Psychemedics Corp. Annual Report 2013

FY2013 Annual Report · Psychemedics Corp.
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2013 ANNUAL REPORT

CORPORATE PROFILE

Psychemedics Corporation is the world’s largest provider of hair testing for the detection of
drugs of abuse. The Company’s patented process is used by thousands of U.S. and
international clients, including over 10% of the Fortune 500 companies, for pre-employment
and random drug testing. Major police departments, Federal Reserve Banks, schools, and
other public entities also rely on our unique patented drug testing process. Our personal
drug testing service, PDT-90, is available via our website, www.drugfreeteenagers.com. The
Company’s drug test provides for the detection of cocaine, marijuana, opiates (including
oxycontin and vicodin), amphetamines (including Ecstasy), and PCP. In addition, the
Company recently launched a hair test for alcohol which also looks back on use over a
90 day period, as our hair drug tests do. We strongly believe our drug testing method to be
superior to any other product currently in use, including traditional urine testing and other
hair testing methods.

Dear Fellow Shareholders,

2013 was an eventful year for our Company:

(cid:129) Record revenues were recorded for the 2nd consecutive year.
(cid:129) Healthy earnings growth was also achieved.

(cid:129) Our strong technological advancement of the hair testing science was once

again demonstrated with the introduction of a hair test for alcohol.

(cid:129)

Exciting new initiatives and opportunities were put in play for the upcoming
year.

2013 was the second consecutive year of record revenues and we also achieved
substantial earnings growth of 28% over 2012. A change in California income tax rate
lowered the Company’s overall income tax rate; this change is permanent so we will
continue to beneﬁt. The total beneﬁt for 2013 was realized in the fourth quarter and had a
positive impact of approximately $0.05 per diluted share. However, without this positive
impact, our EPS would still have been up 18%.

Our new business remains strong. New business accounted for all our growth in 2013
and, in fact, also offset the softness in our base business as existing clients continued to be
cautious in their hiring due to uncertainties in the economic outlook.

In July, Psychemedics announced the launch of its hair alcohol test − a test that
measures average alcohol consumption over a period of approximately three months and
provides a behavioral indication of excessive use and possible dependence.

Psychemedics established its technological and market leadership position in 1987 with

the development of the ﬁrst hair test to detect drugs of abuse. As I reported in last year’s
letter, we re-established our strong patent position/protection as we received new patents
covering the process that releases virtually 100% of the drugs trapped in the hair without
destroying the drugs. Our patented process is fundamental to hair analysis because if you
can’t get the drugs out of the hair, you cannot measure them. Psychemedics was the ﬁrst
and only lab to gain a fundamental patent 20 years ago. Our new patents demonstrate that
we remain the only lab to master this scientiﬁc challenge.

At the same time, I also reported that we developed and received FDA clearance for 5

new custom-designed EIA immunoassays that meet the standards of the robust
radioimmunoassays we previously used, which were the gold standard in screening for
drugs. This also represented a signiﬁcant technological breakthrough.

Our Company has, for over 25 years, offered the most effective hair testing technology
based upon scientiﬁcally validated drug testing methods. After many years of investing time
and research, we are proud to now provide the market with a reliable test to measure
alcohol consumption over a period of time. Continued advancement in the science of hair
testing is important to Psychemedics strong position and growth; and now this new alcohol
test provides clients with another method to identify substance abuse.

We have a number of initiatives domestically and internationally which we are excited

about. One of the most signiﬁcant potential opportunities is in Brazil.

Late last year, the Brazilian Federal Government announced new guidelines that will

require professional drivers in the transportation industry to pass a hair drug test when
obtaining a driver’s license or when renewing it every ﬁve years. The new guidelines
became effective January 1, 2014, with the ﬁrst testing to begin on July 1, 2014. This is in
direct response to a United Nations initiative to reduce traffic fatalities worldwide. Brazil
has the third highest rate of traffic fatalities in the world, and we applaud the Brazilian
Federal Government for their leadership role in utilizing the rigorous hair test to ensure
public safety on the roads of Brazil.

Psychemedics’ hair test for drugs of abuse has been relied upon by numerous Brazilian

clients for the past 15 years. The Psychemedics hair test has been made available through
Psychemedics Corporation’s Brazilian-owned independent distributor, Psychemedics Brasil.

We are very excited about this opportunity to compete for Brazil’s hair testing business,

and believe the potential volume could be substantial. In order to service that potential
volume, we need to make signiﬁcant investments in plant, equipment and people. These
investments must be made in the ﬁrst half of 2014 to be ready for the July 1 start date.
During this period, we will not have any revenues from this Brazil opportunity to offset
these costs. Therefore, we would expect earnings in the ﬁrst half of 2014 to be unfavorably
impacted.

The Company’s balance sheet remains strong, with approximately $4.0 million in cash

equivalents and no long-term debt at year end. However, with the Company’s plans to
expand capacity in the ﬁrst half of 2014, we anticipate some reduction in cash and the use
of equipment ﬁnancing in order to meet our expansion plans. Nonetheless, 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. At the end of
2013, the Company had paid 69 consecutive quarterly dividends which is more than 17
years. We are also proud that we have been proﬁtable every year for the last 21 years −
since 1993 − through numerous recessions and other challenges.

I 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 at Psychemedics for their
commitment and dedication to excellence in serving our customers. And I want to thank
you, our shareholders, for your continued support.

Sincerely,

Raymond C. Kubacki
Chairman, President and
Chief Executive Officer

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(cid:2)

□

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

For the Fiscal Year Ended December 31, 2013

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) 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
Identiﬁcation No.)

01720
(Zip Code)

Registrant’s Telephone Number Including Area Code: (978) 206-8220

Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.005 par value
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by a check mark if the registrant is a well-known seasoned issuer (as deﬁned in Rule 405 of the Securities Exchange

Act of 1934). Yes (cid:4) No (cid:2)

Indicate by a check mark if the registrant is not required to ﬁle reports pursuant to Section 13 or Section 15(d) of the Securities

Exchange Act of 1934). Yes (cid:4) No (cid:2)

Indicate by check mark whether the registrant (1) has ﬁled all reports required to be ﬁled by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to ﬁle
such reports), and (2) has been subject to such ﬁling requirements for the past 90 days. Yes (cid:2) No (cid:4)

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 S-T during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such ﬁles.) Yes (cid:2) No (cid:4)

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 registrant’s knowledge, in deﬁnitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:2)

Indicate by check mark whether the registrant is a large accelerated ﬁler, an accelerated ﬁler, or a 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 (cid:2)

(Do not check if a smaller reporting company)

Indicate by a check mark whether the registrant is a shell company (as deﬁned in Rule 12b-2 of the Securities and Exchange Act

of 1934). Yes (cid:4) No (cid:2)

As of June 30, 2013, there were 5,311,378 shares of Common Stock of the Registrant outstanding. The aggregate market value

of the Common Stock of the Registrant held by non-affiliates (assuming for these purposes, but not conceding, that all executive
officers, directors and 5% shareholders are ‘‘affiliates’’ of the Registrant) as of June 30, 2013 was approximately $44 million,
computed based upon the closing price of $10.74 per share on June 30, 2013.

As of February 28, 2014, there were 5,320,355 shares of Common Stock of the Registrant outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Annual Report on Form 10-K incorporates by reference portions of the Registrant’s 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
proxy statement is not ﬁled with the Commission in such 120-day period, an amendment to this Form 10-K shall be ﬁled no later
than the end of the 120-day period.

[This page intentionally left blank.] 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements under ‘‘Business,’’ ‘‘Risk Factors,’’ ‘‘Legal Proceedings,’’ ‘‘Market for

Registrant’s Common Stock and Related Stockholder Matters’’ and ‘‘Management Discussion and Analysis of
Financial Condition and Results of Operations’’ and elsewhere in this Annual Report on Form 10-K (this
‘‘Form 10-K’’) constitute forward-looking statements under Section 27A of the Securities Act of 1933, as
amended, and Section 21E of 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, performance, 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 such as ‘‘may,’’ ‘‘should,’’ ‘‘believe,’’ ‘‘anticipate,’’ ‘‘future,’’
‘‘potential,’’ ‘‘estimate,’’ ‘‘encourage,’’ ‘‘opportunity,’’ ‘‘growth,’’ ‘‘leader,’’ ‘‘could’’, ‘‘expect,’’ ‘‘intend,’’
‘‘plan,’’ ‘‘expand,’’ ‘‘focus,’’ ‘‘through,’’ ‘‘strategy,’’ ‘‘provide,’’ ‘‘offer,’’ ‘‘allow,’’ ‘‘commitment,’’
‘‘implement,’’ ‘‘result,’’ ‘‘increase,’’ ‘‘establish,’’ ‘‘perform,’’ ‘‘make,’’ ‘‘continue,’’ ‘‘can,’’ ‘‘ongoing,’’
‘‘include’’ or the negative of such terms or comparable terminology. All forward-looking statements 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.’’

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PSYCHEMEDICS CORPORATION
FORM 10-K
ANNUAL REPORT
For the Year Ended December 31, 2013

TABLE OF CONTENTS

PART I

Item 1.

Business

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Item 1A.

Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Item 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Item 2.

Item 3.

Item 4.

Item 5.

Item 6.

Item 7.

Properties

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Mine Safety Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART II

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Management’s Discussion and Analysis of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Item 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . .

Item 8.

Item 9.

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

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Power of Attorney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART IV

Page

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7

11

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11

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12

14

14

19

20

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36

36

37

38

38

38

38

39

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Available Information; Background

PART I

Psychemedics Corporation (‘‘the Company’’ or ‘‘Psychemedics’’) maintains executive offices located at

125 Nagog Park, Acton, MA 01720. Our telephone number is (978) 206-8220. Our stock is traded on the
NASDAQ Stock Exchange Market under the symbol ‘‘PMD’’. Our Internet address is www.psychemedics.com.
The Company makes available, 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 reasonably practicable after such material is electronically ﬁled with the Securities
and Exchange Commission (the ‘‘SEC’’). Copies are also available, without charge, from Psychemedics
Corporation, Attn: Investor Relations, 125 Nagog Park, Acton, MA 01720. Alternatively, reports ﬁled with the
SEC may be viewed or obtained at the SEC Public Reference Room in Washington, D.C., or the SEC’s
Internet site at www.sec.gov. We do not intend for information contained in our website to be part of this
Annual Report on Form 10-K.

Item 1. Business

General

Psychemedics Corporation is a 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 Company’s testing
methods utilize a patented technology that digests the hair and releases 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 the drug out of the hair, you cannot measure it. The
Company then performs a proprietary custom-designed enzyme immunoassay (EIA) on the liquid supernatant,
with conﬁrmation testing by mass spectrometry.

The Company’s primary application of its patented technology is as a testing service that analyzes hair

samples for the presence of certain drugs of abuse. The Company’s customized proprietary EIA procedures to
drug test hair samples differ from the more commonly-used immunoassay procedures employed to test urine
samples. The Company’s tests provide quantitative information that can indicate the approximate amount of
drug ingested as well as historical data, which can show a pattern of individual drug use over a 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 children’s drug use. The
Company provides screening and conﬁrmation by mass spectrometry using industry-accepted practices for
cocaine, marijuana, PCP, amphetamines (including ecstasy) and opiates (including heroin, hydrocodone,
hydromorphone, oxycodone and codeine). In addition, in 2013, the Company launched a hair test for alcohol
which also looks back on use over a 90 day period, as our hair drug tests do.

Testing services are currently performed at the Company’s laboratory at 5832 Uplander Way, Culver City,

California.

Background on Drug Testing with Hair

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 utilizes a patented drug extraction method followed by a unique enzyme immunoassay
(EIA) procedure to identify drugs in the hair. The patented drug extraction method effectively releases drugs
from the hair without destroying the drugs — getting virtually 100% of the drug out of the hair. The patented
method can be used with a broad range of immunoassay screen techniques, mass spectrometry methods, and
chromatographic procedures.

The immunoassays produced by the Psychemedics R&D team were uniquely designed speciﬁcally to
meet and even exceed the standards of radioimmunoassay (‘‘RIAH’’), the original testing method created
and utilized by the Company prior to 2013. 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 Company’s creation of the its EIA assays with equivalence to its own previously
FDA-cleared radioimmunoassays.

1

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 on drug use by the person from whom the
sample was obtained. Because head hair grows approximately 1.3 centimeters per month, a 3.9 centimeter
head hair sample can reﬂect drug ingestion over the approximate three months prior to the collection of the
sample. Another option is sectional analysis of the head hair sample, in which the hair is sectioned lengthwise
to approximately correspond to certain time periods, thereby providing information on patterns of drug use.

Validation of the Company’s Proprietary Testing Methods

The process of analyzing human hair for the presence of drugs has been the subject of numerous

peer-reviewed, scientiﬁc ﬁeld studies. Some of these studies were performed with the following organizations:
Boston University School of Public Health; Citizens for a 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; Maternal/Child Substance Abuse Project, Matrix Center,
National Public Services Research Institute, Narcotic and Drug Research Institute, San Diego State
University-Chemical Dependency Center, Spectrum Inc.; Stapleford Centre (London); Task Force 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 of Washington, VA Medical
Center-Georgia; U.S. Probation Parole-Santa Ana; and Wayne State University. The above studies included
research in the following areas: effects of prenatal drug use, treatment 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 usefulness of hair analysis.

Some of the Company’s customers have also completed their own testing to validate the Company’s
hair test results compared to other companies’ urine test results. These studies consistently conﬁrmed the
Company’s superior detection rate compared to urinalysis testing. When results from the Company’s hair
testing methods were compared to urine results in side-by-side evaluations, 5 to 10 times as many drug
abusers were accurately identiﬁed by the Company’s proprietary methods.

In 1998, the National Institute of Justice, utilizing Psychemedics’ previously utilized RIAH hair testing
assay, completed a Pennsylvania Prison study where hair analysis revealed an average prison drug use level of
approximately 7.9% in 1996. Comparatively, urinalysis revealed virtually no positives. After measures to
curtail drug use were instituted (drug-sniffing dogs, searches and scanners), the use level fell to approximately
2% according 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 Food and Drug Administration (FDA) on seven EIA

assays used to test head and body hair for drugs of abuse. As of the date of this document, Psychemedics is
the only company to receive FDA clearance for testing of drugs of abuse using both head and body hair for
seven drugs of abuse.

Advantages of Using the Company’s 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 a few days of the
test. Studies published in many scientiﬁc publications have indicated that most drugs disappear from urine
within a few days.

In contrast to urinalysis testing, hair testing using the Company’s patented method can provide long-term

historical drug use information resulting in a signiﬁcantly wider window of detection. This window may be
several months or longer depending on the length of the hair sample. The Company’s standard test offering,
however, uses a 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

2

patterns and severity of drug use (information most helpful in determining the scope of an individual’s
involvement with drugs), while serving as a deterrent against drug use. Hair testing employing the Company’s
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, a drug user who
abstains from use for a 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 Company’s 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 2,000 ng/ml) on December 1, 1998, and testing for the presence of a 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 a positive urinalysis test result is challenged, a test on a newly collected urine sample is not

a viable remedy. Unless the forewarned individual continues to use drugs prior to the date of the newly
collected sample, a re-test may yield a negative result when using urinalysis testing because of temporary
abstinence. In contrast, when the Company’s hair testing method is offered on a 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 Company’s assays cleared by the FDA for

head and body hair, they also employ a unique patented method of digesting hair that the Company believes
allows for the most efficient release of drugs from the hair without destroying the drugs. The Company’s
method of releasing drugs from hair is a 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 investigation. It does, however, provide a drug history which can complement
urinalysis information in ‘‘for cause’’ testing.

The Company’s 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 Company’s sales volume.

Hair Alcohol Testing

In 2013, the Company launched a test for alcohol using hair. This test measures average alcohol

consumption over a period of approximately three months, indicates the level of alcohol use during that time
period, and can provide a behavioral indication of excessive use. The test measures the amount of ethyl
glucuronide (EtG) in the hair — a trace metabolite of ethanol and a direct alcohol biomarker. The test follows
the guidelines determined by the World Health Organization in association with the Society of Hair Testing
for measuring consumption.

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 a total of eight US patents, including
a patent issued to the Company in 2011 that focuses on digesting hair and releasing drugs trapped in the hair

3

without destroying the drugs. This patent can be used with a broad range of immunoassay screen techniques,
mass spectrometry methods, and chromatographic procedures. In 2012, the Company received an additional
patent that extended the range of the patent received in 2011.

The Company also relies on trade secrets to protect certain aspects of its proprietary technology. The
Company’s ability to protect the conﬁdentiality of its trade secrets is dependent upon the Company’s 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

Company’s competitors succeed in duplicating the Company’s products, the Company’s 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 to screen job applicants and employees. The Hazeldon Foundation
survey from 2007 indicated that 85 percent of human resource (‘‘HR’’) professionals believe that drug testing
is an effective way to diagnose substance abuse. The prevalence of drug screening programs reﬂects a concern
that drug use contributes to employee health problems and costs (as the same study found that 62 percent of
HR professionals believe that absenteeism is the most signiﬁcant problem caused by substance abuse and
addiction, followed at 49 percent by reduced productivity, a lack of trustworthiness at 39 percent, a negative
impact on the company’s 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 testing programs centers on the effectiveness of the testing

program. Most private sector testing programs use urinalysis. Such programs are susceptible to evasive
maneuvers and the inability to obtain conﬁrmation through repeat samples in the event of a challenged result.
An industry has developed over the Internet, and through direct mail, marketing a 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 a few days in order to escape detection by urinalysis.

The Company presents its patented hair analysis method to potential clients as a better technology well
suited to employer needs. Field studies and actual client results support the accuracy and effectiveness of the
Company’s 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 applicant’s or an employee’s drug problem.

The Company performs a conﬁrmation test of all screened positive results through mass spectrometry.

The use of mass spectrometry is an industry accepted practice used to conﬁrm a positive test result from the
screening process. The Company offers its clients an expanded drug screen with mass spectrometry
conﬁrmation of cocaine, PCP, marijuana, amphetamines (including Ecstasy and Eve), and opiates (including
heroin, codeine, hydrocodone, hydromorphone, and oxycodone). In addition, the Company offers a hair test
for alcohol which also looks back on use over a 90 day period, as our hair drug tests do.

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 Company’s workplace testing service. In addition, the Company offers a
hair test for alcohol which also looks back on use over a 90 day period, as our hair drug tests do.

Parents

The Company also offers a personal drug testing service, known as ‘‘PDT-90’’(cid:5), for parents concerned

about drug use by their children. It allows parents to collect a small sample from their child in the privacy of

4

the home, send it to the Company’s laboratory and have it tested for drugs of abuse by the Company. The
PDT-90 testing service uses the same patented method that is used with the Company’s workplace testing
service.

Research

The Company is involved in the following ongoing studies involving use of drugs of abuse in various

populations: Mclean Hospital; Wayne State University and Chemistry and Drug Metabolism Section; 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 increasing its base of corporate customers and believes that future success
with new customers is dependent on the Company’s ability to communicate the advantages of implementing a
drug program utilizing the Company’s patented hair analysis method.

The Company’s ability to compete is also a function of pricing. The Company’s 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 customer’s ability to test less frequently due to hair testing’s 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 the Company obtains through use of its unique
patented extraction method (getting drug out of the hair), in combination with the Company’s FDA cleared
immunoassay screen.

In addition, Psychemedics is the only laboratory with FDA clearance for a 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 for the testing of both head and body hair
samples (two other laboratories have either partial FDA clearance or clearance speciﬁc to head hair samples
only).

Government Regulation

The Company is licensed as a clinical laboratory by the State of California as well as certain other states.

All tests are performed according to the laboratory standards established by the Department of Health and
Human Services, through the Clinical Laboratories Improvement Amendments (‘‘CLIA’’), and various state
licensing statutes.

A 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.

The Federal Food, Drug and Cosmetic Act, as amended (the ‘‘FDC Act’’) requires companies engaged in
the business of testing for drugs of abuse using a test (screening assay) not previously recognized by the FDA
are required to submit their assay to the FDA for recognition prior to marketing. In addition, the laboratory
performing the tests is required to be certiﬁed by a recognized agency. In 2002, the Company received 510k
clearance to market all ﬁve of its assays utilizing RIAH technology.

In 2008, the Company received the ﬁrst CAP (College of American Pathologists) certiﬁcation speciﬁcally

including hair testing.

5

In 2011, the Company received ISO/IEC 17025 International Accreditation for a 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.

In 2012, the Company received 510k clearance from the FDA to market ﬁve of its assays utilizing the

Company’s custom developed EIA technology.

In 2013, the Company had received 510k clearance from the FDA to market two additional assays

utilizing the Company’s custom developed EIA technology.

Research and Development

The Company is continuously engaged in research and development activities. During the years ended

December 31, 2013, 2012 and 2011, $825,102, $825,518, and $607,408, respectively, were expended for
research and development. The Company continues to perform research activities to develop new products and
services and to improve existing products and services utilizing the Company’s proprietary technology. The
Company also continues to evaluate methodologies to enhance its drug screening capabilities. Additional
research using the Company’s proprietary technology is being conducted by outside research organizations
through government-funded studies.

Employees

As of December 31, 2013, the Company had 151 full-time equivalent employees, 7 of whom are
full-time employees in R&D. None of the Company’s employees are subject to a collective bargaining
agreement.

6

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
a 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 products that compete with our products and some of these companies may be
larger and better capitalized than we are.

Many of our competitors and potential competitors are larger and have greater ﬁnancial resources than
we do and offer a range of products broader than our products. Some of the companies with which we now
compete or may compete in the future may develop more extensive research and marketing capabilities and
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 a material impact on the Company’s net
revenues and proﬁtability.

Our business is intensely competitive, both in terms of price and service. Pricing of drug testing services

is a signiﬁcant factor often considered by customers in selecting a drug testing laboratory. As a 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 a result, its
net earnings and cash ﬂows could be negatively impacted by such price competition. The Company may also
face increased competition from companies that do not comply with existing laws or regulations or otherwise
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 a result of increased or additional competition. Additional competition, including price
competition, could have a material adverse impact on the Company’s 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 a large extent, on the general condition of the economy. Results for a
particular quarter may vary due to a number of factors, including:

(cid:129)

(cid:129)

(cid:129)

(cid:129)

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.

A failure to obtain and retain new customers, or a loss of existing customers, or a reduction in tests
ordered, could impact the Company’s ability to successfully grow its business.

The Company needs to obtain and retain new customers. In addition, a reduction in tests ordered, without

offsetting growth in its customer base, could impact the Company’s ability to successfully grow its business
and could have a material adverse impact on the Company’s 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 Company’s failure to successfully compete on any of these factors could
result in the loss of customers and a reduction in the Company’s ability to expand its customer base.

Our business could be harmed if we are unable to protect our technology.

We rely primarily on a 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

7

disclosed until either (1) 18 months after the application ﬁling date or (2) the publication date of an issued
patent wherein applicant(s) seek only US patent protection, applications not yet disclosed may have been ﬁled
which relate to our technology. Moreover, there is a risk that 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 a computer or other IT System failure.

A computer or IT system failure could affect our ability to perform tests, report test results or properly

bill customers. Failures could occur as a 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 Company’s systems in one or
more of its operations could disrupt the Company’s ability to process and provide test results in a timely
manner and/or bill the appropriate party. Failure of the Company’s information systems could adversely affect
the Company’s business, proﬁtability and ﬁnancial condition.

Failure to maintain conﬁdential information could result in a 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 a
computer security breach, could expose the Company to a 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 necessary for the development of our business. We do not have key personnel
under contract other than 3 officers who have agreements providing for severance and non compete covenants
in the event of termination of employment following a change of control. Further, we do not have any key
man life insurance for any of our officers or other key personnel.

There is a risk that our insurance will not be sufficient to protect us from errors and omissions liability or
other claims, or that in the future errors and omissions insurance will not be available to us at a
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 a 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 Company’s customers using new technologies to perform their own
tests, could adversely affect the Company’s 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 a freestanding laboratory. Development of such technology and its
use by the Company’s customers could reduce the demand for its testing services and negatively impact our
revenues.

8

We may not be able to recruit and retain the experienced scientists and management we need to compete in
our industry.

Our future success depends upon our ability to attract, retain and motivate highly skilled scientists and

management. Our ability to achieve our business strategies depends on our ability to hire and retain high
caliber scientists and other qualiﬁed experts. We compete with other 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 a
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, among other things, quality control, quality assurance and the maintenance of
records and documentation. If we fail to comply with these requirements, we may not be able to continue our
services to certain customers, or we could be subject to ﬁnes and penalties, suspension of production, or
withdrawal of our certiﬁcations. We operate a 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 a regulatory authority in a 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 a material adverse effect on the Company’s 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 a
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 a timely manner could create.

9

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 and
proprietary information agreements may conﬂict with, or be subject to, the rights of third parties with whom
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 a 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 have ﬂuctuated in the past and are likely to ﬂuctuate in the future. Our

results are impacted by the extent to which we are able to gain new customers 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 a long lead time. Accordingly, negotiation can be lengthy and is subject to a
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 signiﬁcant ﬂuctuations in quarterly operating results due to factors such as general and
industry-speciﬁc economic conditions 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 a 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 a company’s
securities. A securities class action suit against us could result in potential liabilities, substantial costs and the
diversion of management’s attention and resources, regardless of whether we win or lose.

Payment of a dividend 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 69 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. Further, if the Company ceases its future dividends, a 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.

10

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 a downturn in new job creation, our business and stock
price could be adversely affected.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

The Company maintains its corporate office and northeast sales office at 125 Nagog Park, Acton,

Massachusetts; the office consists of 3,971 square feet and is leased through February 2015.

The Company leases 18,000 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 5,400 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 3. 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 a material adverse effect on the
continuing operations or ﬁnancial condition of the Company.

Item 4. Mine Safety Disclosures

Not applicable.

11

PART II

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities

The Company’s common stock is traded on the NASDAQ Stock Market under the symbol ‘‘PMD’’. As
of February 28, 2014, there were 184 record holders of the Company’s common stock. The number of record
owners was determined from the Company’s stockholder records maintained by the Company’s transfer agent
and does not include beneﬁcial owners of the Company’s 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 Company’s common stock held by others as or in nominee names exceeds 2,000.

The following table sets forth for the periods indicated the range of prices for the Company’s common

stock as reported by the NASDAQ Stock Exchange and dividends declared by the Company.

Fiscal 2012:

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
First Quarter
Second Quarter
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Fiscal 2013:

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
First Quarter
Second Quarter
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

High

Low

Dividends

$10.40
10.48
12.19
12.49

$12.48
12.03
13.40
14.90

$ 9.11
9.46
10.10
10.60

$10.76
10.55
10.75
12.00

$0.150
0.150
0.150
0.150

$0.150
0.150
0.150
0.150

The Company has paid dividends over the past seventeen years. It most recently declared a dividend on
February 10, 2014, which will be paid on March 7, 2014. The Company’s 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 2013, 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 2013.

12

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information as of December 31, 2013, with respect to shares of the

Company’s common stock that were issuable under the Company’s 2006 Incentive Plan (the ‘‘2006 Incentive
Plan’’).

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, 2013. Footnote (2) 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, 2013, and the weighted average exercise price of those
options. No additional options may be granted under such other expired or discontinued plans.

Plan Category

Number of
Securities to Be
Issued Upon
Exercise of
Outstanding
Options, Warrants
and Rights(a)

Weighted Average
Exercise Price of
Outstanding
Options, Warrants
and Rights(b)

Number of Securities
That Remained
Available for Future
Issuance(c)

Equity compensation plans approved by

security holders(1)(2) . . . . . . . . . . . . . . . .

138,975

Equity compensation plans not approved by

security holders

. . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

—
138,975

$0.00

—
$0.00

181,581

—
181,581

(1) Consists of the 2006 Incentive Plan.
(2) This table does not include information for the Company’s 2000 Stock Option Plan (discontinued on

May 11, 2006). As of December 31, 2013, a total of 176,950 shares of common stock were issuable upon
the exercise of outstanding options under the foregoing discontinued plan. The weighted average exercise
price of outstanding options under such plan is $14.04 per share. No additional options may be granted
under the 2000 Stock Option Plan.

Performance Graph

Psychemedics Corporation . . . . . . . .
Russell 2000 Index . . . . . . . . . . . . .
NASDAQ Composite Index . . . . . . .

2008
100.00
100.00
100.00

2009
128.10
134.63
143.89

2010
145.08
170.09
168.22

2011
168.25
160.91
165.19

2012
203.97
182.06
191.47

2013
275.87
249.42
264.84

Calculated by the Company using www.yahoo.com/ﬁnance historical prices

13

(1) The above graph assumes a $100 investment on December 31, 2008, through the end of the 5-year period

ended December 31, 2013 in the Company’s Common Stock, the Russell 2000 Index and the NASDAQ
Composite Index. The prices all assume the reinvestment of dividends.

(2) The Russell 2000 Index is composed of the smallest 2,000 companies in the Russell 3,000 Index. The

Company has been unable to identify a 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 a peer index based on market
capitalization.

(3) The NASDAQ Composite Index includes companies whose shares are traded on the NASDAQ Stock

Exchange Market.

Item 6. Selected Financial Data

The selected ﬁnancial data presented below is derived from our ﬁnancial statements and should be read

in connection with those statements.

Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross proﬁt
. . . . . . . . . . . . . . . . . . . . . . . .
Income from operations . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . .
Basic net income per share . . . . . . . . . . . . . .
Diluted net income per share . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . .
Working capital . . . . . . . . . . . . . . . . . . . . . .
Shareholders’ equity . . . . . . . . . . . . . . . . . . .
Basic net income per share . . . . . . . . . . . . . .
Diluted net income per share . . . . . . . . . . . . .
Cash dividends declared per common share . . .

2013

$26,870
15,394
5,706
3,805
0.72
0.72
16,550
6,998
12,277
0.72
0.72
0.60

2012

2010

As of and for the Years Ended
December 31,
2011
(In Thousands, Except for per Share Data)
$20,109
$24,090
$25,224
12,042
14,473
14,252
4,414
5,800
4,936
2,614
3,489
2,980
0.50
0.67
0.57
0.50
0.67
0.57
11,766
13,801
14,121
8,566
9,217
7,491
9,748
11,035
11,223
0.50
0.67
0.57
0.50
0.67
0.57
0.48
0.48
0.60

2009

$16,955
9,610
2,584
1,527
0.29
0.29
10,602
8,471
9,294
0.29
0.29
0.53

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Management’s 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 appear elsewhere in this annual report on Form 10-K. This annual report may contain certain
‘‘forward-looking’’ information within the meaning of the Private Securities Litigation Reform Act of 1995.
This information involves risks and uncertainties. Actual results may differ materially from the results
discussed in the forward-looking statements. Factors that might cause such a difference include, but are not
limited to, those discussed in ‘‘Item 1A — Risk Factors.’’

Overview

Psychemedics Corporation is the world’s largest provider of hair testing for drugs of abuse, utilizing a

patented hair analysis method involving digestion of hair, enzyme immunoassay technology and conﬁrmation
by mass spectrometry to analyze human hair to detect abused substances. The Company’s 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, 2013, the Company generated
$26.9 million in revenue, while maintaining a gross margin of 57% and pre-tax margins of 22%. At
December 31, 2013, the Company had $4.0 million of cash, and cash equivalents. During 2013, the Company
had operating cash ﬂow of $6.0 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-nine consecutive quarterly cash
dividends.

14

The following table sets forth, for the periods indicated, the selected statements of operations data as a

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

Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total other income . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Year Ended December 31,
2012
100.0%
43.5%
56.5%

2013
100.0%
42.7%
57.3%

2011
100.0%
39.9%
60.1%

15.5%
17.5%
3.1%
36.1%
21.2%

0.4%
0.4%
21.6%
7.4%
14.2%

15.6%
18.0%
3.3%
36.9%
19.6%

0.0%
0.0%
19.6%
7.8%
11.8%

16.4%
17.1%
2.5%
36.0%
24.1%

0.0%
0.0%
24.1%
9.6%
14.5%

Results for the Year Ended December 31, 2013 Compared to Results for the Year Ended December 31,
2012

Revenue increased $1.7 million or 7% to $26.9 million in 2013 compared to $25.2 million in 2012. This

increase was due to an increase in volume from new and existing clients. The increase in volume was
primarily driven by new customers which is a result of our recently expanded sales force and several sales
initiatives. Average revenue per sample decreased 2% between 2013 and 2012. The revenue per sample
decrease was driven primarily from by the mix of customers, with a larger percentage of the business coming
from lower priced customers.

Gross proﬁt increased $1.1 million to $15.4 million in 2013 compared to $14.3 million in 2012. Direct

costs increased by 5% from 2012 to 2013, driven by the higher volume. The gross proﬁt margin remained the
same at 57% in 2013 and 2012.

General and administrative (‘‘G&A’’) expenses were $4.2 million in 2013 compared to $3.9 in 2012, an

increase of 5%. As a percentage of revenue, G&A expenses were 15.5% and 15.6% for 2013 and 2012,
respectively.

Marketing and selling expenses were $4.7 million in 2013, compared to $4.5 million in 2012, an increase

of 4%. Total marketing and selling expenses represented 17.5% and 18.0% of revenue for 2013 and 2012,
respectively.

Research and development (‘‘R&D’’) expenses were $0.8 million in 2013 and 2012. R&D expenses

represented 3.1% and 3.3% of revenue for 2013 and 2012, respectively.

Other income increased approximately $90 thousand to approximately $92 thousand for 2013 compared

to $2 thousand for 2012. The increase was from an insurance reimbursement of legal expenses.

During the year ended December 31, 2013, the Company recorded a tax provision of $2.0 million,
representing an effective tax rate of 34.4%. During the year ended December 31, 2012, the Company recorded
a tax provision of $2.0 million, representing an effective tax rate of 39.7%. The change in tax rate was driven
by a new allocation method for calculating income tax in California. This new calculation requires income tax
to be paid only on the sales made within California. The old method taxed all income produced in California,
and as the Company has only one laboratory, which is located in California, 100% of the income had been

15

subject to California income tax. The rate also beneﬁted from an R&D tax credit from 2012 which was
recognized in 2013. We expect the tax rate to be approximately 34% for the foreseeable future.

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. The increase in volume was
primarily driven by new customers which is a result of our recently expanded sales force and several sales
initiatives. Average revenue per sample decreased 3% between 2012 and 2011. The revenue per sample
decrease was driven primarily from by the mix of customers, with a larger percentage of the business coming
from lower priced customers.

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.

General and administrative (‘‘G&A’’) expenses were $3.9 million for 2012 and 2011. As a percentage of

revenue, G&A expenses were 15.6% and 16.4% for the years 2012 and 2011, respectively.

Marketing and selling expenses were $4.5 million for 2012, compared to $4.1 million for 2011, an
increase of 10%. Total marketing and selling expenses represented 18.0% and 17.1% of revenue for 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.

Research and development (‘‘R&D’’) expenses for 2012 were $0.8 million compared to $0.6 million for
2011. R&D expenses represented 3.3% and 2.5% of revenue for 2012 and 2011, respectively. The additional
expenses related to the new enzyme immunoassay (EIA) screening process.

Interest income decreased approximately $3,000 to approximately $2,000 for the year ended
December 31, 2012 compared to $5,000 for the year ended December 31, 2011. Interest income in both
periods represented interest and dividends earned on cash equivalents and short-term investments. A decrease
in the yield and a decrease in investment balances in 2012 as compared to 2011 caused the decrease in
interest income.

During the year ended December 31, 2012, the Company recorded a tax provision of $2.0 million,
representing an effective tax rate of 39.7%. During the year ended December 31, 2011, the Company recorded
a tax provision of $2.3 million, representing an effective tax rate of 39.9%.

Liquidity and Capital Resources

At December 31, 2013, the Company had $4.0 million of cash and cash equivalents, compared to
$3.1 million at December 31, 2012. The Company’s operating activities generated net cash of $6.0 million in
2013, $3.1 million in 2012 and $3.9 million in 2011. Investing activities used $1.8 million in 2013, used
$2.3 million in 2012 and generated $0.5 million in 2011. Financing activities used $3.3 million in 2013,
$3.2 million in 2012 and $2.6 million in 2011.

Operating cash ﬂow of $6.0 million in 2013 primarily reﬂected net income of $3.8 million adjusted for

depreciation and amortization of $0.9 million, stock compensation expense of $0.5 million, and an increase in
net deferred tax liabilities of $0.4 million. This was affected by the following changes in assets and liabilities:
a decrease in accounts receivable of $0.3 million, a decrease in accounts payable of $0.2 million, a decrease
in accrued expenses of $0.1 million, and a decrease in prepaid expenses (and other current assets) of
$0.4 million. The increase in operating cash ﬂow of $2.9 million over 2012 was primarily driven by higher
net income and a reduction of income tax receivable. 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, and an increase in net deferred tax liabilities of $0.4 million. This was
affected by the following changes in assets and liabilities: an increase in accounts receivable of $0.1 million, a
decrease in accounts payable of $0.3 million, a decrease in accrued expenses of $0.4 million, and an increase
in prepaid expenses (and other current assets) of $0.5 million, Operating cash ﬂow of $3.9 million in 2011

16

primarily reﬂected net income of $3.5 million adjusted for depreciation and amortization of $0.4 million, stock
compensation expense of $0.4 million, and an increase in net deferred tax liabilities of $0.4 million. This was
affected by the following changes in assets and liabilities: an increase in accounts receivable of $0.6 million,
an increase in accounts payable of $0.3 million, and an increase in prepaid expenses (and other current assets)
of $0.4 million.

Investing cash ﬂow principally reﬂected the purchase and sale of short-term investments and capital

expenditures. During 2013, there was an increase of $0.2 million in other assets which primarily related to
patent costs. 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 of $2.0 million. Also in 2011,
there was an increase of $0.1 million in other assets which primarily related to patent costs. Capital
expenditures were $1.5 million, $2.2 million, and $1.4 million in 2013, 2012 and 2011, respectively. The
expenditures related principally to new equipment and new software, including laboratory and computer
equipment.

During 2013 and 2012, the Company did not repurchase any shares of common stock for treasury.
During 2011, the Company repurchased 2,785 shares of common stock for treasury. The Company has
authorized 750,000 shares for repurchase since June of 1998, of which 250,000 shares of common stock were
authorized in March of 2008 for repurchase. Since 1998, a total of 550,684 shares have been repurchased. The
Company also distributed $3.2 million, $3.2 million, and $2.5 million of cash dividends to its shareholders in
2013, 2012, and 2011 respectively.

At December 31, 2013, the Company’s principal sources of liquidity included approximately $4.0 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 Company’s results of operations, its future capital needs and available
marketing opportunities, the Company may use various ﬁnancing sources to raise additional funds. Such
sources could include joint ventures, issuance of common stock or debt ﬁnancing, lines of credit, or
equipment leasing, 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, 2013, the Company had no long-term debt.

The Company has paid dividends over the past sixty-nine quarters. It most recently declared a dividend

in February 2014 which will be paid in March 2014 in the amount of $798,053. The Company’s 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.

Contractual obligations as of December 31, 2013 were as follows:

Payments Due by Period

Contractual Obligation

Less Than
1 Year

1 − 3
Years

Operating leases

. . . . . . . . . . . . . . . . . . . . . . .

$609

$575

Purchase Commitment

Greater
Than 5
Years

4 − 5
Years
(Amounts in Thousands)
$—

$—

Total

$1,184

Operating leases consist of rent obligations for the company’s facilities. The Company has no signiﬁcant

contractual obligation for supply agreements as of December 31, 2013.

Signiﬁcant Customers

The Company did not have any individual customers that exceeded 10% of revenue for the years ended

December 31, 2013, 2012 and 2011 or accounts receivable as of December 31, 2013, 2012 and 2011.

17

Critical Accounting Policies

The Company’s signiﬁcant accounting policies are described in Note 2 to the ﬁnancial statements

included in Item 8 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

Company’s drug testing services include training for collection of samples and storage of positive samples for
its customers for an agreed-upon fee per unit tested of samples. The revenues are recognized when the
predominant deliverable, drug testing, is provided and reported to the customer.

The Company recognizes revenue in accordance with Accounting Standards Codiﬁcation ‘‘ASC’’ 605,
‘‘Revenue Recognition.’’ In accordance with ASC 605, the Company considers testing, training and storage
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, long-lived asset lives, 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 in
accordance with U.S. generally accepted accounting standards. 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 5 years. Costs incurred during
the post-implementation/operation stage, including training costs and maintenance costs, are expensed as
incurred. We capitalized internally developed software costs of $715,000, $794,000 and $387,000 during the
years ended December 31, 2013, 2012 and 2011, respectively. The software development is for primarily for
two projects. Determining whether particular costs incurred are more properly attributable to the preliminary
or conceptual stage, and thus expensed, or to the application development phase, and thus capitalized and
amortized, depends on subjective judgments about the nature of the development work, and our judgments in
this regard may differ from those made by other companies. General and administrative costs related to
developing or obtaining such software are expensed as incurred.

Allowance for Doubtful Accounts

The allowance for doubtful accounts is based on management’s assessment of the ability to collect
amounts owed to it by its customers. Management reviews its accounts receivable aging for doubtful accounts
and uses a methodology based on calculating the allowance using a combination of factors including the age
of the receivable along with management’s judgment to identify accounts that may not be collectible. The
Company routinely assesses the ﬁnancial strength of its customers and, as a consequence, believes that its
accounts receivable credit risk exposure is limited. The Company maintains an allowance for potential credit
losses but historically has not experienced any signiﬁcant losses related to individual customers or groups of
customers in any particular industry or geographic area. Bad debt expense has been within management’s
expectations.

18

Income Taxes

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

The Company had net deferred tax liabilities in the amount of $1.0 million at December 31, 2013, 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 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 a general and administrative expense.
The Company did not have any unrecognized tax beneﬁts and did not have any interest or penalties accrued
as of December 31, 2013 or 2012. The Company does not expect the unrecognized tax beneﬁts to change
signiﬁcantly over the next twelve months.

The above listing is not intended to be a comprehensive list of all of the Company’s accounting policies.

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

Recent Accounting Pronouncements

There were no new accounting pronouncements issued or effective during the ﬁscal year which have had
or are expected to have a material impact on the Financial Statements. See Note 2 — Accounting Policies, to
the Financial Statements for further detail on applicable accounting pronouncements that were adopted in
2013.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Not Required.

19

Item 8. Financial Statements and Supplementary Data

(a) Financial Statements:

Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Balance Sheets as of December 31, 2013 and 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Statements of Income and Comprehensive Income for the Years Ended December 31, 2013, 2012

and 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Statements of Shareholders’ Equity for the Years Ended December 31, 2013, 2012 and 2011 . . . . .

Statements of Cash Flows for the Years Ended December 31, 2013, 2012 and 2011 . . . . . . . . . . . .

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 Psychemedics Corporation (the ‘‘Company’’) as of
December 31, 2013 and 2012 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, 2013. These ﬁnancial
statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on
these ﬁnancial statements based on our audits.

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 included consideration of internal control over ﬁnancial reporting as a 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 Company’s internal control over ﬁnancial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures
in the ﬁnancial statements, assessing the accounting principles used and signiﬁcant estimates made by
management, as well as evaluating the overall ﬁnancial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the ﬁnancial statements referred to above present fairly, in all material respects, the
ﬁnancial position of the Company at December 31, 2013 and 2012 and the results of its operations and its
cash ﬂows for each of the three years in the period ended December 31, 2013, in conformity with accounting
principles generally accepted in the United States of America.

/s/ BDO USA, LLP

Boston, Massachusetts
February 28, 2014

21

PSYCHEMEDICS CORPORATION

BALANCE SHEETS

December 31,
2013

December 31,
2012

Current Assets:

ASSETS

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable, net of allowance for doubtful accounts of

$144,921 in 2013 and $121,583 in 2012 . . . . . . . . . . . . . . . . . . . .
Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . .
Income tax receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Current Assets

$ 3,970,512

$ 3,065,785

4,368,864
769,269
554,828
292,795
9,956,268

4,620,768
823,274
854,212
209,877
9,573,916

Property and equipment:

Computer software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Office furniture and equipment
. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Laboratory equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less − accumulated depreciation and amortization . . . . . . . . . . . . . . .

Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Assets

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities:

1,958,780
779,891
8,047,840
439,414
11,225,925
(5,175,722)
6,050,203
543,345
$ 16,549,816

1,210,734
659,866
6,634,043
92,371
8,597,014
(4,395,605)
4,201,409
345,293
$ 14,120,618

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax liabilities, long-term . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$

510,550
2,447,920
2,958,470
1,314,221
4,272,691

$

669,789
1,413,541
2,083,330
814,619
2,897,949

Commitments and Contingencies (Note 9)
Shareholders’ Equity:

Preferred-stock, $0.005 par value, 872,521 shares authorized, no shares
issued or outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Common stock, $0.005 par value; 50,000,000 shares authorized

5,981,896 shares issued in 2013 and 5,940,558 shares issued 2012,
5,313,766 shares outstanding in 2013 and 5,272,428 shares
outstanding in 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital
Less − Treasury stock, at cost, 668,130 shares . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated deﬁcit
Total Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Liabilities and Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . .

—

—

29,910
28,888,712
(10,081,789)
(6,559,708)
12,277,125
$ 16,549,816

29,703
28,460,764
(10,081,789)
(7,186,009)
11,222,669
$ 14,120,618

The accompanying notes are an integral part of these ﬁnancial statements.

22

PSYCHEMEDICS CORPORATION

STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross proﬁt

Operating Expenses:

General & administrative . . . . . . . . . . . . . . . . . . . . .
Marketing & selling . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Research & development
Total Operating Expenses . . . . . . . . . . . . . . . . . . . . . . .
Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other 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 . . . . . . . . . . . . . . . . . . . .
Weighted average common shares outstanding, basic . . . .

Weighted average common shares outstanding, diluted . . .

2013
$26,870,297
11,476,263
15,394,034

Year Ended December 31,
2012
$25,223,534
10,971,886
14,251,648

2011
$24,089,608
9,616,985
14,472,623

4,157,597
4,704,970
825,102
9,687,669
5,706,365
92,273
5,798,638
1,993,428
$ 3,805,210

$
$
$

0.72
0.72
0.60
5,299,060

5,315,463

3,946,844
4,543,598
825,518
9,315,960
4,935,688
1,889
4,937,577
1,957,948
$ 2,979,629

$
$
$

0.57
0.57
0.60
5,260,320

5,272,542

3,948,706
4,116,059
607,408
8,672,173
5,800,450
5,346
5,805,796
2,316,513
$ 3,489,283

$
$
$

0.67
0.67
0.48
5,229,646

5,235,940

The accompanying notes are an integral part of these ﬁnancial statements.

23

PSYCHEMEDICS CORPORATION

STATEMENTS OF SHAREHOLDERS’ EQUITY

Common Stock

Treasury Stock

BALANCE, December 31, 2010 .
Shares issued − vested .
.
.
Tax withholding related to vested

.

.

.

.

Shares

.
.

.
.

. 5,877,358
26,194
.

$0.005 par
Value

$29,387
131

Paid-In
Capital

$27,764,992
(131)

Shares

665,345
—

—
—
2,785

Cost

Accumulated
Deﬁcit

Total

$(10,059,398)
—

$(7,987,468) $ 9,747,513
—

—

—
—
(22,391)

—
—
—

(86,992)
418,077
(22,391)

(86,992)
418,077
—

—
—
28,095,946
(185)

—
—
668,130
—

— (2,510,861)
3,489,283
—
(7,009,046)
(10,081,789)
—
—

(2,510,861)
3,489,283
11,034,629
—

(93,164)
458,167

—
—

—
—

—
—

(93,164)
458,167

—
—
28,460,764
(185)
20,817

—
—
668,130
—
—

— (3,156,592)
2,979,629
—
(7,186,009)
(10,081,789)
—
—
—
—

(3,156,592)
2,979,629
11,222,669
—
20,839

(154,522)
538,304

23,534

—
—

—

—
—

—

—
—

—

(154,522)
538,304

23,534

.
.
.

—
—
—

.
.
.
.

.
.
.
.

—
.
.
—
. 5,903,552
37,006
.

.
.

—
—

.
.
.
.
.

.
.
.
.
.

—
.
.
—
. 5,940,558
36,988
.
4,350
.

.
.

.

—
—

—

.
.

.
.

shares from employee stock plans .
.
.

.
Stock compensation expense .
.
Acquisition of treasury stock .
Cash dividends declared ($0.48 per
.
.
share)
.
Net income
.
.
BALANCE, December 31, 2011 .
.
.
Shares issued – vested
Tax withholding related to vested

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.

.

.

.

.

shares from employee stock plans .
.

.

.

.

.
.

.
.

.
.

.
.

.
.

Stock compensation expense .
.
Cash dividends declared ($0.60 per
.
.
.
share)
Net income
.
.
BALANCE, December 31, 2012 .
.
.
Shares issued − vested .
.
.
.
Exercise of stock options .
Tax withholding related to vested

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.

.

.

shares from employee stock plans .
.

compensation plans .

Stock compensation expense .
.
Excess tax beneﬁt from stock-based
.
Cash dividends declared ($0.60 per
.
.
share)
.
Net income
.
.
BALANCE, December 31, 2013 .

.

.
.
.

.

.
.
.

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.
.

.

.

.

.

.

.

—
—
—

—
—
29,518
185

—
—

—
—
29,703
185
22

—
—

—

—
.
.
—
. 5,981,896

—
—
$29,910

—
—
$28,888,712

—
—
668,130

— (3,178,909)
3,805,210
—
$(10,081,789)

(3,178,909)
3,805,210
$(6,559,708) $12,277,125

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 . . . . . . . . . . . . . .
Increase in long-term assets; capitalized patent costs . . .
Purchases of property and equipment and capitalized

Year Ended December 31,
2012

2011

2013

$ 3,805,210

$ 2,979,629

$ 3,489,283

872,171
416,684
538,304

586,968
437,720
458,167

370,020
406,853
418,077

251,904

(129,792)

(585,155)

353,389
(159,239)
(126,876)
—
5,951,547

(547,895)
(292,055)
(406,011)
—
3,086,731

(428,769)
262,011
19,486
(16,605)
3,935,201

—
(226,130)

—
(121,375)

2,018,452
(130,874)

software development costs . . . . . . . . . . . . . . . . . .
Net cash provided by (used in) investing activities . . . . . .

(1,531,632)
(1,757,762)

(2,214,048)
(2,335,423)

(1,358,790)
528,788

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

. . . . . . . . . . . . . . . . . . . . .

(3,178,909)

(3,156,592)

(2,510,861)

(110,149)
—
(3,289,058)
904,727
3,065,785
$ 3,970,512

(93,164)
—
(3,249,756)
(2,498,448)
5,564,233
$ 3,065,785

(86,992)
(22,391)
(2,620,244)
1,843,745
3,720,488
$ 5,564,233

$ 1,233,000

$ 1,715,000

$ 2,401,957

Non-cash investing and ﬁnancing activities:
Issuance of restricted stock awards

. . . . . . . . . . . . . . . .

Exercise of stock options . . . . . . . . . . . . . . . . . . . . . . .

$

$

185

20,817

Purchases of equipment through accrued liabilities . . . . . .

$ 1,161,255

$

$

$

185

—

497,696

$

$

$

131

—

—

The accompanying notes are an integral part of these ﬁnancial statements.

25

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

1. Nature of Business and Basis of Presentation

Psychemedics Corporation (the ‘‘Company’’) is the world’s largest provider of hair testing for drugs of

abuse, utilizing a patented hair analysis method involving digestion of hair, enzyme immunoassay technology
and conﬁrmation by mass spectrometry to analyze human hair to detect abused substances. The Company’s
customers include Fortune 500 companies, as well as small to mid-size corporations, schools and
governmental entities located in the United States and internationally.

2. Summary of Signiﬁcant Accounting Policies

Risks and Uncertainties

The Company is subject to a number of risks and uncertainties similar to those of other companies,

such as those associated with the continued expansion of the Company’s 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 limited to, Food and Drug Administration regulations), competition and general
economic conditions.

Estimates

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, 2013.
While the money market account contains U.S. federal government backed issues, the account itself is not
federally insured. As of December 31, 2013, $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 a liability (an exit price) in the principal or most advantageous market for the asset or
liability in an orderly transaction between market 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 a 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 1 — Quoted prices in active markets for identical assets or liabilities.

Level 2 — Inputs other than Level 1 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, 2013

2. Summary of Signiﬁcant Accounting Policies − (continued)

Level 3 — Unobservable inputs that are supported by little or no market activity and that are signiﬁcant

to the fair value.

A ﬁnancial instrument’s 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 Company’s ﬁnancial assets that are measured at fair value on a

recurring basis as of December 31, 2013 and 2012 are cash equivalents. Cash equivalents are measured using
Level 1 inputs. At December 31, 2013 and 2012, the Company had $0.4 million of Level 1 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

3 to 5 years
3 to 7 years
5 to 7 years
Lesser of estimated − useful life or lease term

The Company recorded depreciation and amortization related to property and equipment of $844,093,

$573,712 and $362,282 in 2013, 2012 and 2011 respectively.

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 5 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, 2013 and 2012, we capitalized internally developed software costs of $715,000 and $794,000,
respectively. Amortization expense related to software development costs was $145,251, $98,301, and $8,840
in 2013, 2012, and 2011, respectively. Determining whether particular costs incurred are more properly
attributable to the preliminary or conceptual stage, and thus expensed, or to the application development
phase, and thus capitalized and amortized, depends on subjective judgments about the nature of the
development work, and our judgments in this regard may differ from those made by other companies. General
and administrative costs related to developing or obtaining such 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 the life of the patent from the date of grant of the applicable patent. The typical
patent life is twenty years. As of December 31, 2013 2012, and 2011 the Company had capitalized legal costs
relating to outstanding patent applications of $497,857, $299,389, and $194,704, respectively. Amortization
expense was $28,078, $13,256 and $7,738 in 2013, 2012, and 2011, respectively. The amount of amortization
related to patent applications is expected to remain below $40,000 per year for the next ﬁve years.

27

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

2. Summary of Signiﬁcant Accounting Policies − (continued)

Revenue Recognition

The Company is in the business of performing drug testing services and reporting the results thereof. The

Company’s services include, drug testing, 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 under ASC 605, ‘‘Revenue Recognition’’ (‘‘ASC 605’’). In accordance

with ASC 605, the Company considers testing, training and storage 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.

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 to address the Company’s tax risk proﬁle. The Company analyzes the potential tax liabilities of
speciﬁc transactions and tax positions based on management’s 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. The Company places its cash and cash equivalents and short-term investments in highly rated
institutions. These include money market accounts 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 a
consequence, believes that its accounts receivable credit risk exposure is limited. The Company maintains an
allowance for potential credit losses but historically has not experienced any signiﬁcant losses related to
individual customers or groups of customers in any particular industry or geographic area. The Company does
not require collateral.

Signiﬁcant Customers

The Company did not have any individual customers that exceeded 10% of revenue for the years ended

December 31, 2013, 2012 and 2011 or accounts receivable as of December 31, 2013, 2012 and 2011.

Comprehensive Income

The Company’s comprehensive income was the same as its reported net income for the years ended

December 31, 2013, 2011 and 2010.

28

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

2. Summary of Signiﬁcant Accounting Policies − (continued)

Stock-Based Compensation

The Company accounts for equity awards in accordance with ASC 718, ‘‘Compensation — Stock
Compensation’’ (‘‘ASC 718’’). ASC 718 requires employee equity awards to be accounted for under the fair
value method. Accordingly, share-based compensation is measured at the grant date based 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 to vest. The Company uses
the straight-line method to recognize share-based compensation over the service period of the award, which is
generally equal to the vesting period.

Under ASC 718, the Company recorded $538,304, $458,167, and $418,077 of stock compensation
expense in the accompanying statements of income for the years ended December 31, 2013, 2012 and 2011,
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 . . . . . . . . . . . . . . . . . . . . .

2013
$112,348
339,098
77,789
9,069
$538,304

2012
$ 91,118
282,375
81,819
2,855
$458,167

2011
$ 85,731
266,915
65,431
—
$418,077

See Note 7 for additional information relating to the Company’s 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 per share is
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 issuable upon the exercise of outstanding options and the unvested
portion of stock unit awards (‘‘SUAs’’).

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

Weighted average common shares outstanding, basic . .
Dilutive common equivalent shares . . . . . . . . . . . . . .
Weighted average common shares outstanding,

2013
5,299,060
16,403

2012
5,260,320
12,222

2011
5,229,646
6,294

assuming dilution . . . . . . . . . . . . . . . . . . . . . . . .

5,315,463

5,272,542

5,235,940

For the years ended December 31, 2013, 2012, and 2011, options to purchase 152,650, 191,597, and

264,088 common shares, respectively, were outstanding but not included in the dilutive common equivalent
share calculation as their effect would have been anti-dilutive.

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.

29

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

2. Summary of Signiﬁcant Accounting Policies − (continued)

Segment Reporting

The Company manages its operations as one segment, drug testing services. As a result, the ﬁnancial
information disclosed herein materially represents all of the ﬁnancial information related to the Company’s
principal operating segment. Most of the Company’s revenues and all of the Company’s assets are in the
United States.

Subsequent Events

The Company evaluated all events and transactions that occurred after December 31, 2013 through the
time of ﬁling with the Securities and Exchange Commission of the Company’s annual report on Form 10-K
for the year ended December 31, 2013. On February 10, 2014, the Company declared a quarterly dividend of
$0.15 per share for a total of $798 thousand, which will be paid on March 7, 2014 to shareholders of record
on February 21, 2014.

Recent Accounting Pronouncements

There were no accounting pronouncements during the year that applied to the Company’s ﬁnancial

statements.

3. Accounts Receivable

The Company maintains an allowance for uncollectible accounts receivable based on management’s
assessment of the collectability of its customer accounts by reviewing customer payment patterns and other
relevant factors. The Company reviews the adequacy of the allowance for uncollectible accounts on a
quarterly basis and adjusts the balance as determined necessary. Write-offs are recorded at the time a customer
account is deemed uncollectable. The following is a rollforward of the Company’s allowance for doubtful
accounts:

Balance, beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for (recoveries of) doubtful accounts . . . . . . . . . . . . . . . .
Write-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2013
$121,583
82,332
(58,994)
$144,921

2012
$169,191
(28,866)
(18,742)
$121,583

4. Accrued Expenses

Accrued expenses consist of the following:

Accrued payroll and employee beneﬁts . . . . . . . . . . . . . . . . . . . . .
Accrued bonus expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued vacation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued hair collection expense . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued audit and tax consulting . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued payable for equipment purchases
. . . . . . . . . . . . . . . . . . .
Accrued payable for building maintenance . . . . . . . . . . . . . . . . . . .
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Accrued Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2013
$ 185,937
251,700
267,080
119,587
144,018
1,161,255
142,340
176,003
$2,447,920

2012
$ 360,702
90,000
119,703
113,355
110,491
497,696
63,785
57,809
$1,413,541

30

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

5. Income Taxes

The income tax provision consists of the following:

Current −
Federal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deferred −
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal
State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Income Tax Provision . . . . . . . . . . . . . . . . . . . . . . .

2013

2012

2011

$1,499,400
77,344
1,576,744

$1,196,926
323,302
1,520,228

$1,450,941
458,719
1,909,660

406,116
10,568
416,684
$1,993,428

346,974
90,746
437,720
$1,957,948

370,710
36,143
406,853
$2,316,513

A 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2013
34.0%
1.1%
-0.7%
0.0%
34.4%

2012
34.0%
5.5%
0.1%
0.0%
39.6%

2011
34.0%
5.6%
0.1%
0.2%
39.9%

The Company had a signiﬁcant reduction in the effective state income tax rate from 5.5% to 1.1%. This

change was a result of a change in the apportionment methodology in California, where the Company’s
primary operation is located. The Company recognized the total impact of this change in the fourth quarter of
2013. The Company expects this to be a permanent rate change. The actual effective rate may change in
future periods as the percentage of customers located in California changes in relation to the Company’s total
sales. The permanent difference is primarily from research and development tax credits.

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 . . . . . . . .

2013

2012

$

$

160,850
48,578
83,367
292,795

$ 162,792
47,959
55,401
$ 266,152

—
(1,314,221)
(1,314,221)

$ (56,275)
(814,619)
(870,894)

Net deferred tax liabilities

. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$(1,021,426)

$(604,742)

31

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

5. 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$

292,795
(1,314,221)
$(1,021,426)

$ 209,877
(814,619)
$(604,742)

ASC 740 contains a two-step approach to recognizing and measuring uncertain tax positions (tax
contingencies). The ﬁrst step is to evaluate the tax position for recognition by determining if the weight of
available evidence indicates it is more likely than not that the position will be sustained on an audit, including
resolution of related appeals or litigation processes, if any. The second step is to measure the tax beneﬁt as the
largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company
considers many factors when evaluating and estimating the Company’s tax positions and tax beneﬁts, which
may require periodic adjustments and which may not accurately forecast actual outcomes.

The Company operates within multiple taxing jurisdictions and could be subject to audit in these
jurisdictions. These audits may involve complex issues, which may require an extended period of time to
resolve. The Company has provided for its estimated taxes payable in the accompanying ﬁnancial statements.
Interest and penalties related to income tax matters are recognized as a general and administrative expense.
The Company did not have any unrecognized tax beneﬁts and did not have any interest or penalties accrued
as of December 31, 2013 and 2012. The tax years ended December 31, 2010 through December 31, 2013
remain subject to examination by all major taxing authorities.

6. Preferred Stock

The Board of Directors 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.

7. 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 restricted stock or
stock unit awards (SUAs), issuances of stock bonuses or grants other stock-based awards, covering up to
500,000 shares of common stock, plus cash based awards, to officers, directors, employees, and consultants.
Such shares are issuable out of the Company’s authorized but unissued common stock. As of December 31,
2013, 181,581 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

a period of two to four years and are convertible into an equivalent number of shares of the Company’s
common stock provided that the employee receiving the award remains continuously employed throughout the
vesting period. The Company records compensation expense related to the SUAs on a straight-line basis over
the vesting term of the SUA. Employees are issued shares upon vesting, net of tax withholdings.

The Company granted 56,500 SUAs on May 8, 2013. The fair value of the SUAs was $11.45 per share,

which was the closing price of the Company’s stock on that date. The SUAs vest over a period of two to
four years and are convertible into an equivalent number of shares of the Company’s common stock provided
that the awardee remains continuously employed throughout the vesting period. In addition, 13,362 SUAs
were withheld for taxes in 2013, in conjunction with the vesting of SUA’s granted in prior years, and
consequently, added back to the shares available for future grant.

The Company granted 65,000 SUAs on May 22, 2012. The fair value of the SUAs was $9.79 per share,

which was the closing price of the Company’s stock on that date. The SUAs vest over a period of two to
four years and are convertible into an equivalent number of shares of the Company’s common stock provided

32

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

7. Stock-Based Awards − (continued)

that the awardee remains continuously employed throughout the vesting period. In addition, 9,619 SUAs were
withheld for taxes in 2012, in conjunction with the vesting of SUA’s granted in prior years, and consequently,
added back to the shares available for future grant.

The Company granted 59,000 SUAs on May 24, 2011. The fair value of the SUAs was $10.03 per share,

which was the closing price of the Company’s stock on that date. The SUAs vest over a period of two to
four years and are convertible into an equivalent number of shares of the Company’s common stock provided
that the awardee remains continuously employed throughout the vesting period.

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 a 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.

A summary of stock option activity for the Company’s stock option plans is as follows:

Outstanding & exercisable, December 31, 2010 . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & exercisable, December 31, 2011 . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & exercisable, December 31, 2012 . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & exercisable, December 31, 2013 . .

Weighted
Average
Exercise
Price per
Share
13.96
—
—
15.06
13.62
—
—
13.61
13.62
—
8.58
13.75
$14.04

Number of
Shares
289,371
—
—
(68,132)
221,239
—
—
(21,401)
199,838
—
(14,988)
(7,900)
176,950

Weighted
Average
Remaining
Contractual
Life

Aggregate
Intrinsic
Value(1)

$ 53,636

1.2 years

$115,135

(1) The aggregate intrinsic value on this table was calculated based on the amount, if any, by which the

closing market value of the Company’s stock on December 31, 2013 ($14.69) exceeded the exercise price
of any of the underlying options, multiplied by the number of shares subject to each such option. For
value on the exercised stock, the calculation is based on the amount the Company’s stock price at
exercise exceeded the exercise price.

33

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

7. Stock-Based Awards − (continued)

A summary of stock unit award activity for the Company is as follows:

Outstanding & Unvested, December 31, 2010 . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Converted to common stock* . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & Unvested, December 31, 2011 . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Converted to common stock* . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & Unvested, December 31, 2012 . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Converted to common stock* . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & Unvested, December 31, 2013 . . . . . . .
Available for grant, December 31, 2013 . . . . . . . . . . .

Number of
Shares
94,700
59,000
(34,600)
—
119,100
65,000
(46,625)
—
137,475
56,500
(50,350)
(4,650)
138,975
181,581

Weighted
Average
Remaining
Contractual
Life

Aggregate
Intrinsic
Value(2)
$ 776,540

$ 355,351

$1,083,810

$ 458,211

$1,477,856

$ 577,321

2.7 years

$2,041,543

(2) The aggregate intrinsic value on this table was calculated based on the closing market price of the
Company’s stock. The price at year end was $14.69, $10.75, $9.10, and $8.20 for the years ended
December 31, 2013, 2012, 2011 and 2010, respectively. For value on the converted stock, the price used
is the price on the grant date.
Figure includes 13,362 shares in 2013, 9,619 shares in 2012, and 8,406 shares in 2011 withheld to cover
income taxes.

*

As of December 31, 2013, a total of 497,506 shares of common stock were reserved for issuance under

the various stock plans. As of December 31, 2013, the unamortized fair value of awards relating to SUAs was
$1,057,142 to be amortized over a weighted average period of approximately 2.7 years.

8. Employee Beneﬁt Plan

The Psychemedics Corporation 401(k) Savings and Retirement Plan (the 401(k) Plan) is a qualiﬁed
deﬁned contribution plan in accordance with Section 401(k) of the Internal Revenue Code. All employees over
the age of 21 are eligible to make pre-tax contributions up to a speciﬁed percentage of their compensation.
Under the 401(k) Plan, the Company may, but is not obligated to, match a portion of the employees’
contributions up to a deﬁned maximum. Matching contributions of $141,661, $147,360, and $122,961 were
made in the years ended December 31, 2013, 2012 and 2011, respectively.

9. Commitments and 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
$605,000, $555,000 and $548,000 in 2013, 2012 and 2011, respectively.

34

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2013

9. Commitments and Contingencies − (continued)

At December 31, 2013, minimum commitments remaining under lease agreements were approximately as

follows:

Years Ending December 31:

2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amount (000’s)

$ 609
550
25
$1,184

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 a material impact on the Company’s 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, 2013 and 2012:

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 (000’s Except Share Amounts)

March 31,
2013
$6,432
3,487
1,202
822
0.16
0.16

June 30,
2013
$6,899
4,079
1,732
1,063
0.20
0.20

September 30,
2013
$7,055
4,176
1,739
1,052
0.20
0.20

December 31,
2013
$6,484
3,652
1,033
868
0.16
0.16

Quarter Ended (000’s Except Share Amounts)

March 31,
2012
$6,244
3,665
1,377
827
0.16
0.16

June 30,
2012
$6,862
4,103
1,664
1,001
0.19
0.19

September 30,
2012
$6,460
3,718
1,431
879
0.17
0.17

December 31,
2012
$5,658
2,766
464
273
0.05
0.05

35

Item 9. 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 13a-15(e)

and 15d-15(e)) that are designed to ensure that information required to be disclosed in reports ﬁled with the
SEC are recorded, processed, summarized and reported within the time period speciﬁed by the SEC’s 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 13a-15 under the Exchange Act, the Company’s management, with the participation
of the Company’s Chief Executive Officer and its Vice President — Finance, has evaluated the effectiveness of
its disclosure controls and procedures as of December 31, 2013. Based on this evaluation, our Chief Executive
Officer and Vice President — Finance concluded that the Company’s disclosure controls and procedures were
effective for ensuring that information required to be disclosed by the Company in the reports that it ﬁles or
submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within
the time periods speciﬁed in the SEC’s rules and forms, and that its disclosure controls and procedures were
also effective to ensure that information required to be disclosed in the reports that it ﬁles or submits under
the Exchange Act is accumulated and communicated to management, including the Company’s principal
executive and ﬁnancial officers, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over ﬁnancial reporting that occurred during
the Company’s last ﬁscal quarter that have materially affected, or are reasonably likely to materially affect, the
Company’s internal control over ﬁnancial reporting.

Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control
over ﬁnancial reporting (as deﬁned in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Under the
supervision and with the participation of management, including our Chief Executive Officer and Vice
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 Company’s evaluation
under the framework in Internal Control — Integrated Framework, the Company’s management concluded that
our internal control over ﬁnancial reporting was effective as of December 31, 2013.

This annual report does not include an attestation report of our independent registered public accounting
ﬁrm regarding internal control over ﬁnancial reporting. Management’s 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 management’s report in this annual report.

Inherent Limitations on Effectiveness of Controls

The Company’s management, including its Chief Executive Officer and its Vice President, Finance, does

not expect that the Company’s disclosure controls and procedures or the Company’s internal controls will
prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives for the control system are met. Further, the design
of a control system must reﬂect the fact that there are resource constraints, and the beneﬁts of controls must
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 and instances of fraud,
if any, within our company have been or will be prevented or detected. Further, internal controls may become
inadequate as a 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 a list that sets forth as of February 28, 2014 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 Company’s 2014 Annual Meeting, to be held on May 8,
2014 at 2:00 P.M. at the The Seaport Hotel, 200 Seaport Boulevard, Boston, Massachusetts.

Name

Raymond C. Kubacki
Neil Lerner
James Dyke
Michael I. Schaffer, Ph.D.
Harry Connick

Walter S. Tomenson, Jr.

Fred J. Weinert

Age

69
46
49
69
88

67

66

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 Company’s President and Chief Executive Officer since 1991. He has also

served as Chairman of the Board of the Company since 2003. He is a director of Integrated Environmental
Technologies, LTD. From 2007 until 2012, he served as a director of Protection One, Inc. and from 2004 to
2007 he served as a director of Integrated Alarm Services Group, Inc. He is also a trustee of the Center for
Excellence in Education based in Washington, D.C. and holds an Executive Masters Professional Director
Certiﬁcation, their highest level award, from the American College of Corporate Directors, a public company
director education and credentialing organization. Mr. Kubacki has been a director of the Company since
1991.

Mr. Lerner 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 at Beacon Rooﬁng Supply, Inc., Corporate Controller with Atlas TMS, Divisional
Controller with Mastec, Inc, and multiple roles with Johnson & Johnson, including plant controller in the
Netherlands. Mr. Lerner is a Certiﬁed Public Accountant and has a 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 a Strategic Sales Consultant and held a variety of Vice President of Sales/Sales &
Marketing and General Management positions with Pitney Bowes Inc. in Canada, the United Kingdom and
United States.

Dr. Schaffer has served as Vice President of Laboratory Operations since 1999. From 1990 to 1999, he

served as Director of Toxicology, Technical Manager and Responsible Person for the Leesburg, Florida
laboratory of SmithKline Beecham Clinical Laboratories. From 1990 to 1999, he was also a member of the
Board of Directors of the American Board of Forensic Toxicologists. Dr. Schaffer has been an inspector for
the Substance Abuse and Mental Health Services Administration’s 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 P. Walters, the Director’s Award for Distinguished Service
in recognition of exemplary accomplishment and distinguished service in the ﬁght against illegal drugs.
Mr. Connick has been a director of the Company since 2003.

Mr. Tomenson is a Senior Advisor to Integro Ltd. Mr. Tomenson was Managing Director and Chairman

of Client Development of Marsh, Inc. from 1998 until 2004. From 1993 to 1998, he was chairman of

37

FINPRO, the ﬁnancial services division of Marsh, Inc. Mr. Tomenson is a Director of the Trinity College
School Fund, Inc. He also serves on the Executive Council of the Inner-City Scholarship Fund and holds an
Executive Masters Professional Director Certiﬁcation, their highest level award, from the American College of
Corporate Directors, a public company director education and credentialing organization. Mr. Tomenson has
been a 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 groups of Waste Management, Inc. and its subsidiaries, including 6 years as the
President of Waste Management International, Inc. Mr. Weinert has been a 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 2014 Annual Meeting of Stockholders to be held on May 8, 2014 and is incorporated
herein by reference.

The Company has a 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. The Company will mail to interested parties a copy of the Code of Ethics upon written request and
without charge. Such request shall be made to our General Counsel, 125 Nagog Park, Acton, 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 2014 Annual Meeting of Stockholders to be held on May 8, 2014 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 2014 Annual Meeting of Stockholders to be held on May 8, 2014 and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneﬁcial Owners and Management and Related Stockholder
Matters

The information required by this item will be set forth in the Proxy Statement of the Company relating to
the 2014 Annual Meeting of Stockholders to be held on May 8, 2014 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 2014 Annual Meeting of Stockholders to be held on May 8, 2014 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 2014 Annual Meeting of Stockholders to be held on May 8, 2014 and is incorporated herein by reference.

38

Item 15. Exhibits, Financial Statement Schedules

PART IV

(a) (1)

Financial Statements required by Item 15 are included and indexed in Part II, Item 8.

(a) (2)

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.

(a) (3)

See ‘‘Exhibit Index’’ included elsewhere in this Report.

39

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the

registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

SIGNATURES

Date: February 28, 2014

PSYCHEMEDICS CORPORATION

By: /s/ Raymond C. Kubacki
Raymond C. Kubacki
Chairman, President and Chief Executive Officer

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 C. 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.

/s/ Raymond C. Kubacki
Raymond C. Kubacki

Chairman, President and Chief Executive
Officer, Director
(Principal Executive Officer)

February 28, 2014

/s/ Neil Lerner
Neil Lerner

/s/ Harry Connick
Harry Connick

/s/ Walter S. Tomenson, Jr.
Walter S. Tomenson, Jr.

/s/ Fred J. Weinert
Fred J. Weinert

Vice President, Finance
(Principal Financial and Accounting Officer)

February 28, 2014

Director

Director

Director

February 28, 2014

February 28, 2014

February 28, 2014

40

Exhibit
Number

3.1

3.2

4.1

10.2.1

10.2.2

10.2.3

10.2.4

10.2.5

10.2.6

10.2.7

10.3*

10.4*

10.5*

10.6*

10.7*

10.8*

10.9*

EXHIBIT INDEX

Description

Amended and Restated Certiﬁcate of Incorporation ﬁled on August 1, 2002 — (Incorporated by
reference from the Registrant’s Quarterly Report on Form 10-Q for the Quarter ended
September 30, 2002).

By-Laws of the Company — (Incorporated by reference from the Registrant’s Annual Report on
Form 10-K for the ﬁscal year ended December 31, 2001).

Specimen Stock Certiﬁcate — (Incorporated by reference from the Registrant’s Registration
Statement on Form 8-A ﬁled on July 31, 2002).

Lease dated October 6, 1992 with Mitchell H. Hersch, et. al with respect to premises in Culver
City, California — (Incorporated by reference from the Registrant’s Annual Report on
Form 10-KSB for the ﬁscal year ended December 31, 1992).

Security Agreement dated October 6, 1992 with Mitchell H. Hersch et. al — (Incorporated by
reference from the Registrant’s Annual Report on Form 10-KSB for the ﬁscal year ended
December 31, 1992).

First Amendment to Lease dated with Mitchell H. Hersch, et.al California — (Incorporated by
reference from the Registrant’s Annual Report on Form 10-K for the ﬁscal year ended
December 31, 1997).
Second Amendment to Lease dated with Mitchell H. Hersch, et.al. California — (Incorporated by
reference from the Registrant’s Annual Report on Form 10-K for the ﬁscal year ended
December 31, 1997).
Third Amendment to Lease dated December 31, 1997 with Mitchell H. Hersch, et.al. California
— (Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the ﬁscal
year ended December 31, 1997).
Fourth Amendment to Lease dated May 24, 2005 with Mitchell H. Hersch, et.al.
California — (Incorporated by reference from the Registrant’s Annual Report on Form 10-K for
the ﬁscal year ended December 31, 2005).
Fifth Amendment to Lease dated November 22, 2011 with Mitchell H. Hersch, et.al. California.

2000 Stock Option Plan, — (Incorporated by reference from the Registrant’s Quarterly Report on
Form 10-Q for the Quarter ended September 30, 2002).
Amended and restated change in Control Severance Agreement with Raymond C. Kubacki dated
July 10, 2008 — (Incorporated by reference from the Registrant’s current report on form 8-k,
ﬁled on July 14, 2008.)
2006 Incentive Plan, as amended — (Incorporated by reference from the Registrant’s Current
Report on Form 8-K ﬁled on May 26, 2011).
Form of Stock Unit Award used with employees and consultants under the 2006 Incentive Plan
— (Incorporated by reference from the Registrant’s Current Report on Form 8-K ﬁled on
May 26, 2011).

Form of Stock Unit Award used with non-employee directors under the 2006 Equity Incentive
Plan — (Incorporated by reference from the Registrant’s Current Report on Form 8-K ﬁled on
May 26, 2011).

Change in control severance agreement with Michael Schaffer PhD dated July 10, 2008
(Incorporated by reference from the registrant’s current report on Form 8-k ﬁled on July 14,
2008).

Amendment dated November 3, 2008 to change in control severance agreement with Ray
Kubacki. (Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the
ﬁscal year ended December 31, 2008).

Exhibit
Number

Description

10.10* Amendment dated November 3, 2008 to change in control severance agreement with Michael

Schaffer. (Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the
ﬁscal year ended December 31, 2008).

10.11*

10.12*

Employment offer letter dated April 7, 2010 with James Dyke (incorporated by reference from
Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010).

Change in Control Severance Agreement with James V Dyke dated April 7, 2010 (Incorporated
by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30,
2010).

10.13*

Employment offer letter dated October 25, 2010 with Neil Lerner (incorporated by reference
from Registrant’s Quarterly Report on Form 10-Q for the year ended December 31, 2010).

23.1

31.1

31.2

32.1

32.2

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.

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.

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 C. Kubacki
Chairman, President and C.E.O.

Harry Connick
Private Investor

Walter S. Tomenson, Jr.
Senior Advisor, Integro Ltd.

Fred J. Weinert
Private Investor

CORPORATE OFFICERS

Raymond C. Kubacki
Chairman, President and C.E.O.

Michael I. Schaffer, Ph.D.
Vice President, Laboratory Operations

Neil Lerner
Vice President, Finance

James Dyke
Corporate Vice President, Sales & Marketing

TRANSFER AGENT

Computershare
P.O. BOX 30170
College Station, TX 77842-3170

Overnight correspondence should be sent to:
211 Quality Circle, Suite 210
College Station, TX 77845

1-877-373-6374 (781-575-3120)
Internet Address: www.computershare.com

COUNSEL

Lynch, Brewer, Hoffman & Fink, LLP
Boston, Massachusetts

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

A copy of the Company’s Form 10-K, as ﬁled with the
Securities and Exchange Commission, may be obtained
by any stockholder at our website:

www.psychemedics.com

or by writing to:

Investor Relations
Psychemedics Corporation
125 Nagog Park
Acton, MA 01720

ANNUAL MEETING

The 2014 Annual Meeting of Stockholders will be
held on May 8, 2014 at 2:00 p.m. at

The Seaport Hotel
200 Seaport Boulevard
Boston, Massachusetts

NASDAQ Stock Exchange Symbol (PMD)

125 NAGOG PARK, ACTON, MA 01720