The following discussion of our results of operations and financial condition should be read in conjunction with Part I, including matters set forth in the "Risk Factors" section of this Annual Report on Form 10-K, and our Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report on Form 10-K. Overview We are a compliance, project management and technology transfer support consulting firm with a laboratory testing facility with headquarters in
Puerto Rico, servicing the Puerto Rico, United Statesand Europemarkets. The compliance consulting service sector in those markets consists of local compliance and validation consulting firms, dedicated validation and compliance consulting firms and large publicly traded and private domestic and foreign engineering and consulting firms. We provide a broad range of compliance related consulting services. We also provide microbiological testing services and chemical testing services through our laboratory testing facility ("Lab") in Puerto Rico. We also provide information technology consulting services and technical training/seminars, which services are not currently significant to our operating results. We market our services to pharmaceutical, chemical, biotechnology and medical devices, and allied products companies in Puerto Rico, the United Statesand Europe. Our team includes more than 300 experienced engineering and life science professionals, and includes former quality assurance managers and directors, and experienced and trained professionals with bachelors, masters and doctorate degrees in health sciences and engineering. We actively operate in Puerto Rico, the United States, Irelandand Spain and pursue to further expand these markets by strengthening our business development infrastructure and by constantly realigning our business strategies as new opportunities and challenges arise. We market our services with an active presence in industry trade shows, professional conventions, industry publications and company provided seminars to the industry. Our senior management is also actively involved in the marketing process, especially in marketing to major accounts. Our senior management and staff also concentrate on developing new business opportunities and focus on the larger customer accounts (by number of professionals or dollar volume) and responding to prospective customers' requests for proposals. While our core business is FDAand international agencies regulatory compliance related services, we feel that our clients are in need of other services that we can provide and allow us to present the company as a global solution provider with a portfolio of integrated services that will bring value added solutions to our customers. Accordingly, our portfolio of services include a laboratory testing facility, an information technology consulting practice and a training center that provides seminars/training to the industry.
The Lab incorporates the latest technology and test methodologies meeting pharmacopoeia industry standards and regulations. It currently offers services to our core industries already serviced as well as the cosmetic and food industries.
We also provide technical seminars/training that incorporate the latest regulatory trends and standards as well as other related areas. A network of leading industry professional experts in their field, which include resources of our own, provide these seminars/training to the industry through our "
Pharma Serv Academy" division. These services are provided in the markets we currently serve, as well as others, and position our Company as a key leader in the industry. Our information technology services and consulting division based in Puerto Rico("Integratek") provide a variety of information technology services such as web pages and portals development, digital art design, intranets, extranets, software development including database integration, Windows and web applications development, software technical training and learning management systems, technology project management, and compliance consulting services, among others. Integratek is a Microsoft Certified Partner and a reseller for technology products from leading vendors in the market. 16 -------------------------------------------------------------------------------- In line with the strategy to further penetrate the United Statesand Puerto Ricomarkets, we submit annually for renewal the certification as a "minority-controlled company" as defined by the National Minority Supplier Development Counciland Growth Initiative ("NMSDC"). This certification allows us to participate in corporate diversity programs available from various potential customers in the United Statesand Puerto Rico. In June 2011, Pharma-Bio, Pharma-PR and Pharma-Serv obtained a new 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 provides relief on various Puerto Ricotaxes, 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. Industry consolidations, the pharmaceutical regulatory environment, changes in tax laws, customers' price sensitive procurement processes, and the local and global economies recession continue to be factors and uncertainties that affect our business. As such, we are constantly realigning our business strategies as new opportunities and challenges arise. For the year ended October 31, 2013, the Company increased its net revenues by $3.8 million, or 13%, when compared to the same period last year. The United Statesconsulting market division and the Lab led the revenue improvement for the year ended October 31, 2013with an increase in revenues of $2.2and $1.0 million, respectively, when compared to the same period last year. Other company divisions sustained minor revenue gains/losses or remained constant, when compared to the same period last year. Business development and operations support expenses in the United Statesand Puerto Ricomarkets were increased to follow the consulting business favorable revenue trend of last fiscal year. In addition, we have made business development investments in Spain to diversify our European division market, and also continue our efforts to broaden the Lab's customer base. The revenue growth, offset by the increase in operational support and business development expenses, has led our year ended October 31, 2013net income to be approximately $4.9 million, an increase of approximately $0.2 million, when compared with the same period last year.
The following table sets forth information as to our revenue for the years ended
Year ended October 31, Revenues by Region 2013 2012 Puerto Rico
$ 17,97354.4 % $ 16,85657.7 % United States 11,492 34.7 % 9,159 31.3 % Europe 3,597 10.9 % 3,212 11.0 % $ 33,062100.0 % $ 29,227100.0 % Weak economies where we do business and worldwide industry consolidations will continue to be unfavorable factors going forward. These factors, and the impact on the industry, if any, of the recently enacted U.S. health care reform (Patient Protection and Affordable Care Act) and Puerto Rico Act 154 which imposed temporary excise taxes to the industry we serve, remain as industry uncertainties that might adversely affect our future performance. We believe that our future profitability and liquidity will be highly dependent on the effect the global economy, changes in tax laws and worldwide lifescience manufacturing industry consolidations will have over our operations, and our ability to seek service opportunities and adapt to the current industry trends. 17 --------------------------------------------------------------------------------
Results of Operations
The following table sets forth our statements of operations for the years ended
October 31, 2013and 2012, (dollars in thousands) and as a percentage of revenue: Year ended October 31, 2013 2012 Revenues $ 33,062100.0 % $ 29,227100.0 % Cost of services 21,229 64.2 % 19,355 66.2 % Gross profit 11,833 35.8 % 9,872 33.8 % Selling, general and administrative expenses 5,761 17.4 % 4,138 14.2 % Other income, net 4 0.0 % 22 0.1 % Income before income taxes 6,076 18.4 % 5,756 19.7 % Income tax expense 1,170 3.6 % 1,069 3.7 % Net income 4,906 14.8 % 4,687 16.0 % Revenues. Revenues for the year ended October 31, 2013were $33.1 million, an increase of approximately $3.8 million, or 13%, when compared to last year. This improvement is mainly attributable to $2.2and $1.0 milliongain in the United Statesconsulting market and Lab services, respectively, plus other minor revenue gains from other Company divisions, offset by a decrease in revenues in the Integratek division of $0.4 million. During the year ended October 31, 2013, the United Statesconsulting operation has been able to capture and maintain projects within existing customers, while the Lab has attracted some additional customers that brought non-recurring volume. Integratek has been affected by the loss of volume of one of its major customers. A significant portion of the revenues for the European market is mostly attributable to one customer located in Ireland.
Cost of Services; gross profit. The overall gross profit for the year ended in
The Company's net increase in gross margin is mainly attributable to gains in the Lab gross margin of 1.4 percentage points, while consulting services accounted for the remaining net gross margin improvement. The favorable Lab contribution to gross margin is attributable to the favorable yield attained in the Lab due to the increase in testing volume, versus the absorption of fixed cost of services.
Selling, General and Administrative Expenses. Selling, general and administrative expenses for the year ended in
Business development and operations support expenses in the
Puerto Ricoand United Statesmarkets were increased to follow the consulting business favorable revenue trend. We have also made business development investments in Spain to diversify our European division market. Income Taxes Expense. The favorable variance in the effective income tax rate from the statutory rate is attributable to the effect of the Puerto Rico Act 73 Tax Grant over income tax expense. For the year ended October 31, 2013, the effective income tax rate increased when compared to the same period last year by 0.7 percentage points. The increase is mainly attributable to the United Statessegment increase in income before tax, which is taxed at a rate higher than nondomestic jurisdictions. Net Income. Our net income for year ended October 31, 2013was approximately $4.9 million, an increase of $0.2 million, or an increase of 4.7%, when compared to last year. For the year ended October 31, 2013, earnings per common share basic and diluted were $0.221and $0.207, respectively, a common share basic decrease of $0.005and common share diluted increase of $0.003, when compared to last year. The decrease is primarily attributable to an increased number of shares outstanding. Our net income improvement is attributable mainly to the increase in overall gross profit, the savings obtained by the Grant, offset by the increase in selling general and administrative expenses to support the favorable revenue trend. 18
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including planned capital expenditures. For the year ended
Our primary cash needs consist of the payment of compensation to our professional staff, overhead expenses, and statutory taxes. Management believes that based on the current level of operations and cash flows from operations, the collectibility of high quality customer receivables will be sufficient to fund anticipated expenses and satisfy other possible long-term contractual commitments for the next twelve months. To the extent that we pursue possible opportunities to expand our operations, either by acquisition or by the establishment of operations in a new locale, we will incur additional overhead, and there may be a delay between the period we commence operations and our generation of net cash flow from operations. While uncertainties relating to the current local and global economic condition, competition, the industries and geographical regions served by us and other regulatory matters exist within the consulting services industry, as described above, management is not aware of any trends or events likely to have a material adverse effect on liquidity or its financial statements.
Off-Balance Sheet Arrangements
We were not involved in any significant off-balance sheet arrangements during the fiscal year ended
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles ("GAAP") in
the United States. We believe the following are the critical accounting policies that impact the consolidated financial statements, some of which are based on management's best estimates available at the time of preparation. Actual experience may differ from these estimates. Consolidation - The accompanying consolidated financial statements include the accounts of all of our wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United Statesrequires 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 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
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.
Prices or valuation techniques that require inputs that are Level 3: 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
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. 19 -------------------------------------------------------------------------------- Revenue Recognition - Revenue is primarily derived from: (1) time and materials contracts (representing approximately 92% 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 2% 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 6% of total revenues) which is mainly recognized as the testing is completed and certified (normally within days of sample receipt from customer). If we determine that a contract will result in a loss, we recognize 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 and liquid investments with original maturities of three months or less.
Marketable Securities- We consider our marketable security investment portfolio and marketable equity investments 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. 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. Our 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 our 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 - We follow 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 October 31, 2013, 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. Equipment and 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 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. We evaluate for impairment our 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. We calculate the fair value of stock options using the Black-Scholes option-pricing model 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. We have not recognized such cash flow 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. 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 our foreign subsidiary is its local currency. The assets and liabilities of our foreign subsidiary 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. 20
-------------------------------------------------------------------------------- Our intercompany accounts are typically denominated in the functional currency of the foreign subsidiary. Gains and losses resulting from the remeasurement of intercompany receivables that we consider 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 we anticipate settlement in the foreseeable future are recorded in the consolidated statements of operations. The net gains and losses recorded in the consolidated statements of income were not significant for the periods presented. New Accounting Standards
Recently issued FASB guidance and
Our business, financial condition, results of operations, cash flows and prospects, and the prevailing market price and performance of our common stock, may be adversely affected by a number of factors, including the matters discussed below. Certain statements and information set forth in this Annual Report on Form 10-K, as well as other written or oral statements made from time to time by us or by our authorized executive officers on our behalf, constitute "forward-looking statements" within the meaning of the Federal Private Securities Litigation Reform Act of 1995. These statements include all statements other than those made solely with respect to historical fact and identified by words such as "believes", "anticipates", "expects", "intends" and similar expressions, but such words are not the exclusive means of identifying such statements. We intend for our forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we set forth this statement and these risk factors in order to comply with such safe harbor provisions. You should note that our forward-looking statements speak only as of the date of this Annual Report on Form 10-K or when made and we undertake no duty or obligation to update or revise our forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that the expectations, plans, intentions and projections reflected in our forward-looking statements are reasonable, such statements are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. The risks, uncertainties and other factors that our stockholders and prospective investors should consider include, but are not limited to, the following:
? Because our business is concentrated in the pharmaceutical industry any
changes in that industry or in the markets we serve could impair our ability
to generate revenue and realize a profit.
adversely the willingness of our customers to do business in
consequently affect our business.
? Changes in tax benefits may affect the willingness of companies to continue or
expand their operations in
the willingness of businesses to commence or expand operations in Puerto
Rico, or may also consider closing operations carried in
Puerto Rico. ? Other factors, including economic factors, may affect the decision of
businesses to continue or expand their operations in the markets we serve.
? Our business and operating results may be impacted if we are unable to maintain our certification as a minority-controlled company.
? Because our business is dependent upon a small number of clients, the loss of
a major client could impair our ability to operate profitably.
? Customer procurement and sourcing practices intended to reduce costs could
have an adverse affect on our margins and profitability. ? Since our business is dependent upon the development and enhancement of
patented pharmaceutical products or processes by our clients, the failure of
our clients to obtain and maintain patents could impair our ability to operate
profitably. ? We may be unable to pass on increased labor costs to our clients.
? Consolidation in the pharmaceutical industry may have a harmful effect on our
? Because the pharmaceutical industry is subject to government regulations,
changes in government regulations relating to this industry may affect the
need for our services. ? Our reputation and divisions may be impacted by regulatory standards impacting our customer products. 21
? If we are unable to protect our clients' intellectual property, our ability to
generate business will be impaired.
? We may be subject to liability if our services or solutions for our clients
infringe upon the intellectual property rights of others.
? We may be held liable for the actions of our employees or contractors when on
assignment. ? To the extent that we perform services pursuant to fixed-price or
incentive-based contracts, our cost of services may exceed our revenue on the
contract. ? Because most of our contracts may be terminated on little or no advance
notice, our failure to generate new business could impair our ability to
? Because we are dependent upon our management, our ability to develop our
business may be impaired if we are not able to engage skilled personnel.
? We may not be able to continue to grow unless we consummate acquisitions or
enter markets outside of
? Our cash could be adversely affected if the financial institutions in which we
hold our cash fail.
? If we identify a proposed acquisition, we may require substantial cash to fund
the cost of the acquisition.
? If we make any acquisitions, they may disrupt or have a negative impact on our
? Because there is a limited market in our common stock, stockholders may have
difficulty in selling our common stock and our common stock may be subject to
significant price swings.
? Our revenues, operating results and profitability will vary from quarter to
quarter, which may result in increased volatility of our stock price.
? The issuance of securities, whether in connection with an acquisition or
otherwise, may result in significant dilution to our stockholders. 22