filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should read the “Risk Factors” section of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
Overview
Our business is currently organized in two reportable segments, Product Development and Integrated Healthcare Services.
Product Development
Product Development provides services and expertise that allow biopharmaceutical companies to outsource the clinical development process from first-in-man trials to post-launch monitoring. Our comprehensive service offering provides the support and functional expertise necessary at each stage of development, as well as the systems and analytical capabilities to help our customers improve product development efficiency and effectiveness. Product Development is comprised of clinical solutions and services and consulting. Clinical solutions and services provides services necessary to develop biopharmaceutical products. These services include project management and clinical monitoring functions for conducting multi-site trials (generally Phase II-IV) (collectively “core clinical”). These also include clinical trial support services that improve clinical trial decision-making, such as global laboratories, data management, biostatistical, safety and pharmacovigilance, early clinical development trials (generally Phase I), and strategic planning and design services, which help improve decisions and performance. Consulting provides strategy and management consulting services based on life science expertise and advanced analytics, as well as regulatory and compliance consulting services.
On September 16, 2013, we completed the acquisition of Novella for approximately $146.6 million in cash (net of approximately $26.2 million of acquired cash) plus potential earn-out payments totaling up to $21.0 million contingent upon the achievement of certain revenue and net new business targets for approximately three years following closing.
Integrated Healthcare Services
Integrated Healthcare Services provides the healthcare industry with both broad geographic presence and commercial capabilities. Our customized commercialization services are designed to accelerate the commercial success of biopharmaceutical and other health-related products. Integrated Healthcare Services provides a broad array of services including commercial services, such as providing contract pharmaceutical sales forces in key geographic markets, as well as a growing number of healthcare business services for the broader healthcare sector. Service offerings include commercial services (sales representatives, strategy, marketing communications and other areas related to commercialization), outcome research (drug therapy analysis, real-world research and evidence-based medicine, including research studies to prove a drug’s value) and other healthcare services (comparative and cost-effectiveness research capabilities, clinical management analytics, decision support services, medication adherence and health outcome optimization services, and web-based systems for measuring quality improvement).
Industry Outlook
The potential of the CRO market served by Product Development is primarily a function of two variables: biopharmaceutical R&D spending and the proportion of this spending that is outsourced (outsourcing penetration). Despite continued softness in the economy and concern about global credit markets, we expect outsourced clinical development to CROs to grow 6%-8% annually from 2013 to 2016. Of this annual growth, we believe that up to 2% will be derived from increased R&D expenditures, with the remainder coming from increased outsourcing penetration. We estimate that overall outsourcing penetration in 2013 was 37%. We believe that our customers will continue to outsource a greater part of their activities to transform their value chain away from a vertically integrated model and focus on their core competencies to lower risk and improve return, with a focus on selecting outsourcing partners that are able to demonstrate the ability to provide flexible and efficient delivery models that leverage patient data to help biopharmaceutical companies deliver more effective patient outcomes. We believe that increased demand will create new opportunities for biopharmaceutical services companies, particularly those with a global reach.
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Integrated Healthcare Services historically has focused on biopharmaceutical companies seeking to commercialize their products. The total market served by Integrated Healthcare Services is diverse, which makes it difficult to estimate the current amount of outsourced integrated healthcare services and the expected growth in such services. However, based on our knowledge of these markets we believe that, while the rate of outsourcing penetration varies by market within Integrated Healthcare Services, the overall outsourcing penetration of the estimated $94 billion addressable market is not more than 20%. We believe that the market for real-world and late phase research and other healthcare services will evolve and expand, and as a result, there will be opportunities to grow our revenues and expand our service offerings, including to payers who are looking to improve the cost-effectiveness of drug therapies and providers who are looking to make evidence-based decisions regarding treatment decisions. As business models continue to evolve in the healthcare sector, we believe that the growth rate for outsourcing across the Integrated Healthcare Services markets will be similar to the growth in clinical development.
Acquisitions
We completed a number of acquisitions in 2011, 2012 and 2013 to enhance our capabilities and offerings in certain areas. In October 2011, we acquired Outcome, for approximately $164.9 million (net of approximately $12.1 million of acquired cash) to strengthen our late phase research offerings and VCG&A, Inc. and its wholly owned subsidiary, VCG BIO, Inc., or collectively VCG, for $8.7 million to strengthen our commercial services. In November 2011, we acquired Advion BioServices, Inc., for $54.9 million to enhance our biomarker and other advanced testing capabilities. In August 2012, we acquired Expression Analysis for $39.7 million to enhance our genetic sequencing and advanced bioinformatics expertise. In September 2013, we acquired Novella for approximately $146.6 million (net of approximately $26.2 million of acquired cash) (with contingent consideration of up to $21.0 million) to complement our clinical service offerings through its focus on emerging companies and by adding expertise in oncology and medical devices. See Note 14 to our audited consolidated financial statements found elsewhere in this Annual Report on Form 10-K for additional information with respect to these acquisitions. The results of operations of acquired businesses have been included since the date of acquisition and were not significant to our consolidated results of operations.
Sources of Revenue
Total revenues are comprised of service revenues and revenues from reimbursed expenses. Service revenues primarily include the revenue we earn from providing product development and commercialization services to our customers, with Product Development services representing 76.7% of our 2013 service revenues and commercialization services representing 22.2% of our 2013 service revenues. Our service revenues also include, or have historically included, product sales and commercial rights and royalties revenues. Product sales, which are approximately 1% or less of consolidated service revenues for all periods presented, represent sales of pharmaceutical products pursuant to distribution agreements. Reimbursed expenses are comprised principally of payments to physicians (investigators) who oversee clinical trials and travel expenses for our clinical monitors and sales representatives. Reimbursed expenses may fluctuate from period-to-period due, in part, to where we are in the lifecycle of the many contracts that are in progress at a particular point in time. For instance, these pass-through costs tend to be higher during the early phases of clinical trials as a result of patient recruitment efforts. As reimbursed expenses are pass-through costs to our customers with little to no profit and we believe that the fluctuations from period to period are not meaningful to our underlying performance, we do not provide analysis of the fluctuations in these items or their impact on our financial results.
Costs and Expenses
Our costs and expenses are comprised primarily of our costs of revenues and selling, general and administrative expenses.
Our costs of revenues consist of service costs and reimbursed expenses. Service costs include compensation and benefits for billable employees, depreciation of assets used in generating revenue and other expenses directly related to service contracts such as courier fees, laboratory supplies, professional services, travel expenses and the cost of products sold under distribution agreements. As noted above, reimbursed expenses are comprised principally of payments to physicians (investigators) who oversee clinical trials and travel expenses for our clinical monitors and sales representatives.
Selling, general and administrative expenses include costs related to administrative functions including compensation and benefits, travel, professional services, training and expenses for advertising, IT, facilities and depreciation and amortization.
Foreign Currency Fluctuations
The impact from foreign currency fluctuations and constant currency information assumes constant foreign currency exchange rates based on the rates in effect for the comparable prior-year period were used in translation. We believe that providing the impact of fluctuations in foreign currency rates on certain financial results can facilitate analysis of period-to-period comparisons of business performance.
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Results of Operations
Year ended December 31, 2013 compared to the year ended December 31, 2012 and the year ended December 31, 2012 compared to the year ended December 31, 2011
Backlog and Net New Business
We began 2013 with backlog in place at the beginning of the year of $8,704 million, which was 9% higher than at the beginning of 2012.
Net new business (as defined under “Net New Business Reporting and Backlog” in Part I, Item 1 of this report) grew 9% in 2013 to $4,899 million from $4,501 million in 2012, driven by growth in both Product Development and Integrated Healthcare Services. Product Development’s net new business increased 9% to $3,772 million in 2013 as compared to $3,474 million in 2012, led by increases in core clinical in North America and Europe (including projects awarded under two sole provider arrangements signed in 2013) and data management services (which benefited from functional resourcing and the sole provider arrangements signed during 2013). Integrated Healthcare Services’ net new business grew 10% in 2013 to $1,127 million from $1,027 million in 2012 due to an increase in North America and Europe.
Net new business grew 11% in 2012 to $4,501 million, of which $1,507 million was generated in the fourth quarter, from $4,044 million in 2011, with the growth driven by Product Development. Product Development’s net new business increased 14% to $3,474 million in 2012, of which $1,088 million was generated in the fourth quarter, as compared to $3,040 million in 2011, led by increases in core clinical in Europe and North America and increases in our late phase, global laboratory and consulting service offerings. Factors contributing to Product Development’s net new business growth in 2012 included increases in our core clinical service offerings in Europe and North America resulting from overall growth in those markets, our ability to leverage our expanding breadth of service offerings in late phase as well as global laboratories due in part to acquisitions made in 2011 and 2012, and net new business for consulting services related to assisting a customer on a regulatory compliance project. These increases were partially offset by lower net new business in the Asia-Pacific and Latin America and from our early clinical development service offerings. Integrated Healthcare Services’ net new business was $1,027 million and $1,004 million in 2012 and 2011, respectively.
Our backlog at December 31, 2013 was $9,855 million compared to backlog of $8,704 million at December 31, 2012. Although an increase in backlog will generally result in an increase in revenues to be recognized over time (depending on the level of contract modifications), an increase in backlog at a particular point in time does not necessarily correspond directly to an increase in revenues during a particular period. The extent to which contracts in backlog will result in revenue depends on many factors, including but not limited to delivery against projected schedules, the need for scope changes (change orders), contract cancellations and the nature, duration, size, complexity and phase of the contracts, each of which factors can vary significantly from time to time. Our $9,855 million of backlog at December 31, 2013 included approximately $6,342 million of backlog that we do not expect to generate revenue in 2014 as compared to our $8,704 million of backlog at December 31, 2012, which included approximately $5,601 million of backlog that we did not expect to generate revenue in 2013. Our ability to grow revenues in the near term at rates comparable to our recent historical results will depend on many factors, including but not limited to the factors affecting the rate at which revenues are derived from backlog, continued growth in net new business that will generate revenue and factors not within our control such as economic conditions and trends in the industry in which we do business.
Service Revenues
| Change | ||||||||||||||||||||||||||||
| Year Ended December 31, | 2013 vs. 2012 | 2012 vs. 2011 | ||||||||||||||||||||||||||
| 2013 | 2012 | 2011 | $ | % | $ | % | ||||||||||||||||||||||
| (dollars in thousands) | ||||||||||||||||||||||||||||
| Service revenues | $ | 3,808,340 | $ | 3,692,298 | $ | 3,294,966 | $ | 116,042 | 3.1 | % | $ | 397,332 | 12.1 | % |
In 2013, our service revenues increased $116.0 million, or 3.1%, as compared to 2012. This increase is comprised of constant currency revenue growth of approximately $186.6 million, or 5.1%, partially offset by a negative impact of approximately $70.6 million from the effects of foreign currency fluctuations. The constant currency revenue growth, which includes the impact from business combinations completed in 2012 and 2013, is comprised of a $214.6 million increase in Product Development, partially offset by a decrease of $28.0 million in Integrated Healthcare Services.
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In 2012, our service revenues increased $397.3 million, or 12.1%, as compared to 2011. This increase is comprised of constant currency revenue growth of approximately $459.0 million, or 13.9%, partially offset by a negative impact of approximately $61.7 million from the effects of foreign currency fluctuations. The constant currency revenue growth resulted from a $328.6 million increase in Product Development and a $130.4 million increase in Integrated Healthcare Services.
Service Costs
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (dollars in thousands) | ||||||||||||
| Service costs | $ | 2,471,426 | $ | 2,459,367 | $ | 2,153,005 | ||||||
| % of service revenues | 64.9 | % | 66.6 | % | 65.3 | % |
When compared to 2012, service costs in 2013 increased $12.1 million. The increase included a constant currency increase in expenses of approximately $85.1 million, or 3.5%, partially offset by a positive impact of approximately $73.0 million from the effects of foreign currency fluctuations. The constant currency service costs growth was due to annual merit increases in compensation and related expenses, partially offset by cost efficiencies gained from restructuring actions taken in prior years, as well as incremental costs resulting from the business combinations completed in 2012 and 2013. These increases were partially offset by a decline in other expenses directly related to our service contracts, as well as by a reduction of an accrual for statutory profit sharing of approximately $5.4 million as a result of guidance handed down by an administrative court in France.
When compared to 2011, service costs in 2012 increased $306.4 million. The increase included a constant currency increase in expenses of approximately $375.1 million, or 17.4%, partially offset by a positive impact of approximately $68.8 million from the effects of foreign currency fluctuations. The constant currency service costs growth was due to an increase in compensation and related expenses and other expenses directly related to our service contracts, as well as incremental costs resulting from the business combinations completed in 2011 and 2012. The increase in compensation and related expenses was primarily as a result of a growth-related increase in billable headcount, annual merit increases and an increase in incentive compensation. Also contributing to the increase in costs of service revenues was a $16.7 million reduction in the benefit from R&D grants received from France and Austria, an increase in third party costs, primarily related to a new agreement to distribute pharmaceutical products in Italy, and various other individually insignificant factors.
Selling, General and Administrative Expenses
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (dollars in thousands) | ||||||||||||
| Selling, general and administrative expenses | $ | 860,510 | $ | 817,755 | $ | 762,299 | ||||||
| % of service revenues | 22.6 | % | 22.1 | % | 23.1 | % |
The $42.8 million increase in selling, general and administrative expenses in 2013 was caused by a constant currency increase of $59.1 million, or 7.2%, partially offset by a decrease of $16.3 million from a positive foreign currency impact. The constant currency increase was primarily due to (1) expenses incurred related to a $25.0 million fee paid in connection with the termination of our management agreement with affiliates of certain of our shareholders, and a $1.5 million fee paid in connection with the modification of an agreement for the business usage of an airplane owned by GFM, (2) severance accruals of approximately $10.0 million related to overhead cost reduction programs to be carried out in 2014, (3) executive separation costs of approximately $5.3 million, (4) the impact from the business combinations completed in 2012 and 2013, (5) increases in compensation and related expenses resulting primarily from annual merit increases, and (6) growth related increases in facilities costs and depreciation and amortization. These increases were partially offset by lower travel costs, lower share-based compensation and the fact that 2012 included expenses related to a bonus paid to certain option holders in connection with dividends paid to our shareholders (totaling $11.3 million), which did not recur in 2013. The lower share-based compensation was as a result of the fact that expense from recent stock option grants was more than offset by a $13.6 million decline in expense related to the repricing of certain stock options in 2012 that did not recur in 2013.
The $55.5 million increase in selling, general and administrative expenses in 2012 was caused by (1) incremental costs resulting from the business combinations completed in the fourth quarter of 2011 and the third quarter of 2012, (2) increased spending on business development and IT costs (including higher depreciation and amortization expense related to an increase in assets in service) and (3) expenses related to the repricing of certain stock options in connection with dividends paid to our shareholders (resulting in incremental share-based compensation expense of $13.6 million) and a bonus paid to certain option holders (totaling $11.3 million). The remaining increase was primarily the result of increases in compensation and related expenses including the impact of merit increases, an increase in headcount and higher incentive compensation. These increases were partially offset by a positive foreign currency impact of approximately $17.9 million and a reduction in facility costs due to a consolidation of offices in Europe (including lower depreciation and amortization expense due to fewer assets in service).
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Restructuring Costs
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Restructuring costs | $ | 14,071 | $ | 18,741 | $ | 22,116 |
We recognized $14.1 million of restructuring charges, net of reversals for changes in estimates, in 2013, which was primarily related to our February 2013 restructuring plan to migrate the delivery of services and to reduce anticipated overcapacity in selected areas. These actions are expected to result in severance for approximately 400 positions. We believe that this plan will result in annual cost savings of approximately $15.0 to $20.0 million.
We recognized $18.7 million of restructuring charges, net of reversals for changes in estimates, in 2012, which was primarily related to our May 2012 restructuring plan to reduce staffing overcapacity and to rationalize non-billable support roles. This restructuring action has resulted in the elimination of approximately 280 positions, primarily in Europe. We believe that this plan has resulted in annual cost savings of approximately $15.0 to $25.0 million.
We recognized $22.1 million of restructuring charges, net of immaterial reversals for changes in estimates, in 2011, primarily related to our July 2011 restructuring plan to reduce staffing overcapacity and to rationalize non-billable support roles. As part of our July 2011 plan, approximately 290 positions were eliminated, primarily in North America and Europe.
Impairment Charges
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Impairment charges | $ | — | $ | — | $ | 12,295 |
In 2011, we recognized a $12.2 million impairment on long-lived assets used in our early clinical development services due to a decline in revenue as well as overcapacity in the market for early clinical development services. Refer to the related disclosure in our audited consolidated financial statements, included elsewhere in this Annual Report on Form 10-K, for more information on this impairment.
Interest Income and Interest Expense
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Interest income | $ | (3,937 | ) | $ | (3,067 | ) | $ | (3,939 | ) | |||
| Interest expense | $ | 123,508 | $ | 134,371 | $ | 109,065 |
Interest income includes interest received from bank balances and investments in debt securities.
Interest expense for 2013 was lower than 2012 primarily due to a decrease in the average debt outstanding in 2013 compared to 2012 resulting from the repayment of the $300.0 million term loan, which Quintiles Transnational Holdings Inc. obtained in February 2012 and paid in full in May 2013, or the Holdings Term Loan, the pay down of $50.0 million of outstanding indebtedness under our senior secured credit facilities in May 2013, and the mandatory prepayment of $33.8 million of outstanding indebtedness under our senior secured credit facilities in the first quarter of 2013, offset by the increase that resulted from the $175.0 million Term Loan B-1, which our wholly-owned subsidiary, Quintiles Transnational, obtained under the credit agreement governing our senior secured credit facilities in October 2012. In addition, the average rate of interest in 2013 on the term loans under our senior secured credit facilities was lower than it was in 2012 due to (1) a 50 basis point decrease in the interest rate on the Term Loan B-2 beginning in August 2013, pursuant to the terms and conditions in the credit agreement, and (2) the reductions in the interest rate that resulted from the refinancing transactions in the fourth quarters of 2012 and 2013.
Interest expense increased in 2012 as compared to 2011 primarily as a result of the Holdings Term Loan which Quintiles Holdings obtained in February 2012, and the $175.0 million Term Loan B-1, which Quintiles Transnational obtained under its credit agreement in October 2012. See “—Liquidity and Capital Resources” for more information on our debt transactions.
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Loss on Extinguishment of Debt
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Loss on extinguishment of debt | $ | 19,831 | $ | 1,275 | $ | 46,377 |
In December 2013, we recognized a $3.3 million loss on extinguishment of debt on a portion of the debt retired related to the refinancing of our senior secured credit facilities. The loss on extinguishment of debt included approximately $1.6 million of unamortized debt issuance costs, $1.6 million of unamortized discount and $25,000 of fees and expenses.
In May 2013, we recognized a $16.5 million loss on extinguishment of debt related to payment of all amounts outstanding under the Holdings Term Loan and a $50.0 million pay down of outstanding indebtedness under our senior secured credit facilities. The loss on extinguishment of debt included approximately $5.6 million of unamortized debt issuance costs, $4.8 million of unamortized discount and $6.1 million of fees and expenses.
In 2012, we recognized a $1.3 million loss on extinguishment of debt on a portion of the debt retired related to our 2012 refinancing. The loss on extinguishment of debt included approximately $634,000 of unamortized debt issuance costs, $631,000 of unamortized discount and $10,000 of fees and expenses.
In 2011, we recognized a $46.4 million loss on extinguishment of debt on a portion of the debt retired related to our 2011 refinancing and related transactions. The loss on extinguishment of debt included approximately $14.1 million of prepayment premiums, $15.2 million of unamortized debt issuance costs, $7.5 million of unamortized discount and $9.6 million of fees and expenses.
See “—Liquidity and Capital Resources” for more information on these transactions.
Other (Income) Expense, Net
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Other (income) expense, net | $ | (185 | ) | $ | (3,572 | ) | $ | 9,073 |
Included in other (income) expense, net for 2013 were approximately $4.0 million of foreign currency net losses. In addition, 2013 included income of approximately $3.5 million due to changes in the estimated fair value of contingent consideration for two of our acquisitions completed in 2011.
Included in other (income) expense, net for 2012 were approximately $1.1 million of foreign currency net losses. In addition, 2012 included income of approximately $4.6 million due to changes in the estimated fair value of contingent consideration for two of our acquisitions completed in 2011.
Included in other (income) expense, net for 2011 were approximately $1.9 million of foreign currency net gains. Also included in 2011 was $11.6 million of expense associated with the termination of interest rate swaps in connection with the refinancing that occurred in June 2011 as we deemed it to be unlikely that the previously forecasted transactions would occur.
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Income Tax Expense
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (dollars in thousands) | ||||||||||||
| Income tax expense | $ | 95,965 | $ | 93,364 | $ | 15,105 | ||||||
| Effective income tax rate | 29.7 | % | 34.9 | % | 8.2 | % |
The effective income tax rate for 2013 was negatively impacted by the settlement of certain intercompany notes in 2013 that had previously been considered long term investments, which resulted in $11.1 million of income tax expense. In addition, the effective income tax rate for 2013 was positively impacted by our change in assertion regarding the undistributed earnings of most of our foreign subsidiaries that are considered to be indefinitely reinvested outside of the United States. Prior to June 2013, we had not considered the majority of the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested. Accordingly, 2011 and 2012 were negatively impacted by income taxes provided on most of the earnings of the foreign subsidiaries, as a deferred income tax liability was recorded each year for the anticipated income tax costs of repatriating those earnings in the future. We reevaluated this assertion following the IPO, as a portion of the IPO proceeds were used to pay down debt held in the United States as well as the fact we do not anticipate paying dividends in the foreseeable future, which had been significant in the past. With this reduction of debt and related interest expense and the change in approach related to payment of dividends, we expect to be able to support the cash needs of our domestic subsidiaries without repatriating cash from the affected foreign subsidiaries. We expect to utilize the cash generated outside of the United States to fund growth outside of the United States. As a result of the assertion change, we recorded an $8.1 million income tax benefit in the second quarter of 2013 to reverse the deferred income tax liability previously recorded on undistributed foreign earnings prior to 2013 that are now considered indefinitely reinvested outside of the United States.
The favorable rate in 2011 was primarily due to an approximately $48.7 million benefit from the recognition of foreign tax credits related to prior years due to an increase in projected foreign source income as a result of improved operational results and the favorable impact of the 2011 refinancing transaction on future results. The rate was also favorably impacted due to a $16.4 million benefit for the release of foreign uncertain tax positions due to the expiration of the statute of limitations. The rate in 2011 was unfavorably impacted by $21.7 million of income tax expense related to the gain on the sale of our investment in Invida. For financial reporting purposes, the gain on the sale is included in equity in earnings from unconsolidated affiliates; however, our income tax on the gain is included in income tax expense.
Equity in (Losses) Earnings of Unconsolidated Affiliates
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Equity in (losses) earnings of unconsolidated affiliates | $ | (1,124 | ) | $ | 2,567 | $ | 70,757 |
In 2011, we sold our investment in Invida for approximately $103.6 million of net proceeds resulting in a gain of approximately $74.9 million.
Segments
Service revenues and income from operations by segment are as follows (dollars in millions):
| Service Revenues | Income from Operations | Operating Profit Margin | ||||||||||||||||||||||||||||||||||
| 2013 | 2012 | 2011 | 2013 | 2012 | 2011 | 2013 | 2012 | 2011 | ||||||||||||||||||||||||||||
| Product Development | $ | 2,919.7 | $ | 2,728.7 | $ | 2,437.8 | $ | 562.3 | $ | 477.9 | $ | 424.7 | 19.3 | % | 17.5 | % | 17.4 | % | ||||||||||||||||||
| Integrated Healthcare Services | 888.6 | 963.6 | 857.2 | 42.1 | 60.5 | 58.2 | 4.7 | 6.3 | 6.8 | |||||||||||||||||||||||||||
| Total segment | 3,808.3 | 3,692.3 | 3,295.0 | 604.4 | 538.4 | 482.9 | 15.9 | % | 14.6 | % | 14.7 | % | ||||||||||||||||||||||||
| General corporate and unallocated expenses | (128.0 | ) | (123.3 | ) | (103.2 | ) | ||||||||||||||||||||||||||||||
| Restructuring costs | (14.1 | ) | (18.7 | ) | (22.1 | ) | ||||||||||||||||||||||||||||||
| Impairment charges | — | — | (12.3 | ) | ||||||||||||||||||||||||||||||||
| Consolidated | $ | 3,808.3 | $ | 3,692.3 | $ | 3,295.0 | $ | 462.3 | $ | 396.4 | $ | 345.3 | ||||||||||||||||||||||||
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Certain costs are not allocated to our segments and are reported as general corporate and unallocated expenses. These costs primarily consist of share-based compensation and expenses for corporate office functions such as senior leadership, finance, human resources, IT, facilities and legal, as well as certain expenses incurred in the second quarter of 2013 including the $25.0 million fee incurred in connection with the termination of the management agreement with affiliates of certain shareholders and the $1.5 million fee paid in connection with the modification of an agreement for the business usage of an airplane owned by GFM.
Product Development
| Change | ||||||||||||||||||||||||||||
| 2013 | 2012 | 2011 | 2013 vs. 2012 | 2012 vs. 2011 | ||||||||||||||||||||||||
| (dollars in millions) | ||||||||||||||||||||||||||||
| Service revenues | $ | 2,919.7 | $ | 2,728.7 | $ | 2,437.8 | $ | 191.0 | 7.0 | % | $ | 290.9 | 11.9 | % | ||||||||||||||
| Costs of revenue, service costs | 1,752.8 | 1,683.3 | 1,464.3 | 69.5 | 4.1 | 219.0 | 15.0 | |||||||||||||||||||||
| as a percentage of service revenues | 60.0 | % | 61.7 | % | 60.1 | % | ||||||||||||||||||||||
| Selling, general and administrative expenses | 604.6 | 567.5 | 548.8 | 37.1 | 6.5 | 18.7 | 3.4 | |||||||||||||||||||||
| Segment income from operations | $ | 562.3 | $ | 477.9 | $ | 424.7 | $ | 84.4 | 17.7 | % | $ | 53.2 | 12.5 | % | ||||||||||||||
| as a percentage of service revenues | 19.3 | % | 17.5 | % | 17.4 | % |
Service Revenues
2013 compared to 2012
Product Development’s service revenues were $2.9 billion in 2013, an increase of $191.0 million, or 7.0%, over 2012. This increase is comprised of constant currency revenue growth of $214.6 million, or 7.9%, partially offset by a negative impact of approximately $23.6 million due to the effect of foreign currency fluctuations. The constant currency service revenues growth was primarily a result of a volume-related increase of $191.4 million in clinical solutions and services and $52.4 million from businesses acquired in the third quarters of 2012 and 2013, which were partially offset by a decrease of $29.2 million from consulting services.
Our clinical solutions and services growth for 2013 was concentrated in Europe and the Americas. This growth was due largely to growth in the overall market as well as a consistent history of year-over-year growth in net new business, including strong inflow of net new business in 2013. This growth was tempered by a decrease in service revenues from consulting services resulting primarily from the winding down of a project assisting a customer on a regulatory compliance matter, and from a large clinical solutions project on which we were executing in 2012 and 2013, but that is now nearing completion.
2012 compared to 2011
Product Development’s service revenues were $2.7 billion in 2012, an increase of $290.9 million, or 11.9%, over 2011. This increase is comprised of constant currency revenue growth of $328.6 million, or 13.5%, partially offset by a negative impact of approximately $37.7 million due to the effect of foreign currency fluctuations. The constant currency service revenues growth was primarily a result of a volume-related increase of $238.5 million in clinical solutions and services, $55.3 million from consulting services and $34.8 million from businesses acquired in the fourth quarter of 2011 and the third quarter of 2012.
Our clinical solutions and services experienced growth in all regions including the Americas, Europe and the Asia-Pacific. This growth was due largely to growth in the overall market as well as a consistent history of year-over-year growth in net new business that resulted in delivery in 2012 on the higher backlog as we entered the year. Also impacting the growth was an increase in global laboratories test volumes and an increase in the delivery of clinical solutions and services provided on a functional basis, principally due to the expansion of services and geographic deployment of resources on existing projects, and from the ramp up of new projects. This growth was partially offset by lower revenues from early clinical development services and was also tempered by a competitive pricing environment. Service revenues from consulting services increased primarily as a result of approximately $47.3 million of revenue related to assisting a customer with a regulatory compliance project.
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Costs of Service Revenues
2013 compared to 2012
Product Development’s costs of service revenues were higher by approximately $69.5 million in 2013, which was comprised of a $105.9 million constant currency increase, or 6.3%, partially offset by a reduction of $36.4 million from the positive effect of foreign currency fluctuations. The constant currency service costs growth was due to increases in compensation and related expenses resulting from an increase in billable headcount needed to support our higher volume of revenue as well as annual merit increases in compensation, partially offset by cost efficiencies gained from restructuring actions taken in prior years and incremental costs resulting from the business combinations completed in 2012 and 2013. The increase in compensation and related expenses was partially offset by a reduction of an accrual for statutory profit sharing of approximately $5.4 million as a result of guidance handed down by an administrative court in France and lower third party and travel costs. As a percent of service revenues, Product Development’s costs of service revenues were 60.0% and 61.7% in 2013 and 2012, respectively. The decrease in costs of service revenues as a percentage of service revenues was primarily a result of a closer alignment of resources with project requirements (including cost efficiencies gained from restructuring actions taken in prior years) as well as the impact related to the profit sharing accrual reversal in Europe.
2012 compared to 2011
Product Development’s costs of service revenues were higher by approximately $219.0 million in 2012, which was comprised of a $268.1 million constant currency increase, or 18.3%, partially offset by a reduction of $49.1 million from the effect of foreign currency fluctuations. On a constant currency basis, the increase in costs of service revenues was primarily due to an increase in compensation and related expenses resulting from an increase in billable headcount needed to support our higher volume of revenue, annual merit increases, an increase in incentive compensation, a $16.7 million reduction in the benefit from R&D grants received from France and Austria, incremental costs from businesses acquired in 2011 and 2012, and various other individually insignificant factors. As a percent of service revenues, Product Development’s costs of service revenues were 61.7% and 60.1% in 2012 and 2011, respectively, with the increase primarily related to (1) a competitive pricing environment, (2) the increase in headcount noted above to meet demand as well as to deliver on several large and complex projects, (3) the impact from the decrease in the benefit from R&D grants noted above, (4) investments in equipment and resources in 2012 that have enabled us to expand our global laboratories testing capabilities as well as our global reach for these services, and (5) overcapacity in the early clinical development services marketplace.
Selling, General and Administrative Expenses
2013 compared to 2012
As a percent of service revenues, Product Development’s selling, general and administrative expenses were 20.7% and 20.8% in 2013 and 2012, respectively. Product Development’s selling, general and administrative expenses increased approximately $37.1 million in 2013 as compared to 2012. This increase was primarily caused by increases in compensation and related expenses resulting from annual merit increases, facilities costs, depreciation and amortization, incremental costs for severance accruals of approximately $8.4 million related to overhead cost reduction programs, and the impact from the business combinations completed in 2012 and 2013. These increases were partially offset by a positive foreign currency impact of approximately $11.2 million.
2012 compared to 2011
As a percent of service revenues, Product Development’s selling, general and administrative expenses were 20.8% and 22.5% in 2012 and 2011, respectively. Product Development’s selling, general and administrative expenses increased approximately $18.7 million in 2012 as compared to 2011. This increase was primarily caused by (1) incremental costs resulting from the business combinations completed in the fourth quarter of 2011 and the third quarter of 2012, and (2) increased spending on business development and IT costs (including higher depreciation and amortization expense related to an increase in assets in service). The remaining increase was primarily the result of increases in compensation and related expenses including the impact of merit increases, an increase in headcount and higher incentive compensation. These increases were partially offset by (1) a positive foreign currency impact of approximately $13.9 million and (2) a reduction in facility costs due to a consolidation of offices in Europe (including lower depreciation and amortization expense due to fewer assets in service).
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Integrated Healthcare Services
| Change | ||||||||||||||||||||||||||||
| 2013 | 2012 | 2011 | 2013 vs. 2012 | 2012 vs. 2011 | ||||||||||||||||||||||||
| (dollars in millions) | ||||||||||||||||||||||||||||
| Service revenues | $ | 888.6 | $ | 963.6 | $ | 857.2 | $ | (75.0 | ) | (7.8 | %) | $ | 106.4 | 12.4 | % | |||||||||||||
| Costs of revenue, service costs | 718.6 | 776.0 | 688.7 | (57.4 | ) | (7.4 | ) | 87.3 | 12.7 | |||||||||||||||||||
| as a percentage of service revenues | 80.9 | % | 80.5 | % | 80.3 | % | ||||||||||||||||||||||
| Selling, general and administrative expenses | 127.9 | 127.1 | 110.3 | 0.8 | 0.7 | 16.8 | 15.3 | |||||||||||||||||||||
| Segment income from operations | $ | 42.1 | $ | 60.5 | $ | 58.2 | $ | (18.4 | ) | (30.4 | %) | $ | 2.3 | 4.0 | % | |||||||||||||
| as a percentage of service revenues | 4.7 | % | 6.3 | % | 6.8 | % |
Service Revenues
2013 compared to 2012
Integrated Healthcare Services’ service revenues were $888.6 million in 2013, a decrease of $75.0 million, or 7.8%, compared to 2012. This decrease was primarily due to a negative impact of approximately $47.0 million due to the effect of foreign currency fluctuations coupled with a constant currency revenue decrease of $28.0 million, or 2.9%. The decline in constant currency service revenues occurred primarily in commercial services in North America as revenues generated from recent strong new business has not yet reached a level sufficient to offset the impact from scope reductions and cancellations that occurred in prior periods.
2012 compared to 2011
Integrated Healthcare Services’ service revenues were $963.6 million in 2012, an increase of $106.4 million, or 12.4%, compared to 2011. This is comprised of constant currency revenue growth of $130.4 million, or 15.2%, which was partially offset by a negative impact of approximately $24.0 million due to the effect of foreign currency fluctuations. The constant currency service revenues growth was related to businesses acquired in 2011 as well as growth in North America, Europe and Japan. The increase in North America was primarily due to delivery on higher backlog in place as we entered the year. The increase in Europe was primarily due to revenue from a new agreement to distribute pharmaceutical products in Italy, partially offset by lower non-product related revenues. The modest revenue increase in Japan reflects the competitive market for these services in that region.
Costs of Service Revenues
2013 compared to 2012
Integrated Healthcare Services’ costs of service revenues in 2013 were lower by approximately $57.4 million as compared to 2012. This decrease was comprised of a reduction of $36.6 million from a positive impact of foreign currency fluctuations and a $20.8 million constant currency decrease. The constant currency decrease was primarily related to a decrease in compensation and related expenses driven mainly by a decrease in billable headcount.
2012 compared to 2011
Integrated Healthcare Services’ costs of service revenues in 2012 were higher by approximately $87.3 million as compared to 2011. This increase was comprised of $107.0 million of constant currency growth, which was partially offset by a reduction of $19.7 million from the effect of foreign currency fluctuations. The constant currency growth was primarily related to an increase in compensation and related expenses driven mainly by an increase in billable headcount, annual merit increases and an increase in incentive compensation, as well as incremental costs from businesses acquired in 2011. Also contributing to the constant currency growth were costs related to a new agreement to distribute pharmaceutical products in Italy. These impacts were partially offset by a decline in recruiting costs, as we were able to redeploy available resources on new business.
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Selling, General and Administrative Expenses
2013 compared to 2012
Integrated Healthcare Services’ selling, general and administrative expenses in 2013 were slightly higher as compared to 2012 primarily due to higher compensation and related expenses, IT costs, and facility costs as well as severance of approximately $1.6 million related to overhead cost reduction programs. These increases were mostly offset by lower depreciation and amortization expense and a reduction of approximately $4.1 million from the positive effect of foreign currency fluctuations.
2012 compared to 2011
As a percent of service revenues, Integrated Healthcare Services’ selling, general and administrative costs were 13.2% and 12.9% in 2012 and 2011, respectively. The $16.8 million increase in Integrated Healthcare Services’ selling, general and administrative expenses in 2012 as compared to 2011 was primarily due to $20.0 million from businesses acquired in the fourth quarter of 2011, which were partially offset by a reduction of $2.6 million from the effect of foreign currency fluctuations.
Liquidity and Capital Resources
Overview
We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Our principal source of liquidity is operating cash flows. In addition to operating cash flows, other significant factors that affect our overall management of liquidity include: capital expenditures, acquisitions, debt service requirements, dividends, equity repurchases, adequacy of our revolving credit facility, and access to the capital markets.
We manage our worldwide cash requirements by monitoring the funds available among our subsidiaries and determining the extent to which those funds can be accessed on a cost effective basis. The repatriation of cash balances from certain of our subsidiaries could have adverse income tax consequences. In 2013, we changed our assertion regarding the earnings of most of our foreign subsidiaries and now consider them indefinitely reinvested outside of the United States. Making this assertion limits our ability to repatriate cash from our foreign subsidiaries for the foreseeable future. In making this assertion, we determined that the cash flows expected to be generated in the United States are expected to be sufficient to fund our operating requirements and debt service obligations in the United States and that we expect the cash generated by the affected foreign subsidiaries will be used to fund growth outside of the United States. A future distribution or change in this assertion could result in additional tax liability.
We had a cash balance of $778.1 million at December 31, 2013 ($320.1 million of which was in the United States), an increase from $567.7 million at December 31, 2012.
On October 30, 2013, our Board approved an equity repurchase program authorizing the repurchase of up to $125.0 million of either our common stock or vested in-the-money employee stock options, or a combination thereof. We have used and intend to continue to use cash on hand to fund the equity repurchase program. The equity repurchase program does not obligate us to repurchase any particular amount of common stock or vested in-the-money employee stock options, and it could be modified, suspended or discontinued at any time. Repurchases of vested in-the-money employee stock options were made through transactions between us and our employees (other than our executive officers, who were not eligible to participate in the program), and this aspect of the equity repurchase program expired in November 2013. The equity repurchase program for common stock does not have an end date. Additional information regarding our equity repurchase program is presented in Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” and Note 13 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
On May 14, 2013, we completed the IPO of our common stock at a price to the public of $40.00 per share. We issued and sold 13,125,000 shares of common stock in the IPO and received proceeds of approximately $489.6 million, after deducting underwriting discounts, commissions and related expenses.
We used the net proceeds from the IPO as follows: (1) we repaid approximately $358.9 million of debt, including accrued interest and related fees and expenses, (2) we paid a one-time fee of $25.0 million to terminate our management agreement with our private equity sponsors, and (3) we used the remaining portion of the net proceeds, together with cash on hand, to complete the acquisition of Novella for approximately $146.6 million in cash (net of approximately $26.2 million of acquired cash).
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Based on our current operating plan, we believe that our available cash and cash equivalents, future cash flows from operations and our ability to access funds under our revolving credit facility, will enable us to fund our operating requirements and capital expenditures and meet debt obligations for at least the next 12 months. We regularly evaluate our debt arrangements, as well as market conditions, and from time to time we may explore opportunities to modify our existing debt arrangements or pursue additional financing arrangements that could result in the issuance of new debt securities by us or our affiliates. We may use our existing cash, cash generated from operations or dispositions of assets or businesses and/or proceeds from any new financing arrangements or issuances of debt or equity securities to repay or reduce some of our outstanding obligations, to repurchase shares from our shareholders or for other purposes. While our Board will review our dividend policy from time to time, we currently do not intend to pay dividends in the foreseeable future. As part of our ongoing business strategy, we also are continually evaluating new acquisition, expansion and investment possibilities or other strategic growth opportunities, as well as potential dispositions of assets or businesses, as appropriate, including dispositions that may cause us to recognize a loss on certain assets. Should we elect to pursue any such transaction, we may seek to obtain debt or equity financing to facilitate those activities. Our ability to enter into any such potential transactions and our use of cash or proceeds is limited to varying degrees by the terms and restrictions contained in our senior secured credit facilities. We cannot provide assurances that we will be able to complete any such alternative financing arrangements or other transactions on favorable terms or at all.
Senior Secured Credit Agreement
Our senior secured credit agreement provides for a $300 million revolving credit facility, due in 2018. There were no amounts drawn on this revolving credit facility in 2013.
On December 20, 2013, we entered into an amendment to our senior secured credit agreement to provide a new Term Loan B-3 with a syndicate of banks for an aggregate principal amount of $2.061 billion due in 2018. The proceeds from the Term Loan B-3 were used to repay the then outstanding balances of the Term Loan B-1 and Term Loan B-2 and related fees and expenses. The Term Loan B-3 bears interest at the greater of LIBOR or 1.25% plus 2.5%, which is 75 and 25 basis points lower than the interest rates that were in effect on the retired Term Loan B-1 and Term Loan B-2, respectively. Quarterly principal payments on the Term Loan B-3 are $5.15 million, commencing on September 30, 2014 and continuing through March 31, 2018, with the balance of the Term Loan B-3 to be repaid at final maturity on June 8, 2018. The credit facility arrangements are collateralized by substantially all of the assets of Quintiles Transnational and the assets of Quintiles Transnational’s domestic subsidiaries including 100% of the equity interests of substantially all of Quintiles Transnational’s domestic subsidiaries and 65% of the equity interests of substantially all of the first-tier foreign subsidiaries of Quintiles Transnational and its domestic subsidiaries (in each case other than certain excluded subsidiaries as defined in the credit agreement). Beginning with fiscal year ending December 31, 2014, we are required to apply 50% of excess cash flow (as defined in the credit agreement), subject to a reduction to 25% or 0% depending upon Quintiles Transnational’s total leverage ratio, for prepayment of the Term Loan B-3, with any such prepayment to be applied, first, in direct order of maturities, pro rata to reduce the Term Loan B-3 principal payments due within eight quarters of such prepayment, then on a pro rata basis to reduce the other principal payments due prior to the maturity date, and then to reduce the principal payments due on the maturity date. The amendment also provides additional flexibility for us to enter into certain securitization financing transactions. Other terms and covenants of the Term Loan B-3 are the same as the terms and covenants of our Term Loan B-1 and Term Loan B-2 prior to the amendment. In connection with this amendment to the credit agreement, we recognized a $3.3 million loss on extinguishment of debt which included approximately $1.6 million of unamortized debt issuance costs, approximately $1.6 million of unamortized discount and approximately $25,000 of related fees and expenses.
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Restrictive Covenants
The credit agreement governing the Quintiles Transnational senior secured credit facilities contains usual and customary restrictive covenants (subject to significant exceptions) that place limitations on Quintiles Transnational’s ability, and the ability of Quintiles Transnational’s restricted subsidiaries, to incur liens; engage in acquisitions, loans and other investments; incur additional indebtedness; merge, dissolve, liquidate or consolidate with or into other persons; sell or otherwise dispose of assets; declare dividends, including to Quintiles Holdings, and make other restricted payments; engage in businesses that are not related to Quintiles Transnational’s and its restricted subsidiaries’ existing business; transact with affiliates; enter into agreements that restrict subsidiaries from paying intercompany dividends or completing intercompany property transfers or that restrict the ability to create liens in favor of Quintiles Transnational’s lenders; amend or otherwise modify organizational documents or terms and conditions of junior financing documents, if any; change the fiscal year of Quintiles Transnational; prepay, redeem or purchase junior financing, if any; designate any other indebtedness as “designated senior indebtedness” or “senior secured financing”; and engage in sale and leaseback transactions. The credit agreement also contains one financial covenant, which is a total leverage ratio financial covenant that provides for a maximum ratio of consolidated debt, as defined in the credit agreement, to consolidated EBITDA, as defined in the credit agreement, for any period of four consecutive fiscal quarters, measured as of the end of such period, of 5.50 to 1.00 in 2013, 5.25 to 1.00 in 2014, 5.00 to 1.00 in 2015, and 4.75 to 1.00 in 2016 and thereafter, and applies at any time Quintiles Transnational makes a revolving loan borrowing, a swingline loan borrowing or issues a letter of credit, and for so long as any revolving loan, swingline loan, unreimbursed drawing under any letter of credit or undrawn letter of credit remains outstanding. In 2013, 2012 and 2011, we believe we were in compliance with our debt covenants.
See Note 10 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details regarding our credit arrangements.
Years ended December 31, 2013, 2012 and 2011
Cash Flow from Operating Activities
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Net cash provided by operating activities | $ | 397,370 | $ | 335,701 | $ | 160,953 |
2013 compared to 2012
Cash provided by operating activities increased by $61.7 million in 2013 as compared 2012. The increase in operating cash flow reflects lower payments for income taxes ($33.0 million) and interest ($11.6 million) in 2013. In addition, net income increased despite including cash expenses totaling $32.5 million for a fee paid in connection with the termination of our management agreement with affiliates of certain of our shareholders ($25.0 million), a fee paid in connection with the modification of an agreement for the business usage of an airplane owned by GFM ($1.5 million), and a termination fee for the repayment of the $300.0 million term loan ($6.0 million). These improvements in operating cash flow were partially offset by higher cash used in days sales outstanding, or DSO ($74.1 million). This higher cash used reflected a five-day increase in DSO in 2013. The net impact on cash from the increase in DSO resulted from the fact that we have continued to experience a trend toward longer payment terms on our contracts. DSO can shift significantly at each reporting period depending on the timing of cash receipts under contractual payment terms relative to the recognition of revenue over a project lifecycle.
2012 compared to 2011
Cash provided by operating activities increased by $174.7 million in 2012 as compared to 2011. The increase in operating cash flow was primarily as a result of the increase in income from operations, an improvement from the impact of the DSO, of ($162.4 million) and $23.7 million less cash used to pay expenses related to extinguishing debt in the 2012 compared to the 2011. The improvement in cash flows from DSO is as a result of a three-day decrease in DSO in 2012 compared to an 11-day increase in DSO in 2011. The net impact on cash from DSO is a result of normal fluctuations in the timing of payments from customers. Although we have continued to experience a trend toward longer payment terms on our contracts, a strong collection effort and significant cash payments late in 2012 on the close out of several large contracts resulted in the timing related decrease in DSO. These increases were partially offset by higher cash payments in 2012 for income taxes and interest of approximately $40.6 million and $26.2 million, respectively.
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Cash Flow from Investing Activities
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Net cash used in investing activities | $ | (240,175 | ) | $ | (132,233 | ) | $ | (224,838 | ) |
2013 compared to 2012
Cash used in investing activities increased by $108.0 million to $240.2 million in 2013, as compared to $132.2 million in 2012. The uses of cash in 2013 consisted primarily of the acquisition of Novella for approximately $145.0 million, acquisitions of property, equipment and software and cash used to fund investments in unconsolidated affiliates.
2012 compared to 2011
Cash used in investing activities decreased by $92.6 million to $132.2 million in 2012, as compared to $224.8 million in 2011. The uses of cash in 2012 consisted primarily of acquisitions of businesses, acquisitions of property, equipment and software and cash used to fund investments in unconsolidated affiliates and the purchase of equity securities. The cash used for the purchase of equity securities was due to the payment of the remaining commitment to fund our Samsung Group joint venture (approximately $13.2 million). Cash used for acquisitions of businesses includes approximately $39.3 million for the acquisition of Expression Analysis in the third quarter of 2012 as well as a $3.9 million scheduled payment pursuant to the terms in the purchase agreement of Outcome, which we acquired in 2011.
Cash Flow from Financing Activities
| Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (in thousands) | ||||||||||||
| Net cash provided by (used in) financing activities | $ | 70,957 | $ | (146,873 | ) | $ | (59,309 | ) |
2013 compared to 2012
Net cash provided by financing activities increased by $217.9 million to $71.0 million in 2013, as compared to cash used of $146.9 million in 2012. The increase in cash provided by financing activities in 2013 was primarily related to 1) the net proceeds of our IPO ($489.6 million), 2) lower cash used for dividends (zero paid in 2013 as compared to $567.9 million paid in 2012) and 3) cash received upon the exercise of stock options ($12.2 million). These increases in financing cash flows were partially offset by $822.3 million higher net use of cash for debt (cash used to pay debt and debt issue costs, less proceeds from the issuance of debt), which was a use of cash of $386.5 million in 2013, as compared to cash provided of $435.8 million in 2012, and $57.1 million of cash used to repurchase common stock and stock options in 2013 under our Board approved equity repurchase program. The increase in net cash used for debt in 2013 was primarily as a result of repayment of all amounts outstanding under the $300.0 million term loan (which was issued in 2012) and $83.8 million of repayments on our senior secured credit facilities (including a voluntary pay down of $50.0 million and a mandatory prepayment of $33.8 million as a result of excess cash flow (as defined in the credit agreement)).
2012 compared to 2011
Net cash used in financing activities increased by $87.6 million to $146.9 million in 2012, as compared to cash used of $59.3 million in 2011. The primary reason for the increase in cash used in financing activities in 2012 was related to an increase in dividends paid partially offset by the issuance of additional debt. Dividends paid on common stock increased by $279.6 million to $567.9 million ($4.91 per share) in 2012 as compared to $288.3 million ($2.48 per share) in 2011. This increase in the use of cash was partially offset by $186.9 million higher net proceeds from debt issuance (proceeds from the issuance of debt, net of costs less principal payments on credit arrangements) which were $435.8 million in 2012, as compared to $248.9 million in 2011.
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Contractual Obligations and Commitments
Below is a summary of our future payment commitments by year under contractual obligations as of December 31, 2013 (in thousands):
| 2014 | 2015-2016 | 2017-2018 | Thereafter | Total | ||||||||||||||||
| Long-term debt, including interest (1) | $ | 90,109 | $ | 198,957 | $ | 2,118,915 | $ | — | $ | 2,407,981 | ||||||||||
| Obligations under capital leases | 132 | 106 | — | — | 238 | |||||||||||||||
| Operating leases | 98,154 | 137,749 | 79,015 | 99,320 | 414,238 | |||||||||||||||
| Purchase obligations (2) | 4,081 | 3,388 | 200 | — | 7,669 | |||||||||||||||
| Commitments to unconsolidated affiliates (3) | 1,224 | — | — | — | 1,224 | |||||||||||||||
| Defined benefit plans (4) | 13,013 | — | — | — | 13,013 | |||||||||||||||
| Uncertain income tax positions (5) | 1,617 | — | — | — | 1,617 | |||||||||||||||
| Contingent consideration (6) | 5,035 | 7,979 | — | — | 13,014 | |||||||||||||||
| Total | $ | 213,365 | $ | 348,179 | $ | 2,198,130 | $ | 99,320 | $ | 2,858,994 | ||||||||||
| (1) | Interest payments on floating rate debt are based on the interest rate in effect on December 31, 2013. |
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| (2) | Purchase obligations are defined as agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable pricing provisions and the approximate timing of the transactions. |
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| (3) | We are currently committed to invest $50.0 million in the Fund. As of December 31, 2013, we have funded approximately $15.8 million of this commitment. We have approximately $34.2 million remaining to be funded under this commitment. |
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| (4) | We made cash contributions totaling approximately $8.6 million to our defined benefit plans in 2013, and we estimate that we will make contributions totaling approximately $13.0 million in 2014. Due to the potential impact of future plan investment performance, changes in interest rates, changes in other economic and demographic assumptions and changes in legislation in foreign jurisdictions, we are not able to reasonably estimate the timing and amount of contributions that may be required to fund our defined benefit plans for periods beyond 2014. |
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| (5) | As of December 31, 2013, our liability related to uncertain income tax positions was approximately $47.8 million, $46.2 million of which has not been included in the above table as we are unable to predict when these liabilities will be paid due to the uncertainties in the timing of the settlement of the income tax positions. |
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| (6) | Contingent consideration payable in connection with acquisitions. |
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Application of Critical Accounting Policies
Note 1 to the consolidated financial statements provided elsewhere in this Annual Report on Form 10-K describes the significant accounting policies used in the preparation of the consolidated financial statements. The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the period. Our estimates are based on historical experience and various other assumptions we believe are reasonable under the circumstances. We evaluate our estimates on an ongoing basis and make changes to the estimates and related disclosures as experience develops or new information becomes known. Actual results may differ from those estimates.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement, (2) the service offering has been delivered to the customer, (3) the collection of fees is probable and (4) the arrangement consideration is fixed or determinable. We do not recognize revenue with respect to start-up activities including contract and scope negotiation, feasibility analysis and conflict of interest review associated with contracts. The costs for these activities are expensed as incurred. For contracts in which portions of revenue are contingent upon the occurrence of uncertain future events we recognize the revenue only after it has been earned and the contingency has been resolved.
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The majority of our revenue is recognized based on objective contractual criteria and does not require significant estimates or judgments. However, at any point in time we are working on thousands of active customer projects, which are governed by individual contracts. Most projects are customized based on the needs of the customer, the type of services being provided, therapeutic indication of the drug, geographic locations and other variables. Project specific terms related to pricing, billing terms and the scope and type of services to be provided are generally negotiated and contracted on a project-by-project basis. Changes in the scope of work are common, especially under long-term contracts, and generally result in a change in contract value. In such situations, we enter into negotiations for a contract amendment to reflect the change in scope and the related price. Depending on the complexity of the amendment, the negotiation process can take from a few weeks for a simple adjustment to several months for a complex amendment. In limited situations, management may authorize the project team to commence work on activities outside the contract scope while we negotiate and finalize the contract amendment. In these limited cases, if we are not able to obtain a contract amendment from the customer, our profit margin on the arrangement may be impacted. This result occurs because our costs of delivery are expensed as they are incurred, while revenue is not recognized unless the customer has agreed to the changes in scope and renegotiated pricing terms, the contract value is amended and all other revenue recognition criteria are met.
For arrangements that include multiple elements, arrangement consideration is allocated to units of accounting based on the relative selling price. The best evidence of selling price of a unit of accounting is vendor-specific objective evidence, or VSOE, which is the price we charge when the deliverable is sold separately. When VSOE is not available to determine selling price, we use relevant third-party evidence, or TPE, of selling price, if available. When neither VSOE nor TPE of selling price exists, we use our best estimate of selling price considering all relevant information that is available without undue cost and effort.
Most contracts are terminable upon 30 to 90 days notice by the customer. Our risk of material loss in these situations is mitigated as these contracts generally require payment to us for expenses to wind down the trial or project, fees earned to date and, in some cases, a termination fee or a payment of some portion of the fees or profits that could have been earned under the contract if it had not been terminated early. In addition, our contract terms provide for payment terms that generally correspond with performance of the services. Termination fees are included in service revenues when realization is assured.
Accounts Receivable and Unbilled Services
Accounts receivable represents amounts billed to customers. Revenues recognized in excess of billings are classified as unbilled services. The realization of these amounts is based on the customer’s willingness and ability to pay us. We have an allowance for doubtful accounts based on management’s estimate of probable losses we expect to incur resulting from a customer failing to pay us. Our allowance for doubtful accounts, and losses from customers failing to pay us, have not been material to our results of operations. If any of these estimates change or actual results differs from expected results, then an adjustment is recorded in the period in which the amounts become reasonably estimable. These adjustments could have a material effect on our results of operations.
Investments in Unconsolidated Affiliates — Equity Method Investments
We have investments in unconsolidated affiliates that are accounted for under the equity method of accounting. Periodically, we review our investments for a decline in value which we believe may be other than temporary. Should we identify such a decline, we will record a loss through earnings to establish a new cost basis for the investment. These losses could have a material adverse effect on our results of operations.
Income Taxes
Certain items of income and expense are not recognized on our income tax returns and financial statements in the same year, which creates timing differences. The income tax effect of these timing differences results in (1) deferred income tax assets that create a reduction in future income taxes and (2) deferred income tax liabilities that create an increase in future income taxes. Recognition of deferred income tax assets is based on management’s belief that it is more likely than not that the income tax benefit associated with certain temporary differences, income tax operating loss and capital loss carryforwards and income tax credits, would be realized. We recorded a valuation allowance to reduce our deferred income tax assets for those deferred income tax items for which it was more likely than not that realization would not occur. We determined the amount of the valuation allowance based, in part, on our assessment of future taxable income and in light of our ongoing income tax strategies. If our estimate of future taxable income or tax strategies changes at any time in the future, we would record an adjustment to our valuation allowance. Recording such an adjustment could have a material effect on our financial position.
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Income tax expense is based on the distribution of profit before income tax among the various taxing jurisdictions in which we operate, adjusted as required by the income tax laws of each taxing jurisdiction. Changes in the distribution of profits and losses among taxing jurisdictions may have a significant impact on our effective income tax rate. Beginning in 2013, we consider the undistributed earnings of most of our foreign subsidiaries to be indefinitely reinvested outside of the United States. Accordingly, we have not provided a deferred income tax liability related to those undistributed earnings.
Business Combinations
We use the acquisition method to account for business combinations, and accordingly, the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree are recorded at their estimated fair values on the date of the acquisition. We use significant judgments, estimates and assumptions in determining the estimated fair value of assets acquired, liabilities assumed and noncontrolling interest including expected future cash flows; discount rates that reflect the risk associated with the expected future cash flows; and estimated useful lives.
When a business combination involves contingent consideration, we recognize a liability equal to the estimated fair value of the contingent consideration obligation at the date of the acquisition. The estimate of fair value of a contingent consideration liability requires subjective assumptions to be made regarding future business results including revenues and net new business, discount rates that reflect the risk associated with the expected future cash flows and probabilities assigned to various potential business result scenarios. We periodically reassess the estimated fair value of the contingent consideration over the term of the arrangement. Any resulting changes are recognized in earnings and could have a material effect on our results of operations.
Goodwill, Tangible and Identifiable Intangible Assets
We have recorded and allocated to our reporting units the excess of the cost over the fair value of the net assets acquired, known as goodwill. The recoverability of the goodwill and indefinite-lived intangible assets are evaluated annually for impairment, or if and when events or circumstances indicate a possible impairment. Goodwill and indefinite-lived intangible assets are not amortized. We review the carrying values of other identifiable intangible assets if the facts and circumstances indicate a possible impairment. Based upon our 2013 annual testing, we believe that the risk of a significant impairment to goodwill or indefinite-lived intangible assets is currently very low. Other identifiable intangible assets are amortized over their estimated useful lives.
For goodwill, we perform a qualitative analysis to determine whether it is more likely than not that the estimated fair value of a reporting unit is less than its book value. This includes a qualitative analysis of macroeconomic conditions, industry and market considerations, internal cost factors, financial performance, fair value history and other company specific events. If this qualitative analysis indicates that it is more likely than not that estimated fair value is less than the book value for the respective reporting unit, we apply a two-step impairment test in which we determine whether the estimated fair value of the reporting unit is in excess of its carrying value. If the carrying value of the net assets assigned to the reporting unit exceeds the estimated fair value of the reporting unit, we perform the second step of the impairment test to determine the implied estimated fair value of the reporting unit’s goodwill. We determine the implied estimated fair value of goodwill by determining the present value of the estimated future cash flows for each reporting unit and comparing the reporting unit’s risk profile and growth prospects to selected, reasonably similar publicly traded companies. The inherent subjectivity of applying a discounted cash flow and market comparables approach to valuing our assets and liabilities could have a significant impact on our analysis. Any future impairment could have a material adverse effect on our financial condition or results of operations.
For indefinite-lived intangible assets, we perform a qualitative analysis to determine whether it is more likely than not that the estimated fair value of the indefinite-lived intangible asset is less than its carrying value. If this qualitative analysis indicates that it is more likely than not that the estimated fair value is less than the carrying value of the indefinite-lived intangible asset, we determine the estimated fair value of the indefinite-lived intangible asset (trade name) by determining the present value of the estimated royalty payments on an after-tax basis that it would be required to pay the owner for the right to use such trade name. If the carrying amount exceeds the estimated fair value, an impairment loss is recognized in an amount equal to the excess. Any future impairment could have a material adverse effect on our financial condition or results of operations.
We review the carrying values of property and equipment if the facts and circumstances suggest that a potential impairment may have occurred. If this review indicates that carrying values will not be recoverable, as determined based on undiscounted cash flows over the remaining depreciation or amortization period, we will reduce carrying values to estimated fair value. The inherent subjectivity of our estimates of future cash flows could have a significant impact on our analysis. Any future write-offs of long-lived assets could have a material adverse effect on our financial condition or results of operations.
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Share-based Compensation Expense
In accordance with ASC 718, “Stock Compensation,” as modified or supplemented, we measure compensation cost for most share-based payment awards (stock options and stock appreciation rights) granted to employees and non-employee directors at fair value using the Black-Scholes-Merton option-pricing model. Share-based compensation expense includes share-based awards granted to employees and non-employee directors and has been reported in selling, general and administrative expenses in our consolidated statements of income based upon the classification of the individuals who were granted share-based awards.
We calculate the fair value of share-based compensation awards using the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton option-pricing model requires the use of subjective assumptions, including share price volatility, the expected life of the award, risk-free interest rate and the fair value of the underlying common shares on the date of grant. In developing our assumptions, we take into account the following:
| • | As a result of our status as a private company prior to our IPO, we do not have sufficient history to estimate the volatility of our common share price. We calculate expected volatility based on reported data for selected reasonably similar publicly traded companies for which the historical information is available. We plan to continue to use the guideline peer group volatility information until the historical volatility of our common shares is relevant to measure expected volatility for future award grants; |
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| • | We determine the risk-free interest rate by reference to implied yields available from United States Treasury securities with a remaining term equal to the expected life assumed at the date of grant; |
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| • | We estimate the dividend yield to be zero since we do not anticipate paying any future dividends subsequent to the IPO; |
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| • | We estimate the average expected life of the award based on our historical experience; and |
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| • | We estimate forfeitures based on our historical analysis of actual forfeitures. |
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