in the
consolidated statements of operations for the stock option plans. Had
compensation cost for the Company's stock based compensation plans been
determined in accordance with the fair value method prescribed by SFAS No. 123,
the Company's proforma net loss and loss per share for the years ended December
31 would have been as follows:
1997 1996 1995
----------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net income (loss), as reported............... $(1,270) $ 46 $(6,811)
Net loss, pro forma.......................... (1,737) (203) (7,119)
Basic earnings (loss) per share, as
reported................................... $ (0.22) $ 0.01 $ (1.23)
Basic loss per share, pro forma.............. (0.30) (0.04) (1.28)
Diluted earnings (loss) per share, as
reported................................... (0.22) 0.01 (1.23)
Diluted loss per share, pro forma............ (0.30) (0.04) (1.28)
The weighted average of fair values of options granted during 1997, 1996
and 1995 were $2.31, $2.09 and $1.53, respectively. The fair value of each grant
is estimated on the date of grant using the Binomial option pricing model with
the following weighted average assumptions: risk-free interest rate of
approximately 6%, corresponding to government securities with original
maturities similar to the estimated option life; option lives ranging from 3 to
5 years; annual volatility of the Company's stock price of 80%; and a dividend
yield of 0%. The above proforma amounts include compensation expense for options
granted since January 1, 1995, and may not be representative of that to be
expected in future years.
6. PROFIT SHARING PLAN
The Company has a 401(k) plan (the "Plan") which is available to all
employees who have reached age 18 and have completed at least one year of
service. The Plan provides that each participant may contribute a portion of his
or her salary, within certain limits set forth in the US Tax Code. The Company
will make a matching contribution of 10% of the amount contributed by each
participant and may make additional matching or discretionary profit sharing
contributions. The Company's contributions vest after three years of service.
Total contribution expense recorded by the Company for 1997, 1996 and 1995 was
$41,000, $20,000, and $52,000, respectively.
7. COMMITMENTS
Future minimum lease payments for the Company's office, laboratory and
warehouse space at December 31, 1997 were as follows (in thousands):
AMOUNT
------
1998................................ $ 869
1999................................ 887
2000................................ 871
2001................................ 553
2002................................ 218
2003 and thereafter................. 117
------
Total commitments............ $3,515
======
30
33
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
Rental expense for operating leases amounted to approximately $944,000,
$825,000 and $789,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
In connection with the original employment and relocation of one employee,
the Company has committed to participate in the purchase of the employee's
residence. Pursuant to this commitment, the Company has an outstanding loan to
the employee of $109,000 at December 31, 1997 and 1996. This loan is included in
"Other assets" in the accompanying consolidated balance sheets. The loan is due
upon the earliest of 2001 or the occurrence of certain maturity events defined
in the agreement. The loan is secured by a deed of trust on the residence and
earns contingent interest on the net proceeds, as defined, upon the sale of the
employee's residence, termination of employment or other maturity events. In
certain circumstances, the Company is contingently liable for a portion of the
mortgage payments, insurance costs and property taxes, until such time as the
property is sold.
8. RESTRUCTURING AND UNUSUAL CHARGES
During the fourth quarter of 1995, the Company recorded a provision for
restructuring and unusual charges as follows (in thousands):
1995
------
Write-off of marketing rights and other expenditures........ $4,073
Write-down of goodwill applicable to Medscreen.............. 2,000
Write-down of certain computer and peripheral equipment..... 1,881
Other one-time costs -- principally severance............... 821
------
$8,775
======
The write-off of marketing rights and other expenditures is related to
costs incurred in connection with the acquisition of marketing rights to
PharmChek(R). The Company believed it prudent to write-off these costs given the
delays in commencing pilot tests which hampered the scheduled commercial launch
of PharmChek(R). The Company's investment in PharmChek(R) marketing rights was
approximately $0, $704,000 and $805,000 during 1997, 1996 and 1995,
respectively. The Company expects to continue its investment in PharmChek(R). To
date, there have been no material revenues generated from PharmChek(R).
During the fourth quarter of 1995, Medscreen lost a customer which
accounted for approximately 20% of its revenues. As a result, the Company
revised its assessment of the realization of the carrying value of its
investment and an additional write-down of $2,000,000 was recognized in the
fourth quarter of 1995. The write-down was determined based on the projected
discounted cash flows of Medscreen compared with the carrying value of the
Company's investment in Medscreen, including goodwill, at the date of the
write-down.
The write-down of computer and peripheral equipment is consistent with the
Company's plan to replace certain existing systems to enhance service to its
customers and provide the infrastructure to better monitor and control expenses.
9. LITIGATION
The Company is the defendant in certain legal matters which are normal for
the industry in which the Company operates. Management believes that these
matters, both individually and in the aggregate, will not have a material
adverse impact on the Company's financial position or results of operations.
31
34
PHARMCHEM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1996
10. GEOGRAPHICAL DATA
Information about the Company's operations in geographic areas where it
operates is as follows:
DOMESTIC EUROPE TOTAL
-------- ------- -------
(IN THOUSANDS)
Net sales for the year ended:
1997........................................ $34,970 $ 4,263 $39,233
1996........................................ 37,781 3,474 41,255
1995........................................ 34,679 4,432 39,111
Income (loss) from operations for the year
ended:
1997........................................ (1,161) 314 (847)
1996........................................ 242 176 418
1995(1)..................................... (6,590) (1,672) (8,262)
Identifiable assets at year end:
1997........................................ 17,158 4,938 22,096
1996........................................ 16,623 4,845 21,468
1995........................................ 17,298 4,885 22,183
- ---------------
(1) Refer to Note 8 for discussion of restructuring and unusual charges.
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized selected quarterly financial data is as follows:
QUARTER ENDED
----------------------------------------
3/31 6/30 9/30 12/31
------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1997
Net sales....................................... $9,058 $10,003 $10,037 $10,135
Gross profit.................................... 1,902 1,989 1,635 2,396
Net income (loss)............................... (378) (267) (662) 37
Basic earnings (loss) per share................. $(0.07) $ (0.05) $ (0.12) $ 0.01
Diluted earnings (loss) per share............... $(0.07) $ (0.05) $ (0.12) $ 0.01
Basic weighted average shares outstanding....... 5,714 5,719 5,726 5,729
Diluted weighted average shares outstanding..... 5,714 5,719 5,726 5,772
1996
Net sales....................................... $9,867 $10,771 $10,631 $ 9,986
Gross profit.................................... 2,241 2,531 2,625 2,101
Net income (loss)............................... (178) 82 155 (13)
Basic earnings (loss) per share................. $(0.03) $ 0.01 $ 0.03 $ 0.00
Diluted earnings (loss) per share............... $(0.03) $ 0.01 $ 0.03 $ 0.00
Basic weighted average shares outstanding....... 5,594 5,601 5,601 5,682
Diluted weighted average shares outstanding..... 5,594 5,791 5,755 5,682
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
32
35
PART III
ITEMS 10 TO 13 INCLUSIVE.
These items have been omitted in accordance with the General Instructions
to Form 10-K and are answered by reference to those portions of the Registrant's
definitive proxy statement with respect to the 1998 Annual Meeting of
Shareholders which contain the information required by these items. The
Registrant will file with the Commission not later than 120 days after the end
of the fiscal year covered by this report such definitive proxy statement
pursuant to Regulation 14A. Information regarding executive officers of the
Company is contained in Part I of this Annual Report on Form 10-K under caption
"Executive Officers of PharmChem."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS.
PAGE
NUMBER
IN THIS
REPORT
-------
Report of KPMG Peat Marwick LLP, Independent
Auditors.............................................. 15
Report of Arthur Andersen LLP, Independent Public
Accountants........................................... 16
Consolidated Balance Sheets at December 31, 1997 and
1996.................................................. 17
Consolidated Statements of Operations for the years
ended December 31, 1997, 1996 and 1995................ 18
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1997, 1996 and 1995.......... 19
Consolidated Statements of Cash Flows for the years
ended December 31, 1997, 1996 and 1995................ 20
Notes to Consolidated Financial Statements............. 21
(a) (2) FINANCIAL STATEMENT SCHEDULE
Schedule II Valuation and Qualifying Accounts.......... 36
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.
33
36
(a)(3) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.01(1) Amended and Restated Articles of Incorporation dated August
21, 1991.
3.02(2) Bylaws, as amended May 19, 1992.
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 to 1992 Director Option Plan dated February 28,
1996.
10.09(9) Amendment to 1992 Director Option Plan dated March 4, 1997.
10.10(11) 1997 Equity Incentive Plan.
10.11(11) Form of Stock Option Agreement (Nonstatutory Stock Option)
in connection with the 1997 Equity Incentive Plan.
10.12(11) Stock Option Agreement (Incentive Stock Option) in
connection with the 1997 Equity Incentive Plan. 401(k) Plan.
10.13(1) 401(k) Plan.
10.14(9) Amendment to 401(k) Plan dated August 25, 1996.
10.15(1) Lease Agreements for the Company's offices in Menlo Park,
California dated October 21, 1988 and September 11, 1990,
respectively.
10.16(8) Lease Amendment for the Company's offices in Menlo Park,
California dated November 30, 1995.
10.17(9) Lease Amendment for the Company's offices in Menlo Park,
California dated March 6, 1996.
10.18(5) Harbour Quay (London) Lease Documents.
10.19(9) Lease Agreement for the Company's offices in Fort Worth,
Texas dated October 24, 1991.
10.20(9) Lease Amendment for the Company's offices in Fort Worth,
Texas dated December 8, 1992.
10.21(9) Lease Amendment for the Company's offices in Fort Worth,
Texas dated February 9, 1996.
10.22(1) Form of Indemnification Agreement.
10.23 Loan and Security Agreement between Comerica Bank of
California and PharmChem Laboratories, Inc. dated December
5, 1997.
10.24 Security Agreement (all assets) between Comerica Bank of
California and PharmChem Laboratories, Inc. dated December
5, 1997.
10.25(4,12) License and Supply Agreement with Sudormed, Inc. dated March
10, 1992.
10.26(5,12) License and Supply Agreement with Sudormed, Inc. dated
October 25, 1993.
10.27(5,12) Supply Agreement with SolarCare Technologies Corporation
dated August 1, 1993.
34
37
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
10.28(8,12) First Amendment to Supply Agreement dated December 1, 1995.
10.29(4,12) Probation Division of the Administration Office of The U.S.
Courts Contract dated October 1, 1992.
10.30(5,12) Sears Merchandise Group Service Agreement dated September
22, 1992.
10.31(11) Master Lease Purchase Agreement dated December 18, 1995 with
Fidelity Leasing Corporation and Lease Purchase Addenda in
connection therewith.
10.32(11) Master Equipment Lease dated March 17, 1996 with Olympus
Commercial Credit.
16.01(10) Letter dated April 8, 1997 from Arthur Andersen LLP to the
Commission. List of Subsidiaries.
21.01 List of Subsidiaries.
23.01 Consent of KPMG Peat Marwick LLP.
23.02 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule.
- ---------------
(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 Current Report on Form 8-K
dated April 7, 1997.
(11) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1997.
(12) Confidential treatment requested as to certain portions of this exhibit.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1997.
(c) EXHIBITS
See (a) (3) above.
(d) FINANCIAL STATEMENT SCHEDULE
See (a) (2) above.
35
38
PHARMCHEM LABORATORIES, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES(1) (WRITE-OFFS) PERIOD
----------- ---------- ----------- ------------ ----------
Allowance for Doubtful Accounts
Year ended:
December 31, 1995................................ $139 $955 $632 $462
==== ==== ==== ====
December 31, 1996................................ $462 $206 $58_ $610
==== ==== ==== ====
December 31, 1997................................ $610 $350 $492 $468
==== ==== ==== ====
- ---------------
(1) For the year ended December 31, 1995, $380 was expensed to restructuring and
unusual charges.
36
39
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 24th day of March, 1998.
PHARMCHEM LABORATORIES, INC.
BY: /s/ JOSEPH W. HALLIGAN
------------------------------------
Joseph W. Halligan
President, Chief Executive Officer and
Director
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 with same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact and agent, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as such person might or could do
in person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ------------------------------ --------------
/s/ JOSEPH W. HALLIGAN President, Chief Executive March 24, 1998
--------------------------------------------- Officer and Director
Joseph W. Halligan (Principal Executive Officer)
/s/ DAVID A. LATTANZIO Chief Financial Officer, Vice March 24, 1998
--------------------------------------------- President, Finance and
David A. Lattanzio Administration (Principal
Accounting and Financial
Officer) and Secretary
/s/ RICHARD D. IRWIN Chairman of the Board and March 24, 1998
--------------------------------------------- Director
Richard D. Irwin
/s/ THOMAS S. VOLPE Director March 24, 1998
---------------------------------------------
Thomas S. Volpe
37
40
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION OF DOCUMENT PAGE
------- ----------------------- ------------
3.01(1) Amended and Restated Articles of Incorporation dated
August 21, 1991...........................................
3.02(2) Bylaws, as amended May 19, 1992...........................
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 to 1992 Director Option Plan dated February 28,
1996......................................................
10.09(9) Amendment to 1992 Director Option Plan dated March 4,
1997......................................................
10.10(11) 1997 Equity Incentive Plan................................
10.11(11) Form of Stock Option Agreement (Nonstatutory Stock Option)
in connection with the 1997 Equity Incentive Plan.........
10.12(11) Stock Option Agreement (Incentive Stock Option) in
connection with the 1997 Equity Incentive Plan.
10.13(1) 401(k) Plan...............................................
10.14(9) Amendment to 401(k) Plan dated August 25, 1996............
10.15(1) Lease Agreements for the Company's offices in Menlo Park,
California dated October 21, 1988 and September 11, 1990,
respectively..............................................
10.16(8) Lease Amendment for the Company's offices in Menlo Park,
California dated November 30, 1995........................
10.17(9) Lease Amendment for the Company's offices in Menlo Park,
California dated March 6, 1996............................
10.18(5) Harbour Quay (London) Lease Documents.....................
10.19(9) Lease Agreement for the Company's offices in Fort Worth,
Texas dated October 24, 1991..............................
10.20(9) Lease Amendment for the Company's offices in Fort Worth,
Texas dated December 8, 1992..............................
10.21(9) Lease Amendment for the Company's offices in Fort Worth,
Texas dated February 9, 1996..............................
10.22(1) Form of Indemnification Agreement.........................
10.23 Loan and Security Agreement between Comerica Bank of
California and PharmChem Laboratories, Inc. dated December
5, 1997...................................................
10.24 Security Agreement (all assets) between Comerica Bank of
California and PharmChem Laboratories, Inc. dated December
5, 1997...................................................
41
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION OF DOCUMENT PAGE
------- ----------------------- ------------
10.25(4,12) License and Supply Agreement with Sudormed, Inc. dated
March 10, 1992............................................
10.26(5,12) License and Supply Agreement with Sudormed, Inc. dated
October 25, 1993..........................................
10.27(5,12) Supply Agreement with SolarCare Technologies Corporation
dated August 1, 1993......................................
10.28(8,12) First Amendment to Supply Agreement dated December 1,
1995......................................................
10.29(4,12) Probation Division of the Administration Office of The
U.S. Courts Contract dated October 1, 1992................
10.30(5,12) Sears Merchandise Group Service Agreement dated September
22, 1992..................................................
10.31(11) Master Lease Purchase Agreement dated December 18, 1995
with Fidelity Leasing Corporation and Lease Purchase
Addenda in connection therewith...........................
10.32(11) Master Equipment Lease dated March 17, 1996 with Olympus
Commercial Credit.........................................
16.01(10) Letter dated April 8, 1997 from Arthur Andersen LLP to the
Commission................................................
21.01 List of Subsidiaries......................................
23.01 Consent of KPMG Peat Marwick LLP..........................
23.02 Consent of Arthur Andersen LLP............................
27.1 Financial Data Schedule...................................
- ---------------
(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 Current Report on Form 8-K
dated April 7, 1997.
(11) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1997.
(12) Confidential treatment requested as to certain portions of this exhibit.