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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period: September 30, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-33505
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LIFE SCIENCES RESEARCH INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND
(JURISDICTION OF INCORPORATION OR ORGANIZATION)
52-2340150
IRS Employer Identification No.
PO BOX 2360, METTLERS ROAD, EAST MILLSTONE, NJ 08875-2360
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 732 649-9961
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or Section 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No __
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
Yes _ No X
Indicate the number of outstanding shares of each of the Registrant's classes of
common stock as of the latest practicable date.
12,283,881 Voting Common Stock of $0.01 as of October 27, 2004
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TABLE OF CONTENTS
PART I FINANCIAL INFORMATION Page
Item 1 Financial Statements (Unaudited).
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 2004 and 2003. 3
Condensed Consolidated Balance Sheets at September 30, 2004 and
December 31, 2003. 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 2004 and 2003. 5
Notes to Condensed Consolidated Financial Statements. 6-10
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations. 11-17
Item 3 Quantitative and Qualitative Disclosures about Market Risk. 18
Item 4 Controls and Procedures 18
PART II OTHER INFORMATION
Item 6 Exhibits 19
Signature 20
Certifications 21-24
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
Three months ended Nine months ended
September 30 September 30
(Dollars in thousands, except per share data) 2004 2003 2004 2003
Net revenues $40,855 $32,723 $116,406 $97,287
Cost of revenues (29,674) (26,164) (87,220) (76,979)
----------- ------------ ----------- -----------
Gross profit 11,181 6,559 29,186 20,308
Selling, general and administrative expenses (6,659) (5,189) (18,345) (15,505)
Other operating income - 387 - 255
----------- ------------ ----------- -----------
Operating income 4,522 1,757 10,841 5,058
Interest income 13 10 41 49
Interest expense (1,689) (1,464) (4,858) (4,616)
Other (expense)/income (105) 308 625 2,037
----------- ------------ ----------- -----------
Income before income taxes 2,741 611 6,649 2,528
Income tax expense (945) (215) (2,261) (630)
----------- ------------ ----------- -----------
Net income $1,796 $396 $4,388 $1,898
----------- ------------ ----------- -----------
Income per common share
- - Basic $0.15 $0.03 $0.36 $0.16
- - Diluted $0.13 $0.03 $0.33 $0.15
Weighted average common shares outstanding
- - Basic (000's) 12,166 11,932 12,085 11,932
- - Diluted (000's) 13,914 12,271 13,369 12,920
See Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data) September 30, December 31,
2004 2003
ASSETS Unaudited Audited
Current assets:
Cash and cash equivalents $20,801 $17,271
Accounts receivable, net of allowance of $576 and $561 in
2004 and 2003 respectively 27,672 17,515
Unbilled receivables 11,972 8,246
Inventories 1,858 1,901
Prepaid expenses and other current assets 3,761 4,610
---------------- ----------------
Total current assets 66,064 49,543
Property and equipment, net 102,766 101,547
Goodwill 843 832
Unamortized Capital Bonds issue costs 299 429
Deferred income taxes 3,140 3,922
---------------- ----------------
Total assets $173,112 $156,273
---------------- ----------------
---------------- ----------------
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT)
Current liabilities:
Accounts payable $9,499 $12,508
Accrued payroll and other benefits 4,859 4,152
Accrued expenses and other liabilities 19,531 13,695
Short term debt 269 338
Fees invoiced in advance 31,006 22,761
--------------- ----------------
Total current liabilities 65,164 53,454
Long-term debt 87,350 87,560
Pension liabilities 21,793 21,414
Deferred income taxes 3,786 2,291
--------------- ----------------
Total liabilities 178,093 164,719
--------------- ----------------
Commitments and contingencies - -
Shareholders' equity/(deficit)
Voting Common Stock, $0.01 par value. Authorized 50,000,000
Issued and outstanding at September 30, 2004: 12,272,929
(December 31, 2003: 12,034,883) 123 120
Non-Voting Common Stock, $0.01 par value. Authorized 5,000,000
Issued and outstanding: None - -
Preferred Stock, $0.01 par value. Authorized 5,000,000
Issued and outstanding: None - -
Paid in capital 75,257 75,101
Less: Promissory notes for the issuance of common stock (627) (661)
Accumulated comprehensive loss (24,089) (22,973)
Accumulated deficit (55,645) (60,033)
--------------- ----------------
Total shareholders' equity /(deficit) (4,981) (8,446)
--------------- ----------------
Total liabilities and shareholders' equity /(deficit) $173,112 $156,273
--------------- ----------------
See Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
Nine months ended September 30
(Dollars in thousands) 2004 2003
Cash flows from operating activities:
Net income $4,388 $1,898
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 7,044 6,407
Foreign exchange gain on Capital Bonds (625) (1,435)
Gain on repurchase of Capital Bonds - (602)
Share of profits of HLS KK prior to June 30, 2003 - (208)
Deferred income taxes 2,256 628
Provision for losses on accounts receivable 15 251
Amortization of warrants 135 266
Amortization of Capital Bonds issue costs 134 123
Changes in operating assets and liabilities:
Accounts receivable, unbilled receivables and prepaid expenses (12,661) (2,053)
Inventories 71 31
Accounts payable, accrued expenses and other liabilities 3,020 (1,539)
Fees invoiced in advance 8,176 (2,434)
-------------- ---------------
Net cash provided by operating activities $11,953 $1,333
-------------- ---------------
Cash flows used in investing activities:
Purchase of property and equipment $(7,049) (5,744)
Cash acquired on acquisition of business - 1,893
-------------- ---------------
Net cash used in investing activities $(7,049) $(3,851)
-------------- ---------------
Cash flows provided by financing activities:
Proceeds from issue of Voting Common Stock 193 56
Repayments of long-term borrowings - (328)
Repayments of short term borrowings (838) (1,216)
-------------- ---------------
---------------
Net cash used in financing activities $(645) $(1,488)
-------------- ---------------
Effect of exchange rate changes on cash and cash equivalents (729) (89)
-------------- ---------------
Increase/(decrease) in cash and cash equivalents 3,530 (4,095)
Cash and cash equivalents at beginning of period 17,271 14,644
-------------- ---------------
Cash and cash equivalents at end of period $20,801 $10,549
============== ===============
Supplementary disclosures
Interest paid in the period $5,261 $4,659
Taxes paid:
Japanese corporate taxes $139 -
US State taxes $5 -
See Notes to Condensed Consolidated Financial Statements.
LIFE SCIENCES RESEARCH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004 and 2003
Unaudited
1. THE COMPANY AND ITS OPERATIONS
Business
Life Sciences Research, Inc. ("LSR") and subsidiaries (collectively, the
"Company") is a global contract research organization, offering worldwide
pre-clinical and non-clinical testing for biological safety evaluation research
services to pharmaceutical, biotechnology, agrochemical and industrial chemical
companies. The Company serves the rapidly evolving regulatory and commercial
requirements to perform safety evaluations on new pharmaceutical compounds and
chemical compounds contained within the products that humans use, eat and are
otherwise exposed to. In addition, the Company tests the effect of such
compounds on the environment and also performs work on assessing the safety and
efficacy of veterinary products.
Organization
LSR was incorporated on July 19, 2001 as a Maryland corporation. It was formed
specifically for the purpose of making a recommended all share offer (the
"Offer") for Life Sciences Research Ltd (LSR Ltd) formerly Huntingdon Life
Sciences Group plc ("Huntingdon"). The Offer was made on October 16, 2001 and
was declared unconditional on January 10, 2002, at which time LSR acquired
approximately 89% of the outstanding ordinary shares of Huntingdon in exchange
for approximately 5.3 million shares of LSR Voting Common Stock. The subsequent
offer period expired on February 7, 2002, by which time approximately 92% of the
outstanding ordinary shares had been offered for exchange. LSR completed its
compulsory purchase under UK law of the remaining outstanding ordinary shares of
Huntingdon on March 26, 2002 at which time Huntingdon became a wholly owned
subsidiary of LSR, in exchange for a total of approximately 5.9 million shares
of LSR Voting Common Stock (the "Exchange Offer").
Under accounting principles generally accepted in the United States ("US GAAP"),
the Company whose stockholders retain the majority interest in a combined
business must be treated as the acquirer for accounting purposes. Accordingly,
the Exchange Offer is accounted for as a reverse acquisition for financial
reporting purposes. The reverse acquisition is deemed a capital transaction and
the net assets of Huntingdon (the accounting acquirer) are carried forward to
LSR (the legal acquirer and the reporting entity) at their carrying value before
the combination. Although Huntingdon was deemed to be the acquiring corporation
for financial accounting and reporting purposes, the legal status of LSR as the
surviving corporation does not change. The relevant acquisition process utilizes
the capital structure of LSR and the assets and liabilities of Huntingdon are
recorded at historical cost. The equity of LSR is the historical equity of
Huntingdon, retroactively restated to reflect the number of shares issued in the
Exchange Offer.
LSR's executive office is based at the Princeton Research Center in New Jersey,
US.
2. SIGNIFICANT ACCOUNTING POLICIES
i) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements reflect
all adjustments of a normal recurring nature, which are, in the opinion of
management, necessary for a fair statement of the results of operations for the
interim periods presented. The condensed consolidated financial statements are
unaudited and are subject to such year-end adjustments as may be considered
appropriate and should be read in conjunction with the historical consolidated
financial statements of LSR years ended December 31, 2003, 2002 and 2001
included in LSR's Annual Report on Form 10-K for the fiscal year ended December
31, 2003. Operating results for the three-month and nine month periods ended
September 30, 2004 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2004.
These financial statements have been prepared in accordance with US GAAP and
under the same accounting principles as the financial statements included in the
Annual Report on Form 10-K. Certain information and footnote disclosures related
thereto normally included in the financial statements prepared in accordance
with the US GAAP have been omitted in accordance with Rule 10-01 of Regulation
S-X.
ii) Stock-Based Compensation
The Company has stock option and stock-based compensation plans, which are
described in detail in Note 2 of our audited consolidated financial statements
included in our Annual Report on Form 10-K for the year ended December 31, 2003.
Under the Long Term Incentive Plan (LTIP), the Company granted 362,658 ten-year
stock options to executives on June 1, 2004. All such options were granted with
an exercise price equal to the market price of the underlying stock on the date
of the grant. These options will vest 100% on March 31, 2007 for those
executives who remain employed with the Company through that date.
Effective January 1, 2003, the Company adopted FASB Statement No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure. Statement
No. 148 amends FASB Statement No. 123, Accounting for Stock-Based Compensation,
to provide, among other things, prominent disclosure of the effects of an
entity's accounting policy with respect to stock-based employee compensation on
reported net income and earnings per share in annual and interim financial
statements. The Company intends to continue to follow the disclosure-only
provisions of FASB Statement No. 123 and, accordingly, will continue to account
for these plans under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations.
Under APB 25, when stock options are issued with an exercise price equal to the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.
ii) Stock-Based Compensation (Cont'd)
No compensation cost is recorded for options granted under the Company's plan
since all options granted are issued with an exercise price equal to the market
value of the underlying common stock on the date of grant, and employees must
pay for these stock issuances. The following table illustrates the effect on net
income and earnings per share for the three and nine months ended September 30,
2004 and 2003 had the Company applied the fair value recognition provisions of
FASB Statement No. 123, Accounting for Stock-Based Compensation, to all of its
stock-based employee compensation plans.
Three months ended September 30 Nine months ended September
30
2004 2003 2004 2003
(Dollars in thousands, except per share data)
Net Income, as reported $1,796 $396 $4,388 $1,898
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects $(40) $(4) $(71) $(68)
---------------- --------------- -------------- --------------
Pro forma net income $1,756 $392 $4,317 $1,830
---------------- --------------- -------------- --------------
Earnings per share:
Basic - as reported $0.15 $0.03 $0.36 $0.16
Basic - pro forma $0.14 $0.03 $0.36 $0.15
Diluted - as reported $0.13 $0.03 $0.33 $0.15
Diluted - pro forma $0.13 $0.03 $0.32 $0.14
There were no grants of stock options during the three months ended September
30, 2004 (nor the three months ended September 30, 2003). The per share weighted
average for value of stock options was $1.82 and $1.03 during the nine months
ended September 30, 2004 and 2003 respectively. The HLS options granted prior to
2002 are considered to have no value. These fair values were estimated using the
Black-Scholes option-pricing model, based on the following assumptions:
9 Months ended September 30
2004 2003
Dividend yield 0% 0%
Volatility 40% 40%
Risk-free interest rate 3.72% 3.72%
Expected term of options (in years) 10 10
3. SEGMENT ANALYSIS
The Company operates within two segments based on geographical markets, the
United Kingdom and the United States. The Company has one continuing activity,
Contract Research.
The analysis of the Company's net revenues and operating income by segment for
the three and nine month periods ended September 30, 2004 and September 30, 2003
is as follows:
Three months ended Nine months ended
September 30 September 30
2004 2003 2004 2003
(Dollars in thousands)
Net revenues
UK 32,944 25,337 93,709 76,585
US
7,911 7,386 22,697 20,702
----------- ----------- ----------- -----------
$40,855 $32,723 $116,406 $97,287
=========== =========== =========== ===========
Operating income before other operating
income
UK 3,669 1,013 9,052 4,082
US 853 357 1,789 721
----------- ----------- ----------- -----------
$4,522 $1,370 $10,841 $4,803
=========== =========== =========== ===========
Other operating income
UK - 387 - 255
US - - - -
----------- ----------- ----------- -----------
$- $387 $- $255
=========== =========== =========== ===========
Operating income
UK 3,669 1,400 9,052 4,337
US
853 357 1,789 721
----------- ----------- ----------- -----------
$4,522 $1,757 $10,841 $5,058
=========== =========== =========== ===========
4. REFINANCING
On March 28, 2002, LSR closed the sale in a private placement of an aggregate of
5,085,334 shares of Voting Common Stock at a price of $1.50 per share. Of the
aggregate proceeds of approximately $7.6 million, $4.4 million was in cash, $2.4
million represented conversion into equity of debt owed to Mr. Baker ($2.1
million) and Focused Healthcare Partners ("FHP") ($0.3 million) and $825,000 was
paid with promissory notes. A net $141,000 of such promissory notes was repaid
during 2002. A net $23,000 was repaid in 2003, and a further $43,000 was repaid
in the first nine months of 2004, offset by an increase due to foreign exchange
movement of $9,000.
5. COMMITMENTS AND CONTINGENCIES
(i) The Company is party to certain legal actions arising out of the normal
course of its business. In management's opinion, none of these actions will
have a material effect on the Company's operations, financial condition or
liquidity. No form of proceedings has been brought, instigated or is known
to be contemplated against the Company by any governmental agency.
(ii) The Compensation Committee approved as of June 1, 2004 a performance based
cash bonus award for executives. This award, issued under the Long Term
Incentive Plan (LTIP), will award cash compensation to select individuals
if certain performance goals relating to operations are reached by December
31, 2006. The amount of the award varies based upon the level of
performance, with a complete default of the award if minimum operating
levels are not achieved.
Management is ratably accruing, as compensation expense, an amount equal to
the currently estimated cash bonus over the performance period. Management
will reevaluate this estimate periodically throughout the performance
period and, if applicable, will adjust the estimate accordingly.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
1. RESULTS OF OPERATIONS
a) Three months ended September 30, 2004 compared with three months ended
September 30, 2003.
Net revenues for the three months ended September 30, 2004 were $40.9 million,
an increase of 24.9% on net revenues of $32.7 million for the three months ended
September 30, 2003. Excluding the effect of exchange rate movements, the
increase was 13.4%. UK net revenues increased by 30.0%; at constant exchange
rates the increase was 15.2%. In the US, net revenues increased by 7.9%. Net new
orders for the three months ended September 30, 2004 at constant exchange rates,
were 31% above the same period last year. This growth in net new orders, which
was particularly strong from the pharmaceutical industry, coming on top of the
high level of orders taken in the first two quarters, have fed through into
revenues in the quarter, but has been partly offset by a decline in
non-pharmaceutical business.
Cost of revenues for the three months ended September 30, 2004 were $29.7
million, an increase of 13.4% on cost of revenues of $26.2 million for the three
months ended September 30, 2003. Excluding the effects of exchange rate
movements, the increase was 2.6%. UK cost of revenues increased by 17.0%; at
constant exchange rates there was a decrease of 3.2% reflecting the
consolidation of duplicate facilities in response to changes in the market
announced at the year-end (with the average headcount for the quarter reducing
by 70 compared with Q3 last year on a like for like basis). US cost of revenues
increased by 1.6%, a slower rate than the increase in revenues as a result of
tighter cost control on labor and materials.
Selling, general and administrative expenses (SG&A) rose by 28.3% to $6.7
million for the three months ended September 30, 2004 from $5.2 million in the
corresponding period in 2003. Excluding the effects of exchange rate movements,
the increase was 14.4%.
Other operating income for the three months ended September 30, 2003 was $0.4
million. They comprised the recognition of the Group's share of the net income
of HLS KK for the period it was held as an investment of $0.2 million. In
addition, $0.4 million related to a recovery of funds, which had been written
off following the bankruptcy of a foreign exchange broker in 2001. Offset
against this were expenses of $0.2 million in connection with specific legal and
other actions taken against animal rights groups.
Net interest expense for the three months ended September 30, 2004 was $1.7
million, which was $0.2 million higher than the net interest expense for the
three months ended September 30, 2003. Excluding the effects of exchange rate
movements, there was a net increase of 2.5% mainly due to an increase in the
charge for warrants.
Other expense in the three months ended September 30, 2004 was $0.1 million
which relates to the non-cash foreign exchange remeasurement loss which arose on
the Convertible Capital Bonds denominated in US dollars (the functional currency
of the financial subsidiary that holds the bonds in UK sterling), with the
strengthening of the dollar against sterling. In the three months ended
September 30, 2003, other income of $0.3 million related to the non-cash foreign
exchange remeasurement gain that arose on the Convertible Capital Bonds, with
the weakening of the dollar against sterling.
The income tax expense on income for the three months ended September 30, 2004
was $0.9 million, which was primarily a non-cash charge due to the company's
operating loss carry forwards. The income tax expense for the three months ended
September 30, 2003 was $0.2 million. The gross net operating losses in the US
are $9.3 million at September 30 2004; with gross net operating losses in the UK
of $52.9 million.
The overall net income for the three months ended September 30, 2004 was $1.8
million compared to $0.4 million for the three months ended September 30, 2003.
The increase in the net income of $1.4 million is due to an increase in
operating income of $2.7 million; offset by an increase in non-cash foreign
exchange remeasurement loss of $0.4 million, an increase in interest expenses of
$0.2 million and an increase in the income tax expense of $0.7 million.
Basic income per common share was 15 cents, compared to 3 cents last year on the
weighted average common shares outstanding of 12,165,643 (2003: 11,932,338).
Earnings before interest, taxes, depreciation and amortization, and other
income/(expense) ("EBITDA") was $7.0 million for the third quarter of 2004, or
17.0% of revenues, compared with $3.9 million, or 11.9% of revenues for the same
period in the prior year.
The Company believes that EBITDA information, which for this Company excludes
other income/(expense), enhances an investor's understanding of our financial
performance and our ability to satisfy principal and interest obligations with
respect to our indebtedness. However, EBITDA should not be considered in
isolation or viewed as a substitute for net income, cash flow from operations or
other measures of performance as defined by generally accepted accounting
principles in the United States. We understand that while securities analysts,
lenders and others in their evaluation of companies frequently use EBITDA,
EBITDA as used herein is not necessarily comparable to other similarly titled
captions of other companies due to potential inconsistencies in the method of
calculation. Our management uses EBITDA to assess financial performance and debt
service capabilities. In assessing financial performance, our management reviews
EBITDA as a general indicator of economic performance compared to prior periods.
Because EBITDA excludes interest, income tax, depreciation and amortization, and
other income/(expense), EBITDA provides an indicator of general economic
performance that is not affected by changes in debt levels, fluctuations in
interest rates or effective tax rates, levels of depreciation and amortization,
or exchange rate movements on the Capital Bonds. Our management believes this
type of measurement is useful for comparing general operating performance from
period to period and making certain management decisions. Nevertheless, our
management recognizes that there are material limitations associated with the
use of EBITDA as compared to net income, which reflects overall financial
performance, including the effects of interest, taxes, depreciation,
amortization and other income/(expense).
b) Nine months ended September 30, 2004 compared with nine months ended
September 30, 2003.
Net revenues for the nine months ended September 30, 2004 were $116.4 million,
an increase of 19.7% on net revenues of $97.3 million for the nine months ended
September 30, 2003. Excluding the effect of exchange rate movements, the
increase was 8.6%. UK net revenues increased by 22.4%; at constant exchange
rates the increase was 8.3%. In the US, net revenues increased by 9.9%. Net new
orders for the nine months ended September 30, 2004 at constant exchange rates
were 29% above the same period last year. This growth in net new orders, which
was particularly strong from the pharmaceutical industry, has fed through into
revenues in the nine months, but has been partly offset by a decline in
non-pharmaceutical business.
Cost of revenues for the nine months ended September 30, 2004 were $87.2
million, an increase of 13.3% on cost of revenue of $77.0 million for the nine
months ended September 30, 2003. Excluding the effects of exchange rate
movements, the increase was 2.8%. UK cost of revenues increased by 15.3%; at
constant exchange rates the increase was 2.1%, reflecting the consolidation of
duplicate facilities in response to changes in the market (with the average
headcount for the nine months reducing by 90 compared with the same period last
year on a like for like basis) offset by the increase in volume, mainly direct
materials cost increases. US cost of revenues increased by 5.8%, a lower rate
than the increase in revenues as a result of tighter cost control.
Selling, general and administrative expenses (SG&A) rose by 18.3% to $18.3
million for the nine months ended September 30, 2004 from $15.5 million in the
corresponding period in 2003. Excluding the effects of exchange rate movements,
the increase was 7.7%.
Other operating income for the nine months ended 2003 was $0.3 million. They
comprised the recognition of the Group's share of the net income of HLS KK for
the period it was held as an investment of $0.2 million. In addition, $0.4
million related to a recovery of funds, which had been written off following the
bankruptcy of a foreign exchange broker in 2001. Offset against this were
expenses of $0.3 million in connection with specific legal and other actions
taken against animal rights groups.
Net interest expense for the nine months ended September 30, 2004 was $4.8
million, which was $0.2 million above net interest expense for the nine months
ended September 30, 2003. Excluding the effects of exchange rate movements,
there was a net decrease of 6.3% due to lower borrowings, and a lower charge for
warrants (as a result of the repayment of related party loans in 2003).
Other income in the nine months ended September 30, 2004 of $0.6 million which
relates to the non-cash foreign exchange remeasurement gain which arose on the
Convertible Capital Bonds denominated in US dollars (the functional currency of
the financial subsidiary that holds the bonds in UK sterling), with the
weakening of the dollar against sterling. In the nine months ended September 30,
2003, other income of $2.0 million related to the non-cash foreign exchange
remeasurement gain of $1.4 million that arose on the Convertible Capital Bonds
with the weakening of the dollar against sterling, and $0.6 million gain on the
repurchase of Capital Bonds.
The income tax expense on income for the nine months ended September 30, 2004
was $2.3 million, which was primarily a non-cash charge due to the company's
operating loss carry forwards. The income tax expense for the nine months ended
September 30, 2003 was $0.6 million.
The overall net income for the nine months ended September 30, 2004 was $4.4
million compared to $1.9 million for the nine months ended September 30, 2003.
The improvement in the net income of $2.5 million is due to an increase in the
operating income of $5.8 million; offset by a decrease in non-cash foreign
exchange remeasurement gains of $0.8 million, an increase in the income tax
expense of $1.7 million, an increase in interest expense of $0.2 million, and a
reduction in the gain on the repurchase of the Capital Bonds of $0.6 million.
Basic income per common share was 36 cents, compared to 16 cents last year on
the weighted average common shares outstanding of 12,085,311 (2003: 11,932,338).
EBITDA for the nine months ended September 30, 2004 was $17.9 million, or 15.4%
of revenues, compared with $11.5 million or 11.8% of revenues for the same
period in 2003.
2. LIQUIDITY & CAPITAL RESOURCES
Bank Loan and Non-Bank Loans
On January 20, 2001, the Company's non-bank loan of (pound)22.6 million ($40.9
million approximately), was refinanced by Stephens' Group Inc. and other
parties. The loan was transferred from Stephens Group Inc., to an unrelated
third party effective February 11, 2002. It is now repayable on September 30,
2006 and interest is payable quarterly at LIBOR plus 1.75%. At the same time the
Company was required to take all reasonable steps to sell off some of its real
estate assets through sale/leaseback transactions and/or obtaining mortgage
financing secured by the Company's real estate assets to discharge this loan.
The loan is held by Life Sciences Research Ltd (LSR Ltd.), and is secured by the
guarantees of the Company's wholly owned subsidiaries, including LSR Ltd,
Huntingdon Life Sciences Ltd, and Huntingdon Life Sciences Inc., and
collateralized by all the assets of these companies.
On October 9, 2001, on behalf of Huntingdon, LSR issued to Stephens Group Inc.
warrants to purchase up to 704,425 shares of LSR Voting Common Stock at a
purchase price of $1.50 per share. The warrants were subsequently transferred to
an unrelated third party. The LSR warrants are exercisable at any time and will
expire on October 9, 2011. These warrants arose out of negotiations regarding
the refinancing of the bank loan by the Stephens Group Inc. in January 2001. In
accordance with APB Opinion No. 14, Accounting for Convertible Debt and Debt
Issued with Stock Purchase Warrants ("APB 14"), the warrants were recorded at
their pro rata fair values in relation to the proceeds received on the date of
issuance. As a result, the value of the warrants was $430,000.
Convertible Capital Bonds
The remainder of the Company's long term financing is provided by Convertible
Capital Bonds repayable in September 2006. At the time of the issue in 1991,
these bonds were for $50 million par and at September 30, 2004, $46.2 million
were outstanding. They carry interest at a rate of 7.5% per annum, payable
biannually in March and September. During 2002, the Company repurchased and
cancelled $2,410,000 principal amount of such bonds resulting in a $1.2 million
gain recorded in other income/expense. In 2003 the Company further repurchased
and cancelled $1,345,000 principal amount of such bonds resulting in a gain of
$0.6 million recorded in other income/expense. At the current conversion rate,
the number of shares of Voting Common Stock to be issued on conversion and
exchange of each unit of $10,000 comprised in a Bond would be 49. The conversion
rate is subject to adjustment in certain circumstances.
Related Party Loans
On June 11, 2002 LSR issued to Focus Healthcare Partners ("FHP") warrants to
purchase up to 410,914 shares of LSR Voting Common Stock at a purchase price of
$1.50 per share. The LSR warrants are exercisable at any time and will expire on
June 11, 2012. These warrants arose out of negotiations regarding the provision
of a $2.9 million loan facility made available to the Company on September 25,
2000 by Mr. Baker, a director of the Company, who controls FHP. This loan was
paid in full in 2002. In accordance with APB 14 the loan and warrants were
recorded at their pro rata fair values in relation to the proceeds received. As
a result, the value of the warrants was $250,000.
Common Shares
On March 28, 2002, LSR closed the sale in a private placement of an aggregate of
5,085,334 shares of Voting Common Stock at a price of $1.50 per share. Of the
aggregate proceeds of approximately $7.6 million, $4.4 million was in cash, $2.4
million represented conversion into equity of debt owed to Mr. Baker ($2.1
million) and FHP ($0.3 million) and $825,000 was paid with promissory notes. A
net $141,000 of such promissory notes was repaid during 2002, a net $23,000 was
repaid in 2003, and a further $43,000 was repaid in the first nine months of
2004, offset by an increase due to foreign exchange movements of $9,000.
Cash flows
During the three months ended September 30, 2004, funds generated were $5.7
million, increasing cash and cash equivalents from $15.1 million at June 30,
2004 to $20.8 million at September 30, 2004.
In the nine months to September 30, 2004, funds generated were $3.5 million,
increasing cash and cash equivalents from $17.3 million in December 31, 2003 to
$20.8 million at September 30, 2004.
Net days sales outstanding ("DSOs") at September 30, 2004 were 20 days, a
decrease from the 22 days at June 30, 2004 and 17 days at both March 31, 2004
and December 31, 2003. DSO is calculated as a sum of accounts receivables,
unbilled receivables and fees in advance over total revenue. Since January 1999,
DSOs at the quarter end have varied from 9 days to 47 days so they are currently
at a relatively low level. The impact on liquidity from a one-day change in DSO
is approximately $435,000.
3. CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's consolidated financial statements, which have
been prepared in accordance with US GAAP. The Company considers the following
accounting policies to be critical accounting policies.
Revenue recognition
The majority of the Company's net revenues have been earned under contracts,
which generally range in duration from a few months to three years. Revenue from
these contracts is generally recognized over the term of the contracts as
services are rendered. Contracts may contain provisions for renegotiations in
the event of changes in the level of work scope. Renegotiated amounts are
included in net revenue when earned and realization is assured. Provisions for
losses to be incurred on contracts are recognized in full in the period in which
it is determined that a loss will result from performance of the contractual
arrangement. The Company's customers may terminate most service contracts for a
variety of reasons, either immediately or upon notice of a future date. The
contracts generally require payments to the Company to recover costs incurred,
including costs to wind down the study, and payment of fees earned to date, and
in some cases to provide the Company with a portion of the fees or income that
would have been earned under the contract had the contract not been terminated
early.
Unbilled receivables are recorded for revenue recognized to date that is
currently not billable to the customer pursuant to contractual terms. In
general, amounts become billable upon the achievement of certain aspects of the
contract or in accordance with predetermined payment schedules. Unbilled
receivables are billable to customers within one year from the respective
balance sheet date. Fees in advance are recorded for amounts billed to customers
for whom revenue has not been recognized at the balance sheet date (such as
upfront payments upon contract authorization, but prior to the actual
commencement of the study).
If the Company does not accurately estimate the resources required or the scope
of work to be performed, or does not manage its projects properly within the
planned periods of time or satisfy its obligations under the contracts, then
future margins may be significantly and negatively affected or losses on
existing contracts may need to be recognized. Any such resulting reductions in
margins or contract losses could, though it is unlikely, be material to the
Company's results of operations.
Use of estimates
The preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities as of
the dates of the financial statements and the results of operations during the
reporting periods. These also include management estimates in the calculation of
pension liabilities covering discount rates, return on plan assets and other
actuarial assumptions. Although these estimates are based upon management's best
knowledge of current events and actions, actual results could differ from those
estimates.
Taxation
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting For Income Taxes"
("SFAS 109"). SFAS 109 requires recognition of deferred tax assets and
liabilities for the estimated future tax consequences of events attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating loss and tax credit
carry forwards. Deferred tax assets and liabilities are measured using enacted
rates in effect for the year in which the differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of
changes in tax rates is recognized in the statement of operations in the period
in which the enactment rate changes. Deferred tax assets and liabilities are
reduced through the establishment of a valuation allowance at such time as,
based on available evidence, it is more likely than not that the deferred tax
assets will not be realized. While the Company has considered future taxable
income and ongoing prudent and feasible tax planning strategies in assessing the
need for the valuation allowance, in the event that the Company were to
determine that it would not be able to realize all or part of its net deferred
tax assets in the future, an adjustment to the deferred tax assets would be
charged to income in the period such determination was made. Likewise, should
the Company determine that it would be able to realize its deferred tax assets
in the future in excess of its net recorded amount, an adjustment to the
deferred tax assets would increase income in the period such determination was
made.
Exchange rate fluctuations and exchange controls
The Company operates on a world-wide basis and generally invoices its clients in
the currency of the country in which it operates. Thus, for the most part,
exposure to exchange rate fluctuations is limited as sales are denominated in
the same currency as costs. Trading exposures to currency fluctuations do occur
as a result of certain sales contracts, performed in the UK for US clients,
which are denominated in US dollars and contribute approximately 9% of total
revenues. Management has decided not to hedge against this exposure.
Also, exchange rate fluctuations may have an impact on the relative price
competitiveness of the Company vis a vis competitors who trade in currencies
other than sterling or dollars. Such fluctuations also have an impact on the
translation of the 7.5% Convertible Capital Bonds payable in September 2006.
Finally, the consolidated financial statements of LSR are denominated in US
dollars. Changes in exchange rates between the UK pounds sterling and the US
dollar will affect the translation of the UK subsidiary's financial results into
US dollars for the purposes of reporting the consolidated financial results. The
process by which each foreign subsidiary's financial results are translated into
US dollars is as follows: income statement accounts are translated at average
exchange rates for the period; balance sheet asset and liability accounts are
translated at end of period exchange rates; and capital accounts are translated
at historical exchange rates and retained earnings are translated at weighted
average of historical rates. Translation of the balance sheet in this manner
affects the stockholders' equity account, referred to as the accumulated
comprehensive loss. Management has decided not to hedge against the impact of
exposures giving rise to these translation adjustments as such hedges may impact
upon the Company's cash flow compared to the translation adjustments which do
not affect cash flow in the medium term.
Exchange rates for translating sterling into US dollars were as follows:
At December 31 At September 30 3 months to 9 months to September 30
September 30 Average Average rate (1)
rate (1)
2002 1.6099 1.5726 1.5493 1.4805
2003 1.7857 1.6614 1.6111 1.6111
2004 - 1.8096 1.8192 1.8209
(1) Based on the average of the exchange rates on each day of each month during
the period.
On October 27, 2004 the noon buying rate for sterling was (pound)1.00 = $1.8369.
The Company has not experienced difficulty in transferring funds to and
receiving funds remitted from those countries outside the US or UK in which it
operates and Management expects this situation to continue.
While the UK has not at this time entered the European Monetary Union, the
Company has ascertained that its financial systems are capable of dealing with
Euro denominated transactions.
The following table summarizes the financial instruments denominated in
currencies other than the US dollar held by LSR and its subsidiaries as of
September 30, 2004:
Expected Maturity Date
2004 2005 2006 2007 2008 Thereafter Total Fair
Value
(In US Dollars, amounts in thousands)
Cash - Pound Sterling 8,233 - - - - - 8,233 8,233
- Euro 416 - - - - - 416 416
- Japanese Yen 2,300 - - - - - 2,300 2,300
Accounts
receivable - Pound Sterling 17,929 - - - - - 17,929 17,929
- Euro 686 - - - - - 686 686
- Japanese Yen 2,486 - - - - - 2,486 2,486
Debt - Pound Sterling - - 40,872 - - - 40,872 40,872
- Japanese Yen - 197 179 100 - - 476 476
4. LEGAL PROCEEDINGS
The Company is party to certain legal actions arising out of the normal course
of its business. In management's opinion, none of these actions will have a
material effect on the Company's operations, financial condition or liquidity.
No form of proceedings has been brought, instigated or is known to be
contemplated against the Company by any governmental agency.
5. FORWARD LOOKING STATEMENTS
Statements in this management's discussion and analysis of financial condition
and results of operations, as well as in certain other parts of this Quarterly
Report on Form 10-Q (as well as information included in oral statements or other
written statements made or to be made by the Company) that look forward in time,
are forward looking statements made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Forward looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance, expectations, predictions, and assumptions and other
statements which are other than statements of historical facts. Although the
Company believes such forward-looking statements are reasonable, it can give no
assurance that any forward-looking statements will prove to be correct. Such
forward-looking statements are subject to, and are qualified by, known and
unknown risks, uncertainties and other factors that could cause actual results,
performance or achievements to differ materially from those expressed or implied
by those statements. These risks, uncertainties and other factors include, but
are not limited to the Company's ability to estimate the impact of competition
and of industry consolidation and risks, uncertainties and other factors more
fully described in the Company's filings with the SEC, including its
Registration Statement on Form S-1, dated July 12, 2002, and Annual Report on
Form 10-K for the year ended December 31, 2003, each as filed with the
Securities and Exchange Commission.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's (pound)22.6 million (approximately $40.9 million) credit facility
is sterling denominated and does not contribute to transaction gains and losses
on the income statement. Interest on all outstanding borrowings under this
credit facility is based upon LIBOR plus a margin and approximated 6.555% per
annum for the three months ended September 30, 2004, and 6.149% per annum for
the nine months ended September 30 2004. At September 30, 2004 this credit
facility was fully drawn down.
In the three and nine months ended September 30, 2004, a 1% change in LIBOR
would have resulted in a fluctuation in interest expense of $103,000 and
$308,000 respectively.
For both the three and nine months ended September 30, 2004, approximately 72%
of the Company's net revenues were from outside the United States. The Company
does not engage in derivative or hedging activities related to its potential
foreign exchange exposures.
On September 30, 2004, the Company's $46.2 million principal amount of
Convertible Capital Bonds is US dollar denominated, but is held by a non-US
subsidiary of the Company. As a result, with respect to these bonds, the Company
experiences exchange related gains and losses which only has a non-cash impact
on the financial statements, based on the movement of exchange rates. Hence, the
Company does not take any actions to hedge against such risks. The Company is
unable to predict whether it will experience future gains or future losses from
such exchange-related risks on the bonds.
See Management's Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM 4 CONTROLS AND PROCEDURES
As of September 30, 2004 we carried out an evaluation, under the supervision and
with the participation of management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of the
quarter ended September 30, 2004 in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to be
included in our periodic SEC filings. During the quarter ended September 30,
2004 there were no significant changes in internal controls or in other factors
that has materially affected, or are reasonably likely to materially affect,
internal controls over financial reporting.
PART II OTHER INFORMATION
ITEM 6 EXHIBITS
Exhibit 31.1 Certification of the Chief Executive Officer
Exhibit 31.2 Certification of the Chief Financial Officer
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of the Chief Executive Officer
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of the Chief Financial Officer
Exhibit 99.1 Press Release, dated October 28, 2004, announcing the
third quarter earnings results for 2004.
SIGNATURE
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, this Quarterly Report on Form 10-Q has been signed below by the
following person on behalf of the Registrant and in the capacities and on the
dates indicated.
Life Sciences Research Inc.
(Registrant)
By: /s/ Richard Michaelson
Name: Richard Michaelson
Title: CFO & Secretary
Date: October 29, 2004