UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
   
 
Form 10-Q
 
x
Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2013
 
or
 
¨
Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the transition period from _________ to __________
 
Commission file number: 1-13738
 
PSYCHEMEDICS CORPORATION
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
58-1701987
(State or Other Jurisdiction of
 
(I.R.S. Employer Identification No.)
Incorporation or Organization)
 
 
 
 
 
125 Nagog Park
 
 
Acton, MA
 
01720
(Address of Principal Executive Offices)
 
(Zip Code)
 
Registrant's telephone number including area code:     (978) 206-8220
 
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 x  No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
 
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer ¨
Smaller Reporting Company x
 
 
(Do not check if smaller reporting Company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes  ¨ No x
 
The number of shares of Common Stock of the Registrant, par value $0.005 per share, outstanding at October 28, 2013 was 5,313,766.
 
 
 
PSYCHEMEDICS CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2013
 
INDEX
 
 
Page
PART I - FINANCIAL INFORMATION
 
 
 
Item 1 - Financial Statements (Unaudited)
 
 
 
Condensed Balance Sheets as of September 30, 2013 and December 31, 2012
3
Condensed Statements of Income and Comprehensive Income for the Three and Nine months Ended September 30, 2013 and 2012
4
Condensed Statements of Cash Flows for the Nine months Ended September 30, 2013 and 2012
5
Notes to Condensed Financial Statements
6
 
 
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Overview
10
Results of Operations
11
Liquidity and Capital Resources
12
Critical Accounting Policies
13
 
 
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
15
 
 
Item 4 - Controls and Procedures
15
 
 
PART II - OTHER INFORMATION
 
 
 
Item 1A - Risk Factors
16
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
16
Item 6 - Exhibits
16
 
 
Signatures
16
 
 
Exhibit Index
17
 
 
2

PSYCHEMEDICS CORPORATION
CONDENSED BALANCE SHEETS
(UNAUDITED)
 
 
 
September 30,
 
December 31,
 
 
 
2013
 
2012
 
ASSETS
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2,842,741
 
$
3,065,785
 
Accounts receivable, net of allowance for doubtful accounts
    of $179,915 in 2013 and $121,583 in 2012
 
 
5,293,505
 
 
4,620,768
 
Prepaid expenses and other current assets
 
 
1,055,363
 
 
823,274
 
Income tax receivable
 
 
—
 
 
854,212
 
Deferred tax assets
 
 
365,094
 
 
209,877
 
 
 
 
 
 
 
 
 
Total Current Assets
 
 
9,556,703
 
 
9,573,916
 
Fixed Assets, net of accumulated amortization and depreciation
    of $5,018,365 in 2013 and $4,395,605 in 2012
 
 
4,954,481
 
 
4,201,409
 
Other assets
 
 
552,955
 
 
345,293
 
 
 
 
 
 
 
 
 
Total Assets
 
$
15,064,139
 
$
14,120,618
 
 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
 
 
Accounts payable
 
$
577,081
 
$
669,789
 
Accrued expenses
 
 
1,598,457
 
 
1,413,541
 
 
 
 
 
 
 
 
 
Total Current Liabilities
 
 
2,175,538
 
 
2,083,330
 
 
 
 
 
 
 
 
 
Deferred tax liabilities, long-term
 
 
814,619
 
 
814,619
 
Total Liabilities
 
 
2,990,157
 
 
2,897,949
 
 
 
 
 
 
 
 
 
Shareholders' Equity:
 
 
 
 
 
 
 
Preferred-stock, $0.005 par value, 872,521 shares authorized,
    no shares issued or outstanding
 
 
—
 
 
—
 
Common stock, $0.005 par value; 50,000,000 shares authorized
    5,981,896 shares issued in 2013 and 5,940,558 shares issued in 2012
 
 
29,910
 
 
29,703
 
Additional paid-in capital
 
 
28,756,444
 
 
28,460,764
 
Accumulated deficit
 
 
(6,630,583)
 
 
(7,186,009)
 
Less - Treasury stock, at cost, 668,130 shares in 2013 and 2012
 
 
(10,081,789)
 
 
(10,081,789)
 
 
 
 
 
 
 
 
 
Total Shareholders' Equity
 
 
12,073,982
 
 
11,222,669
 
 
 
 
 
 
 
 
 
Total Liabilities and Shareholders' Equity
 
$
15,064,139
 
$
14,120,618
 
 
See accompanying notes to condensed financial statements
 
 
3

PSYCHEMEDICS CORPORATION
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
 
September 30,
 
 
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
7,055,202
 
$
6,459,775
 
$
20,386,381
 
$
19,565,350
 
Cost of revenues
 
 
2,879,150
 
 
2,742,072
 
 
8,644,109
 
 
8,079,141
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
4,176,052
 
 
3,717,703
 
 
11,742,272
 
 
11,486,209
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
General & administrative
 
 
1,075,133
 
 
921,891
 
 
3,075,794
 
 
2,921,880
 
Marketing & selling
 
 
1,158,355
 
 
1,067,768
 
 
3,435,257
 
 
3,413,388
 
Research & development
 
 
203,265
 
 
297,090
 
 
558,011
 
 
679,031
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Operating Expenses
 
 
2,436,753
 
 
2,286,749
 
 
7,069,062
 
 
7,014,299
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
 
1,739,299
 
 
1,430,954
 
 
4,673,210
 
 
4,471,910
 
Other income
 
 
280
 
 
447
 
 
91,993
 
 
1,442
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income before provision for income taxes
 
 
1,739,579
 
 
1,431,401
 
 
4,765,203
 
 
4,473,352
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Provision for income taxes
 
 
687,579
 
 
552,920
 
 
1,827,932
 
 
1,766,336
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income and comprehensive income
 
$
1,052,000
 
$
878,481
 
$
2,937,271
 
$
2,707,016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic net income per share
 
$
0.20
 
$
0.17
 
$
0.55
 
$
0.52
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted net income per share
 
$
0.20
 
$
0.17
 
$
0.55
 
$
0.51
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dividends declared per share
 
$
0.15
 
$
0.15
 
$
0.45
 
$
0.45
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding, basic
 
 
5,312,105
 
 
5,272,428
 
 
5,301,330
 
 
5,256,240
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding, diluted
 
 
5,330,515
 
 
5,289,808
 
 
5,314,224
 
 
5,266,237
 
 
See accompanying notes to condensed financial statements
 
 
4

PSYCHEMEDICS CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
 
Nine Months Ended
 
 
 
September 30,
 
 
 
2013
 
2012
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
 
 
Net income
 
$
2,937,271
 
$
2,707,016
 
 
 
 
 
 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
 
 
642,580
 
 
419,541
 
Stock-based compensation
 
 
386,297
 
 
337,078
 
Changes in assets and liabilities:
 
 
 
 
 
 
 
Accounts receivable
 
 
(672,737)
 
 
(852,362)
 
Prepaid expenses, other current assets, and income tax receivable
 
 
622,123
 
 
36,183
 
Accounts payable
 
 
(92,708)
 
 
304,759
 
Accrued expenses
 
 
184,916
 
 
(337,391)
 
Deferred income taxes
 
 
(155,217)
 
 
(136,180)
 
Net cash provided by operating activities
 
 
3,852,525
 
 
2,478,644
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
 
 
 
Purchases of equipment and leasehold improvements
 
 
(835,735)
 
 
(1,180,786)
 
Cost of internally developed software
 
 
(540,097)
 
 
(656,415)
 
Other assets
 
 
(227,482)
 
 
(81,889)
 
Net cash used in investing activities
 
 
(1,603,314)
 
 
(1,919,089)
 
 
 
 
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
 
 
 
Net proceeds from exercise of stock options
 
 
20,839
 
 
—
 
Proceeds from issuance of stock, net of tax withholding
 
 
(111,249)
 
 
(94,559)
 
Cash dividends paid
 
 
(2,381,845)
 
 
(2,365,730)
 
Net cash used in financing activities
 
 
(2,472,255)
 
 
(2,460,289)
 
 
 
 
 
 
 
 
 
Net decrease in cash and cash equivalents
 
 
(223,044)
 
 
(1,900,734)
 
Cash and cash equivalents, beginning of period
 
 
3,065,785
 
 
5,564,233
 
Cash and cash equivalents, end of period
 
$
2,842,741
 
$
3,663,499
 
 
 
 
 
 
 
 
 
Supplemental Disclosures of Cash Flow Information:
 
 
 
 
 
 
 
Cash paid for income taxes
 
$
643,000
 
$
1,208,800
 
 
See accompanying notes to condensed financial statements
 
 
5

PSYCHEMEDICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
 (UNAUDITED)
 
1.    Interim Financial Statements
 
The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Accordingly, certain information and footnote disclosure required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the financial statements and related notes of Psychemedics Corporation (“the Company,” “our Company,” “our” or “we”) as reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, filed on March 8, 2013. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of financial position, results of operations, and cash flows at the dates and for the periods presented have been included. The results of operations for the nine months ended September 30, 2013 may not be indicative of the results that may be expected for the year ending December 31, 2013, or any other period.

2.    Cash and Cash Equivalents
 
The Company considers all highly liquid investments with original maturities of 90 days or less to be cash equivalents. Cash equivalents consist of cash savings and a bank money market account.

3.    Stock-Based Compensation
 
2006 Equity Incentive Plan
The Company’s 2006 Incentive Plan provides for the grant or issuance to officers, directors, employees and consultants of options with terms of up to ten years, restricted stock, stock unit awards (SUA’s), issuances of stock bonuses or other stock-based awards, covering up to 500,000 shares of common stock. As of September 30, 2013, 181,581 shares remained available for future grant under the 2006 Incentive Plan.
 
The Company granted SUAs covering 56,500 shares of common stock on May 23, 2013. The SUAs vest over a period of two years for non-employee board members and four years for employees and are convertible into an equivalent number of shares of the Company’s common stock provided that the director or employee receiving the award remains continuously employed throughout the vesting period. The Company records compensation expense related to the SUAs on a straight-line basis over the vesting term of the SUAs. Employees are issued shares upon vesting, net of tax withholdings, unless the employee chooses to receive all shares and pay for the associated employment taxes. No other types of equity-based awards have been granted or issued under the 2006 Incentive Plan.
 
 
6
 
PSYCHEMEDICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
 
3.    Stock-Based Compensation (continued)
A summary of activity for SUAs under the Company’s 2006 Incentive Plan for the nine months ended September 30, 2013 is as follows:
 
 
 
 
 
 
Aggregate
 
 
 
Number of
 
Intrinsic
 
 
 
Shares
 
Value (1)
 
 
 
 
 
 
(000s)
 
Unvested, December 31, 2012
 
 
137,475
 
 
 
 
Granted
 
 
56,500
 
 
 
 
Forfeited/expired
 
 
(18,012)
 
 
 
 
Converted to common stock
 
 
(36,988)
 
 
 
 
Unvested, September 30, 2013
 
 
138,975
 
$
1,841
 
 
 
 
 
 
 
 
 
Available for grant, September 30, 2013
 
 
181,581
 
 
 
 
 
(1)      The aggregate intrinsic value on this table was calculated based on the closing market value of the Company’s stock on September 30, 2013 ($13.25).
 
Expired Plans
As of September 30, 2013, the Company also had outstanding an aggregate of 176,950 options to acquire common stock under plans that had previously expired. A summary of stock option activity for the Company’s expired stock option plans for the nine months ended September 30, 2013 is as follows:
 
 
 
 
 
 
Weighted
 
Weighted
 
 
 
 
 
 
 
 
 
Average
 
Average
 
 
 
 
 
 
 
 
 
Exercise
 
Remaining
 
Aggregate
 
 
 
Number of
 
Price Per
 
Contractual
 
Intrinsic
 
 
 
Shares
 
Share
 
Life
 
Value (2)
 
 
 
 
 
 
 
 
 
 
 
 
(000s)
 
Outstanding, December 31, 2012
 
 
199,838
 
$
13.62
 
 
 
 
 
 
 
Granted
 
 
-
 
 
-
 
 
 
 
 
 
 
Exercised
 
 
(14,988)
 
$
8.58
 
 
 
 
 
 
 
Terminated/Expired
 
 
(7,900)
 
$
13.75
 
 
 
 
 
 
 
Outstanding, September 30, 2013
 
 
176,950
 
$
14.04
 
 
1.5 years
 
$
36
 
Exercisable, September 30, 2013
 
 
176,950
 
$
14.04
 
 
1.5 years
 
$
36
 
Available for grant, September 30, 2013
 
 
-
 
 
 
 
 
 
 
 
 
 
 
(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 the September 30, 2013 ($13.25) exceeded the exercise price of the underlying options, multiplied by the number of shares subject to each option.
 
 
7
 
PSYCHEMEDICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
 
3.    Stock-Based Compensation (continued)
 
All Stock-Based Compensation Plans
As of September 30, 2013, a total of 497,506 shares of common stock were reserved for issuance under the various stock option and stock-based plans. As of September 30, 2013, the unamortized fair value of awards relating to outstanding SUAs and options was $1.2 million, which is expected to be amortized over a weighted average period of 2.9 years.

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

Basic and diluted weighted average common shares outstanding are as follows:
 
 
 
Three Months Ended
 
Nine months Ended
 
 
 
September
30,
 
September
30,
 
September
30,
 
September
30,
 
 
 
2013
 
2012
 
2013
 
2012
 
 
 
(in thousands)
Weighted average common shares outstanding, basic
 
 
5,312
 
 
5,272
 
 
5,301
 
 
5,256
 
Dilutive common equivalent shares
 
 
19
 
 
18
 
 
13
 
 
10
 
Weighted average common shares outstanding, dilutive
 
 
5,331
 
 
5,290
 
 
5,314
 
 
5,266
 
 
For the three months ended September 30, 2013 and 2012, options to purchase 153 thousand and 231 thousand common shares, respectively, were outstanding but not included in the diluted weighted average common share calculation as the effect would have been antidilutive. The amounts for the nine month period ended September 30, 2013 and 2012 were 167 thousand and 264 thousand common shares, respectively.

5.   Fair Value Measurements
 
ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), provides guidance for using fair value to measure assets and liabilities. It also responds to investors’ requests for expanded information about the extent to which companies’ measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. ASC 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances.
8
 
PSYCHEMEDICS CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
 
5.    Fair Value Measurements (continued)
 
It establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy prioritizes the inputs in three broad levels as follows:
 
⋅    Level 1 inputs are unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets and liabilities.
⋅    Level 2 inputs are quoted prices for similar assets and liabilities in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
⋅    Level 3 inputs are prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
 
A financial asset’s or liability’s classification within the hierarchy is determined based on the lowest level of any input that is significant to the fair value measurement.
 
The financial assets of the Company measured at fair value on a recurring basis are cash and cash equivalents. The Company’s cash and cash equivalents are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices that are accessible at the measurement date for identical assets and liabilities.

6.  Subsequent Events
 
On October 28, 2013, the Company declared a quarterly dividend of $0.15 per share for a total of $797 thousand, which will be paid on November 22, 2013 to shareholders of record on November 11, 2013.

7.  Commitments and Contingencies
 
The Company is subject to legal proceedings and claims, which arise in the ordinary course of its business. The Company believes that based upon information available to the Company at this time, the expected outcome of these matters would not have a material impact on the Company’s results of operations or financial condition.
 
 
9

Item 2.
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
FACTORS THAT MAY AFFECT FUTURE RESULTS
 
From time to time, information provided by the Company or statements made by its employees may contain "forward-looking" information which involves risks and uncertainties. In particular, statements contained in this report which are not historical facts (including, but not limited to, the Company's expectations regarding earnings, earnings per share, revenues, operating cash flows, dividends, future business, growth opportunities, new accounts, customer base, test volume, sales and marketing strategy, business strategy, general and administrative expenses, marketing and selling expenses, research and development expenses, anticipated operating results, strategies with respect to governmental agencies and regulations, cost savings, capital expenditures, liquidity of investments and anticipated cash requirements) may be "forward-looking" statements. The Company's actual results may differ from those stated in any "forward-looking" statements. Factors that may cause such differences include, but are not limited to, risks associated with employee hiring practices of the Company’s principal customers, development of markets for new products and services offered by the Company, government regulation (including, but not limited to, Food and Drug Administration regulations), competition and general economic conditions. With respect to the continued payment of cash dividends, factors include, but are not limited to, available surplus, cash flow, capital expenditure reserves required, and other factors that the Board of Directors of the Company may take into account.
 
OVERVIEW
 
Revenues for the third quarter of 2013 were $7.1 million, an increase of 9% from the third quarter of 2012 of $6.5 million. The Company reported net income of $0.20 per diluted share for the third quarter of 2013 and $0.17 per diluted share for the third quarter of 2012.
 
At September 30, 2013, the Company had $2.8 million of cash and cash equivalents.  The Company distributed $2.4 million or $0.45 per share of cash dividends to its shareholders in the nine months ended September 30, 2013.  The Company has paid sixty-eight consecutive quarterly cash dividends.
 
 
10
 
RESULTS OF OPERATIONS
 
Revenues were $7.1 million for three months ended September 30, 2013 compared to revenues of $6.5 million for the three months ended September 30, 2012, representing an increase of 9%. The increase in revenues for the three months ended September 30, 2013 was a result of an increase in testing volume of 11%.  The average revenue per sample decreased 2% from the comparative period in 2012, which was primarily driven by the mix of customers.  Revenues for the nine months ended September 30, 2013 were $20.4 million, representing an increase of 4% in revenues from the comparable period of 2012 of $19.6 million.  The increase was primarily due to an increase in volume, as test samples increased 7% from the first nine months of 2012.  The average revenue per sample decreased 3% from the comparative period in 2012, which was primarily driven by the mix of customers.
 
Gross profit was $4.2 million for the three months ended September 30, 2013, compared to $3.7 million for the three months ended September 30, 2012, representing an increase of 12%. Direct costs increased by $137 thousand or 5% for the three months ended September 30, 2013 compared to the same period in 2012, mainly due to a greater volume of samples. The gross profit margin was 59% for the three months ended September 30, 2013 and 58% for the comparable period of 2012. Gross profit for the nine months ended September 30, 2013 increased $256 thousand to $11.7 million compared to $11.5 million for the comparable period in 2012. Direct costs increased by $565 thousand or 7% for the nine months ended September 30, 2013 when compared to the same period in 2012, mostly due to a greater volume in samples. The gross profit margin for the nine month period ended September 30, 2013 was 58% compared to 59% for the comparable period in 2012.
 
General and administrative (“G&A”) expenses were $1.1 million for the three months ended September 30, 2013, compared to $922 thousand for the three months ended September 30, 2012.  As a percentage of revenue, G&A expenses were 15% and 14% for the three months ended September 30, 2013 and 2012.  General and administrative expenses were $3.1 million for the nine months ended September 30, 2013, compared to $2.9 million for the nine months ended September 30, 2012.  As a percentage of revenue, G&A expenses were 15% for the nine months ended September 30, 2013 and 2012.  The G&A expense for the three and nine months ended 2012 was lower than 2013 due to the capitalization of software costs related to our custom designed enzyme immunoassay (EIA) project in 2012.
 
Marketing and selling expenses were $1.2 million for the three months ended September 30, 2013, compared to $1.1 million for the three months ended September 30, 2012.  Total marketing and selling expenses represented 16% of revenue for the three months ended September 30, 2013, compared to 17% for the comparable period of 2012. The increase in marketing and selling expenses were driven by higher commissions from higher sales.   Marketing and selling expenses were $3.4 million for the nine months ended September 30, 2013 and 2012.  Total marketing and selling expenses represented 17% of revenue for the nine months ended September 30, 2013 and 2012.
 
Research and development (“R&D”) expenses for the three months ended September 30, 2013 were $203 thousand compared to $297 thousand for the comparable period of 2012.  As a percentage of revenue, R&D expenses were 3% and 5% for the three months ended September 30, 2013 and 2012.  Research and development expenses for the nine months ended September 30, 2013 were $558 thousand compared to $679 thousand in the prior year. R&D expenses represented 3% of revenue for the nine months ended 2013 and 2012.  The R&D expense for the three and nine months ended 2012 was higher than 2013 due to additional costs related to our custom designed enzyme immunoassay (EIA) project in 2012.
 
 
11
 
Provision for income taxes During the three months ended September 30, 2013 and 2012, the Company recorded tax provisions of $688 thousand and $553 thousand, respectively. These provisions represented effective tax rates of 40% for the three months ended September 30, 2013 and 39% for the comparable period of 2012. A tax provision of $1.8 million was made for the nine months ended September 30, 2013 and September 30, 2012. These provisions represented effective tax rates of 38% for the nine month periods ended September 30, 2013 and 39% for the comparative period last year. The 38% represents the current estimate of the year-end tax rate. The Company continues to monitor the effective tax rate, but does not expect a significant change for the remaining three months of 2013.
 
LIQUIDITY AND CAPITAL RESOURCES
 
At September 30, 2013, the Company had approximately $2.8 million of cash and cash equivalents. The Company's operating activities provided net cash of $3.9 million for the nine months ended September 30, 2013. Investing activities used $1.6 million of cash while financing activities used $2.5 million of cash during the first nine months of 2013.
 
Cash provided by operating activities of $3.9 million reflected net income of $2.9 million adjusted for depreciation and amortization of $643 thousand and stock-based compensation of $386 thousand. This was affected by the following changes in assets and liabilities: an increase in accounts receivable of $673 thousand, a decrease in prepaid expenses, income tax receivable and other current assets of $622 thousand, a decrease in accounts payable of $93 thousand, an increase in accrued expenses of $185 thousand and an increase for deferred income tax assets of $155 thousand.  At December 31, 2012, the Company had an income tax receivable of $854 thousand.  This receivable was used to reduce the current year tax payments which positively impacted the cash flow.
 
Cash used in investing activities included equipment and leasehold improvements of $835 thousand, cost of internally developed software of $540 thousand, and other assets of $227 thousand which were purchased during the first nine months of 2013. The other assets primarily consists of patent application costs. We anticipate spending $0.4 million to $0.6 million in additional capital purchases for the remainder of 2013.
 
Cash used in financing activities of $2.5 million included $2.4 million in cash dividends to shareholders. On October 28, 2013, the Company declared a quarterly dividend of $0.15 per share for a total of $797 thousand, which will be paid on October 22, 2013 to shareholders of record on October 11, 2013.
 
Contractual obligations as of September 30, 2013 were as follows:
 
 
 
Less Than
One Year
 
1-3
Years
 
4-5
years
 
After 5
Years
 
Total
 
 
 
(in thousands)
 
Operating leases
 
$
616
 
$
737
 
$
-
 
$
-
 
$
1,353
 
 
At September 30, 2013, the Company's principal sources of liquidity included an aggregate of approximately $2.8 million of cash and cash equivalents. Management currently believes that such funds, together with cash generated from operations, should be adequate to fund anticipated working capital requirements and capital expenditures for the next 12 months. Depending upon the Company's results of operations and capital needs, the Company may use various financing sources to raise additional funds, although the Company does not have any such plans at this time. At September 30, 2013, the Company had no long-term debt.
 
 
12
 
CRITICAL ACCOUNTING POLICIES
 
Management believes the most critical accounting policies are as follows:
 
Revenue Recognition
 
The Company is in the business of performing drug testing services 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 under 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, stock compensation expense, and income taxes, and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Allowance for Doubtful Accounts
 
The allowance for doubtful accounts is based on management's assessment of the collectability of its customer accounts. Management reviews its accounts receivable aging for doubtful accounts and specifically identifies accounts that may not be collectible. The Company routinely assesses the financial strength of its customers and, as a consequence, believes that its accounts receivable credit risk exposure is limited. The Company maintains an allowance for potential credit losses but historically has not experienced any significant losses related to individual customers or groups of customers in any particular industry or geographic area. Bad debt expense has been within management’s expectations.
 
 
13
 
Capitalized Development Costs
 
The Company capitalizes 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. The Company capitalized internally developed software costs of $540 thousand and $656 thousand for the nine months ended September 30, 2013 and 2012, 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.
 
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 follows the guidance of ASC 740, Income Taxes (“ASC 740”). 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. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes.

The Company operates within multiple taxing jurisdictions and could be subject to audit in these jurisdictions. These audits may involve complex issues, which may require an extended period of time to resolve. The Company has provided for its estimated taxes payable in the accompanying financial statements. Interest and penalties related to income tax matters are recognized as a general and administrative expense. The Company did not have any unrecognized tax benefits and did not have any interest or penalties accrued as of September 30, 2013 or December 31, 2012.
 
 
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The above listing is not intended to be a comprehensive list of all of the Company’s accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk
 
Interest Rate Sensitivity. The Company maintains cash and cash equivalents which consist of cash, money market funds and certificates of deposit with financial institutions. Due to the conservative nature and relatively short duration of our cash and cash equivalents interest rate risk is mitigated.
 
Based on our ability to access our cash and cash equivalents, our expected operating cash flows and our other sources of cash; we do not anticipate that any lack of liquidity will materially affect our ability to operate our business.
 
Item 4. Controls and Procedures
 
As of the date of this report, our Chief Executive Officer and our Vice President - Finance performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the 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 disclosed 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 principal financial officers, to allow timely decisions regarding required disclosure. There were no significant changes in the Company’s internal controls over financial reporting or in other factors that could significantly affect these internal controls over financial reporting subsequent to the date of the most recent evaluation.
 
 
15
 
PART II OTHER INFORMATION
 
Item 1A. Risk Factors

There have been no material changes in our risk factors from those disclosed in our 2012 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
There were no purchases of treasury stock in the first nine months of 2013.
 
Item 6. Exhibits
 
See Exhibit Index included in this Report
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
Psychemedics Corporation
 
Date:
October 30, 2013
 
By:
/s/ Raymond C. Kubacki
 
 
 
Raymond C. Kubacki
 
 
 
Chairman and Chief Executive Officer
 
 
 
(principal executive officer)
 
Date:
October 30, 2013
 
By:
 /s/ Neil L. Lerner
 
 
 
Neil L. Lerner
 
 
 
Vice President - Finance
 
 
 
(principal accounting officer)
 
 
16
 
PSYCHEMEDICS CORPORATION
FORM 10-Q
September 30, 2013
EXHIBIT INDEX
 
 
  
Page No.
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
18
 
 
 
31.2
Certification of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
19
 
 
 
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
20
 
 
 
32.2
Certification of Principal Accounting Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
21
 
 
17