Notes To Condensed Consolidated Financial Statements
January 31, 2017
(Unaudited)
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
ORGANIZATION
Pharma-Bio
Serv, Inc. (“Pharma-Bio”) is a Delaware corporation
organized on January 14, 2004. Pharma-Bio is the parent company of
Pharma-Bio Serv PR, Inc. (“Pharma-PR”), Pharma Serv,
Inc. (“Pharma-Serv”) and Scienza Labs, Inc.
(“Scienza Labs”), each a Puerto Rico corporation,
Pharma-Bio Serv US, Inc. (“Pharma-US”), a Delaware
corporation, Pharma-Bio Serv Validation & Compliance Limited
(“Pharma-IR”), an Irish corporation, Pharma-Bio Serv SL
(“Pharma-Spain”), a Spanish limited liability company,
and Pharma-Bio Serv Brasil Servicos de Consultoria Ltda.
(“Pharma-Brazil”), a Brazilian limited liability
company. Pharma-Bio, Pharma-PR, Pharma-Serv, Pharma-US, Pharma-IR,
Pharma-Spain and Pharma-Brazil are collectively referred to as the
“Company.” The Company operates in Puerto Rico, the
United States, Ireland, Spain and Brazil under the name of
Pharma-Bio Serv and is engaged in providing technical compliance
consulting service, and microbiological and chemical laboratory
testing.
Scienza
Labs is a wholly owned subsidiary, which was organized in Puerto
Rico in April 2016. As of October 31, 2016, this subsidiary was in
development stage and has not incurred significant revenues or
expenses.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The
condensed consolidated balance sheet of the Company as of October
31, 2016 is derived from audited consolidated financial statements
but does not include all disclosures required by generally accepted
accounting principles. The unaudited interim condensed consolidated
financial statements, include all adjustments, consisting of normal
recurring adjustments, which are, in the opinion of management,
necessary for a fair presentation of the financial position and
results of operations and cash flows for the interim periods. The
results of operations for the three months ended January 31, 2017
are not necessarily indicative of expected results for the full
2017 fiscal year.
The
accompanying financial data as of January 31, 2017, and for the
three-month period ended January 31, 2017 and 2016 has been
prepared by us, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (the
“SEC”). Certain information and footnote disclosures
normally contained in financial statements prepared in accordance
with generally accepted accounting principles have been condensed
or omitted. These condensed consolidated financial statements
should be read in conjunction with the financial statements and
notes contained in our audited Consolidated Financial Statements
and the notes thereto for the fiscal year ended October 31,
2016.
Consolidation
The
accompanying condensed consolidated financial statements include
the accounts of the Company and all of its wholly owned
subsidiaries. All intercompany transactions and balances have been
eliminated in consolidation.
Use of Estimates
The
preparation of condensed consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the condensed consolidated financial statements and the
reported amounts of revenues and expenses during the reporting
periods. Actual results may differ from these
estimates.
Fair Value of Financial Instruments
Accounting
standards have established a fair value hierarchy that requires an
entity to maximize the use of observable inputs and minimize the
use of unobservable inputs when measuring fair value. A financial
instrument’s categorization within the fair value hierarchy
is based upon the lowest level of input that is significant to the
fair value measurement. Accounting standards have established three
levels of inputs that may be used to measure fair
value:
Level1:
Quoted prices in
active markets for identical assets and liabilities.
Level 2:
Observable inputs
other than Level 1 prices such as quoted prices for similar assets
or liabilities, quoted prices in markets with insufficient volume
or infrequent transactions (less active markets), or model-derived
valuations in which all significant inputs are observable or can be
derived principally from or corroborated by observable market data
for substantially the full term of the assets or
liabilities.
Level 3:
Prices or
valuation techniques that require inputs that are both significant
to the fair value measurement and unobservable (supported by little
or no market activity).
Marketable
securities available-for-sale consist of U.S. Treasury securities
and an obligation from the Puerto Rico Government Development Bank
valued using quoted market prices in active markets. Accordingly,
these securities are categorized in Level 1.
The
carrying value of the Company's financial instruments (excluding
marketable securities and obligations under capital leases), cash
and cash equivalents, accounts receivable, accounts payable and
accrued liabilities, are considered reasonable estimates of fair
value due to their liquidity or short-term nature. Management
believes, based on current rates, that the fair value of its
obligations under capital leases approximates the carrying
amount.
Revenue Recognition
Revenue
is primarily derived from: (1) time and materials contracts
(representing approximately 83% of total revenues), which is
recognized by applying the proportional performance model, whereby
revenue is recognized as performance occurs, (2) short-term
fixed-fee contracts or "not to exceed" contracts (representing
approximately 1% of total revenues), which revenue is recognized
similarly, except that certain milestones also have to be reached
before revenue is recognized, and (3) laboratory testing revenue
(representing approximately 16% of total revenues) is mainly
recognized as the testing is completed and certified (normally
within days of sample receipt from the customer). If the Company
determines that a contract will result in a loss, the Company
recognizes the estimated loss in the period in which such
determination is made.
Cash Equivalents
For
purposes of the consolidated statements of cash flows, cash
equivalents include investments in a money market obligations trust
that is registered under the U.S. Investment Company Act of 1940,
as amended, and liquid investments with original maturities of
three months or less.
Marketable Securities
We
consider our marketable security investment portfolio and
marketable equity investments as available-for-sale and,
accordingly, these investments are recorded at fair value with
unrealized gains and losses generally recorded in other
comprehensive income; whereas realized gains and losses are
included in earnings and determined based on the specific
identification method.
We
review our available-for-sale securities for other-than-temporary
declines in fair value below their cost basis on a quarterly basis
and whenever events or changes in circumstances indicate that the
cost basis of an asset may not be materially recoverable. This
evaluation is based on a number of factors including, the length of
time and extent to which the fair value has been less than our cost
basis and adverse conditions specifically related to the security
including any changes to the rating of the security by a rating
agency.
Accounts Receivable
Accounts
receivable are recorded at their estimated realizable value.
Accounts are deemed past due when payment has not been received
within the stated time period. The Company's policy is to review
individual past due amounts periodically and write off amounts for
which all collection efforts are deemed to have been exhausted. Due
to the nature of the Company’s customers, bad debts are
mainly accounted for using the direct write-off method whereby an
expense is recognized only when a specific account is determined to
be uncollectible. The effect of using this method approximates that
of the allowance method.
Income Taxes
The
Company follows an asset and liability approach method of
accounting for income taxes. This method measures deferred income
taxes by applying enacted statutory rates in effect at the balance
sheet date to the differences between the tax basis of assets and
liabilities and their reported amounts on the financial statements.
The resulting deferred tax assets or liabilities are adjusted to
reflect changes in tax laws as they occur. A valuation allowance is
provided when it is more likely than not that a deferred tax asset
will not be realized.
The
Company follows guidance from the Financial Accounting Standards
Board (“FASB”) related to
Accounting for Uncertainty in Income
Taxes,
which includes a two-step approach to recognizing,
de-recognizing and measuring uncertain tax positions. As of January
31, 2017, the Company had no significant uncertain tax positions
that would be reduced as a result of a lapse of the applicable
statute of limitations.
Property and Equipment
Owned
property and equipment, and leasehold improvements are stated at
cost. Vehicles under capital leases are stated at the lower of fair
market value or net present value of the minimum lease payments at
the inception of the leases.
Depreciation
and amortization of owned assets are provided for, when placed in
service, in amounts sufficient to relate the cost of depreciable
assets to operations over their estimated service lives, using
straight-line basis. Assets under capital leases and leasehold
improvements are amortized over the shorter of the estimated useful
lives of the assets or initial lease term. Major renewals and
betterments that extend the life of the assets are capitalized,
while expenditures for repairs and maintenance are expensed when
incurred. As of January 31, 2017 and October 31, 2016, the
accumulated depreciation and amortization amounted to $2,016,125
and $1,936,699, respectively.
The
Company evaluates for impairment its long-lived assets to be held
and used, and long-lived assets to be disposed of, whenever events
or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable.
Based on management estimates, no
impairment of the operating properties was present.
Stock-based Compensation
Stock-based
compensation expense is recognized in the consolidated financial
statements based on the fair value of the awards granted.
Stock-based compensation cost is measured at the grant date based
on the fair value of the award and is recognized as expense over
the requisite service period, which generally represents the
vesting period, and includes an estimate of awards that will be
forfeited. The Company calculates the fair value of stock options
using the Black-Scholes option-pricing model at the grant date,
while for restricted stock units the fair market value of the units
is determined by Company’s share market value at grant date.
Excess tax benefits related to stock-based compensation are
reflected as cash flows from financing activities rather than cash
flows from operating activities. The Company has not recognized
such cash flows from financing activities since there has been no
tax benefit related to the stock-based compensation.
Income Per Share of Common Stock
Basic
income per share of common stock is calculated by dividing net
income by the weighted average number of shares of common stock
outstanding. Diluted income per share includes the dilution of
common stock equivalents,
which
include principally shares that may be issued upon the exercise of
warrants, stock option and restricted stock unit
awards.
The
diluted weighted average shares of common stock outstanding were
calculated using the treasury stock method for the respective
periods.
Foreign Operations
The
functional currency of the Company’s foreign subsidiaries is
its local currency. The assets and liabilities of the
Company’s foreign subsidiaries are translated into U.S.
dollars at exchange rates in effect at the balance sheet date.
Income and expense items are translated at the average exchange
rates prevailing during the period. The cumulative translation
effect for subsidiaries using a functional currency other than the
U.S. dollar is included as a cumulative translation adjustment in
stockholders’ equity and as a component of comprehensive
income.
The
Company’s intercompany accounts are typically denominated in
the functional currency of the foreign subsidiary. Gains and losses
resulting from the remeasurement of intercompany receivables that
the Company considers to be of a long-term investment nature are
recorded as a cumulative translation adjustment in
stockholders’ equity and as a component of comprehensive
income, while gains and losses resulting from the remeasurement of
intercompany receivables from those international subsidiaries for
which the Company anticipates settlement in the foreseeable future
are recorded in the consolidated statements of operations. The net
gains and losses recorded in the condensed consolidated statements
of income were not significant for the periods
presented.
Subsequent Events
The
Company has evaluated subsequent events through the filing
date of this report. The Company has determined that there are no
events occurring in this period that required disclosure or
adjustment.
Reclassifications
Certain
reclassifications have been made to the January 31, 2016 condensed
consolidated financial statements to conform them to the January
31, 2017 condensed consolidated financial statements presentation.
Such reclassifications do not affect net income as previously
reported.
Recent accounting pronouncements
In May
2014, a new accounting standard was issued that amends the guidance
for the recognition of revenue from contracts with customers to
transfer goods and services. This new standard will be effective
for interim and annual periods beginning after December 15, 2017,
including interim periods within the reporting period, reporting is
required to be adopted prospectively and early adoption is not
permitted. We are currently evaluating the provisions of this new
standard and have not yet determined what impact it will have on
our financial statements, if any. Other recently issued FASB
guidance and Securities and Exchange Commission (“SEC”)
Staff Accounting Bulletins have either been implemented, are
not applicable to the Company, or will have limited effects upon
the Company’s implementation.
NOTE B – MARKETABLE SECURITIES AVAILABLE FOR
SALE
The amortized cost, gross unrealized gains, gross unrealized losses
and estimated fair values of available-for-sale securities by type
of security were as follows as of January 31, 2017 and October 31,
2016:
Type of security as of January 31, 2017
|
|
|
|
|
U.S.
Treasury securities
|
$
4,500,000
|
$
—
|
$
—
|
$
4,500,000
|
Other
government-related debt securities:
|
|
|
|
|
Puerto
Rico Commonwealth Government Development Bond
|
40,000
|
—
|
(18,031
)
|
21,969
|
Total
interest-bearing and available-for-sale securities
|
$
4,540,000
|
$
—
|
$
(18,031
)
|
$
4,521,969
|
Type of security as of October 31, 2016
|
|
|
|
|
U.S.
Treasury securities
|
$
4,500,000
|
$
-
|
$
-
|
$
4,500,000
|
Other
government-related debt securities:
|
|
|
|
|
Puerto
Rico Commonwealth Government Development Bond
|
40,000
|
-
|
(19,717
)
|
20,283
|
Total
interest-bearing and available-for-sale securities
|
$
4,540,000
|
$
-
|
$
(19,717
)
|
$
4,520,283
|
At
January 31, 2017 and October 31, 2016, the above marketable
securities included a 5.4% Puerto Rico Commonwealth Government
Development Bank Bond in the amount of $95,000, purchased at par
and maturing in August 2019.
The fair values of available-for-sale securities by classification
in the Consolidated Balance Sheets were as follows as of January
31, 2017 and October 31, 2016:
Classification in the Consolidated Balance Sheets
|
|
|
Cash
and cash equivalents
|
$
4,500,000
|
$
4,500,000
|
Marketable
securities
|
21,969
|
20,283
|
Total
available-for-sale securities
|
$
4,521,969
|
$
4,520,283
|
Cash and cash equivalents in the table above exclude cash in banks
of approximately $9.0 million and $9.3 million as of January 31,
2017 and October 31, 2016, respectively.
The
primary objectives of the Company’s investment portfolio are
liquidity and safety of principal. Investments are made with the
objective of achieving the highest rate of return consistent with
these two objectives. Our investment policy limits investments to
certain types of debt and money market instruments issued by
institutions primarily with investment grade credit ratings and
places restrictions on maturities and concentration by type and
issuer.
NOTE C - INCOME TAXES
In June
2011, Pharma-Bio, Pharma-PR and Pharma-Serv obtained a Grant of
Industrial Tax Exemption pursuant to the terms and conditions set
forth in Act No. 73 of May 28, 2008 (“the Grant”)
issued by the Puerto Rico Industrial Development Company
(“PRIDCO”). The Grant was effective as of November 1,
2009 and covers a fifteen year period. The Grant provides relief on
various Puerto Rico taxes, including income tax, with certain
limitations, for most of the activities carried on within Puerto
Rico, including those that are for services to parties located
outside of Puerto Rico. Industrial Development Income
(“IDI”) covered under the Grant are subject to a fixed
income tax rate of 4%. In addition, IDI earnings distributions
accumulated since November 1, 2009 are totally exempt from Puerto
Rico earnings distribution tax.
Puerto
Rico operations not covered in the exempt activities of the Grant
are subject to Puerto Rico income tax at a maximum tax rate of 39%
as provided by the 1994 Puerto Rico Internal Revenue Code, as
amended. The operations carried out in the United States by the
Company and its subsidiary are taxed in the United States at a
maximum regular federal income tax rate of 35%.
Distribution
of earnings by the Puerto Rican subsidiaries to its parent are
taxed at the federal level, however, the parent is able to receive
a credit for the taxes paid by the subsidiary on its operations in
Puerto Rico, to the extent of the federal taxes that result from
those earnings. As a result, the income tax expense of the Company,
under its present corporate structure, would normally be the Puerto
Rico taxes on operations in Puerto Rico, federal taxes on
operations in the United States, plus the earnings distribution tax
in Puerto Rico from dividends paid to the Puerto Rican
subsidiaries’ parent, and the parent’s federal income
tax, if any, incurred upon the subsidiary’s earnings
distribution.
Deferred
income tax assets and liabilities are computed for differences
between the consolidated financial statements and tax bases of
assets and liabilities that will result in taxable or deductible
amounts in the future, based on enacted tax laws and rates
applicable to the periods in which the differences are expected to
affect taxable income.
The
Company has not recognized deferred income taxes on undistributed
earnings of its Puerto Rican subsidiaries, since such earnings are
considered to be reinvested indefinitely. If the earnings were
distributed in the form of dividends, the Company would be subject
to Puerto Rico earnings distribution tax (to the extent not covered
by the Grant), and United States federal income tax, as
applicable.
Pharma-Spain
and Pharma-IR have unused operating losses which result in a
potential deferred tax asset. However, an allowance has been
provided covering the total amount of such balance since it is
uncertain whether the net operating losses can be used to offset
future taxable income before their expiration dates. Realization of
future tax benefits related to a deferred tax asset is dependent on
many factors, including the company’s ability to generate
taxable income. Accordingly, the income tax benefit will be
recognized when realization is determined to be more probable than
not. These net operating losses are available to offset future
taxable income in Pharma-Spain through 2029 and 2030, and
indefinitely for Pharma-IR.
The
statutory income tax rate differs from the effective rate, mainly
due to the effect of the Puerto Rico Act 73 Tax Grant over income
tax expense, and income tax permanent differences between financial
and tax books income.
The
Company files income tax returns in the United States (federal and
various states jurisdictions), Puerto Rico, Ireland, Spain and
Brazil. The 2012 (2011 for Puerto Rico) through 2015 tax years are
open and may be subject to potential examination in one or more
jurisdictions. Currently, the Company has no federal, state, Puerto
Rico or foreign income tax examination.
NOTE D – WARRANTS
On
December 2014, the Company entered into an agreement with a firm
for providing (i) business development and (ii) mergers and
acquisition services to the Company. Pursuant to the agreement
terms, the Company issued warrants for the purchase of 1,000,000
common shares at an exercise price of $1.80 per share. The
underlying common shares of the warrants are fully vested and
expire on December 1, 2019.
NOTE E – CAPITAL TRANSACTIONS
On June
13, 2014, the Board of Directors of the Company authorized the
Company to repurchase up to two million shares of its outstanding
common stock. The timing, manner, price and amount of any
repurchases will be at the discretion of the Company, subject to
the requirements of the Securities Exchange Act of 1934, as
amended, and related rules. The program does not oblige the Company
to repurchase any shares and it may be modified, suspended or
terminated at any time and for any reason. No shares will be
repurchased directly from directors or officers of the Company. As
of January 31, 2017 and October 31, 2016, pursuant to the program,
a total of 219,552 and 216,952 shares of the Company’s common
stock were purchased for an aggregate amount of $234,618 and
$232,736, respectively.
NOTE F – EARNINGS (LOSSES) PER SHARE
The
following data shows the amounts used in the calculations of basic
and diluted earnings (losses) per share.
|
Three
months
ended January
31,
|
|
|
|
Net income (loss)
available to common equity holders - used to
compute basic and
diluted earnings per share
|
$
(382,135
)
|
$
350,011
|
Weighted average
number of common shares - used to compute
basic earnings
(losses) per share
|
23,051,349
|
23,019,517
|
Effect of warrants
to purchase common stock
|
-
|
-
|
Effect of
restricted stock units to common stock
|
11,224
|
27,345
|
Effect of options
to purchase common stock
|
25,987
|
211,461
|
Weighted average
number of shares - used to compute diluted
earnings (losses)
per share
|
23,088,560
|
23,258,323
|
Warrants
for the purchase of 1,000,000 shares of common stock for the
three-month periods ended in January 31, 2017 and 2016 were not
included in computing diluted earnings per share because their
effects were antidilutive. In addition, options for the purchase of
570,000 and 160,000 shares of common stock for the three-month
periods ended in January 31, 2017 and 2016, respectively, were not
included in computing diluted earnings per share because their
effects were also antidilutive.
NOTE G - CONCENTRATIONS OF RISK
Cash and cash equivalents
The
Company’s domestic cash and cash equivalents consist of cash
deposits in FDIC insured banks (substantially covered by FDIC
insurance by the spread of deposits in multiple FDIC insured
banks), a money market obligations trust registered under the US
Investment Company Act of 1940, as amended, and U.S. Treasury
securities with maturities of three months or less. In the foreign
markets we serve, we also maintain cash deposits in foreign banks,
which tend to be not significant and have no specific insurance. No
losses have been experienced or are expected on these
accounts.
Accounts receivable and revenues
Management
deems all of its accounts receivable to be fully collectible, and,
as such, does not maintain any allowances for uncollectible
receivables.
The
Company's revenues, and the related receivables, are concentrated
in the pharmaceutical industry in Puerto Rico, the United States,
Ireland, Spain and Brazil. Although a few customers represent a
significant source of revenue, the Company’s functions are
not a continuous process, accordingly, the client base for which
the services are typically rendered, on a project-by-project basis,
changes regularly.
The
Company provided a substantial portion of its services to three
customers, which accounted for 10% or more of its revenues in
either of the three-month periods ended January 31, 2017 and 2016.
During the three months ended January 31, 2017, revenues from these
customers were 13.8%, 3.9% and 4.6%, or a total of 22.3%, as
compared to the percentages for the same period last year of 13.3%,
12.6% and 16.2%, or a total of 42.1%, respectively. At January 31,
2017, amounts due from these customers represented 10.2% of the
Company’s total accounts receivable balance.
The
information related to major customers in the above paragraph is
based on revenues earned from said customers at the segment level
because in management’s opinion contracts by segments are
totally independent of each other, and therefore such information
is more meaningful to the reader. These revenues pertain to three
global groups of affiliated companies. During the three months
ended January 31, 2017, aggregate revenues from these global groups
of affiliated companies were 13.8%, 10.8% and 4.6%, or a total of
29.2%, as compared to the same period last year for 13.3%, 18.4%
and 16.2%, or a total of 47.9%, respectively. At January 31, 2017
amounts due from these global groups of affiliated companies
represented 14.1% of total accounts receivable
balance.
As of
January 31, 2017, one of the Company’s customers owes the
Company approximately $2.6 million, which represents approximately
50.3% of the Company’s total accounts receivable trade
balances. We are providing multiple services to this customer
related to their construction of a manufacturing facility in Puerto
Rico. From this facility the customer will do the manufacturing and
distribution of an existing product and an investigational new drug
to be marketed to worldwide markets, once approved by regulators. A
significant portion of the customer’s funding comes from
different financing sourcing. Management estimates that
collectability of the account is reasonably assured, accordingly,
no provision for losses, if any, have been recorded in the
financial statements.
NOTE H - SEGMENT DISCLOSURES
The
Company’s segments are based on the organizational structure
for which financial results are regularly evaluated by the
Company’s senior executive management to determine resource
allocation and assess performance. Each reportable segment is
managed by its own management team and reports to executive
management. The Company has four reportable segments: (i) Puerto
Rico technical compliance consulting, (ii) United States technical
compliance consulting, (iii) Europe technical compliance
consulting, and (iv) a Puerto Rico microbiological and chemical
laboratory testing division (“Lab”). These reportable
segments provide services primarily to the pharmaceutical,
chemical, medical device and biotechnology industries in their
respective markets.
The
following table presents information about the reported revenue
from services and earnings from operations of the Company for the
three-month periods ended in January 31, 2017 and 2016. There is no
intersegment revenue for the mentioned periods. Corporate expenses
that support the operating units have been allocated to the
segments. Asset information by reportable segment is not presented,
since the Company does not produce such information internally, nor
does it use such data to manage its business.
|
Three months
ended January 31,
|
|
|
|
REVENUES:
|
|
|
Puerto Rico
consulting
|
$
2,790,020
|
$
3,539,659
|
United States
consulting
|
347,200
|
345,815
|
Europe
consulting
|
182,424
|
202,188
|
Lab
(microbiological and chemical testing)
|
641,893
|
783,931
|
Other
segments¹
|
84,754
|
28,862
|
Total consolidated
revenues
|
$
4,046,291
|
$
4,900,455
|
|
|
|
INCOME (LOSS)
BEFORE TAXES:
|
|
|
Puerto Rico
consulting
|
$
(150,840
)
|
$
251,645
|
United States
consulting
|
(238,643
)
|
(167,458
)
|
Europe
consulting
|
(26,750
)
|
(68,353
)
|
Lab
(microbiological and chemical testing)
|
(87,617
)
|
229,346
|
Other
segments¹
|
123,465
|
136,263
|
Total consolidated
income before taxes
|
$
(380,385
)
|
$
381,443
|
¹
|
Other segments
represent activities that fall below the reportable threshold and
are carried out in Puerto Rico, United States and Brazil. These
activities include a Brazilian compliance consulting division,
technical seminars/training division, a calibrations division, and
corporate headquarters, as applicable.
|
|
Long
lived assets (property and equipment and intangible assets) as of
January 31, 2017 and October 31, 2016, and related depreciation and
amortization expense for the three months ended January 31, 2017
and 2016, were concentrated in Puerto Rico. The aggregate amount of
long lived assets for other operations is considered
insignificant.