July 27th, 2022

Dear Shareholders,

This has been a quarter of significant activity for our company, including a withdrawn debt issuance, a cancelled tender offer, and management reorganization. The long-term results of our decisions will have to speak for themselves, but shareholders deserve insight into our decision-making.

Discretionary SG&A Expenses

Our Q2 2022 sales were slightly down vs. 2021 (down 2%). Without our ongoing salesforce efforts, revenue would have been down nearly 7% as we continue to decline off our COVID peak. Our expenses were much higher, including our continued efforts to grow revenue. This business on a standstill basis produces meaningful cashflow each month before growth spending. We are spending shareholder cash today to attempt to increase long-termFCF per share by growing sales and shrinking shares outstanding.We think it's helpful to disaggregate the standstill cash flow of this business from "elective" operating expenses we decide to undertake. Elective expenditures can be further divided into "capital structure reorganization," like buybacks and recapitalization legal costs, and "growth opex" buckets. Net elective expenditures totaled approximately $400,000 for Q2 2022.

Capital Structure Reorganization

Capital structure reorganization expenses were large this quarter, and are all the more frustrating because they did not result in any changes to our shares outstanding or capital structure. We aim to reduce shares outstanding at accretive prices when no attractive internal expenditures present themselves. Legal and advisory expenses were approximately $200,000. While we would take advantage of low-priced shares or low-cost debt if we had the opportunity, current plans do not include further debt issuance or buyback. We will wait to see if new internal growth opex spending proves attractive. We think it will.

Growth Opex

Ongoing growth opex is the spending we are doing to try to grow gross margin dollars beyond the current steady-state of this business. Today this includes compensation for our new CEO and three salespersons, totaling between $500 - $600k per year (~$200k this quarter net of management reorganization efficiencies). This will increase our SG&A by around 25% on an annual basis. Our hurdle rate on opex expenditure is high, but with the strategic avenues our new CEO Matt Katz is exploring, we might expect to happily spend significantly more in this column going forward.

Our preliminary data on the salesforce is beginning to indicate that this is a productive use of shareholder capital, that the NPV of incremental gross margin dollars generated by additional sales exceeds all-in ongoing compensation costs. Q2 new customer sale revenue was twice Q1's. We are still gathering data, as the sales cycle is a slow one. Our sales force increased gross margin dollars in Q2 by nearly $50,000, and we hope for this to ramp up such that it justifies the additional SG&A drag.

Matt is exploring several new "blue sky" verticals to apply our patch IP and sales force. One immediate target is employer/employee private use. Some of the longer-term targets may include direct-to- consumer or international market. Matt only began four weeks ago, so we will reserve judgment on the value of his additional compensation spend until we have more data.

Pro forma Operating Income without Growth and Buyback Spending

If one pretends for a moment that we didn't spend the net $400,000 in elective expenses this quarter, and didn't enjoy the additional sales from that spend, quarterly pro forma EBIT would have been ~$560,000, or right at $0.11 per share. We have approximately exhausted our NOL shield, and will pay taxes at a ~22% rate going forward barring any further developments.

These expenses were real - the shareholder's cash was spent! - and we will likely incur similar onetime and recurring expenses going forward both to try to grow and to try to reorganize the capital structure. We break this out in an effort to provide you, the shareholder, with the same data we use to make decisions.

Customer Disruption

Our single largest customer has notified us that their funding will not permit any purchases in Q3 2022. This customer represents approximately 10% of our revenue. This is a federal customer, and our degree of customer concentration with them is a historical anomaly of this business. Excluding this customer, federal sales are now a small percentage of our ongoing business. We have no further information on whether they will continue purchases in October 2022 when their funding resumes. Our current growth initiative ambitions are such that we hope that this sales loss, whether it is short-lived or permanent, will not be a long-term impairment to the value of the company.

As we posted in detail on our Investor Relations page, our Annual Meeting will be held in Fort Worth, Texas, on August 31. We hope to see you there.

Thank you again for the trust you've put in us.

Tice Brown

Chairman of the Board

**Please read the Disclaimer Below.**

DISCLAIMER

This letter contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933 ("Forward-looking Statements"), which are subject to the "safe harbor" created by these Sections. Forward-looking statements are statements about future financial results, future products or services and www.pharmchem.com other events that have not yet occurred. These forward-looking statements contain words such as, but not limited to, "expect", "anticipate", "estimate", "believe", "will", "may" or "might". Investors should be aware that actual results may differ materially from our expressed expectations because of risks and uncertainties about the future. We will not

necessarily update the information in this letter if any forward-looking statement later turns out to be inaccurate.

To supplement our unaudited condensed consolidated financial statements presented on a GAAP basis, we disclose certain non-GAAP and Pro Forma financial measures, including Return on Invested Capital (ROIC), free cash flow (FCF), steady-state free cash flow, pro forma EBIT, and steady-state free cash flow per share that exclude certain amounts, one-time expenses from corporate actions and new sales force employee compensation costs. These non-GAAP financial measures are not in accordance with generally accepted accounting principles in the United States and should not be considered in isolation from or as a replacement for the most directly comparable GAAP financial measures. Further, other companies may calculate these non-GAAP financial measures differently than we do, which may limit the usefulness of those measures for comparative purposes.

We believe that presenting Return on Invested Capital, free cash flow, steady-state free cash flow, and steady-state free cash flow per share, in addition to the corresponding GAAP financial measures, provides investors greater transparency to the information used by management for its operational decision- making and allows investors to see our results "through the eyes" of management. We further believe that providing this information assists our investors in understanding our operating performance and the methodology used by management to evaluate and measure such performance.

PHARMCHEM, INC.

BALANCE SHEETS

June 30,

December 31,

2022

2021

(unaudited)

(audited)

Current Assets:

Cash

$

2,253,922

$

2,217,270

Securities

-

-

Receivables:

2,253,922

2,217,270

Trade

681,777

691,883

Other

241,200

241,200

Less: Allowance for Doubtful Accounts

(15,000)

(15,000)

Total Receivables, Net

907,977

918,083

Inventories

319,737

68,009

Prepaids & Other

41,721

20,124

Deferred Tax Asset, Net

53,116

166,861

TOTAL CURRENT ASSETS

3,576,473

3,390,347

Equipment

17,818

17,818

L.H. Improvements

13,750

13,750

NetSuite Implementation

-

-

TOTAL

31,568

31,568

Less: Accumulated Depreciation/Amortization

(31,025)

(30,941)

Net Fixed Assets

543

627

TOTAL ASSETS

$

3,577,016

$

3,390,974

Current Liabilities:

Accounts Payable

$

194,737

$

188,941

TOTAL CURRENT LIABILITIES

194,737

188,941

Accrued Expenses:

Other Accrued Expenses

118,643

87,772

Accrued Income Taxes

-

-

Accrued Compensation

119,889

265,745

Dividend Payable

-

-

TOTAL ACCRUED LIABILITIES

238,532

353,517

TOTAL LIABILITIES

433,269

542,458

Stockholders' Equity:

Common Stock

5,059

5,103

Additional Paid-In Capital

13,696,917

13,819,663

Accumulated Deficit

(10,558,229)

(10,976,250)

TOTAL EQUITY

3,143,747

2,848,516

TOTAL LIABILITIES & EQUITY

$

3,577,016

$

3,390,974

Shares Authorized

25,000,000

25,000,000

Shares Outstanding

5,058,995

5,103,273

PHARMCHEM, INC.

STATEMENTS OF INCOME

(unaudited)

Three Months Ended June 30,

2022

2021

% Inc(Dec)

Sales, net

$

1,508,119

$

1,531,905

(1.6%)

Cost of sales

543,022

593,083

(8.4%)

Gross profit

965,097

938,822

2.8%

Operating Expenses:

Sales and marketing

208,596

113,799

83.3%

General and administrative

559,060

382,971

46.0%

Total operating expenses

767,656

496,770

54.5%

Income from operations

197,441

442,052

(55.3%)

Other income (expense):

Dividend and interest income

1,989

666

Forgiveness of PPP loan

-

125,455

Other income (expenses)

-

200

Total other income

1,989

126,321

(98.4%)

Income before provision for income taxes

199,430

568,373

(64.9%)

Provision for income taxes

Federal - current

9,878

99,995

Federal - deferred

41,880

-

51,758

99,995

(48.2%)

Net income

147,672

468,378

(68.5%)

Earnings per share

$

0.029

$

0.080

Diluted earnings per share

$

0.028

$

0.067

Common shares outstanding

5,058,995

5,852,593

Diluted common shares outstanding

5,298,995

6,992,593

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PharmChem Inc. published this content on 27 July 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 27 July 2022 20:24:22 UTC.