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.
For the year ended December 31, 2015, our service revenues increased $160.6 million, or 3.9%, to $4.3 billion at actual foreign exchange rates compared to 2014. Our growth in service revenues excluding the impact of foreign currency fluctuations (“constant currency”) was $372.9 million, or 9.0%, with $223.5 million, or 7.2%, growth in the Product Development segment and $149.4 million, or 14.0%, growth in the Integrated Healthcare Services segment.
For the year ended December 31, 2015, our income from operations was $646.6 million, an increase of $56.2 million (which included a positive impact of approximately $30.6 million from the effects of foreign currency fluctuations).
Our net income attributable to Quintiles Transnational Holdings Inc. was $387.2 million with diluted earnings per share of $3.08 for the year ended December 31, 2015.
Net new business was $5,319 million for the year ended December 31, 2015. This net new business contributed to an ending backlog of $12,038 million at December 31, 2015. “Net new business” and “backlog” are defined under “Net New Business Reporting and Backlog” in Part I, Item 1, “Business” of this Annual Report on Form 10-K.
Product Development
Product Development provides services and expertise that allow biopharmaceutical companies to outsource the clinical development process from first-in-man clinical trials to post-launch monitoring. Our comprehensive service offerings provide 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 advisory services (formerly consulting services). Clinical solutions and services provides services necessary to develop biopharmaceutical products. These services include project management and clinical monitoring functions for conducting multi-site clinical trials (generally Phase II-IV) (collectively “core clinical”). These also include clinical trial support services that improve clinical trial decision-making, such as global clinical trial 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. We also provide functional resourcing services that cover a range of areas. Advisory services provides strategy and management advisory services based on life science expertise and advanced analytics, as well as regulatory and compliance advisory services.
Integrated Healthcare Services
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. Our customized commercialization services are designed to accelerate the commercial success of biopharmaceutical and other health-related products. Service offerings include commercial services (sales representatives, strategy, marketing communications and other areas related to market access and commercialization), real-world and late phase research (drug therapy analysis, real-world research and evidence-based medicine, including research studies to prove a drug’s value), other healthcare services (comparative and cost-effectiveness research capabilities, decision support services, communication services and health engagement, medication adherence and health outcome optimization services, and web-based systems for measuring quality improvement), and EHR implementation and advisory services.
Industry Outlook
The potential of the CRO market served by Product Development is primarily a function of two variables: biopharmaceutical research and development spending and the proportion of this spending that is outsourced (outsourcing penetration). We expect outsourced clinical development to CROs to increase 6%-8% annually from 2015 to 2018, and believe this annual growth will be driven largely by increased outsourcing penetration, with up to 2% of this growth coming from increased research and development expenditures over 2015 to 2018. In estimating these growth rates, we monitor the ability of biopharmaceutical companies, including biotechnology companies, to raise capital, as well as the potential impact from merger and acquisition activity between biopharmaceutical companies. We estimate that overall outsourcing penetration of the addressable market in 2015 was 41%, and 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.
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 $101 billion market is approximately 23%. 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. As business models continue to evolve in the healthcare sector, we believe, based on industry data, analysis, and our own estimates, that the growth rate for outsourcing across the Integrated Healthcare Services markets should increase 6%-8% annually from 2015 to 2018.
Business Combinations
We completed a number of business combinations in 2013, 2014 and 2015 to enhance our capabilities and offerings in certain areas. In September 2013, we acquired Novella Clinical Inc., or 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 Product Development segment service offerings through its focus on emerging companies and by adding expertise in oncology and medical devices. In July 2014, we completed the acquisition of Encore for approximately $91.5 million in cash (net of approximately $2.2 million of acquired cash) to enhance our EHR expertise within our Integrated Healthcare Services segment. In July 2015, we combined our global clinical trials laboratory operations in our Product Development segment with the clinical trials laboratory operations of Quest with the resulting combined business referred to as Q2 Solutions. We own 60% of Q2 Solutions and Quest owns the remaining 40%. See Note 14 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information with respect to these business combinations. 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 73.8% of our 2015 service revenues and Integrated Healthcare Services representing 26.2% of our 2015 service revenues. 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 and travel expenses. 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 Translation
In 2015, approximately 32% of our service revenues were denominated in currencies other than the United States dollar. Because a large portion of our service revenues and expenses are denominated in currencies other than the United States dollar and our financial statements are reported in United States dollars, changes in foreign currency exchange rates can significantly affect our results of operations. The revenue and expenses of our foreign operations are generally denominated in local currencies and translated into United States dollars for financial reporting purposes. Accordingly, exchange rate fluctuations will affect the translation of foreign results into United States dollars for purposes of reporting our consolidated results. In 2015, foreign exchange rates in certain currencies in which we do business have fluctuated significantly as compared to the prior year, particularly the Euro, the Japanese Yen and the British Pound.
As a result, 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. 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.
Consolidated Results of Operations
For additional information regarding results of operations for Product Development and Integrated Healthcare Services, refer to “Segment Results of Operations” later in this section.
Year ended December 31, 2015 compared to the year ended December 31, 2014 and the year ended December 31, 2014 compared to the year ended December 31, 2013
Backlog and Net New Business
2015 compared to 2014
Backlog at December 31, 2015 was $12,038 million, which was 7% higher than 2014, including the incremental impact from the businesses that Quest contributed to Q2 Solutions.
Net new business decreased 5.1% (including a negative impact from foreign currency) in 2015 to $5,319 million from $5,602 million in 2014, driven by decreases in both Product Development and Integrated Healthcare Services. Product Development’s net new business decreased 5.8% in 2015 to $4,121 million from $4,374 million in 2014. Product Development had growth in net new business in 2015 from core clinical services and global clinical trial laboratory services including the incremental impact from the businesses that Quest contributed to Q2 Solutions. These increases were more than offset by lower net new business for functional resourcing services primarily because 2014 included renewals for two five-year contracts. Integrated Healthcare Services’ net new business decreased 2.5% in 2015 to $1,198 million from $1,228 million in 2014, related primarily to cancellations in North America as well as lower signings for commercial services in Europe, partially offset by net new business growth from the Encore acquisition which closed in July 2014 and from real-world and late phase research services.
2014 compared to 2013
Backlog at December 31, 2014 was $11,244 million, which was 14% higher than 2013.
Net new business grew 14% in 2014 to $5,602 million from $4,899 million in 2013, driven by growth in both Product Development and Integrated Healthcare Services. Product Development’s net new business increased 16% in 2014 to $4,374 million from $3,772 million in 2013, led by higher growth in net new business for functional resourcing services, which included renewals of two five-year contracts, growth in net new business for core clinical services in Asia, as well as net new business generated from the Novella acquisition and clinical trial support services, including early clinical development and lifecycle safety. Integrated Healthcare Services’ net new business increased 9% in 2014 to $1,228 million from $1,127 million in 2013, related primarily to growth in commercial services in North America, an increase in new business from real-world and late phase research services, and net new business from the Encore acquisition.
Our backlog at December 31, 2015 was $12,038 million compared to backlog of $11,244 million at December 31, 2014. 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. Revenue recognition occurs over extended periods of time and is subject to unanticipated delays. Fluctuations in our reported backlog and net new business levels may result from a small number of relatively large orders in any given reporting period that may be included in our backlog and net new business. Because of these large orders, our backlog and net new business in that reporting period may reach levels that may not be sustained in subsequent reporting periods. Our $12,038 million of backlog at December 31, 2015 included approximately $8,188 million of backlog that we do not expect to generate revenue in 2016 as compared to our $11,244 million of backlog at December 31, 2014, which included approximately $7,593 million of backlog that we did not expect to generate revenue in 2015. 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
| Year Ended December 31, | ||||||||||||
| 2015 | 2014 | 2013 | ||||||||||
| (dollars in millions) | ||||||||||||
| Service revenues | $ | 4,326.4 | $ | 4,165.8 | $ | 3,808.3 | ||||||
| % change from prior year | 3.9 | % | 9.4 | % |
2015 compared to 2014
In 2015, our service revenues increased $160.6 million, or 3.9%, as compared to 2014. This increase was comprised of constant currency service revenue growth of approximately $372.9 million, or 9.0%, and a negative impact of approximately $212.3 million from the effects of foreign currency fluctuations. The constant currency service revenue growth was comprised of a $223.5 million increase in Product Development, which includes the incremental impact from the businesses that Quest contributed to Q2 Solutions, and a $149.4 million increase in Integrated Healthcare Services, which includes the impact from the Encore acquisition which closed in July 2014.
2014 compared to 2013
In 2014, our service revenues increased $357.5 million, or 9.4%, as compared to 2013. This increase is comprised of constant currency revenue growth of approximately $383.2 million, or 10.1%, offset by a negative impact of approximately $25.7 million from the effects of foreign currency fluctuations. The constant currency service revenue growth, which includes the impact from the Novella and Encore acquisitions, is comprised of a $183.2 million increase in Product Development and a $200.0 million increase in Integrated Healthcare Services.
Costs of Revenue, Service Costs
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (dollars in millions) | ||||||||||||
| Costs of revenue, service costs | $ | 2,725.6 | $ | 2,684.1 | $ | 2,471.4 | ||||||
| % of service revenues | 63.0 | % | 64.4 | % | 64.9 | % |
2015 compared to 2014
When compared to 2014, service costs in 2015 increased $41.5 million. This increase included a constant currency increase in expenses of approximately $239.5 million, or 8.9%, partially offset by a positive impact of approximately $198.0 million from the effects of foreign currency fluctuations. The constant currency growth was comprised of a $140.0 million increase in Product Development, which included the incremental impact from the businesses that Quest contributed to Q2 Solutions, and a $99.5 million increase in Integrated Healthcare Services, which included the impact from the Encore acquisition which closed in July 2014.
The decrease in service costs as a percent of service revenues for 2015 was primarily as a result of an improvement in constant currency profit margin in both the Product Development and Integrated Healthcare Services segments (as more fully described in the segment discussion later in this section). For 2015, this constant currency profit margin expansion was partially offset by the effect from a higher proportion of consolidated service revenues being contributed by our lower margin Integrated Healthcare Services segment when compared to 2014 as well as a negative impact from foreign currency fluctuations.
2014 compared to 2013
When compared to 2013, service costs in 2014 increased $212.7 million. The increase included a constant currency increase in expenses of approximately $253.5 million, or 10.3%, partially offset by a positive impact of approximately $40.8 million from the effects of foreign currency fluctuations. The constant currency growth was comprised of a $94.0 million increase in Product Development, and a $159.5 million increase in Integrated Healthcare Services, which included the impact from the Encore acquisition which closed in July 2014.
Selling, General and Administrative
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (dollars in millions) | ||||||||||||
| Selling, general and administrative | $ | 921.0 | $ | 882.3 | $ | 860.5 | ||||||
| % of service revenues | 21.3 | % | 21.2 | % | 22.6 | % |
2015 compared to 2014
The $38.7 million increase in selling, general and administrative expenses in 2015 included a constant currency increase of $80.8 million, or 9.2%, partially offset by a positive impact of approximately $42.1 million from the effects of foreign currency fluctuations. The constant currency growth was comprised of a $47.2 million increase in Product Development, which included the incremental impact from the businesses that Quest contributed to Q2 Solutions, a $20.7 million increase in Integrated Healthcare Services, which included the impact from the Encore acquisition which closed in July 2014, and a $12.9 million increase in general corporate and unallocated expenses. The constant currency increase in 2015 for general corporate and unallocated expenses was primarily due to an increase in share-based compensation and costs associated with the Q2 Solutions transaction.
2014 compared to 2013
The $21.8 million increase in selling, general and administrative expenses in 2014 included a constant currency increase of $29.3 million, or 3.4%, partially offset by a positive impact of approximately $7.5 million from the effects of foreign currency fluctuations. The constant currency growth was comprised of a $33.6 million increase in Product Development, which includes the impact from the Novella acquisition which closed in September 2013, and a $13.0 million increase in Integrated Healthcare Services, which includes the impact from the Encore acquisition which closed in July 2014. The constant currency growth was partially offset by a $17.3 million decrease in general corporate and unallocated expenses. The constant currency decrease in 2014 for general corporate and unallocated expenses was primarily due to expenses incurred in 2013 that did not recur in 2014 including a $25.0 million fee paid in connection with the termination of our management agreement with affiliates of certain of our shareholders, approximately $5.3 million of executive separation costs, and a $1.5 million fee paid in connection with the modification of an agreement for the business usage of an airplane owned by GF Management Company, LLC, or GFM, a company controlled by our former Executive Chairman who retired effective December 31, 2015 but remains one of our directors. These decreases in general corporate and unallocated expenses were partially offset by an increase in share-based compensation and increases in compensation and related expenses resulting primarily from annual merit increases and an increase in headcount.
Restructuring Costs
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Restructuring costs | $ | 30.8 | $ | 9.0 | $ | 14.1 |
During 2015, we recognized $30.8 million of restructuring charges, net of reversals for changes in estimates, associated with both the February 2015 restructuring plan and the Q2 Solutions restructuring plan. The remaining actions under these plans are expected to occur throughout 2016 and 2017, and are expected to consist of severance, facility closure and other exit-related costs. We believe that these plans will result in annualized cost savings of approximately $50.0 million to $60.0 million.
During 2014, we recognized $9.0 million of restructuring charges, net of reversals for changes in estimates, which was primarily related to our 2014 restructuring plans to better align our resources with our strategic direction.
During 2013, we recognized $14.1 million of restructuring charges, net of reversals for changes in estimates, which was primarily related to our February 2013 restructuring plan to migrate the delivery of services and to reduce anticipated overcapacity in selected areas.
Impairment Charges
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Impairment charges | $ | 2.5 | $ | — | $ | — |
During the fourth quarter of 2015, we exited a training facility in Japan that is being actively marketed for sale, resulting in a $2.5 million impairment of the land and building.
Interest Income and Interest Expense
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Interest income | $ | (4.3 | ) | $ | (3.4 | ) | $ | (3.9 | ) | |||
| Interest expense | $ | 101.8 | $ | 100.6 | $ | 123.5 |
Interest income included interest received primarily from bank balances and investments.
Interest expense during 2015 was slightly higher than 2014 due to an increase in the average debt outstanding, primarily as a result of the $275.0 million term loan that was issued under the receivables financing facility in December 2014 and our new senior secured credit agreement and senior notes, both of which are described in Liquidity and Capital Resources. This increase was partially offset by a decrease in the average rate of interest incurred on our debt as compared to 2014.
Interest expense during 2014 was lower than 2013 in part due to a decrease in the average rate of interest. The average rate of interest on the term loan under our senior secured credit facility during 2014 was lower than it was during 2013 due to a reduction in the interest rate pursuant to the terms and conditions in the credit agreement as well as from the refinancing transaction we completed in the fourth quarter of 2013. In addition to the lower average rate of interest, interest expense during 2014 also benefited from a decrease in the average debt outstanding as a result of 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, the pay down of $50.0 million of outstanding indebtedness under our senior secured credit facilities in May 2013, the mandatory prepayment of $33.8 million of outstanding indebtedness under our senior secured credit facilities in the first quarter of 2013, and the $25.0 million prepayment of outstanding indebtedness under our senior secured credit facilities in December 2014. These repayments more than offset the impact on the average debt outstanding of the $275.0 million term loan issued under the receivables financing facility in December 2014 and the $150.0 million draw on our line of credit in 2014, which was repaid with the proceeds of the receivables financing facility term loan.
Loss on Extinguishment of Debt
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Loss on extinguishment of debt | $ | 7.8 | $ | — | $ | 19.8 |
In May 2015, we recognized a $7.8 million loss on extinguishment of debt related to the refinancing of our senior secured credit facilities. The loss on extinguishment of debt included $1.1 million of unamortized debt issuance costs, $1.3 million of unamortized discount and $5.4 million of related fees and expenses.
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 $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 $300.0 million 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 $5.6 million of unamortized debt issuance costs, $4.8 million of unamortized discount and $6.1 million of fees and expenses.
See “—Liquidity and Capital Resources” for more information on these transactions.
Other Expense (Income), Net
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Other expense (income), net | $ | 2.4 | $ | (9.0 | ) | $ | (0.2 | ) |
Other expense (income), net for 2015 primarily consisted of $5.9 million of expense related to the change in fair value of contingent consideration related to an acquisition, partially offset by $4.6 million of foreign currency net gains.
Other expense (income), net for 2014 included income of approximately $8.6 million due to changes in the estimated fair value of contingent consideration from an acquisition as well as a gain from the sale of marketable equity securities of approximately $5.0 million, partially offset by other expenses, primarily consisting of $4.9 million of foreign currency net losses.
Other expense (income), net for 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. In addition, 2013 included approximately $4.0 million of foreign currency net losses.
Income Tax Expense
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (dollars in millions) | ||||||||||||
| Income tax expense | $ | 159.0 | $ | 150.1 | $ | 96.0 | ||||||
| Effective income tax rate | 29.5 | % | 29.9 | % | 29.7 | % |
The decrease in the 2015 effective income tax rate was due to an income tax benefit related to the reversal of uncertain tax positions for tax years whose statute of limitations expired in 2015 and also a change in the relative mix of the profitability between taxing jurisdictions. These benefits were partially offset by additional income tax expense related to an increase in the amount of current year earnings of our foreign subsidiaries not considered permanently reinvested.
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. This negative impact was primarily offset 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. 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 and we do not anticipate paying dividends in the foreseeable future, which had been significant in the past. Given our debt balance, 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.
Equity in Earnings (Losses) of Unconsolidated Affiliates
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Equity in earnings (losses) of unconsolidated affiliates | $ | 8.3 | $ | 4.4 | $ | (1.1 | ) |
Equity in earnings (losses) of unconsolidated affiliates in 2015 primarily included earnings from our investment in NovaQuest Pharma Opportunities Fund III, L.P., or Fund III. The increase in 2014 when compared to 2013 was primarily due to earnings from Fund III partially offset by losses and write-downs incurred on another equity method investment.
Net (Income) Loss Attributable to Noncontrolling Interests
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Net (income) loss attributable to noncontrolling interests | $ | (1.1 | ) | $ | (0.1 | ) | $ | 0.6 |
Net (income) loss attributable to noncontrolling interests in 2015 primarily included Quest’s interest in Q2 Solutions.
Segment Results of Operations
Service revenues and income from operations by segment are as follows (dollars in millions):
| Service Revenues | Income from Operations | Operating Profit Margin | ||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | 2015 | 2014 | 2013 | 2015 | 2014 | 2013 | ||||||||||||||||||||||||||||
| Product Development | $ | 3,191.6 | $ | 3,097.8 | $ | 2,919.7 | $ | 714.6 | $ | 645.2 | $ | 562.3 | 22.4 | % | 20.8 | % | 19.3 | % | ||||||||||||||||||
| Integrated Healthcare Services | 1,134.8 | 1,068.0 | 888.6 | 84.0 | 64.8 | 42.1 | 7.4 | 6.1 | 4.7 | |||||||||||||||||||||||||||
| Total segments | 4,326.4 | 4,165.8 | 3,808.3 | 798.6 | 710.0 | 604.4 | 18.5 | % | 17.0 | % | 15.9 | % | ||||||||||||||||||||||||
| General corporate and unallocated | (118.7 | ) | (110.6 | ) | (128.0 | ) | ||||||||||||||||||||||||||||||
| Restructuring costs | (30.8 | ) | (9.0 | ) | (14.1 | ) | ||||||||||||||||||||||||||||||
| Impairment charges | (2.5 | ) | — | — | ||||||||||||||||||||||||||||||||
| Consolidated | $ | 4,326.4 | $ | 4,165.8 | $ | 3,808.3 | $ | 646.6 | $ | 590.4 | $ | 462.3 |
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. We do not allocate restructuring or impairment charges to our segments.
Product Development
| Change | ||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | 2015 vs. 2014 | 2014 vs. 2013 | ||||||||||||||||||||||||
| (dollars in millions) | ||||||||||||||||||||||||||||
| Service revenues | $ | 3,191.6 | $ | 3,097.8 | $ | 2,919.7 | $ | 93.8 | 3.0 | % | $ | 178.1 | 6.1 | % | ||||||||||||||
| Costs of revenue, service costs | 1,828.7 | 1,820.9 | 1,752.8 | 7.8 | 0.4 | 68.1 | 3.9 | |||||||||||||||||||||
| as a percentage of service revenues | 57.3 | % | 58.8 | % | 60.0 | % | ||||||||||||||||||||||
| Selling, general and administrative | 648.3 | 631.7 | 604.6 | 16.6 | 2.6 | 27.1 | 4.5 | |||||||||||||||||||||
| as a percentage of service revenues | 20.3 | % | 20.4 | % | 20.7 | % | ||||||||||||||||||||||
| Segment income from operations | $ | 714.6 | $ | 645.2 | $ | 562.3 | $ | 69.4 | 10.8 | % | $ | 82.9 | 14.8 | % | ||||||||||||||
| as a percentage of service revenues | 22.4 | % | 20.8 | % | 19.3 | % |
Service Revenues
2015 compared to 2014
Product Development’s service revenues were $3,191.6 million in 2015, an increase of $93.8 million, or 3.0%, over 2014. This increase was comprised of constant currency service revenue growth of $223.5 million, or 7.2%, partially offset by a negative impact of approximately $129.7 million from the effects of foreign currency fluctuations. The constant currency service revenue growth primarily included $230.7 million from a volume-related increase from clinical solutions and services and the incremental impact from the businesses that Quest contributed to Q2 Solutions, which was partially offset by a decrease of $7.2 million from advisory services.
The volume-related service revenue growth was related to core clinical services, clinical solutions provided on a functional resource basis and clinical trial support services. This growth was due largely to execution on the higher backlog in place as we entered the year. In addition, we recognized $16.9 million of revenue in the second quarter of 2015 as a result of the release of deferred revenue upon the early close out of a customer arrangement. Lower revenues from advisory services were primarily due to lower activity on projects related to regulatory compliance remediation.
Constant currency service revenue growth during the year ended December 31, 2015 was also negatively impacted by cancellations from 2014.
2014 compared to 2013
Product Development’s service revenues were $3.1 billion in 2014, an increase of $178.1 million, or 6.1%, over 2013. This increase was comprised of constant currency service revenue growth of $183.2 million, or 6.3%, offset by a negative impact of approximately $5.1 million from the effects of foreign currency fluctuations. The constant currency service revenue growth was primarily a result of a volume-related increase of $100.2 million in clinical solutions and services and $89.6 million from the Novella acquisition, which were partially offset by a decrease of $6.6 from advisory services.
The volume-related service revenue growth from clinical solutions and services was related to an increase in clinical solutions provided on a functional resource basis, clinical trial support services, and core clinical services in Asia and Japan. This growth was due largely to execution on the higher backlog in place as we entered 2014. The rate of year-over-year revenue growth was negatively impacted by the wind-down of a large clinical solutions project delivered throughout 2013.
Costs of Revenue, Service Costs
2015 compared to 2014
Product Development’s service costs increased approximately $7.8 million in 2015 over 2014. This increase included a constant currency increase of $140.0 million, or 7.7%, which included the incremental impact from the businesses that Quest contributed to Q2 Solutions, partially offset by $132.2 million from the positive effects of foreign currency fluctuations.
The constant currency service costs growth was primarily due to the impact from the Q2 Solutions transaction and an increase in compensation and related expenses. The increase in compensation and related expenses resulted from an increase in billable headcount as a result of the ramp up of new projects, which we expect to continue, as well as annual merit increases and an increase in competition for qualified personnel in certain markets. Also contributing to the constant currency increase was $17.2 million of expense recognized in the second quarter of 2015 as a result of the release of deferred contract costs upon the early close out of a customer arrangement. Service cost growth was partially offset by an $8.3 million increase in the benefit from research and development credits received in Europe when compared to the same period in the prior year. As a percent of service revenues, Product Development’s service costs were 57.3% and 58.8% in 2015 and 2014, respectively. The decrease in service costs as a percentage of service revenues reflected a favorable impact of 170 basis points from the effects of foreign currency fluctuations and a closer alignment of resources with project requirements, including cost efficiencies gained from restructuring actions taken in prior years, which more than offset the impact of the constant currency service costs growth noted above.
2014 compared to 2013
Product Development’s service costs increased approximately $68.1 million in 2014 over 2013. This increase was comprised of a $94.0 million constant currency increase, or 5.4%, partially offset by a reduction of $25.9 million from the positive effect of foreign currency fluctuations.
The constant currency service costs growth was due to (1) incremental costs resulting from the Novella acquisition, (2) an increase in billable headcount and other expenses directly related to our service contracts to support our higher volume of revenue, and (3) a reduction of an accrual for statutory profit sharing of approximately $5.4 million in 2013 as a result of guidance handed down by an administrative court in France. These increases in service costs were partially offset by a $10.6 million increase in the benefit from research and development grants primarily from France and Austria as well as efficiencies gained from restructuring activities taken in prior years. As a percent of service revenues, Product Development’s service costs were 58.8% and 60.0% in 2014 and 2013, respectively. The decrease in service costs 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.
Selling, General and Administrative
2015 compared to 2014
Product Development’s selling, general and administrative expenses increased approximately $16.6 million, or 2.6%, in 2015 as compared to 2014. This increase was primarily caused by a constant currency increase of $47.2 million, which included the incremental impact from the businesses that Quest contributed to Q2 Solutions, partially offset by a reduction of $30.6 million from the positive effects of foreign currency fluctuations. As a percent of service revenues, Product Development’s selling, general and administrative expenses were 20.3% and 20.4% in 2015 and 2014, respectively.
The constant currency increase was primarily due to the incremental impact from the businesses that Quest contributed to Q2 Solutions, higher compensation and related expenses due to annual merit increases and an increase in headcount.
2014 compared to 2013
Product Development’s selling, general and administrative expenses increased approximately $27.1 million, or 4.5%, in 2014 as compared to 2013. This increase was primarily caused by a constant currency increase of $33.6 million, which included the impact from the Novella acquisition. These increases were partially offset by $8.4 million of costs incurred in 2013 that did not recur in 2014 for severance associated with cost reduction programs as well as a positive impact of approximately $6.5 million from the effects of foreign currency fluctuations. As a percent of service revenues, Product Development’s selling, general and administrative expenses were 20.4% and 20.7% in 2014 and 2013, respectively.
The constant currency increase was primarily caused by the impact from the Novella acquisition, increases in compensation and related expenses resulting from annual merit increases and an increase in headcount, and a growth related increase in IT costs.
Integrated Healthcare Services
| Change | ||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | 2015 vs. 2014 | 2014 vs. 2013 | ||||||||||||||||||||||||
| (dollars in millions) | ||||||||||||||||||||||||||||
| Service revenues | $ | 1,134.8 | $ | 1,068.0 | $ | 888.6 | $ | 66.8 | 6.3 | % | $ | 179.4 | 20.2 | % | ||||||||||||||
| Costs of revenue, service costs | 896.9 | 863.2 | 718.6 | 33.7 | 3.9 | 144.6 | 20.1 | |||||||||||||||||||||
| as a percentage of service revenues | 79.0 | % | 80.8 | % | 80.9 | % | ||||||||||||||||||||||
| Selling, general and administrative | 153.9 | 140.0 | 127.9 | 13.9 | 9.9 | 12.1 | 9.5 | |||||||||||||||||||||
| as a percentage of service revenues | 13.6 | % | 13.1 | % | 14.4 | % | ||||||||||||||||||||||
| Segment income from operations | $ | 84.0 | $ | 64.8 | $ | 42.1 | $ | 19.2 | 29.7 | % | $ | 22.7 | 53.8 | % | ||||||||||||||
| as a percentage of service revenues | 7.4 | % | 6.1 | % | 4.7 | % |
Service Revenues
2015 compared to 2014
Integrated Healthcare Services’ service revenues were $1,134.8 million in 2015, an increase of $66.8 million, or 6.3%, over 2014. This increase was comprised of constant currency service revenue growth of $149.4 million, or 14.0%, including $43.8 million from the Encore acquisition which closed in July 2014, partially offset by a negative impact of approximately $82.6 million due to the effects of foreign currency fluctuations.
The increase in constant currency service revenues was due to the impact from the Encore acquisition which closed in July 2014, an increase in commercial services in North America, as well as growth in real-world and late phase research services. In addition, 2015 was impacted by a decline in Europe due to the loss of revenue from an agreement to distribute pharmaceutical products in Italy that ended in the fourth quarter of 2014.
2014 compared to 2013
Integrated Healthcare Services’ service revenues were $1,068.0 million in 2014, an increase of $179.4 million, or 20.2%, over 2013. This increase is comprised of constant currency service revenue growth of $200.0 million, or 22.5%, partially offset by a negative impact of approximately $20.6 million due to the effect of foreign currency fluctuations.
The increase in constant currency service revenues was driven by $35.4 million from the Encore acquisition and an increase in commercial services in North America and Japan, as well as growth in real-world and late phase research services. These increases were partially offset by a decline in Europe due to lower revenue from an agreement to distribute pharmaceutical products in Italy as well as lower commercial services revenues. The agreement to distribute pharmaceutical products in Italy ended in the fourth quarter of 2014.
Costs of Revenue, Service Costs
2015 compared to 2014
Integrated Healthcare Services’ service costs increased approximately $33.7 million in 2015. This increase was comprised of a $99.5 million constant currency increase, or 11.5%, partially offset by a reduction of $65.8 million from the positive effects of foreign currency fluctuations.
The constant currency increase for 2015 was due to the impact of the Encore acquisition and an increase in compensation and related expenses resulting from an increase in billable headcount needed to support the higher volume of constant currency revenue and annual merit increases. These increases in compensation and related expenses were partially offset by a decline in other expenses directly related to the agreement to distribute pharmaceutical products in Italy, which ended in the fourth quarter of 2014.
As a percent of service revenues, costs of revenue was 79.0% in 2015 as compared to 80.8% in the prior year. This improvement in profit margin (as a percent of service revenues) resulted primarily from constant currency profit margin expansion in real-world and late phase research services, and commercial services in Japan as well as in Europe, including the impact from the termination of the low margin agreement to distribute pharmaceutical products in Italy in 2014. This constant currency profit margin expansion was partially offset by a negative impact from foreign currency fluctuations.
2014 compared to 2013
Integrated Healthcare Services’ service costs increased approximately $144.6 million in 2014. This increase was comprised of a $159.5 million constant currency increase, or 22.2%, partially offset by a reduction of $14.9 million from the positive effect of foreign currency fluctuations.
The constant currency increase was primarily due to the impact from the Encore acquisition and increases in compensation and related expenses resulting from an increase in billable headcount needed to support the higher volume of revenue and annual merit compensation increases. These increases in compensation and related expenses were partially offset by a decline in other expenses directly related to the agreement to distribute pharmaceutical products in Italy, which ended in the fourth quarter of 2014.
Selling, General and Administrative
2015 compared to 2014
Integrated Healthcare Services’ selling, general and administrative expenses increased approximately $13.9 million, or 9.9%, in 2015 as compared to 2014. This increase was comprised of a $20.7 million constant currency increase, or 14.8%, partially offset by a reduction of $6.8 million from the positive effects of foreign currency fluctuations.
The constant currency increase was primarily due to the impact from the Encore acquisition which closed in July 2014 and an increase in compensation and related expenses.
2014 compared to 2013
Integrated Healthcare Services’ selling, general and administrative expenses increased approximately $12.1 million, or 9.5%, in 2014 as compared to 2013. This increase was comprised of a $13.0 million constant currency increase, or 10.2%. This increase was partially offset by $1.6 million of costs incurred in 2013 that did not recur in 2014 for severance associated with cost reduction programs as well as a positive impact of approximately $900,000 from the effects of foreign currency fluctuations.
The constant currency increase was primarily due to the impact from the Encore acquisition which closed in July 2014 and increases in compensation and related expenses. The increase in compensation and related expenses resulted from annual merit increases and an increase in headcount.
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, investments, debt service requirements, dividends, equity repurchases, adequacy of our revolving credit and receivables financing facilities 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. The earnings of most of our foreign subsidiaries are considered indefinitely reinvested outside the United States, which limits our ability to repatriate cash from our foreign subsidiaries for the foreseeable future.
We had a cash balance of $977.2 million at December 31, 2015 ($244.9 million of which was in the United States), an increase from $867.4 million at December 31, 2014.
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 and receivables financing facilities 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. 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 financing arrangements or other transactions on favorable terms or at all.
Equity Repurchases
Since 2013, we have repurchased approximately $995.6 million of our equity securities as discussed further below.
Equity Repurchase Program
On October 30, 2013, our Board approved the 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. During 2015, our Board increased the share repurchase authorization under the Repurchase Program by $600.0 million, which increased the total amount that has been authorized under the Repurchase Program to $725.0 million. The Repurchase Program does not obligate us to repurchase any particular amount of common stock or vested in-the-money employee stock options and it can 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 Repurchase Program expired in November 2013. The Repurchase Program for common stock does not have an end date. Under the Repurchase Program in 2015, we repurchased 7,855,796 shares of common stock for an aggregate purchase price of $515.0 million (representing an average price per share of $65.56). From inception through December 31, 2015, we have repurchased $59.1 million of stock options and $521.4 million of common stock under the Repurchase Program. As of December 31, 2015, we have remaining authorization under the Repurchase Program to repurchase up to $144.5 million of our common stock. Additional information regarding the 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 12 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Other Equity Repurchases
On May 28, 2014, we completed the repurchase of 3,287,209 shares of our common stock for $50.23 per share from TPG Quintiles Holdco, L.P., one of our existing shareholders, in a private transaction for an aggregate purchase price of approximately $165.1 million. The repurchase price per share of common stock was equal to 98% of the closing market price of our common stock on the NYSE on May 27, 2014 (which was $51.26). The repurchase of shares from our existing shareholder was authorized in compliance with our related party transactions approval policy. We funded this private repurchase transaction with cash on hand. This private repurchase transaction was separate from and in addition to the Repurchase Program.
On November 10, 2014, we completed the repurchase of 4,303,666 shares of our common stock for $58.09 per share for an aggregate purchase price of approximately $250.0 million. We funded this repurchase transaction with a combination of cash on hand and a $150.0 million draw on our revolving credit facility which was subsequently repaid. This repurchase transaction was separate from and in addition to the Repurchase Program.
Senior Secured Credit Agreement and Senior Notes
On May 12, 2015, Quintiles Transnational entered into new senior secured credit facilities, or the New Facilities, totaling $1.95 billion. The New Facilities consist of a five-year $500.0 million revolving credit facility, or the New Revolver, and $1.45 billion of term loans ($850 million in Term Loan A due 2020, or Term Loan A, and $600 million in Term Loan B due 2022, or Term Loan B). In addition, Quintiles Transnational issued $800 million of 4.875% senior unsecured notes due 2023, or the Senior Notes, in a private placement. The New Facilities and the Senior Notes are referred to collectively as the “New Debt.” Annual maturities on the Term Loan A and the Term Loan B are 5% and 1%, respectively, of the respective original principal amount with the remaining balances to be repaid on their respective maturity dates. Beginning with the fiscal year ending December 31, 2016, we will be required to make mandatory repayments on Term Loan A and Term Loan B of 50% of excess cash flow (as defined in the credit agreement covering the New Facilities, subject to a reduction to 25% or 0% depending upon our leverage ratio). Based on our current expectations, we do not anticipate any significant mandatory repayments. Mandatory repayments will be allocated pro rata between Term Loan A and Term Loan B (subject to increases in the amount of Term Loan A repayments with amounts declined by Term Loan B lenders), and applied, first, to reduce the next eight quarterly amortization installments in direct order of maturity, and, second, to reduce all remaining amortization installments pro rata. We also will be required to make mandatory repayments with 100% of the net cash proceeds of certain asset dispositions, subject to thresholds and reinvestment rights. Any amounts outstanding under the New Facilities may be voluntarily repaid at any time without penalty. The new senior secured credit facilities 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. Interest on the Senior Notes is paid semiannually on May 15 and November 15 of each year until maturity. The Senior Notes are unsecured senior obligations of Quintiles Transnational and are effectively subordinated in right of payment to all secured obligations of Quintiles Transnational, to the extent of the value of any collateral. We used the proceeds from the New Debt (i) to repay the Term Loan B-3 under our then outstanding senior credit agreement which was due in 2018, (ii) to pay related fees and expenses including $11.0 million of breakage fees associated with the terminated interest rate swaps, and (iii) for general corporate purposes including the share repurchase discussed above.
Receivables Financing Facility
On December 5, 2014, we entered into a four-year arrangement to securitize certain of our accounts receivable. Under the receivables financing facility, certain of our accounts receivable are sold on a non-recourse basis by certain of our consolidated subsidiaries to another of our consolidated subsidiaries, a bankruptcy-remote special purpose entity, or SPE. The SPE obtained a term loan and revolving loan commitment from a third party lender, secured by liens on the assets of the SPE, to finance the purchase of the accounts receivable, which included a $275.0 million term loan and a $25.0 million revolving loan commitment. The revolving loan commitment may be increased by an additional $35.0 million as amounts are repaid under the term loan. Quintiles Transnational has guaranteed the performance of the obligations of existing and future subsidiaries that sell and service the accounts receivable under the receivables financing facility. The assets of the SPE are not available to satisfy any of our obligations or any obligations of our subsidiaries. The interest rate under the receivables financing facility is a reserve-adjusted LIBOR rate for amounts outstanding on the term loan and a reserve-adjusted LIBOR market index rate for amounts outstanding on the revolving loan. Interest is payable monthly. We used the proceeds from the term loan under the receivables financing facility to repay in full the amount outstanding on the revolving credit facility under our senior secured credit agreement ($150.0 million), to repay $25.0 million of the Term Loan B-3 under our then outstanding senior secured credit agreement, to pay related fees and expenses and the remainder was used for general working capital purposes. As of December 31, 2015, the full $25.0 million of revolving loan commitment was available under the receivables financing facility.
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 Transnational Holdings Inc., 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 that provides for a maximum ratio of consolidated total debt 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 5.75 to 1.00, and applies at any time that the Term Loan A or New Revolver commitments remain outstanding. Violations of the financial covenant will not entitle the Term Loan B lenders to take any enforcement action prior to an acceleration of the New Revolver and the Term Loan A and, subject to customary limitations, may be cured with an equity contribution.
The agreement governing the Senior Notes limits Quintiles Transnational’s and its restricted subsidiaries’ (as defined in the agreement) ability to create liens and enter into sale and lease-back transactions.
The agreement governing the receivables financing facility contains certain usual and customary covenants and termination events for a securitization transaction, including certain financial reporting covenants and requirements to maintain the existence of the SPE separate from Quintiles Transnational and its other affiliates. An occurrence of an event of default or a termination event under this facility may give rise to the right of the third party lender to terminate this facility.
In 2015, 2014 and 2013, we believe we were in compliance with our restrictive covenants.
As of December 31, 2015, we had $2.5 billion of total indebtedness, excluding $534.0 million of additional available borrowings under our revolving credit facilities. There were no amounts drawn on the revolving credit facilities in 2015. 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, 2015, 2014 and 2013
Cash Flow from Operating Activities
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Net cash provided by operating activities | $ | 475.7 | $ | 431.8 | $ | 393.4 |
2015 compared to 2014
Cash provided by operating activities increased by $43.9 million in 2015 as compared to 2014. The increase in cash provided by operating activities primarily reflects the increase in net income including adjustments for non-cash items necessary to reconcile net income to cash provided by operating activities. Also contributing to the increase was an increase in accounts payable and accrued expenses ($58.5 million) as well as lower payments for interest ($11.6 million) and income taxes ($18.1 million). These improvements in operating cash flow were partially offset by higher cash used in days sales outstanding, or DSO. The higher cash used in DSO reflects a seven-day increase in DSO in 2015 compared to a two-day increase in DSO in 2014. 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.
2014 compared to 2013
Cash provided by operating activities increased by $38.4 million in 2014 as compared to 2013. The increase in operating cash flow reflects an increase in net income, lower payments for interest ($21.6 million), and lower cash used in DSO ($21.1 million) in 2014 as compared to 2013. This lower cash used in DSO reflects a two-day increase in DSO in 2014 compared to a five-day increase in 2013. In addition, net income for 2013 included 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), which did not recur in 2014. These increases in operating cash flow were partially offset by higher payments for income taxes ($67.9 million) and higher cash used for incentive compensation.
Cash Flow from Investing Activities
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Net cash used in investing activities | $ | (67.0 | ) | $ | (173.1 | ) | $ | (236.2 | ) |
2015 compared to 2014
Cash used in investing activities decreased by $106.1 million in 2015 as compared to 2014. This decrease was primarily related to cash acquired in the Q2 Solutions transaction ($31.7 million) compared to cash used for the acquisition of businesses ($92.2 million) in 2014, partially offset by the termination of interest rate swaps in connection with the refinancing transaction in 2015 ($11.0 million) and higher cash used for investments.
2014 compared to 2013
Cash used in investing activities decreased by $63.1 million to $173.1 million in 2014, as compared to $236.2 million in 2013. This decline in the use of cash in 2014 was primarily related to lower cash used for the acquisition of businesses. Cash used to acquire businesses in 2014 was $92.2 million, consisting primarily of the acquisition of Encore, as compared to 2013 which included the acquisition of Novella for approximately $145.0 million. Also contributing to the decline was lower cash used to acquire property, equipment and software and an increase in proceeds from the sale of equity securities.
Cash Flow from Financing Activities
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2015 | 2014 | 2013 | ||||||||||
| (in millions) | ||||||||||||
| Net cash (used in) provided by financing activities | $ | (249.2 | ) | $ | (130.3 | ) | $ | 71.0 |
2015 compared to 2014
Cash used in financing activities increased by $118.9 million in 2015 as compared to 2014. The increase in cash used in financing activities in 2015 was primarily related to higher cash used to repurchase common stock ($99.9 million) and lower cash provided by debt issuances, net of repayments ($75.4 million), partially offset by higher cash from stock issued under employee stock purchase and option plans ($29.1 million), and an increase in the excess income tax benefits from share-based award activities ($18.8 million).
2014 compared to 2013
Net cash used in financing activities was $130.3 million in 2014, as compared to cash provided by financing activities of $71.0 million in 2013. The cash used in financing activities in 2014 was primarily related to the repurchase of common stock ($415.1 million), partially offset by the proceeds from issuance of debt ($275.0 million) and the proceeds from stock issued under employee stock purchase and option plans ($35.2 million). The repurchase of common stock was funded, in part, by a $150.0 million draw on our line of credit under our senior secured credit facility. This line of credit draw was repaid in full in 2014 from the proceeds of a $275.0 million term loan under our receivables financing facility, which closed in December 2014. The proceeds from the $275.0 million term loan were also used to repay $25.0 million of outstanding indebtedness on the Term Loan B-3 under our senior secured credit facility.
Contractual Obligations and Commitments
Below is a summary of our future payment commitments by year under contractual obligations as of December 31, 2015 (in millions):
| 2016 | 2017-2018 | 2019-2020 | Thereafter | Total | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Long-term debt, including interest (1) | $ | 131.9 | $ | 536.1 | $ | 853.3 | $ | 1,489.5 | $ | 3,010.8 | ||||||||||
| Operating leases | 84.7 | 104.4 | 54.9 | 111.3 | 355.3 | |||||||||||||||
| Purchase obligations (2) | 2.3 | 0.9 | 0.4 | 0.2 | 3.8 | |||||||||||||||
| Commitments to unconsolidated affiliates (3) | 0.8 | — | — | — | 0.8 | |||||||||||||||
| Defined benefit plans (4) | 5.5 | — | — | — | 5.5 | |||||||||||||||
| Uncertain income tax positions (5) | 0.3 | — | — | — | 0.3 | |||||||||||||||
| Contingent consideration (6) | 4.4 | — | — | — | 4.4 | |||||||||||||||
| Total | $ | 229.9 | $ | 641.4 | $ | 908.6 | $ | 1,601.0 | $ | 3,380.9 |
| (1) | Interest payments on floating rate debt for the senior secured credit agreement and receivables financing facility are based on the interest rates in effect on December 31, 2015. |
|---|
| (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. |
|---|
| (3) | We are currently committed to invest $70.0 million in private equity funds. As of December 31, 2015, we have funded approximately $37.3 million of these commitments and we have approximately $32.7 million remaining to be funded. |
|---|
| (4) | We made cash contributions totaling approximately $6.0 million to our defined benefit plans in 2015, and we estimate that we will make contributions totaling approximately $5.5 million in 2016. 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 2016. |
|---|
| (5) | As of December 31, 2015, our liability related to uncertain income tax positions was approximately $32.1 million, $31.8 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. |
|---|
| (6) | Contingent consideration payable in connection with an acquisition. |
|---|
Subsequent Event
In February 2016, our Board approved a restructuring plan for approximately $22 million, primarily for severance and other exit costs, to align our resources and reduce overcapacity. Some of these actions are subject to certain legal and regulatory requirements. We anticipate that these actions, if implemented, will occur in 2016 and are expected to result in a reduction of approximately $18 million to $20 million of service revenues during the year ended December 31, 2016 when compared to the same period in 2015.
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.
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. 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 clinical 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.
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. 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 2015 annual testing, we believe that the risk of an impairment to goodwill or indefinite-lived intangible assets is currently very low, except for the Encore reporting unit. While we have concluded at this time that it is more likely than not that there is no impairment in the Encore reporting unit and concluded that a quantitative analysis was not necessary, if certain strategic initiatives do not perform as expected during 2016, a quantitative analysis may be required. 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.
Share-based Compensation
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.
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 as we do not currently anticipate paying any future dividends; |
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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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