PSYCHEMEDICS CORP - Quarter Report: 2005 June (Form 10-Q)

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

þ		QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		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 1-13738

PSYCHEMEDICS CORPORATION

(exact name of Issuer as specified in its charter)

Delaware		58-1701987
(State or other jurisdiction of		(I.R.S. Employer
incorporation of organization)		Identification No.)

125 Nagog Park, Acton, MA		01720
(Address of principal executive offices)		(Zip Code)

Issuer’s telephone number, including area code (978) 206-8220

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15 (d) of the Exchange Act during the past 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 þ No o

Indicate by check mark whether the registrant is an accelerated filer.

YES o NO þ

Number of shares outstanding of only class of Issuer’s Common Stock as of August 15, 2005: Common Stock $.005 par value (5,167,097 shares).

 

 

PSYCHEMEDICS CORPORATION

		Page No.
Part I FINANCIAL INFORMATION
Item 1 Financial Statements (Unaudited)
Condensed Balance Sheets as of June 30, 2005 and December 31, 2004			3
Condensed Statements of Income for the three month periods ended June 30, 2005 and 2004			4
Condensed Statements of Income for the six month periods ended June 30, 2005 and 2004			5
Condensed Statements of Cash Flows for the six month periods ended June 30, 2005 and 2004			6
Notes to Condensed Financial Statements			7-10
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			11-16
Item 3 Quantitative and Qualitative Disclosures about Market Risk			16
Item 4 Controls and Procedures			16
Part II OTHER INFORMATION
Item 4 Submission of Matters to a Vote of Security Holders			17
Item 6 Exhibits			17
SIGNATURES			18
EXHIBIT INDEX			19
EX-31.1 Section 302 Certification of CEO
EX-31.2 Section 302 Certification of CFO
EX-32.1 Section 906 Certification of CEO
EX-32.2 Section 906 Certification of CFO

PSYCHEMEDICS CORPORATION

CONDENSED BALANCE SHEETS

		JUNE 30,				DECEMBER 31,
		2005				2004
		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	2,433,196			$	3,260,178
Short-term investments			2,000,000				—
Accounts receivable, net of allowance for doubtful accounts of $483,230 in 2005 and 2004			3,562,190				3,289,863
Prepaid expenses and other current assets			597,351				246,372
Deferred tax assets			529,752				529,752
Total current assets			9,122,489				7,326,165
PROPERTY AND EQUIPMENT:
Equipment and leasehold improvements, at cost			9,939,266				9,960,831
Less-accumulated depreciation and amortization			(9,163,472	)			(9,099,472	)
			775,794				861,359
DEFERRED TAX ASSETS			166,583				166,583
OTHER ASSETS, NET			43,624				79,529
		$	10,108,490			$	8,433,636
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	205,921			$	554,214
Accrued expenses			1,296,559				1,157,740
Deferred revenue			577,553				487,633
Total current liabilities			2,080,033				2,199,587
SHAREHOLDERS’ EQUITY:
Preferred stock, $0.005 par value; 872,521 shares authorized; none issued or outstanding			—				—
Common stock; $0.005 par value; 50,000,000 shares authorized; 5,750,894 shares and 5,710,704 shares issued in 2005 and 2004, respectively			28,754				28,554
Paid-in capital			25,446,781				24,978,039
Accumulated deficit			(8,324,387	)			(9,649,853	)
Less — Treasury stock, at cost; 583,797 shares			(9,122,691	)			(9,122,691	)
Total shareholders’ equity			8,028,457				6,234,049
		$	10,108,490			$	8,433,636

See accompanying notes to financial statements and management’s discussion and
analysis of financial condition and results of operations.

PSYCHEMEDICS CORPORATION

CONDENSED STATEMENTS OF INCOME

(UNAUDITED)

		THREE MONTHS
		ENDED JUNE 30,
		2005				2004
REVENUE		$	5,615,329			$	5,347,049
COST OF REVENUE			2,224,449				2,252,240
Gross profit			3,390,880				3,094,809
EXPENSES:
General and administrative			755,974				869,055
Marketing and selling			678,168				613,624
Research and development			73,854				73,319
			1,507,996				1,555,998
OPERATING INCOME			1,882,884				1,538,811
INTEREST INCOME			26,962				6,979
OTHER INCOME			—				3,750
			26,962				10,729
NET INCOME BEFORE INCOME TAXES			1,909,846				1,549,540
PROVISION FOR INCOME TAXES			709,000				585,500
NET INCOME		$	1,200,846			$	964,040
BASIC NET INCOME PER SHARE		$	0.23			$	0.19
DILUTED NET INCOME PER SHARE		$	0.23			$	0.19
DIVIDENDS DECLARED PER SHARE		$	0.08			$	0.08
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC			5,163,506				5,126,907
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, DILUTED			5,173,941				5,130,138

See accompanying notes to financial statements and management’s discussion and
analysis of financial condition and results of operations.

PSYCHEMEDICS CORPORATION

CONDENSED STATEMENTS OF INCOME

(UNAUDITED)

		SIX MONTHS
		ENDED JUNE 30,
		2005				2004
REVENUE		$	10,953,079			$	9,502,921
COST OF REVENUE			4,389,279				4,256,946
Gross profit			6,563,800				5,245,975
EXPENSES:
General and administrative			1,628,612				1,612,856
Marketing and selling			1,407,249				1,220,153
Research and development			145,801				150,338
			3,181,662				2,983,347
OPERATING INCOME			3,382,138				2,262,628
INTEREST INCOME			39,598				14,900
OTHER INCOME			1,250				7,500
			40,848				22,400
INCOME BEFORE PROVISION FOR INCOME TAXES			3,422,986				2,285,028
PROVISION FOR INCOME TAXES			1,274,000				868,000
NET INCOME		$	2,148,986			$	1,417,028
BASIC NET INCOME PER SHARE		$	0.42			$	0.28
DILUTED NET INCOME PER SHARE		$	0.42			$	0.28
DIVIDENDS DECLARED PER SHARE		$	0.16			$	0.16
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC			5,146,103				5,126,907
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, DILUTED			5,158,159				5,131,470

See accompanying notes to financial statements and management’s discussion and
analysis of financial condition and results of operations.

PSYCHEMEDICS CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

		SIX MONTHS
		ENDED JUNE 30,
		2005				2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	2,148,986			$	1,417,028
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			219,321				273,263
Tax benefit associated with exercise of options			35,503				—
Changes in operating assets and liabilities:
Accounts receivable			(272,327	)			(1,203,036	)
Prepaid expenses and other assets			(350,979	)			(130,122	)
Accounts payable			(348,294	)			(3,744	)
Accrued expenses			138,819				(87,741	)
Deferred revenue			89,920				25,896
Net cash provided by operating activities			1,660,949				291,544
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments			(2,000,000	)			—
Purchases of property and equipment			(100,078	)			(118,081	)
Decrease (Increase) in other assets — net			2,228				(5,772	)
Net cash used in investing activities			(2,097,850	)			(123,853	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid			(823,520	)			(820,306	)
Net proceeds from the issuance of common stock			433,439				—
Net cash used in financing activities			(390,081	)			(820,306	)
NET DECREASE IN CASH AND CASH EQUIVALENTS			(826,982	)			(652,615	)
CASH AND CASH EQUIVALENTS, beginning of period			3,260,178				3,022,467
CASH AND CASH EQUIVALENTS, end of period		$	2,433,196			$	2,369,852

See accompanying notes to financial statements and management’s discussion and
analysis of financial condition and results of operations.

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

June 30, 2005

1. Interim Financial Statements

The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Accordingly, certain information and footnote disclosure required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the financial statements and related notes of Psychemedics Corporation (the “Company”) as reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of financial position, results of operations, and cash flows at the dates and for the periods presented have been included. The results of operations for the three months and the six months ended June 30, 2005 may not be indicative of the results that may be expected for the year ending December 31, 2005, or any other period.

2. Stock-Based Compensation

The Company accounts for its stock compensation arrangements with employees under the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure.

Statement of Financial Accounting Standards, (SFAS) No. 123, Accounting for Stock-Based Compensation, requires the measurement of the fair value of stock options or warrants to be included in the statement of income or disclosed in the notes to financial statements. The Company has computed the value of options using the Black-Scholes option pricing model prescribed by SFAS No. 123.

The assumptions used and the weighted average information are as follows:

		Three Months Ended				Six Months Ended
		June 30, 2005		June 30, 2004		June 30, 2005		June 30, 2004
Risk-free interest rates range		3.8%		3.9%		3.8%		2.7 — 3.9%
Expected dividend yield range		2.3%		2.7%		2.3%		2.7%
Expected lives		5 years		5 years		5 years		5 years
Expected volatility range		30.09%		23.99%		30.09%		23.99 — 27.94%

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

Consistent with SFAS No. 123, net income and basic and diluted net income per share would have been as follows:

		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
		2005				2004				2005				2004
Net income, as reported		$	1,200,846			$	964,040			$	2,148,986			$	1,417,028
Less: Total stock based compensation cost determined under the fair value based method for all employee awards			(919,325	)			(82,266	)			(928,882	)			(107,937	)
Pro forma net income		$	281,521			$	881,774			$	1,220,104			$	1,309,091
Income per share:
Basic and diluted, as reported		$	0.23			$	0.19			$	0.42			$	0.28
Basic and diluted, pro forma		$	0.05			$	0.17			$	0.24			$	0.26

The weighted average fair value of options granted for the three months ended June 30, 2005 and 2004 was $3.76 per share and $1.88 per share, respectively. The weighted average fair value of options granted for the six months ended June 30, 2005 and 2004 was $3.76 per share and $2.19 per share, respectively.

3. Basic and Diluted Net Income Per Share

Basic net income per share was computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share was computed by dividing net income by the weighted average number of common and dilutive common equivalent shares outstanding during the period. The number of dilutive common equivalent shares outstanding during the period has been determined in accordance with the treasury-stock method. Common equivalent shares consist of common stock issuable upon the exercise of outstanding options.

Basic and diluted weighted average common shares outstanding were as follows:

		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
		2005				2004				2005				2004
Weighted average common shares			5,163,506				5,126,907				5,146,103				5,126,907
Dilutive common stock options			10,435				3,231				12,056				4,563
Weighted average common shares outstanding, assuming dilution			5,173,941				5,130,138				5,158,159				5,131,470

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

For the three months ended June 30, 2005 and 2004, options to purchase 522,833 and 462,217 common shares, respectively, were outstanding but not included in the diluted weighted average common share calculation as the effect would have been antidilutive. For the six months ended June 30, 2005 and 2004, options to purchase 533,133 and 405,437 common shares, respectively, were outstanding but not included in the diluted weighted average common share calculation as the effect would have been antidilutive.

4. Revenue Recognition

The Company performs drug testing as well as provides training for collection of samples and storage of positive samples for its customers for an agreed-upon fee per unit tested of samples. Revenues are recognized when the predominant deliverable, drug testing, is provided and reported to the customer. The Company also provides expert testimony, when and if necessary, to support the results of the tests, which is generally billed separately and recognized as the services are provided.

In 2003, the Company adopted Emerging Issue Task Force 00-21, Revenue Arrangements with Multiple Deliverables, which was effective for all transactions entered into subsequent to June 15, 2003. The Company applied the consensus reached under EITF 00-21 and concluded that the testing, training and storage elements are considered one unit of accounting for revenue recognition purposes as the training and storage costs do not have stand-alone value to the customer. The Company has concluded that the predominant deliverable in the arrangement is the testing of the units and has recognized revenue as that service is performed and reported to the customer.

At June 30, 2005 and December 31, 2004, the Company had deferred revenue of approximately $578,000 and $488,000, respectively, reflecting sales of its personal drug testing service for which the performance of the related test had not yet occurred.

5. Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. The provisions of SFAS No. 123(R) are effective for all employee equity awards granted and to any unvested awards outstanding as of January 1, 2006. The Company has not yet assessed the impact of adopting this new standard.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. The amendments made by SFAS No. 153 are based on the principle

PSYCHEMEDICS CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The new standard will be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company has not yet assessed the impact of adopting this new standard.

6. Contingencies

The Company is subject to legal proceedings and claims, which arise in the ordinary course of its business. The Company believes that based upon information available to the Company at this time, the expected outcome of these matters would not have a material impact on the Company’s results of operations or financial condition.

7. Subsequent Event — Dividends

On August 3, 2005, the Company declared a quarterly dividend of $.10 per share, which will be paid on September 23, 2005 to shareholders of record on September 9, 2005.

Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Psychemedics Corporation was incorporated in 1986. The Company utilizes a patented hair analysis method involving radioimmunoassay technology to analyze human hair to detect abused substances.

Revenue for the second quarter of 2005 was $5.6 million and was 5% above revenue of $5.3 million for the second quarter of 2004. Revenue for the first two quarters of 2005 was $11.0 million and was 15% above revenue of $9.5 million for the first two quarters of 2004. Due to the increase in revenue and gross profit, the Company reported net income of $0.23 per share in the quarter ended June 30, 2005 and net income of $0.42 per share for the six months ended June 30, 2005. At June 30, 2005, the Company had $4.4 million of cash, cash equivalents and short-term investments. The Company distributed $0.4 million, or $0.08 per share, of cash dividends to its shareholders in both the first and second quarters of 2005, which represented year to date totals of $0.8 million, or $0.16 per share. As of the date of this Report, the Company has paid thirty-five consecutive quarterly cash dividends.

RESULTS OF OPERATIONS

Revenue was $5,615,329 for the three month period ended June 30, 2005 as compared to $5,347,049 for the comparable period of 2004, representing an increase of 5%. Revenue was $10,953,079 for the six month period ended June 30, 2005 as compared to $9,502,921 for the comparable period of 2004, representing an increase of 15%. The increase in revenue for the second quarter of 2005 was due to an increase of 4% in testing volume from both new and existing clients, while the average revenue per sample increased by 1% as compared to the comparable period of 2004. The increase in revenue for the six months ended June 30, 2005 was due to an increase of 15% in testing volume from both new and existing clients, while the average revenue per sample remained constant as compared to the comparable period of 2004. The Company continued to add approximately the same number of new clients in the first and second quarter of 2005 as it did in the comparable period of 2004.

Gross margin was 60% of revenue for the three month period ended June 30, 2005, as compared to 58% for the comparable period of 2004. Gross margin was 60% of revenue for the six month period ended June 30, 2005, as compared to 55% for the comparable period of 2004. Fixed and semi-variable direct costs were spread over a greater number of tests performed for the three month period and the six month period ended June 30, 2005, as compared to the same periods of 2004. Also, reduced depreciation and amortization expense contributed to a decline in fixed costs for the three month period and the six month period ended June 30, 2005 as compared to the year earlier periods.

General and administrative (“G&A”) expenses were $755,974 for the three month period ended June 30, 2005 as compared to $869,055 for the comparable period of 2004, representing a decrease of 13%. G&A expenses were $1,628,612 for the six month period ended June 30, 2005 as compared to $1,612,856 for the comparable

period of 2004, representing an increase of 1%. The decrease in general and administrative expenses for the three month period ended June 30, 2005 as compared to the comparable period of 2004 was due primarily to reduced professional fees related to legal services and a decrease in rent expense pertaining to the Company’s headquarters. All other general and administrative expenses remained relatively constant. The increase in general and administrative expenses for the six month period ended June 30, 2005 as compared to the comparable period of 2004 was due primarily to greater professional fees related to accounting services and Sarbanes-Oxley compliance along with an increase in personnel expenses, partially offset by reduced professional fees related to legal services and a decrease in rent expense pertaining to the Company’s headquarters. All other general and administrative expenses remained relatively constant. As a percentage of revenue, G&A expenses decreased to 14% for the three month period ended June 30, 2005 from 16% for the comparable period of 2004 and decreased to 15% for the six months ended June 30, 2005 from 17% for the comparable period of 2004. The Company expects general and administrative expenses to increase in absolute dollars and decrease as a percentage of revenue during the remainder of 2005 primarily due to increased professional fees and costs related to corporate governance and Sarbanes-Oxley compliance.

Marketing and selling expenses were $678,168 for the three month period ended June 30, 2005 as compared to $613,624 for the comparable period of 2004, an increase of 11%. Marketing and selling expenses were $1,407,249 for the six month period ended June 30, 2005 as compared to $1,220,153 for the comparable period of 2004, an increase of 15%. The increase for both the three month and the six month periods ended June 30, 2005 as compared to the comparable periods of 2004 was due primarily to an increase in personnel expenses pertaining to the Company’s sales and support staff. Total marketing and selling expenses represented 12% of revenue in the second quarter of 2005 and 11% of revenue in the second quarter of 2004. Total marketing and selling expenses represented 13% of revenue for both of the six month periods ended June 30, 2005 and June 30, 2004. The Company expects marketing and selling expenses to increase in absolute dollars and decrease as a percentage of revenue during the remainder of 2005 as resources are committed to direct selling efforts to aggressively promote its drug testing services in order to expand its client base.

Research and development (“R&D”) expenses for the three month period ended June 30, 2005 increased by $535 from the comparable period of the prior year to $73,854, an increase of 1%. Research and development (“R&D”) expenses for the six month period ended June 30, 2005 decreased by $4,537 from the comparable period of the prior year to $145,801, a decrease of 3%. This decrease was primarily due to reduced consumables costs. R&D expenses represented 1% of revenue for both of the three month periods ended June 30, 2005 and June 30, 2004. R&D expenses represented 1% of revenue for both of the six month periods ended June 30, 2005 and June 30, 2004.

Interest income for the three month period ended June 30, 2005 increased by $19,983 and increased by $24,698 for the six month period ended June 30, 2005 as compared to the comparable year earlier periods and represented interest and dividends earned on cash equivalents and short-term investments. Higher average investment balances along with an increase in the yield on investment balances in 2005 as compared to 2004 caused the increase in interest income.

During the three month period ended June 30, 2005, the Company recorded a tax provision of $709,000 reflecting an effective tax rate of 37.1% as compared to a tax provision of $585,500 reflecting an effective tax rate of 37.8% for the three month period ended June 30, 2004. During the six months ended June 30, 2005 and June 30, 2004, the Company recorded tax provisions of $1,274,000 and $868,000 representing effective tax rates of 37.2% and 38.0%, respectively. The variation in the effective tax rate was due primarily to reduced state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2005, the Company had approximately $4.4 million of cash, cash equivalents and short-term investments. The Company’s operating activities generated net cash of $1,660,949 in the six months ended June 30, 2005. Investing activities used $2,097,850 in the six month period while financing activities used a net amount of $390,081 during the period.

Operating cash flow of $1,660,949 for the six months ended June 30, 2005 principally reflected net income of $2,148,986 adjusted for depreciation and amortization of $219,321 offset partially by the growth in accounts receivable and prepaid expenses along with the decrease in accounts payable.

Capital expenditures in the first two quarters of 2005 were $100,078. The expenditures primarily consisted of new equipment, including laboratory and computer equipment. The Company currently plans to make additional capital expenditures of approximately $550,000 during the balance of 2005, primarily in connection with the purchase of additional laboratory and computer equipment. The Company believes that within the next two to five years it may be required to expand its existing laboratory or develop a second laboratory, the cost of which is currently believed to range from $2 million to $4 million.

During the six month period ended June 30, 2005, the Company distributed $823,520 in cash dividends to its shareholders. The Company did not repurchase any shares for treasury during the six month period ended June 30, 2005. The Company has authorized 500,000 shares for repurchase since June of 1998 of which 466,351 shares have been repurchased as of June 30, 2005.

Contractual obligations as of June 30, 2005 were as follows:

		Less Than				1-3				4-5				After 5
		One Year				Years				years				Years				Total
Operating leases		$	484,000			$	922,000			$	893,000			$	783,000			$	3,082,000
Purchase commitment			247,000																247,000
		$	731,000			$	922,000			$	893,000			$	783,000			$	3,329,000

The Company signed a seven year extension in May of 2005 with an option to renew for an additional three years on the space leased for laboratory purposes in Culver City, California. This extension commences on January 1, 2006. The Company also signed a five year lease extension in May of 2005 with an option to renew for an additional two

years on the space leased for customer service and information technology purposes in Culver City, California. This extension also commences on January 1, 2006. The lease obligations are reflected in the above table.

          Purchase Commitment

The Company has a supply agreement with a vendor which requires the Company to purchase isotopes used in its drug testing procedures from this sole supplier in exchange for variable annual payments based upon prior year purchases. Purchases amounted to $247,151 for the six months ended June 30, 2005 as compared to $219,510 for the comparable period of 2004. The Company expects to purchase approximately $247,000 for the remainder of 2005. In exchange for exclusivity, the supplier has provided the Company with the right to purchase the isotope technology at fair market value under certain conditions, including the failure to meet the Company’s purchase commitments. This agreement does not include a fixed termination date, however, it is cancelable upon mutual agreement by both parties or six months after termination notice by the Company of its intent to use a different technology in connection with its drug testing procedures.

At June 30, 2005, the Company’s principal sources of liquidity included an aggregate of approximately $4.4 million of cash, cash equivalents and short-term investments. Management currently believes that such funds, together with cash generated from operations, should be adequate to fund anticipated working capital requirements and capital expenditures in the near term. Depending upon the Company’s results of operations, its future capital needs and available marketing opportunities, the Company may use various financing sources to raise additional funds. Such sources could potentially include joint ventures, issuances of common stock or debt financing, although the Company does not have any such plans at this time. At June 30, 2005, the Company had no long-term debt.

CRITICAL ACCOUNTING POLICIES

Management believes the most critical accounting policies include revenue recognition and income taxes.

          Revenue Recognition

The Company is in the business of performing drug testing and reporting the results thereof. The Company performs drug testing which includes training for collection of samples and storage of positive samples for its customers for an agreed-upon fee per unit tested of samples. The revenues are recognized when the predominant deliverable, drug testing, is provided and reported to the customer. The Company also provides expert testimony, when and if necessary, to support the test results, which is generally billed separately and recognized as the services are provided.

In 2003, the Company adopted Emerging Issue Task Force 00-21, Revenue Arrangements with Multiple Deliverables, which was effective for all transactions entered into subsequent to June 15, 2003. The Company applied the consensus reached under EITF 00-21 and concluded that the testing, training and storage elements are considered one unit of accounting for revenue recognition purposes as the training and storage costs do not have stand-alone value to the customer. The

Company has concluded that the predominant deliverable in the arrangement is the testing of the units and has recognized revenue as that service is performed and reported to the customer.

Deferred revenue represents payments received in advance of the performance of drug testing procedures. Deferred revenue is reclassified as revenue when the underlying test results are delivered. With respect to a portion of these transactions, there may be instances where the customer ultimately does not require performance (referred to as breakage). Revenue is then recognized (as other income) when the Company can reasonably, reliably and objectively determine the breakage has occurred. Breakage is deemed to occur only at the point it becomes remote that performance will be required. The Company has not recorded any breakage in the first two quarters of 2005 and during 2004. The Company continues to monitor this to determine whether breakage can be reasonably, reliably and objectively determined.

          Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, including bad debts and income taxes, and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

          Allowance for Doubtful Accounts

The allowance for doubtful accounts is based on management’s assessment of the collectibility of its customer accounts. Management reviews its accounts receivable aging for doubtful accounts and specifically identifies accounts that may not be collectible. The Company routinely assesses the financial strength of its customers and, as a consequence, believes that its accounts receivable credit risk exposure is limited. The Company maintains an allowance for potential credit losses but historically has not experienced any significant losses related to individual customers or groups of customers in any particular industry or geographic area. Bad debt expense and the issuance of credit memos have been within management’s expectations.

          Income Taxes

The Company accounts for income taxes using the liability method, which requires the Company to recognize a current tax liability or asset for current taxes payable or refundable and a deferred tax liability or asset for the estimated future tax effects of temporary differences between the financial statement and tax reporting bases of assets and liabilities to the extent that they are realizable. Deferred tax expense (benefit) results from the net change in deferred tax assets and liabilities during the year. A deferred tax valuation allowance is required if it is more likely than not that all or a portion of the recorded deferred tax assets will not be realized.

The Company operates within multiple taxing jurisdictions and could be subject to audit in these jurisdictions. These audits may involve complex issues, which may require an extended period of time to resolve. The Company has provided for its estimated taxes payable in the accompanying financial statements.

The above listing is not intended to be a comprehensive list of all of the Company’s accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.

FACTORS THAT MAY AFFECT FUTURE RESULTS

From time to time, information provided by the Company or statements made by its employees may contain “forward-looking” information which involves risks and uncertainties. In particular, statements contained in this report which are not historical facts (including, but not limited to, the Company’s expectations regarding revenues, business strategy, anticipated operating results, strategies with respect to governmental agencies and regulations, cash dividends, capital expenditures and anticipated cash requirements) may be “forward-looking” statements. The Company’s actual results may differ from those stated in any “forward-looking” statements. Factors that may cause such differences include, but are not limited to, employee hiring practices of the Company’s principal customers, development of markets for new products and services offered by the Company, the economic health of principal customers of the Company, financial and operational risks associated with possible expansion of testing facilities used by the Company, government regulation (including, but not limited to, Food and Drug Administration regulations), competition and general economic conditions. With respect to the continued payment of cash dividends, factors include, but are not limited to, available surplus, cash flow, capital expenditure reserves required, and other factors that the Board of Directors of the Company may take into account.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Sensitivity. The Company maintains a short-term investment portfolio consisting principally of money market securities and Taxable Auction Rate Preferred, 7 and 28 day Dutch Auction securities that are not sensitive to sudden interest rate changes. The Company does not use derivative financial instruments for speculative or trading purposes.

Item 4. Controls and Procedures

As of the date of this report, our Chief Executive Officer and Chief Financial Officer performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring the reporting of material information required to be included in the Company’s periodic filings with the Securities and Exchange Commission. There were no significant changes in the Company’s internal controls over financial reporting or in other factors that could significantly affect these internal controls over financial reporting subsequent to the date of the most recent evaluation.

PART II OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

The Annual Meeting of Shareholders of Psychemedics Corporation was held on May 24, 2005 for the purpose of electing a board of directors. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934 and there was no solicitation in opposition to management’s solicitations.

Description and tabulation by the Company’s transfer agent of each matter voted upon at the Annual Meeting of Shareholders of Psychemedics Corporation held on May 24, 2005:

All of management’s nominees for directors, as listed in the proxy statement, were elected with the following votes:

Election of Directors.

		Number of Shares
		For				Withheld
Raymond C. Kubacki, Jr.			4,708,453				180,966
Harry F. Connick			4,710,388				179,031
Walter S. Tomenson, Jr.			4,712,344				177,075
Fred J. Weinert			4,708,520				180,899

Item 6. Exhibits

See Exhibit Index included in this Report

SIGNATURES

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

		Psychemedics Corporation
Date: August 15, 2005		By:		/s/ Raymond C. Kubacki, Jr.
		Raymond C. Kubacki, Jr.
		Chairman and Chief Executive Officer
Date: August 15, 2005		By:		/s/ Peter C. Monson
		Peter C. Monson
		Vice President, Treasurer &
		Chief Financial Officer

PSYCHEMEDICS CORPORATION
FORM 10-Q
June 30, 2005

EXHIBIT INDEX

				Page No.
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002			20
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002			22
32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002			24
32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002			25