Psychemedics Corp.

2015 ANNUAL REPORT

CORPORATE PROFILE

Psychemedics pioneered the use of hair drug testing, and remains the largest and leading supplier 
of drugs of abuse hair testing worldwide. Psychemedics is the only company to develop and patent 
a process that releases virtually 100% of the drugs from the inside of the hair, providing the 
greatest ability to detect drug use.  

Offering over 25 years of global experience, Psychemedics has provided its expertise and superior 
drug testing technology to thousands of organizations to aid in transitioning their drug screening 
programs to achieve the goal of a drug-free environment. Our drug testing services are trusted by 
over 10% of the Fortune 500 companies, numerous international organizations, many of the 
largest police departments, rehabilitation programs, schools and parents throughout the world.  

Psychemedics established its scientific and market leadership position through dedicated 
research and development efforts. Psychemedics has set the industry standards for sensitivity, 
robustness, quality and consistency. As a further example, the Company also developed and 
offers a hair test for alcohol which also looks back on use over a 90 days period, as our hair drug 
tests do.  A partnership with Psychemedics ensures that our clients' drug testing programs stay 
current as drug challenges change and evolve.   

Dear Fellow Shareholders, 

2015 was a challenging, yet exciting year for us.  After three consecutive years of record revenues, we experienced a 
small decline in our business.  Along with the headwinds in the economy, many industries and clients were impacted 
by the steep drop in the price of oil.  While oil and gas clients were most directly impacted, there also was a ripple 
effect on other industries.  However, we did bring in a healthy amount of new business which is a most important 
positive.   

Earnings for the year continued to be impacted by the increase in our capacity and other costs related to the Brazil 
opportunity (described below).  We estimate the total impact from these projects in 2015 was about $0.28 per diluted 
share.  However, earnings were positively impacted by R&D tax credits from prior years related to the development of 
several strategic information technology projects – amounting to $0.09 per diluted share.   

The additional capacity costs were needed to prepare Psychemedics for future growth, including a significant 
opportunity in Brazil.  This project included additional lease space and over $7 million of new equipment and 
leasehold improvements in 2014.  In 2015, the Company invested an additional $1.7 million of equipment and 
leasehold improvements which included automating some of our laboratory processes to help increase capacity, as well 
as generate significant costs savings in the future.  In 2015, to finance this continued expansion, the Company obtained 
additional equipment financing of $1.1 million, for a total borrowing of $8.1 million ($5.9 million of which was 
outstanding as of December 31, 2015) at a very favorable interest rate of 2.19% for 2015.  

As we have previously reported, we believe we have a very exciting opportunity to compete for major business in 
Brazil.  To recap, at the end of 2013, the Brazilian Federal Government announced a new regulation that would require 
professional drivers in the transportation industry to pass a hair drug test. There also was a bill introduced in the 
Brazilian Congress that would require professional drivers be drug tested on a more rigorous basis (testing every 2 ½ 
years vs. every 5 years) than the announced regulation.  The bill also required professional drivers to be tested when 
being hired or fired.  The Brazilian Congress passed the law and it was signed by the President and published on 
March 2, 2015.  It stipulated that testing was to begin on June 1, 2015 for professional drivers when obtaining or 
renewing a professional drivers license and on March 2, 2016 when professional drivers are hired or fired.  Due to 
administrative issues in implementation, the start date for the drivers license testing requirement was delayed to March 
2, 2016, coinciding with the start date of the testing when being hired or fired.    

We believe there will be a ramp up period as this is a major new program and some of the states in Brazil are requiring 
additional time to implement the law.   In fact, the agency administering the hire and fire test requirement has just 
extended the starting date by 45 days to April 16, 2016. This new drug testing requirement was in direct response to a 
United Nations initiative to reduce traffic fatalities worldwide.  Brazil has one of the highest rates 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 over 16 years.  The 
Psychemedics hair test has been made available through Psychemedics Corporation’s Brazilian-owned independent 
distributor, Psychemedics Brasil.  

We are continually looking at advancing the science of hair testing, which is important to Psychemedics’ strong 
position and growth.   This commitment was reflected in 2015 with a 21% increase in spending on Research and 
Development over 2014, after increasing by 63% the year before.   Psychemedics established its technological and 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
 
market leadership position in 1987 with the development of the first hair test to detect drugs of abuse.  We have 
continued this leadership role with significant achievements over the last few years, including: 

• 

• 

• 

• 

In 2012, 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.  This is 
fundamental to all hair testing, because if you can’t get the drugs out of the hair, you can’t measure them. We 
also 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 represented a significant technological breakthrough.   

In 2013, after many years of investing time and research, we came to the market with a hair test to measure 
alcohol consumption over a period of time.  This new alcohol test provides clients with another method to 
identify substance abuse.  

In 2014, we were proud to once again be recognized as the industry and scientific leader with the publishing of 
a peer-reviewed paper by scientists at the FBI in the Journal of Analytical Toxicology. This paper provides 
additional validation of the Psychemedics extensive wash protocol used to exclude the risk of false positives 
from external contamination.  Our wash protocol plays a significant role in safeguarding our clients and those 
being tested.  

In 2015, we were very pleased to have added 2 new drugs to the company’s drug testing panels. In response to 
growing abuse concerns, the addition of Oxymorphone (brand name Opana®) was made to the synthetic 
opiate testing panel and D-Amphetamine/Adderall® was added as an option to the Amphetamine panel.   

As the scientific leader in drug testing, we at Psychemedics continue to advance the science and use our top flight 
scientific team and R&D resources to develop new tests that will deter people from abusing these additional drugs.  
We look forward to making further advances in our field in 2016 and beyond, and maintaining our scientific leadership 
position.      

The Company’s balance sheet remains strong, with approximately $4.9 million in working capital, and $2.7 million in 
cash at year end. 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 2015, the Company had paid 
77 consecutive quarterly dividends which is more than 19 years. We are also proud that we have been profitable every 
year for the last 23 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, 2015

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:

Title of Class

Name of each exchange on which registered:

Common Stock, $0.005 par value

The Nasdaq Stock Market L.L.C.

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 □
(Do not check if a smaller
reporting company)

Accelerated Filer □

Non-Accelerated Filer □

Smaller Reporting Company (cid:2)

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, 2015, there were 5,422,541 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, 2015 was approximately $58.5 million,
computed based upon the closing price of $14.83 per share on June 30, 2015.

As of February 26, 2016, there were 5,422,541 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.

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.

Factors that may cause such differences include but are not limited to: (1) intense competition in the drug

testing industry, particularly among companies that test utilizing hair samples; (2) risks associated with the
development of markets for new products and services offered; (3) risks associated with capacity expansion;
(4) risks associated with U.S. government regulations, including, but not limited to, FDA regulations, (5) risks
associated with our international operations, including, but not limited to, Brazilian laws, proposed laws and
regulations, and currency risks; (6) Psychemedics’ ability to maintain its reputation and brand image; (7) the
ability of Psychemedics to achieve its business plans, productivity improvements, cost controls, leveraging of
its global operating platform, and acceleration of the rate of innovation; (8) information technology system
failures and data security breaches; (9) the uncertain global economy; (10) our ability to attract, develop and
retain executives and other qualified employees; (11) Psychemedics’ ability to obtain and protect intellectual
property rights; and (12) changes in economic conditions which affect demand for our products and services.

Additional 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.’’

i

PSYCHEMEDICS CORPORATION
FORM 10-K
ANNUAL REPORT
For the Year Ended December 31, 2015

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

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

PART IV

Item 15.

Exhibits and Financial Statement Schedules

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

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

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

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ii

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 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 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, eve and Adderall) and opiates (including heroin,
hydrocodone, hydromorphone, oxycodone, oxymorphone 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 Culver City, California campus located at

5832 Uplander Way and 6100 Bristol Parkway.

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 and mass spectrometry methods.

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 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.

The Company’s decontamination wash protocol and the effects in eliminating surface contamination were

analyzed in a study conducted by scientists at the Laboratory of the Federal Bureau of Investigation and
published in August 2014 in the Journal of Analytical Toxicology. The FBI concluded that the use of an
extended wash protocol of the type used by the Company will exclude false positive results from
environmental contact with cocaine. In the study, the FBI cited Psychemedics’ studies published in 1993,
2002, 2004, and 2005, and named our lab director Dr. Michael Schaffer and our lab in its acknowledgments.
The FBI study also supported the use of metabolites known as hydroxycocaines as evidence of ingestion.
These metabolites were first identified in hair by Psychemedics.

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.

2

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
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-MAM,
was required. These requirements, however, effectively reduced the detection time frame for confirmed heroin
use, such that 6-MAM in urine can typically only be detected for several hours post drug use. In contrast, the
metabolite 6-MAM 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.

3

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 approximate 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 ten US patents, including a
patent issued to the Company in 2011 that focuses on digesting hair and releasing drugs trapped in the hair
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. Additional patent applications are currently
pending in the U.S. and internationally.

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 identify 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 superior
effectiveness of the Company’s patented technology and its ability to detect varying levels of drug use.

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

4

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 of hair from their child in the
privacy of 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 and Wayne State University.

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.

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.

5

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
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.

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 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, 2015, 2014 and 2013, $1.6 million, $1.3 million and $825 thousand, 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, 2015, the Company had 154 full-time equivalent employees, 7 of whom are 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:

•

•

•

•

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 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 laboratory facilities.

Our operations are dependent upon the continued use of our 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. 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, both domestically and
internationally, and on the hiring practices of our existing customers, which are, in turn, impacted by changes
in government requirements regarding testing for drugs of abuse, delays in implementation of such
requirements, as well as 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.

10

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 77 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.

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 2018.

The Company leases two facilities for laboratory purposes in Culver City, California. The first is
13,900 square feet of space with an additional 9,600 feet of storage space. This facility is leased through
December 31, 2020 with an option to renew for an additional two years. In 2014, the Company added a
second facility of 16,000 square feet of space. This facility is leased through March 14, 2017 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 26, 2016, there were 180 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 3,000.

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 Market and dividends declared by the Company.

Fiscal 2015:

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

Fiscal 2014:

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

High

Low

Dividends

$16.85
17.83
15.10
11.80

$18.76
17.47
15.39
15.46

$14.25
14.10
9.82
9.50

$14.41
14.06
12.42
13.06

$0.15
0.15
0.15
0.15

$0.15
0.15
0.15
0.15

The Company has paid dividends over the past nineteen years. It most recently declared a dividend on
February 9, 2016, which will be paid on March 4, 2016. 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 2015, 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 2015.

12

Performance Graph

COMPARE 5-YEAR CUMULATIVE TOTAL RETURN AMONG
PSYCHEMEDICS CORPORATION, NASDAQ COMPOSITE
INDEX AND RUSSELL 2000 INDEX

300

250

200

150

100

50

0

2010

2011

2012

2013

2014

2015

PSYCHEMEDICS CORPORATION

RUSELL 2000 INDEX

NASDAQ COMPOSITE INDEX

. . . . . . . . . . . . .
Psychemedics Corp.
Russell 2000 Index . . . . . . . . . . . . .
NASDAQ Composite Index . . . . . . .

2010
100.00
100.00
100.00

2011
117.96
94.60
98.20

2012
145.63
107.03
113.82

2013
201.35
146.64
157.44

2014
214.39
151.81
178.53

2015
160.15
143.14
188.75

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

(1) The above graph assumes a $100 investment on December 31, 2010, through the end of the 5-year period

ended December 31, 2015 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

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 . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets
. . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .
Working capital
Shareholders’ equity . . . . . . . . . . . . . . . . . . .
Basic net income per share . . . . . . . . . . . . . . .
Diluted net income per share
. . . . . . . . . . . . .
Cash dividends declared per common share . . . .

2015

$26,975
12,717
1,471
1,511
22,363
4,892
11,674
0.28
0.28
0.60

13

2012

2014

As of and for the Years Ended December 31,
2013
(In Thousands, Except for per Share Data)
$25,224
$26,870
$29,205
14,252
15,394
15,138
4,936
5,706
4,690
2,980
3,805
3,206
14,121
16,550
24,078
7,491
6,998
6,980
11,223
12,277
12,837
0.57
0.72
0.60
0.57
0.72
0.60
0.60
0.60
0.60

2011

$24,090
14,473
5,800
3,489
13,801
9,217
11,035
0.67
0.67
0.48

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, 2015, the Company generated
$27.0 million in revenue, while maintaining a gross margin of 47% and pre-tax margins of 5%. The Company
received $710 thousand of R&D tax credits in 2015, of which $479 thousand related to prior years. At
December 31, 2015, the Company had $2.7 million of cash. During 2015, the Company had operating cash
flow of $4.6 million and it distributed approximately $3.2 million or $0.60 per share of cash dividends to its
shareholders. In addition, the Company spent approximately $1.8 million on equipment, leasehold
improvements and software development which was partially financed with a loan of $1.0 million. To date,
the Company has paid seventy-seven consecutive quarterly cash dividends.

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

Total operating expenses

Operating expenses:
General and administrative . . . . . . . . . . . . . . . . . . . . . . . . . .
Marketing and selling . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Research and development . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . .
Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income (expense) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Year Ended December 31,
2014
100.0%
48.2%
51.8%

2015
100.0%
52.9%
47.1%

2013
100.0%
42.7%
57.3%

16.9%
18.7%
6.0%
41.6%
5.5%
-0.5%
5.0%
-0.6%
5.6%

15.3%
15.8%
4.6%
35.7%
16.1%
-0.2%
15.9%
4.9%
11.0%

15.5%
17.5%
3.1%
36.1%
21.2%
0.4%
21.6%
7.4%
14.2%

Results for the Year Ended December 31, 2015 Compared to Results for the Year Ended December 31, 2014

Revenue decreased $2.2 million or 8% to $27.0 million in 2015 compared to $29.2 million in 2014. This
decrease was due to a decrease in volume from both existing customers and from new customers. Volume was
negatively impacted by the price of oil and other economic factors which reduced hiring, and consequently
testing, with our customer base. Average revenue per sample was unchanged from 2014 to 2015.

Gross profit decreased $2.4 million to $12.7 million in 2015 compared to $15.1 million in 2014. Direct
costs increased by $192 thousand from 2014 to 2015. The capacity expansion costs within cost of sales was
approximately $1.4 million and included; $0.4 million for hiring and training of additional personnel and
$1.0 million for building related costs. The gross profit margin decreased from 52% in 2014 to 47% in 2015.

14

General and administrative (‘‘G&A’’) expenses were $4.6 million in 2015 compared to $4.5 million in
2014, an increase of 2%. As a percentage of revenue, G&A expenses were 16.9% and 15.3% for 2015 and
2014, respectively.

Marketing and selling expenses were $5.1 million in 2015 compared to $4.6 million in 2014, an

increase of 9%. The increase was driven by spending on information technology projects supporting the sales
function. Total marketing and selling expenses represented 18.7% and 15.8% of revenue for 2015 and 2014,
respectively.

Research and development (‘‘R&D’’) expenses were $1.6 million in 2015 compared to $1.3 million in
2014, an increase of 21%. R&D expenses increased from additional personnel and supplies used to develop
new tests for drugs of abuse as well as process improvements. R&D expenses represented 6.0% and 4.6% of
revenue for 2015 and 2014, respectively.

Other income (expense) represented $125 thousand of other expenses for 2015 compared to $57 thousand

of other income for 2014. The other expense primarily consists of interest expense related to long term debt.

During the year ended December 31, 2015, the Company recorded a tax benefit of $164 thousand,

representing an effective tax rate of (12.2%). The tax rate for 2015 was affected by additional R&D tax credits
related to information technology development projects. The Company recognized $479 thousand of R&D
tax credits related to these projects for prior years. Without the prior year credits, the 2015 tax rate would
have been 23.3%. During the year ended December 31, 2014, the Company recorded a tax provision of
$1.4 million, representing an effective tax rate of 30.8%. We expect the tax rate to range from 32% to 34%
for the foreseeable future.

Results for the Year Ended December 31, 2014 Compared to Results for the Year Ended December 31, 2013

Revenue increased $2.3 million or 9% to $29.2 million in 2014 compared to $26.9 million in 2013. 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 remained the same between 2014 and 2013.

Gross profit decreased $256 thousand to $15.1 million in 2014 compared to $15.4 million in 2013. Direct

costs increased by 23% from 2013 to 2014, driven by the Company’s capacity expansion project and higher
volume. The capacity expansion costs within cost of sales was approximately $1.3 million and included;
$0.5 million for hiring and training of additional personnel, $0.5 million for building related costs, and
$0.3 million for information technology and other one-time project costs. The gross profit margin decreased
from 57% in 2013 to 52% in 2014.

General and administrative (‘‘G&A’’) expenses were $4.5 million in 2014 compared to $4.2 million in
2013, an increase of 8%. In 2014, G&A costs included approximately $0.2 million related to the Company’s
capacity expansion project. As a percentage of revenue, G&A expenses were 15.3% and 15.5% for 2014 and
2013, respectively.

Marketing and selling expenses were $4.6 million in 2014, compared to $4.7 million in 2013, a decrease

of 2%. Total marketing and selling expenses represented 15.8% and 17.5% of revenue for 2014 and 2013,
respectively.

Research and development (‘‘R&D’’) expenses were $1.3 million in 2014 compared to $0.8 million in
2013. R&D expenses increased from additional personnel and supplies used to develop new tests for drugs of
abuse as well as process improvements. R&D expenses represented 4.6% and 3.1% of revenue for 2014 and
2013, respectively.

Other income (expense) represented $57 thousand of other expenses for 2014 compared to $92 thousand

of other income for 2013. The expense in 2014 was driven by interest expense related to long term debt
incurred in 2014, while the income in 2013 represented a one-time insurance reimbursement of legal expenses.

During the year ended December 31, 2014, the Company recorded a tax provision of $1.4 million,
representing an effective tax rate of 30.8%. During the year ended December 31, 2013, the Company recorded

15

a tax provision of $2.0 million, representing an effective tax rate of 34.4%. The change in tax rate was driven
by R&D tax credits from higher R&D spending and from a California R&D tax credit which was not
previously taken.

Liquidity and Capital Resources

At December 31, 2015, the Company had $2.7 million of cash, compared to $3.6 million at
December 31, 2014. The Company’s operating activities generated net cash of $4.6 million in 2015,
$4.5 million in 2014 and $6.0 million in 2013. Investing activities used $1.8 million in 2015, $7.8 million in
2014 and $1.8 million in 2013. Financing activities used $3.7 million in 2015, generated $3.0 million in 2014
and used $3.3 million in 2013.

Operating cash flow of $4.6 million in 2015 primarily reflected net income of $1.5 million adjusted for

depreciation and amortization of $1.7 million, stock compensation expense of $0.7 million, and an increase in
net deferred tax liabilities of $0.1 million. This was affected by the following changes in assets and liabilities:
a decrease in accounts receivable of $0.5 million, a decrease in accounts payable of $0.1 million, a decrease
in accrued expenses of $0.5 million, and a decrease in prepaid expenses (and other current assets) of
$0.6 million. While the operating cash flow was $0.1 million greater than in 2014, the net income was down
$1.7 million. This was offset by a decrease in income tax receivable of $1.0 million which reduced the current
tax due and an increase in depreciation and amortization of $0.7 million due to new equipment and leasehold
improvements.

Operating cash flow of $4.5 million in 2014 primarily reflected net income of $3.2 million adjusted for

depreciation and amortization of $1.1 million, stock compensation expense of $0.6 million, and an increase in
net deferred tax liabilities of $1.4 million. This was affected by the following changes in assets and liabilities:
a decrease in accounts receivable of $0.3 million, an increase in accounts payable of $0.3 million, a decrease
in accrued expenses of $1.2 million, and an increase in prepaid expenses (and other current assets) of
$1.2 million. The decrease in accrued expenses was driven by a $1.2 million reduction in the liability for
equipment purchases which were paid for in 2014. The change in deferred tax liabilities and other current
assets was driven by bonus depreciation on new assets purchased as part of the tax extender bill passed in
December 2014.

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.

Investing cash flow principally reflected the purchase of capital expenditures. Capital expenditures

were $1.8 million, $7.6 million, and $1.5 million in 2015, 2014 and 2013, respectively. In 2015, the
expenditures related principally to laboratory equipment, computer equipment, new software, and leasehold
improvements for the Company’s new facility. Capitalized patent costs were $46 thousand, $244 thousand,
and $226 thousand in 2015, 2014, and 2013, respectively.

During 2015, 2014 and 2013, the Company did not repurchase any 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 of cash dividends to its shareholders in 2015,
2014 and 2013.

At December 31, 2015, the Company’s principal sources of liquidity included approximately
$2.7 million of cash and $700 thousand of available credit under its equipment financing arrangement.
See Note 10 — Debt and Other Financing to the Financial Statements for further detail on the equipment
financing arrangement. Management currently believes that such funds, together with future operating profits,
should be adequate to fund anticipated working capital requirements, including debt obligations, 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

16

funds. Such sources could include, 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.

The Company has paid dividends over the past seventy-seven quarters. It most recently declared a

dividend in February 2016 which will be paid in March 2016 in the amount of $813 thousand. 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, 2015 were as follows:

Contractual Obligation

Less Than
1 Year

1 − 3
Years

Operating leases . . . . . . . . . . . . . . . . . . .
Loan Obligations . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .
Total

$ 889
$1,620
$2,509

Purchase Commitment

Greater Than
5 Years

Payments Due by Period
4 − 5
Years
(Amounts in Thousands)
$ 763
$1,033
$1,795

$ 993
$3,239
$4,232

$—
$—
$—

Total

$2,645
$5,892
$8,537

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, 2015.

Significant Customers

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

December 31, 2015, 2014 and 2013. The Company had one customer that accounted for 11% of the total
accounts receivable balance as of December 31, 2015. There were no customers who exceeded 10% of the
accounts receivable balance as of December 31, 2014 or 2013.

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.

17

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 approximately $364 thousand, $403 thousand
and $715 thousand during the years ended December 31, 2015, 2014 and 2013, respectively. The software
development is for primarily for three 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.

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 $2.5 million at December 31, 2015, which

primarily related to depreciation and amortization, an increase of $0.1 million from 2014.

In 2015, the Company had a net tax benefit as a result of R&D tax credits related to information
technology projects. This is the first year this benefit was recognized. The benefit from prior years related to
these tax credits was $479 thousand. Without the prior year impact, the current year tax rate would have been
23.3%. In 2015, there was $108 thousand of tax credits related to information technology projects. The
Company operates within multiple taxing jurisdictions and could be subject to audit in these jurisdictions.
These audits may involve complex issues, which may require an extended period of time to resolve. The
Company has provided for its estimated taxes payable in the accompanying financial statements. The
Company did not have any unrecognized tax benefits and did not have any interest or penalties accrued as of
December 31, 2015 or 2014. 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.

18

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 2015.

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, 2015 and 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Statements of Income and Comprehensive Income for the Years Ended December 31, 2015, 2014

and 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Statements of Shareholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013 . . . . .

Statements of Cash Flows for the Years Ended December 31, 2015, 2014 and 2013 . . . . . . . . . . . .

Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Page

21

22

23

24

25

26

20

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Psychemedics Corporation
Acton, Massachusetts:

We have audited the accompanying balance sheets of Psychemedics Corporation (the ‘‘Company’’) as of
December 31, 2015 and 2014 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, 2015. 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
audits 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 Psychemedics Corporation at December 31, 2015 and 2014 and the results of its
operations and its cash flows for each of the three years in the period ended December 31, 2015, in
conformity with accounting principles generally accepted in the United States of America.

/s/ BDO USA, LLP
Boston, Massachusetts
February 26, 2016

21

PSYCHEMEDICS CORPORATION

BALANCE SHEETS

December 31,
2015

December 31,
2014

Current Assets:

ASSETS

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable, net of allowance for doubtful accounts of $58,684
in 2015 and $95,525 in 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . .
Income tax receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Current Assets

$ 2,689,464

$ 3,612,153

3,538,765
1,060,587
840,122
327,442
8,456,380

4,078,133
689,995
1,819,743
376,529
10,576,553

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:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .
Current portion of long-term debt
Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Long-term debt
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax liabilities, long-term . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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

6,090,671 shares issued in 2015 and 6,043,191 shares issued 2014,
5,422,541 shares outstanding in 2015 and 5,375,061 shares
outstanding in 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less − Treasury stock, at cost, 668,130 shares . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated deficit
Total Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Liabilities and Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . .

2,745,214
1,209,307
13,723,760
2,096,334
19,774,615
(6,642,501)
13,132,114
774,474
$ 22,362,968

2,361,388
1,068,264
13,297,548
1,801,482
18,528,682
(5,788,551)
12,740,131
761,025
$ 24,077,709

$

747,291
1,197,632
1,619,633
3,564,556
4,272,137
2,852,745
10,689,438

$

845,071
1,351,333
1,399,925
3,596,329
4,848,158
2,796,666
11,241,153

—

—

30,453
30,021,604
(10,081,789)
(8,296,738)
11,673,530
$ 22,362,968

30,216
29,454,023
(10,081,789)
(6,565,894)
12,836,556
$ 24,077,709

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 (expense)
. . . . . . . . . . . . . . . . . . . . . . . .
Net income before provision for income taxes . . . . . . . . .
(Benefit from)/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 . . .

2015
$26,975,406
14,258,465
12,716,941

Year Ended December 31,
2014
$29,204,818
14,066,652
15,138,166

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

4,560,684
5,053,217
1,631,664
11,245,565
1,471,376
(124,588)
1,346,788
(164,388)
$ 1,511,176

$
$
$

0.28
0.28
0.60
5,405,032

5,412,487

4,474,654
4,625,375
1,348,496
10,448,525
4,689,641
(56,576)
4,633,065
1,426,984
$ 3,206,081

$
$
$

0.60
0.60
0.60
5,355,367

5,376,998

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

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

23

PSYCHEMEDICS CORPORATION

STATEMENTS OF SHAREHOLDERS’ EQUITY

Common Stock

Treasury Stock

Shares

BALANCE, December 31, 2012 . . . . . . . . 5,940,558
36,988
Shares issued − vested . . . . . . . . . . . . . .
Exercise of stock options
4,350
. . . . . . . . . . . .
Tax withholding related to vested shares

$0.005
par Value
$29,703
185
22

Paid-In
Capital
$28,460,764
(185)
20,817

Shares
668,130
—
—

Cost

Accumulated
Deficit
$(10,081,789) $(7,186,009) $11,222,669
—
20,839

—
—

—
—

Total

from employee stock plans . . . . . . . . . .
Stock compensation expense . . . . . . . . . .
Excess tax benefit from stock-based

—
—

—
—

(154,522)
538,304

—
—

—
—

—
—

(154,522)
538,304

compensation plans

—
. . . . . . . . . . . . . .
—
Cash dividends declared ($0.60 per share) . .
—
Net income . . . . . . . . . . . . . . . . . . . . .
BALANCE, December 31, 2013 . . . . . . . . 5,981,896
52,046
Shares issued − vested . . . . . . . . . . . . . .
Exercise of stock options
9,249
. . . . . . . . . . . .
Tax withholding related to vested shares

from employee stock plans . . . . . . . . . .
Stock compensation expense . . . . . . . . . .
Excess tax benefit from stock-based

compensation plans

—
. . . . . . . . . . . . . .
—
Cash dividends declared ($0.60 per share) . .
Net income . . . . . . . . . . . . . . . . . . . . .
—
BALANCE, December 31, 2014 . . . . . . . . 6,043,191
39,814
Shares issued − vested . . . . . . . . . . . . . .
7,666
. . . . . . . . . . . .
Exercise of stock options
Tax withholding related to vested shares

from employee stock plans . . . . . . . . . .
Stock compensation expense . . . . . . . . . .
Excess tax benefit from stock-based

—
—

—
—

compensation plans

—
. . . . . . . . . . . . . .
—
Cash dividends declared ($0.60 per share) . .
Net income . . . . . . . . . . . . . . . . . . . . .
—
BALANCE, December 31, 2015 . . . . . . . . 6,090,671

—
—
—
29,910
260
46

23,534
—
—
28,888,712
(260)
32,722

—
—
—
668,130
—
—

—
—
— (3,178,909)
— 3,805,210
(6,559,708)
—
—

(10,081,789)
—
—

23,534
(3,178,909)
3,805,210
12,277,125
—
32,768

—
—

(147,378)
608,645

—
—

—
—

—
—

(147,378)
608,645

—
—
—
$30,216
199
38

71,582
—
—
29,454,023
(199)
60,394

—
—
—
668,130
—
—

—
—
— (3,212,267)
— 3,206,081
(6,565,894)
—
—

(10,081,789)
—
—

71,582
(3,212,267)
3,206,081
12,836,556
—
60,432

—
—

(226,612)
673,855

—
—

—
—

—
—

(226,612)
673,855

—
—
—
$30,453

60,143
—
—
$30,021,604

—
—
—
668,130

60,143
(3,242,020)
1,511,176
$(10,081,789) $(8,296,738) $11,673,530

—
—
— (3,242,020)
1,511,176
—

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

$ 1,511,176

$ 3,206,081

$ 3,805,210

Year Ended December 31,

2015

2014

2013

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

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

1,730,306
105,166
673,855

1,050,281
1,398,711
608,645

872,171
416,684
538,304

539,368

290,731

251,904

receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . .

Net cash provided by operating activities

609,029
(97,780)
(491,283)
4,579,837

(1,185,641)
334,521
(1,246,096)
4,457,233

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

Cash flows from investing activities:

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

(45,573)

(243,704)

(226,130)

development costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . .

(1,752,583)
(1,798,156)

(7,564,676)
(7,808,380)

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

Cash flows from financing activities:

Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from stock options and tax withholding related to

vested shares from employee stock plans

. . . . . . . . . . . . .
Proceeds from equipment financing . . . . . . . . . . . . . . . . . . .
Payments of equipment financing . . . . . . . . . . . . . . . . . . . .
Net cash (used in) provided by financing activities . . . . . . . . . .
Net (decrease) increase 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 . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash paid for interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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

Exercise of stock options

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

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

(3,242,020)

(3,212,267)

(3,178,909)

(106,037)
1,098,539
(1,454,852)
(3,704,370)
(922,689)
3,612,153
$ 2,689,464

(43,028)
6,999,626
(751,543)
2,992,788
(358,359)
3,970,512
$ 3,612,153

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

$

$

$

$

$

39,813

$ 1,167,920

$ 1,233,000

128,250

$

77,046

$

$

—

185

20,817

199

60,394

337,582

$

$

$

260

32,722

149,509

$ 1,161,255

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

25

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

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 expansion of testing facilities used by the Company, government regulation
(including, but not limited to, Food and Drug Administration regulations, Brazilian laws, proposed laws and
regulations, and delays in implementation of laws and 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. As of December 31, 2015 and 2014, there were no investments 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.

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

to the fair value

26

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

2. Summary of Significant Accounting Policies − (continued)

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.

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:

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 estimated lease term

The Company recorded depreciation and amortization related to property and equipment and capitalized

software of $1.7 million, $1.0 million, and $844 thousand in 2015, 2014 and 2013 respectively. As of
December 31, 2015, there was approximately $3.6 million of new equipment not placed in service.

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, 2015, 2014 and 2013, we capitalized internally developed software costs of $364 thousand,
$403 thousand and $715 thousand, respectively. Amortization expense related to software development costs
was $429 thousand, $224 thousand and $145 thousand in 2015, 2014, and 2013, 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 is expensed as incurred.

Other Assets

Other assets primarily consist of capitalized legal costs relating to patent applications. The Company
amortizes these costs over the lesser of the legal life or estimated useful life of the patent from the date of
grant of the applicable patent. The typical life is twenty years. As of December 31, 2015, 2014, and 2013 the
Company had capitalized legal costs relating to outstanding patent applications of $670 thousand,
$656 thousand and $498 thousand, respectively. Amortization expense was $32 thousand, $26 thousand, and
$28 thousand in 2015, 2014 and 2013, respectively. The amount of amortization related to patent applications
is expected to remain below $50 thousand per year for the next five years.

Revenue Recognition

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

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

27

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

2. Summary of Significant Accounting Policies − (continued)

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 expenses all research and development costs 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 accounts receivable. The Company’s policy is to place
its cash in high quality financial institutions. At time, these deposits may exceed federally insured limits. The
Company does not believe significant credit risk exists with respect to these institutions. 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, 2015, 2014 and 2013. The Company had one customer that accounted for 11% of the total
accounts receivable balance as of December 31, 2015. There were no customers who exceeded 10% of the
accounts receivable balance as of December 31, 2014 or 2013.

Comprehensive Income

The Company’s comprehensive income was the same as net income for the years ended December 31,

2015, 2014 and 2013.

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

28

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

2. Summary of Significant Accounting Policies − (continued)

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 $674 thousand, $609 thousand and $538 thousand of stock

compensation expense in the accompanying statements of income for the years ended December 31, 2015,
2014 and 2013, 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 . . . . . . . . . . . . . . . . . . . . .

2015
$100,887
433,362
107,853
31,753
$673,855

2014
$114,795
372,325
103,798
17,727
$608,645

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

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 available to common shareholders 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, assuming

2015
5,405,032
7,455

2014
5,355,367
21,631

2013
5,299,060
16,403

dilution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,412,487

5,376,998

5,315,463

For the years ended December 31, 2015 and 2013, options to purchase 80,975 and 152,650 common
shares, respectively, were outstanding but not included in the dilutive common equivalent share calculation as
their effect would have been anti-dilutive. There were no options to purchase shares that were anti-dilutive for
the year ended December 31, 2014.

29

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

2. Summary of Significant Accounting Policies − (continued)

Financial Instruments

Financial instruments include cash and accounts receivable and accounts payable. Estimated fair values of

these financial instruments approximate carrying values due to their short-term nature. The Company has
outstanding equipment loans which have an interest rate of the 30-day LIBOR rate + 2.00%. As there is a
market interest rate on the loans, the carrying amount is fair value.

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, 2015 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, 2015. On February 10, 2016, the Company declared a quarterly dividend of
$0.15 per share for a total of $813 thousand, which will be paid on March 4, 2016 to shareholders of record
on February 22, 2016. On February 23, 2016, the 2006 Incentive Plan was amended to increase the total
number of shares issuable there under from 500,000 shares to 850,000 shares, subject to shareholder approval
of such amendment.

Recent Accounting Pronouncements

In November 2015, the FASB issued Accounting Standards Update No 2015-17, Income Taxes —
Balance Sheet Classification of Deferred Taxes, that simplifies the presentation of deferred taxes by requiring
deferred tax assets and liabilities be classified as noncurrent on the balance sheet. ASU 2015-17 is effective
for public companies for annual reporting periods beginning after December 15, 2016, and interim periods
within those fiscal years. Early application for public entities is permitted. The amendments can be applied
either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. We are
currently evaluating the provisions of ASU 2015-17, but do not expect it to have a material impact on our
financial statements.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts
with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under
U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services
are transferred to customers in an amount that reflects the consideration to which an entity expects to be
entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle
and, in doing so, more judgment and estimates may be required within the revenue recognition process than
are required under existing U.S. GAAP.

The standard’s implementation date, as amended by ASU 2015-14, is effective for annual periods

beginning after December 15, 2017, and interim periods therein, using either of the following transition
methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting
period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative
effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional
footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our
financial statements and have not yet determined the method by which we will adopt the standard in 2018.

30

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

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:

Provision for (recoveries of) doubtful accounts

Balance, beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . .
Write-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2015
$ 95,525
(2,966)
(33,875)
$ 58,684

2014
$144,921
44,178
(93,574)
$ 95,525

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 building maintenance . . . . . . . . . . . . . . . . . . .
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total Accrued Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2015
$ 211,978
192,113
365,952
45,681
30,675
138,482
212,751
$1,197,632

2014
$ 208,252
300,008
319,118
147,787
104,615
85,283
186,270
$1,351,333

5. Income Taxes

The income tax provision consists of the following:

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

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

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

2015

2014

2013

$(214,297)
(55,258)
(269,555)

$ 155,602
(127,329)
28,273

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

544,492
(439,325)
105,167
$(164,388)

1,363,093
35,618
1,398,711
$1,426,984

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

31

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

5. Income Taxes − (continued)

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 . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal R&D Credits
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effective tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2015
34.0%
-22.0%
1.3%
3.9%
-29.4%
-12.2%

2014
34.0%
1.1%
-2.7%
0.0%
-1.6%
30.8%

2013
34.0%
1.1%
0.6%
0.0%
-1.3%
34.4%

The Company’s -12.2% effective income tax rate is primarily due to Federal and California research and

development (R&D) tax credits. The total benefit recognized from R&D tax credits was $710 thousand in
2015, $208 thousand in 2014 and $75 thousand in 2013, respectively. As of December 31, 2015, there were
$95 thousand of Federal tax credit carryforwards from 2015 which have a 20 year carryforward period. As of
December 31, 2015, there were $463 thousand of California tax credit carryforwards relating to 2012 to 2015
which have an unlimited carryforward period.

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
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
R&D tax credits

Deferred tax liabilities:

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Excess of tax over book depreciation and amortization . . . . .

Net deferred tax liabilities

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

These amounts are shown net on the balance sheets as follows:

2015

2014

$

$

127,754
20,599
115,221
407,705
671,279

$

$

168,926
33,585
89,212
84,806
376,529

(57,697)
(3,138,885)
(3,196,582)
$(2,525,303)

(44,565)
(2,752,101)
(2,796,666)
$(2,420,137)

Deferred tax asset short-term . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax liability long-term . . . . . . . . . . . . . . . . . . . . . . . .
Net deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2015
$
327,442
(2,852,745)
$(2,525,303)

2014
$
376,529
(2,796,666)
$(2,420,137)

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.

32

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

5. Income Taxes − (continued)

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, 2015 and 2014. The tax years ended December 31, 2012 through December 31, 2015
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, 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 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, 2015, 70,232 shares remained available for future grant under the 2006 Incentive Plan. On
February 23, 2016, the 2006 Incentive Plan was further amended to increase the total number of shares
issuable there under from 500,000 shares to 850,000 shares, subject to shareholder approval of such
amendment.

The fair value of the SUAs is determined by the closing price on the date of grant. The fair value of
options is determined using a Black-Scholes model. 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. For the options granted in
September 2015, the Company accelerated the expense for employees who had reached retirement age as the
agreement guaranteed vesting upon reaching retirement age. Otherwise, the Company records compensation
expense related to the SUAs and options on a straight-line basis over the vesting term. Employees are issued
shares upon vesting, net of tax withholdings. The Company calculates a forfeiture amount based on stock
awards expected to be forfeited from future employee departures. For 2015, the Company estimated (and
recorded) $60 thousand of expense would be forfeited.

The following table represents all shares granted by the Company under the 2006 Incentive Plan for the

last three years:

Grant Date
September 15, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . .
September 15, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . .
April 29, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
May 8, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
May 23, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Type
Options
SUA
SUA
SUA
SUA

Shares
47,000
1,000
43,950
44,575
56,500

Price(1)
$ 1.91
$10.21
$16.10
$14.97
$11.45

(1) The price for the SUA represents the fair value of the award, which was the closing price of the

Company’s stock on that date. The price which represents the fair value for options are calculated using
the Black-Scholes model. The options granted on September 15, 2015 have contractual lives of 10 years,
an exercise price of $10.21 per share and become exercisable ratably over 5 years.

33

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

7. Stock-Based Awards − (continued)

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

Outstanding & exercisable, December 31, 2012 . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & exercisable, December 31, 2013 . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & exercisable, December 31, 2014 . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised(3)
. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & exercisable, December 31, 2015 . . . . .

Number of
Shares
199,838
—
(14,988)
(7,900)
176,950
—
(40,900)
—
136,050
—
(134,350)
(1,700)
—

Weighted
Average
Exercise Price
per Share
13.62
—
8.58
13.75
14.04
—
12.84
—
14.40
—
14.40
—
$ —

Weighted
Average
Remaining
Contractual
Life

Aggregate
Intrinsic
Value(2)
$ 32,492

$ 53,636

$115,135

$157,897

$102,038

$ 65,232

—

$

—

(2) 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 of the applicable year 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.

(3) The 134,350 options were exercised on a net basis, resulting in 7,666 shares issued.

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

Outstanding & exercisable, December 31, 2014 . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & exercisable, December 31, 2015 . . . . .

Number of
Shares
—
47,000
—
—
47,000

Weighted
Average
Exercise Price
per Share
$ —
10.21
—
—
$10.21

Weighted
Average
Remaining
Contractual
Life

Aggregate
Intrinsic
Value(4)
$—

9.7 years

$—

(4) 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, 2015 ($10.14) exceeded the exercise price
of any of the underlying options, multiplied by the number of shares subject to each such option.

(5) The fair value of the options using the Black-Scholes model is $1.91 per share. This was calculated using

an exercise price of $10.21, 10 year terms with an estimated 6.5 year expiration based on vesting
schedule, stock price volatility of 36, interest rate of 2.2% and dividend yield of 6%.

34

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

7. Stock-Based Awards − (continued)

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

Outstanding & Unvested, December 31, 2012 . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Converted to common stock(6)
. . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & Unvested, December 31, 2013 . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Converted to common stock(6)
. . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & Unvested, December 31, 2014 . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Converted to common stock(6)
. . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding & Unvested, December 31, 2015 . . . . .
Available for grant, December 31, 2015 . . . . . . . . .

Number of
Shares
137,475
56,500
(50,350)
(4,650)
138,975
44,575
(61,925)
—
121,625
44,950
(55,111)
—
111,464
70,232

Weighted
Average
Period to Vest

Aggregate
Intrinsic
Value(5)
$1,477,856

$ 577,321

$2,041,543

$ 922,330

$1,842,619

$ 824,215

2.7 years

$1,130,245

(6) 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 $10.14, $15.15, $14.69, and $10.75 for the years ended
December 31, 2015, 2014, 2013 and 2012, respectively. For value on the converted stock, the price used
is the price on the vesting date.
Includes 15,297 shares in 2015, 9,879 shares in 2014, 13,362 shares in 2013, and 9,619 shares in 2012
withheld to cover income taxes.

(7)

As of December 31, 2015, a total of 228,696 shares of common stock were reserved for issuance under

the various stock plans. As of December 31, 2015, the unamortized fair value of awards relating to SUAs was
$1,190,004 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 $242 thousand, $152 thousand, and
$142 thousand were made in the years ended December 31, 2015, 2014 and 2013, respectively.

9. Commitments and Contingencies

Commitments

The Company leases certain of its facilities and equipment under operating lease agreements expiring on

various dates through December 2020. 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 $1.0 million, $908 thousand and $605 thousand in 2015, 2014 and 2013, respectively.

35

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

9. Commitments and Contingencies − (continued)

At December 31, 2015, minimum commitments remaining under lease agreements were approximately as

follows:

Years Ending December 31:
2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total

Amount
(000’s)
$ 889
579
414
390
373
$2,645

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. Debt and Other Financing Arrangements

On March 20, 2014, the Company entered into an equipment financing arrangement with Banc of
America Leasing & Capital, LLC (the ‘‘Lender’’), which it amended on August 8, 2014 and September 15,
2015, including a Master Loan and Security Agreement and related documentation (collectively the
‘‘Equipment Loan Arrangement’’) which provided the Company with the ability to finance, at its option, up to
$8.8 million of new and used equipment purchases. Each such purchase financed under the Equipment Loan
Arrangement is documented by the execution of an equipment note. Each note has a maturity date of
60 months from the applicable loan date, and bears interest at the then current 30-day LIBOR rate + 2.00%.
Principal and interest are payable over the 60-month repayment period and principal is repayable without
premium or penalty. Borrowings under the Equipment Loan Arrangement are secured by a first priority
security interest in the equipment acquired with the proceeds of the equipment notes. Under the Equipment
Loan Arrangement, the Company is subject to a maximum quarterly funded debt to EBITDA ratio and a
minimum fixed charge coverage ratio. The Company was in compliance with all loan covenants as of
December 31, 2015.

Under the Equipment Loan Arrangement, the Company executed notes on March 24, 2014, May 22,
2014, June 13, 2014, August 8, 2014 and September 15, 2015 in the amounts of $1,052,943, $1,935,241,
$3,011,816, $999,626 and 1,098,539, respectively, for total borrowings of $8.1 million, of which $1.5 million
and $700 thousand was repaid in 2015 and 2014, respectively. The interest rate for these notes for the year
ended December 31, 2015 was 2.19%, and represented $128,700 of interest expense. As of December 31,
2015, the interest rate was 2.34%.

The annual principal repayment requirements for debt obligations as of December 31, 2015 are as

follows:

2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total long-term debt
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less current portion of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total long-term debt, net of current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,619,633
$ 1,619,633
$ 1,619,633
868,090
$
$
164,781
$ 5,891,770
$(1,619,633)
$ 4,272,137

36

PSYCHEMEDICS CORPORATION

NOTES TO FINANCIAL STATEMENTS
December 31, 2015

11. Selected Quarterly Financial Data (Unaudited)

The following are selected quarterly financial data for the years ended December 31, 2015 and 2014:

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,
2015
$6,756
3,339
451
278
0.05
0.05

June 30,
2015
$7,001
3,270
356
252
0.05
0.05

September 30,
2015
$7,084
3,457
551
796
0.15
0.15

December 31,
2015
$6,134
2,652
114
185
0.03
0.03

Quarter Ended (000’s Except Share Amounts)

March 31,
2014
$7,045
3,796
1,168
756
0.14
0.14

June 30,
2014
$7,694
3,891
1,320
857
0.16
0.16

September 30,
2014
$7,704
3,970
1,244
917
0.17
0.17

December 31,
2014
$6,762
3,482
958
676
0.13
0.13

37

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, 2015. 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 in 1992. 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, 2015.

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.

38

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

39

PART III

Item 10. Directors, Executive Officers and Corporate Governance

Following is a list that sets forth as of February 26, 2016 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 2015 Annual Meeting, to be held on May 12,
2016 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.

A. Clinton Allen
Fred J. Weinert

Age

71

48

51

71

90

69

72
68

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, 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 financial management roles with Johnson & Johnson. 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 held the position of Vice President US Sales and Marketing for Pitney Bowes DMT and
worked as a Strategic Sales Consultant. Prior to immigrating to the USA from Canada, he held the position of
General Manager DMT United Kingdom and Ireland from 2005 to 2007, and VP/General Manager DMT
Canada 2002 to 2005, both with Pitney Bowes Ltd. Since joining the Company, he has served on drug testing
industry advisory boards and been an active speaker discussing the challenges of workplace drug abuse.

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 also served as an
inspector for the College of American Pathologists since 1990.

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.

40

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
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. Allen is the Founder and President of the American College of Corporate Directors, a public
company director education and credentialing organization. Mr. Allen also serves as the Chairman of the
Board of Collectors Universe,(CLCT: NASDAQ), a member of the board of Brooks Automation
(BRKS: NASDAQ), and is Lead Director of LKQ Corporation (LKQ:NASDAQ), a Fortune 500 Company.
Mr. Allen had previously served as Vice-Chairman of the Company from 1990 to 2000 and Chairman from
2000 to 2002. He rejoined the Board as an independent member in 2015.

Mr. Weinert is an entrepreneur whose current activities are concentrated in commercial real estate,
international business development and environmental consulting. He served on the Business Advisory
Council for the University of Dayton for over 20 years from 1984 until 2005. 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 2015 Annual Meeting of Stockholders to be held on May 12, 2016 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 2015 Annual Meeting of Stockholders to be held on May 12, 2016 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 2015 Annual Meeting of Stockholders to be held on May 12, 2016 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 2015 Annual Meeting of Stockholders to be held on May 12, 2016 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 2015 Annual Meeting of Stockholders to be held on May 12, 2016 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 2015 Annual Meeting of Stockholders to be held on May 12, 2016 and is incorporated herein by
reference.

41

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.

42

SIGNATURES

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

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

Date: February 26, 2016

By: /s/ RAYMOND C. KUBACKI

PSYCHEMEDICS CORPORATION

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.

/s/ RAYMOND C. KUBACKI
Raymond C. Kubacki

/s/ NEIL LERNER
Neil Lerner

HARRY CONNICK*
Harry Connick

WALTER S. TOMENSON, JR*
Walter S. Tomenson, Jr.

FRED J. WEINERT*
Fred J. Weinert

A. CLINTON ALLEN*
A. Clinton Allen

* By:

/s/ RAYMOND C. KUBACKI
Raymond C. Kubacki

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

Vice President, Finance (Principal
Financial and Accounting Officer)

February 26, 2016

February 26, 2016

Director

Director

Director

Director

Attorney-in-Fact

February 26, 2016

43

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

10.2.8
10.3*

10.4*

10.5*

10.6*

10.7*

10.8*

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).

Amended and Restated By-Laws of the Company — (Incorporated by reference from the
Registrant’s Current Report on Form 8-K filed on July 31, 2015).

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 — (Incorporated by reference from the Registrant’s Annual Report on Form 10-K for
the fiscal year ended December 31, 2011).

Sixth Amendment to Lease dated October 13, 2015 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).
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).

Form of Incentive Stock Option Agreement used with employees under the 2006 Incentive Plan
(Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2015)

Form of Non Qualified Stock Option Agreement used with employees, non-employee directors
and consultants under the 2006 Incentive Plan (Incorporated by reference from the Registrant’s
Quarterly Report on Form 10-Q for the quarter ended September 30, 2015)

44

Exhibit
Number

10.9*

10.10*

10.11*

10.12*

10.13*

10.14*

10.15

10.16

10.17

23.1

24
31.1

31.2

32.1

32.2

Description

Form of Stock Unit Award Agreement used with employees, non-employee directors and
consultants under the 2006 Incentive Plan (Incorporated by reference from the Registrant’s
Quarterly Report on Form 10-Q for the quarter ended September 30, 2015)

Change in control severance agreement with Ray Kubacki dated March 2014. (Incorporated by
reference from the Registrant’s Current Report on Form 8-K filed March 8, 2014).

Change in control severance agreement with Michael Schaffer dated March 2014. (Incorporated
by reference from the Registrant’s Current Report on Form 8-K filed March 8, 2014).

Employment offer letter dated April 7, 2010 with James V. 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 February 24, 2015
(Incorporated by reference from Registrant’s Current Report on Form 8-K filed on February 27,
2015)

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)

Lease dated March 12, 2015 with Bristol-Culver Associates, LLC and Mountain Organic Farms,
LLC with respect to 6100 Bristol parkway premises in Culver City, CA — (Incorporated by
reference from the Quarterly Report on Form 10-Q for the quarter ended March 31, 2015)
Loan agreement dated March 20, 2015 with Banc of America Leasing and Capital, LLC —
(Incorporated by reference from the Quarterly Report on Form 10-Q for the quarter ended
March 31, 2015)
Letter Agreement dated September 15, 2015 with Banc of America Leasing and Capital, LLC,
together with Equipment Security Note dated September 15, 2015 and Proposal Letter dated
August 19, 2015 — (Incorporated by reference from the Quarterly Report on Form 10-Q for the
quarter ended September 30, 2015)
Consent of BDO USA, LLP, Independent Registered Public Accounting Firm

Power of Attorney
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

45

EXHIBIT 24

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned, being a director or officer, or

both, of Psychemedics Corporation, a Delaware corporation (hereinafter called the ‘‘Corporation’’), does
hereby constitute and appoint Raymond C. Kubacki and Neil L. Lerner, with full power to each of them to act
alone, as the true and lawful attorneys and agents of the undersigned, with full power of substitution and
resubstitution to each of said attorneys, to execute, file or deliver any and all instruments and to do all acts
and things which said attorneys and agents, or any of them, deem advisable to enable the Corporation to
comply with the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, and
any requirements of the Securities and Exchange Commission in respect thereof, in connection with the filing
under said Securities Exchange Act of the Corporation’s Annual Report on Form 10-K for the year ended
December 31, 2015, including specifically, but without limitation of the general authority hereby granted, the
power and authority to sign his or her name as a director or officer, or both, of the Corporation, as indicated
below opposite his or her signature, to the Annual Report on Form 10-K, or any amendment, post-effective
amendment, or papers supplemental thereto to be filed in respect of said Annual Report on Form 10-K; and
each of the undersigned does hereby fully ratify and confirm all that said attorneys and agents, or any of
them, or the substitute of any of them, shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, each of the undersigned has subscribed these presents, as of the 23rd day of

February, 2016.

Signature

Title

/s/ RAYMOND C. KUBACKI
Raymond C. Kubacki

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

/s/ NEIL LERNER
Neil Lerner

/s/ HARRY CONNICK
Harry Connick

/s/ WALTER S. TOMENSON, JR.
Walter S. Tomenson, Jr.

/s/ A. CLINTON ALLEN
A. Clinton Allen

/s/ FRED J. WEINERT
Fred J. Weinert

Vice President, Finance
(Principal Financial and Accounting Officer)

Director

Director

Director

Director

46

MANAGEMENT AND CORPORATE INFORMATION

AUDITORS

BDO USA, LLP
Boston, Massachusetts

CORPORATE OFFICES

Corporate Headquarters:
125 Nagog Park
Acton, Massachusetts 01720

Primary Laboratory Facility:
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 2016 Annual Meeting of Stockholders will be
held on May 12, 2016 at 2:00 p.m. at

The Seaport Hotel
200 Seaport Boulevard
Boston, Massachusetts

NASDAQ Stock Exchange Symbol (PMD)

BOARD OF DIRECTORS

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

Harry Connick
Independent Director

Walter S. Tomenson, Jr.
Independent Director

Fred J. Weinert
Independent Director

A. Clinton Allen
Independent Director 

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:

Computershare 
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

125 NAGOG PARK, ACTON, MA 01720