II It .1 yti 1% Dear Fellow Shareholders 2012 was year of major accomplishments transition and investment in the future At the same time we were able to achieve record revenues primarily due to strong new business growth Our major accomplishments included the reestablishment of our strong patent position protection FDA clearance of custom-designed enzyme immunoassays EIA that are equivalent to the robust radioimmunoassays we have been using and successful transition to new production process with our custom-designed assays In December 2011 and 2012 we received new patents covering process that releases virtually 100% of the drugs trapped in hair without destroying the drugs These patents are fundamental to hair analysis drug testing because if you cant get the drugs out of the hair you cannot measure them Psychemedics was the first and only lab to gain fundamental patent on getting drugs out of the hair almost 20 years ago Now with our new patent we still remain the only lab to master that scientific challenge This is great testament to Psychemedics ongoing commitment to providing the highest quality test possible and distinguishes us from other labs In the second quarter of 2012 the FDA granted the Company 510k clearances for five new additional assays to test for the detection and marijuana using EIA analysis of head and body hair As you know Psychemedics have historically of cocaine opiates PCP methamphetamine as radioimmunoassays has been always used radioimmunoassays the gold standard among the broad class of for screening immunoassays produced by the RD team at Psychemedics immunoassays The newly developed EIA were uniquely custom-designed specifically to meet the standards of our radioimmunoassays and represent significant technological breakthrough No other hair testing lab has accomplished this By combining our new patented method of releasing the drugs from the hair with our new FDA-cleared custom-designed enzyme immunoassays which are equivalent in effectiveness and sensitivity to radioimmunoassay we continue to demonstrate our technological leadership we re-established our strong patent position and we continue to offer truly proprietary patented technology that provides superior detection of drugs of abuse for our many clients That is what sets us apart Once we received transition from radioimmunoassay the patent and FDA clearances we needed to implement our to our custom-designed EIA process This actual transition was major effort that involved all aspects of our Company am pleased to say that we made this once in generation transition with an almost seamless impact to our clients That said the transition impacted 2012 profits because of additional costs to re-engineer several operational processes and systems and maintain two processes in parallel to ensure smooth transition for our clients as well as one-time development costs Even with this impact we still recorded pre-tax margin for 2012 of 20% For the last couple years have discussed the continued investment we have made in our sales and marketing area This continued in 2012 and was reflected in strong new business numbers This was not as evident when looking at the top line growth This is because our base business declined primarily from customers hiring less which stemmed from general economic conditions In addition to sales and marketing we made significant investment in equipment and software as upgrading lab equipment and supporting marketing initiatives to support our new EIA process as well The capital investment over the last two years is in excess of $4 million reflecting our continued commitment towards the future Our focus has been and will continue to be the accelerated growth of the companys top and bottom lines We are well positioned for future growth We are the worlds largest provider of drug testing using hair analysis We have the most sensitive drug test available which results in higher detection rate This higher detection rate serves as powerful upfront deterrent to drug use What makes our test the most sensitive and effective is our patented 100% of the drug out of the hair if you cant get we have the most sensitive screening tests and all allows us to get virtually process the drug out you cant measure tests are cleared by the FDA it we have been and continue to be the leader in mass-spectrometry confirmation testing and we have the most extensive legal track record supporting our patented testing method We have very strong technology platform and customer base to build on and are excited about the years ahead The Companys balance sheet remains strong with approximately $3.1 million in cash equivalents and no long-term debt Our directors share our confidence in the future of Psychemedics and remain committed to rewarding shareholders and sharing the financial success of the Company as we grow As result at the end of 2012 the Company had paid 65 consecutive quarterly dividends which is more than 16 years We are also very proud that we have been profitable every year for the last 20 years since 1993 through numerous recessions and other challenges would like to take this opportunity to express my sincere appreciation to all our clients for the contribution they are making to deter the use of drugs of abuse to our Directors for their counsel and guidance and to all my teammates commitment and dedication to excellence in serving our customers And at Psychemedics for their want to thank you our shareholders for your continued support Sincerely4A4 Raymond Kubacki Chairman President and Chief Executive Officer UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15d OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31 2012 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15d OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-13738 PSYCHEMEDICS CORPORATION Exact Name of Registrant as Specified in Its Charter Delaware State or Other Jurisdiction of Incorporation or Organization 125 Nagog Park Acton Massachusetts Address of Principal Executive Offices 58-1701987 I.R.S Employer No Identification 01720 Zip Registrants Telephone Number Including Area Code 978 Securities registered pursuant to Section 12b of the Act Common Stock $0.005 par value Title of Class Securities registered pursuant to Section 12g of the Act None Indicate by check mark if the registrant is well-known seasoned issuer as defined in Rule 405 of the Exchange Act of 1934 Yes No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15d of the Securities Exchange Act of 1934 Yes No Indicate by check mark whether the registrant has filed all reports required to be filed by Section 13 or 15d 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 has been subject to such filing requirements for the past 90 days Yes No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site if any every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation for such shorter period that the registrant was required to submit and post such files Yes S-T during the preceding No 12 months or Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 229.405 of this chapter is not contained herein and will not be contained to the best of registrants knowledge in definitive proxy or information statements incorporated by reference in Part ifi of this Form 10-K or any amendment to this Form 10-K Indicate by check mark whether the registrant is large accelerated filer an accelerated filer or non-accelerated filer See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Securities Exchange Act of 1934 Large Accelerated Filer Accelerated Filer Non-Accelerated Filer Smaller Reporting Company Indicate by of 1934 Yes No check mark whether the registrant is shell company as defined in Rule 12b-2 of the Securities and Exchange Act Do not check if smaller reporting company As of June 30 2012 there were 5272428 shares of Common Stock of the Registrant outstanding The aggregate market value the Common Stock of the Registrant held by non-affiliates of officers directors and 5% shareholders are affiliates assuming for these purposes but not conceding that all executive of the Registrant as of June 30 2012 was approximately $38 million computed based As of February upon the closing price of $10.29 per 25 2013 there were 5272428 shares of Common Stock of share on June 30 2012 the Registrant outstanding Part III of this Annual Report on Form 10-K incorporates by reference portions of the Registrants definitive proxy statement to be filed with the Securities and Exchange Commission no later than 120 days after the close of its fiscal year provided that if such DOCUMENTS INCORPORATED BY REFERENCE proxy statement than the end of the 120-day period is not filed with the Commission in such 120-day period an amendment to this Form 10-K shall be filed no later SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Some of the statements under Business Risk Factors Legal Proceedings Market for Registrants Common Stock and Related Stockholder Matters Financial Condition and Results of Operations and elsewhere and Management Discussion in this Annual Report on Form 10-K this and Analysis of Form 10-K constitute forward-looking amended and Section 21E of statements under Section 27A of the Securities Act of 1933 as the Securities Exchange Act of 1934 as amended including statements made with respect to future earnings per share future revenues future operating income future cash flows competitive and strategic initiatives potential stock repurchases and future liquidity needs These statements involve known and unknown risks uncertainties and other factors that may cause results levels of activity growth perfonnance earnings per share or achievements to be materially different from any future results levels of activity growth performance earnings per share or achievements expressed or implied by such forward-looking statements The forward-looking statements included in this Form 10-K and referred to elsewhere are related to future events or our strategies or future financial performance In some cases you can identify forward-looking statements by terminology estimate encourage potential plan expand focus through strategy provide offer allow commitment implement result increase establish perform make continue can ongoing include or the negative terms or comparable terminology All forward-looking statements of such such as may should believe anticipate opportunity growth leader could expect future intend included in this Form 10-K are based on information available to us as of the filing date of this report and the Company assumes no obligation to update any such forward-looking statements Our actual results could differ materially from the forward-looking statements Important factors that could cause actual results to differ materially from expectations reflected in our forward-looking statements include those described in Item 1A Risk Factors PSYCHEMEDICS CORPORATION FORM 10-K ANNUAL REPORT For the Year Ended December 31 2012 TABLE OF CONTENTS PART Item Business Item 1A Risk Factors Item lB Unresolved Staff Comments Item Item Item Item Item Item Properties Legal Proceedings Mine Safety Disclosures Market for Registrants Common Equity Related Stockholder Matters and Issuer PART II Purchases of Equity Securities Selected Financial Data Managements Discussion and Analysis of Financial Condition and Results of Operations Item 7A Quantitative and Qualitative Disclosures About Market Risk Item Item Financial Statements and Supplementary Data Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Item 9A Controls and Procedures Item 9B Other Information PART III Item 10 Directors Executive Officers and Corporate Governance Item 11 Executive Compensation Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13 Certain Relationships and Related Transactions and Director Independence Item 14 Principal Accountant Fees and Services Item 15 Exhibits and Financial Statement Schedules PART IV Signatures Power of Attorney Page 11 11 11 11 12 14 15 19 20 36 36 36 37 38 38 38 38 39 40 40 11 Available Information Background PART Psychemedics Corporation 125 Nagog Park Acton MA 01720 Our NASDAQ Stock Exchange Market under The Company makes available the Company or Psychemedics the symbol PMD Our number telephone maintains executive offices located at is 978 206-8220 Our stock is traded on the Internet address is wwwpsychemedics.com free of charge on the Investor Information section of its website its Annual Report on Form 10-K Quarterly Reports on Form 10-Q Current Reports on Form 8-K and all amendments to those reports as soon as and Exchange Conmiission reasonably practicable the SEC Copies after such material is electronically filed with the Securities are also available without charge from Psychemedics Corporation Attn Investor Relations SEC may be viewed or obtained Internet site at wwwsec.gov We do not Annual Report on Form 10-K 125 Nagog Park Acton MA 01720 Alternatively reports filed with the at the SEC Public Reference Room in Washington D.C or the SECs intend for information contained in our website to be part of this Item Business General Psychemedics Corporation is Delaware corporation organized on September 24 1986 to provide testing services for the detection of drugs of abuse through the analysis of hair samples The Companys testing methods utilize patented technology that focuses on liquefying hair and releasing drugs trapped in the hair without destroying the drugs This is fundamental to the entire process because the patented method gets virtually 100% of the drug out of the hair and if you cannot get it The Company then performs proprietary custom-designed enzyme with confirmation testing by mass spectrometry the drug out of the hair you cannot measure immunoassay EIA on the precipitate The Companys primary application of its patented technology is as testing service that analyzes hair samples for the presence of certain drugs of abuse The Companys customized proprietary EIA procedures to drug test hair samples differ from the more commonly-used immunoassay procedures employed to test urine samples The Companys tests provide quantitative information that can indicate the approximate amount of drug ingested as well as historical data which can show pattern of individual drug use over longer period of time thereby providing superior detection compared to other types of drug testing This information is useful to employers for both applicant and employee testing as well as to physicians treatment professionals law enforcement agencies school administrators and parents concerned about their childrens drug use The Company provides screening cocaine marijuana PCP amphetamines and confirmation by mass spectrometry using industry-accepted practices for including ecstasy and opiates including heroin hydrocodone hydromorphone oxycodone and codeine Testing services are currently performed at the Companys laboratory at 5832 Uplander Way Culver City California Development of Testing Method for Drugs of Abuse Using Hair The analysis of drugs in the hair was initially developed in 1978 by the founders of the Company Annette Baumgartner and Werner Baumgartner Ph.D The Baumgartners demonstrated that when certain chemical substances enter the bloodstream the blood carries these substances to the hair where they become entrapped in the protein matrix in amounts approximately proportional to the amount ingested The Company initially utilized patented drug extraction method followed procedure to identify drugs in the hair In 2011 the Company developed by unique radioimmunoassy RIAH new patented method which it is currently using for drug extraction This patent covers the efficient liquefaction of hair and release of the drugs without destroying the drugs getting virtually 100% of the drug out of the hair The new patented method can be used with broad range of immunoassay screen techniques mass spectrometry methods and chromatographic procedures In 2012 the Company developed In its 510k the RIAH test filing with the U.S Food its current custom designed immunoassay EIA test and Drug Administration FDA the Company enzyme to replace demonstrated to the FDAs satisfaction that the new EIA assay is substantially equivalent to the RIAH assay This is significant newly developed as the RIAH process immunoassays produced by the Psychemedics RD team were uniquely set the standard for its sensitivity designed robustness and consistency The specifically to meet and even exceed the standards of radioimmunoassay and represent significant technological breakthrough Because Psychemedics is the only hair testing laboratory that manufactures its own screening assays it has full control over all aspects of its technology and that powerful advantage facilitated the Companys creation of the new assays with equivalence to its own previously FDA-cleared radioimmunoassay The EIA screened positive results are then confirmed by mass spectrometry Depending upon the length of hair the Company is able to provide historical information sample was obtained Because head hair grows approximately on drug use by the person 1.3 centimeters per month from whom the 3.9 centimeter head hair sample can sample Another option is sectional analysis of the head hair sample in which the hair is sectioned ingestion over reflect drug the approximate three months prior to the collection of the lengthwise to approximately correspond to certain time periods thereby providing information on patterns of drug use Validation of the Companys Proprietary Testing Methods The process cf analyzing human hair for the presence of drugs has been the subject of numerous peer-reviewed publication scientific field studies The results from the studies have been published or accepted for in scientific journals have been generally favorable to the Companys technology Some of these studies were performed with the following organizations Boston University School of Public Health Citizens for Better Community Court Columbia University Connecticut Department of Mental Health and Addictive Services Koba Associates-DC Initiative Harvard Cocaine Recovery Project Hutzel Hospital ISA Associates Interscience America-NIDA Workplace Study University of California-Sleep State Organization MaternallChild Substance Abuse Project Matrix Center National Public Services Research Institute Narcotic and Drug Research Stapleford Centre London Task Force Institute San Diego State University-Chemical Dependency Center Spectrum Inc on Violent Crime Cleveland Ohio University of Miami-Department of Psychiatry University of Miami-Division of Neonatology University of South Florida-Operation Par Inc University University of Washington VA Medical Center-Georgia U.S Probation Parole-Santa Ana and Wayne State The above studies included research effects of prenatal drug use treatment areas in the following evaluation workplace drug use the criminal justice system and epidemiology Many of the studies have been funded by the National Institute of Justice or the National Institute on Drug Abuse NIDA Several hundred research articles written by independent researchers have been published supporting the general validity and usefuiLness of hair analysis Some of the Companys customers have also completed their own testing to validate the Companys hair test results compared to other companies urine test results These studies consistently confirmed the Companys superior detection rate compared to urinalysis testing When testing methods were compared to urine results in side-by-side evaluations results from the Companys hair to 10 times as many drug abusers were accurately identified by the Companys proprietary methods In 1998 the National Institute of Justice utilizing Psychemedics RIAH hair testing assay completed Pennsylvania Prison study where hair analysis revealed an average prison drug use level of approximately 7.9% in 1996 Comparatively urinalysis revealed virtually were instituted drug-sniffing dogs searches and scanners no positives After measures to curtail drug use 2% according the use level to approximately fell to the results of hair analysis in 1998 Again the urine tests showed virtually no positives The study illustrates the usefulness of hair analysis to monitor populations and the weakness of urinalysis The Company has received 510k clearance from the FDA on all five of its assays used to test head and body hair FDA clearance for drugs of abuse As of the date of for testing of drugs of abuse this document Psychemedics using both head and body hair is the only company to receive Advantages of Using the Companys Patented Method The Company asserts that hair testing using its patented method confers substantive advantages over detection through urinalysis Although urinalysis testing can provide accurate drug use information the scope of the information is short-term and is generally limited to the type of drug ingested within few days of the test Studies published in many scientific publications have indicated that most drugs disappear from urine within few days In contrast to urinalysis testing hair testing using the Companys patented method can provide long-term historical drug use information resulting in significantly wider window of detection This window may be several months or longer depending on the length of the hair sample The Companys standard test offering however uses 3.9 centimeter length head hair sample cut close to the scalp which measures use for approximately three months prior to collection of the sample This wider window enhances the detection efficiency of hair analysis making it particularly useful in pre-employment and random testing Hair testing not only identifies more drug users but it may also uncover patterns and severity of drug use information most helpful in determining the scope of an individuals involvement with drugs while serving as deterrent against drug use Hair testing employing the Companys patented method greatly reduces the incidence of false negatives associated with evasive measures typically encountered with urinalysis testing For example urinalysis test results are adversely impacted by excessive fluid intake prior to testing and by adulteration or substitution of the urine sample Moreover drug user who abstains from use for few days prior to urinalysis testing can usually escape detection Hair testing is effectively free of these problems as it cannot be thwarted by evasive measures typically encountered with urinalysis testing Hair testing is also attractive to customers since sample collection is typically performed under close supervision yet is less intrusive and less embarrassing for test subjects Hair testing using the Companys patented method with mass spectrometry confirmation further reduces the prospects of error in conducting drug detection tests Urinalysis testing is more susceptible to problems such as evidentiary false positives resulting from passive drug exposure or poppy seeds To combat this problem in federally mandated testing the opiate cutoff levels for urine testing were raised 667% from 300 to 2000 ng/ml on December 1998 and testing for the presence of heroin metabolite 6-AM was required These requirements however effectively reduced the detection time frame for confirmed heroin with 6-AM in urine down to several hours post drug use In contrast the metabolite 6-AM is stable in hair and can be detected for months In the event positive urinalysis test result is challenged test on newly collected urine sample is not viable remedy Unless the forewarned individual continues to use drugs prior to the date of the newly collected sample re-test may yield negative result when using urinalysis testing because of temporary abstinence In contrast when the Companys hair testing method is offered on repeat hair sample the individual suspected of drug use cannot as easily affect the results because historical drug use data remains locked in the hair fiber When compared to other hair testing methods not only are the Companys assays cleared by the FDA for head and body hair they also employ unique patented method of liquefying hair that the Company believes allows for the most efficient release of drugs from the hair without destroying the drugs The Companys method of releasing drugs from hair is key advantage and results in superior detection rates Disadvantages of Hair Testing There are some disadvantages of hair testing as compared to drug detection through urinalysis Because hair starts growing below the skin surface drug ingestion evidence does not appear in hair above the scalp until approximately five to seven days after use Thus hair testing is not suitable for determining drug presence in for cause testing as is done in connection with an accident It does however provide drug history which can complement urinalysis information investigation in for cause testing The Companys prices for its tests are generally somewhat higher than prices for tests using urinalysis but the Company believes that its superior detection rates provide more value to the customer This pricing policy could however adversely impact the growth of the Companys sales volume Intellectual Property Certain aspects of the hair analysis method currently used by the Company are covered by US and foreign patents owned by the Company The Company has been granted total of eight US patents On December 27 2011 patent was issued to the Company that focuses on liquefying hair and releasing drugs trapped in the hair without destroying the drugs The new patented method can be used with broad range of immunoassay screen techniques mass spectrometry methods and chromatographic procedures On December 11 2012 the company received an additional patent that extended the range of the patent received in 2011 for the liquefying of hair The Company also relies on trade secrets to protect certain aspects of its proprietary technology The Companys ability to protect the confidentiality of its trade secrets is dependent upon the Companys internal safeguards and upon the laws protecting trade secrets and unfair competition In the event that patent protection or protection under the laws of trade secrets is not sufficient and the Companys competitors succeed in duplicating the Companys products the Companys business could be materially adversely affected Target Markets Workplace The Company focuses its primary marketing efforts on the private sector with particular emphasis on job applicant and employee testing Most businesses use drug testing survey from 2007 indicated that 85 percent to screen job applicants and employees of human resource HR professionals believe that drug testing The Hazeldon Foundation is an effective way to diagnose substance abuse The prevalence of drug screening programs reflects concern use contributes to employee health problems and costs as the same study found that 62 percent of that drug HR professionals believe that absenteeism is the most significant problem caused by substance abuse and addiction followed at 49 percent by reduced productivity lack of trustworthiness at 39 percent negative impact on the companys external image at 32 percent missed deadlines at 31 percent and in certain industries safety hazards It has been estimated that the cost to American businesses is more than $100 billion annually The principal criticism of employee drug program Most private sector testing programs testing programs centers on the effectiveness of use urinalysis Such programs are susceptible to evasive the testing maneuvers and the inability to obtain confirmation through repeat samples in the event of challenged result An industry has developed over the Internet and through direct mail marketing wide variety of adulterants dilutants clean urine and devices to assist drug users in falsifying urine test results Moreover scheduled tests such as pre-employment testing and some random testing programs provide an opportunity for many drug users to simply abstain for few days in order to escape detection by urinalysis The Company presents its patented hair analysis method to potential clients as better technology well suited to employer needs Field studies and actual client results support the accuracy and effectiveness of the Companys patented technology and its ability to detect varying levels of drug use This information provides an employer with greater flexibility in assessing the scope of an applicants or an employees drug problem The Company performs The use of mass spectrometry confirmation test of all screened positive results through mass spectrometry is an industry accepted practice used to confirm positive test result from the The Company offers screening cocaine PCP marijuana amphetamines process its clients five-drug screen with mass spectrometry confirmation of including Ecstasy and opiates including heroin and oxycodone Schools The Company currently serves hundreds of schools throughout the United States and in several foreign countries The Company offers its school clients the same five-drug screen with mass spectrometry confirmation that is used with the Companys workplace testing service Parents The Company also offers personal drug testing service known as PDT90 for parents concerned about drug use by their children It allows parents to collect small sample from their child in the privacy of the home send it to the Companys laboratory and have it tested for drugs of abuse by the Company The PDT-90 testing testing service service uses the same patented method that is used with the Companys workplace Research The Company is involved in the following ongoing studies involving use of drugs of abuse in various populations Boston Medical Center Boston University School of Public Health University of North Carolina-Chapel Hill Johns Hopkins Bloomberg School of Public Health Mclean Hospital Wayne State University and Chemistry and Drug Metabolism Section NIDA and Emmes Corporation Sales and Marketing The Company markets its corporate drug testing services primarily through its own sales force and through distributors Sales offices are located in several major cities in the United States in order to facilitate communications with corporate employers The Company markets its home drug testing service PDT-90 through the Internet Competition The Company competes directly with numerous commercial laboratories that test for drugs primarily through urinalysis testing Most of these laboratories such as Quest Diagnostics have substantially greater financial resources market identity marketing organizations facilities and more personnel than the Company The Company has been steadily with new customers is dependent drug program utilizing on the Companys ability the Companys patented hair analysis method increasing its base of corporate customers and believes that future success to communicate the advantages of implementing The Companys ability to compete is also function of pricing The Companys prices for its tests are generally somewhat higher than prices for tests using urinalysis However the Company believes that its superior detection rates coupled with the customers ability to test less frequently due to hair testings wider window of detection several months versus approximately three days with urinalysis provide more value to the customer This pricing policy could however lead to slower sales growth for the Company The Company also competes with other hair testing laboratories The Company distinguishes itself from hair testing competitors by emphasizing the superior results patented extraction method getting drug out of the hair in combination immunoassay screen the Company obtains through its unique with the Companys FDA cleared use of In addition Psychemedics is the only laboratory with FDA clearance for five-drug panel test that is not limited to head hair samples for drugs of abuse To date no other laboratory engaged in hair testing has received approval or clearance from the FDA on all of its assays partial FDA clearance for the testing or clearance of both head and body hair to head hair specific samples two other laboratories have either samples only Government Regulation The Company is licensed as clinical laboratory by the State of California as well as certain other states All tests are performed according to the laboratory standards Human Services through the Clinical Laboratories Improvement licensing statutes established by the Department of Health and Amendments CLIA and various state substantial number of states regulate drug testing The scope and nature of such regulations varies greatly from state to state and is subject to change from time to time The Company addresses state law issues on an ongoing basis In 2000 the FDA issued regulations under FDC Act with respect the regulations to companies that market drugs of abuse the Federal Food Drug and Cosmetic Act as amended the test sample collection systems Under companies engaged in the business of testing not previously recognized by the FDA are required to submit for drugs of abuse their assay to the FDA for recognition prior to test screening using assay marketing In addition the laboratory performing the tests is required to be certified by recognized agency The regulations included transitional period in order for companies not immediately in compliance with the proposed requirements to obtain the necessary data they needed for submission Company had received 510k clearance to market all five of its assays utilizing RIAH technology to the FDA By May 2002 the In June 2008 Psychemedics also received the first CAP College of American Pathologists certification specifically including hair testing In November 2011 the Company received ISO/IEC 17025 International Accreditation for broad spectrum of laboratory testing including drugs of abuse and forensics in hair and urine specimens ISO/IEC 17025 accreditation provides formal recognition to laboratories that demonstrate technical competency and maintains this recognition through periodic evaluations to ensure continued compliance By June 2012 the Company had received 510k clearance to market all five of its assays utilizing EIA technology Research and Development The Company is continuously engaged in research and development activities During the years ended December 31 2012 2011 and 2010 $825518 $607408 and $481433 respectively were expended for research and develcpment The Company continues to perform research activities to develop new products and services and to improve existing products and services utilizing the Companys proprietary technology The Company also continues to evaluate methodologies to enhance its drug screening capabilities Additional research using the Companys proprietary technology is being conducted by outside research organizations through government-funded studies Employees As of December full-time employees bargaining agreement 31 2012 the Company had 132 in RD None of the Companys employees is subject full-time equivalent employees of whom are to collective Item 1A Risk Factors In addition to other information contained in this Form 10-K the following risk factors should be carefully considered in evaluating Psychemedics Corporation and its business because such factors could have significant impact on our business operating results and financial condition These risk factors could cause actual results to materially differ from those projected in any forward-looking statements Companies may develop larger and better capitalized products than we are that compete with our products and some of these companies may be Many of our competitors and potential competitors are larger and have greater financial resources than we do and offer range of products broader compete or may compete in the future may develop more extensive research than our products Some of the companies with which we now and and marketing capabilities greater technical and personnel resources than we do and may become better positioned to compete in an evolving industry Failure to compete successfully could harm our business and prospects Increased competition including price competition could have material impact on the Companys net revenues and profitability Our business is intensely competitive both in terms of price and service Pricing of drug testing services is significant factor often considered by customers in selecting drug testing laboratory As result of the clinical laboratory industry undergoing significant consolidation larger clinical laboratory providers are able to increase cost efficiencies afforded by large-scale automated testing This consolidation results in greater price competition The Company may be unable to increase cost efficiencies sufficiently if at all and as result its net earnings and cash flows could face increased competition be negatively The Company may also from companies that do not comply with existing laws or regulations or otherwise by such price competition impacted disregard compliance standards in the industry Additionally the Company may also face changes in fee schedules competitive bidding for laboratory services or other actions or pressures reducing payment schedules as result of increased or additional competition Additional competition including price competition could have material adverse impact on the Companys net revenues and profitability Our results of operations are subject in part to variation in our customers hiring practices and other factors beyond our controL Our results of operations have been and may continue to be subject to variation in our customers hiring practices which in turn is dependent to large extent on the general condition of the economy Results for particular quarter may vary due to number of factors including economic conditions in our markets in general economic conditions affecting our customers and their particular industries the introduction of new products and product enhancements by us or our competitors and pricing and other competitive conditions failure to obtain and retain new customers or loss of existing customers or reduction in tests ordered could impact the Companys ability to successfully grow its business The Company needs to obtain and retain new customers In addition reduction in tests ordered without offsetting growth in its customer base could impact the Companys ability to successfully grow its business and could have material adverse impact on the Companys net revenues and profitability We compete primarily on the basis of the quality of testing reputation in the industry the pricing of services and ability to employ qualified personnel The Companys failure to successfully compete on any of these factors could result in the loss of customers and reduction in the Companys ability to expand its customer base Our business could be harmed if we are unable to protect our technology We rely primarily on combination of trade secrets patents and trademark laws and confidentiality procedures to protect our technology Despite these precautions unauthorized third parties may infringe or copy portions of our technology In addition because patent applications in the United States are not publicly disclosed until either 18 months after the application filing date or the publication date of an issued patent wherein applicants seek only US patent protection which relate to our there is technology Moreover risk that applications not yet disclosed may have been filed foreign intellectual property laws will not protect our intellectual property rights to the same extent as United States intellectual property laws In the absence of the foregoing protections we may be vulnerable to competitors who attempt to copy our products processes or technology Our business could be affected by computer or other IT System failure computer or IT system failure could affect our ability to perform tests report test results or properly bill customers Failures could occur as result of the standardization of our IT systems and other system conversions telecommunications failures malicious human acts such as electronic break-ins or computer viruses or natural disasters Sustained system failures or interruption of the Companys systems in one or more of its operations could disrupt the Companys ability to process and provide test results in timely manner and/or bill the appropriate party Failure of the Companys information systems could adversely affect the Companys business profitability and financial condition Failure to maintain confidential information could result in significant financial impact The Company maintains confidential information regarding the results of drug tests and other information including credit card and payment information from our customers The failure to protect this information could result in lawsuits fines or penalties Any loss of data or breach of confidentiality such as through computer security breach could expose the Company to financial liability Our future success will depend on the continued services of our key personnel The loss of any of our key personnel could harm our business and prospects We may not be able to attract and retain personnel under contract other than necessary officers who have agreements the development for of our business We do not have key personnel providing for severance and non compete covenants in the event of termination of employment following change of control Further we do not have any key man life insurance for any of our officers or other key personnel There is risk that our insurance other claims or that in the future will not be sufficient errors and omissions to protect us from errors and omissions liability or insurance will not be available to us at reasonable cost if at all Our business involves the risk of claims of errors and omissions and other claims inherent to our business We maintain errors and omissions and general liability insurance subject to deductibles and exclusions There is risk that our insurance will not be sufficient to protect us from all such possible claims An under-insured or uninsured claim could harm our operating results or financial condition Our research and development capabilities may not produce viable new services or products In order to remain competitive we need to continually improve our products develop new technologies to replace older technologies that have either become obsolete or for which patent protection is no longer available It is uncertain whether we will continually be able to develop services that are more efficient effective or that are suitable for our customers Our ability to create viable products or services depends on many factors including the implementation of appropriate technologies the development of effective new research tools the complexity of the chemistry and biology the lack of predictability in the scientific process and the performance and decision-making capabilities of our scientists There is no guarantee that our research and development teams will be successful in developing improvements to our technology Improved testing technologies or the Companys customers using new technologies to perform their own tests could adversely affect the Companys business Advances in technology may lead to the development of more cost-effective technologies such as point-of-care testing equipment that can be operated by third parties or customers themselves in their own offices without requiring the services of freestanding laboratory Development of such technology and its use by the Companys customers could reduce the demand for its testing services and negatively impact our revenues We may not be able to recruit and retain the experienced our industry scientists and management we need to compete in Our future success depends upon our ability to attract retain and motivate highly skilled scientists and management caliber scientists Our ability to achieve our business and other qualified experts We compete with other strategies depends on our ability to hire and retain high testing companies research companies and academic and research institutions to recruit personnel and face significant competition for qualified personnel We may incur greater costs than anticipated or may not be successful in attracting new scientists or management or in retaining or motivating our existing personnel Our future success also depends on the personal efforts and abilities of the principal members of our senior management and scientific staff to provide strategic direction to manage our operations and maintain cohesive and stable environment Our facilities and practices may fail to comply with government regulations Our testing facilities and processes must be operated in conformity with current government regulations These requirements include records and documentation among other things quality control quality assurance If we fail to comply with these requirements we may not be able to continue our and the maintenance of services to certain customers or we could be subject to fines and penalties suspension of production or withdrawal of our certifications We operate facility that we believe conforms to all applicable requirements This facility and our testing practices are subject to periodic regulatory inspections to ensure compliance Our business could be harmed from the loss or suspension of any licenses The forensic laboratory testing industry is subject to significant regulation and many of these statutes and regulations are subject to change The Company cannot assure that applicable statutes and regulations will not be interpreted or applied by regulatory authority in manner that would adversely affect its business Potential sanctions for violation of these regulations could include the suspension or loss of various licenses certificates and authorizations which could have material adverse effect on the Companys business If our use of chemical and hazardous materials violates applicable laws or regulations or causes personal injury we may be liable for damages Our drug testing activities including the analysis and synthesis of chemicals involve the controlled use of chemicals including flammable combustible and toxic materials that are potentially hazardous Our use storage handling and disposal of these materials is subject to federal state and local laws and regulations including the Resource Conservation and Recovery Act the Occupational Safety and Health Act and local fire codes and regulations promulgated by the Department of Transportation the Drug Enforcement Agency the Department of Energy and the California Department of Public Health and Environment We may incur significant costs to comply with these laws and regulations in the future In addition we cannot completely eliminate the risk of accidental contamination or injury from these materials which could result in material unanticipated expenses such as substantial fines or penalties remediation costs or damages or the loss of permit or other authorization to operate or engage in our business Those expenses could exceed our net worth and limit our ability to raise additional capital Our operations could be interrupted by damage to our specialized laboratory facilities Our operations are dependent upon the continued use of our highly specialized laboratories and equipment in Culver City California Catastrophic events including earthquakes fires or explosions could damage our laboratories equipment scientific data work in progress or inventories of chemicals and may materially interrupt our business We employ safety precautions in our laboratory activities in order to reduce the likelihood of the occurrence of certain catastrophic events however we cannot eliminate the chance that such events will occur The availability of laboratory space in these locations is limited and rebuilding our facilities could be time consuming and result in substantial delays in fulfilling our agreements with our customers We maintain business interruption insurance to cover continuing expenses and lost revenue caused by such occurrences However this insurance does not compensate us for the loss of opportunity and potential harm to customer relations that our inability to meet our customers needs in timely manner could create and parties with whom Agreements we have with our employees consultants and customers may not afford adequate protection for our trade secrets confidential information and other proprietary information In addition to patent protection we also rely on copyright and trademark protection trade secrets know- how continuing technological innovation and licensing opportunities In an effort to maintain the confidentiality and ownership of our trade secrets and proprietary information we require our employees consultants and advisors to execute confidentiality and proprietary information agreements However these agreements may not provide us with adequate protection against improper use or disclosure of confidential information and there may not be adequate remedies in the event of unauthorized use or disclosure Furthermore we may from time to time hire scientific personnel formerly employed by other companies involved in one or more areas similar to the activities we conduct In some situations our confidentiality proprietary information agreements may conflict with or be subject to the rights of third our employees consultants or advisors have prior employment or consulting relationships Although we require our employees and consultants to maintain the confidentiality of all proprietary information of their previous employers these individuals or we may be subject to allegations of trade secret misappropriation or other similar claims as result of their prior affiliations Finally others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets Our failure or inability to protect our proprietary information and techniques may inhibit or limit our ability to compete effectively or exclude certain competitors from the market Risks Related to Our Stock Our quarterly operating results could fluctuate significantly which could cause our stock price to decline Our quarterly operating results results are impacted by the extent have fluctuated in the past and are likely to which we are able to gain new customers to fluctuate in the future Our and on the hiring practices of our existing customers which are in turn impacted by general economic conditions Entering into new customer contracts can involve long lead time Accordingly negotiation can be lengthy and is subject to number of significant risks including customers budgetary constraints and internal reviews Due to these and other market factors our operating results could fluctuate significantly from quarter to quarter In addition we may experience industry-specific economic conditions significant fluctuations in quarterly operating results due to factors such as general and that may affect the budgets and the hiring practices of our customers Due to the possibility of fluctuations in our revenue and expenses we believe that quarter-to-quarter comparisons of our operating results are not necessarily good indication of our future performance Our operating results in some quarters may not meet the expectations of stock market analysts and investors If we do not meet analysts and/or investors expectations our stock price could decline Our stock price could experience substantial volatility The market price of our common stock has historically experienced and may continue to experience extensive volatility Our quarterly operating results the success or failure of future development efforts changes in general conditions in the economy or the financial markets and other developments affecting our customers our competitors or us could cause the market price of our common stock to fluctuate substantially This volatility may adversely affect the price of our common stock In the past securities class action litigation has often been instituted following periods of volatility in the market price of companys securities securities class action suit against us could result in potential liabilities substantial costs and the diversion of managements attention and resources regardless of whether we win or lose Payment of div(cid:252)frnd could decline or cease Because we have historically paid dividends any cessation of our program or reduction in our quarterly dividend could affect our stock price We have paid dividends on our common stock for 65 consecutive quarters It is our intent to continue this practice as long as we are able However if we are forced to cease this practice or reduce the amount of the regular dividend due to operating or economic conditions our stock price could suffer December 2008 the Company also paid special dividend Investors should not anticipate or expect any future or recurring special dividends Further if the Company ceases its future 10 dividends return on investment in our common stock would depend entirely upon future appreciation There is no guarantee that our common stock will appreciate in value or even maintain the price at which stockholders have purchased their shares The general economic condition could deteriorate Our business is dependent upon new hiring and the supply of new jobs created by overall economic conditions If the economy deteriorates leading to downturn in new job creation our business and stock price could be adversely affected Item lB Unresolved Staff Comments Not applicable Item Properties The Company maintains its corporate office and northeast sales office at 125 Nagog Park Acton Massachusetts the office consists of 3971 square feet and is leased through February 2015 The Company leases 18000 square feet of space in Culver City California for laboratory purposes This facility is leased through December 31 2015 with an option to renew for an additional two years The Company also leases an additional 5400 square feet of space in Culver City California for customer service and information technology purposes This office space is leased through December 31 2015 with an option to renew for an additional two years Item Legal Proceedings The Company is involved in various suits and claims in the ordinary course of business The Company does not believe that the disposition of any such suits or claims will have material adverse effect on the continuing operations or financial condition of the Company Item Mine Safety Disclosures Not applicable 11 PART II Item Market for Registrants Common Equity Related Shareholder Matters and Issuer Purchases Equity Securities of The Companys common stock is traded on the NASDAQ Stock Market under the symbol PMD As of February 25 2013 there were 189 record holders of the Companys common stock The number of record owners was determined from the Companys stockholder records maintained by the Companys transfer agent and does not include beneficial owners of the Companys common stock whose shares are held in the names of various security holders dealers and clearing agencies The Company believes that the number of beneficial owners of the Companys common stock held by others as or in nominee names exceeds 2000 The following table sets forth for the periods indicated the range of prices for the Companys common stock as reported by the NASDAQ Stock Exchange and dividends declared by the Company Fiscal 2011 First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal 2012 First Quarter Second Quarter Third Quarter Fourth Quarter High Low Dividends $11.09 11.12 9.84 9.34 $10.40 10.48 12.19 12.49 7.98 9.00 6.85 7.33 9.11 9.46 10.10 10.60 $0.120 0.120 0.120 0.120 $0.150 0.150 0.150 0.150 The Company has paid dividends over the past sixteen years It most recently declared dividend in February 2013 which will be paid in March 2013 The Companys current intention is to continue to declare dividends to the extent funds are available and not required for operating purposes or capital requirements and only then upon approval by the Board of Directors Issuer Purchases of Equity Securities During 2012 the Company did not repurchase any common shares for treasury Unregistered Sales of Equity Securities and Use of Proceeds There were no unregistered sales of common stock of the Company during 2012 EQUITY COMPENSATION PLAN INFORMATION The following table provides information as of December 31 2012 with respect Companys common stock Incentive Plan that were issuable under the Companys 2006 Incentive Plan to shares of the the 2006 The table does not include information with respect to shares subject to outstanding options granted under other equity compensation plans that were no longer in effect on December 31 2012 Footnote to the table sets forth the total number of shares of common stock issuable upon the exercise of options under such expired or discontinued plans as of December 31 2012 and the weighted average exercise price of those options No additional options may be granted under such other expired or discontinued plans 12 Number of Securities to Be Issued Upon of Exercise Outstanding Options Warrants and Rights Weighted Average Exercise Price of Outstanding Options Warrants and Rights Number of Securities That Remained Available for Future Issuance Plan Category Equity compensation plans approved by security holderslX2 137475 $0.00 220069 Equity compensation plans not approved by security holders Total Consists of the 2006 Incentive Plan 137475 $0.00 220069 This table does not include information for the Companys 2000 Stock Option Plan discontinued on May 11 2006 As of December the exercise of outstanding options under 31 2012 total of 199838 the foregoing price of outstanding options under such plan is $13.62 under the 2000 Stock Option Plan shares of common stock were issuable upon exercise discontinued plan The weighted per share No additional options may be granted average Performance Graph COMPARE 5-YEAR CUMULATIVE TOTAL RETURN AMONG PSYCHEMEDICS CORPORATION NASDAQ COMPOSITE INDEX AND RUSSELL 2000 INDEX 200 150 100 50 2007 2008 2009 2010 2011 2012 1PSYCHEMEDICS CORPORATION 4RUSSELL 2000 INDEX NASDAQ COMPOSITE INDEX 2007 2008 2009 2010 2011 Psychemedics Corporation Russell 2000 Index NASDAQ Composite Index 100.00 46.34 100.00 100.00 60.91 59.46 57.33 82.01 85.55 2012 87.02 63.98 73.04 103.61 98.02 110.90 100.02 98.22 116.55 Calculated by the Company using wwwyahoo.comlfinance historical prices The above graph assumes investment 31 2012 in the Companys Common Stock on December $100 31 2007 through the end of the 5-year period the Russell 2000 Index and the NASDAQ ended December Composite Index The prices all assume the reinvestment of dividends The Russell 2000 Index is composed of the smallest 2000 companies in the Russell 3000 Index The Company has been unable to identify peer group of companies that engage in testing of drugs of abuse except for large pharmaceutical companies where such business is insignificant to such companies other lines of businesses The Company therefore uses in its proxy statements peer index based on market capitalization The NASDAQ Composite Index Exchange Market Market from the AMEX Stock Exchange Market includes companies whose shares are traded on the NASDAQ Stock In September 2008 Psychemedics moved its listing to the NASDAQ Stock Exchange 13 Item Selected Financial Data The selected financial data presented below is derived from our financial statements and should be read in connection with those statements As of and for the Years Ended December 31 2012 2011 2010 2009 2008 Revenue Gross profit Income from operations Net income Basic net income share per Diluted net income per share Total assets Working capital Shareholders equity In Thousands Except for per Share Data $25224 $24090 $20109 $16955 14252 14473 12042 4936 2980 0.57 0.57 5800 3489 0.67 0.67 4414 2614 0.50 0.50 9610 2584 1527 0.29 0.29 14212 13801 11766 10602 7491 9217 11223 11035 8566 9748 0.48 8471 9294 0.53 $22949 13350 4707 2969 0.57 0.57 12628 9516 10560 1.16 Cash dividends deciared per common share 0.60 0.48 14 Item Managements Discussion and Analysis of Financial Condition and Results of Operations The Managementc Discussion and Analysis of Financial Condition and Results of Operations should be read together with the more detailed business information and financial statements and related notes that in this annual report on Form 10-K This annual report may contain certain appear elsewhere forward-looking information within the meaning of the Private Securities Litigation Reform Act of 1995 This infornuition involves risks and uncertainties results may differ materially from the results Actual discussed in the forward-looking statements Factors that might cause such djference include but are not limited to those discussed in Item IA Risk Factors Overview Psychemedics Corporation is the worlds largest provider of hair testing for drugs of abuse utilizing patented hair analysis method involving liquefying hair enzyme immunoassay technology and confirmation by mass spectrometry to analyze human hair to detect abused substances The Companys customers include Fortune 500 companies as well as small to mid-size corporations schools and governmental entities located in the United States and internationally During the year ended December 31 2012 the Company generated $25.2 million in revenue while maintaining gross margin of 57% and pre-tax margins of 20% At December 31 2012 the Company had $3.1 million of cash and cash equivalents During 2012 the Company had operating cash flow of $3.6 million and it distributed approximately $3.2 million or $0.60 per share of cash dividends to its shareholders To date the Company has paid sixty-five consecutive quarterly cash dividends The following table sets forth for the periods indicated the selected statements of operations data as percentage of total revenue Revenue Cost of revenue Gross profit Operating expenses General and administrative Marketing and selling Research and development Total operating expenses Operating income Other income Interest income Total other income Income before taxes Provision for income taxes Net income Year Ended December 31 2012 2011 2010 100.0% 100.0% 100.0% 43.5% 39.9% 56.5% 60.1% 40.1% 59.9% 15.6% 16.4% 20.9% 18.0% 17.1% 14.6% 3.3% 2.5% 2.4% 36.9% 36.0% 37.9% 19.6% 24.1% 22.0% 0.0% 0.0% 0.0% 0.0% 19.6% 24.1% 7.8% 9.6% 11.8% 14.5% 0.1% 0.1% 22.1% 9.1% 110% Results for the Year Ended December 31 2012 Compared to Results for the Year Ended December 31 2011 Revenue increased $1.1 million or 5% to $25.2 million in 2012 compared to $24.1 million in 2011 This increase was due to an increase in volume from new and existing clients Average revenue per sample decreased 3% between 2012 and 2011 Gross profit decreased $221 thousand to $14.3 million in 2012 compared to $14.5 million in 2011 Direct costs increased by 14% from 2011 to 2012 mainly associated with the cost of labor and materials The higher costs were driven by the transition in screening technologies as well as from higher volume The gross profit margin decreased to 57% in 2012 from 60% in 2011 15 General and administrative GA expenses were $3.9 million for and December 31 2011 As percentage of revenue GA expenses were 15.6% and 16.4% for the the year ended December 31 2012 years ended December 31 2012 and 2011 respectively Marketing and selling expenses were $4.5 million for the year ended December 31 2012 compared to $4.1 million for the year ended December 31 2011 an increase of 10% Total marketing and selling expenses represented 18.0% and 17.1% of revenue for the years ended December 31 2012 and 2011 respectively The increase was driven by an expansion of the sales staff as well as higher information technology costs for marketing and selling projects and development RD expenses Research 2011 RD expenses 2011 respectively represented 3.3% and 2.5% of revenue for the years ended December 31 2012 and The additional expenses related to the new enzyme immunoassay EIA screening process for 2012 were $0.8 million compared to $0.6 million for Interest income decreased approximately $3000 to approximately December 31 2012 compared to $5000 for the year ended December $2000 for 31 2011 Interest the year ended income in both periods represented interest and dividends earned on cash equivalents and short-term investments decrease in the yield and interest income decrease in investment balances in 2012 as compared to 2011 caused the decrease in During the year ended December 31 2012 the Company recorded tax provision of $2.0 million representing an effective tax rate of 39.7% During the year ended December 31 2011 the Company recorded tax provision of $2.3 million representing an effective tax rate of 39.9% We do not expect significant change in our tax rate in the foreseeable future Results for the Year Ended December 31 2011 Compared to Results for the Year Ended December 31 2010 Revenue increased $4.0 million or 20% to $24.1 million in 2011 compared to $20.1 million in 2010 This increase was due to an increase in volume from new and existing clients Average revenue per sample decreased 1% between 2011 and 2010 Gross profit increased $2.5 million to $14.5 million in 2011 compared to $12.0 million in 2010 Direct costs increased higher volumes by 19% from 2010 to 2011 mainly associated with the direct The gross profit margin remained 60% from 2010 to 2011 General and administrative GA expenses were $3.9 million for 31 2010 representing revenue GA expenses were 16.4% and 20.9% for the years ended December the year of compared to $4.2 million for percentage cost of materials resulting from the year ended December of 7% As decrease 31 2011 ended December 31 2011 and 2010 respectively of 2010 This reduction is attributable to the retirement of the VP-General Counsel at the end Marketing and selling expenses were $4.1 million for the year ended December 31 2011 compared to $2.9 million for the year ended December 31 2010 an increase of 41% Total marketing and selling expenses represented 17.1% and 14.6% of revenue for the years ended December 31 2011 and 2010 respectively The increase was driven by an expansion of the sales and development RD expenses staff as well as higher commissions for new business growth for 2011 were $0.6 million compared to $0.5 million for represented 2.5% and 2.4% of revenue for the years ended December 31 2011 and Research 2010 RD expenses 2010 respectively Interest income decreased approximately $18000 to approximately December 31 2011 compared to $23000 for the year ended December $5000 for the year ended 31 2010 Interest income in both periods represented interest and dividends earned on cash equivalents and short-term investments decrease in the yield and decrease in investment balances in 2011 as compared to 2010 caused the decrease in interest income During the year ended December 31 2011 the Company recorded tax provision of $2.3 million representing an effective tax rate of 39.9% During the year ended December 31 2010 the Company recorded 16 tax provision of $1.8 million representing an effective tax rate of 41.1% We do not expect significant change in our tax rate in the foreseeable future Liquidity and Capital Resources At December 31 2012 the Company had $3.1 million of cash and cash equivalents compared to $5.6 million at December 31 2011 The Companys operating activities generated net cash of $3.1 million in 2012 $3.9 million in 2011 $0.5 million in 2011 and used and $3.3 million in 2010 Investing $1.9 million in 2010 Financing activities used $2.3 million in 2012 generated activities used $3.3 million in 2012 $2.6 million in 2011 and $2.6 million in 2010 Operating cash flow of $3.1 million in 2012 primarily reflected net income of $3.0 million adjusted for depreciation and amortization of $0.6 million stock compensation expense of $0.5 million an increase in accounts receivable of $0.1 million decrease in accounts payable of $0.3 million decrease in accrued expenses of $0.4 million an increase in prepaid expenses and other current assets of $0.5 million and an increase in net deferred tax liabilities of $0.4 million Operating cash flow of $3.9 million in 2011 primarily reflected net income of $3.5 million adjusted for depreciation and amortization of $0.4 million stock compensation expense of $0.4 million an increase in accounts receivable of $0.6 million an increase in accounts payable of $0.3 million an increase in prepaid expenses and other current assets of $0.4 million and an increase in net deferred tax liabilities of $0.4 million Operating cash flow of $3.3 million in 2010 primarily reflected net income of $2.6 million adjusted for depreciation and amortization of $0.3 million stock compensation expense of $0.4 million an increase in prepaid expenses and accounts receivable of $0.9 million and an increase in accounts payable of $0.5 million and an increase in accrued expenses of $0.2 million Investing cash flow principally reflected the purchase and sale of short-term investments and capital expenditures During 2012 there was an increase of $0.1 million in other assets which primarily related to patent costs During 2011 the Company redeemed at par short-term investments there was an increase of $0.1 million in other assets which primarily related to patent costs During 2010 the of $2.0 million Also in 2011 Company invested in short-term investments of $1.0 million Capital expenditures were $2.2 million $1.4 million and $0.08 million in 2012 2011 and 2010 respectively The expenditures related principally to new equipment and new software including laboratory and computer equipment 2012 had large increase in capital expenditures primarily due to the implementation of the Companys new EIA technology The Company does not expect this level of investment to recur in the near future During 2012 the Company did not repurchase any shares of common stock for treasury During 2011 the Company repurchased 2785 shares of common stock for treasury The Company has authorized 750000 shares for repurchase since June of 1998 of which 250000 shares of common stock were authorized in March of 2008 for repurchase Since 1998 total of 550684 shares have been repurchased The Company also distributed $3.2 million $2.5 million and $2.5 million of cash dividends to its shareholders in 2012 2011 and 2010 respectively At December 31 2012 the Companys principal sources of liquidity included approximately $3.1 million of cash and cash equivalents Management currently believes that such funds together with future operating profits should be adequate to fund anticipated working capital requirements and capital expenditures in the near term Depending upon the Companys 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 include joint ventures issuance of common stock or debt financing although there is no assurance that such financings will be available to the Company on terms it deems acceptable if at all At December 31 2012 the Company had no long-term debt The Company has paid dividends over the past sixty-five quarters It most recently declared dividend in February 2013 which will be paid in March 2013 in the amount of $790864 The Companys current intention is to continue to declare dividends to the extent funds are available and not required for operating purposes or capital requirements and only then upon approval by the Board of Directors There can be no assurance that in the future the Company will declare dividends 17 Contractual obligations as of December 31 2012 were as follows Contractual Obligation Operating leases Purchase commitment Total Purchase Commitment The Company has had supply agreement with in its radioimmunoassay RIAH drug isotopes used Payments Due by Period 45 Years Greater Than Years Amounts in Thousands Less Than Year Years $608 113 $721 $1171 $1171 Total $1779 113 $1892 vendor which required the Company to purchase testing procedures Purchases amounted to $609965 $527000 and $432000 isotopes in the first quarter of 2013 As in 2012 2011 and 2010 respectively The Company expects to purchase $113000 of result of the conversion from RIAH to EIA testing methods the supply agreement will terminate in March 2013 at which time all transition activities are expected to be complete Significant Customers The Company did not have any individual customers that exceeded 10% of revenue for the years ended December 31 2012 and 2011 or accounts receivable as of December 31 2012 and 2011 Critical Accounting Policies The Companys significant accounting policies are described in Note to the financial statements included in Item of this Form 10-K 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 Companys 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 recognizes revenue Revenue Recognition In accordance in accordance with ASC 605 the Company considers testing training Standards Codification ASC 605 and storage with Accounting elements as 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 recognizes revenue as the service is performed and reported to the customer since the predominant deliverable in each arrangement is the testing of the units 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 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 tax valuation 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 Capitalized Development Costs We capitalize costs related to significant software projects developed or obtained for internal use Costs incurred during the preliminary project work stage or conceptual stage such as determining the performance requirements system requirements and data conversion are expensed as incurred Costs incurred in the 18 application development phase such as coding testing for new software and upgrades that result in additional functionality are capitalized and are amortized using the straight-line method over the useful life of the software for and maintenance years Costs incurred during the post-implementation/operation stage including training costs costs are expensed as incurred In accordance with Company policy during the years ended December 31 2012 and 2011 we capitalized internally developed software costs of $794000 and $387000 related to software development respectively Depreciation 2012 2011 and 2010 respectively Determining whether particular costs incurred are more properly costs was $98301 $8840 and $0 in expense attributable to the preliminary or conceptual stage and thus expensed or to the application development phase and thus capitalized development work and our judgments in this regard may differ and administrative such costs related to developing or obtaining and amortized depends on subjective judgments about the nature of the from those made by other companies General software are expensed as incurred Allowance for Doubtful Accounts The allowance for doubtful accounts is based on managements assessment of the ability to collect amounts owed to it by its customers Management and uses methodology on calculating based reviews its accounts receivable aging for doubtful accounts the allowance using combination of factors including the age of the receivable along with managements judgment to identify accounts Company routinely assesses the financial strength of its customers and as that may not be collectible The 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 managements expectations Income Taxes The Company accounts for income taxes using the liability method which requires the Company to recognize current tax liability or asset for current taxes payable or refundable and deferred tax liability or asset for the estimated future tax effects of temporary and liabilities to the extent differences between the financial statement and tax that they are realizable Deferred tax expense benefit reporting bases of assets results from the net change in deferred tax assets and liabilities during the year deferred tax valuation allowance is required if it is more likely than not that all or portion of the recorded deferred tax assets will not be realized The Company had net deferred tax liabilities in the amount of $605000 at December 31 2012 which primarily relate to timing differences The Company operates within multiple taxing jurisdictions and could be subject to audit in these jurisdictions These audits may involve complex resolve The Company has provided and penalties related to income tax matters are recognized its estimated taxes payable for Interest issues which may require an extended period of time to in the accompanying financial statements as general and administrative expense The Company did not have as of December any unrecognized 31 2012 or 2011 The Company does tax benefits and did not have any interest or penalties accrued not expect the unrecognized tax benefits to change significantly over the next twelve months The above listing is not intended to be comprehensive list of all of the Companys accounting policies In many cases the accounting treatment of particular transaction is specifically dictated by accounting principles generally accepted in the United States with no need for managements judgment in their application There are also areas in which managements judgment in selecting any available alternative would not produce materially different result Recent Accounting Pronouncements There were no new accounting pronouncements issued or effective during the fiscal year which have had or are expected to have material impact on the Financial Statements See Note Accounting Policies to the Financial Statements for further detail on applicable accounting pronouncements that were adopted in 2012 Item 7A Quantitative and Qualitative Disclosures About Market Risk Not Required 19 Item Financial Statements and Supplementary Data Financial Statements Report of Independent Registered Public Accounting Firm Balance Sheets as of December 31 2012 and 2011 Statements of Income and Comprehensive Income for the Years Ended December 31 2012 2011 and 2010 Statements of Shareholders Equity for the Years Ended December 31 2012 2011 and 2010 Statements of Cash Flows for the Years Ended December 31 2012 2011 and 2010 Notes to Financial Statements Page 21 22 23 24 25 26 20 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Psychemedics Corporation Acton Massachusetts We have audited the accompanying balance sheets of the Company as of December 31 2012 and 2011 and the related statements of income and comprehensive income shareholders equity and cash flows for each of the three years in the period ended December 31 2012 These financial statements are the responsibility of the Companys management Our responsibility is to express our audits an opinion on these financial statements based on We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board United States Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement The Company is not required to have nor were we engaged to perform an audit of its internal control over financial reporting Our audit includes consideration of internal control over financial reporting as basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Companys internal opinion An audit also includes examining on the financial statements assessing the accounting control over financial reporting Accordingly we express no such test basis evidence supporting the amounts and disclosures in principles used and significant estimates made by management as well as evaluating the overall financial statement presentation We believe that our audits provide reasonable basis for our opinion In our opinion the financial statements referred to above present fairly in all material respects the financial position of the Company at December 31 2012 and 2011 and the results of its operations and its cash flows for each of the three years in the period ended December 31 2012 in conformity with accounting principles generally accepted in the United States of America Is BDO USA LLP Boston Massachusetts March 2013 21 PSYCHEMEDICS CORPORATION BALANCE SHEETS ASSETS Current Assets Cash and cash equivalents Short term investments Accounts receivabLe net of allowance for doubtful accounts of $121583 in 2012 and $169191 in 2011 Prepaid expenses and other current assets Income tax receivable Deferred tax assets Total Current Assets Property and equipment Computer softwar Office furniture and equipment Laboratory equipment Leasehold improvements Less accumulated depreciation and amortization Other assets Total Assets LIABILITIES AND SHAREHOLDERS EQUITY Current Liabilities Accounts payable Accrued expenses Total Current Liabilities Deferred tax liabilities long-term Total Liabilities Commitments and Contingencies Note Shareholders Equity December 31 2012 December 31 2011 3065785 5564233 4620768 823274 854212 209877 4490976 565508 564083 315501 9573916 11500301 1210734 659866 6634043 92371 8597014 4395605 4201409 345293 $14120618 1622900 2173285 8363371 930099 13089655 11026278 2063377 237174 13800852 669789 1413541 2083330 814619 961844 1321856 2283700 482523 2897949 2766223 Preferred-stock $0005 par value 872521 shares authorized no shares issued or outstanding Common stock $0.005 par value 50000000 shares authorized 5940558 shares 5272428 shares outstanding in 2012 and 5235422 shares issued in 2012 and 5903552 shares issued 2011 outstanding in 2011 Additional paid-in capital Less Treasury stock at cost 668130 shares Accumulated deficit Total Shareholders Equity Total Liabilities and Shareholders Equity 29703 28460764 10081789 7186009 11222669 29518 28095946 10081789 7009046 11034629 $14120618 $13800852 The accompanying notes are an integral part of these financial statements 22 STATEMENTS PSYCHEMEDICS CORPORATION OF INCOME AND COMPREHENSIVE INCOME Revenues Cost of revenues Gross profit Operating Expenses General administrative Marketing selling Research development Total Operating Expenses Operating income Interest income Net income before provision for income taxes Provision for income taxes Net income and comprehensive income Basic net income per share Diluted net income per share Dividends declared per share Year Ended December 31 2012 2011 2010 $25223534 10971886 $24089608 $20108862 9616985 8067229 14251648 14472623 12041633 3946844 4543598 825518 9315960 4935688 1889 4937577 1957948 2979629 0.57 0.57 0.60 3948706 4116059 607408 8672173 5800450 5346 5805796 2316513 3489283 0.67 0.67 0.48 4195998 2949739 481433 7627170 4414463 23091 4437554 1823834 2613720 0.50 0.50 0.48 Weighted average common shares outstanding basic 5260320 5229646 5207244 Weighted average common shares outstanding diluted 5272542 5235940 5226454 The accompanying notes are an integral part of these financial statements 23 PSYCHEMEDICS CORPORATION STATEMENTS OF SHAREHOLDERS EQUITY Common Stock Treasury Stock Shares $O.005 par Value Paid-In Capital Shares Cost Deficit Total Accumulated BALANCE December 31 2009 5861872 $29309 $27419359 664523 $10053364 $8lOO920 9294384 Shares issued vested 15486 78 Tax withholding related to vested shares from employee stock plans Stock compensation expense Acquisition of treasury stock Cash dividends declared $0.48 per share Net income BALANCE 78 49261 394972 December 31 2010 5877358 29387 27764992 Shares issued vested 26194 131 131 822 6034 49261 394972 6034 2500268 2500268 2613720 2613720 665345 10059398 7987468 9747513 December 31 2011 5903552 29518 28095946 Shares issued vested 37006 185 185 Tax withholding related to vested shares from employee stock plans Stock compensation expense Acquisition of treasury stock Cash dividends declared $0.48 per share Net income BALANCE Tax withholding related to vested shares from employee stock plans Stock compensation expense Cash dividends declared $0.60 per share Net income BALANCE December 86992 418077 2785 22391 86992 418077 22391 2510861 2510861 3489283 3489283 668130 10081789 7009046 11034629 93164 458167 93164 458167 3156592 3156592 2979629 2979629 31 2012 5940558 $29703 $28460764 668130 $10081789 $7186009 $11222669 The accompanying notes are an integral part of these financial statements 24 PSYCHEMEDICS CORPORATION STATEMENTS OF CASH FLOWS Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization Deferred income taxes Stock compensation expense Changes in operating assets and liabilities Accounts receivable Prepaid expenses other current assets and income tax receivable Accounts payable Accrued expenses Deferred revenue Net cash provided by operating activities Cash flows from investing activities Maturities of short-term investments Purchases of short-term investments Increase in other long-term assets Purchases of property and equipment Net cash provided by used in investing activities Cash flows from financing activities Dividends paid Tax withholding related to vested shares from employee stock plans Acquisition of treasury stock Net cash used in financing activities Net increase decrease in cash and cash equivalents Cash and cash equivalents beginning of year Cash and cash equivalents end of year Supplemental disclosures of cash flow information Cash paid for income taxes Non-cash investing and financing activities Issuance of restricted stock awards Year Ended December 31 2012 2011 2010 2979629 3489283 2613720 586968 437720 458167 370020 406853 418077 284911 218154 394972 129792 585155 889737 547895 292055 406011 428769 262011 19486 16605 37389 519049 211472 19755 3086731 3935201 ___________ 3295397 ___________ 121375 2214048 ___________ 2335423 ___________ 2018452 130874 1358790 528788 1012016 29737 817960 ___________ 1859713 ___________ 3156592 2510861 2500268 93164 3249756 2498448 5564233 3065785 86992 22391 2620244 1843745 3720488 5564233 49261 6034 2555563 1119879 4840367 3720488 1715000 2401957 2009694 185 131 78 Acquisition of equipment through accrued liabilities 497696 The accompanying notes are an integral part of these financial statements 25 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Nature of Business and Basis of Presentation Psychemedics Corporation the Company is the worlds largest provider of hair testing for drugs of abuse utilizing and confirmation patented hair analysis method involving by mass spectrometry to analyze liquefying hair enzyme immunoassay technology human hair to detect abused substances The Companys customers include Fortune 500 companies as well as small to mid-size corporations schools and governmental entities located in the United States and internationally Summary of Significant Accounting Policies Risks and Uncertainties The Company is subject to number of risks and uncertainties similar to those of other companies such as those associated with the continued expansion of the Companys sales and marketing network technological developments intellectual property protection 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 economic conditions Estimates limited to Food and Drug Administration regulations competition and general The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates including those related to bad debts and income tax valuation 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 Changes in estimates are recorded in the period in which they become known Cash Equivalents All highly liquid investments with original maturities of 90 days or less are considered cash equivalents These consist of cash savings and U.S government reserve money market accounts at December 31 2012 While the money market federally insured As of December account contains U.S federal government backed issues the account itself is not 31 2012 $0.4 million was in U.S federal government-backed money-market accounts which is classified as cash equivalents Fair Value Measurements The Company follows the provisions of Accounting Standards Codification ASC 820 Fair Value Measurements and Disclosures ASC 820 which defines fair value establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements and expands disclosures regarding fair value measurements Fair value is defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer liability an exit price in an orderly transaction between market liability in the principal or most advantageous market for the asset or participants on the measurement date Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs The standard describes fair value hierarchy based on three levels of inputs of which the first two are considered observable and the last unobservable that may be used to measure fair value which are the following Level Level Quoted prices in active markets for identical assets or liabilities Inputs other than Level that are observable either directly or indirectly such as quoted prices for similar assets or liabilities quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities 26 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Summary of Significant Accounting Policies continued Level Unobservable inputs that are supported by little or no market activity and that are significant to the fair value financial instruments level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement In accordance with ASC 820 the Companys financial assets that are measured at fair value on recurring basis as of December 31 2012 and 2011 are cash equivalents Cash equivalents are measured using level one inputs At December 31 2012 and 2011 the Company had $0.4 million of level one cash equivalents for each period Inventory The Company typically expenses consumables such as chemicals antibodies and tubes as purchased Property and Equipment Property and equipment are stated at cost Depreciation and amortization are provided over the estimated useful lives of the assets using the straight-line method Repair and maintenance costs are expensed as incurred The estimated useful lives of the assets are as follows Computer software Office furniture and equipment Laboratory equipment Leasehold improvements to to to years years years Lesser of estimated useful life or lease term The Company recorded depreciation and amortization related to property and equipment of $573712 $362282 and $282397 in 2012 2011 and 2010 respectively In 2012 in connection with the transition to ETA from RIAH the Company disposed of $7.2 million of RIAH and other equipment all of which had been fully depreciated and as result had no impact on earnings or net assets Capitalized Software Development Costs We capitalize costs related to significant software projects developed or obtained for internal use Costs incurred during the preliminary project work stage or conceptual stage such as determining the performance requirements system requirements and data conversion are expensed as incurred Costs incurred in the application development phase such as coding testing for new software and upgrades that result in additional functionality are capitalized and are amortized using the straight-line method over the useful life of the software for years Costs incurred during the post-implementation/operation stage including training costs and maintenance costs are expensed as incurred In accordance with Company policy during the years ended December 31 2012 and 2011 we capitalized internally developed software costs of $794000 and $387000 respectively Depreciation related to software development 2012 2011 and 2010 respectively Determining whether particular costs incurred are more properly costs was $98301 $8840 and $0 in expense attributable to the preliminary or conceptual stage and thus expensed or to the application development phase and thus capitalized development work and our judgments in this regard may differ and administrative costs related to developing or obtaining such and amortized depends on subjective judgments about the nature of the from those made by other companies General software are expensed as incurred Other Assets Other assets primarily consist of capitalized legal costs relating to patent applications The Company amortizes these costs over ten years from the date of grant of the applicable patent As of December 31 2012 and 2011 the Company had capitalized legal costs relating to outstanding patent applications of $299389 and 27 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Summary of Significant Accounting Policies continued $194704 respectively Amortization expense was $13256 $7738 and $2574 in 2012 2011 and 2010 respectively The amount of amortization related to patent applications is expected to remain below $20000 per year for the next five years Revenue Recognition The Company is in the business of performing drug testing services and reporting the results thereof The Companys services include drug testing training for collection of samples for its customers for an agreed-upon fee per unit tested of samples The revenues and storage of positive samples when the are recognized predominant deliverable drug testing is provided and reported to the customer The Company recognizes revenue under ASC 605 Revenue Recognition ASC 605 In accordance with ASC 605 the Company considers testing training and storage elements the training and storage costs are recognition purposes revenue as as one unit of accounting for de minimis and do not have stand-alone value to the customer The Company recognizes revenue as the service is perfonned and reported to the customer since the predominant deliverable in each arrangement is the testing of the units 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 Research and Development Expenses The Company charges all research and development expenses to operations as incurred Income Taxes The Company accounts for income taxes using the liability method pursuant to ASC 740 Income Taxes Under this method the Company recognizes deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse The Company evaluates uncertain tax positions annually and considers whether the amounts recorded for income taxes are adequate specific to address i.he Companys tax risk profile The Company analyzes the potential tax liabilities of transactions and tax positions based on managements judgment as to the expected outcome Concentration of Credit Risk and Off-Balance Sheet Risk The Company has no significant off-balance-sheet risk such as foreign exchange contracts option contracts or other foreign hedging arrangements Financial instruments that potentially subject the Company to concentrations of credit risk are principally cash and cash equivalents short-term investments and accounts receivable institutions The Company places These include money market accounts its cash and cash equivalents and short-term investments in highly rated holding U.S federal government reserve securities While the underlying securities are federally issued the account itself is not insured Concentration of credit risk with respect to accounts receivable is limited to certain customers to whom the Company makes substantial sales To reduce risk the Company routinely assesses the financial strength of its customers and as 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 The Company does not require collatera Significant Customers The Company lid not have any individual customers that exceeded 10% of revenue for the years ended December 31 2012 and 2011 or accounts receivable as of December 31 2012 and 2011 28 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Summary of Significant Accounting Policies continued Comprehensive Income The Companys comprehensive income was the same as its reported net income for the years ended December 31 2012 2011 and 2010 Stock-Based Compensation The Company for equity awards in accordance Compensation ASC 718 ASC 718 requires employee equity awards to be accounted value method Accordingly share-based is measured at the grant date based compensation with ASC 718 Compensation accounts Stock for under the fair on the fair value of the award It also requires the measurement of compensation cost at fair value on the date of grant and recognition of compensation expense over the service period for awards expected the straight-line method to recognize share-based compensation over generally equal to the vesting period to vest The Company uses the service period of the award which is Under ASC 718 the Company recorded $458167 $418077 and $394972 of stock compensation expense in the accompanying statements of income for the years ended December 31 2012 2011 and 2010 respectively Stock compensation expense by income statement account is as follows Cost of revenues General administrative Marketing and selling Research and development Total stock compensation 2012 91118 282375 81819 2855 2011 85731 266915 65431 2010 83286 258916 52770 $458167 $418077 $394972 See Note for additional information relating to the Companys stock plans Basic and Diluted Net Income per Share Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period Diluted net income share is per computed by dividing net income by the weighted average number of common shares and dilutive common stock equivalents outstanding during the period The number of dilutive common stock equivalents outstanding during the period has been determined in accordance with the treasury-stock method Common equivalent shares consist of common stock portion of stock unit awards SUAs issuable upon the exercise of outstanding options and the unvested Basic and diluted weighted average common shares outstanding are as follows Weighted average common shares outstanding 5260320 5229646 5207244 Dilutive common equivalent shares 12222 6294 19210 Weighted average common shares outstanding assuming dilution 5272542 5235940 5226454 2012 2011 2010 For the years ended December 31 2012 2011 and 2010 options to purchase 191597 264088 and 298390 common shares respectively were outstanding but not included in the dilutive common equivalent share calculation as their effect would have been anti-dilutive 29 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Summary of Significant Accounting Policies continued Financial Instruments Financial instruments include cash equivalents and accounts receivable/payable Estimated fair values of these financial instruments approximate carrying values due to their short-term nature Segment Reporting The Company manages its operations as one segment drug testing services As result the financial information disclosed herein materially represents all of the financial information related to the Companys principal operating segment Substantially all of the Companys revenues and assets are in the United States Subsequent Events The Company evaluated all events and transactions that occurred after December time of filing with the Securities and Exchange Commission of the Companys annual 31 2012 through report on Form 10-K the for the year ended December 31 2012 On February 25 2013 the Company declared quarterly dividend of $0.15 per share for total of $791 thousand which will be paid on March 21st 2013 to shareholders of record on March 7th 2013 On February TruTouch Technologies rapid optical 28th 2013 the Company alcohol detection and biometric announced an agreement to market test in the US Psychemedics will exclusively distribute the TruTouch solutions to targeted organizations within the United States The Company did not have any other material recognizable subsequent events Recent Accounting Pronouncements In December 2011 the Financial Accounting Update ASU 2011-12 Comprehensive Standards Board FASB issued Accounting Standards Income Topic 220 Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No 2011-05 In June 2011 the FASB issued ASU 2011-05 Comprehensive Income Topic 220 Presentation of Comprehensive after December annual reporting periods beginning 15 2011 ASU 2011-05 eliminates the option to present Income Both ASUs are effective for the components of other comprehensive income as part of the statement of changes in stockholders equity In addition items of other comprehensive income that are reclassified to profit or loss are required to be presented separately on the face of the financial statements This guidance is intended to increase the prominence of other comprehensive income in financial statements by requiring that such amounts be presented either in single continuous statement of income and comprehensive income or separately in consecutive statements of income and comprehensive income ASU 2011-12 defers the changes in ASU 2011-05 that pertain to how when and where reclassification adjustments are presented The Companys adoption of these standards is not expected to have material impact on the financial statements Accounts Receivable The Company maintains an allowance for uncollectible accounts receivable based on managements assessment of the ccllectability of its customer accounts by reviewing customer payment patterns and other relevant factors The Company reviews quarterly basis and adjusts the balance the adequacy of the allowance for uncollectible accounts on as determined necessary The following is roliforward of the Companys allowance for doubtful accounts Balance beginning of period Provision for recoveries of doubtful accounts Write-offs wrile-backs Balance end of period 30 2012 2011 $169191 $119295 28866 18742 49896 $121583 $169191 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Accrued Expenses Accrued expenses consist of the following Accrued payroll and employee benefits Accrued hair collection expense Accrued audit and tax consulting Accrued payable for equipment purchases Other accrued expenses Total Accrued Expenses Income Taxes The income tax provision consists of the following Current Federal State Deferred Federal State Income Tax Provision 2012 570405 113355 110491 497696 121594 2011 979686 35676 106945 199549 $1413541 $1321856 2012 2011 2010 $1196926 $1450941 $1261670 323302 1520228 458719 344010 1909660 1605680 346974 90746 437720 370710 36143 171848 46306 406853 218154 $1957948 $2316513 $1823834 reconciliation of the effective rate with the federal statutory rate is as follows Federal statutory rate State income taxes net of federal benefit Permanent differences Stock based compensation Effective tax rate 2012 34.0% 5.5% 0.1% 0.0% 2011 34.0% 5.6% 0.1% 0.2% 39.6% 39.9% 2010 34.0% 5.6% -0.2% 1.7% 41.1% The components of the net deferred tax assets included in the accompanying balance sheets are as follows at December 31 Deferred tax assets Stock-based compensation Allowance for doubtful accounts Accrued expenses Deferred tax liabilities Prepaid expenses Excess of tax over book depreciation and amortization Net deferred tax liabiliites 31 2012 2011 162792 161807 47959 55401 266152 56275 814619 870894 66900 110639 339346 23845 482523 506368 $604742 $167022 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Income Taxes continued These amounts are shown on the balance sheets as follows Deferred tax asset short-term Deferred tax liability long-term Net deferred tax liabilities 209877 315501 814619 482523 $604742 $167022 ASC 740 contains two-step approach to recognizing and measuring uncertain tax positions tax contingencies The first step is to evaluate available evidence indicates it is more likely the tax position for recognition by determining if the weight of than not that the position will be sustained on an audit including resolution of related appeals or litigation amount which is more than 50% likely of being considers many factors when evaluating and estimating processes largest if any The second step is to measure the tax benefit as the realized upon ultimate settlement The Company the Companys tax positions and tax benefits which may require periodic adjustments and which may not accurately forecast actual outcomes The Company adopted these provisions effective January 2007 without material effect in the financial statements The Conipany 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 Interest and penalties related to income tax matters are recognized as general and administrative expense The Company did not have any unrecognized as of December 31 2012 and 2011 tax benefits and did not have any interest or penalties accrued The tax years ended December 31 2009 through December 31 2012 remain subject to examination by all major taxing authorities Preferred Stock The Board of has the authority to designate authorized preferred shares in one or more series and to fix the relative rights and preferences without vote or action by the stockholders The Board of Directors has no present plans to designate or issue any shares of preferred stock Stock-Based Awards The 2006 Incentive Plan initially adopted in 2006 and amended and restated in 2011 the 2006 Incentive Plan provides for grants of options with terms of up to ten years grants of stock unit awards SUAs issuances 500000 shares of common stock of stock bonuses or grants other stock-based to officers directors employees plus cash awards awards based restricted stock or covering up to and consultants As of December 31 2012 220069 shares remained available for future grant under the 2006 Incentive Plan The fair value of the SUAs is determined by the closing price on the date of grant The SUAs vest over period of two to four years and are convertible into an equivalent number of shares of the Companys common stock provided that the employee receiving vesting period The Company the vesting term of the SUA Employees records compensation are issued shares upon the award remains continuously expense related to the SUAs on vesting net of tax withholdings employed throughout the straight-line basis over The Company granted 65000 SUAs on May 22 2012 The fair value of the SUAs was $9.79 per share which was the closing price of the Companys stock on that date The SUAs vest over period of two to four years and are convertible into an equivalent number of shares of the Companys common stock provided that the awardee remains continuously employed throughout the vesting period In addition 9619 SUAs were withheld for taxes in conjunction with the vesting of SUAs granted in prior years and consequently added back to the shares available for future grant The Company granted 59000 SUAs on May 24 2011 The fair value of the SUAs was $10.03 per share which was the closing price of the Companys stock on that date The SUAs vest over period of two to four 32 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Stock-Based Awards continued years and are convertible into an equivalent number of shares of the Companys common stock provided that the awardee remains continuously employed throughout the vesting period The Company granted 94000 SUAs on April 2010 The fair value of the SUAs was $7.75 per share which was the closing price of the Companys stock on that date The SUAs vest over period of two to four years and are convertible into an equivalent number of shares of the Companys common stock provided that the awardee remains continuously employed throughout the vesting period Of these 94000 units 20350 were cancelled upon termination of three employees in 2010 The Company also has stock option plans that have expired or been terminated but shares can be issued upon exercise of outstanding options that were granted prior to such expiration or termination No additional grants of options or other stock based awards may be made under such expired or terminated plans Activity for these plans is included in this footnote Options granted under the plans consisted of both non-qualified and incentive stock options and were granted in each case at price that was not less than the fair market value of the common stock at the date of grant These options generally have contractual lives of ten years and they are all fully exercisable summary of stock option activity for the Companys stock option plans is as follows Outstanding December 31 2009 336921 $14.80 Number of Shares Weighted Average Excersise Price per Share Weighted Average Remaining Contractual Life Aggregate Intrinsic VaIue Granted Exercised Terminated Outstanding December 31 2010 Granted Exercised Terminated Outstanding December 31 2011 Granted Exercised Terminated Outstanding December 31 2012 47550 289371 68132 221239 19.93 13.96 15.06 13.62 21401 199838 13.61 $13.62 2.lyears $32492 The aggregate intrinsic value on this table was calculated based on the amount if any by which the closing market value of the Companys stock on December 31 2012 $10.75 exceeded the exercise price of any of the underlying options multiplied by the number of shares subject to each such option 33 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Stock-Based Awards continued summary of stock unit award activity for the Company is as follows Outstanding Granted Unvested December 31 2009 Converted to common stock Terminated Outstanding Granted ljnvested December 31 2010 Converted to common stock Terminated Outstanding Granted Unvested December 31 2011 Converted to common stock Terminated Outstanding Unvested December 31 2012 Available for grant December 31 2012 Weighted Average Remaining Contractual Life ____________ Aggregate Intrinsic Va1ue2 _____________ 179801 355351 2.8years 458211 $1477856 Number of Shares 42600 94000 21550 20350 94700 59000 34600 119100 65000 46625 ______ 137475 ______ 220069 ritnnsic The aggregate Companys stock on December price on the grant date value on this table was calculated based 31 2012 $10.75 For value on the closing market price of the on the converted stock the price used is the Figure includes 9619 shares in 2012 8406 shares in 2011 and 6064 shares in 2010 withheld to cover federal income taxes As of December 31 2012 total of 557382 shares of common stock were reserved for issuance under the various stock plans As of December 31 2012 the unamortized fair value of awards relating to SUAs was $990031 to be amortized over weighted average period of approximately 2.8 years Employee Benefit Plan The Psychemedics Corporation 40 1k Savings and Retirement Plan the 40 1k Plan is qualified defined contribution plan in accordance with Section 401k of the Internal Revenue Code All employees over the age of 21 are eligible to make pre-tax contributions up to specified percentage of their compensation Under the 401k Plan the Company may but is not obligated to match portion of the employees contributions up to defined maximum Matching contributions of $147360 $122961 and $0 were made in the years ended December 31 2012 2011 and 2010 respectively Commitments arid Contingencies Commitments The Company leases certain of its facilities and equipment under operating lease agreements expiring on various dates through April 2016 Total minimum lease payments including scheduled increases are charged to operations on the straight-line basis over the life of the respective lease Rent expense was approximately $555129 $548000 and $558000 in 2012 2011 and 2010 respectively 34 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS December 31 2012 Commitments and Contingencies continued At December 31 2012 minimum commitments remaining under lease agreements were approximately as follows Years Ending December 31 2013 2014 2015 2016 Purchase Commitment The Company has had supply agreement with in its radioimmunoassay RIAH drug isotopes used Amount 608000 603000 546000 22000 $1779000 vendor which required the Company to purchase testing procedures Purchases amounted to $609965 $527000 and $432000 isotopes in the first quarter of 2013 As in 2012 2011 and 2010 respectively The Company expects to purchase $113000 of result of the conversion from RIAH to ETA testing methods the supply agreement will terminate in March 2013 at which time all transition activities are expected to be complete Contingencies The Company is subject to legal proceedings and claims which arise in the ordinary course of its business The Company believes that although there can be no assurance as to the disposition of these proceedings based upon information available to the Company at this time the expected outcome of these matters would not have material impact on the Companys results of operations or financial condition 10 Selected Quarterly Financial Data Unaudited The following are selected quarterly financial data for the years ended December 31 2012 and 2011 Revenues Gross profit Income from operations Net income and comprehensive income Basic net income per share Diluted net income per share Revenues Gross profit Income from operations Net income and comprehensive income Basic net income per share Diluted net income per share Quarter Ended 000s Except Share Amounts March 31 2012 $6244 3665 1377 827 0.16 0.16 June 30 2012 $6862 4103 1664 1001 0.19 0.19 September 30 2012 December 31 2012 $6460 3718 1431 879 0.17 0.17 $5658 2766 464 273 0.05 0.05 Quarter Ended 000s Except Share Amounts June 30 2011 $6228 3739 1758 1093 0.21 0.21 September 30 2011 $6315 3944 1808 1099 0.21 0.21 December 31 2011 $5547 3173 746 438 0.08 0.08 March 31 2011 $6000 3617 1490 858 0.16 0.16 35 Item Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None Item 9A Controls and Procedures Disclosure Controls and Procedures The Company maintains disclosure controls and procedures as defined in Exchange Act Rules 3a- 15e and 15d-15e that SEC are are designed to ensure that information required to be disclosed in reports filed with the recorded processed summarized and reported within the time period specified by the SECs rules and forms and that such information is accumulated and communicated to our management including to our Chief Executive Officer and our Vice President-Finance as appropriate to allow for timely decisions regarding required disclosure As required by Rule 3a- 15 under the Exchange Act the Companys management with the participation of the Companys Chief Executive Officer and its Vice President-Finance has evaluated the effectiveness of its disclosure controls arid procedures Officer and Vice President-Finance as of December concluded that 31 2012 Based the Companys disclosure controls and procedures on this evaluation our Chief Executive were effective for ensuring that information required to be disclosed by the Company in the reports that it files or submits under the time periods specified in the SECs rules the Securities Exchange Act of 1934 is recorded processed summarized and reported within and forms and that its disclosure controls and procedures were also effective to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is accumulated and communicated to management including the Companys principal executive and financial officers to allow timely decisions regarding required disclosure Changes in Internal Control Over Financial Reporting There were no changes in the Companys internal control over financial reporting that occurred during the Companys last fiscal quarter that have materially affected or are reasonably likely to materially affect the Companys internal control over financial reporting Managements Report on Internal Control Over Financial Reporting The Companys management is responsible for establishing and maintaining adequate internal control over financial rig as defined in Rules supervision and with the participation of management including reporti 3a- 15f and 15d- 15f under the Exchange Act Under our Chief Executive Officer and Vice the President-Finance the Company conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission Based on the Companys evaluation under the framework in Internal Control Integrated Framework the Companys management concluded that our internal control over financial reporting was effective as of December 31 2012 This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting Managements report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only managements report in this annual report Inherent Limitations on Effectiveness of Controls The Companys management including its Chief Executive Officer and its Vice President-Finance does not expect that the Companys disclosure controls and procedures or the Companys internal controls will prevent all error and all fraud control system no matter how well conceived only reasonable not absolute assurance that the objectives for the control of control system rriust reflect the fact that there are resource constraints and operated system are met Further and the benefits the design of controls must can provide be considered relative to their costs Because of the inherent limitations in all control systems no evaluation of controls can provide absolute assurance that all control issues misstatements errors if any within our company have been or will be prevented or detected Further internal and instances of fraud controls may become inadequate as result of changes in conditions or through the deteriorations of the degree of compliance with policies or procedures Item 9B Other Information None 36 PART III Item 10 Directors Executive Officers and Corporate Governance Following is list that sets forth as of March 2013 the names ages and positions within the Company of all of the Executive Officers of the Company and the Directors of the Company Each such director has been nominated for reelection at the Companys 2013 Annual Meeting 215 Charles Street Boston Massachusetts to be held on May 23 2013 at 200 P.M at the Liberty Hotel Name Raymond Kubacki Neil Lerner James Dyke Michael Schaffer Ph.D Harry Connick Walter Tomenson Jr Fred Weinert Age 68 45 48 68 87 66 65 Position Chairman Chief Executive Officer President Director Vice President- Finance Corporate Vice President Sales Marketing Vice President Laboratory Operations Director Audit Committee member Compensation Committee Member Nominating Committee member Director Audit Committee member Compensation Committee Member Nominating Committee member Director Audit Committee member Compensation Committee Member Nominating Committee member All Directors hold office until the next annual meeting of stockholders or until their successors are elected Officers serve at the discretion of the Board of Directors Mr Kubacki has been the Companys President and Chief Executive Officer since 1991 He has also served as Chairman of the Board of the Company since 2003 He is director of Integrated Environmental Technologies LTD From 2007 until 2012 he served 2007 he served director of as Excellence in Education based as director of Protection One Inc and from 2004 to Integrated Alarm Services Group Inc He is also in Washington D.C and holds Masters trustee of the Center for Professional Director Certification from the American College of Directors Mr Kubacki has been director of the Company since 1991 Mr Lemer has served as Vice President Finance and Treasurer since May 2011 From October 2010 until May 2011 he served as Vice President Controller Prior to joining the Company he served as Director of Operational Accounting Controller with Mastec Netherlands Mr Lerner at Beacon Roofing Supply Inc Corporate Controller with Atlas TMS Divisional Inc and multiple roles with Johnson plant controller in the Johnson including is Certified Public Accountant and has masters degree in International Management Mr Dyke joined the Company as Corporate Vice President Sales and Marketing in 2010 Prior to joining the Company he worked as Marketing and General Management United States Strategic Sales Consultant variety of Vice President of Sales/Sales positions with Pitney Bowes Inc in Canada the United Kingdom and and held Dr Schaffer has served as Vice President of Laboratory Operations since 1999 From 1990 to 1999 he served as Director laboratory of SmithKiine Board of Directors of Toxicology Technical for the Leesburg Florida he was also member of of the American Board of Forensic Toxicologists Dr Schaffer has been an inspector Beecham Clinical Laboratories From 1990 to 1999 and Responsible Manager Person the for the Substance Abuse and Mental Health Services Administrations National Laboratory Certification Program since 1989 Mr Connick served as District Attorney for Orleans Parish New Orleans LA from 1974 to 2003 In 2002 Mr Connick received from Drug Czar John Walters the Directors Award for Distinguished Service in recognition Mr Connick of exemplary accomplishment has been director of and distinguished the Company since 2003 service in the fight against illegal drugs Mr Tomenson is of Client Development FINPRO the financial Senior Advisor to Integro Ltd Mr Tomenson of Marsh Inc from 1998 until 2004 From 1993 to 1998 services division of Marsh Inc Mr Tomenson is he was chairman of Director of the Trinity College was Managing Director and Chairman 37 School Fund Inc He also serves on the Executive Council of the Inner-City Scholarship Fund and holds Master Professional Director Certification from the American College of Directors Mr Tomenson has been director of the Company since 1999 Mr Weinert is an entrepreneur whose current activities are concentrated in commercial real estate new business development and environmental consulting He has served on the Business Advisory Council for the University of Dayton for over 20 years From 1973 until 1989 Mr Weinert held various executive positions in the Finance and Operations President of Waste Management groups of Waste Management Inc Mr Weinert International Inc and its subsidiaries including years as the has been director of the Company since 1991 The information required by Item 405 of Regulation S-K will be set forth in the Proxy Statement of the Company relating to the 2013 Annual Meeting of Stockholders to be held on May 23 2013 and is incorporated herein by reference The Company has code of ethics that applies to all employees and non-employee directors This code satisfies the requirements set forth in Item 406 of Regulation S-K and applies to all relevant persons set forth therein without The CompaRy will mail charge Such request shall be made to our General Counsel to interested parties copy of 125 Nagog Park Acton the Code of Ethics upon written request and Massachusetts 01720 The information required by Item 407 of Regulation S-K will be set forth in the Proxy Statement of the Company relating to the 2013 Annual Meeting of Stockholders to be held on May 23 2013 and is incorporated herein by reference Item 11 Executive Compensation The information required by this item will be set forth in the Proxy Statement of the Company relating to the 2013 Annual Meeting of Stockholders to be held on May 23 2013 and is incorporated herein by reference Item 12 Security Ownership Stockholder Matters of Certain Beneficial Owners and Management and Related The information required by this item will be set forth in the Proxy Statement of the Company relating to the 2013 Annual Meeting of Stockholders to be held on May 23 2013 and is incorporated herein by reference Item 13 Certain Relationships and Related Transactions and Director Independence The information required by this item will be set forth in the Proxy Statement of the Company relating to the 2013 Annual Meeting of Stockholders to be held on May 23 2013 and is incorporated herein by reference Item 14 Principal Accounting Fees and Services The information required by this item will be set forth in the Proxy Statement of the Company relating to the 2013 Annual Meeting of Stockholders to be held on May 23 2013 and is incorporated herein by reference 38 Item 15 Exhibits Financial Statement Schedules PART IV Financial Statements required by Item 15 are included and indexed in Part II Item Financial Statement Schedules included in Part IV of this report Schedule II is omitted because information is included in Notes to Financial Statements All other schedules under the accounting regulations of the SEC are not required under the related instructions and are inapplicable and thus have been omitted See Exhibit Index included elsewhere in this Report 39 SIGNATURES Pursuant to the requirements of Section 13 or 15d 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 March 2013 By Is Raymond Kubacki Raymond Chairman President and Chief Executive Officer Kubacki Pursuant to the requirements of the Securities Exchange Act of 1934 this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS that each person whose signature appears below appoints jointly and severally Raymond Kubacki and Neil Lerner and each one of them his attorneys-in-fact each with the power of substitution for him in any and all capacities to sign any and all amendments to this Annual Report on Form 10-K and to file the same with exhibits thereto and other documents in connection therewith with the SEC hereby ratifying and confirming all that each attorney-in- fact or his substitute or substitutes may do or cause to be done by virtue hereof Is Raymond Kubacki Raymond Kubacki Is Neil Lerner Neil Lerner Is Harry Connick Harry Connick Chairman President and Chief Executive March 2013 Officer Director Principal Executive Officer Vice President Finance March 2013 Principal Financial and Accounting Officer Director March 2013 Is Walter Tomenson Jr Director March 2013 Walter Tomenson Jr Is Fred Weinert Fred Weinert Director March 2013 40 Exhibit Number 3.1 3.2 EXHIBIT INDEX Description Amended and Restated Certificate filed on August reference from the Registrants Quarterly Report on Form 10-Q for September 30 2002 Incorporation of 2002 Incorporated by the Quarter ended By-Laws Form 10-K for of the Company the fiscal year ended December 31 2001 Incorporated by reference from the Registrants Annual Report on 4.1 Specimen Stock Certificate Incorporated by reference from the Registrants Registration Statement on Form 8-A filed on July 31 2002 10.2.1 Lease dated October 1992 with Mitchell Hersch et al with respect to premises in Culver City California Incorporated by reference from the Registrants Annual Report on Form 10-KSB for the fiscal year ended December 31 1992 10.2.2 Security Agreement reference from the Registrants Annual Report December dated October 31 1992 1992 with Mitchell Hersch et al Incorporated by on Form 10-KSB for the fiscal year ended 10.2.3 First Amendment to Lease dated with Mitchell Hersch et al California Incorporated by reference from the Registrants Annual Report on Form 10-K for the fiscal year ended December 31 1997 10.2.4 Second Amendment to Lease dated with Mitchell by reference from the Registrants Annual Report December 31 1997 Hersch et al California Incorporated on Form 10-K for the fiscal year ended 10.2.5 Third Amendment to Lease dated December 31 1997 with Mitchell Hersch et al California Incorporated by reference from the Registrants Annual Report on Form 10-K for the fiscal year ended December 31 1997 10.2.6 Fourth Amendment to Lease dated May 24 2005 with Mitchell Hersch et al California Incorporated by reference from the Registrants Annual Report on Form 10-K for the fiscal year ended December 31 2005 10.2.7 Fifth Amendment to Lease dated November 22 2011 with Mitchell Hersch et al California 10.3 10.4 2000 Stock Option Plan Form 10-Q for the Quarter ended September 30 2002 Amended and restated change July 10 2008 Incorporated in Control Severance Incorporated by reference from the Registrants current report on form 8-k Agreement with Raymond Kubacki dated by reference from the Registrants Quarterly Report on filed on July 14 2008 10.5 2006 Incentive Plan as amended Incorporated by reference from the Registrants Current Report on Form 8-K filed on May 26 2011 10.6 Form of Stock Unit Award used with employees and consultants under the 2006 Incentive Plan Incorporated May 26 2011 by reference from the Registrants Current Report on Form 8-K filed on 10.7 Form of Stock Unit Award used with non-employee directors under by reference from the Registrants Current Report the 2006 Equity Incentive on Form 8-K filed on Plan Incorporated May 26 2011 10.8 Change in control severance agreement with Michael Schaffer PhD dated July 10 2008 Incorporated by reference from the registrants current report on Form 8-k filed on July 14 2008 10.9 Amendment dated November 2008 to change in control severance agreement with Ray Kubacki Incorporated by reference from the Registrants Annual Report on Form 10-K for the fiscal year ended December 31 2008 Exhibit Number 10.10 Amendment dated November 2008 to change in control severance Description Schaffer Incorporated by reference from the Registrants Annual Report agreement with Michael on Form 10-K for the fiscal year ended December 31 2008 10.11 Employment offer letter dated April 2010 with James Dyke incorporated by reference from Registrants Quarterly Report on Form l0-Q for the quarter ended June 30 2010 10.12 Change in Control Severance Agreement with James Dyke dated April 72010 Incorporated by reference from Registrants Quarterly Report on Form 10-Q for the quarter ended June 30 2010 10.13 Employment offer letter dated October from Registrants Quarterly Report on Form 10-Q for 25 2010 with Neil Lerner incorporated the year ended December by reference 31 2010 23.1 31.1 31.2 Consent of BDO USA LLP Independent Registered Public Accounting Firm Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certification of Vice President Finance Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 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 32.2 Certification of Vice President Finance Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Management compensation plan or arrangement MANAGEMENT AND CORPORATE INFORMATION BOARD OF DIRECTORS Raymond Chairman President and C.E.O Kubacki Harry Connick Private Investor Walter Tomenson Jr Senior Advisor Integro Ltd Fred Weinert Private Investor CORPORATE OFFICERS Raymond Chairman President and C.E.O Kubacki Michael Schaffer Ph.D Vice President Laboratory Operations Neil Lerner Vice President Finance James Dyke AUDITORS BDO USA LLP Boston Massachusetts CORPORATE OFFICES Corporate Headquarters 125 Nagog Park Acton Massachusetts 01720 Laboratory Facilities 5832 Uplander Way Culver City California 90230 FORM 10-K copy of Securities the Companys Form 10-K as and Exchange Commission may be obtained filed with the by any stockholder at our website www.psychernedics corn or by writing to Corporate Vice President Sales Marketing Investor Relations TRANSFER AGENT do Computershare Trust Company N.A P.O Box 43078 Providence RI 02940-3078 Investor Relations Telephone Number 1-800-426-5523 Internet Address http//www.computershare.com COUNSEL Lynch Brewer Hoffman Fink LLP Boston Massachusetts Psychemedics Corporation 125 Nagog Acton MA 01720 Park ANNUAL MEETING The 2013 Annual Meeting of Stockholders will be held on May 23 2013 at 200 p.m at The Liberty Hotel 215 Charles Street Boston Massachusetts NASDAQ Stock Exchange Symbol PMD