PMDI 10-Q Quarter ended June 30, 2021

1. Basis of Presentation

The interim condensed consolidated financial statements of Psychemedics Corporation (the “Company”) presented herein, have been prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10 -Q and do not include all the information and note disclosures required by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2020, included in the Company's 2020 Annual Report on Form 10 -K ( “10 -K”), as filed with the SEC.

The condensed consolidated balance sheet as of June 30, 2021, the condensed consolidated statements of operations and comprehensive income/(loss) for the three and six months ended June 30, 2021 and 2020, the condensed consolidated statements of shareholders’ equity for the six months ended June 30, 2021 and 2020 and the condensed consolidated statements of cash flows for the six months ended June 30, 2021 and 2020 are unaudited but, in the opinion of management, include all adjustments necessary for a fair presentation of results for these interim periods. The condensed consolidated balance sheet as of December 31, 2020, has been derived from the Company’s annual financial statements that were audited by an independent registered public accounting firm, but does not include all of the information and footnotes required for complete annual financial statements.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates 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. The results of operations for the three and six months ended June 30, 2021, may not be indicative of the results that may be expected for the year ending December 31, 2021, or any other period.

Unless the context requires otherwise, the terms “we”, “us”, “our”, or “the Company” refer to Psychemedics Corporation and its wholly-owned consolidated subsidiaries.

2. COVID- 19 Pandemic

The outbreak of coronavirus (“COVID- 19” ) which was declared by the World Health Organization to be a pandemic, has impacted, and is expected to continue to impact worldwide economic activity. While our domestic business was deemed an essential business and we have been able to continue to provide services to our customers, COVID- 19 has had a significant impact on our entire operations. COVID- 19’s effect on the overall economy has had an adverse impact on hiring; which has had a negative impact on both our domestic and international volume.

The Coronavirus Aid, Relieve and Economic Security Act (“CARES”) Act, enacted on March 27, 2020, and the Families First Coronavirus Response Act (“FFCRA”), in each case

modified by the Consolidated Appropriations Act (“CAA”) enacted in December 2020, was an emergency economic stimulus package that included spending provisions and tax cuts to strengthen the United States economy and to fund a nationwide effort to curtail the effect of COVID- 19. The principal impact of the CARES Act and subsequent legislation was the adoption of the Paycheck Protection Program (“PPP”) described below. The CARES Act, together with subsequent legislation, also provided sweeping tax changes in response to the COVID- 19 pandemic, including amendments to certain provisions of the previously enacted Tax Cuts and Jobs Act (“TCJA”). The Company recognized a benefit of $ 0.8 million and $ 1.6 million for the three and six months ended June 30, 2021, as a reduction to cost of revenues and operating expenses related to the employee retention credit which was a tax provision in the CARES Act and subsequent legislation. Additionally, the CARES Act allowed the Company to fully carryback the 2020 net operating loss, for a refund of corporate income taxes previously paid.  See Item 2: “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources”.

Liquidity and Management ’ s Plans

At June 30, 2021, the Company’s principal sources of liquidity included approximately $ 2.7 million of cash. Management currently believes that such funds, together with future operating profits, which are expected to be positively impacted by employee retention credit provisions of the CAA, and the effect of the full forgiveness of the PPP loan (the “PPP Loan” – see Note 12 – “Subsequent Events”), should be adequate to fund anticipated working capital requirements, including equipment financing obligations, and capital expenditures for at least the next 12 months. Furthermore, depending upon the Company’s results of operations, its future capital needs and available marketing opportunities, the Company may use various financing sources to raise additional funds. Such sources could include but are not limited to, issuance of common stock, 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.

Accounts Receivable

The Company believes its allowance for credit losses related to its accounts receivable remained adequate as of June 30, 2021, due to the essential nature of its customers business, as well as the diversity of its large customer base. While the Company anticipates there could be an increase in the aging of its accounts receivable, the Company does not anticipate a significant increase in default risk.

Risk and Uncertainties

The duration and severity of COVID- 19 -related potential disruptions involve risks and uncertainties, and it is not possible at this time to estimate the full impact on the Company’s business and could adversely affect our estimates, results of operations and financial condition.

3. Stock-Based Compensation

The Company’s 2006 Incentive Plan (“the Plan”) provides for cash-based awards or the grant or issuance of stock-based awards. As of December 31, 2020, 45 thousand shares were then available for future grant under the Plan. At the 2021 Annual Meeting, an additional 350 thousand shares were approved for future grant under the Plan. As of June 30, 2022, 276 thousand shares remained available for future grant under the Plan.

Stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as an expense over the requisite service period (generally the vesting period of the equity grant). The compensation cost charged against income is included in cost of revenues and operating expenses as follows (in thousands):

There was no income tax benefit recognized in the condensed consolidated statements of operations and comprehensive income/(loss) for stock-based compensation arrangements for the three and six months ended June 30, 2021, and 2020.

A summary of the Company’s stock option activity for the six months ended June 30, 2021, is as follows (in thousands except per share amounts):

A summary of the Company’s stock unit award (“SUA”) activity for the six months ended June 30, 2021, is as follows (in thousands except per share amounts):

As of June 30, 2021, 901 thousand shares of common stock were reserved for issuance under the Plan. As of June 30, 2021, the unamortized fair value of awards relating to outstanding SUAs and options was $ 1.6 million, which is expected to be amortized over a weighted average period of 3.3 years.

4. Basic and Diluted Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income (or loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (or loss) by the weighted average number of common and dilutive common equivalent shares outstanding during the period when the effect is dilutive. The number of dilutive common equivalent shares outstanding during the period was determined in accordance with the treasury-stock method. Common equivalent shares consisted 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 for the three and six months ended June 30, 2021, and 2020 were as follows (in thousands):

The computation of diluted earnings (loss) per share for the three and six months ended June 30, 2021, and 2020 excludes the effect of the potential exercise of stock awards, including stock options, when the effect is anti-dilutive. For the three and six months ended June 30, 2021, the number of antidilutive stock awards excluded from diluted earnings per share was 550 thousand.

5. Commitments and Contingencies

The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. While the ultimate outcome of individual legal claims is inherently unpredictable, we believe that the final resolution of any pending actions will not have a material adverse effect on our results of operations, financial position, liquidity, or capital resources.

6. Operating Leases

The Company has five operating leases for office and laboratory space used to conduct business. The exercise of lease renewal options is at our discretion. There is one lease which contains renewal options to extend the lease terms included in our Right-Of-Use (“ROU”) assets and lease liabilities as they are reasonably certain of exercise. The Company regularly evaluates the renewal options and when they are reasonably certain of exercise. As most of the Company’s leases do not provide an implicit rate, the Company uses the incremental borrowing rate based on the information available at the lease commencement date in determining the net present value (NPV) of the lease payments.

As of June 30, 2021, the Company recognized a Right-Of-Use (“ROU”) asset of $ 4.0 million and an operating lease liability of $ 4.5 million based on the present value of the minimum rental payments as a result of adoption of ASC Topic 842. The weighted average discount rate used for leases as of June 30, 2021, is 3.9 %. The weighted average lease term as of June 30, 2021, is 4.5 years. The operating lease expense for the three and six months ended June 30, 2021, was $ 269 thousand and $ 538 thousand, respectively.

Maturities and balance sheet presentation of the Company’s lease liabilities for all operating leases as of June 30, 2021, is as follows (in thousands):

7. Debt and Other Financing Arrangements

On March 20, 2014, the Company entered into an equipment financing arrangement (“Loan Agreement”) with Banc of America Leasing & Capital, which it amended on August 8, 2014, September 15, 2015, October 30, 2017, and December 2, 2019. The terms of the arrangement are detailed in the 10 -K.

The weighted average interest rate on outstanding debt under the Loan Agreement was 3.4 % and 3.4 % for the three and six months ended June 30, 2021. The interest expense was $ 13 thousand and $ 27 thousand for the three and six months ended June 30, 2021, respectively. As of June 30, 2021, the weighted average interest rate was 3.1 % and there was $ 1.6 million of outstanding debt related under the loan agreement. The Company was in compliance with all loan covenants as of June 30, 2021.

On May 1, 2020, the Company entered into a term loan with Bank of America N.A. under the PPP administered by the United States Small Business Administration (“SBA”) under the CARES Act. The principal amount of the loan was $ 2,181,157 , which was evidenced by a promissory note with a maturity date of May 4, 2022. The note bore interest on the unpaid balance at the rate of one percent ( 1% ) per annum. In July 2021, the PPP Loan was 100% forgiven by the SBA (see Note 12 – “Subsequent Events” and the Company’s Current Report on Form 8 -K filed on July 20, 2021).

The annual principal repayment requirements for debt obligations as of June 30, 2021, were as follows (in thousands):

8. Revenue

The table below disaggregates our external revenue by major source (in thousands).  For additional revenue detail relating to geographic breakdown of sales, see Note 9 – “Business Segment Reporting”.

9. Business 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. All Brazil sales are through one independent distributor. The Company’s revenues by geographic region are as follows (in thousands):

10. Significant Customers

The Company had no customers that represented over 10% of revenue during the six months ended June 30, 2021. The Company had one customer that represented 11 % of revenue for the six months ended June 30, 2020. The Company had one customer that represented 12 % of the total accounts receivable balance as of June 30, 2021. The Company had no customers that represented greater than 10% of the total accounts receivable balance as of December 31, 2020.

11. Recently Adopted Accounting Pronouncements

December 2019, the FASB issued ASU 2019 - 12, “Income Taxes (Topic 740 ): Simplifying the Accounting for Income Taxes”. The amendments in this update simplify the accounting for income taxes by removing certain exceptions to the general principles in ASU Topic 740. The amendments also improve consistent application of and simplify U.S. GAAP for other areas of ASU Topic 740 by clarifying and amending existing guidance. The amendments in this update are effective for interim and annual periods for the Company beginning after December 15, 2020, with early adoption permitted. The Standard may be adopted using the prospective or retrospective transition approach and could be applied to a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year adoption. The Company adopted ASU 2019 - 12 as of January 1, 2021, with no material impact to the Company’s consolidated financial statements.

12. Subsequent Events

In July 2021, the outstanding principal and accrued interest for the PPP Loan was forgiven in full by the SBA.