See notes to condensed consolidated financial statements.
See notes to the condensed consolidated financial statements.
Notes To Condensed Consolidated Financial Statements
April 30, 2023
(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. (currently inactive) (“Scienza Labs”), each a Puerto Rico corporation, Pharma-Bio Serv US, Inc. (“Pharma-US”), a Delaware corporation, Pharma-Bio Serv SL (“Pharma-Spain”), a Spanish limited liability company, and Pharma-Bio Serv Brasil Servicos de Consultoria Ltda. (currently insignificant) (“Pharma-Brazil”), a Brazilian limited liability company. Pharma-Bio, Pharma-PR, Pharma-Serv, Scienza Labs, Pharma-US, Pharma-Spain and Pharma-Brazil are collectively referred to as the “Company.” The Company operates in Puerto Rico, the United States, Europe and Brazil under the name of Pharma-Bio Serv and is engaged in providing technical compliance consulting service.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The condensed consolidated balance sheet of the Company as of October 31, 2022 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 six months ended April 30, 2023 are not necessarily indicative of expected results for the full 2023 fiscal year.
The accompanying financial data as of April 30, 2023, and for the three-month and six-month periods ended April 30, 2023 and 2022 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, 2022.
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
The Company 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 condensed consolidated financial statements are presented to show these three reportable segments.
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). |
Marketable securities consist of U.S. Treasury securities, which are categorized in Level 1 and have a short-term maturity.
The carrying value of the Company’s financial instruments, 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.
Revenue Recognition
The Company records revenue under Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. We evaluate our revenue contracts with customers based on the five-step model under ASC 606: (i) Identify the contract with the customer; (ii) Identify the performance obligations in the contract; (iii) Determine the transaction price; (iv) Allocate the transaction price to separate performance obligations; and (v) Recognize revenue when (or as) each performance obligation is satisfied.
Revenue is primarily derived from: (1) time and material contracts (representing approximately 99% of total revenues), and (2) short-term fixed-fee contracts or “not to exceed” contracts (representing approximately 1% of total revenues). Time and material contracts are typically based on the number of hours worked at contractually agreed upon rates. These service contracts relate to work which has no alternative use and for which the Company has an enforceable right to payment for the work completed to date. As a result, revenue is recognized over time when or as the Company transfers control of the promised products or services (known as performance obligations) to its customers. Revenue for short term fixed fee contracts or “not to exceed” contracts 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 a 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, including US Treasury securities, 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 accounted for using the direct write-off method whereby an expense is recognized only when a specific balance is determined to be uncollectible in full. The effect of using this method approximates that of the allowance method. However, in the event the Company determines that the collectability of any account receivable reaches a certain uncertainty threshold, the Company will provide an allowance for doubtful account to reduce said balance.
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 April 30, 2023, the Company had no significant uncertain tax positions that would be reduced as a result of a lapse of the applicable statute of limitations.
Leases
The Company follows accounting standards issued by the FASB for the accounting and disclosure of leases. Under those standards, assets and liabilities that arise from leases are recognized on the balance sheet, and the leases are categorized at their inception as either operating or finance leases.
Operating lease right-of-use assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments under the lease. Lease recognition occurs at the commencement date, and lease liability amounts are based on the present value of lease payments made during the lease term.
Property and Equipment
Owned property and equipment are stated at cost. Depreciation 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. Expenditures for repairs and maintenance are expensed when incurred. As of April 30, 2023 and October 31, 2022, the accumulated depreciation amounted to $618,785 and $587,089, respectively.
Impairment of Long-Lived Assets
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 long-lived assets was present as of April 30, 2023 and October 31, 2022.
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 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 the 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 Per Share of Common Stock
Basic earnings per share of common stock is calculated by dividing net earnings by the weighted average number of shares of common stock outstanding. Diluted earnings 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 require disclosure or adjustment.
Reclassifications
Certain reclassifications have been made to the April 30, 2022 condensed consolidated financial statements to conform them to the April 30, 2023 condensed consolidated financial statements presentation. Such reclassifications do not affect net income as previously reported.
Recent Accounting Pronouncements
Recent accounting pronouncements pending adoption not discussed above or in the Form 10-K for the year ended October 31, 2022, are either not applicable or will not have or are not expected to have a material impact on us.
NOTE B – MARKETABLE SECURITIES
Marketable securities consist of short-term U.S. Treasury securities with maturities over three months, which are held until maturity and accordingly, are measured at amortized cost.
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 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 was determined to be approximately $2.7 million. The Transition Tax liability must be paid over a period of eight years which started with the Company’s second quarter of 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. However, foreign subsidiaries earnings are subject to U.S. tax at a reduced rate of 10.5%.
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 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 exempt from Puerto Rico earnings distribution tax. Under provisions of Puerto Rico Acts 60-2019 and 73-2008, the Company has requested PRIDCO the renegotiation of the Grant for an additional term of fifteen years.
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 37.5% as provided by the 1994 Puerto Rico Internal Revenue Code, as amended. The operations carried in the United States by the Company’s subsidiaries, is taxed in the United States at a maximum regular federal income tax rate of 21%.
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. Realization of future tax benefits related to a deferred tax asset is dependent on many factors. Accordingly, the income tax benefit will be recognized when realization is determined to be more probable than not.
The Company files income tax returns in the United States (federal and various states jurisdictions), Puerto Rico, Spain and Brazil. The 2018 (2017 for Puerto Rico) through 2022 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 – EARNINGS PER SHARE
The following data shows the amounts used in the calculations of basic and diluted earnings per share.
| | Three months ended April 30, | | | Six months ended April 30, | |
| | 2023 | | | 2022 | | | 2023 | | | 2022 | |
Net income available to common equity holders - used to compute basic and diluted earnings per share | | $ | 404,654 | | | $ | 240,027 | | | $ | 831,086 | | | $ | 545,271 | |
| | | | | | | | | | | | | | | | |
Weighted average number of common shares - used to compute basic earnings per share | | | 22,962,633 | | | | 22,961,401 | | | | 22,953,694 | | | | 22,986,597 | |
Effect of options to purchase common stock | | | 53,746 | | | | 25,641 | | | | 33,716 | | | | 40,340 | |
Weighted average number of shares - used to compute diluted earnings per share | | | 23,016,379 | | | | 22,987,042 | | | | 22,987,410 | | | | 23,026,937 | |
For the three-month and six-month periods ended April 30, 2023, options for the purchase of 80,000 and 223,350 shares of common stock, respectively, and options for the purchase of 300,000 shares of common stock for the three-month and six-month periods ended April 30, 2022, were not considered in computing diluted earnings per share because their effect was antidilutive.
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 under the Company Stock Repurchase Program (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 April 30, 2023 and October 31, 2022, a total of 480,557 and 451,057 shares of the Company’s common stock were purchased under the Repurchase Program for an aggregate amount of $467,733 and $439,264, respectively.
On February 28, 2023, the Board of Directors of the Company declared a cash dividend of $0.075 per common share for shareholders of record as of the close of business on March 29, 2023. Accordingly, an aggregate dividend payment of $1,723,819 was paid on April 14, 2023.
NOTE F - 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 operations of the Company for the three-month and six-month periods ended on April 30, 2023 and 2022. 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 April 30, | | | Six months ended April 30, | |
| | 2023 | | | 2022 | | | 2023 | | | 2022 | |
REVENUES: | | | | | | | | | | | | |
Puerto Rico consulting | | $ | 1,955,803 | | | $ | 3,073,939 | | | $ | 4,130,463 | | | $ | 6,437,815 | |
United States consulting | | | 1,175,558 | | | | 1,225,978 | | | | 2,269,522 | | | | 2,412,685 | |
Europe consulting | | | 1,425,547 | | | | 666,839 | | | | 2,395,279 | | | | 1,131,807 | |
Other segment | | | 6,234 | | | | 562 | | | | 6,234 | | | | 4,115 | |
Total consolidated revenues | | $ | 4,563,142 | | | $ | 4,967,318 | | | $ | 8,801,498 | | | $ | 9,986,422 | |
| | | | | | | | | | | | | | | | |
INCOME (LOSS) BEFORE TAXES: | | | | | | | | | | | | | | | | |
Puerto Rico consulting | | $ | (6,827 | ) | | $ | 23,140 | | | $ | 54,823 | | | $ | 159,715 | |
United States consulting | | | (12,919 | ) | | | 121,076 | | | | 161,153 | | | | 201,150 | |
Europe consulting | | | 606,673 | | | | 162,608 | | | | 963,223 | | | | 315,684 | |
Other segment | | | (14,233 | ) | | | (21,790 | ) | | | (31,328 | ) | | | (35,052 | ) |
Total consolidated income before taxes | | $ | 572,694 | | | $ | 285,034 | | | $ | 1,147,871 | | | $ | 641,497 | |
Long lived assets (property and equipment) as of April 30, 2023 and October 31, 2022, and related depreciation and amortization expense for the three and six months ended April 30, 2023 and 2022, 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 related to the corporate headquarters.
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 have no specific insurance. No losses have been experienced or are expected on these accounts.
Accounts receivable and revenues
The Company has established a full allowance for doubtful accounts for those accounts receivable balances for which collectability have reached a certain uncertainty threshold. Management deems all other of the Company’s accounts receivable to be fully collectible, and, as such, does not maintain any additional allowance for uncollectible receivables.
The Company’s revenues, and the related receivables, are concentrated in the pharmaceutical industry in Puerto Rico, the United States, Europe 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 six customers, which accounted for 10% or more of its revenues in either of the three-month and six-month periods ended April 30, 2023 and 2022. During the three months ended April 30, 2023, revenues from these customers were 14.6%, 11.6%, 10.6%, 7.5%, 8.8% and 7.3%, or a total of 60.4%, as compared to the same period last year of 0.0%, 3.3%, 12.2%, 10.4%, 8.5%, and 17.7%, or a total of 52.1%, respectively. During the six months ended April 30, 2023, revenues from these customers were 9.8%, 9.6%, 11.8%, 6.8%, 8.6% and 7.5%, or a total of 54.1%, as compared to the same period last year of 0.0%, 3.3%, 13.3%, 10.1%, 10.4% and 17.9%, or a total of 55.0%, respectively. For the three months ended April 30, 2023 and 2022, these customers represented for the Puerto Rico, United States and Europe consulting reportable segments 26.7%, 19.1% and 14.6%, as compared to 38.4%, 13.7% and 0.0%, respectively. For the six months ended April 30, 2023 and 2022, these customers represented for the Puerto Rico, United States and Europe consulting reportable segments 27.9%, 16.4% and 9.8%, as compared to 41.6%, 13.4% and 0.0%, respectively. On April 30, 2023, amounts due from these customers represented 53.0% of the Company’s total accounts receivable balance. This customer information 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.
At the global level, six global groups of affiliated companies accounted for 10% or more of its revenues in either of the three-month and six-month periods ended April 30, 2023 and 2022. During the three months ended April 30, 2023, aggregate revenues from these global groups of affiliated companies were 14.6%, 13.4%, 10.6%, 10.0%, 8.8% and 7.3%, or a total of 64.7%, as compared to the same period last year for 0.0%, 6.3%, 12.2%, 10.4%, 8.5% and 17.7%, or a total of 55.1%, respectively. During the six months ended April 30, 2023, aggregate revenues from these global group of affiliated companies were 9.8%, 12.0%, 11.8%, 8.1%, 8.6% and 7.5%, or a total of 57.8%, as compared to the same period last year for 0.0%, 6.3%, 13.3%, 10.1%, 10.4% and 17.9%, or a total of 58.0%, respectively. For the three months ended April 30, 2023 and 2022, these customers represented for the Puerto Rico, United States and Europe consulting reportable segments 31.0%, 19.1% and 14.6%, as compared to 41.4%, 13.7% and 0.0%, respectively. For the six months ended April 30, 2023 and 2022, these customers represented for the Puerto Rico, United States and Europe consulting reportable segments 31.6%, 16.4% and 9.8%, as compared to 44.6%, 13.4% and 0.0%, respectively. At April 30, 2023, amounts due from these global groups of affiliated companies represented 55.1% of total accounts receivable balance.
