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SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549




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FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2003

OR

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|o |  | 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

(PHARMCHEM LOGO)

(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 North 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   þ   No   o

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.)   Yes   o   No   þ

As of July 31, 2003, 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
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                              | Item 4. Controls and Procedures                                                              
|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 10.38                
|EXHIBIT 10.39                
|EXHIBIT 10.40                
|EXHIBIT 10.41                
|EXHIBIT 10.42                
|EXHIBIT 10.43                
|EXHIBIT 10.44                
|EXHIBIT 10.45                
|EXHIBIT 31.1                 
|EXHIBIT 31.2                 
|EXHIBIT 32.1                 
|EXHIBIT 32.2                 



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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) atJune 30, 2003 and December 31, 2002                                               |  |  | 4  |     
|          |  | Condensed
Consolidated Statements of Operations (unaudited) for theThree and Six Months ended June 30, 2003 and 2002                  |  |  | 5  |     
|          |  | Condensed
Consolidated Statements of Comprehensive Income (Loss)(unaudited) for the Three and Six Months ended June 30, 2003 and 2002 |  |  | 6  |     
|          |  | Condensed
Consolidated Statements of Cash Flows (unaudited)for the Three and Six Months ended June 30, 2003 and 2002                  |  |  | 7  |     
|          |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                      |  |  | 8  |     
|Item 2    |  | Management's
Discussion and Analysis of Financial Conditionand Results of Operations                                                  |  |  | 12 |     
|Item 3    |  | Quantitative and Qualitative Disclosures About Market Risk                                                                            |  |  | 18 |     
|Item 4    |  | Controls and Procedures                                                                                                               |  |  | 18 |     
|Part II   |  | Other Information                                                                                                                     |  |  |    |     
|Item 4    |  | Submission of Matters to a Vote of Security Holders                                                                                   |  |  | 18 |     
|Item 6    |  | Exhibits and Reports on Form 8-K                                                                                                      |  |  | 19 |     
|Signature |  |                                                                                                                                       |  |  |    |      | 20 | 

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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, 2002 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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PHARMCHEM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except par value)

|                                           |                                                                                                                                      |                            |        |          |        |              |        |        |        | 
|------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------ | -------- | ------ | ------------ | ------ | ------ | ------ | 
|                                           |                                                                                                                                      |                            |        | June 30, |        | December 31,
|                                           |                                                                                                                                      |                            |        | 2003     |        | 2002        
|                                           |                                                                                                                                      |                            |        |          |        |             
|ASSETS                                    
|CURRENT ASSETS:                            |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           | Cash and cash equivalents                                                                                                            |                            | $      | 2,426    |        |              | $      | 4,213  |       
|                                           | Accounts receivable, net of allowance for doubtful
accounts of $246 and $197                                                         |                            |        | 3,851    |        |              |        | 3,792  |       
|                                           | Inventories                                                                                                                          |                            |        | 1,055    |        |              |        | 1,318  |       
|                                           | Prepaid expenses                                                                                                                     |                            |        | 505      |        |              |        | 501    |       
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           |                                                                                                                                      | TOTAL CURRENT ASSETS       |        |          | 7,837  |              |        |        | 9,824  | 
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|PROPERTY AND EQUIPMENT, net                |                                                                                                                                      |                            | 11,246 |          |        |              | 12,074 |       
|OTHER ASSETS                               |                                                                                                                                      |                            | 39     |          |        |              | 40     |       
|GOODWILL, net of amortization of $1,892    |                                                                                                                                      |                            | 729    |          |        |              | 729    |       
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           |                                                                                                                                      | TOTAL ASSETS               |        | $        | 19,851 |              |        | $      | 22,667 | 
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|LIABILITIES AND STOCKHOLDERS EQUITY      
|CURRENT LIABILITIES:                       |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           | Revolving line of credit                                                                                                             |                            | $      |         |        |              | $      | 3,334  |       
|                                           | Current portion of long-term debt                                                                                                    |                            |        | 1,879    |        |              |        | 2,388  |       
|                                           | Accounts payable                                                                                                                     |                            |        | 2,153    |        |              |        | 2,918  |       
|                                           | Accrued compensation                                                                                                                 |                            |        | 593      |        |              |        | 837    |       
|                                           | Accrued collectors and other liabilities                                                                                             |                            |        | 2,529    |        |              |        | 2,017  |       
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           |                                                                                                                                      | TOTAL CURRENT LIABILITIES  |        |          | 7,154  |              |        |        | 11,494 | 
|LONG-TERM DEBT, net of current portion     |                                                                                                                                      |                            | 3,626  |          |        |              | 814    |       
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           |                                                                                                                                      | TOTAL LIABILITIES          |        |          | 10,780 |              |        |        | 12,308 | 
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|STOCKHOLDERS EQUITY:                      |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           | Common stock, $0.001 par value, 25,000 shares authorized,
5,853 shares issued and outstanding at June 30, 2003 and
December 31, 2002 |                            |        | 6        |        |              |        | 6      |       
|                                           | Additional paid-in capital                                                                                                           |                            |        | 19,589   |        |              |        | 19,589 |       
|                                           | Accumulated deficit                                                                                                                  |                            |        | (10,524  | )      |              |        | (9,236 | )     
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|                                           |                                                                                                                                      | TOTAL STOCKHOLDERS EQUITY |        |          | 9,071  |              |        |        | 10,359 | 
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                                                      | $                          | 19,851 |          |        | $            | 22,667 |       
|                                           |                                                                                                                                      |                            |        |          |        |              |        |       

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,        
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                 
|                                                    |                                                                             |                          |                       |       |       |       |       | 2003               |       | 2002             |        | 2003  |       | 2002 
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |      
|NET SALES                                           |                                                                             | $                        | 7,114                 |       |       | $     | 8,066 |                    |       | $                | 13,449 |       |       | $     | 15,542 |      
|COST OF SALES                                       |                                                                             |                          | 5,545                 |       |       |       | 6,249 |                    |       |                  | 10,670 |       |       |       | 11,917 |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|GROSS PROFIT                                        |                                                                             |                          | 1,569                 |       |       |       | 1,817 |                    |       |                  | 2,779  |       |       |       | 3,625  |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|OPERATING EXPENSES:                                 |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|                                                    | Selling, general and administrative                                         |                          |                       | 1,984 |       |       |       | 1,933              |       |                  |        | 3,782 |       |       |        | 3,946 |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|                                                    |                                                                             | Total operating expenses |                       |       | 1,984 |       |       |                    | 1,933 |                  |        |       | 3,782 |       |        |       | 3,946 |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|LOSS FROM OPERATIONS                                |                                                                             |                          | (415                  | )     |       |       | (116  | )                  |       |                  | (1,003 | )     |       |       | (321   | )    
|Interest expense                                    |                                                                             |                          | 143                   |       |       |       | 177   |                    |       |                  | 303    |       |       |       | 339    |      
|Other income                                        |                                                                             |                          | (3                    | )     |       |       | (98   | )                  |       |                  | (18    | )     |       |       | (73    | )    
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|                                                    |                                                                             |                          | 140                   |       |       |       | 79    |                    |       |                  | 285    |       |       |       | 266    |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|LOSS FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES |                                                                             |                          | (555                  | )     |       |       | (195  | )                  |       |                  | (1,288 | )     |       |       | (587   | )    
|PROVISION FOR (BENEFIT FROM) INCOME TAXES           |                                                                             |                          |                      |       |       |       | 13    |                    |       |                  |       |       |       |       | (69    | )    
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|LOSS FROM CONTINUING OPERATIONS                     |                                                                             |                          | (555                  | )     |       |       | (208  | )                  |       |                  | (1,288 | )     |       |       | (518   | )    
|DISCONTINUED OPERATIONS:                            |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|                                                    | Income from discontinued operations, net of applicable
income taxes of $184 |                          |                       |      |       |       |       |                   |       |                  |        |      |       |       |        | 359   |      
|                                                    | Gain on disposition, net of applicable income taxes of
$1,116               |                          |                       |      |       |       |       |                   |       |                  |        |      |       |       |        | 4,277 |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|NET INCOME (LOSS)                                   |                                                                             | $                        | (555                  | )     |       | $     | (208  | )                  |       | $                | (1,288 | )     |       | $     | 4,118  |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|NET INCOME (LOSS) PER COMMON SHARE:                 |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|                                                    | BASIC:                                                                      |                          | Continuing operations |       | $     | (0.09 | )     |                    | $     | (0.04            | )      |       | $     | (0.22 | )      |       | $     | (0.09 | )
|                                                    |                                                                             | Discontinued operations  |                       |       |      |       |       |                    |      |                  |        |       |      |       |        |       | 0.79  |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |       |       |       |   | 
|                                                    |                                                                             | Net income (loss)        |                       | $     | (0.09 | )     |       | $                  | (0.04 | )                |        | $     | (0.22 | )     |        | $     | 0.70  |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |       |       |       |   | 
|                                                    | DILUTED:                                                                    |                          | Continuing operations |       | $     | (0.09 | )     |                    | $     | (0.04            | )      |       | $     | (0.22 | )      |       | $     | (0.09 | )
|                                                    |                                                                             | Discontinued operations  |                       |       |      |       |       |                    |      |                  |        |       |      |       |        |       | 0.79  |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |       |       |       |   | 
|                                                    |                                                                             | Net income (loss)        |                       | $     | (0.09 | )     |       | $                  | (0.04 | )                |        | $     | (0.22 | )     |        | $     | 0.70  |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|WEIGHTED AVERAGE SHARES OUTSTANDING:                |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|                                                    | BASIC                                                                       |                          |                       | 5,853 |       |       |       | 5,853              |       |                  |        | 5,853 |       |       |        | 5,853 |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      
|                                                    | DILUTED                                                                     |                          |                       | 5,853 |       |       |       | 5,853              |       |                  |        | 5,853 |       |       |        | 5,853 |      
|                                                    |                                                                             |                          |                       |       |       |       |       |                    |       |                  |        |       |       |       |        |      



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,        
|                                   |                                                                                                |   |                    |   |                 
|                                   |                                                                                                |   | 2003               |   | 2002             |   | 2003 |   | 2002
|                                   |                                                                                                |   |                    |   |                  |   |      |   |     
|NET INCOME (LOSS)                  |                                                                                                | $ | (555               | ) |                  | $ | (208 | ) |      | $ | (1,288 | ) |  | $ | 4,118 |    
|OTHER COMPREHENSIVE INCOME (LOSS): |                                                                                                |   |                    |   |                  |   |      |   |      |   |        |   |  |   |       |    
|                                   | Foreign currency translation                                                                   |   |                    |  |                  |   |      |  |      |   |        |  |  |   |       | (53 | )
|                                   | Reclassification adjustment for realized foreign
currency exchange loss included in net income |   |                    |  |                  |   |      |  |      |   |        |  |  |   |       | 332 |  
|                                   |                                                                                                |   |                   |   |                  |   |     |   |      |   |       |   |  |   | 279   |    
|                                   |                                                                                                |   |                    |   |                  |   |      |   |      |   |        |   |  |   |       |    
|COMPREHENSIVE INCOME (LOSS)        |                                                                                                | $ | (555               | ) |                  | $ | (208 | ) |      | $ | (1,288 | ) |  | $ | 4,397 |    
|                                   |                                                                                                |   |                    |   |                  |   |      |   |      |   |        |   |  |   |       |    

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)                                          |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      | Six Months Ended
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      | June 30,        
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                 
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      | 2003             |        | 2002 
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|CASH FLOWS FROM OPERATING ACTIVITIES                 |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     | Net income (loss)                                                                                  |                                                           | $                                                     | (1,288                                                                       | )    |                  | $      | 4,118 |       
|                                                     | Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities: |                                                           |                                                       |                                                                              |      |                  |        |       |       
|                                                     |                                                                                                    |                                                           | Income from discontinued operations                   |                                                                              |      |                 |        |       |        | (359   | )     
|                                                     |                                                                                                    |                                                           | Depreciation and amortization                         |                                                                              |      | 1,091            |        |       |        | 1,121  |       
|                                                     |                                                                                                    |                                                           | Bad debt expense                                      |                                                                              |      | 55               |        |       |        | 35     |       
|                                                     |                                                                                                    |                                                           | Gain on sale of disposition of subsidiary, net of tax |                                                                              |      |                 |        |       |        | (4,277 | )     
|                                                     |                                                                                                    |                                                           | Amortization of discount on subordinated debt         |                                                                              |      | 86               |        |       |        | 86     |       
|                                                     | Changes in operating assets and liabilities:                                                       |                                                           |                                                       |                                                                              |      |                  |        |       |       
|                                                     |                                                                                                    |                                                           | Accounts receivable                                   |                                                                              |      | (114             | )      |       |        | 553    |       
|                                                     |                                                                                                    |                                                           | Inventory                                             |                                                                              |      | 263              |        |       |        | 555    |       
|                                                     |                                                                                                    |                                                           | Prepaids and other current assets                     |                                                                              |      | (4               | )      |       |        | 91     |       
|                                                     |                                                                                                    |                                                           | Other assets                                          |                                                                              |      | 1                |        |       |        | (2     | )     
|                                                     |                                                                                                    |                                                           | Accounts payable and other accrued liabilities        |                                                                              |      | (497             | )      |       |        | (1,674 | )     
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    |                                                           |                                                       | Net cash provided by (used in) operating activities of continuing
operations |      |                  | (407   | )     |        |        | 247    |  
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    |                                                           |                                                       | Net cash provided by operating activities of discontinued operations         |      |                  |       |       |        |        | 161    |  
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|CASH FLOWS FROM INVESTING ACTIVITIES                 |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    | Purchases of property and equipment                       |                                                       |                                                                              | (267 | )                |        |       | (836   | )     
|                                                     |                                                                                                    | Proceeds from sale of property and equipment              |                                                       |                                                                              | 4    |                  |        |       |       |       
|                                                     |                                                                                                    | Proceeds from sale of discontinued operations             |                                                       |                                                                              |     |                  |        |       | 10,000 |       
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    |                                                           |                                                       | Net cash provided by (used in) investing activities of continuing
operations |      |                  | (263   | )     |        |        | 9,164  |  
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    |                                                           |                                                       | Net cash used in investing activities of discontinued operations             |      |                  |       |       |        |        | (40    | )
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|CASH FLOWS FROM FINANCING ACTIVITIES                 |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    | Principal payments on long-term debt                      |                                                       |                                                                              | (610 | )                |        |       | (1,994 | )     
|                                                     |                                                                                                    | Repayments on revolving line of credit, net of borrowings |                                                       |                                                                              | (507 | )                |        |       | (663   | )     
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    |                                                           |                                                       | Net cash used in financing activities of continuing operations               |      |                  | (1,117 | )     |        |        | (2,657 | )
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|                                                     |                                                                                                    |                                                           |                                                       | Net cash used in financing activities of discontinued operations             |      |                  |       |       |        |        | (1,987 | )
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |                                                                                                    |                                                           | (1,787                                                | )                                                                            |      |                  | 4,888  |      
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD     |                                                                                                    |                                                           | 4,213                                                 |                                                                              |      |                  | 197    |      
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      
|CASH AND CASH EQUIVALENTS AT END OF PERIOD           |                                                                                                    | $                                                         | 2,426                                                 |                                                                              |      | $                | 5,085  |      
|                                                     |                                                                                                    |                                                           |                                                       |                                                                              |      |                  |        |      

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. Summary of Significant Accounting Policies

Basis of Presentation, General and Business

PharmChem, Inc. is a leading independent laboratory that provides
integrated drug testing services. Our customers include private and public
employers, criminal justice agencies and drug treatment programs in the United
States who seek to detect and deter the use of illegal drugs and alcohol. The
consolidated financial statements include the accounts of PharmChem and
Medscreen Limited (Medscreen), a United Kingdom company. Medscreen was sold
on March 25, 2002 and, as a result, is presented as discontinued operations in
the accompanying financial statements for all periods presented. Medscreens
financial statements were translated based on the month-end spot rate for the
balance sheets and a weighted average of the spot rates for the statements of
operations.

The accompanying condensed consolidated financial statements are prepared
in accordance with the instructions to Form 10-Q, are unaudited and do not
include all the information and disclosures required by accounting principles
generally accepted in the United States of America for complete financial
statements. We have made certain reclassifications to prior year amounts to
conform to current year presentation. All adjustments that, in the opinion of
management, are necessary for a fair presentation of the results of operations
for the interim periods have been made and are of a recurring nature unless
otherwise disclosed herein. The results of operations for such interim periods
are not necessarily indicative of results of operations for a full year.

In the first quarter of 2002, we implemented Financial Accounting
Standards Board Statement No. 142 (SFAS 142), Goodwill and Other Intangible
Assets.SFAS 142 requires 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 SFAS 142. This Statement further
requires intangible assets with definite useful lives to be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets.As permitted by SFAS 142, we
implemented the impairment provisions in the second quarter of 2002. On an
ongoing basis, the amortization of goodwill noted in the Condensed Consolidated
Statements of Operations was eliminated beginning January 1, 2002.

Stock Based-Compensation

In December 2002, the Financial Accounting Standards Board issued SFAS No.
148, Accounting for Stock-Based Compensation  Transition and
Disclosure  an
amendment of SFAS No. 123.This statement amends SFAS No. 123, Accounting for
Stock-Based Compensation,to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of

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accounting for stock-based employee compensation and the effect of the method
used on reported results. We continue to account for stock-based compensation
using Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees,and have not adopted the recognition provisions of SFAS
No. 123, as amended by SFAS No. 148. However, we have adopted the disclosure
provisions for the current fiscal year. The exercise price of options granted
under our stock option plans is equal to the market price of our stock on the
date of grant. Therefore, we have not recorded compensation cost under APB No.
25.

We continue to apply APB No. 25 in accounting for our stock-based
compensation plans. Accordingly, no compensation cost has been recorded in the
consolidated statements of operations for the stock option plans. If we had
determined compensation cost for all of our stock based compensation plans in
accordance with the fair value method prescribed by SFAS No. 123, our proforma
net income (loss) and income (loss) per share for the three months and six
months ended June 30 would have been as follows (in thousands, except per share
amounts):

|                                                                      |  |                           |       |                         |  |      |       |      |  |   |        |   |  |   |       |  
|--------------------------------------------------------------------- |  | ------------------------- | ----- | ----------------------- |  | ---- | ----- | ---- |  | - | ------ | - |  | - | ----- | -
|                                                                      |  | Three Mos. Ended June 30, |       | Six Mos. Ended June 30,
|                                                                      |  |                           |       |                        
|                                                                      |  | 2003                      |       | 2002                    |  | 2003 |       | 2002
|                                                                      |  |                           |       |                         |  |      |       |     
|Net income (loss), as reported                                        |  | $                         | (555  | )                       |  | $    | (208  | )    |  | $ | (1,288 | ) |  | $ | 4,118 |  
|Stock-based employee compensation expense,
net of related tax effects |  |                           | (33   | )                       |  |      | (40   | )    |  |   | (67    | ) |  |   | (68   | )
|                                                                      |  |                           |       |                         |  |      |       |      |  |   |        |   |  |   |       |  
|Net income (loss), pro forma                                          |  | $                         | (588  | )                       |  | $    | (248  | )    |  | $ | (1,355 | ) |  | $ | 4,050 |  
|                                                                      |  |                           |       |                         |  |      |       |      |  |   |        |   |  |   |       |  
|Basic income (loss) per share, as reported                            |  | $                         | (0.09 | )                       |  | $    | (0.04 | )    |  | $ | (0.22  | ) |  | $ | 0.70  |  
|                                                                      |  |                           |       |                         |  |      |       |      |  |   |        |   |  |   |       |  
|Basic income (loss) per share, pro forma                              |  | $                         | (0.10 | )                       |  | $    | (0.05 | )    |  | $ | (0.23  | ) |  | $ | 0.69  |  
|                                                                      |  |                           |       |                         |  |      |       |      |  |   |        |   |  |   |       |  
|Diluted income (loss) per share, as reported                          |  | $                         | (0.09 | )                       |  | $    | (0.04 | )    |  | $ | (0.22  | ) |  | $ | 0.70  |  
|                                                                      |  |                           |       |                         |  |      |       |      |  |   |        |   |  |   |       |  
|Diluted income (loss) per share, pro forma                            |  | $                         | (0.10 | )                       |  | $    | (0.05 | )    |  | $ | (0.23  | ) |  | $ | 0.69  |  
|                                                                      |  |                           |       |                         |  |      |       |      |  |   |        |   |  |   |       |  

2. Discontinued Operations

On March 25, 2002, we completed the sale of Medscreen for approximately
$10.0 million. In connection with the sale, Medscreens two loan facilities
totaling approximately $1,663,000 were fully repaid. Closing and other
settlement costs totaled approximately $324,000 and approximately $929,000 was
used to repay a portion of our revolving line of credit. The remainder of the
proceeds have been and will be used for general corporate purposes.

Net sales of the discontinued operations were $1,949,000 for the six
months ended June 30, 2002. We recorded a gain on the sale of Medscreen of
$0.73 per share.

3. Net Income (Loss) per Share

We compute and disclose our income (loss) per share in accordance with
Statement of Financial Accounting Standards No. 128, Earnings Per Share,which
requires the presentation of basic and diluted income per share. Basic income
(loss) per share is calculated using the weighted average number of common
shares outstanding during the period. Diluted income 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 warrants
and are calculated using the treasury stock method.

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Options and warrants to purchase 1,150,000 and 1,190,000 shares of our
common stock for the three months ended June 30, 2003 and 2002, respectively,
and 1,150,000 and 1,190,000 shares for the six months ended June 30, 2003 and
2002, respectively, were not included in the computation of diluted income per
share because their effect would have been anti-dilutive.

4. Inventories

Inventories include laboratory materials, collection materials and
products and are 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. Inventories consisted of the following at June 30,
2003 and December 31, 2002 (in thousands):

|                     |  |      |       |      |  |   |       | 
|-------------------- |  | ---- | ----- | ---- |  | - | ----- | 
|                     |  | 2003 |       | 2002
|                     |  |      |       |     
|Laboratory
materials |  | $    | 147   |      |  | $ | 225   | 
|Collection
materials |  |      | 542   |      |  |   | 542   | 
|Products             |  |      | 366   |      |  |   | 551   | 
|                     |  |      |       |      |  |   |       | 
|                     |  | $    | 1,055 |      |  | $ | 1,318 | 
|                     |  |      |       |      |  |   |       | 

5. Debt

Our debt at June 30, 2003 and December 31, 2002 consisted of the following
(in thousands):

|                                                                                                                                                                                              |  |      |        |      |  |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | -
|                                                                                                                                                                                              |  | 2003 |        | 2002
|                                                                                                                                                                                              |  |      |        |     
|Revolving line of credit                                                                                                                                                                      |  | $    | 2,827  |      |  | $ | 3,334  |  
|Subordinated debt, net of discount of $43 and $129 at June 30,
2003
and December 31, 2002, respectively (paid July 2, 2003)                                                                   |  |      | 1,457  |      |  |   | 1,371  |  
|Obligations under capitalized leases, due in monthly installments
through 2005, secured by laboratory equipment, office
equipment
and computer software, interest rates ranging from 8% to 9% |  |      | 1,221  |      |  |   | 1,831  |  
|                                                                                                                                                                                              |  |      |        |      |  |   |        |  
|                                                                                                                                                                                              |  |      | 5,505  |      |  |   | 6,536  |  
|Less: current portion and revolving line of credit                                                                                                                                            |  |      | (5,106 | )    |  |   | (5,722 | )
|                                                                                                                                                                                              |  |      |        |      |  |   |        |  
|                                                                                                                                                                                              |  |      | 399    |      |  |   | 814    |  
|Add: Debt reclassified to long-term pursuant to new borrowings
funded in July, 2003                                                                                                           |  |      | 3,227  |      |  |   |       |  
|                                                                                                                                                                                              |  |      |        |      |  |   |        |  
|Long-term portion                                                                                                                                                                             |  | $    | 3,626  |      |  | $ | 814    |  
|                                                                                                                                                                                              |  |      |        |      |  |   |        |  

On June 26, 2003, the Company entered into a Loan and Security Agreement
(the Agreement) with a new lender replacing its existing credit agreement.
The new Agreement provides for a revolving line of credit of $3,500,000,
permits borrowing at 80% of eligible receivables, has a term of three years,
bears interest at prime plus 1% (5.0% as of June 30, 2003), has a one-time
commitment fee of $10,000, a monthly collateral monitoring fee of $1,000, an
unused line fee of 0.50% per annum, and requires the Company to maintain
certain financial ratios. In addition, the Agreement provides for a term loan
of up to $1,500,000 which bears interest at prime plus 3% (7.0% as of June 30,
2003), has a one-time

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commitment fee of $15,000 and is repayable monthly over 36 months; the initial
draw down under this term loan facility was $900,000. These facilities funded
on July 2, 2003 at which time our prior credit facility was fully paid and
terminated. The remaining $600,000 balance of the term loan, if drawn, must be
drawn within ninety days from the date of the loan agreement.

The new Agreement is secured by a lien on a significant portion of our
assets and permits up to $1,500,000 of the revolving line of credit to be used
to repurchase our common stock under our common stock repurchase program and
permits the declaration and distribution of a dividend in connection with our
stockholder rights plan. Should the revolving line of credit be paid off prior
to the end of the term, there would be a prepayment penalty of $35,000.

As of June 30, 2003, the calculated maximum that could be borrowed and the
amount outstanding were $3,319,000 and $2,827,000, respectively.

On June 30, 2003, the Companys subordinated debt holders agreed to an
early payoff of the subordinated debt at a 50% discount. The subordinated
debt, as discounted, was repaid from proceeds of the term loan facility. The
Company agreed to a reduction in the exercise price of the 150,000 warrants
held by the subordinated debt holders from $3.00 to $0.29 (the average of the
closing prices for the 30 days ending June 26, 2003). The warrants continue to
expire on September 30, 2006.

As a result of the foregoing, the Company will report a gain on the early
extinguishment of debt in the third quarter of approximately $665,000 which
includes reductions for the unamortized discount (established when the
subordinated debt was issued) and the fair value of re-pricing the warrants.

6. Restructuring Charge

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

|                               |       |   |                   |     |          |   |               |    |         |   |     |     | 
|------------------------------ | ----- | - | ----------------- | --- | -------- | - | ------------- | -- | ------- | - | --- | --- | 
|                               |       |   | Accrual           |     |          |   |               |    | Accrual
|                               |       |   | As of             |     | 2003     |   | As of        
|                               |       |   | December 31, 2002 |     | Payments |   | June 30, 2003
|                               |       |   |                   |     |          |   |              
|Severance and related benefits |       | $ | 26                |     |          | $ | (4            | )  |         | $ | 22  |    
|Clean-up and remediation       |       |   | 171               |     |          |   |              |    |         |   | 171 |    
|Repairs                        |       |   | 9                 |     |          |   |              |    |         |   | 9   |    
|Legal and other                |       |   | 28                |     |          |   | (3            | )  |         |   | 25  |    
|                               |       |   |                   |     |          |   |               |    |         |   |     |    
|                               | Total |   | $                 | 234 |          |   | $             | (7 | )       |   | $   | 227 | 
|                               |       |   |                   |     |          |   |               |    |         |   |     |    

The restructuring plan was designed to provide for costs associated with
leaving our facilities in Menlo Park, California. 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

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and administration, of which 157 employees were terminated as of June 30, 2003.
The clean-up and remediation includes removal of a previously unknown storage
vault and potential restoration of the facility per the lease agreement.
Repairs includes sewer line repair or replacement as contractually provided for
in the lease agreement. In addition, we expect to continue to incur legal and
other fees related to interpretation of the leases contractual obligations.
The accrual balance of $227,000 is classified as a component in Accrued
collectors and other liabilities on the balance sheet. Costs for relocation
were expensed as incurred.

On September 19, 2002, the Companys attorneys received a letter from
counsel for the landlord of the Companys former Menlo Park, California
facility claiming damages in the amount of $4.7 million. This amount is based
primarily on the landlords claim for lost and reduced rent arising from the
Companys alleged failure to vacate the Menlo Park premises timely under the
terms of the lease. On April 30, 2003, the Companys attorneys received a
second letter together with a draft complaint from the landlords counsel
reiterating these allegations and requesting that the parties meet and confer
to resolve the matter; otherwise the complaint will be filed. On May 14, 2003,
the Companys attorneys met with the landlords counsel. Further discussions
will be held during which time the complaint will not be filed. The Company
and its counsel are continuing to review the details of this claim and the
Company will defend itself vigorously.




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, 2002. We assume no obligation to
update the forward-looking statements or such factors.

Recent Events

See Note 5, (Debt) to the Notes to Condensed Consolidated Financial
Statements for information regarding a Loan and Security Agreement entered into
on June 26, 2003 between the Company and a new lender.

On July 11, 2003, the Company received a Nasdaq Staff Determination Letter
stating that it had evidenced compliance with the $1 million minimum market
value requirement for its publicly held shares (MVPHS) as required by
Marketplace Rule 4310(c)(7) for continued listing on the Nasdaq SmallCap
Market. However, the Company is no longer in compliance with the $1 minimum bid
price requirement as set forth in Marketplace Rule 4310(c)(4). The Company had
previously been provided until July 7, 2003 to regain compliance with this
rule.

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The Company appeared at a hearing (the request for which stays the
delisting of the Companys securities) on July 17, 2003 before a Nasdaq Listing
Qualification Panel (the Panel), to review the Staff Determination. The
panel is expected to report its findings shortly; however, there can be no
assurance the Panel will grant the Companys request for continued listing on
the Nasdaq SmallCap Market.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of
operations are based upon PharmChems consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate these estimates,
including those related to bad debts, inventories, goodwill, restructuring
accruals, contingencies, revenue recognition, specimen collector accruals and
litigation. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.

PharmChem believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of the
consolidated financial statements. We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. We estimate the quantity and value of
our unused specimen collection kit inventory existing at our customer and
contract specimen collector field locations using a model that considers actual
shipments to these locations, specimens returned to our laboratory for
processing, replacement costs and estimates of shrinkage. If the estimated
value of this inventory decreases beyond our expectations of recovery,
additional inventory write-downs may be required.

Continued adverse changes in market conditions or poor operating results
of our operations could result in additional losses or an inability to recover
the carrying value of the related goodwill, thereby possibly requiring an
impairment charge in the future. Revenue is recognized upon the communication
of results from laboratory analysis of specimens submitted by our customers, at
the time of shipment for products and at the completion of rendered services.
We accrue expected payments to specimen collectors who perform specimen
collection services on behalf of our managed customers. The specimen collector
accrual calculation is based on a combination of our reporting of results from
laboratory analysis of specimens and cost information maintained in our
internal systems for each specimen collector. We include in the accrual
estimates of retroactive rate increases and services performed but not reported
to customers.

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Results of Operations

Refer to Note 2, Discontinued Operations, to the accompanying Notes to
Condensed Consolidated Financial Statements for further information on the sale
of Medscreen in March 2002. 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,
|                                          |                                                                     |                          |       |                             |       |                          
|                                          |                                                                     |                          |       | 2003                        |       | 2002                      |       | 2003  |       | 2002 |      | 2003                  |       | 2002 |      | 2003 |       | 2002
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |     
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      | (As a % of net sales) |       |      |      |      |       |      |        |       |        | (As a % of net sales)
|NET SALES:                                |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|                                          | Workplace employers analysis                                        |                          | $     | 2,018                       |       |                           | $     | 2,473 |       |      |      | 28.4                  | %     |      |      | 30.7 | %     |      | $      | 3,722 |        |                       | $      | 4,713 |        |  |      | 27.7 | %     |  |      | 30.3 | %    
|                                          | Criminal justice agencies analysis                                  |                          |       | 3,352                       |       |                           |       | 3,844 |       |      |      | 47.1                  |       |      |      | 47.6 |       |      |        | 6,624 |        |                       |        | 7,732 |        |  |      | 49.2 |       |  |      | 49.7 |      
|                                          | Other analysis                                                      |                          |       | 89                          |       |                           |       | 45    |       |      |      | 1.2                   |       |      |      | 0.6  |       |      |        | 170   |        |                       |        | 90    |        |  |      | 1.3  |       |  |      | 0.6  |      
|                                          | Products and other                                                  |                          |       | 1,655                       |       |                           |       | 1,704 |       |      |      | 23.3                  |       |      |      | 21.1 |       |      |        | 2,933 |        |                       |        | 3,007 |        |  |      | 21.8 |       |  |      | 19.4 |      
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|                                          |                                                                     | Total net sales          |       |                             | 7,114 |                           |       |       | 8,066 |      |      |                       | 100.0 |      |      |      | 100.0 |      |        |       | 13,449 |                       |        |       | 15,542 |  |      |      | 100.0 |  |      |      | 100.0 | 
|COST OF SALES                             |                                                                     |                          | 5,545 |                             |       |                           | 6,249 |       |       |      | 77.9 |                       |       |      | 77.5 |      |       |      | 10,670 |       |        |                       | 11,917 |       |        |  | 79.3 |      |       |  | 76.7 |     
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|GROSS PROFIT                              |                                                                     |                          | 1,569 |                             |       |                           | 1,817 |       |       |      | 22.1 |                       |       |      | 22.5 |      |       |      | 2,779  |       |        |                       | 3,625  |       |        |  | 20.7 |      |       |  | 23.3 |     
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|OPERATING EXPENSES:                       |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|                                          | Selling, general and administrative                                 |                          |       | 1,984                       |       |                           |       | 1,933 |       |      |      | 27.9                  |       |      |      | 24.0 |       |      |        | 3,782 |        |                       |        | 3,946 |        |  |      | 28.1 |       |  |      | 25.4 |      
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|                                          |                                                                     | Total operating expenses |       |                             | 1,984 |                           |       |       | 1,933 |      |      |                       | 27.9  |      |      |      | 24.0  |      |        |       | 3,782  |                       |        |       | 3,946  |  |      |      | 28.1  |  |      |      | 25.4  | 
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|LOSS FROM OPERATIONS                      |                                                                     |                          | (415  | )                           |       |                           | (116  | )     |       |      | (5.8 | )                     |       |      | (1.5 | )    |       |      | (1,003 | )     |        |                       | (321   | )     |        |  | (7.4 | )    |       |  | (2.1 | )   
|OTHER EXPENSE, net                        |                                                                     |                          | 140   |                             |       |                           | 79    |       |       |      | 2.0  |                       |       |      | 1.0  |      |       |      | 285    |       |        |                       | 266    |       |        |  | 2.1  |      |       |  | 1.7  |     
|PROVISION FOR (BENEFIT FROM)
INCOME TAXES |                                                                     |                          |      |                             |       |                           | 13    |       |       |      |     |                       |       |      | 0.2  |      |       |      |       |       |        |                       | (69    | )     |        |  |     |      |       |  | (0.4 | )   
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|LOSS FROM CONTINUING OPERATIONS           |                                                                     |                          | (555  | )                           |       |                           | (208  | )     |       |      | (7.8 | )                     |       |      | (2.7 | )    |       |      | (1,288 | )     |        |                       | (518   | )     |        |  | (9.5 | )    |       |  | (3.4 | )   
|DISCONTINUED OPERATIONS:                  |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|                                          | Income from discontinued operations,
net of applicable income taxes |                          |       |                            |       |                           |       |      |       |      |      |                      |       |      |      |     |       |      |        |      |        |                       |        | 359   |        |  |      |     |       |  |      | 2.3  |      
|                                          | Gain on sale of disposition, net of
applicable income taxes         |                          |       |                            |       |                           |       |      |       |      |      |                      |       |      |      |     |       |      |        |      |        |                       |        | 4,277 |        |  |      |     |       |  |      | 27.5 |      
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     
|NET INCOME (LOSS)                         |                                                                     | $                        | (555  | )                           |       | $                         | (208  | )     |       |      | (7.8 | )%                    |       |      | (2.7 | )%   |       | $    | (1,288 | )     |        | $                     | 4,118  |       |        |  | (9.5 | )%   |       |  | 26.4 | %   
|                                          |                                                                     |                          |       |                             |       |                           |       |       |       |      |      |                       |       |      |      |      |       |      |        |       |        |                       |        |       |        |  |      |      |       |  |      |     

Second Quarter 2003 vs. 2002

Net salesfor the three months ended June 30, 2003 were $7,114,000, a
decrease of 11.8% from last years second quarter sales of $8,066,000. While
the overall volume of laboratory specimen analysis was down by 19.0%, revenue
was down only 11.8%. Average selling prices of laboratory analysis rose 5.9%
in the current quarter, a function of customer and service mix, as there have
been no significant price increases in 2003. The continued weakness in the
economy is still having an adverse impact on pre-employment testing by
workplace customers. More customers are implementing stringent cost controls
and performing less drug testing and criminal justice agencies are performing
more in-house testing with external confirmation by laboratories. In addition,
presumptive positive test rates of criminal justice customers are increasing,
causing more higher priced confirmation tests which is contributing to the
higher average price per specimen. Sales of products and other services were
lower by only 2.9%, confirming a shift toward in-house testing.

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Cost of salesfor the three months ended June 30, 2003 were $5,545,000
(77.9% of net sales), a decrease of 11.3% from last years second quarter cost
of sales of $6,249,000 (77.5% of net sales). Variable costs decreased 13.7%
from the second quarter last year, more than the decrease in sales, due to
on-going cost reduction efforts. Specimen collection service fees continued to
decrease through the implementation of our preferred collector program.
Decreases in collection forms and supplies also outpaced the decline in sales.
Increases in fixed costs such as business insurance, professional services and
depreciation were offset by lower repair and maintenance costs in the quarter.

Selling, General & Administrative (SG&A)expenses for the three months
ended June 30, 2003 were $1,984,000 (27.9% of net sales) as compared to
$1,933,000 (24.0% of net sales) in 2002. Higher legal and other professional
services primarily accounted for the increase.

Net lossfrom continuing operations for the three months ended June 30,
2003 was $555,000 or $0.09 per share compared to a net loss of $208,000 or
$0.04 per share in 2002.

Six Months 2003 vs. 2002

Net salesfor the six months ended June 30, 2003 decreased $2,093,000
(13.5%) to $13,449,000 in 2003 from $15,542,000 in 2002. Specimen volume was
down significantly for both workplace and criminal justice customers, 23.5% and
19.6% respectively. Sales of products and other services were lower by only
2.5%. Declines in sales of PharmScreen® were largely offset by higher
non-laboratory services.

Cost of salesfor the six months ended June 30, 2003 decreased $1,247,000
(10.5%) to $10,670,000 in 2003 (79.3% of net sales) from $11,917,000 in 2002
(76.7% of net sales). The increase in cost of sales as a percentage of net
sales was the result of increased fixed costs, primarily the result of
increases in depreciation expense related to laboratory software and increases
in the cost of facility insurance, which were partially offset by lower repair
and maintenance expenses for lab equipment. Variable costs decreased 14.3%
from the first six months of last year, greater than the decline in sales.
Specimen collection service fees continued to decrease through the
implementation of our preferred collector program. Collection forms and
supplies, labor and fringe benefits, and inbound transportation of specimens
account for the majority of the decrease in variable costs. Product costs
decreases exceeded the decrease in sales, primarily due to a change in product
mix.

Selling, General & Administrative (SG&A)expenses for the six months ended
June 30, 2003 decreased $164,000 (4.2%) to $3,782,000 in 2003 (28.1% of net
sales) from $3,946,000 in 2002 (25.4% of net sales). Bad debt expense was
lower as a result of improved credit and collection efforts. A corresponding
reduction of days sales outstanding from 57.0 days at June, 2002 to 54.1 days
in 2003 was also achieved. Lower software development costs and marketing
expenses account for the balance of the reduction.

Discontinued Operationsfor the six months ended June 30, 2002 resulted in
net income of $4,636,000 (or $0.79 per share) which is comprised of net income
from Medscreens operations for three months of $359,000 (or $0.06 per share)
and the gain on the sale of Medscreen of $4,277,000 (or $0.73 per share).

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Net Lossfrom continuing operations for the six months ended June 30, 2003
was $1,288,000, or $0.22 per share compared to a net loss in 2002 of $518,000,
or $0.09 per share. The net income for the six months ended June 30, 2002
including discontinued operations was $4,118,000, or $0.70 per share. There
were no discontinued operations in the first six months of this year.

Liquidity and Capital Resources

Our continuing operations during the six-month period ended June 30, 2003
used cash of $407,000 and provided $247,000 of cash during the first six months
in 2002. The decrease in cash flow from operations was principally the result
of the larger loss from continuing operations in the first six months of 2003.
Working capital management continues to remain a priority.

As of June 30, 2003, we had $2,426,000 in cash and cash equivalents.
During the six months ended June 30, 2003, we used approximately $267,000 in
cash to purchase property and equipment, principally for information systems
development.

On June 26, 2003, the Company entered into a Loan and Security Agreement
(the Agreement) with a new lender replacing its existing credit agreement.
The new Agreement provides for a revolving line of credit of $3,500,000,
permits borrowing at 80% of eligible receivables, has a term of three years,
bears interest at prime plus 1% (5.0% as of June 30, 2003), has a one-time
commitment fee of $10,000, a monthly collateral monitoring fee of $1,000, an
unused line fee of 0.50% per annum, and requires the Company to maintain
certain financial ratios. In addition, the Agreement provides for a term loan
of up to $1,500,000 which bears interest at prime plus 3% (7.0% as of June 30,
2003), has a one-time commitment fee of $15,000 and is repayable monthly over
36 months; the initial draw down under this term loan facility was $900,000.
These facilities funded on July 2, 2003 at which time our prior credit facility
was fully paid and terminated. The remaining $600,000 balance of the term
loan, if drawn, must be drawn within ninety days from the date of the loan
agreement.

The new Agreement is secured by a lien on a significant portion of our
assets and permits up to $1,500,000 of the revolving line of credit to be used
to repurchase our common stock under our common stock repurchase program and
permits the declaration and distribution of a dividend in connection with our
stockholder rights plan. Should the revolving line of credit be paid off prior
to the end of the term, there would be a prepayment penalty of $35,000.

As of June 30, 2003, the calculated maximum that could be borrowed and the
amount outstanding were $3,319,000 and $2,827,000, respectively.

On June 30, 2003, the Companys subordinated debt holders agreed to an
early payoff of the subordinated debt at a 50% discount. The subordinated
debt, as discounted, was repaid from proceeds of the term loan facility. The
Company agreed to a reduction in the exercise price of the 150,000 warrants
held by the subordinated debt holders from $3.00 to $0.29 (the average of the
closing prices for the 30 days ending June 26, 2003). The warrants continue to
expire on September 30, 2006.

As a result of the foregoing, the Company will report a gain on the early
extinguishment of debt in the third quarter of approximately $665,000 which
includes reductions for the unamortized discount (established when the
subordinated debt was issued) and the fair value of re-pricing the warrants.

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We anticipate the existing cash balances, amounts available under existing
and future credit agreements and 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 June 2001, the FASB issued Statement No. 143 (SFAS 143), Accounting for
Asset Retirement Obligations.SFAS 143 requires liability recognition for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. We adopted the provisions of SFAS 143
effective January 1, 2003. The adoption of this standard did not have a
material effect on our consolidated financial position or results of
operations.

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.FIN 45 requires that a
liability be recorded in the guarantors balance sheet upon issuance of certain
guarantees. FIN 45 also requires disclosure about certain guarantees that an
entity has issued. The Company has implemented the disclosure requirements
required by FIN 45, which were effective for fiscal years ending after December
15, 2002. The Company will apply the recognition provisions of FIN 45
prospectively to guarantees issued after December 31, 2002. The Company does
not expect FIN 45 to have a material effect on its financial condition and
results of operations.

In May 2003, the Financial Accounting Standards board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 requires that certain financial instruments, which under
previous guidance were accounted for as equity, most now be accounted for as
liabilities. The financial instruments affected include mandatorily redeemable
stock, certain financial instruments that require or may require the issue to
buy back some of its shares in exchange for cash or other assets and certain
obligations that can be settled with shares of stock. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003
     , and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. PharmChem does not expect SFAS No. 150 to have
a material effect on its financial condition or results of operations.

In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new variable interest
entities created or acquired after January 31, 2003. For Variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN
46 must be applied for the first interim or annual period beginning after June
15, 2003. PharmChem does not expect FIN 46 to have a material effect on its
financial condition or results of operations.

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In November 2002, the FASBs Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or
rights to use assets. The provisions of EITF Issue No. 00-21 will apply to
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. PharmChem does not expect EITF Issue No. 00-21 to have a material effect
on its financial condition or results of operations.




Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk with respect to our debt outstanding. Our
new credit agreement carries interest at the prime rate plus 1.0% for the
revolving line of credit and prime rate plus 3.0% for the term loan. 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.
A 1.0% change in the prime rate would not materially change interest expense
assuming levels of debt consistent with historical amounts. The market risks
are not considered significant and, therefore, we do not intend to engage in
significant hedging transactions.




Item 4. Controls and Procedures

Within the 90 days prior to the date of this report, under the supervision
and with the participation of management, including our Chief Executive Officer
and our Chief Financial Officer, we have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15. Based upon that evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that our disclosure
controls and procedures are effective in timely alerting them to material
information relating to us required to be included in our periodic SEC filings.
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the
date of their evaluation.




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 13, 2003,
the Companys stockholders took the following actions:
| |  | -----------------------------------------------------------------------------------------------------------------



| | (a) |  | The following directors were elected to serve until the next Annual Meeting:
| | --- |  | ----------------------------------------------------------------------------

| |  |                                                                           
| |  | --------------------------------------------------------------------------
| |  | Joseph W. Halligan  5,298,844 shares in favor and 1,900 shares withheld; 
| |  | Richard D. Irwin  5,300,344 shares in favor and 400 shares withheld;     
| |  | Stephen I. Schorr  5,300,344 shares in favor and 400 shares withheld; and
| |  | Donald R. Stroben  5,300,344 shares in favor and 400 shares withheld.    



| | (b) |  | Ratification of the appointment of KPMG LLP as
Independent Certified Public Accountants for the Company for
the 2003 fiscal year, by a vote of 5,300,344 shares in favor,
400 shares against, and zero shares abstained.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Item 6. Exhibits and Reports on Form 8-K



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

|      |  |   |  |                                                                                                                                                   
|----- |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|10.38 |  |  |  | Letter agreement between PharmChem, Inc. and Irwin Family
Limited Partnership dated June 30, 2003.                                                
|10.39 |  |  |  | Letter Agreement between PharmChem, Inc. and Richard D.
Irwin dated June 30, 2003.                                                                
|10.40 |  |  |  | Letter Agreement between PharmChem, Inc. and MicroCap
Partners, L.P. dated June 30, 2003.                                                         
|10.41 |  |  |  | Warrant from PharmChem, Inc. to Irwin Family Limited
Partnership dated June 30, 2003.                                                             
|10.42 |  |  |  | Warrant from PharmChem, Inc. to Richard D. Irwin dated June
30, 2003.                                                                             
|10.43 |  |  |  | Warrant from PharmChem, Inc. to MicroCap Partners, L.P.
dated June 30, 2003.                                                                      
|10.44 |  |  |  | Loan and Security Agreement between Silicon Valley Bank and
PharmChem, Inc., dated June 26, 2003.                                                 
|10.45 |  |  |  | Intellectual Property Security Agreement between Silicon
Valley Bank and PharmChem, Inc. dated June 26, 2003.                                     
|31.1  |  |  |  | Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|31.2  |  |  |  | Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|32.1  |  |  |  | Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
|32.2  |  |  |  | Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.



| | (b) |  | Reports on Form 8-K:                                                                                                        
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------
|
| |     |  | Press release issued on August 11, 2003 reporting second quarter
2003 financial results.                                    
|
| |     |  | Press release issued on July 15, 2003 reporting Nasdaq determination
letter received on July 11, 2003.                      
|
| |     |  | Press Release issued on July 2, 2003 announcing a new loan and
security agreement and the early payoff of subordinated debt.
|
| |     |  | Press release issued on May 28, 2003 disclosing possible delisting
action by Nasdaq.                                        
|
| |     |  | Press release issued on May 15, 2003 reporting first quarter 2003
financial results.                                        

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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 11, 2003 |  | 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

|      |  |   |  |                                                                                                                                                   
|----- |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|10.38 |  |  |  | Letter agreement between PharmChem, Inc. and Irwin Family
Limited Partnership dated June 30, 2003.                                                
|10.39 |  |  |  | Letter Agreement between PharmChem, Inc. and Richard D.
Irwin dated June 30, 2003.                                                                
|10.40 |  |  |  | Letter Agreement between PharmChem, Inc. and MicroCap
Partners, L.P. dated June 30, 2003.                                                         
|10.41 |  |  |  | Warrant from PharmChem, Inc. to Irwin Family Limited
Partnership dated June 30, 2003.                                                             
|10.42 |  |  |  | Warrant from PharmChem, Inc. to Richard D. Irwin dated June
30, 2003.                                                                             
|10.43 |  |  |  | Warrant from PharmChem, Inc. to MicroCap Partners, L.P.
dated June 30, 2003.                                                                      
|10.44 |  |  |  | Loan and Security Agreement between Silicon Valley Bank and
PharmChem, Inc., dated June 26, 2003.                                                 
|10.45 |  |  |  | Intellectual Property Security Agreement between Silicon
Valley Bank and PharmChem, Inc. dated June 26, 2003.                                     
|31.1  |  |  |  | Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|31.2  |  |  |  | Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|32.1  |  |  |  | Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
|32.2  |  |  |  | Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.

21