N
otes To Condensed Consolidated
Financial Statements
January 31, 2019
(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 currently
inactive, 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, Scienza Labs, 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 until September 17, 2018 microbiological
and chemical laboratory testing (the
“Lab”).
On September 17, 2018 (the “Sales Closing Date”), the
Company sold substantially all of its Lab business assets (the
“Laboratory Assets”).
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The
condensed consolidated balance sheet of the Company as of October
31, 2018 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, 2019
are not necessarily indicative of expected results for the full
2019 fiscal year.
The
accompanying financial data as of January 31, 2019, and for the
three-month period ended January 31, 2019 and 2018 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,
2018.
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.
Segments
On the Sales Closing Date, the Company sold substantially all of
its Laboratory Assets. As a result of the sale, the Company
currently operates in three reportable business segments: (i)
Puerto Rico technical compliance consulting, (ii) United States
technical compliance consulting, and (iii) Europe technical
compliance consulting. Accordingly, the accompanying consolidated
financial statements are presented to show these three reportable
segments as continuing operations, while the Lab is presented as a
discontinued operation.
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:
Level 1
:
|
|
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).
|
The
carrying value of the Company's financial instruments (excluding
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
In May 2014, the Financial Accounting Standards Board (FASB) issued
a new accounting standard that amends the guidance for the
recognition of revenue from contracts with customers to transfer
goods and services. The FASB subsequently issued additional,
clarifying standards to address issues arising from implementation
of the new revenue recognition standard. The new revenue
recognition standard and clarifying standards require an entity to
recognize revenue when control of promised goods or services is
transferred to the customer at an amount that reflects the
consideration to which the entity expects to be entitled in
exchange for those goods or services. We adopted this new standard
as of November 1, 2018, by applying the modified-retrospective
method to those contracts that were not completed as of that date.
The results for reporting periods beginning after November 1, 2018,
are presented in accordance with the new standard, although
comparative information has not been restated and continues to be
reported under the accounting standards and policies in effect for
those periods.
The
adoption of this new standard had an immaterial impact on our
reported total revenues and operating income as compared to what
reported amounts would have been under the prior standard, and we
expect the impact of adoption in future periods to also be
immaterial.
Revenue
is primarily derived from: (1) time and materials contracts
(representing approximately 99% of total revenues), which is
recognized by applying the proportional performance model, whereby
revenue is recognized as performance occurs, and (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. 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.
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, 2019, 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 the lease term, including renewals that have
been determined to be reasonable assured. 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, 2019 and October 31, 2018, the
accumulated depreciation and amortization amounted to $523,791 and
$496,953, 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 as of January
31, 2019 and October 31, 2018.
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.
Earnings (Loss) Per Share of Common Stock
Basic
earnings (loss) per share of common stock is calculated by dividing
net earnings (loss) by the weighted average number of shares of
common stock outstanding. Diluted loss 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.
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, 2018 condensed
consolidated financial statements to conform them to the January
31, 2019 condensed consolidated financial statements presentation.
Such reclassifications do not affect net loss as previously
reported.
Recent accounting pronouncements not implemented
In February 2016, the FASB issued a new accounting standard that
amends the guidance for the accounting and disclosure of leases.
This new standard requires that lessees recognize the assets and
liabilities that arise from leases on the balance sheet and
disclose qualitative and quantitative information about their
leasing arrangements. The new standard is effective for interim and
annual periods beginning on January 1, 2019 and may be adopted
earlier. The Company continues to evaluate the impact that this new
standard will have on its consolidated financial statements. The
Company does not expect that this standard will have a material
impact to its Consolidated Statements of Operations but expects
that this standard will have a material impact on the assets and
liabilities on its Consolidated Balance Sheets upon
adoption.
NOTE B – PROMISSORY NOTE
On September 17, 2018, the Company completed the sale of its
Laboratory Assets for $5 million and received, as partial payment,
a $3 million Promissory Note from the purchaser. The Promissory
Note is composed of two tranches; (i) Tranche A for $2 million and
secured with lab equipment and (ii) Tranche B for $1 million which
is unsecured. The interest rate accrual is 3% for Tranche A and 5%
for Tranche B. Interest is due semi-annually in arrears commencing
on the six-month after the Sales Closing Date. Tranche A is due in
two installments of $750,000 and $1,250,000, on September 17, 2019
and 2020, respectively. Tranche B is due in two equal installments
of $500,000 each, on March 17, 2019 and September 17,
2019.
NOTE C - INCOME TAXES
On December 22, 2017, Public Law 115-97, commonly known as the Tax
Cuts and Jobs Act of 2017 (the “Tax Reform”), was
enacted. The Tax Reform is applicable to the Company commencing
with its fiscal year 2018. The Tax Reform imposed a mandatory
one-time transition tax (the “Transition Tax”) over
foreign subsidiaries undistributed earnings and profits
(“E&Ps”) earned prior to a date set by the statute.
Based on the Company’s E&Ps, the Transition Tax is
estimated to be approximately $2.7 million. The Transition Tax
liability may be paid over a period of eight years starting with
the Company’s fiscal year 2019. In the past, most of these
E&Ps’ were not repatriated since such E&Ps’
were considered to be reinvested indefinitely in the foreign
location, therefore no US tax liability was incurred unless the
E&Ps were repatriated as a dividend. After December 31, 2017,
the Tax Reform has established a 100% tax exemption on the
foreign-source portion of dividends received attributable to
E&Ps, with certain limitations.
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’s subsidiary was taxed in the United States at a
maximum regular federal income tax rate of 35%. Among the Tax
Reform provisions, effective with the Company’s fiscal year
ending on October 31, 2018, is a provision whereby the regular
federal income tax rate is reduced to a 23.5% blended rate and 21%
thereafter.
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.
Pharma-Spain, Pharma-IR, Pharma-Bio/Pharma-US, Pharma-PR and
Pharma-Serv
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 through
2033 for
Pharma-Spain; indefinitely for Pharma-IR; until 2038 for
Pharma-Bio/Pharma-US; until 2027 for Pharma-PR and
Pharma-Serv
.
The
Company files income tax returns in the United States (federal and
various states jurisdictions), Puerto Rico, Ireland, Spain and
Brazil. The 2014 (2013 for Puerto Rico) through 2017 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 – EQUITY 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 “Repurchase Program”). The timing,
manner, price and amount of any repurchases under the Repurchase
Program 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 Repurchase 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 under the Repurchase Program directly from directors or
officers of the Company. As of January 31, 2019 and October 31,
2018, a total of 318,204 and 315,404 shares of the Company’s
common stock were purchased under the Repurchase Program for an
aggregate amount of $307,471 and $304,688, respectively. Also,
o
n November 26, 2018, the Company
repurchased 62,972 shares of common stock, outside of the
Repurchase Program, from the Company’s Chief Executive
Officer at $1.00 per share. These shares were repurchased at a
discount to market to provide for an orderly disposition of the
shares.
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 (losses) per share
(continuing operations)
|
$
471,020
|
$
(2,472,314
)
|
Net income (loss) available to common equity
holders - used to compute
basic and diluted earnings (losses) per share
(discontinued operations)
|
$
-
|
$
(191,698
)
|
|
|
|
Weighted average
number of common shares - used to compute basic earnings (losses)
per share
|
23,038,999
|
23,063,997
|
Effect of warrants
to purchase common stock
|
-
|
-
|
Effect of
restricted stock units to common stock
|
-
|
-
|
Effect of options
to purchase common stock
|
80,028
|
1,293
|
Weighted average
number of shares - used to compute diluted earnings (losses) per
share
|
23,119,027
|
23,065,290
|
Warrants
for the purchase of 1,000,000 shares of common stock for the
three-month periods ended in January 31, 2019 and 2018 were not
included in computing diluted earnings per share because their
effects were antidilutive. In addition, options for the purchase of
80,000 and 620,000 shares of common stock for the three-month
periods ended in January 31, 2019 and 2018, 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 five
customers, which accounted for 10% or more of its revenues in
either of the three-month periods ended January 31, 2019 and 2018.
During the three months ended January 31, 2019, revenues from these
customers were 18.0%, 14.2%, 11.1%, 11.0%, and 0.0%, or a total of
54.3%, as compared to the percentages for the same period last year
of 3.1%, 3.6%, 9.0%, 16.1% and 11.3%, or a total of 43.1%,
respectively. At January 31, 2019, amounts due from these customers
represented 57.9% of the Company’s total accounts receivable
balance.
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 chief operating decision maker 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 three reportable segments: (i) Puerto
Rico technical compliance consulting, (ii) United States technical
compliance consulting, and (iii) Europe technical compliance
consulting. 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 continuing operations of the
Company for the three-month periods ended in January 31, 2019 and
2018. 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
|
$
3,888,554
|
$
2,698,365
|
United States
consulting
|
526,645
|
286,635
|
Europe
consulting
|
91,730
|
721,132
|
Other
segments¹
|
59,268
|
20,464
|
Total consolidated
revenues
|
$
4,566,197
|
$
3,726,596
|
|
|
|
INCOME (LOSS)
BEFORE TAXES:
|
|
|
Puerto Rico
consulting
|
$
375,270
|
$
(2,015
)
|
United States
consulting
|
(11,910
)
|
(87,165
)
|
Europe
consulting
|
(49,911
)
|
221,602
|
Other
segments¹
|
200,526
|
96,287
|
Total consolidated
income before taxes
|
$
513,975
|
$
228,709
|
¹
|
Other
segments represent activities that fall below the reportable
threshold and are carried out in Puerto Rico and Brazil. These
activities include a Brazilian compliance consulting division and
corporate headquarters, as applicable.
|
Long
lived assets (property and equipment) as of January 31, 2019 and
October 31, 2018, and related depreciation and amortization expense
for the three months ended January 31, 2019 and 2018,
were concentrated in the corporate headquarters in
Puerto Rico. Accordingly, depreciation expense and acquisition of
property and equipment, as presented in the statements of cash
flows are mainly related to the corporate
headquarters.