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SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549



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FORM 10-Q

(Mark One)

|    |                                                                                         
|--- | ----------------------------------------------------------------------------------------
|[ü] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2001

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 0-19371




(Exact name of registrant as specified in its charter)

|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 77-0187280                          
|(State or other jurisdiction
of incorporation or organization) |  | (IRS Employer
Identification Number)

|                                         |  |           
|---------------------------------------- |  | ----------
|4600 Beach Street
Haltom City, Texas     |  | 76137     
|(Address of principal executive offices) |  | (Zip Code)

Registrants telephone number, including area code: (817) 605-5300

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 report(s), and (2) has been subject to
such filing requirements for the past 90 days. Yes [ü]  No [   ]

As of July 31, 2001, the registrant had outstanding 5,852,593 shares of
Common Stock, $0.001 par value.



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TABLE OF CONTENTS



|                              |                                                                                               |                                                                  |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------------------- |  |  |  |  |  | 
|PART I. Financial Information
|                              | Item 1. Condensed Consolidated Financial Statements                                          
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS                           
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                 
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                 
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS            
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|PART II. Other Information   
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|Signature                    
|EXHIBIT INDEX                
|EXHIBIT 10.41                
|EXHIBIT 10.42                
|EXHIBIT 10.43                
|EXHIBIT 10.44                

PHARMCHEM, INC.
 QUARTERLY REPORT ON FORM 10-Q
 INDEX

|          |                                                                                                                                        |    |    |  | 
|--------- | -------------------------------------------------------------------------------------------------------------------------------------- | -- | -- |  | 
|          | Page                                                                                                                                  
|          |                                                                                                                                       
|Part I    | Financial Information                                                                                                                 
|         
|Item 1.   | Condensed Consolidated Financial Statements                                                                                            |    | 3 
|         
|          | Condensed Consolidated Balance Sheets (unaudited) at
June 30, 2001 and December 31, 2000                                               |    | 4 
|         
|          | Condensed Consolidated Statements of Operations (unaudited) for the
Three and Six Months ended June 30, 2001 and 2000                  |    | 5 
|         
|          | Condensed Consolidated Statements of Comprehensive Income (Loss)
(unaudited) for the Three and Six Months ended
June 30, 2001 and 2000 |    | 6 
|         
|          | Condensed Consolidated Statements of Cash Flows (unaudited)
for the Six Months ended June 30, 2001 and 2000                            |    | 7 
|         
|          | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                       |    | 8 
|         
|Item 2.   | Managements Discussion and Analysis of Financial Condition
and Results of Operations                                                  |    | 11
|         
|Part II.  | Other Information                                                                                                                     
|         
|Item 4.   | Submission of Matters to a Vote of Security Holders                                                                                    |    | 15
|         
|Item 6.   | Exhibits and Reports on Form 8-K                                                                                                       |    | 15
|         
|Signature |                                                                                                                                        | 16



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##### Table of Contents






PART I. Financial Information




Item 1. Condensed Consolidated Financial Statements

The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in complete financial statements prepared in
accordance with accounting principles generally accepted in the United States
of America have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures made are
adequate to make the information presented not misleading. It is suggested
that the condensed consolidated financial statements be read in conjunction
with the consolidated financial statements and the notes thereto for the year
ended December 31, 2000 included in the Companys Annual Report on Form 10-K.

These financial statements have been prepared in all material respects in
conformity with the standards of accounting measurements set forth in
Accounting Principles Board Opinion No. 28, Interim Financial Reporting, and
the rules and regulations as specified by the Securities and Exchange
Commission and reflect all adjustments, consisting only of normal recurring
adjustments which, in the opinion of management, are necessary to summarize
fairly our consolidated financial position and the results of operations and
cash flows for the periods presented. The results of operations for such
interim periods are not necessarily indicative of the results to be expected
for the full year.



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##### Table of Contents






PHARMCHEM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)

|                                           |                                                                                                                                                              |                            |        |          |        |              |        |        |        | 
|------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------ | -------- | ------ | ------------ | ------ | ------ | ------ | 
|                                           |                                                                                                                                                              |                            |        | June 30, |        | December 31,
|                                           |                                                                                                                                                              |                            |        | 2001     |        | 2000        
|                                           |                                                                                                                                                              |                            |        |          |        |             
|ASSETS                                    
|                                          
|                                          
|                                          
|                                          
|CURRENT ASSETS:                           
|                                          
|                                          
|                                          
|                                          
|                                           | Cash and cash equivalents                                                                                                                                    |                            | $      | 1,045    |        |              | $      | 1,714  |       
|                                          
|                                          
|                                          
|                                          
|                                           | Accounts receivable, net                                                                                                                                     |                            |        | 6,898    |        |              |        | 8,004  |       
|                                          
|                                          
|                                          
|                                          
|                                           | Inventory                                                                                                                                                    |                            |        | 1,687    |        |              |        | 1,855  |       
|                                          
|                                          
|                                          
|                                          
|                                           | Deferred income taxes                                                                                                                                        |                            |        | 390      |        |              |        | 386    |       
|                                          
|                                          
|                                          
|                                          
|                                           | Prepaid expenses and other current assets                                                                                                                    |                            |        | 1,387    |        |              |        | 834    |       
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|                                           |                                                                                                                                                              | TOTAL CURRENT ASSETS       |        |          | 11,407 |              |        |        | 12,793 | 
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|PROPERTY AND EQUIPMENT, net                |                                                                                                                                                              |                            | 12,664 |          |        |              | 11,026 |       
|                                          
|                                          
|                                          
|                                          
|OTHER ASSETS                               |                                                                                                                                                              |                            | 829    |          |        |              | 826    |       
|                                          
|                                          
|                                          
|                                          
|GOODWILL, net                              |                                                                                                                                                              |                            | 2,528  |          |        |              | 2,620  |       
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|TOTAL ASSETS                               |                                                                                                                                                              | $                          | 27,428 |          |        | $            | 27,265 |       
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|                                          
|LIABILITIES AND STOCKHOLDERS EQUITY      
|                                          
|CURRENT LIABILITIES:                      
|                                          
|                                          
|                                          
|                                          
|                                           | Revolving line of credit                                                                                                                                     |                            | $      | 3,933    |        |              | $      | 731    |       
|                                          
|                                          
|                                          
|                                          
|                                           | Current portion of long-term debt                                                                                                                            |                            |        | 3,227    |        |              |        | 1,368  |       
|                                          
|                                          
|                                          
|                                          
|                                           | Accounts payable                                                                                                                                             |                            |        | 4,732    |        |              |        | 4,097  |       
|                                          
|                                          
|                                          
|                                          
|                                           | Accrued compensation                                                                                                                                         |                            |        | 1,199    |        |              |        | 1,404  |       
|                                          
|                                          
|                                          
|                                          
|                                           | Accrued collectors and other liabilities                                                                                                                     |                            |        | 3,941    |        |              |        | 2,786  |       
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|                                           |                                                                                                                                                              | TOTAL CURRENT LIABILITIES  |        |          | 17,032 |              |        |        | 10,386 | 
|                                          
|                                          
|                                          
|                                          
|LONG-TERM DEBT, net of current portion     |                                                                                                                                                              |                            | 1,592  |          |        |              | 1,731  |       
|                                          
|                                          
|                                          
|                                          
|OTHER NONCURRENT LIABILITIES               |                                                                                                                                                              |                            | 142    |          |        |              | 153    |       
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|                                           |                                                                                                                                                              | TOTAL LIABILITIES          |        |          | 18,766 |              |        |        | 12,270 | 
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|STOCKHOLDERS EQUITY:                      |                                                                                                                                                              |                            |        |          |        |              |        |       
|                                          
|                                          
|                                          
|                                          
|                                           | Common stock, $0.001 par value, 25,000
shares authorized, 5,853 and
5,847 shares issued and outstanding
at June 30, 2001 and
December 31, 2000, respectively |                            |        | 6        |        |              |        | 6      |       
|                                          
|                                          
|                                          
|                                          
|                                           | Additional paid-in capital                                                                                                                                   |                            |        | 19,244   |        |              |        | 19,233 |       
|                                          
|                                          
|                                          
|                                          
|                                           | Accumulated other comprehensive loss                                                                                                                         |                            |        | (229     | )      |              |        | (142   | )     
|                                          
|                                          
|                                          
|                                          
|                                           | Accumulated deficit                                                                                                                                          |                            |        | (10,359  | )      |              |        | (4,102 | )     
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|                                           |                                                                                                                                                              | TOTAL STOCKHOLDERS EQUITY |        |          | 8,662  |              |        |        | 14,995 | 
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                                                                              | $                          | 27,428 |          |        | $            | 27,265 |       
|                                           |                                                                                                                                                              |                            |        |          |        |              |        |       




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



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PHARMCHEM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)

|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |       |       | 
|----------------------------------------------- | ----------------------------------- | ------------------------ | ------ | ------------------ | ----- | ---------------- | ------ | ----- | ----- | ---- | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                                |                                     |                          |        | Three Months Ended |       | Six Months Ended
|                                                |                                     |                          |        | June 30,           |       | June 30,        
|                                                |                                     |                          |        |                    |       |                 
|                                                |                                     |                          |        | 2001               |       | 2000             |        | 2001  |       | 2000
|                                                |                                     |                          |        |                    |       |                  |        |       |       |     
|NET SALES                                       |                                     | $                        | 10,789 |                    |       | $                | 11,580 |       |       | $    | 22,338 |       |       | $ | 22,188 |      
|                                               
|                                               
|                                               
|                                               
|COST OF SALES                                   |                                     |                          | 10,166 |                    |       |                  | 8,060  |       |       |      | 18,873 |       |       |   | 15,270 |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|GROSS PROFIT                                    |                                     |                          | 623    |                    |       |                  | 3,520  |       |       |      | 3,465  |       |       |   | 6,918  |      
|                                               
|                                               
|                                               
|                                               
|OPERATING EXPENSES                             
|                                               
|                                               
|                                               
|                                               
|                                                | Selling, general and administrative |                          |        | 4,918              |       |                  |        | 2,860 |       |      |        | 8,236 |       |   |        | 5,696 |      
|                                               
|                                               
|                                               
|                                               
|                                                | Amortization of goodwill            |                          |        | 46                 |       |                  |        | 46    |       |      |        | 92    |       |   |        | 92    |      
|                                               
|                                               
|                                               
|                                               
|                                                | Restructuring charge                |                          |        | 1,029              |       |                  |        |      |       |      |        | 1,029 |       |   |        |      |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|                                                |                                     | Total operating expenses |        |                    | 5,993 |                  |        |       | 2,906 |      |        |       | 9,357 |   |        |       | 5,788 | 
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|INCOME (LOSS) FROM OPERATIONS                   |                                     |                          | (5,370 | )                  |       |                  | 614    |       |       |      | (5,892 | )     |       |   | 1,130  |      
|                                               
|                                               
|                                               
|                                               
|Interest expense                                |                                     |                          | 86     |                    |       |                  | 80     |       |       |      | 155    |       |       |   | 160    |      
|                                               
|                                               
|                                               
|                                               
|Other income, net                               |                                     |                          | (2     | )                  |       |                  | (52    | )     |       |      | (40    | )     |       |   | (67    | )    
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|                                               
|                                               
|                                               
|                                               
|                                                |                                     | Total other expenses     |        |                    | 84    |                  |        |       | 28    |      |        |       | 115   |   |        |       | 93    | 
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES |                                     |                          | (5,454 | )                  |       |                  | 586    |       |       |      | (6,007 | )     |       |   | 1,037  |      
|                                               
|                                               
|                                               
|                                               
|PROVISION FOR INCOME TAXES                      |                                     |                          | 103    |                    |       |                  | 212    |       |       |      | 250    |       |       |   | 381    |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|NET INCOME (LOSS)                               |                                     | $                        | (5,557 | )                  |       | $                | 374    |       |       | $    | (6,257 | )     |       | $ | 656    |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|EARNINGS (LOSS) PER SHARE:                      |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|                                               
|                                               
|                                               
|                                               
|                                                | Basic                               |                          | $      | (0.95              | )     |                  | $      | 0.06  |       |      | $      | (1.07 | )     |   | $      | 0.11  |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|                                                | Diluted                             |                          | $      | (0.95              | )     |                  | $      | 0.06  |       |      | $      | (1.07 | )     |   | $      | 0.11  |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|WEIGHTED AVERAGE SHARES OUTSTANDING:            |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|                                               
|                                               
|                                               
|                                               
|                                                | Basic                               |                          |        | 5,851              |       |                  |        | 5,823 |       |      |        | 5,849 |       |   |        | 5,816 |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      
|                                                | Diluted                             |                          |        | 5,851              |       |                  |        | 5,986 |       |      |        | 5,849 |       |   |        | 6,088 |      
|                                                |                                     |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |        |      




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



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PHARMCHEM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands)

|                                   |                              |   |                    |    |                  |   |      |      |      |   |        |     |   |   |     |      |  
|---------------------------------- | ---------------------------- | - | ------------------ | -- | ---------------- | - | ---- | ---- | ---- | - | ------ | --- | - | - | --- | ---- | -
|                                   |                              |   | Three Months Ended |    | Six Months Ended
|                                   |                              |   | June 30,           |    | June 30,        
|                                   |                              |   |                    |    |                 
|                                   |                              |   | 2001               |    | 2000             |   | 2001 |      | 2000
|                                   |                              |   |                    |    |                  |   |      |      |     
|NET INCOME (LOSS)                  |                              | $ | (5,557             | )  |                  | $ | 374  |      |      | $ | (6,257 | )   |   | $ | 656 |     
|                                  
|                                  
|                                  
|                                  
|OTHER COMPREHENSIVE INCOME (LOSS): |                              |   |                    |    |                  |   |      |      |      |   |        |     |   |   |     |     
|                                  
|                                  
|                                  
|                                  
|                                   | Foreign currency translation |   |                    | 49 |                  |   |      | (140 | )    |   |        | (87 | ) |   |     | (173 | )
|                                   |                              |   |                    |    |                  |   |      |      |      |   |        |     |   |   |     |     
|COMPREHENSIVE INCOME (LOSS)        |                              | $ | (5,508             | )  |                  | $ | 234  |      |      | $ | (6,344 | )   |   | $ | 483 |     
|                                   |                              |   |                    |    |                  |   |      |      |      |   |        |     |   |   |     |     




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



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PHARMCHEM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |      |        |       |        |  
|------------------------------------------------ | ---------------------------------------------------------------------------------------- | ------------------------------------------- | ---------------------------------------------- | --------------------------------------------------- | ------ | ---------------- | ------ | ---- | ------ | ----- | ------ | -
|                                                 |                                                                                          |                                             |                                                |                                                     |        | Six Months Ended
|                                                 |                                                                                          |                                             |                                                |                                                     |        | June 30,        
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                 
|                                                 |                                                                                          |                                             |                                                |                                                     |        | 2001             |        | 2000
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|CASH FLOWS FROM OPERATING ACTIVITIES             |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|                                                
|                                                
|                                                
|                                                
|                                                 | Net income (loss)                                                                        |                                             | $                                              | (6,257                                              | )      |                  | $      | 656  |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Adjustments to reconcile net income (loss) to net cash provided by
operating activities: |                                             |                                                |                                                     |        |                  |        |      |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Depreciation and amortization                  |                                                     |        | 1,132            |        |      |        | 1,088 |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Provision for doubtful accounts                |                                                     |        | 54               |        |      |        | (225  | )     
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Deferred income taxes                          |                                                     |        | (4               | )      |      |        | 95    |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | (Gain) loss on sale or disposal of assets      |                                                     |        | (1               | )      |      |        | 5     |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Restructuring charge                           |                                                     |        | 1,029            |        |      |        | -     |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Changes in operating assets
and liabilities                                              |                                             |                                                | 1,052                                               |        |                  |        | (711 | )     
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Inventory                                      |                                                     |        | 168              |        |      |        | 151   |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Prepaids and other current assets              |                                                     |        | (553             | )      |      |        | (320  | )     
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Other assets                                   |                                                     |        | (3               | )      |      |        | 30    |       
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Accounts payable and other accrued liabilities |                                                     |        | 611              |        |      |        | (314  | )     
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          |                                             | Other noncurrent liabilities                   |                                                     |        | (11              | )      |      |        | (30   | )     
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|                                                 |                                                                                          |                                             |                                                | Net cash provided by (used in) operating activities |        |                  | (2,783 | )    |        |       | 425    |  
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|CASH FLOWS FROM INVESTING ACTIVITIES             |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          | Purchases of property and equipment         |                                                |                                                     | (2,732 | )                |        |      | (1,698 | )    
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|                                                 |                                                                                          |                                             |                                                | Net cash used in investing activities               |        |                  | (2,732 | )    |        |       | (1,698 | )
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|CASH FLOWS FROM FINANCING ACTIVITIES             |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          | Borrowings on revolving line of credit, net |                                                |                                                     | 3,202  |                  |        |      | 1,856  |      
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          | Principal payments on long-term debt        |                                                |                                                     | (1,066 | )                |        |      | (727   | )    
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          | Proceeds from financing and short term debt |                                                |                                                     | 2,786  |                  |        |      |       |      
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                          | Proceeds from exercise of stock options     |                                                |                                                     | 11     |                  |        |      | 43     |      
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|                                                 |                                                                                          |                                             |                                                | Net cash provided by financing activities           |        |                  | 4,933  |      |        |       | 1,172  |  
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|FOREIGN CURRENCY TRANSLATION                     |                                                                                          |                                             | (87                                            | )                                                   |        |                  | (173   | )   
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|NET DECREASE IN CASH AND CASH EQUIVALENTS        |                                                                                          |                                             | (669                                           | )                                                   |        |                  | (274   | )   
|                                                
|                                                
|                                                
|                                                
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD |                                                                                          |                                             | 1,714                                          |                                                     |        |                  | 1,804  |     
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     
|CASH AND CASH EQUIVALENTS AT END OF PERIOD       |                                                                                          | $                                           | 1,045                                          |                                                     |        | $                | 1,530  |     
|                                                 |                                                                                          |                                             |                                                |                                                     |        |                  |        |     




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



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PHARMCHEM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Earnings (Loss) per Share

We compute and disclose our earnings (loss) per share in accordance with
SFAS No. 128, Earnings Per Share,which requires the presentation of basic
and diluted earnings per share. Basic earnings per share is calculated using
the weighted average number of common shares outstanding during the period.
Diluted earnings per share is calculated using the weighted average number of
common shares and dilutive potential common shares outstanding during the
period. Dilutive potential common shares represent shares issuable upon the
exercise of outstanding options and are calculated using the treasury stock
method.

Options to purchase 1,070,000 shares of our common stock for the three and
six month periods ended June 30, 2001, were not included in the computation of
diluted earnings per share because their effect would have been anti-dilutive.
Options to purchase 183,000 shares and 110,000 shares of our common stock for
the three months and six months ended June 30, 2000, respectively, were not
included in the computation of diluted earnings per share because their
exercise prices were greater than the average market price of our common stock
of $2.943 and $3.492 per share, respectively. Weighted average dilutive
options of 163,000 and 274,000 were used in the computation of dilutive
earnings per share for the three month and six month periods ended June 30,
2000, respectively.

2. Inventory

Inventory includes laboratory materials, collection materials and products
and is stated at the lower of cost or market. Cost is determined using standard
costs, including freight, that approximate actual costs on a first-in,
first-out basis. Inventory consisted of the following as of June 30, 2001 and
December 31, 2000, respectively:

|                     |  |                |       |      |  |   |       | 
|-------------------- |  | -------------- | ----- | ---- |  | - | ----- | 
|                     |  | 2001           |       | 2000
|                     |  |                |       |     
|                     |  | (In thousands)
|Laboratory materials |  | $              | 467   |      |  | $ | 733   | 
|                    
|                    
|                    
|                    
|Collection materials |  |                | 1,086 |      |  |   | 841   | 
|                    
|                    
|                    
|                    
|Products             |  |                | 134   |      |  |   | 281   | 
|                     |  |                |       |      |  |   |       | 
|                     |  | $              | 1,687 |      |  | $ | 1,855 | 
|                     |  |                |       |      |  |   |       | 



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3. Reportable Segments

We have two reportable segments, Domestic and International, providing
integrated drug testing services. Our Domestic segment serves the United States
(US) and the International segment serves primarily the United Kingdom but also
serves the European, Asian, Middle Eastern and South American markets. The
Domestic segment is serviced by our California and Texas operations and the
International segment is serviced by Medscreen, our London-based subsidiary.
The accounting policies of the segments are the same as those described in the
Summary of Significant Accounting Policies in the notes to the consolidated
financial statements for the year ended December 31, 2000 included in our
Annual Report on Form 10-K. We evaluate segment profit (loss) based on income
or loss from operations before intercompany interest, other income or expense
and income taxes and excluding goodwill amortization. Intersegment sales and
transfers are not material. Information about our segments for the three and
six month periods ended June 30 is as follows:

|      |                                   |  |               |        |       |  |   |       |  |  |   |        |  
|----- | --------------------------------- |  | ------------- | ------ | ----- |  | - | ----- |  |  | - | ------ | -
|      | Domestic                          |  | International |        | Total
|      |                                   |  |               |        |      
|      | (In thousands)                   
|      | Three Months Ending June 30,      |  |               |        |       |  |   |       |  |  |   |        |  
|     
|     
|     
|     
|2001: | Net sales from external customers |  | $             | 9,036  |       |  | $ | 1,753 |  |  | $ | 10,789 |  
|     
|     
|     
|     
|      | Segment profit (loss)             |  |               | (5,632 | )     |  |   | 308   |  |  |   | (5,324 | )
|     
|2000: | Net sales from external customers |  | $             | 9,772  |       |  | $ | 1,808 |  |  | $ | 11,580 |  
|     
|     
|     
|     
|      | Segment profit                    |  |               | 344    |       |  |   | 316   |  |  |   | 660    |  
|     
|      | Six Months Ending June 30,       
|     
|     
|     
|     
|2001: | Net sales from external customers |  | $             | 18,664 |       |  | $ | 3,674 |  |  | $ | 22,338 |  
|     
|     
|     
|     
|      | Segment profit (loss)             |  |               | (6,532 | )     |  |   | 732   |  |  |   | (5,800 | )
|     
|     
|     
|     
|2000: | Net sales from external customers |  | $             | 18,435 |       |  | $ | 3,753 |  |  | $ | 22,188 |  
|     
|     
|     
|     
|      | Segment profit                    |  |               | 353    |       |  |   | 869   |  |  |   | 1,222  |  

4. Debt

We have a revolving line of credit agreement (Credit Agreement) with a
bank. The Credit Agreement provides for borrowings under the revolving line of
credit limited to 85% of qualified accounts receivable (up to a maximum of
$6,000,000) and is secured by a lien on substantially all of our assets
(excluding computer software and certain other assets). The Credit Agreement
contains certain financial covenants, which, among others, require PharmChem to
maintain certain ratios of working capital and net worth.

On January 3, 2001, we completed a $2,363,000 financing lease agreement
with a group of lessors to refinance certain modules of ATLAS, our new
laboratory information management system. The lease agreement bears interest
at 8.9% and is payable over 36 to 48 months. The proceeds from the lease were
used to reduce amounts outstanding under our revolving line of credit and to
fund additional capital expenditures. This lease has been accounted for as a
capital lease.

On April 17, 2001, our Credit Agreement was amended to provide an
additional $600,000 of short



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term financing to be used to finance construction of our new Haltom City, Texas
facility. The $600,000 note bears interest at the prime rate and matures
October 31, 2001. As of June 30, 2001, $423,000 was outstanding under this
short term financing.

On May 25, 2001, our Credit Agreement was amended to change the revolving
maturity date to May 31, 2002, reduce the interest rate to the banks prime
rate and reduce the commitment fee to 0.1%.

On July 18, 2001, our Credit Agreement was amended to provide an
additional $600,000 of borrowing capacity under the revolving line of credit
and this additional amount matures August 20, 2001. As of June 30, 2001, the
maximum that could be borrowed and the amount outstanding under the amended
Credit Agreement were $5,483,000 and $3,933,000, respectively.

Due to the restructuring charge and nonrecurring expenses associated with
the relocation of our Menlo Park, California headquarters and main laboratory
to Haltom City, Texas, we were not in compliance with our current ratio, cash
flow, liability, net worth and capital expenditures covenants. We are
currently negotiating waivers of such non compliance with our bank.
Accordingly, we have reclassified $875,000 of our term debt with the bank from
long-term debt to current portion of long-term debt on our balance sheet as of
June 30, 2001.

5. Restructuring Charge

During the second quarter of 2001, our Board of Directors approved a plan
to close our Menlo Park, California corporate headquarters and main laboratory
and relocate these operations to Texas. These expenses were recorded in
continuing operations for the three months ended June 30, 2001. Detail of the
charges to expense, payment activity and ending accrual balance related to the
restructuring is presented in the following table (in thousands):

|                               |       |        |       |          |  |               |      |      |       |   |         |     | 
|------------------------------ | ----- | ------ | ----- | -------- |  | ------------- | ---- | ---- | ----- | - | ------- | --- | 
|                               |       |        |       |          |  |               |      |      |       |   | Accrual
|                               |       |        | Total |          |  |               |      |      | As of
|Restructuring Expense          |       | Charge |       | Payments |  | June 30, 2001
|                               |       |        |       |          |  |              
|Severance and related benefits |       | $      | 330   |          |  | $             | (140 | )    |       | $ | 190     |    
|                              
|                              
|                              
|                              
|Clean-up and remediation       |       |        | 371   |          |  |               | (78  | )    |       |   | 293     |    
|                              
|                              
|                              
|                              
|Repairs                        |       |        | 226   |          |  |               | (210 | )    |       |   | 16      |    
|                              
|                              
|                              
|                              
|Legal and other                |       |        | 102   |          |  |               | (15  | )    |       |   | 87      |    
|                               |       |        |       |          |  |               |      |      |       |   |         |    
|                               | Total |        | $     | 1,029    |  |               | $    | (443 | )     |   | $       | 586 | 
|                               |       |        |       |          |  |               |      |      |       |   |         |    

The restructuring plan was designed to provide for costs associated with
leaving our main facility in Menlo Park, California. The lease on our Menlo
Park facility terminated on June 1, 2001 and the restructuring expenses
represent estimated and actual costs related to workforce reductions, clean-up,
repairs and legal services. As part of the workforce reduction, we recorded
severance and related fringe benefits costs for approximately 160 employees
from operations and administration, of which 80 employees were terminated as of
June 30, 2001. In addition, we expect to incur legal and other fees related to
our departure. The accrual balance of $586,000 is classified as a component in
Accrued collectors and other liabilities on the balance sheet.

During the process of relocating to Texas, we have incurred significant
costs that have been financed through a combination
of internal operations, increased borrowing under our existing and new credit facilities and a sale-leaseback transaction.
We believe these costs are of a nonrecurring nature and will be reduced upon the Company's final relocation
into our new Haltom City, Texas building. The Haltom City building construction is scheduled to be completed
during the current year's third quarter. As a result of the restructuring charge and nonrecurring expenses associated with the relocation
to Texas, we were not in compliance with our current ratio, cash flow, liability, net worth and capital expenditures
covenants. We are currently negotiating waivers of such non compliance with our bank. Accordingly, we have reclassified $875,000 of our term
debt with the bank from long-term debt to current portion of long-term debt on our balance sheet as of June 30, 2001.
We anticipate the existing cash balances, amounts available under existing and anticipated credit agreements, including
sale-leaseback transactions, dividends from Medscreen, a credit agreement with Medscreen's bank and investor related debt together with
funds to be generated from future operations will be sufficient to fund operations and forecasted capital expenditures
through the foreseeable future.



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|        |                                                                                      
|------- | -------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

Managements Discussion and Analysis of Financial Condition and Results
of Operations 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, which are subject to the safe harbor created by these
Sections. Our actual future results could differ materially from those
projected in the forward-looking statements. Some factors which could cause
future actual results to differ materially from our recent results and those
projected in the forward-looking statements are described in our Annual Report
on Form 10-K for the year ended December 31, 2000. We assume no obligation to
update the forward-looking statements or such factors.

Results of Operations

The following table sets forth for the periods indicated certain financial
data (dollars in thousands):

|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |      |       | 
|----------------------------- | --------------------------------- | ------------------------ | ------ | --------------------------- | ------ | ------------------------- | ----- | ----- | ------ | ---- | ----- | --------------------- | ----- | ---- | ---- | ---- | ----- | ---- | ------ | ----- | ------ | --------------------- | ------ | ----- | ------ |  | ----- | ---- | ----- |  | ---- | ---- | ----- | 
|                              |                                   |                          |        | Three Months Ended June 30, |        | Six Months Ended June 30,
|                              |                                   |                          |        |                             |        |                          
|                              |                                   |                          |        | 2001                        |        | 2000                      |       | 2001  |        | 2000 |       | 2001                  |       | 2000 |      | 2001 |       | 2000
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |     
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       | (As a % of net sales) |       |      |      |      |       |      |        |       |        | (As a % of net sales)
|NET SALES:                    |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|                             
|                             
|                             
|                             
|                              | Workplace employers               |                          | $      | 3,405                       |        |                           | $     | 3,741 |        |      |       | 31.6                  | %     |      |      | 32.3 | %     |      | $      | 6,885 |        |                       | $      | 6,739 |        |  |       | 30.8 | %     |  |      | 30.4 | %    
|                             
|                             
|                             
|                             
|                              | Criminal justice agencies         |                          |        | 3,537                       |        |                           |       | 4,419 |        |      |       | 32.8                  |       |      |      | 38.2 |       |      |        | 7,982 |        |                       |        | 8,828 |        |  |       | 35.7 |       |  |      | 39.8 |      
|                             
|                             
|                             
|                             
|                              | Drug rehabilitation programs      |                          |        | 219                         |        |                           |       | 287   |        |      |       | 2.0                   |       |      |      | 2.5  |       |      |        | 510   |        |                       |        | 604   |        |  |       | 2.3  |       |  |      | 2.7  |      
|                             
|                             
|                             
|                             
|                              | Domestic products & other         |                          |        | 1,875                       |        |                           |       | 1,325 |        |      |       | 17.4                  |       |      |      | 11.4 |       |      |        | 3,287 |        |                       |        | 2,264 |        |  |       | 14.7 |       |  |      | 10.2 |      
|                             
|                             
|                             
|                             
|                              | Medscreen                         |                          |        | 1,753                       |        |                           |       | 1,808 |        |      |       | 16.2                  |       |      |      | 15.6 |       |      |        | 3,674 |        |                       |        | 3,753 |        |  |       | 16.5 |       |  |      | 16.9 |      
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|                              |                                   | Total net sales          |        |                             | 10,789 |                           |       |       | 11,580 |      |       |                       | 100.0 |      |      |      | 100.0 |      |        |       | 22,338 |                       |        |       | 22,188 |  |       |      | 100.0 |  |      |      | 100.0 | 
|                             
|                             
|                             
|                             
|COST OF SALES                 |                                   |                          | 10,166 |                             |        |                           | 8,060 |       |        |      | 94.2  |                       |       |      | 69.6 |      |       |      | 18,873 |       |        |                       | 15,270 |       |        |  | 84.5  |      |       |  | 68.8 |     
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|GROSS PROFIT                  |                                   |                          | 623    |                             |        |                           | 3,520 |       |        |      | 5.8   |                       |       |      | 30.4 |      |       |      | 3,465  |       |        |                       | 6,918  |       |        |  | 15.5  |      |       |  | 31.2 |     
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|OPERATING EXPENSES:           |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|                             
|                             
|                             
|                             
|                              | Selling, general & administrative |                          |        | 4,918                       |        |                           |       | 2,860 |        |      |       | 45.6                  |       |      |      | 24.7 |       |      |        | 8,236 |        |                       |        | 5,696 |        |  |       | 36.9 |       |  |      | 25.7 |      
|                             
|                             
|                             
|                             
|                              | Amortization of goodwill          |                          |        | 46                          |        |                           |       | 46    |        |      |       | 0.4                   |       |      |      | 0.4  |       |      |        | 92    |        |                       |        | 92    |        |  |       | 0.4  |       |  |      | 0.4  |      
|                             
|                             
|                             
|                             
|                              | Restructuring charge              |                          |        | 1,029                       |        |                           |       |      |        |      |       | 9.6                   |       |      |      | 0.0  |       |      |        | 1,029 |        |                       |        |      |        |  |       | 4.6  |       |  |      | 0.0  |      
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|                              |                                   | Total operating expenses |        |                             | 5,993  |                           |       |       | 2,906  |      |       |                       | 55.6  |      |      |      | 25.1  |      |        |       | 9,357  |                       |        |       | 5,788  |  |       |      | 41.9  |  |      |      | 26.1  | 
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|INCOME (LOSS) FROM OPERATIONS |                                   |                          | (5,370 | )                           |        |                           | 614   |       |        |      | (49.8 | )                     |       |      | 5.3  |      |       |      | (5,892 | )     |        |                       | 1,130  |       |        |  | (26.4 | )    |       |  | 5.1  |     
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|OTHER EXPENSES, net           |                                   |                          | 84     |                             |        |                           | 28    |       |        |      | 0.8   |                       |       |      | 0.3  |      |       |      | 115    |       |        |                       | 93     |       |        |  | 0.5   |      |       |  | 0.4  |     
|                             
|                             
|                             
|                             
|PROVISION FOR INCOME TAXES    |                                   |                          | 103    |                             |        |                           | 212   |       |        |      | 0.9   |                       |       |      | 1.8  |      |       |      | 250    |       |        |                       | 381    |       |        |  | 1.1   |      |       |  | 1.7  |     
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     
|NET INCOME (LOSS)             |                                   | $                        | (5,557 | )                           |        | $                         | 374   |       |        |      | (51.5 | )%                    |       |      | 3.2  | %    |       | $    | (6,257 | )     |        | $                     | 656    |       |        |  | (28.0 | )%   |       |  | 3.0  | %   
|                              |                                   |                          |        |                             |        |                           |       |       |        |      |       |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |       |      |       |  |      |     

Net salesfor the three months ended June 30, 2001 decreased $791,000
(6.8%) to $10,789,000 in 2001 from $11,580,000 in 2000. We recorded 15.2%
lower domestic laboratory service sales which more than offset a 41.5% increase
in domestic product and non-laboratory sales. Domestic specimen (including
product related analyses) volume decreased 18.5% across all customer classes
and average selling prices for domestic laboratory analyses (including product
related analyses) increased 4.0%. The lower domestic laboratory sales reflect
logistical and operational challenges encountered during the



11



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relocation of our Menlo Park, California corporate headquarters and main
laboratory to Haltom City, Texas. Our Menlo Park lease terminated on June 1,
2001. Due to construction delays at our new Haltom City facility, we quickly
expanded our Fort Worth, Texas laboratory to accommodate the significant
specimen volume transferred from Menlo Park and, as a consequence, we fell
behind in our specimen processing while the new workforce was being trained.
Medscreen, our London-based subsidiary, reported a decrease in sales of $55,000
(3.0%) and a 3.0% decrease in specimen volume. Product sales of the
PharmScreen® On-site Screening Device increased 68.6% while sales of the
PharmChek® Drugs of Abuse Patch (excluding analysis) increased 2.7%, compared
to the prior year. Non-laboratory service sales increased 19.0% compared to
the prior year. Under our Premium Comprehensive Management (PCM®) umbrella of
integrated drug testing services, such non-laboratory services include our
web-based specimen collection management system.

Net sales for the six months ended June 30, 2001 increased $150,000 (0.7%)
to $22,338,000 in 2001 from $22,188,000 in 2000. We recorded 45.2% higher
domestic product and non-laboratory sales which were substantially offset by a
4.9% decrease in domestic laboratory analysis. Domestic specimen (including
product related analyses) volume decreased 10.3%, principally by criminal
justice customers. Average selling prices for domestic laboratory analyses
(including product related analyses) increased 6.0%. Medscreens sales
decreased $79,000 (2.1%) due to a 4.1% decrease in specimen volume.

Cost of salesfor the three months ended June 30, 2001 increased
$2,106,000 (26.1%) to $10,166,000 in 2001 from $8,060,000 in 2000. The
increase in cost of sales includes $2,028,000 of nonrecurring costs directly
related to the transfer of production from our Menlo Park main laboratory to
our expanded Fort Worth laboratory. These nonrecurring costs include duplicate
payroll, lab materials, training and transportation and certain of the costs
are expected to continue until we move into our new Haltom City laboratory in
this years third quarter. In addition, domestic specimen collection costs
increased $256,000 (13.2%) due to a 16.6% increase in managed specimen
collection volume. Cost of sales as a percentage of net sales increased to
94.2% in 2001 from 69.6% in 2000. Gross profit as a percentage of net sales
decreased to 5.8% in 2001 from 30.4% in 2000.

Cost of sales for the six months ended June 30, 2001 increased $3,603,000
(23.6%) to $18,873,000 in 2001 from $15,270,000 in 2000. The increase in cost
of sales includes $2,504,000 of nonrecurring costs directly related to the
transfer of production from our Menlo Park main laboratory to our expanded Fort
Worth laboratory. Domestic specimen collection costs increased $749,000
(22.2%) due to a 18.3% increase in managed collection volume and higher rates
charged by our network of collector draw stations. Cost of sales as a
percentage of net sales increased to 84.5% in 2001 from 68.8% in 2000. Gross
profit as a percentage of net sales decreased to 15.5% in 2001 from 31.2% in
2000.

Selling, General & Administrative (SG&A)expenses for the three months
ended June 30, 2001 increased $2,058,000 (72.0%) to $4,918,000 in 2001 from
$2,860,000 in 2000. The increase principally reflects $1,417,000 of
nonrecurring costs associated with the relocation of our Company from
California to Texas. These nonrecurring costs include significant relocation,
travel and subsistence expenses. In addition, we continued our investment in
sales, marketing, customer service and information systems. SG&A expenses as a
percentage of net sales increased to 45.6% in 2001 from 24.7% in 2000.

SG&A expenses for the six months ended June 30, 2001 increased $2,540,000
(44.6%) to $8,236,000 in 2001 from $5,696,000 in 2000. The increase
principally reflects $1,502,000 of



12



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nonrecurring costs associated with the relocation of our Company from
California to Texas. These nonrecurring costs include significant relocation,
travel and subsistence expenses and our continued investment in sales,
marketing, customer service and information systems. SG&A expenses as a
percentage of net sales increased to 36.9% in 2001 from 25.7% in 2000.

Restructuring Chargeof $1,029,000 was recorded in the current years
second quarter in accordance with a plan approved by our Board of Directors to
provide for costs associated with closing our former headquarters and main
laboratory in Menlo Park, California. The charge consisted of $330,000 for
severance and related benefits costs of a workforce reduction and $699,000 for
repairs, clean-up and professional services.

Provision for Income Taxesfor the three month and six month periods ended
June 30, 2001 was $103,000 and $250,000, respectively, compared to $212,000 and
$381,000, respectively for the same periods in 2000. The current year's provision for income taxes reflects Medscreen's provision
on its income.

Net lossfor the three months ended June 30, 2001 was $5,557,000 or $0.95
per common share compared to net income of $374,000 or $0.06 per diluted common
share in 2000. Excluding the impact of the $3,445,000 in nonrecurring costs and
$1,029,000 restructuring charge related to the Companys relocation, proforma
net loss for the three months ended June 30, 2001 would have been $1,083,000 or
$0.19 per share. Net loss for the six months ended June 30, 2001 was $6,257,000
or $1.07 per common share compared to net income of $656,000 or $0.11 per
diluted common share in 2000. Excluding the impact of the $4,006,000 in
nonrecurring costs and $1,029,000 restructuring charge related to the Companys
relocation, proforma net loss for the six months ended June 30, 2001 would have
been $1,222,000 or $0.21 per common share.

Liquidity and Capital Resources

Our operations during the six month period ended June 30 used cash of
$2,783,000 and provided cash of $425,000 in 2001 and 2000, respectively. The
decrease in cash flow from operations between 2001 and 2000 principally
reflects a $6,913,000 decrease in income which more than offset reductions in
accounts receivable and higher accounts payable. As of June 30, 2001, we had
$1,045,000 in cash and cash equivalents. During the six months ended June 30,
2001, we used approximately $2,732,000 in cash to purchase property and
equipment, principally for ATLAS, our new laboratory information system under
development, new laboratory confirmation analyzers and leasehold improvements
for our new Haltom City, Texas facility.

We have a revolving line of credit agreement (Credit Agreement) with a
bank. The Credit Agreement provides for borrowings under the revolving line of
credit limited to 85% of qualified accounts receivable (up to a maximum of
$6,000,000) and is secured by a lien on substantially all of our assets
(excluding computer software and certain other assets). The Credit Agreement
contains certain financial covenants, which, among others, require PharmChem to
maintain certain ratios of working capital and net worth.

On January 3, 2001, we completed a $2,363,000 financing lease agreement
with a group of lessors to refinance certain modules of ATLAS, our new
laboratory information management system. The lease agreement bears interest
at 8.9% and is payable over 36 to 48 months. The proceeds from the



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lease were used to reduce amounts outstanding under our revolving line of
credit and to fund additional capital expenditures. This lease has been
accounted for as a capital lease.

On April 17, 2001, our Credit Agreement was amended to provide an
additional $600,000 of short term financing to be used to finance construction
of our new Haltom City, Texas facility. The $600,000 note bears interest at
the prime rate and matures October 31, 2001. As of June 30, 2001, $423,000 was
outstanding under this short term financing.

On May 25, 2001, our Credit Agreement was amended to change the revolving
maturity date to May 31, 2002, reduce the interest rate to the banks prime
rate and reduce the commitment fee to 0.1%.

On July 18, 2001, our Credit Agreement was amended to provide an
additional $600,000 of borrowing capacity under the revolving line of credit
and this additional amount matures August 20, 2001. As of June 30, 2001, the
maximum that could be borrowed and the amount outstanding under the amended
Credit Agreement were $5,483,000 and $3,933,000, respectively.

During the process of relocating to Texas, we have incurred significant
costs that have been financed through a combination of internal operations,
increased borrowing under our existing and new credit facilities and a
sale-leaseback transaction. We believe these costs are of a nonrecurring
nature and will be reduced upon the Companys final relocation into our new
Haltom City, Texas building. The Haltom City building construction is
scheduled to be completed during the current years third quarter. As a result
of the restructuring charge and nonrecurring expenses associated with the
relocation to Texas, we were not in compliance with our current ratio, cash
flow, liability, net worth and capital expenditures covenants. We are
currently negotiating waivers of such non compliance with our bank. Accordingly, we have reclassified $875,000 of our term debt with the
bank from long-term debt to current portion of long-term debt on our balance
sheet as of June 30, 2001. We anticipate the existing cash balances, amounts
available under existing and anticipated credit agreements, including
sale-leaseback transactions, dividends from Medscreen, a credit
agreement with Medscreens bank and investor related debt together
with funds to be generated from future operations will be sufficient to fund
operations and forecasted capital expenditures through the foreseeable future.

Impact of Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board issued Statement
No. 142, Goodwill and Other Intangible Assets.Statement No. 142 will require
that goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of Statement No. 142. This Statement will further require
intangible assets with definite useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for
impairment in accordance with Statement of Financial Accounting Standards No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of.Statement No. 142 is effective January 1, 2002.
Upon adoption of Statement No. 142, we will be required to reassess the useful
lives and residual values of all intangible assets acquired in purchase
business combinations and make any necessary amortization period adjustments by
the end of the first interim period after adoption. Any impairment loss will
be measured as of the date of adoption and recognized as the cumulative effect
of a change in accounting principle in the first interim period. On an ongoing
basis, the amortization of goodwill noted in the Statements of Operations will
be eliminated beginning January 1, 2001. At this time, the adoption of the
impairment



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provisions of Statement No. 142 is not expected to have a material effect
on our consolidated financial position or results of operations.

Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk with respect to our debt outstanding and
foreign currency transactions. Our revolving credit agreement and installment
note carry interest at the prime rate plus 0.5%. As the prime rate increases,
we will incur higher relative interest expense and similarly, a decrease in the
prime rate will reduce relative interest expense. Despite recent changes in
the prime rate, a 1.0% change in the prime rate would not materially change
interest expense assuming levels of debt consistent with historical amounts.
Due to our international operations, certain transactions are conducted in
foreign currencies. Medscreens transactions are denominated approximately 84%
in pound sterling and 16% in US currency. During the six month periods ending
June 30, 2001 and 2000, Medscreens net sales represented 16.4% and 16.9%,
respectively, of our total net sales and, as a result, the impact of market
risk on foreign currency transactions is not considered material. These market
risks are not considered significant and, therefore, we do not intend to engage
in significant hedging transactions.




PART II. Other Information




Item 4. Submission of Matters to a Vote of Security Holders



| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | At the Annual Meeting of the Company held on May 15, 2001, the Companys
stockholders
took the following actions:



| | (a) |  | The following directors were elected to serve until the next
Annual Meeting:
Joseph W. Halligan  5,187,258 shares in favor and 1,200 shares withheld;
Richard D. Irwin  5,187,258 shares in favor and 1,200 shares withheld;
and
Donald R. Stroben  5,187,258 shares in favor and 1,200 shares withheld.
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | Ratification of the appointment of KPMG LLP as Independent
Certified Public
Accountants for the Company for the 2001 fiscal year, by a vote of
5,187,258 shares in favor, 500 shares against, 658,852 shares broker
non-vote and 600 shares abstained.                                                     




Item 6. Exhibits and Reports on Form 8-K



| | (a) |  | Exhibits:
| | --- |  | ---------

|        |  |                                                                                                                                           
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|10.41  |  | Modification to Amended and Restated Loan and
Security Agreement between Comerica Bank-California and
PharmChem, Inc dated April 17, 2001.
|       
|       
|       
|       
|10.42  |  | Modification to Amended and Restated Loan and
Security Agreement between Comerica Bank-California and
PharmChem, Inc dated May 25, 2001.  
|       
|       
|       
|       
|10.43  |  | Modification to Amended and Restated Loan and
Security Agreement between                                                                  



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|        |  |                                                                                                                    
|------- |  | -------------------------------------------------------------------------------------------------------------------
|       
|       
|       
|       
|        |  | Comerica Bank-California and PharmChem, Inc dated July 18,
2001.                                                   
|       
|       
|       
|       
|10.44  |  | Lease Agreement for the Companys offices in
Haltom City, Texas dated February 16, 2001 and effective July
1, 2001.



| | (b) |  | Reports on Form 8-K:
| | --- |  | --------------------



| |                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On June 1, 2001, our Board of Directors elected Steven Schorr to
the Companys Board of Directors to hold office until the next
annual meeting of stockholders. Mr. Schorr was also appointed to
serve as a member and chair of the Companys Audit Committee.




Signature

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.

|                      |                                                                                                                                        |                       
|--------------------- | -------------------------------------------------------------------------------------------------------------------------------------- | ----------------------
|                      | PharmChem, Inc.
(Registrant)                                                                                                          
|                     
|Date: August 14, 2001 | By:                                                                                                                                    | /S/ DAVID A. LATTANZIO
|                      |                                                                                                                                       
|                      | David A. Lattanzio
Chief Financial Officer and Vice President,
Finance and Administration
(Principal Financial and Accounting Officer)



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EXHIBIT INDEX

|        |  |                                                                                                                                           
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|10.41  |  | Modification to Amended and Restated Loan and
Security Agreement between Comerica Bank-California and
PharmChem, Inc dated April 17, 2001.
|       
|       
|       
|       
|10.42  |  | Modification to Amended and Restated Loan and
Security Agreement between Comerica Bank-California and
PharmChem, Inc dated May 25, 2001.  
|       
|       
|       
|       
|10.43  |  | Modification to Amended and Restated Loan and
Security Agreement between
Comerica Bank-California and PharmChem, Inc dated July 18,
2001. 
|       
|       
|       
|       
|10.44  |  | Lease Agreement for the Companys offices in
Haltom City, Texas dated February 16, 2001 and effective July
1, 2001.