PSYCHEMEDICS CORP - Quarter Report: 2006 March (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

For quarterly period ended March 31, 2006

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                          to                                         

PSYCHEMEDICS CORPORATION

(exact name of Issuer as specified in its charter)

Delaware (State or other jurisdiction of incorporation of organization)		58-1701987 (I.R.S. Employer Identification No.)
125 Nagog Park, Acton, MA (Address of principal executive offices)		01720 (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 a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer o       Accelerated filer o       Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company.

		YES o		NO þ

Number of shares outstanding of only class of Issuer’s Common Stock as of May 12, 2006: 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 March 31, 2006 and December 31, 2005		3
				Condensed Statements of Income for the three months ended March 31, 2006 and 2005		4
				Condensed Statements of Cash Flows for the three months ended March 31, 2006 and 2005		5
				Notes to Condensed Financial Statements		6-9
		Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations		10-14
		Item 3		Quantitative and Qualitative Disclosures about Market Risk		15
		Item 4		Controls and Procedures		15
Part II OTHER INFORMATION
		Item 1A		Risk Factors		15
		Item 6		Exhibits		15
SIGNATURES						16
EXHIBIT INDEX						17
EX-31.1 Section 302 CEO Certification
EX-31.2 Section 302 CFO Certification
EX-32.1 Section 906 CEO Certification
EX-32.2 Section 906 CFO Certification

PSYCHEMEDICS CORPORATION

CONDENSED BALANCE SHEETS

		MARCH 31,				DECEMBER 31,
		2006				2005
		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	2,254,890			$	3,352,519
Short-term investments			3,050,000				2,550,000
Accounts receivable, net of allowance for doubtful accounts of $431,282 in 2006 and $461,282 in 2005			3,380,455				3,272,278
Prepaid expenses and other current assets			706,504				387,426
Deferred tax assets			520,152				520,152
Total current assets			9,912,001				10,082,375
PROPERTY AND EQUIPMENT:
Equipment and leasehold improvements, at cost			10,135,839				10,119,679
Less-accumulated depreciation and amortization			(9,421,270	)			(9,342,747	)
			714,569				776,932
DEFERRED TAX ASSETS			245,889				245,889
OTHER ASSETS, NET			39,830				39,830
		$	10,912,289			$	11,145,026
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	262,113			$	367,535
Accrued expenses			739,667				1,292,257
Deferred revenue			602,846				590,670
Total current liabilities			1,604,626				2,250,462
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 issued			28,754				28,754
Paid-in capital			25,454,425				25,446,781
Accumulated deficit			(7,052,825	)			(7,458,280	)
Less — Treasury stock, at cost; 583,797 shares			(9,122,691	)			(9,122,691	)
Total shareholders’ equity			9,307,663				8,894,564
		$	10,912,289			$	11,145,026

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 MARCH 31,
		2006				2005
REVENUE		$	5,066,730			$	5,337,750
COST OF REVENUE			2,116,149				2,164,830
Gross profit			2,950,581				3,172,920
EXPENSES:
General and administrative			763,981				872,638
Marketing and selling			665,567				729,081
Research and development			112,578				71,947
			1,542,126				1,673,666
OPERATING INCOME			1,408,455				1,499,254
INTEREST INCOME			58,710				12,636
OTHER INCOME			—				1,250
			58,710				13,886
INCOME BEFORE INCOME TAXES			1,467,165				1,513,140
PROVISION FOR INCOME TAXES			545,000				565,000
NET INCOME		$	922,165			$	948,140
BASIC NET INCOME PER SHARE		$	0.18			$	0.18
DILUTED NET INCOME PER SHARE		$	0.18			$	0.18
DIVIDENDS DECLARED PER SHARE		$	0.10			$	0.08
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC			5,167,097				5,128,508
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, DILUTED			5,209,456				5,141,527

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)

		THREE MONTHS
		ENDED MARCH 31,
		2006				2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	922,165			$	948,140
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization			78,523				120,408
Stock option expense			7,644				—
Tax benefit associated with exercise of options			—				21,411
Changes in current assets and liabilities:
Accounts receivable			(108,177	)			(237,440	)
Prepaid expenses and other current assets			(319,078	)			(322,055	)
Accounts payable			(105,422	)			(4,113	)
Accrued expenses			(552,590	)			405,150
Deferred revenue			12,176				14,910
Net cash (used in) provided by operating activities			(64,759	)			946,411
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments			(500,000	)			(2,000,000	)
Purchases of property and equipment			(16,160	)			(40,058	)
Decrease in other assets			—				2,228
Net cash used in investing activities			(516,160	)			(2,037,830	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid			(516,710	)			(410,153	)
Net proceeds from the issuance of common stock			—				310,177
Net cash used in financing activities			(516,710	)			(99,976	)
NET DECREASE IN CASH AND CASH EQUIVALENTS			(1,097,629	)			(1,191,395	)
CASH AND CASH EQUIVALENTS, beginning of period			3,352,519				3,260,178
CASH AND CASH EQUIVALENTS, end of period		$	2,254,890			$	2,068,783

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

March 31, 2006

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, 2005. 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 ended March 31, 2006 may not be indicative of the results that may be expected for the year ending December 31, 2006, or any other period.

2. Stock-Based Compensation

The Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (SFAS 123R) effective January 1, 2006. SFAS 123R requires the recognition of the fair value of stock-based compensation as a charge against earnings. The Company recognizes stock-based compensation expense over the requisite service period of the individual grantees, which generally equals the vesting period. Based on the provisions of SFAS 123R the Company’s stock-based compensation is accounted for as equity instruments. Prior to January 1, 2006, the Company followed Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for stock-based compensation. The Company has elected the modified prospective transition method for adopting SFAS 123R. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption, as well as to the future vesting of awards granted and not vested as of the date of adoption.

The Company has a stock option plan (the “2000 Stock Option Plan”) under which options to acquire shares of the Company’s common stock may be granted to directors, officers and certain employees of the Company. The Company also has stock option plans that have expired, but shares can be issued upon exercise of outstanding options that were granted prior to such expiration. Activity for these plans is included in this footnote. Options granted under the plans may be either non-qualified or incentive stock options and are granted at a price that is not less than the fair market value of the common stock at the date of grant. These options generally have lives of ten years and vest either immediately or over periods up to four years.

Under the provisions of SFAS 123R, the Company recorded $7,644 of stock-based compensation in the accompanying statement of income for the three months ended March 31, 2006. No options were granted or modified during the three months ended

PSYCHEMEDICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

March 31, 2006.

In March 2006 the Company adopted a new stock-based plan (the “2006 Equity Incentive Plan”), which is subject to shareholder approval at the 2006 Annual Shareholders’ meeting. During the three months ended March 31, 2006, no options were granted under the 2006 Equity Incentive Plan.

SFAS 123R requires the presentation of pro forma information for the comparative period prior to the adoption as if the Company had accounted for all its employee stock options under the fair value method of the original SFAS 123. The following table illustrates the effect on net income (loss) and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123R to stock-based employee compensation to the prior-year:

		Three
		Months
		Ended
		March 31,
		2005
Net income, as reported		$	948,140
Less: Total stock-based compensation cost determined under the fair value based method for all employee awards			(9,558	)
Pro forma net income		$	938,582
Net income per share:
Basic and diluted, as reported		$	0.18
Basic and diluted, pro forma		$	0.18

A summary of stock option activity for the three months ended March 31, 2006 is as follows:

						Weighted				Weighted
						Average				Average
		Number				Exercise				Remaining				Aggregate
		of				Price				Contractual				Intrinsic
		Shares				Per Share				Life				Value (1)
Outstanding, December 31, 2005			556,946			$	16.09
Granted			—				—
Exercised			—				—
Terminated			(6,438	)			22.03
Outstanding, March 31, 2006			550,508			$	16.01			6.5 years				$	1,439,050
Exercisable, March 31, 2006			540,060			$	16.08			6.5 years				$	1,387,558
Available for grant, March 31, 2006			88,211

PSYCHEMEDICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

As of March 31, 2006, a total of 638,719 shares of common stock were reserved for issuance under the various stock option plans. As of March 31, 2006, the unamortized fair value of awards relating to stock options was $5,642.

3. Basic and Diluted Net Income Per Share

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

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

		Three Months Ended
		March 31,				March 31,
		2006				2005
Weighted average common shares outstanding			5,167,097				5,128,508
Dilutive common equivalent shares			42,359				13,019
Weighted average common shares outstanding, assuming dilution			5,209,456				5,141,527

For the three months ended March 31, 2006 and 2005, options to purchase 200,919 and 291,283 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 is in the business of performing drug testing and reporting the results thereof. The Company’s drug testing services include 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 (“EITF”) Issue No. 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

PSYCHEMEDICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

purposes as the training and storage costs are de minimis and 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 March 31, 2006 and December 31, 2005, the Company had deferred revenue of approximately $603,000 and $591,000, 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 May 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154, Accounting Changes and Error Corrections, which replaced Accounting Principles Board (“APB”) Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements – An Amendment of APB Opinion No. 28. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, as of the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS No. 154 became effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material impact on the Company’s financial position, results of operations or cash flows during the three months ended March 31, 2006, however, the impact of adopting SFAS No. 154 is dependent upon events that could occur in future periods and, therefore, cannot be determined until, and if, an event occurs in the future period.

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 May 2, 2006, the Company declared a quarterly dividend of $.125 per share, which will be paid on June 23, 2006 to shareholders of record on June 9, 2006.

Item 2

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

FACTORS THAT MAY AFFECT FUTURE RESULTS

From time to time, information provided by the Company or statements made by its employees may contain “forward-looking” information which involves risks and uncertainties. In particular, statements contained in this report which are not historical facts (including, but not limited to, the Company’s expectations regarding revenues, business strategy, general and administrative expenses, marketing and selling expenses, research and development expenses, anticipated operating results, strategies with respect to governmental agencies and regulations, cash dividends, cost savings, 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.

OVERVIEW

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

Revenue was $5.1 million for the first quarter of 2006 and was 5% below revenue of $5.3 million for the first quarter of 2005. The Company reported net income of $0.18 per share in the quarter ended March 31, 2006 and in the quarter ended March 31, 2005. At March 31, 2006, the Company had $5.3 million of cash, cash equivalents, and short-term investments. During the first quarter of 2006, the Company distributed $0.5 million, or $0.10 per share, of cash dividends to its shareholders. The Company has paid thirty-eight consecutive quarterly cash dividends.

RESULTS OF OPERATIONS

Revenue was $5,066,730 for the three months ended March 31, 2006 as compared to $5,337,750 for the comparable period of 2005, representing a decrease of 5%. The decrease in revenue for the first quarter of 2006 was due to a decrease of 8% in testing volume from both new and existing clients, while the average revenue per sample increased by 3% as compared to the comparable period of 2005. The Company continued to add approximately the same number of new clients in the first quarter of 2006 as it did in the first quarter of 2005.

Gross margin was 58% of revenue for the three months ended March 31, 2006, as compared to 59% for the comparable period of 2005. Even though average revenue per sample increased by 3%, gross margin decreased primarily due to the decrease in testing volume of 8% as fixed and semi-variable direct costs were spread over a lesser number of tests performed for the three months ended March 31, 2006, as compared to the same period of 2005. Also, a slight increase in material costs contributed to the decrease in gross margin for the three month period ended March 31, 2006, as compared to the year earlier period.

General and administrative (“G&A”) expenses were $763,981 for the three months ended March 31, 2006 as compared to $872,638 for the comparable period of 2005, representing a decrease of 12%. The decrease in general and administrative expenses was due primarily to reduced professional fees related to Sarbanes-Oxley compliance work performed in the first quarter of 2005, reduced legal fees and a decrease in bad debt expense, partially offset by an increase in personnel expenses. All other general and administrative expenses remained relatively constant. As a percentage of revenue, G&A expenses represented 15% of revenues in the first quarter of 2006 and 16% of revenues in the first quarter of 2005. The Company expects general and administrative expenses to remain relatively flat in absolute dollars and decrease as a percentage of revenue during the remainder of 2006 unless the Company is required to fully comply with the internal control testing and attestation provisions of Sarbanes-Oxley by December 31, 2006 based on its June 30, 2006 market capitalization, in which case it will incur increased professional fees and costs related to Sarbanes-Oxley testing and compliance.

Marketing and selling expenses were $665,567 for the three months ended March 31, 2006 as compared to $729,081 for the comparable period of 2005, a decrease of 9%. This decrease was due primarily to reduced personnel expenses resulting from short-term fluctuations in the Company’s sales and support staff for the three months ended March 31, 2006 as compared to the comparable period of 2005. Total marketing and selling expenses represented 13% of revenues in the first quarter of 2006 and 14% of revenues in the first quarter of 2005. The Company expects marketing and selling expenses to increase in absolute dollars and decrease as a percentage of revenue during the remainder of 2006 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 were $112,578 for the three months ended March 31, 2006 as compared to $71,947 for the comparable period of 2005, an increase of 56%. This increase was primarily due to an increase in personnel expenses. R&D expenses represented 2% of revenues for the three months ended March 31, 2006 and 1% of revenues for the three months ended March 31, 2005. The Company expects research and development expenses to increase slightly during the remainder of 2006 as compared to 2005.

Interest income for the three months ended March 31, 2006 increased by $46,074 as compared to the comparable period of 2005 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 2006 as compared to 2005 caused the increase in interest income.

During the three months ended March 31, 2006, the Company recorded a tax provision of $545,000 reflecting an effective tax rate of 37.1% as compared to a tax provision of $565,000 reflecting an effective tax rate of 37.3% for the three months ended March 31, 2005.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2006, the Company had approximately $5.3 million of cash, cash equivalents and short-term investments. The Company’s operating activities used net cash of $64,759 in the three months ended March 31, 2006. Investing activities used $516,160 in the three month period while financing activities used a net amount of $516,710 during the period.

Cash used in operating activities of $64,759 principally reflected a decrease in accrued expenses and an increase in prepaid expenses along with a lesser decrease in accounts payable and a lesser increase in accounts receivable, partially offset by net income of $922,165 adjusted for depreciation and amortization of $78,523. The decrease in accrued expenses was due to the payment during the first quarter of increased income tax amounts and of bonus expense that was accrued as of December 31, 2005. The increase in prepaid expenses was due primarily to the payment of annual insurance premiums during the first quarter of 2006.

Capital expenditures in the first three months of 2006 were $16,160. The expenditures primarily consisted of new equipment, including laboratory and computer equipment. The Company currently plans to make capital expenditures of approximately $600,000 in 2006, 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, which the Company expects to fund primarily through its operating cash flows.

During the three months ended March 31, 2006, the Company distributed $516,710 in cash dividends to its shareholders. The Company did not repurchase any shares for treasury during the quarter ended March 31, 2006. The Company has authorized 500,000 shares for repurchase since June of 1998, of which 466,351 shares have been repurchased.

Contractual obligations as of March 31, 2006 were as follows:

		Less Than				1-3				4-5				After 5
		One Year				Years				years				Years				Total
Operating leases		$	505,000				899,000				832,000				507,000			$	2,743,000
Purchase commitment			272,000				—				—				—				272,000
		$	777,000			$	899,000			$	832,000			$	507,000			$	3,015,000

          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 $135,958 for the three months ended March 31, 2006 as compared to $123,576 for the comparable period of 2005. The Company expects to purchase approximately $408,000 for the remainder of 2006. 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 March 31, 2006, the Company’s principal sources of liquidity included an aggregate of approximately $5.3 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 March 31, 2006, the Company had no long-term debt.

CRITICAL ACCOUNTING POLICIES

Management believes the most critical accounting policies are as follows:

          Revenue Recognition

The Company is in the business of performing drug testing and reporting the results thereof. The Company’s drug testing services include 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 (“EITF”) Issue No. 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 are de minimis and 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 recognized 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). Realized gain is then recognized (as other income) when the Company can reasonably, reliably and objectively determine that an estimated amount of breakage has occurred. Breakage is deemed to occur only at the point it becomes remote that performance will be required for an estimable portion of transactions. The Company has not recorded any breakage in the first quarter of 2006 or during all of 2005. 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 has 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.

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 1A. Risk Factors

There have been no material changes in our risk factors from those disclosed in our 2005 Annual Report on Form 10-K.

Item 6. Exhibits

See Exhibit Index included in this Report

15

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: May 12, 2006		By:		/s/ Raymond C. Kubacki, Jr.
		Raymond C. Kubacki, Jr.
		Chairman and Chief Executive Officer
Date May 12, 2006		By:		/s/ Peter C. Monson
		Peter C. Monson
		Vice President, Treasurer & Chief Financial Officer

PSYCHEMEDICS CORPORATION
FORM 10-Q
March 31, 2006

EXHIBIT INDEX

				Page No.
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002			18
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002			19
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			20
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			21