UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2015

or

For the transition period from            to             .

Commission File Number: 001-35907

 

QUINTILES TRANSNATIONAL HOLDINGS INC.

(Exact name of registrant as specified in its charter)

 

 

4820 Emperor Blvd., Durham, North Carolina 27703

(Address of principal executive offices and Zip Code)

(919) 998-2000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 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 reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.

 

 

 

 

 

 

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QUINTILES TRANSNATIONAL HOLDINGS INC.

FORM 10-Q

TABLE OF CONTENTS

 

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

QUINTILES TRANSNATIONAL HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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QUINTILES TRANSNATIONAL HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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QUINTILES TRANSNATIONAL HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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QUINTILES TRANSNATIONAL HOLDINGS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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QUINTILES TRANSNATIONAL HOLDINGS INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. Summary of Significant Accounting Policies

Unaudited Interim Financial Information

The accompanying unaudited condensed consolidated financial statements of Quintiles Transnational Holdings Inc. and its subsidiaries (the “Company”) have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the Company’s financial condition and results of operations have been included. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014. The balance sheet at December 31, 2014 has been derived from the audited consolidated financial statements of the Company but does not include all the disclosures required by GAAP.

Reclassifications

Certain immaterial prior period amounts have been reclassified to conform to the current presentation including the reclassification of debt issuance costs related to non-revolving debt from deposits and other assets to a direct reduction to the carrying amount of the long-term debt on the balance sheet. These changes had no effect on previously reported total revenues, net income, comprehensive income, shareholders’ deficit or cash flows.

Recently Issued Accounting Standards

In February 2015, the United States Financial Accounting Standards Board (“FASB”) issued new accounting guidance which changes the analysis in determining whether an entity is considered a variable interest entity (“VIE”) and the identification of the primary beneficiary of the VIE to determine whether the VIE should be included in an entity’s consolidated financial statements. The Company will adopt the new accounting guidance on January 1, 2016, as required. The Company is currently evaluating the impact of this update on its consolidated financial statements.

In May 2014, the FASB and the International Accounting Standards Board issued a converged standard on the recognition of revenue from contracts with customers. The objective of the new standard is to establish a single comprehensive revenue recognition model that is designed to create greater comparability of financial statements across industries and jurisdictions. Under the new standard, companies will recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also will require expanded disclosures on revenue recognition including information about changes in assets and liabilities that result from contracts with customers. Companies have an option to use either a retrospective approach or a cumulative effect adjustment approach to implement the new guidance. The new standard will be effective for annual reporting periods beginning after December 15, 2017. Early adoption is permitted for annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the impact of this new standard on its consolidated financial statements, the date of adoption, and the transition approach to implement the new guidance.

Research and Development Costs

In January 2010, the Company entered into a collaboration agreement with a related party, HUYA Bioscience International, LLC (“HUYA”), to fund up to $2.3 million of its research and development activity for a specific compound. Under the agreement, the Company had the potential to receive additional consideration which contractually would not exceed $16.5 million excluding interest if certain events had occurred. In February 2015, the Company and HUYA agreed to terminate the collaboration agreement. In connection with the termination, HUYA paid the Company $5.0 million to satisfy all of HUYA’s various payment obligations under the collaboration agreement.

 

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2. Employee Stock Compensation

The Company granted the following share-based awards:

 

 

There were no share-based awards granted during the three months ended September 30, 2014.

The Company had the following share-based awards outstanding:

 

 

The Company used the following assumptions when estimating the value of the share-based compensation for stock options and stock appreciation rights issued as follows:

 

 

In March 2015, the Company awarded performance units that contain both service and performance based vesting criteria. Vesting occurs if the recipient remains employed and depends on the degree to which the Company achieves certain cumulative adjusted diluted earnings per share goals during a three-year performance period (as defined in the award agreements). The fair value of these awards is equal to the closing price of the Company’s common stock on the grant date.

In November 2013, the Company’s Board of Directors (the “Board”) approved an Employee Stock Purchase Plan (“ESPP”) which was approved by the Company’s shareholders in May 2014. The ESPP allows eligible employees to authorize payroll deductions of up to 10% of their base salary to be applied toward the purchase of full shares of the Company’s common stock on the last day of the offering period. Offering periods under the ESPP are six months in duration. The first two offering periods for the ESPP began March 1, 2014 and September 1, 2014, respectively. In November 2014, the ESPP was amended to change the start of the offering periods to begin on April 1 and October 1 of each year, beginning April 1, 2015. Participating employees purchase shares on the last day of each offering period at a discount of 15% of the closing price of the common stock on such date as reported on the New York Stock Exchange. During the nine months ended September 30, 2015 and 2014, the Company issued 90,079 shares and 46,032 shares, respectively, of common stock for purchases under the ESPP.

The Company recognized share-based compensation expense of $8.4 million and $6.8 million during the three months ended September 30, 2015 and 2014, respectively, and $28.7 million and $22.4 million during the nine months ended September 30, 2015 and 2014, respectively.

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3. Concentration of Credit Risk

No customer accounted for 10% or more of consolidated service revenues for the three and nine months ended September 30, 2015 or 2014.

 

4. Accounts Receivable and Unbilled Services

Accounts receivable and unbilled services consist of the following (in thousands):

 

 

5. Goodwill

The following is a summary of goodwill by segment for the nine months ended September 30, 2015 (in thousands):

 

 

6. Derivatives

As of September 30, 2015, the Company held the following derivative positions: (i) forward exchange contracts to protect against foreign exchange movements for certain forecasted foreign currency cash flows related to service contracts and (ii) interest rate swaps to hedge the exposure to variability in interest payments on variable interest rate debt. The Company does not use derivative financial instruments for speculative or trading purposes.

As of September 30, 2015, the Company had 15 open foreign exchange forward contracts to hedge certain forecasted foreign currency cash flow transactions occurring in 2015 and the first six months of 2016 with notional amounts totaling $116.1 million. These contracts were executed to hedge the risk of the potential volatility in the cash flows resulting from fluctuations in currency exchange rates during the remainder of 2015 and the first six months of 2016. These transactions are accounted for as cash flow hedges, as such, the effective portion of the gain or loss on the contracts is recorded as unrealized gains (losses) on derivatives included in the accumulated other comprehensive income (loss) (“AOCI”) component of shareholders’ deficit. These hedges are highly effective. Upon expiration of the hedge instruments in 2015 and the first six months of 2016, the Company will reclassify the unrealized holding gains and losses on the derivative instruments included in AOCI into earnings.

On June 9, 2011, the Company entered into six interest rate swaps which expired between September 30, 2013 and March 31, 2016 in an effort to limit its exposure to changes in the variable interest rate on its senior secured credit facilities. During May 2015, in conjunction with the debt refinancing described in Note 8, the Company terminated the remaining open interest rate swaps for a cash payment to the counterparty of $12.4 million which included $1.4 million of accrued interest. Since the hedged forecasted cash transactions continue to be probable of occurring, the accumulated loss ($6.2 million at September 30, 2015) related to the terminated interest rate swaps in AOCI will be reclassified to earnings as a component of interest expense in the same periods as the hedged forecasted transactions occur over the next six months.

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On June 3, 2015, the Company entered into seven forward starting interest rate swaps with a notional value of $440.0 million in an effort to limit its exposure to changes in the variable interest rate on its senior secured credit facilities. Interest on the swaps begins to accrue on June 30, 2016 and the interest rate swaps expire between March 31, 2017 and March 31, 2020. The critical terms of the interest rate swaps were substantially the same as those of the Company’s senior secured credit facilities, including quarterly interest settlements. These interest rate swaps are being accounted for as cash flow hedges as these transactions were executed to hedge the Company’s interest payments, and these hedges are deemed to be highly effective. As such, changes in the fair value of these derivative instruments are recorded as unrealized gains (losses) on derivatives included in AOCI. The fair value of these interest rate swaps represents the present value of the anticipated net payments the Company will make to the counterparty, which, when they occur, are reflected as interest expense on the condensed consolidated statements of income. These payments, together with the variable rate of interest incurred on the underlying debt, result in a fixed rate of interest of 2.1% plus the applicable margin on the affected borrowings. These interest rate swaps in conjunction with the Company’s Senior Notes, as defined below, will result in a debt mix of approximately 50% fixed rate debt and 50% variable rate debt. The Company expects that $1.9 million of unrealized losses will be reclassified out of AOCI and will form the interest rate swap component of the 2.1% fixed rate of interest incurred over the next 12 months as the underlying net payments are settled.

The fair values of the Company’s derivative instruments designated as hedging instruments and the line items on the accompanying condensed consolidated balance sheets to which they were recorded are summarized in the following table (in thousands):

 

 

The effect of the Company’s cash flow hedging instruments on other comprehensive income (loss) is summarized in the following table (in thousands):

 

 

7. Fair Value Measurements

The Company records certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. A three-level fair value hierarchy that prioritizes the inputs used to measure fair value is described below. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

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Recurring Fair Value Measurements

The following table summarizes the fair value of the Company’s financial assets and liabilities that are measured on a recurring basis as of September 30, 2015 (in thousands):

 

 

Below is a summary of the valuation techniques used in determining fair value:

Marketable equity securities — The Company values marketable equity securities utilizing quoted market prices.

Foreign exchange forward contracts — The Company values foreign exchange forward contracts using quoted market prices for identical instruments in less active markets or using other observable inputs.

Interest rate swaps — The Company values interest rate swaps using market inputs with mid-market pricing as a practical expedient for bid-ask spread.

Contingent consideration — The Company values contingent consideration related to business combinations using a weighted probability calculation of potential payment scenarios discounted at rates reflective of the risks associated with the expected future cash flows. Key assumptions used to estimate the fair value of contingent consideration include revenue, net new business and operating forecasts and the probability of achieving the specific targets.

The following table summarizes the changes in Level 3 financial assets and liabilities measured on a recurring basis for the nine months ended September 30 (in thousands):

 

 

The revaluations for the contingent consideration are recognized in other (income) expense, net on the accompanying condensed consolidated statements of income.

Non-recurring Fair Value Measurements

Certain assets are carried on the accompanying condensed consolidated balance sheets at cost and are not remeasured to fair value on a recurring basis. These assets include cost and equity method investments and loans that are written down to fair value for declines which are deemed to be other-than-temporary, and goodwill and identifiable intangible assets which are tested for impairment annually and when a triggering event occurs.

As of September 30, 2015, assets carried on the balance sheet and not remeasured to fair value on a recurring basis totaling approximately $1,175.1 million and were identified as Level 3. These assets are comprised of cost and equity method investments of $76.7 million, goodwill of $724.0 million and other identifiable intangibles, net of $374.4 million.

The Company has unfunded cash commitments totaling approximately $40.2 million related to its cost and equity method investments as of September 30, 2015.

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8. Credit Arrangements

The following is a summary of the Company’s revolving credit facilities at September 30, 2015:

 

 

The Company did not have any outstanding borrowings under any of the revolving credit facilities at September 30, 2015 or December 31, 2014. At September 30, 2015, there were bank guarantees totaling approximately £3.9 million (approximately $5.9 million) issued against the availability of the general banking facility with a European-headquartered bank through its operations in the United Kingdom.

Long-term debt consists of the following (in thousands):

 

 

Contractual maturities of long-term debt at September 30, 2015 are as follows (in thousands):

 

The estimated fair value of the Company’s long-term debt approximates its carrying value as of September 30, 2015 and December 31, 2014. The estimated fair value of the long-term debt is primarily based on rates in which the debt is traded among banks.

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Refinancing Transaction

On May 12, 2015, Quintiles Transnational Corp. (“Quintiles Transnational”), a wholly-owned subsidiary of the Company, entered into new senior secured credit facilities (the “New Facilities”) totaling $1.95 billion. The New Facilities consist of a five-year $500.0 million revolving credit facility (the “New Revolver”) and $1.45 billion of term loans ($850 million in Term Loan A due 2020 (“Term Loan A”) and $600 million in Term Loan B due in 2022 (“Term Loan B”)). In addition, Quintiles Transnational issued $800 million of 4.875% senior unsecured notes due 2023 (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 balance to be repaid on their respective maturity dates. Beginning with the fiscal year ending December 31, 2016, the Company 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 the Company’s leverage ratio). 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. The Company will also be required to make mandatory repayments with 100% of the net cash proceeds of certain asset dispositions, subject to thresholds and reinvestment rights. 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 (beginning November 15, 2015) 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.

The Company used the proceeds from the New Debt (i) to repay the then-outstanding Term Loan B-3 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 discussed further in Note 6, and (iii) for general corporate purposes including the share repurchase discussed further in Note 10.

In connection with this refinancing transaction, in the second quarter of 2015 the Company recognized a $7.8 million loss on extinguishment of debt which included $1.1 million of unamortized debt issuance costs, $1.3 million of unamortized discount and $5.4 million of related fees and expenses.

Debt Covenants

The Company’s long-term debt agreements contain usual and customary restrictive covenants that, among other things, place limitations on its ability to declare dividends and make other restricted payments; prepay, redeem or purchase debt; incur liens; make loans and investments; incur additional indebtedness; amend or otherwise alter debt and other material documents; engage in mergers, acquisitions and asset sales; transact with affiliates; and engage in businesses that are not related to the Company’s existing business. In the nine months ended September 30, 2015, the Company was in compliance with its debt covenants.

 

9. Business Combinations

On July 1, 2015, the Company and Quest Diagnostics Incorporated (“Quest”) closed on a joint venture transaction that resulted in the combination of their respective global clinical trials laboratory operations. The joint venture transaction was affected through the creation of two primary new legal entities that the Company controls. Both the Company’s and Quest’s clinical trials laboratory operations were contributed to these new legal entities. Quest was issued a 40% equity interest in the legal entities, the fair value of which was $423.3 million (40% of the fair value of all operations contributed by both parties) and represents the purchase price paid by the Company for the clinical trials laboratory operations that Quest contributed to the joint venture transaction. The resulting combined capabilities will provide its customers with globally scaled end-to-end clinical trials laboratory services and the combined business will be hereafter referred to and marketed as Q² Solutions.

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The Company accounted for the contribution of the Quest businesses as a business combination and consolidated the related new legal entities in its financial statements with a noncontrolling interest for the portion owned by Quest and, accordingly, the assets acquired and the liabilities assumed have been recorded at their respective estimated fair values as of the transaction date. As a result, the Company recorded goodwill, primarily attributable to assembled workforce and expected synergies. This business combination is part of the Product Development segment and the resulting goodwill is not deductible for income tax purposes. The Company is continuing to evaluate the initial fair value measurement of the assets acquired and liabilities assumed as of the acquisition date. Further adjustments may be necessary as additional information related to the fair values of assets acquired and liabilities assumed is assessed during the measurement period (up to one year from the acquisition date). Pro forma information is not presented as the operations of the acquired business are not significant to the overall operations of the Company. Acquisition-related expenses were immaterial and are also not presented.

The following table summarizes the estimated fair value of the net assets acquired at the date of the business combination (in thousands):

 

The other identifiable intangible assets consisted of the following (in thousands):

 

The acquired trade name is an indefinite-lived intangible asset that is not amortized.

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10. Shareholders’ Deficit

Below is a summary of the changes in shareholders’ deficit during the nine months ended September 30, 2015 (in thousands, except share information):

 

The Company’s contribution of its businesses to the joint venture was recorded at book value (carryover basis) because the Company maintains control of these businesses. As a result, Quest’s noncontrolling interest in Q² Solutions is equal to 40% of the combined carrying value of the net assets contributed by the Company plus the fair value of the net assets contributed by Quest, or $231.0 million.

On October 30, 2013, the Company’s Board of Directors (the “Board”) approved an equity repurchase program (the “Repurchase Program”) authorizing the repurchase of up to $125.0 million of either the Company’s common stock or vested in-the-money employee stock options, or a combination thereof. The Repurchase Program for vested in-the-money employee stock options expired in November 2013. In April 2015, the Board increased the share repurchase authorization under the Repurchase Program by $300.0 million. The Repurchase Program does not obligate the Company to repurchase any particular amount of common stock, and it could be modified, suspended or discontinued at any time. The Repurchase Program for common stock does not have an end date. As of September 30, 2015, the Company has remaining authorization under the Repurchase Program to repurchase up to $109.5 million of its common stock.

11. Restructuring

In February 2015, the Board approved a restructuring plan for approximately $30.0 million to align the Company’s resources and reduce overcapacity in certain roles. These actions are expected to occur throughout 2015 and 2016, and are expected to consist of severance, facility closure and other exit-related costs. Since February 2015, the Company has recognized approximately $11.0 million, $3.0 million and $547,000 of restructuring costs related to this plan for activities in the Product Development segment, Integrated Healthcare Services segment and corporate activities, respectively. To date, all of the restructuring costs have been severance and related costs. Restructuring costs are not allocated to the Company’s reportable segments as they are not part of the segment performance measures reviewed by management.

Also, in connection with consummating the joint venture transaction with Quest, during the third quarter of 2015, a restructuring plan was approved to reduce facility overcapacity and eliminate redundant roles. These actions are expected to occur throughout 2016 and 2017, and are expected to consist of severance, facility closure and other exit-related costs of approximately $14.0 million. During the three and nine months ended September 30, 2015, the Company has recognized approximately $8.4 million of restructuring costs related to this plan for activities in the Product Development segment.

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The following amounts were recorded for the February 2015 restructuring plan, the joint venture restructuring plan and the restructuring plans initiated in prior years (in thousands):

 

 

The Company expects that the majority of the restructuring accruals at September 30, 2015 will be paid in 2015, 2016 and 2017.

12. Income Taxes

The effective income tax rate was 28.0% and 31.1% in the three months ended September 30, 2015 and 2014, respectively, and 28.4% and 30.1% in the nine months ended September 30, 2015 and 2014, respectively. The decrease in the 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 the third quarter of 2015 and also a change in the relative mix of the Company’s projected 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 not considered permanently reinvested by the Company in its foreign subsidiaries.

13. Employee Benefit Plans

Defined Benefit Plans

The following table summarizes the components of pension expense related to the Company’s defined benefit plans (in thousands):

 

 

Other

As of September 30, 2015 and December 31, 2014, the Company had a severance accrual included in accounts payable and accrued expenses on the accompanying condensed consolidated balance sheets of $3.6 million and $6.3 million, respectively. The Company recognizes obligations associated with severance related to contractual termination benefits at fair value on the date that it is probable that the affected employees will be entitled to the benefit and the amount can reasonably be estimated. The severance accrual is related to cost reduction programs that will result in severance for approximately 270 positions, which are expected to lower operating costs and improve profitability. During the first nine months of 2015, the Company recognized approximately $944,000 of net reversals related to these cost reduction programs, primarily as a result of affected individuals transferring into other positions within the Company. Of the $944,000 decrease from net reversals recognized for these cost reduction programs, approximately $739,000 and $205,000 were related to activities in the Product Development segment and Integrated Healthcare Services segment, respectively. The Company expects the majority of the severance accrual at September 30, 2015 will be paid in 2015.

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The following amounts were recorded for the severance associated with cost reduction programs (in thousands):

 

 

14. Comprehensive Income

Below is a summary of the components of AOCI (in thousands):

 

 

Below is a summary of the (gains) losses reclassified from AOCI into the condensed consolidated statements of income and the affected financial statement line item (in thousands):

 

 

15. Segments

The following table presents the Company’s operations by reportable segment. The Company is managed through two reportable segments, Product Development and Integrated Healthcare Services. Product Development, which primarily serves biopharmaceutical customers engaged in research and development, provides clinical research and clinical trial services. Integrated Healthcare Services provides commercialization services to biopharmaceutical customers and research, analytics, real-world and late phase research, and other services to both biopharmaceutical customers and the broader healthcare market.

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Certain costs are not allocated to the Company’s segments and are reported as general corporate and unallocated expenses. These costs primarily consist of share-based compensation and expenses for corporate overhead functions such as finance, human resources, information technology, facilities and legal. The Company does not allocate restructuring or impairment charges to its segments. Information presented below is in thousands:

 

 

 

16. Earnings Per Share

The following table shows the weighted average number of outstanding share-based awards not included in the computation of diluted earnings per share as the effect of including such share-based awards in the computation would be anti-dilutive (in thousands):

 

 

Share-based awards will have a dilutive effect under the treasury method only when the respective period’s average market value of the Company’s common stock exceeds the exercise proceeds.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement for Forward-Looking Information

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect, among other things, our current expectations and anticipated results of operations, all of which are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements, market trends, or industry results to differ materially from those expressed or implied by such forward-looking statements. Therefore, any statements contained herein that are not statements of historical fact may be forward-looking statements and should be evaluated as such. Without limiting the foregoing, the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “should,” “targets,” “will” and the negative thereof and similar words and expressions are intended to identify forward-looking statements. We assume no obligation to update any such forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information.

We caution you that any such forward-looking statements are further qualified by important factors that could cause our actual operating results to differ materially from those in the forward-looking statements, including without limitation, that most of our contracts may be terminated on short notice, and we may be unable to maintain large customer contracts or to enter into new contracts; our financial results may be adversely affected if we underprice our contracts, overrun our cost estimates or fail to receive approval for or experience delays in documenting change orders; the historical indications of the relationship of our backlog to revenues may not be indicative of their future relationship; we may be unable to maintain our information systems or effectively update them; customer or therapeutic concentration could harm our business; our business is subject to risks associated with international operations, including economic, political and other risks, such as compliance with a myriad of laws and regulations, complications from conducting clinical trials in multiple countries simultaneously and changes in exchange rates; the market for our services may not grow as we expect; government regulators or our customers may limit the scope of prescription or withdraw products from the market, and government regulators may impose new regulatory requirements or may adopt new regulations affecting the biopharmaceutical industry; we may be unable to successfully develop and market new services or enter new markets; our failure to perform services in accordance with contractual requirements, regulatory standards and ethical considerations may subject us to significant costs or liability, which could also damage our reputation and cause us to lose existing business or not receive new business; our services are related to treatment of human patients, and we could face liability if a patient is harmed; we may be unable to successfully identify, acquire and integrate businesses, services and technologies; and we have substantial indebtedness and may incur additional indebtedness in the future, which could adversely affect our financial condition. For a further discussion of the risks relating to our business, see “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, as updated by our subsequent quarterly reports on Form 10-Q.

Overview

Our business is currently organized in two reportable segments, Product Development and Integrated Healthcare Services.

Product Development

Product Development provides services and expertise that allow biopharmaceutical companies to outsource the clinical development process from first-in-man trials to post-launch monitoring. Our comprehensive service 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 trials (generally Phase II-IV) (collectively “core clinical”). These also include clinical trial support services that improve clinical trial decision-making, such as global laboratories, data management, biostatistical, safety and pharmacovigilance, early clinical development trials (generally Phase I), and strategic planning and design services, which help improve decisions and performance. 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.

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On July 1, 2015, we combined our global clinical trials laboratories business with the clinical trials laboratory operations of Quest Diagnostics Incorporated, or Quest, through the combination of our respective clinical trials laboratories operations, with the resulting combined business referred to as Q² Solutions. We own 60% of Q² Solutions and Quest owns the remaining 40%. We believe our combined capabilities will provide customers with globally scaled end-to-end clinical trials laboratory services and will strengthen our position as the second-largest provider of such services in the world. The Q² Solutions transaction was accounted for as a business combination and is included in our consolidated financial information since the acquisition date with a noncontrolling interest for the portion which we do not own.

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 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 electronic health record implementation and advisory services.

On July 1, 2014, we completed the acquisition of Encore Health Resources, LLC, or Encore, for approximately $91.5 million in cash (net of approximately $2.2 million of acquired cash).

Reimbursed Expenses

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.

Foreign Currency Translation

In the first nine months of 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. Foreign exchange rates in certain currencies in which we do business have fluctuated significantly in the three and nine months ended September 30, 2015 as compared to the same periods of 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.

Backlog and Net New Business

We began 2015 with backlog of $11,244 million, which was 14% higher than at the beginning of 2014. Backlog at September 30, 2015 was $11,748 million.

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Net new business decreased 23.0% in the third quarter of 2015 to $1,164 million from $1,512 million in the third quarter of 2014, driven by decreases in both Product Development and Integrated Healthcare Services. Product Development’s net new business decreased 23.4% to $971 million for the third quarter of 2015 as compared to $1,268 million for the same period in 2014. Product Development had growth in net new business in the third quarter of 2015 from core clinical services and the incremental impact from the businesses that Quest contributed to Q² Solutions. These increases were more than offset by lower net new business for clinical trial support services primarily because the third quarter of 2014 included a renewal for net new business on a large five-year functional resourcing contract. Integrated Healthcare Services’ net new business decreased 20.7% to $193 million in the third quarter of 2015 as compared to $244 million for the same period in 2014, related primarily to a large cancelation for commercial services in North America as well as lower net new business for commercial services in Japan and for real-world and late phase research services.

Net new business decreased 4.5% in the first nine months of 2015 to $3,832 million from $4,014 million in the first nine months of 2014, driven by decreases in both Product Development and Integrated Healthcare Services. Product Development’s net new business decreased 3.7% to $3,025 million for the first nine months of 2015 as compared to $3,140 million for the same period in 2014. Product Development had growth in net new business in the first nine months of 2015 from core clinical services and the incremental impact from the businesses that Quest contributed to Q² Solutions. These increases were more than offset by lower net new business for clinical trial support services primarily because the first nine months of 2014 included renewals of net new business for large five-year functional resourcing contracts. Integrated Healthcare Services’ net new business decreased 7.6% to $807 million in the first nine months of 2015 as compared to $874 million for the same period in 2014, related primarily to a large cancellation as well as lower signings for commercial services in North America, partially offset by net new business growth from real-world and late phase research services and from the Encore acquisition which closed in July 2014.

Refer to “Net New Business Reporting and Backlog” elsewhere within this section for more information on how we report on net new business and backlog.

Service Revenues

 

For the three months ended September 30, 2015, our service revenues increased $32.5 million, or 3.1%, as compared to the same period in 2014. This increase was comprised of constant currency service revenue growth of approximately $88.1 million, or 8.3%, and a negative impact of approximately $55.6 million from the effects of foreign currency fluctuations. The constant currency service revenue growth was comprised of a $72.4 million increase in Product Development, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, and a $15.7 million increase in Integrated Healthcare Services.

 

For the nine months ended September 30, 2015, our service revenues increased $96.0 million, or 3.1%, as compared to the same period in 2014. This increase was comprised of constant currency service revenue growth of approximately $272.8 million, or 8.8%, and a negative impact of approximately $176.8 million from the effects of foreign currency fluctuations. The constant currency service revenue growth was comprised of a $129.9 million increase in Product Development, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, and a $142.9 million increase in Integrated Healthcare Services, which includes the impact from the Encore acquisition which closed in July 2014.

 Costs of Revenue, Service Costs

 

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When compared to the same period in 2014, service costs in the third quarter of 2015 decreased $8.0 million. This decrease included a constant currency increase in expenses of approximately $45.5 million, or 6.5%, which was more than offset by a positive impact of approximately $53.5 million from the effects of foreign currency fluctuations. The constant currency increase was comprised of a $39.1 million increase in Product Development, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, and a $6.4 million increase in Integrated Healthcare Services.

When compared to the same period in 2014, service costs in the first nine months of 2015 increased $19.4 million. This increase included a constant currency increase in expenses of approximately $179.9 million, or 9.0%, partially offset by a positive impact of approximately $160.5 million from the effects of foreign currency fluctuations. The constant currency growth was comprised of a $83.6 million increase in Product Development, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, and a $96.3 million increase in Integrated Healthcare Services, which includes the impact from the Encore acquisition which closed in July 2014.

The decrease in service costs as a percent of service revenues for both the three and nine months ended September 30, 2015 was primarily as a result of an improvement in profit margin in the Product Development segment (including a benefit from restructuring activities and an increase in research and development credits as more fully described in the Product Development segment discussion later in this section) as well as the positive impact of foreign currency fluctuations. For the nine months ended September 30, 2015, the improvements in the Product Development segment more than offset the effect from a higher proportion of consolidated service revenues being contributed by our lower margin Integrated Healthcare Services segment when compared to the same period in the prior year.

Selling, General and Administrative

 

The $12.4 million increase in selling, general and administrative expenses in the third quarter of 2015 included a constant currency increase of $23.8 million, or 10.9%, partially offset by a positive impact of approximately $11.4 million from the effects of foreign currency fluctuations. The constant currency growth was comprised of a $20.7 million increase in Product Development, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, a $2.6 million increase in Integrated Healthcare Services, and a $579,000 increase in general corporate and unallocated expenses.

The $19.6 million increase in selling, general and administrative expenses in the first nine months of 2015 included a constant currency increase of $53.3 million, or 8.1%, partially offset by a positive impact of approximately $33.7 million from the effects of foreign currency fluctuations. The constant currency growth was comprised of a $31.3 million increase in Product Development, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, a $17.5 million increase in Integrated Healthcare Services, which includes the impact from the Encore acquisition which closed in July 2014, and a $4.5 million increase in general corporate and unallocated expenses.

The constant currency increase for both the three and nine months ended September 30, 2015 for general corporate and unallocated expenses were primarily due to an increase in share-based compensation and costs associated with the Q² Solutions transaction.

Restructuring Costs

 

We recognized $12.0 million and $23.5 million of restructuring charges, net of reversals for changes in estimates, during the three and nine months ended September 30, 2015, respectively, associated with both the February 2015 and the Q² Solutions restructuring plans. The remaining actions are expected to occur throughout 2015, 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.

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Interest Income and Interest Expense

 

Interest income includes interest received primarily from bank balances and investments.

Interest expense during the three and nine months ended September 30, 2015 was higher than the same periods in 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 the New Debt discussed in Liquidity and Capital Resources.

Loss on Extinguishment of Debt

 

In the second quarter of 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.

Other (Income) Expense, Net

 

Other (income) expense, net for the third quarter of 2015 primarily included $2.1 million of foreign currency net gains. The third quarter of 2014 primarily consisted of $8.8 million in income related to the change in fair value of contingent consideration related to an acquisition, partially offset by other expenses, primarily consisting of $926,000 of foreign currency net losses.

Other (income) expense, net for the first nine months of 2015 primarily consisted of $644,000 of foreign currency net losses and $6.0 million of expense related to the change in fair value of contingent consideration related to an acquisition. The first nine months of 2014 included income of $8.6 million related to the change in fair value of contingent consideration related to an acquisition as well as a gain from the sale of marketable equity securities of $5.0 million, partially offset by other expenses, primarily consisting of $4.3 million of foreign currency net losses.

Income Tax Expense

 

The effective income tax rate was 28.0% and 31.1% in the third quarter of 2015 and 2014, respectively, and 28.4% and 30.1% in the first nine months of 2015 and 2014, respectively. The decrease in the 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 the third quarter of 2015 and also a change in the relative mix of the projected 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.

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Equity in Earnings of Unconsolidated Affiliates

 

Equity in earnings of unconsolidated affiliates primarily includes gains from our investment in the NovaQuest Pharma Opportunities Fund III, L.P.

Net Loss (Income) Attributable to Noncontrolling Interests

 

 

Net loss (income) attributable to noncontrolling interests primarily includes Quest’s interest in Q² Solutions.

Segment Results of Operations

Service revenues and income from operations by segment are as follows (dollars in millions):

 

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, information technology, facilities and legal. We do not allocate restructuring charges to our segments.

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Product Development

 

Service Revenues

Product Development’s service revenues were $810.1 million in the third quarter of 2015, an increase of $38.7 million, or 5.0%, over the same period in 2014. This increase was comprised of constant currency service revenue growth of $72.4 million, or 9.4%, partially offset by a negative impact of approximately $33.7 million from the effects of foreign currency fluctuations. The constant currency service revenue growth primarily included a volume-related increase of $27.7 million from clinical solutions and services and the incremental impact from the businesses that Quest contributed to Q² Solutions.

The volume-related service revenue growth in the three months ended September 30, 2015 was related to an increase in core clinical services, clinical solutions provided on a functional resource basis and clinical trial support services. This growth was largely due to execution on the higher backlog in place as we entered the quarter.

Product Development’s service revenues were $2,346.0 million in the first nine months of 2015, an increase of $22.6 million, or 1.0%, over the same period in 2014. This increase was comprised of constant currency service revenue growth of $129.9 million, or 5.6%, partially offset by a negative impact of approximately $107.3 million from the effects of foreign currency fluctuations. The constant currency service revenue growth primarily included a volume-related increase of $92.3 million 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 $7.5 million from advisory services.

The volume-related service revenue growth in the nine months ended September 30, 2015 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 as well as from $16.9 million of revenue recognized in the second quarter of 2015 as a result of the release of deferred revenue upon 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 in both the three and nine months ended September 30, 2015 was negatively impacted by cancellations from 2014.

Costs of Revenue, Service Costs

Product Development’s service costs increased approximately $3.2 million in the third quarter of 2015 over the same period in 2014. This increase included a constant currency increase of $39.1 million, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, partially offset by $35.9 million from the positive effects of foreign currency fluctuations.

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The constant currency service costs growth for the three months ended September 30, 2015 was primarily due to the impact from the Q² Solutions transaction and an increase in compensation and related expenses resulting from an increase in billable headcount as a result of the ramp up of new projects resulting from recent net new business, which we expect to continue over the remainder of the year, as well as annual merit increases. These increases in service costs were partially offset by efficiencies gained from restructuring activities taken in prior years.

Product Development’s service costs decreased approximately $21.8 million in the first nine months of 2015 over the same period in 2014. This decrease included $105.4 million from the positive effects of foreign currency fluctuations, partially offset by a constant currency increase of $83.6 million, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions.

The constant currency service costs growth for the nine months ended September 30, 2015 was primarily due to the impact from the Q² Solutions transaction and an increase in compensation and related expenses resulting from an increase in billable headcount as a result of the ramp up of new projects resulting from recent net new business, which we expect to continue over the remainder of the year, as well as annual merit increases. These increases in service costs were partially offset by efficiencies gained from restructuring activities taken in prior years. 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 early close out of a customer arrangement. Service cost growth was partially offset by a $15.0 million increase in the benefit from research and development credits received in Europe, when compared to the same period in the prior year.

Selling, General and Administrative

Product Development’s selling, general and administrative expenses increased approximately $12.3 million, or 8.0%, in the third quarter of 2015 as compared to the same period in 2014. This increase was primarily caused by a constant currency increase of $20.7 million, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, partially offset by a reduction of $8.4 million from the positive effects of foreign currency fluctuations.

Product Development’s selling, general and administrative expenses increased approximately $7.0 million, or 1.5%, in the first nine months of 2015 as compared to the same period in 2014. This increase was primarily caused by a constant currency increase of $31.3 million, which includes the incremental impact from the businesses that Quest contributed to Q² Solutions, partially offset by a reduction of $24.3 million from the positive effects of foreign currency fluctuations.

For both the three and nine months ended September 30, 2015 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.

Integrated Healthcare Services

 

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Service Revenues

Integrated Healthcare Services’ service revenues were $283.4 million in the third quarter of 2015, a decrease of $6.2 million, or 2.1%, over the same period in 2014. This decrease was comprised of a negative impact of approximately $21.9 million due to the effects of foreign currency fluctuations, partially offset by constant currency service revenue growth of $15.7 million, or 5.5%.

Integrated Healthcare Services’ service revenues were $851.8 million in the first nine months of 2015, an increase of $73.4 million, or 9.4%, over the same period in 2014. This increase was comprised of constant currency service revenue growth of $142.9 million, including $43.8 million from the Encore acquisition which closed in July 2014, or 18.3%, partially offset by a negative impact of approximately $69.5 million due to the effects of foreign currency fluctuations.

The increase in constant currency service revenues for the third quarter of 2015 was largely due to growth in real-world and late phase research services. The increase in constant currency service revenues for the first nine months of 2015 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. Both periods in 2015 were 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.

Costs of Revenue, Service Costs

Integrated Healthcare Services’ service costs decreased approximately $11.1 million in the third quarter of 2015. This decrease was comprised of a reduction of $17.5 million from the positive effects of foreign currency fluctuations, partially offset by a $6.4 million constant currency increase, or 2.8%.

Integrated Healthcare Services’ service costs increased approximately $41.2 million in the first nine months of 2015. This increase was comprised of a $96.3 million constant currency increase, or 15.2%, partially offset by a reduction of $55.1 million from the positive effects of foreign currency fluctuations.

The constant currency increase for both the three and nine months ended September 30, 2015 was due to 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. In addition, the increase in the nine months ended September 30, 2015 includes the impact from the Encore acquisition which closed in July 2014.

Selling, General and Administrative

Integrated Healthcare Services’ selling, general and administrative expenses were slightly higher in the third quarter of 2015 as compared to the same period in 2014. This increase was comprised of a $2.6 million constant currency increase, or 6.9%, partially offset by a reduction of $1.8 million from the positive effects of foreign currency fluctuations.

Integrated Healthcare Services’ selling, general and administrative expenses increased approximately $11.8 million, or 11.5%, in the first nine months of 2015 as compared to the same period in 2014. This increase was comprised of a $17.5 million constant currency increase, or 17.0%, partially offset by a reduction of $5.7 million from the positive effects of foreign currency fluctuations.

The constant currency increase for the nine months ended September 30, 2015 was primarily due to an increase in compensation and related expenses and the impact from the Encore acquisition which closed in July 2014.

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 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.

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We had a cash balance of $1,081.8 million at September 30, 2015 ($411.9 million of which was in the United States), an increase from $867.4 million at December 31, 2014.

On October 30, 2013, our Board approved an equity repurchase program, or 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. In April 2015, our Board increased the share repurchase authorization under the Repurchase Program by $300.0 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. On May 19, 2015, we completed the repurchase of 3,855,050 shares of our common stock for $64.85 per share for an aggregate purchase price of approximately $250.0 million. Additional information regarding the Repurchase Program is presented in Part II, Item 2 “Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities” of this Quarterly Report on Form 10-Q.

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.

Long-Term Debt

On May 12, 2015, Quintiles Transnational Corp., or Quintiles Transnational, our wholly-owned subsidiary, 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 in 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). 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. 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 (beginning November 15, 2015) 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 then-outstanding Term Loan B-3 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.

As of September 30, 2015, we had $2.5 billion of total indebtedness, excluding $534.3 million of additional available borrowings under our revolving credit facilities. There were no amounts drawn on the revolving credit facilities in the first nine months of 2015. Our long-term debt arrangements contain usual and customary restrictive covenants, and as of September 30, 2015, we believe we were in compliance with these covenants.

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See “Management’s Discussion and Analysis – Liquidity and Capital Resources” and Note 10 to our audited consolidated financial statements, each included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, for additional details regarding our credit arrangements.

Nine months ended September 30, 2015 and 2014

Cash Flow from Operating Activities

 

Cash provided by operating activities increased by $93.6 million during the first nine months of 2015 as compared to the same period in 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 were lower payments for interest ($18.4 million) and income taxes ($28.5 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 nine-day increase in DSO in the first nine months of 2015 compared to a seven-day increase in DSO in the first nine months of 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.

Cash Flow from Investing Activities

 

Cash used in investing activities decreased by $106.5 million during the first nine months of 2015 as compared to the same period in 2014. This decrease was primarily related to cash acquired in the Q² Solutions transaction ($31.0 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 during the first nine months of 2015 ($11.0 million).

Cash Flow from Financing Activities

 

Cash provided by financing activities was $21.7 million during the first nine months of 2015, as compared to cash used in financing activities of $144.4 million in the same period in 2014. The increase in cash provided by financing activities in the first nine months of 2015 was primarily related to net cash provided by debt refinancing ($178.3 million), higher cash from stock issued under employee stock purchase and option plans ($35.1 million), an increase in the excess tax benefits on stock option exercises ($22.3 million) and lower cash used related to stock option repurchases ($8.4 million), partially offset by higher cash used to repurchase common stock ($84.9 million).

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Net New Business Reporting and Backlog

Net new business is the value of services awarded during the period from projects under signed contracts, letters of intent and, in some cases, pre-contract commitments, which are supported by written communications and adjusted for contracts that were modified or canceled during the period. Consistent with our methodology for calculating net new business during a particular period, backlog represents, at a particular point in time, future service revenues from work not yet completed or performed under signed contracts, letters of intent and, in some cases, pre-contract commitments that are supported by written communications. Once work begins on a project, service revenues are recognized over the duration of the project. Historically, net new business and backlog denominated in foreign currencies was valued each month throughout the year using foreign exchange rates that were in effect at the beginning of each fiscal year. Beginning with the first quarter of 2015, net new business and backlog denominated in foreign currencies is valued each month using the actual average foreign exchange rates in effect during the month. The application of this new approach to value foreign currency denominated net new business and backlog would not have had a significant impact to any prior period’s reported amounts, therefore historical amounts have not been restated to reflect this change in methodology. Included within backlog at September 30, 2015 is approximately $8,020 million of backlog that we do not expect to generate revenue in the next 12 months.

Backlog was as follows:

 

Net new business was as follows:

 

Contractual Obligations and Commitments

We have various contractual obligations, which are recorded as liabilities in our consolidated financial statements. Other items, such as operating lease obligations, are not recognized as liabilities in our consolidated financial statements but are required to be disclosed.

With the exception of the refinancing transaction described in Note 8, there have been no material changes, outside of the ordinary course of business, to our contractual obligations as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

Application of Critical Accounting Policies

There have been no material changes to our critical accounting policies as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our quantitative and qualitative disclosures about market risk as compared to the quantitative and qualitative disclosures about market risk described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our CEO and CFO have concluded that as of such date, our disclosure controls and procedures were effective.

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In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

We are party to legal proceedings incidental to our business. While the outcome of these matters could differ from management’s expectations, we do not believe that the resolution of these matters is reasonably likely to have a material adverse effect to our financial statements.

Item 1A. Risk Factors

For a further discussion of the risks relating to our business, see “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, as updated by our subsequent quarterly reports on Form 10-Q.

Item 2. Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities

Recent Sales of Unregistered Securities

Not applicable.

Use of Proceeds from Registered Securities

Not applicable.

Purchases of Equity Securities by the Issuer

Not applicable.

Item 6. Exhibits

The exhibits in the accompanying Exhibit Index following the signature page are filed or furnished as a part of this report and are incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Durham, State of North Carolina, on October 28, 2015.

 

 

 

 

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EXHIBIT INDEX

 

 

 

 

 

 

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