Pharma-Bio Serv, Inc (OTCQB:PBSV), headquartered in Dorado, Puerto Rico and with other offices in the U.S., Ireland and Spain, is principally engaged in providing compliance consulting to the pharmaceutical industry including to pharmaceutical, biotech, medical device and chemical manufacturing companies located in Puerto Rico, the United States and Europe. The company has regularly been recognized as one of the top validation companies in Puerto Rico.
Compliance consulting, which encompasses a broad range of services including regulatory (FDA and international regulatory agencies) compliance, validation, technology transfer, and project management, accounts for approximately 93% of the company's revenue. PBSV also provides information technology services and technical training (~2% of total revenue) and the company has a laboratory in Puerto Rico which provides microbiological and chemical testing services (~5% of total revenue). The company employs about 300 people, many of whom are highly-skilled engineers and quality assurance professionals with advanced degrees in their respective fields of expertise. The company counts many of the pharma "majors" as clients. Their clients include eight of the top ten global bio-pharma companies and seven of the top ten global medical technology companies.
PBSV has grown revenues from a combination of organic growth as well as through acquisitions over the last several years. Increasing awareness among many of the major pharma and medical device companies of the company's reputation as an eminent life sciences consulting firm without the relatively high cost of larger competitors has facilitated organic revenue growth. This has been complemented by small acquisitions since 2006 which has expanded the company's service offerings as well as their geographic footprint.
PBSV's small size has also been an asset, allowing the company to be very nimble and to rapidly adapt to regulatory, industry, market and competitive changes, affording the chance to quickly capitalize on new opportunities. When pharmaceutical activity in PBSV's homeland, Puerto Rico, began to stagnate they were able to quickly focus resources elsewhere which held greater opportunities. This meant entering the European market, initially in Ireland and then branching out to Spain. The U.S. market has been a particular boon for the company, accounting for over 40% of the revenue growth from 2010 to 2012.
A major focus for continuing their recent rapid growth (60% revenue CAGR over last two years) is to take their current capabilities and further expand geographically, in particular to areas of the world that hold the most promise - those with a high concentration of life sciences manufacturing and, preferably which are highly regulated. The U.S. market, with ever-increasing demand for compliance consulting services and where PBSV has already demonstrated early success, is likely where the bulk of the near-to-mid term growth opportunity lies for the company.
Focus Is Running The Biz With Integrity, Not On Investor Relations…
PBSV is somewhat of a rare-bird in terms of their lack investor-awareness activities and borderline shyness of the investment community. There's little question that management's focus is well directed given the company's double-digit revenue growth, double-digit net margins and a rock-solid balance sheet. PBSV's leadership has also placed significant importance on high ethics, integrity, honesty and values - which while maybe not explicitly shown in the income statement columns, almost certainly has contributed to the company's financial performance (via customer retention, repeat business, employee satisfaction, etc). Comb through the corporate website and, based on the amount of space dedicated to ethics, morals, trust and integrity versus that dedicated towards investor relations, it offers a glimpse of where management's priorities lie. Trust, honesty and integrity are characteristics not always present with micro-cap company managements and, coupled with PBSV's impressive financial performance and prospects for continued growth, offers what we believe is a very attractive investment.
PBSV also enjoys a lower tax rate than if they were domiciled in the U.S. As a result of a tax grant awarded PBSV by the government of Puerto Rico, the company is partially exempt from various taxes including Puerto Rico income tax.
Management's efforts have been rewarded with recognition from customers and other industry organizations, which have included;
PBSV's core business is FDA and international agencies regulatory compliance and related services, although they also offer other integrated services that affords them the ability to be a full-service solution provider.
The vast majority of the company's services are provided through time and materials contracts where clients are charged for the time, materials and expenses incurred on a particular project or service. Time and material contracts, which account for approximately 94% of the company's revenue, have somewhat of a built-in margin to PBSV.
Laboratory testing, which is usually completed and certified within days of sample receipt, represents about 5% of total revenue.
PBSV has over 20 years of compliance consulting experience. Their consulting business caters to some of the largest life sciences organizations in the world including eight of the top ten pharmaceutical companies and seven of the top ten medical technology companies. The company believes their competitive advantages relative to compliance consulting include their two decades of experience, ability to offer a wide range and depth of services with very high levels of expertise, accomplished track record of exceptional performance that consistently meets or exceeds client's expectations, and being able to provide their services at a significantly lower cost. PBSV also puts considerable effort into maintaining close and trusting relationships with their client companies, which provides clear benefits in terms of repeat business. Compliance consulting services accounts for approximately 93% of the company's total revenue.
PBSV's compliance consulting spans a large menu of services under a variety categories.
Per the company's website and company filings, Scienza Labs is a state of the art microbiological testing facility with the latest equipment and technology and test methodologies available, harmonized with the current pharmacopeias. The labs are designed to exceed customers' expectations with an excellent organization, on time delivery, and shorter testing cycle times. The lab provides services to the company's core industry (life sciences) as well as to the cosmetic and food industries. Microbiology and chemical testing services accounts for approximately 5% of the company's total revenue.
Per the company's website and company filings, Integratek, their Puerto Rico based information technology services and consulting division, provides 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. IT services and the company's Pharma Serv Academy (technical training) account for approximately 2% of PBSV's total revenue.
Pharma Serv Academy
Pharma Serv Academy (per company filings and website), through a network of leading industry professional experts in their field, including those from PBSV, provides technical seminars/training that incorporate the latest regulatory trends and standards as well as other related areas. These services are provided in the markets that PBSV currently serves, as well as other industries.
Financial Condition / Financial Performance
Solid, Spotless Balance Sheet and Significant Positive Cash Flow
PBSV maintains a stellar balance sheet, which is particularly impressive for a micro-cap company. At the most recent quarter-end (April 30, 2013) cash balance stood at $8.5 million, up from $7.0 million from the previous quarter-end (January 31, 2012). The company has zero debt, zero preferred stock, and just 22.6 million basic (23.4 million fully-diluted) common shares outstanding. Quality of assets appears to be strong with an immaterial amount of intangibles, cash and securities accounting for about 48% of total assets, and no indication that all of A/R is anything other than collectible.
PBSV also has a history of positive cash flow generation. Cash flow from operating activities was $2.1 million in fiscal 2011 (ending 10/31/2011), $2.5 million in fiscal 2012 and was $2.0 million in the six months ending 4/30/13.
The business is also not very capital intensive, with CapEx of just $123k in fiscal 2011, $169k in fiscal 2012 and $100k in the most recent six months.
Impressive Performance: Revenue Grows 76% in 2011, 47% in 2012, 19% in 1H 2013 and Mid-Teen Net Margins
PBSV has grown revenues from $11.4 million in fiscal 2010 to $19.9 million (+76%) in 2011 to $29.2 million (+47%) in 2012. Through the first half (ending 4/30/13) of the current fiscal year, revenue grew 19% to $15.9 million. Almost all of this revenue growth is organic, with little contribution from any acquisitions over these periods.
The company points to a few factors that have attributed to this impressive revenue growth including some contraction in the pharmaceutical industry which has eliminated some competition as well as recent regulatory changes that have increased demand for their services. As we indicated earlier, PBSV's relatively small size coupled with their high levels of expertise in various disciplines allows them to quickly shift resources when opportunities present themselves and to capitalize on changes within the regulatory environment and the industry. This appears to have been a significant benefit to PBSV over the recent past.
The company has done an excellent job with not just growing revenue but also with keeping expenses in check. The combination has resulted in EPS growing from $0.02 in fiscal 2010 to $0.14 in 2011 to $0.20 in 2012. EPS was $0.11 through the first half of the current year (compared to $0.10 in the year-earlier comparable period).
Beneficial Income Tax Status…
One somewhat unique advantage that PBSV enjoys and helps maximize the amount of revenue that flows to the bottom line is that they are subject to a lower than normal statutory Puerto Rico income tax rate. In June 2011 the company obtained a Grant of Industrial Tax Exemption from the Puerto Rico Industrial Development Company. The grant was effective November 2009. 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. The grant, which is effective through 2024, significantly reduces PBSV's Puerto Rico income tax liability from what would have been a tax rate of 30% to what was an effective rate of 5.5% in fiscal 2011, 5.4% in 2012 and will be 4% in fiscal 2013 (and should remain at 4% until expiration).
This grant only covers operations in Puerto Rico. Operations carried out in the United States are taxed at a maximum regular federal income tax rate of 35%.
PBSV's total effective tax rate in 2011 and 2012 were 14.7% and 18.6% which is significantly favorable relative to the 35% U.S. federal statutory rate and PBSV's 2010 effective rate of 40.1% (which was prior to obtaining the grant).
The company is in the process of making a more deliberate effort to communicate with the investing public which we expect will provide more insight into the current status of operations and their near-term plans for continued growth. We also think it will confirm that management's lack of investor-awareness activities had everything to do with them spending their energies focused on running the company and running it in the right way, something that we think speaks highly of where their priorities lie and which should provide investors comfort.
Our current financial model, which is subject change, is largely based on recent trends along with some very general "guidance" that the company has publicly disclosed. This guidance includes that the bulk of PBSV's near-term growth opportunity lies with the U.S. market, that growth in Puerto Rico will likely be limited for the foreseeable future and that growth in Europe, while having meaningful potential over the longer-term, may be constrained for a period of time due to the widespread economic weakness.
Our modeled revenue growth (14% 2013, 12% 2014, 9% 2015, 9% 2016) is arguably conservative given PBSV's recent historical financial performance (revenue growth of 76% 2011, 47% 2012). We reiterate that our estimates are subject to change. The majority of our modeled revenue growth is driven by growth in the U.S., with Puerto Rico revenue growth relatively flat to barely positive, and European revenue starting to pick up more meaningfully towards the 2015 - 2016 timeframe. We have incorporated very little expansion in gross margin from current levels - which is also potentially conservative. We look for SG&A spend to remain considerably higher (on both an absolute as well as a % of sales basis) in the current year compared to 2012 as a result of the company beefing up its U.S.-related capabilities and resources. We look for SG&A spend to be leverageable in future periods.
With U.S. revenue increasing as a % of total sales and Puerto Rico revenue remaining relatively flat, the benefit from the low Puerto Rico income tax rate will be lessened. As a result, we model the effective tax rate to increase throughout our modeled periods.
Valuation / Recommendation
Based on our model we look for EPS to grow at a five-year CAGR of about 16% through 2016. We use an industry PE/G ratio of 1.2x to value PBSV. We look for 2013 EPS of $0.21 which values the company at approximately $4.00/share. The stock currently trades at about $1.50, indicating the shares are trading cheaper than fair value. As such we recommend accumulating up to our $4.00 price target.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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