-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GZ9C0Vkh1bnhYp3nANCz5CYxKyFA5KtYBgC4OqrkoeXGh3UUE/ev1Wumz/l/FaPF laJnwogkMZMNzFs8OfjG/Q== 0000950144-99-003691.txt : 19990402 0000950144-99-003691.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950144-99-003691 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUINTILES TRANSNATIONAL CORP CENTRAL INDEX KEY: 0000919623 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 561714315 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23520 FILM NUMBER: 99580814 BUSINESS ADDRESS: STREET 1: 4709 CREEKSTONE DR STREET 2: RIVERBIRCH BLDG STE 200 CITY: DURHAM STATE: NC ZIP: 27703-8411 BUSINESS PHONE: 9199982000 MAIL ADDRESS: STREET 1: 4709 CREEKSTONE DR STREET 2: STE 300 CITY: DURHAM STATE: NC ZIP: 27703-8411 10-K 1 QUINTILES TRANSNATIONAL CORP. 10-K 12/31/1998 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 340-23520 QUINTILES TRANSNATIONAL CORP. (Exact name of registrant as specified in its charter) NORTH CAROLINA 56-1714315 (State of incorporation) (I.R.S. Employer Identification Number) 4709 CREEKSTONE DRIVE, SUITE 200 DURHAM, NORTH CAROLINA 27703-8411 (Address of principal executive (Zip Code) office)
Registrant's telephone number, including area code: (919) 998-2000 Securities registered pursuant to Section 12(b) of the Act: NONE. Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE PER SHARE (Title of Class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [ ] The aggregate market value of the registrant's Common Stock at February 28, 1999 held by those persons deemed by the registrant to be non-affiliates was approximately $3,050,657,065. As of February 28, 1999 (the latest practicable date), there were 78,202,633 shares of the registrant's Common Stock, $.01 par value per share, outstanding. DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED - -------- ------------------ 1. Proxy Statement for the Annual Meeting of Shareholders to be held June 14, 1999 Part III
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 QUINTILES TRANSNATIONAL CORP. FORM 10-K ANNUAL REPORT INDEX
PAGE ---- PART I.................................................................. 1 Item 1. Business.................................................... 1 Item 2. Properties.................................................. 17 Item 3. Legal Proceedings........................................... 17 Item 4. Submission of Matters to a Vote of Security Holders......... 18 PART II................................................................. 19 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................................... 19 Item 6. Selected Financial Data..................................... 20 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 21 Item 7a. Quantitative and Qualitative Disclosures about Market Risk...................................................... 29 Item 8. Financial Statements and Supplementary Data................. 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 54 PART III................................................................ 54 Item 10. Directors and Executive Officers of the Registrant.......... 54 Item 11. Executive Compensation...................................... 54 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................ 54 Item 13. Certain Relationships and Related Transactions.............. 54 PART IV................................................................. 55 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................................... 55
i 3 PART I ITEM 1. BUSINESS GENERAL Quintiles Transnational Corp. ("Quintiles" or the "Company") is a market leader in providing full-service contract research, sales, marketing and healthcare policy consulting and health information management services to the global pharmaceutical, biotechnology, medical device and healthcare industries. Supported by its extensive information technology capabilities, the Company provides a broad range of contract services to help its clients reduce the length of time from the beginning of development to peak sales of a new drug or medical device. The Company's product development services include a full range of services focused on helping its clients through the development and regulatory approval of a new drug or medical device. The Company's commercialization services, including sales and specialized marketing support services, focus on helping its clients achieve commercial success for a new product or medical device. The Company also offers healthcare policy research and management consulting, which emphasize improving the quality, availability and cost-effectiveness of healthcare. Through its March 1999 acquisitions of Pharmaceutical Marketing Services, Inc. ("PMSI") and ENVOY Corporation ("ENVOY"), the Company will also offer healthcare electronic data interchange, data mining and market research services which will form the core of its healthcare informatics services. Since its inception in 1982, the Company has continued to expand the scope of its services and its geographic presence to support the needs of its customers on a worldwide basis. The Company has implemented a number of strategic initiatives to broaden its array of services and create new opportunities for growth. As part of this strategy, the Company has completed approximately 32 acquisitions over the past five years. For example, in February 1998, the Company made four acquisitions: Pharma Networks N.V., a leading contract sales and healthcare recruitment organization based in Brussels, Belgium; Technology Assessment Group ("TAG"), an international health outcomes assessment firm based in San Francisco, California specializing in patient registries and in evaluating the economic, quality-of-life and clinical effects of drug therapies and disease management programs; T2A S.A., a leading French contract sales and marketing organization; and More Biomedical Contract Research Organization Ltd., a contract research organization based in Taiwan. In May 1998, the Company acquired two companies, ClinData International Pty Ltd., a leading biostatistics and data management company in South Africa, and Crossbox Limited t/a Cardiac Alert, a U.K.-based company which provides a centralized electrocardiogram monitoring service for international clinical trials. In August 1998, the Company acquired The Royce Consultancy plc, a leading pharmaceutical sales representative recruitment and contract sales organization in the U.K. In September 1998, the Company acquired Data Analysis Systems Inc. ("DAS"), a leader in sales force planning and territory optimization systems for the pharmaceutical industry. In October 1998, the Company acquired New Jersey-based Simirex Inc. and Simirex International Ltd. (collectively, "Simirex"), which provide clinical packaging services for the pharmaceutical industry. Also in October 1998, the Company acquired Groupe H2V SA ("Serval"), a French contract sales and marketing company, and Q.E.D. International Inc. ("Q.E.D."), a New York-based provider of integrated product marketing and communication services for pharmaceutical companies in the U.S. market. Effective January 1, 1999, the Company completed its previously announced acquisition of substantial assets of Hoechst Marion Roussel's Kansas City-based Drug Innovation and Approval organization and the opening of a Kansas City contract research facility. In February 1999, the Company acquired Chicago-based Oak Grove Technologies Inc., a leader in providing current Good Manufacturing Practice ("cGMP") compliance services to the pharmaceutical, biotechnology and medical device industries. In December 1998, the Company also announced two acquisitions that were completed in the first quarter of 1999. On March 29, 1999, the Company acquired all of the outstanding stock of PMSI in a merger that resulted in PMSI becoming a subsidiary of the Company. Through its Scott-Levin subsidiary in the United States, PMSI provides a range of information and market research services to pharmaceutical and healthcare companies to enable them to optimize the performance of their sales and marketing activities. 1 4 On March 30, 1999, the Company acquired all of the outstanding stock of ENVOY in a merger resulting in ENVOY becoming a subsidiary of the Company. ENVOY is a leading provider of healthcare electronic data interchange ("EDI") and transaction processing based in Nashville, Tennessee. ENVOY provides healthcare EDI services on a real-time and batch-processing basis by utilizing proprietary computer and telecommunications software and microprocessor technology. Through its subsidiary, Synergy Health Care, Inc., ENVOY provides healthcare data warehousing and analysis, performance tracking, patient studies and disease management support. ENVOY is one of the largest processors of electronic real-time pharmacy and commercial third-party payor batch transactions in the United States based upon annual transaction volume. In addition, ENVOY believes that it has one of the largest patient statement processing and printing services business in the United States, processing more than 160 million patient statements annually. ENVOY's transaction network, which processed approximately 1.2 billion transactions in 1998, consisted of approximately 200,000 physicians, 36,000 pharmacies, 42,000 dentists, 4,600 hospitals and 865 payors, including approximately 47 Blue Cross Blue Shield Plans, 59 Medicare Plans and 40 Medicaid Plans as of December 31, 1998. In addition to acquisitions, the Company also has entered strategic alliances and made strategic investments that the Company believes will position it to explore new opportunities and areas for potential growth. The Company added, including acquisitions, approximately 51 new offices since January 1, 1998. In June 1998, the Company acquired a clinical trial supply production and warehouse facility in Livingston, Scotland. The Company has integrated the modern 58,000 square-foot facility with its two other nearby facilities, the Bathgate facility, which specializes in clinical trial packaging and distribution, and the Edinburgh facility, which provides services in all aspects of preclinical and pharmaceutical drug development. SERVICES The Company provides globally integrated contract research, sales, marketing and healthcare policy consulting and health information management services to the global pharmaceutical, biotechnology, medical device and healthcare industries. Through its recent acquisitions of ENVOY and PMSI, the Company has added healthcare EDI, data mining and market research services to its portfolio. The Company has been managed through two reportable segments, namely the commercialization service group (the "Commercialization Group") and the product development service group (the "Product Development Group"). Management has distinguished these segments based on the normal operations of the Company. The Commercialization Group is primarily responsible for sales force deployment and strategic marketing services. The Product Development Group is primarily responsible for all phases of clinical research and outcomes research consulting. Please refer to Note 13 in the Company's Notes to Consolidated Financial Statements for financial information regarding each segment. The Company provides its customers with a continuum of services which span across both segments. The Company's service offerings are described below. Product Development Offerings Clinical Services The Company provides a full range of drug development services focused on helping its clients to achieve regulatory success, from strategic planning and preclinical services to regulatory submission and approval. Clinical Trial Services The Company offers comprehensive clinical trial services which are the basis for obtaining regulatory approval for drugs and medical devices. The Company has specialized business units and extensive experience in the therapeutic areas of the central nervous system, cardiovascular, infectious and respiratory diseases as well as in the field of oncology. The Company also has significant clinical trials experience in the therapeutic areas of endocrinological, gastroenterological, genitourinary and musculoskeletal diseases, as well as in the 2 5 area of stroke. The Company is experienced in managing large trials involving several thousand patients at several hundred sites and in multinational trials conducted simultaneously in the Americas, Europe, the Asia-Pacific region and South Africa. The Company provides its customers with one or more of the following core clinical trial services: Study Design. The Company assists its customers in preparing the study protocol and designing case report forms ("CRFs"). The study protocol defines the medical issues to be examined, the number of patients required to produce statistically valid results, the period of time over which they must be tracked, the frequency and dosage of drug administration and the study procedures. The study's success often depends on the protocol's ability to predict correctly the requirements of the applicable regulatory authorities. Investigator Recruitment. During clinical trials, the drug is administered to patients by physicians, also referred to as investigators, at hospitals, clinics or other locations, also referred to as sites. The Company has access to several thousand investigators who have conducted clinical trials worldwide for the Company. Study Monitoring. The Company provides study monitoring services which include investigational site initiation, patient enrollment assistance and data collection and clarification. Site visits serve to assure the quality of the data, which are gathered according to Good Clinical Practice ("GCP"), and to meet the sponsors' and regulatory agencies' requirements as specified in the study protocol. Clinical Data Management and Biostatistical Services. The Company has extensive experience in the United States and Europe in the creation of scientific databases for all phases of the drug development process, including the creation of customized databases to meet customer-specific formats, integrated databases to support New Drug Application ("NDA") submissions and databases in accordance with the United States Food and Drug Administration ("FDA") and European specifications. Phase I Services. Phase I clinical trials involve testing a new drug on a limited number of healthy individuals. The Company's Phase I services include dose ranging, bioavailability/bioequivalence studies, pharmacokinetic/pharmacodynamic modeling, first administration to humans, multiple dose tolerance, dose effect relationship and metabolism studies. In addition to the Company's core clinical trial management services, the Company provides its customers with the following specialized services: Centralized Clinical Trial Laboratory. In addition to providing comprehensive safety and efficacy testing for clinical trials, the Company's centralized clinical trial laboratory provides site-specific study materials, customized lab report design and specimen archival and management on behalf of a study sponsor. The centralized laboratory offers a 48-hour turnaround time for laboratory results and is capable of providing direct electronic integration of laboratory data into safety and efficacy reports for NDA submissions. Formulation, Manufacturing and Packaging Services. The Company offers services in the design and development of pharmaceutical dose forms as well as the manufacture of study drug and placebos and the appropriate packaging of these for double blinded studies. These services can expedite the drug development process because clinical trials are often postponed by delays in the manufacture of study drug materials. In June 1998, the Company acquired a 58,000 square foot clinical trial production and warehouse facility in Livingston, Scotland, which expands the Company's existing capacity at its two nearby facilities in Bathgate and Edinburgh. The Company also expanded its clinical packaging capabilities to the United States through its October 1998 acquisition of Simirex. Preclinical Services The Company's preclinical unit provides customers with a wide array of pre-clinical and toxicology services. These services are designed to produce the data required to identify, quantify, and evaluate the risks 3 6 to humans resulting from the manufacture or use of pharmaceutical and biotechnology products, including developmental and reproductive toxicology, genetic toxicology, neurotoxicology, carcinogenicity testing, pharmacology, analytical chemistry, pathology, metabolism and pharmacokinetics. Regulatory Affairs Services The Company provides comprehensive medical and regulatory services for its pharmaceutical and biotechnology customers. The Company's medical services include medical oversight of studies, review and interpretation of adverse experiences, medical writing of reports and study protocols and strategic planning of drug development programs. Regulatory services for product registration include regulatory strategy design, document preparation, consultation, and liaison with various regulatory agencies. The Company's regulatory affairs professionals help to define the steps necessary to obtain registration in the most expeditious manner. The Company is able to provide such services in numerous countries to meet its clients' needs to launch products in multiple countries simultaneously. Medical Device Services The Company's service offerings for medical devices include: review of global strategies for device development and introduction; identifying regulatory requirements in targeted markets; clinical study design and planning; data management; statistical analysis of report preparations; global clinical trial management and monitoring capabilities; consultation on quality control and quality assurance issues; regulatory filings; compliance with United States, European and European Union regulations relating to medical devices; long-range planning for multinational product launches; compliance with legislative requirements for market access; post-marketing requirements; managing relationships with national governments and regulatory authorities; and European pricing strategies. Late-Phase Clinical Studies The Company's services, designed primarily for Phase IIIb and Phase IV clinical trials, include post-submission studies in support of marketing claims, post-marketing surveillance and health management support programs. These services are designed and implemented using clinical and health management programs to promote a favorable environment for new product introductions in advance of the product launch and assist in sales generation post-launch. Disease Management and Healthcare Services The Company provides healthcare policy research, pharmacoeconomics analysis and management consulting focused on improving the quality, availability and cost-effectiveness of healthcare. Disease Management Services The Company's disease management services focus on applying healthcare outcomes analysis to the economic valuation of drugs and the treatment of diseases. The Company's February 1998 acquisition of TAG adds specialization in pharmacoeconomics, as well as expertise in developing patient registries and designing disease management programs. Together, these services enable regulators, healthcare providers, pharmaceutical and biotechnology companies and third parties to assess the pricing and cost-effectiveness of new medical therapies. Healthcare Policy Research and Consulting The Company's healthcare policy research and healthcare consulting services are designed to assist customers in evaluating healthcare programs and policies and developing strategies for doing business in the highly regulated and rapidly changing healthcare environment. These services include corporate strategic planning and management, program and policy development, financial and cost-effectiveness analysis, evaluation design, microsimulation modeling and data analysis across five general practice areas: public health and finance policy, healthcare organizations, economic analysis, managed care and medical technology. The 4 7 Company has access to more than 158 healthcare-related databases and has developed the expertise to analyze such complex data to respond to its clients' information needs. These services represent the core competencies of The Lewin Group, a nationally-recognized healthcare consulting firm acquired by the Company in 1996. Commercialization Offerings Sales and Marketing Services The Company provides a range of services focused on commercial success, including health management services and sales and marketing. The Company offers a flexible range of contract sales services which are delivered through dedicated and syndicated sales teams. Dedicated sales teams are comprised of sales representatives recruited by the Company in accordance with customer specifications to conduct sales efforts for a particular customer. Dedicated sales teams can be managed by the Company or can report directly to the customer, depending on customer preference. In certain circumstances, the Company can transfer an entire dedicated sales team to the customer for an additional placement fee. Syndicated sales teams promote a number of drugs for different customers and are generally managed directly by the Company. The Company's contract sales teams form a highly skilled network of professionals that afford customers substantial flexibility in selecting the extent and cost of promoting products as well as their level of involvement in managing the sales effort. The Company also provides a range of specialized marketing services specifically for pharmaceutical companies aimed at influencing the decisions of patients and physicians and accelerating the acceptance of drugs into treatment guidelines and formularies. Such services are typically purchased by the marketing departments of pharmaceutical companies. The Company believes that its commercial orientation, clinical and promotional expertise and international experience enable it to tailor programs to specific customer needs in a wide range of geographic markets and therapeutic areas. The acquisition of DAS in September 1998 strengthened the Company's ability to help pharmaceutical companies optimize sales force productivity. Strategic Marketing and Communications Services The Company provides strategic marketing and communications services to international pharmaceutical companies beginning in the early stages of product development and continuing through product launch and peak market penetration. These services include communications strategy and planning, product positioning and branding, opinion leader development, symposia organization, patient education, and sponsored publications. As early as Phase II trials, the Company begins providing marketing information to help shape data and influence opinion leader support for a new drug. Such services represent the core competencies of Medical Actions Communications Limited, a leading strategic medical communications consultancy acquired by the Company in 1997, and Q.E.D., a United States provider of integrated product marketing and communications services acquired by the Company in October 1998. ENVOY and PMSI Service Offerings The Company has added the service offerings described below as a result of its March 1999 acquisitions of ENVOY and PMSI. The ENVOY and PMSI businesses will form the basis of the Company's healthcare informatics services. As these acquisitions are integrated, the Company intends to broaden its existing products and services and to offer new products and services in the healthcare informatics area. For example, ENVOY's access to healthcare information may form the basis for new data mining products and services which could be provided to the Company's existing customers and other companies in the broader healthcare industry. The Company believes that ENVOY's expertise and access to health information will enhance its opportunity to create new products and enter new markets to provide value-added analysis and market research through ENVOY's ability to deliver near real-time production of raw prescription data and other claims data. Additionally, the Company believes that ENVOY's existing products, services and operations and potential new products and services will expand the Company's interface with a broader spectrum of participants in the healthcare industry. 5 8 In addition to the other difficulties associated with the development of any new service, the Company's ability to develop these services may be limited further by contractual provisions limiting its use of the healthcare information or the legal rights of others that may prevent or impair its use of the healthcare information. Due to these and other limitations, the Company cannot be certain that it will be able to develop these types of services successfully. The Company's inability to develop new products or services or any delay in the development of them may adversely affect its ability to realize some of the synergies the Company anticipates from the acquisition of ENVOY. ENVOY Services ENVOY provides various EDI and transaction processing services to participants in the healthcare market. Through its transaction network, ENVOY provides an electronic link, directly and indirectly through other clearinghouses or vendors, to approximately 280,000 physicians, 36,000 pharmacies, 42,000 dentists, 4,600 hospitals and 868 payors, including approximately 47 Blue Cross Blue Shield Plans, 49 Medicare Plans and 40 Medicaid Plans. Real-time Transaction Processing ENVOY provides real-time transaction processing for pharmacy claim adjudication and managed care transactions for healthcare providers and payors. A standard pharmacy transaction is the inquiry by the pharmacy, through a point-of-service terminal or personal computer terminal, to determine whether the patient is covered by a benefit program. After eligibility is confirmed, the claim is settled, and the payor transmits to the pharmacy the amount and timing of the pending payment. As of December 31, 1998, ENVOY's EDI network was linked to approximately 36,000 of the estimated 45,000 retail pharmacies in the United States, including 40 of the top 50 retail pharmacy chains. ENVOY's real-time managed care transactions between providers and payors include (i) verification of the patient's enrollment in a program; (ii) verification that the provider is eligible to treat the patient; (iii) verification that the patient is eligible for a particular treatment; (iv) filing of encounter data; (v) referral to a specialist; and (vi) other ancillary transactions. These transactions are enabled by ENVOY's network connections to various databases. ENVOY has access to managed care and commercial insurer databases for Prudential, CIGNA, Aetna U.S. Healthcare, Oxford Health Plans, MetraHealth, Pacificare, Blue Cross of California, Empire Blue Cross and Blue Shield, Blue Cross and Blue Shield for the National Capital Area, Blue Cross and Blue Shield of Arkansas, QualMed, Access Med Plus and Health 123, and is a sponsored participant to the Blue Cross and Blue Shield BluesNet network. For Medicaid eligibility verification and related transactions, ENVOY has access to state databases in Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Minnesota, Mississippi, Missouri, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Dakota, Tennessee, Texas, Vermont, Washington, West Virginia, Wisconsin and Wyoming. In addition, if the patient wishes to pay the deductible or co-payment amounts by credit card, ENVOY's services provide the ability to obtain payment authorization and verification at the provider's offices. Batch Transaction Processing ENVOY is one of the nation's largest processors of commercial third-party payor claims with electronic connections to a significant number of healthcare providers and payors across the United States. Batch transactions are predominantly used to process reimbursement claims in traditional fee-for-service commercial or government payor systems and to process encounter data in capitated environments. These transactions are not time-sensitive or as easily processed on a real-time basis and, as a result are processed on a collective and delayed basis, usually daily. To submit claims, healthcare providers collect data throughout the day and then electronically forward these claims in bulk to a clearinghouse. ENVOY's clearinghouse electronically collects and verifies receipt of the claims and performs reformatting required to conform to a particular payor's specifications, aggregates daily transactions by payor and transmits claims to payors based upon each payor's 6 9 chosen communications protocols. ENVOY's transaction network is connected with 732 of the commercial third-party payors, including all of the top 20 commercial payors (based upon the number of members covered by such third-party payors). EDI Products and Interfaces ENVOY has developed a range of hardware and software products and interfaces to facilitate the adoption of EDI by its customers. ENVOY supports industry standards of the American National Standards Institute, X12N Subcommittee and Healthcare Financing Administration National Standards. ENline(R). ENVOY's ENline family of proprietary software products performs all of the transactions of a stand alone point-of-service terminal and has enhanced functionality to facilitate both batch and real-time processing. The point-of-service terminal product, called ENline Genesis, is designed to handle real-time transactions and allow ENVOY to rapidly and cost effectively connect a significant number of providers into the transaction network. The point-of-service terminals can be accessed remotely to modify application software and communications parameters, allowing ENVOY the flexibility to implement changes in services relatively easily. Point-of-service terminals often are purchased from ENVOY by payors, who are sponsoring a managed care network, and offered by the payors to providers free of charge. In addition, providers may purchase terminals from ENVOY for a fee. ENVOY also has developed certain ENline PC-based products with enhanced functionality features and open Application Program Interfaces ("APIs"). The APIs are established at the operating system level and are designed to enable ENVOY's software to run on a wide variety of operating systems including DOS, UNIX and Windows. The ENline PC-based products can either function as a stand alone data entry system or work in conjunction with physician practice management software. The stand alone version, ENline Companion, is offered directly to providers. ENline Synergy is designed for integration into a practice management software product. ENVOY, in conjunction with the practice management vendor, integrates ENline Synergy into the practice management system for distribution by the practice management vendor to the provider. ENline Synergy also controls the editing and distribution of the information-from the practice management system to the Company's network. Automatic Eligibility Verification. This technology interfaces with hospital and large practice management information systems to automatically verify patient eligibility at the time of admission or scheduling. Eligibility requests are obtained from ENVOY's real-time transaction processing network. In addition to eligibility verification, ENVOY's eligibility verification system provides statistical reporting on patient demographics for hospitals and/or physician practices. Automatic Transaction Posting. This EDI technology is used for automatic posting of transactions into a hospital or practice management information system. This technology, which has been integrated to work in tandem with the automatic eligibility verification technology, uses transactions obtained from ENVOY's real-time and batch processing centers to perform automated remittance posting, accelerated secondary billing and member update of eligibility information. Patient Statements Through its ExpressBill subsidiary, ENVOY is able to offer automated patient billing services to the hospital and other healthcare provider markets. ENVOY believes it has the largest stand alone patient statement processing and printing services business in the United States, processing more than 160 million patient statements annually. ENVOY's patient statement services include electronic data transmission and formatting, statement printing and mailing services for healthcare providers and practice management system vendors. ENVOY Synergy Service Offerings On May 6, 1998, ENVOY acquired all of the outstanding capital stock of Synergy Health Care, Inc. ("Synergy"). Synergy, founded in 1995 by N. Stephen Ober, M.D., M.B.A., is a healthcare information 7 10 company providing strategic marketing information and analytic services to the pharmaceutical industry. Synergy provides customers with insights into how their products are utilized by patients, physicians and payors, and how their products can best be positioned. Synergy's products and services quantify the value of pharmaceuticals in terms of cost effectiveness and outcomes, helping pharmaceutical manufacturers to differentiate their products beyond the traditional measures of safety and efficacy. Synergy's products and services fall into the following categories: Disease Management Services Working directly with target accounts of pharmaceutical manufacturers (managed care plans, integrated delivery systems, practice management companies and provider groups), Synergy transfers all necessary data directly from these organizations to Synergy's consolidated data warehouse to perform analytic tasks, such as patient targeting, physician targeting, baseline economic assessment, benchmarks, quality of life/satisfaction measurements, program impact analysis, pharmacoeconomic analysis and forecasting. Performance Tracking Synergy uses national data in conjunction with data derived from health plans to develop products that provide clients with drug performance information on a national and regional level. For each disease class, Synergy provides reports on patients, providers and payors, and each such report contains strategic information concerning (i) drug usage by specific disease indication, (ii) related and unrelated multi-drug usage, (iii) patient drug compliance and duration of therapy and (iv) drug switches among competitive agents. Data Warehousing and Reporting On a daily basis, Synergy aggregates millions of records of disparate healthcare information, including prescriptions, payor data, patient diagnoses, medical procedures and physician data, into a segmented data warehouse. From this data warehouse, Synergy's team of analysts can extract, group, compare, benchmark, interpret and stratify the data into manageable and meaningful sub-sets for standard, as well as ad-hoc, reporting. PMSI Services Through its Scott-Levin subsidiary in the United States, PMSI provides a range of pharmaceutical and healthcare information and market research services. These services are comprised of (1) proprietary database services, (2) syndicated market research audits, (3) managed care and governmental information services and added value services, including strategic studies and surveys and (4) consulting service and software solutions. Scott-Levin has implemented state-of-the-art data access and integration technology and internet capabilities for virtually all services. Proprietary Healthcare Databases The foundation of Scott-Levin's business is a variety of databases. Through self-administered surveys, Scott-Levin maintains various comprehensive databases that contain information collected from physicians on their diagnoses, prescribing activities; the incidence of, and response to, direct selling and other promotion activities; information regarding healthcare legislation and key influencers in the United States; a managed care database, detailing cost containment measures imposed by United States managed care organizations ("MCOs") that influence or restrict physicians' prescribing activities, which also covers formularies, administrators and the physicians affiliated with the MCOs. Pursuant to a contract with National Data Corporation ("NDC"), Scott-Levin obtains prescription information which NDC collects from approximately 34,000 pharmacies located across the United States. Scott-Levin creates projected state and national data on product level prescription movement from which, among other things, it generates the Source Prescription Audit. 8 11 Scott-Levin does not hold any identifiable individual patient data, except data collected directly from the patient, which is held with the patients' permission. Syndicated Market Research Audits Scott-Levin's marketing research audits are generated from databases containing information collected by questionnaire, diary or personal interview, dispensed prescriptions and secondary research. The results of the audits are delivered in hard copy or through PC-based data delivery systems. These audits include the Source Prescription Audit, including data supplied by NDC, which analyzes pharmaceutical product consumption; Physician Drug And Diagnosis Audit, which analyzes the pharmaceuticals prescribed by physicians relative to the associated diagnosis; the Personal Selling Audit ("PSA"), which analyzes the effectiveness of the client company's sales activities compared with those of its competitors; the Hospital Personal Selling Audit, which complements the PSA by monitoring and analyzing sales activity in the hospital environment; the Physician Meeting And Event Audit, which assesses the impact of this promotional activity on subsequent attendee prescribing; the HIV Therapy Audit, which provides a projectable database tracking physicians who treat HIV, and HIV positive patients; and the Direct-To-Consumer Advertising Audit, designed to evaluate and measure the impact of direct-to-consumer advertising on physicians and consumers. Managed Care Information and Governmental Information Services Scott-Levin provides a range of services derived from its managed care database, including the Integrated Managed Care Profiles service, which enables pharmaceutical companies to identify, target and prioritize those MCOs that are most relevant to their own specific pharmaceutical products. Additionally, Scott-Levin has developed information services that identify the influences of federal and state governments on pharmaceutical prescribing and dispensing. An example of these services is Stateline, a PC-based database product which provides pharmaceutical companies with detailed information on the health policies of each of the 50 states and the District of Columbia and on the government officials involved in shaping these policies. Added Value Services Scott-Levin provides pharmaceutical companies in the United States with a range of added value and research services that are used (1) to study specific issues and trends in the marketplace and the broader health care industry, (2) to evaluate the effectiveness of marketing programs, (3) to analyze in depth particular components of a product marketing program at any stage of its implementation, and (4) for consultancy on optimizing company strategy, sales and marketing activities and product commercialization. INFORMATION TECHNOLOGY The foundation for the Company's information technology ("IT") capabilities is a worldwide network, which the Company continues to improve and expand. The network links approximately 60 local networks and interconnects over 10,000 office-based and 5,000 mobile personal computers and systems worldwide. The Company's systems enable the exchange of information among the Company's offices on a worldwide basis, facilitating concurrent multinational clinical trials and regulatory submissions. Customers also are able to gain direct access to key up-to-date data related to their products in testing, such as adverse events, CRFs and clinical laboratory testing results. Customers using the Company's sales and marketing services can likewise access information related to sales calls and provide feedback about the performance of the Company's sales representatives. The Company has an ongoing program of developing advanced data capture and data management systems designed to speed the drug development process and sales force automation systems for planning, targeting, reporting, analysis and communication of sales and marketing activities. These systems allow the Company to centralize management of sales activities across a broad geographic area. The Company also uses an advanced system for screening and tracking resumes as the cornerstone of its recruitment of qualified sales representatives. In 1998, the Company further expanded its IT capabilities, completing far-reaching infrastructure upgrades and developing important new Internet-based (Quinternet(TM)) capabilities. WebCollect(TM), the 9 12 Company's latest addition to its integrated suite of advanced data capture systems called Collect Suite, is designed to use the internet to dramatically reduce the elapsed time from initial data capture through data clearing and to support near real-time monitoring. ITMS(TM), the Company's sales force automation or electronic territory management system, already web-based, was significantly improved in 1998 and supplemented by a suite of sales-force optimization tools added through the Company's September 1998 acquisition of DAS. The Company intends to further integrate internet-based clinical trial and contract sales and marketing services by using secure intranets. Some of the internally developed systems which the Company uses to facilitate its services are described below: FaxCollect(TM)....................... Advanced data capture system which uses faxed images and OCR technology. InnTrax(R)........................... Computerized clinical trial administrative management system. ITMS(TM)............................. Sales force automation (electronic territory management) system. QTONE(TM)............................ Touchtone and voice response patient information system. (A member of the Collect Suite) QSTAR(TM)............................ Imaging technology which reduces time and minimizes errors in data management by routing and tracking CRF images. QLIMS(TM)............................ Laboratory information management system which provides protocol-specific validity checks. QNET(TM)............................. System which allows online monitoring and review of laboratory test data. QuERxI(TM)........................... Software for analyzing prescribing patterns to help improve health outcomes or identify cost savings. WebCollect(TM)....................... Advanced Internet-based data capture system. Genius(TM)........................... Digital medical imaging software which enables image enhancement, reliable measurements and the compilation of accurate records. Pyramid(TM).......................... Digital medical imaging software which enables image enhancement, reliable measurements and the compilation of accurate records.
The Company's March 1999 acquisition of ENVOY adds new IT capabilities relating to ENVOY's EDI services. See "-- Services -- ENVOY Services -- EDI Products and Interfaces." The Company has established a Year 2000 Program to address the Year 2000 issue, which results from computer processors and software failing to process date values correctly, potentially causing system failures or data corruption. The Year 2000 issue could cause disruptions of the Company's operations, including, among other things, a temporary inability to process information; receive information, services or products from third parties; interface with customers in the performance of contracts; or operate or communicate in some or all of the regions in which the Company does business. Please refer to "Management's Discussion and Analysis of Results of Operations and Financial Conditions" included in Part II of this Annual Report on Form 10-K for additional details regarding the Company's Year 2000 Program. CUSTOMERS AND MARKETING The Company coordinates its business development efforts across its service offerings through integrated business development functions, which direct the activities of business development personnel in each of the Company's United States locations, as well as other key locations throughout Europe, Asia-Pacific, Canada 10 13 and Latin America. ENVOY has historically developed and maintained payor, provider and vendor relationships primarily through its direct sales and marketing personnel located throughout the United States. ENVOY's primary sales and marketing strategy focuses on selling its services to commercial and governmental payors and organizations that have relationships with or access to a large number of providers including major healthcare practice management system vendors. These relationships give ENVOY access to a large healthcare provider population as ENVOY expands the breadth of its services from the payor to the healthcare provider's desktop. In the pharmacy sector, ENVOY traditionally has established relationships with large retail pharmacy chains and pharmacy software vendors. Scott-Levin has historically employed marketing, sales and client service professionals. The Company is a market leader in providing full-service contract research, sales, marketing and healthcare policy consulting and health information management services to the global pharmaceutical, biotechnology, medical device and healthcare industries. For the year ended December 31, 1998, approximately 49.0% of the Company's net revenue from external customers was attributed to operations in the United States and 51.0% to operations outside the United States. Please refer to the Notes to the Company's Consolidated Financial Statements included in Item 8 hereof for further details regarding the Company's foreign and domestic operations. Approximately 54.7%, 55.5% and 64.2% of the Company's net revenue was attributed to clinical and data management services in 1998, 1997 and 1996, respectively, and approximately 39.6%, 39.4%, and 30.9% of the Company's 1998, 1997, and 1996 net revenue, respectively, was attributed to its sales and marketing services. The Company's disease management, healthcare consulting and strategic marketing and communications services, and its laboratory, formulation and packaging services accounted for less than 10% of the Company's net revenue in each of these years. ENVOY's principal customers consist of healthcare providers, such as pharmacies, physicians, hospitals, dentists and billing services, and third-party payors, such as commercial indemnity insurers, managed care organizations and state and federal government agencies. PMSI derives its revenues primarily from sales to the pharmaceutical or information services industry. PMSI also provides certain information services to the financial services industry. The Company has in the past derived, and may in the future derive, a significant portion of its net revenue from a relatively limited number of major projects or customers. As pharmaceutical companies continue to outsource large projects and studies to fewer full-service providers, the concentration of business could increase. The Company may experience concentration in 1999 and in future years. However, no customer accounted for more than 10% of the Company's consolidated net revenue in 1997 and 1998, while one customer accounted for 11.3% of the Company's consolidated net revenue in 1996. COMPETITION The market for the Company's product development services is highly competitive, and the Company competes against traditional contract research organizations ("CROs") and the in-house research and development departments of pharmaceutical companies, as well as universities and teaching hospitals. Among the traditional CROs, there are several hundred small, limited-service providers, several medium-sized firms, and only a few full-service companies with global capabilities. Consolidation among CROs likely will result in greater competition among the larger contract research providers for customers and acquisition candidates. The Company's primary contract research competitors include Covance Inc., PAREXEL International Corp. and Pharmaceutical Product Development, Inc. In commercialization services, the Company competes against the in-house sales and marketing departments of pharmaceutical companies and other contract sales organizations in each country in which it operates. The Company also competes against national consulting firms offering healthcare consulting and medical communications services, including boutique firms specializing in the healthcare industry and the healthcare departments of large firms. Competitive factors for product development services include previous experience, medical and scientific experience in specific therapeutic areas, the quality of contract research, speed to completion, the ability to organize and manage large-scale trials on a global basis, the ability to manage large and complex medical databases, the ability to provide statistical and regulatory services, the ability to recruit investigators, the 11 14 ability to integrate information technology with systems to improve the efficiency of contract research, an international presence with strategically located facilities, financial viability, and price. The primary competitive factors affecting commercialization services are the proven ability to quickly assemble, train and manage large qualified sales forces to handle broad scale launches of new drugs and price. Competitive factors affecting healthcare consulting and medical communications services include experience, reputation and price. The Company believes that it competes favorably in these areas. In addition, the Company believes that the synergies arising from integrating product development services with commercialization services, supported by global operations and information technology, differentiate the Company from its competitors. Potential competition in the healthcare EDI and transaction processing market arises not only from companies like ENVOY that are similarly specialized including former regional partners of ENVOY that have direct provider relationships, but also from companies involved in other, more highly developed sectors of the EDI transaction processing market. Such companies could enter into, or focus more attention on, the healthcare EDI transaction processing market as it develops. In addition, ENVOY faces competition by selected providers bypassing ENVOY's electronic network and going directly to the payor. There can be no assurance that ENVOY can continue to compete successfully with its existing and potential competitors in the healthcare EDI and transaction processing market. Factors influencing competition in the healthcare EDI and transaction processing market include (1) compatibility with the provider's software and inclusion in practice management software products, (2) in the case of the pharmacy market, relationships with major retail pharmacy chains, and (3) relationships with third-party payors and managed care organizations. ENVOY believes that the breadth, price and quality of its services are the most significant factors in developing and maintaining relationships with pharmaceutical chains, third-party payors and managed care organizations. Although PMSI's information services in the United States have been systematically established over sixteen years, its market position may be affected in the future by competitors' efforts to create or acquire enhanced databases or to develop and market new information products and services. Competitors for PMSI's information services include IMS Health Incorporated ("IMS") and NDC. EMPLOYEES As of February 28, 1999, the Company had approximately 15,520 employees, comprised of approximately 7,025 in the Americas, 7,894 in Europe and Africa and 601 in the Asia-Pacific region. The Company added approximately 1,235 new employees as a result of the PMSI and ENVOY acquisitions. BACKLOG The Company reports backlog based on anticipated net revenue from uncompleted projects which have been authorized by the customer, through a written contract or otherwise. Once work begins on a project, net revenue is recognized over the duration of the project. Using this method of reporting backlog, at December 31, 1998, backlog was approximately $1.9 billion, as compared to approximately $1.09 billion at December 31, 1997. The Company believes that backlog may not be a consistent indicator of future results because backlog can be affected by a number of factors, including the variable size and duration of projects, many of which are performed over several years. Additionally, projects may be terminated by the customer or delayed by regulatory authorities. Moreover, the scope of work can change during the course of a project. POTENTIAL LIABILITY In connection with its provision of product development services, the Company contracts with physicians to serve as investigators in conducting clinical trials to test new drugs on human volunteers. Such testing creates risk of liability for personal injury to or death of volunteers, particularly to volunteers with life-threatening illnesses, resulting from adverse reactions to the drugs administered. Although the Company does 12 15 not believe it is legally accountable for the medical care rendered by third party investigators, it is possible that the Company could be held liable for the claims and expenses arising from any professional malpractice of the investigators with whom it contracts or in the event of personal injury to or death of persons participating in clinical trials. In addition, as a result of its Phase I clinical trial facilities, the Company could be liable for the general risks associated with a Phase I facility including, but not limited to, adverse events resulting from the administration of drugs to clinical trial participants or the professional malpractice of Phase I medical care providers. The Company also could be held liable for errors or omissions in connection with the services it performs through each of its service groups. The Company believes that its risks are reduced by contractual indemnification provisions with customers and investigators, insurance maintained by customers and investigators and by the Company, and various regulatory requirements, including the use of institutional review boards and the procurement of each volunteer's informed consent to participate in the study. The contractual indemnifications generally do not fully protect the Company against certain of its own actions such as negligence. The contractual arrangements are subject to negotiation with customers and the terms and scope of such indemnification vary from customer to customer and from trial to trial. The financial performance of these indemnities is not secured. Therefore, the Company bears the risk that the indemnifying party may not have the financial ability to fulfill its indemnification obligations. The Company maintains professional liability insurance that covers worldwide territories in which the Company currently does business and includes drug safety issues as well as data processing errors and omissions. The Company could be materially and adversely affected if it were required to pay damages or bear the costs of defending any claim outside the scope of or in excess of a contractual indemnification provision or beyond the level of insurance coverage or in the event that an indemnifying party does not fulfill its indemnification obligations. GOVERNMENT REGULATION The preclinical, laboratory and clinical trial supply services performed by the Company are subject to various regulatory requirements designed to ensure the quality and integrity of the data or products of these services. The industry standard for conducting preclinical and laboratory testing is embodied in the good laboratory practice ("GLP") regulations. The requirements for facilities engaging in clinical trial supplies preparation, labeling and distribution are set forth in the cGMP regulations. GLP and cGMP regulations have been mandated by the FDA and the Department of Health in the U.K., and adopted by similar regulatory authorities in other countries. GLP and cGMP stipulate requirements for facilities, equipment, supplies and personnel engaged in the conduct of studies to which these regulations apply. The regulations require that written, standardized procedures are followed during the conduct of studies and for the recording, reporting and retention of study data and records. To help assure compliance, the Company has established Quality Assurance programs at its preclinical, laboratory and clinical trial supply facilities which monitor ongoing compliance with GLP and cGMP regulations by auditing study data and conducting regular inspections of testing procedures. The industry standard for the conduct of clinical research and development studies is embodied in GCP regulations and guidelines. The FDA and many other regulatory authorities require that study results and data submitted to such authorities be based on studies conducted in accordance with GCP provisions. These provisions include: (i) complying with specific regulations governing the selection of qualified investigators; (ii) obtaining specific written commitments from the investigators; (iii) verifying that patient informed consent is obtained; (iv) instructing investigators to maintain records and reports; (v) verifying drug or device accountability; and (vi) permitting appropriate governmental authorities access to data for their review. Records for clinical studies must be maintained for specified periods for inspection by the FDA during audits. Non-compliance with GCP requirements can result in the disqualification of data collected during the clinical trial. The Company's standard operating procedures related to clinical studies are written in accordance with regulations and guidelines appropriate to the region where they will be used, thus ensuring compliance with GCP. Within Europe, all work is carried out in accordance with the European Community Note For Guidance "Good Clinical Practice for Trials on Medicinal Products in the European Community." Studies beginning after January 17, 1997 to be submitted to the European Medicines Evaluation Agency must meet 13 16 the requirements of the International Congress of Harmonization -- GCP. In addition, FDA regulations and guidelines serve as a basis for the Company's North American standard operating procedures. The Company's offices in the Asia-Pacific region have developed standard operating procedures in accordance with their local requirements and in harmony with the Company's North American and European operations. From a transnational perspective, the Company has implemented common standard operating procedures across regions to assure consistency whenever it is feasible to do so. The Company's commercialization services are subject to detailed and comprehensive regulation in each geographic market in which it operates. Such regulation relates, among other things, to the qualifications of sales representatives and the use of healthcare professionals in sales functions. In the U.K., the Company complies with the Association of the British Pharmaceutical Industry Code of Practice for the Pharmaceutical Industry, which prescribes, among other things, an examination that must be passed by sales representatives within two years of their taking up employment, and which prevents the employment of healthcare professionals as sales representatives. The Company follows similar guidelines which are in effect in the other countries where it offers commercialization services. The Company's United States laboratories are subject to licensing and regulation under federal, state and local laws relating to hazard communication and employee right-to-know regulations, the handling and disposal of medical specimens and hazardous waste and radioactive materials, as well as the safety and health of laboratory employees. All of the Company's laboratories are operated in material compliance with applicable federal and state laws and regulations relating to the storage and disposal of all laboratory specimens including the regulations of the Environmental Protection Agency, the Nuclear Regulatory Commission, the Department of Transportation, the National Fire Protection Agency and the Resource Conservation and Recovery Act. The use of controlled substances in testing for drugs of abuse is regulated by the United States Drug Enforcement Administration (the "DEA"). All of the Company's laboratories using controlled substances for testing purposes are licensed by the DEA. The regulations of the United States Department of Transportation, the Public Health Service and the Postal Service apply to the surface and air transportation of laboratory specimens. The Company's laboratories also comply with International Air Transport Association regulations, which govern international shipments of laboratory specimens. Furthermore, when the materials are sent to a foreign country, the transportation of such materials becomes subject to the laws, rules and regulations of such foreign country. In addition to its comprehensive regulation of safety in the workplace, the United States Occupational Safety and Health Administration has established extensive requirements relating to workplace safety for healthcare employers whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These regulations, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations and other measures designed to minimize exposure to chemicals, and transmission of blood-borne and airborne pathogens. Furthermore, relevant employees of the Company receive initial and periodic training to ensure compliance with applicable hazardous materials regulations and health and safety guidelines. Although the Company believes that it is currently in compliance in all material respects with such federal, state and local laws, failure to comply could subject the Company to denial of the right to conduct business, fines, criminal penalties and other enforcement actions. Governmental regulatory policies also affect the charges for and the terms of ENVOY's access to private line and public communications networks. ENVOY must obtain certification on the applicable communications network for design innovations for point-of-service devices and proprietary software. Any delays in obtaining necessary certifications with respect to future products and services could delay their introduction. In addition, the Federal Communications Commission requires ENVOY's products and services to comply with certain rules and regulations governing performance. The Company believes ENVOY's existing products and services comply with all current rules and regulations. The Company can give no assurance, however, that such rules and regulations regarding access to communications networks will not change in the future. Changes in such rules, regulations or policies or the adoption of legislation that make it more costly to communicate on networks could adversely affect the demand for or the cost of supply services in the healthcare EDI transaction processing business. 14 17 The Company's disease management and healthcare information management services relate to the diagnosis and treatment of disease and are, therefore, subject to substantial governmental regulation. The confidentiality of patient-specific information and the circumstances under which such patient-specific records may be released for inclusion in the Company's databases or used in other aspects of its business are heavily regulated. Legislation has been proposed which would mandate standards and impose restrictions on the Company's ability to use, transmit and disclose patient-specific health information. Specifically, two separate initiatives being considered at the federal level could impact the manner in which ENVOY conducts its business. The Health Insurance Portability and Accountability Act of 1996 requires the use of standard transactions, standard identifiers, security and other administrative simplification provisions and instructs the Secretary of Health and Human Services to promulgate regulations regarding these standards. The Act also requires the Secretary of Health and Human Services to develop recommendations regarding the privacy of individually identifiable health information. On September 11, 1997, the Secretary presented her recommendations, which, among other things, advise that patient information should not be disclosed except when authorized by the patient. This Act further establishes an August 1999 deadline for Congress to enact privacy legislation. If Congress does not meet this deadline, the Secretary is directed to issue regulations setting privacy standards to protect health information that is transmitted electronically. Such changes could occur as early as the year 2000, and their impact cannot be predicted. Such legislation or regulations could materially affect the Company's business. This Act also specifically names clearinghouses as the compliance facilitators for providers and payors, and permits clearinghouses to convert non-standard transactions to standard transactions on behalf of their clients. ENVOY is preparing to comply with the mandated standards within three to six months after they are published. Whether ENVOY is successful in complying with these standards may depend on whether providers, payors and others are also successful in complying with the standards. In addition, broad-based health information privacy legislation restricting third party processors from using, transmitting or disclosing certain patient data without specific patient consent has recently been introduced in the United States Congress. If this legislation is adopted, it could prevent third party processors from using, transmitting or disclosing certain treatment and clinical data. It is difficult to predict the impact of the legislation described above, but such legislation could materially adversely affect the Company's business. The Market Research Code of Conduct, a pharmaceutical industry-promulgated code of conduct to which PMSI adheres, provides that the identity of the individual researched may never be disclosed to the company sponsoring such research without such individual's consent. PMSI supplies only aggregated statistics to the sponsoring company when information is generated from market research databases. As recommended by the board of directors of the Pharmaceutical Manufacturer's Association, the PMSI databases do not contain patient names, thus preserving confidentiality. Data provided at the physician level is obtained from prescribing activity by product or therapy class over a given period. Pharmaceutical companies receive information as to the projected prescribing levels of particular physicians. PMSI does not hold any identifiable individual patient data, except on a temporary basis with the patients' prior permission for follow-up research and disease management purposes. PMSI is directly subject to certain restrictions on the collection and use of data. In the United States, certain states have enacted legislation prohibiting the use of personally identifiable prescription drug information without consent. Because PMSI does not generally receive information regarding the identity of patients, the Company believes that such state legislation will have no material adverse effect on PMSI's business. There can be no assurance that future legislation or regulations will not directly or indirectly restrict the dissemination of information regarding physicians or prescriptions. Such legislation, if enacted, could have a material adverse effect on the operations of PMSI. 15 18 EXECUTIVE OFFICERS OF THE REGISTRANT The following table provides information on the executive officers of the Company. There are no family relationships between any of the executive officers or directors of the Company.
NAME AGE POSITION WITH THE COMPANY - ---- --- ------------------------- Dennis B. Gillings, Ph.D............... 54 Chairman of the Board of Directors and Chief Executive Officer Santo J. Costa......................... 53 President, Chief Operating Officer and Director Rachel R. Selisker..................... 43 Chief Financial Officer, Executive Vice President Finance and Director Gregory D. Porter...................... 42 Executive Vice President, Chief Administrative and Legal Officer and Secretary Ludo J. Reynders, Ph.D................. 45 Chief Executive Officer, Quintiles CRO, and Director David F. White......................... 55 Chief Executive Officer, Innovex Limited, and Director Lawrence S. Lewin...................... 60 Chief Executive Officer, The Lewin Group, and Director
Dennis B. Gillings, Ph.D. founded the Company in 1982 and has served as Chief Executive Officer and Chairman of the Board of Directors since its inception. From 1972 to 1988, Dr. Gillings served as a professor in the Department of Biostatistics at the University of North Carolina at Chapel Hill. During his tenure as a professor, he was active in statistical consulting for the pharmaceutical industry. Dr. Gillings currently serves on the Board of Directors of the University of North Carolina School of Public Health Foundation. Dr. Gillings also serves on the Board of Directors of Triangle Pharmaceuticals, Inc., a company engaged in the development of new drug candidates primarily in the antiviral area. Dr. Gillings has been published widely in scientific and medical journals. Dr. Gillings received a Diploma in Mathematical Statistics from the University of Cambridge and a Ph.D. in Mathematics from the University of Exeter. Santo J. Costa became President and Chief Operating Officer of the Company on April 1, 1994 and has been a director since April 1994. From July 1, 1993 to March 31, 1994, Mr. Costa directed the affairs of his own consulting firm, Santo J. Costa & Associates, which focused on pharmaceutical and biotechnology companies. Prior to June 30, 1993, Mr. Costa served seven years at Glaxo, Inc., a pharmaceutical company, as Senior Vice President Administration and General Counsel and a member of the Board of Directors. Mr. Costa serves as a director of NPS Pharmaceuticals Inc., a company engaged in the discovery and development of small molecule drugs that address a variety of diseases. Mr. Costa received a law degree from St. John's University. Rachel R. Selisker, a certified public accountant, serves as Executive Vice President Finance and Chief Financial Officer for the Company and has been the Company's principal financial officer since 1987. Ms. Selisker has served as a director of the Company since November 1995. From 1981 to 1987, Ms. Selisker was with the accounting firm of Oppenheim, Appel, Dixon & Co. in Raleigh, North Carolina. Ms. Selisker serves on the Advisory Board for the Accounting Curriculum at Wake Technical Community College. Gregory D. Porter has served as Executive Vice President, Chief Administrative and Legal Officer and Secretary since January 1997. Mr. Porter joined the Company in September 1994 as Vice President, General Counsel and Secretary. From 1982 to September 1994, Mr. Porter was in the private practice of law. From 1981 to 1982, Mr. Porter clerked with the Honorable William Matthew Byrne of the U.S. District Court for the Central District of California. Mr. Porter received his law degree from the University of North Carolina at Chapel Hill. Ludo J. Reynders, Ph.D. has served as Chief Executive Officer of the Product Development Group since 1996. He managed European clinical operations from 1988 to 1996. Dr. Reynders has served as a director of 16 19 the Company since January 1995. Prior to joining the Company, Dr. Reynders managed the biostatistics and data management department of the Bristol-Myers Co. Pharmaceutical Research and Development Division, located in Brussels, Belgium. Dr. Reynders serves as a director of Oxford Asymmetry International plc., a company producing products for the pharmaceutical, biotechnology and agrochemical industries. Dr. Reynders received an M.S. and Ph.D. in Applied Sciences from the University of Louvain, Louvain, Belgium. David F. White serves as the Chief Executive Officer of Innovex Limited. Mr. White has served as a director of the Company since November 1997. Mr. White joined Innovex Limited, a subsidiary of the Company, as Group Chief Executive Officer in September 1994 from ICI plc, where he had a broad career principally in the international pharmaceutical business. After successive appointments as Managing Director of Stuart Pharmaceuticals from June 1984 to October 1985 and General Manager, ICI Pharmaceuticals (U.K.) from November 1985 to December 1988, he was promoted to lead the global plastics and acrylics businesses, culminating in an assignment to steer the integration of Dupont Acrylics into ICI Acrylics. Lawrence S. Lewin has served as the Chief Executive Officer of The Lewin Group, Inc., a subsidiary of the Company, since May 1996. Mr. Lewin has been a director of the Company since June 1996. Between November 1992 and May 1996, Mr. Lewin served as the Chairman and Chief Executive Officer of Lewin-VHI, Inc., a healthcare consulting firm specializing in performing economic analyses, product profiles, and strategic development for healthcare reform and medical reimbursement and the establishment of medical guidelines. Mr. Lewin serves as a director of Apache Medical Systems, Inc., a provider of clinically-based decision support information systems to the health care industry, and as a member of the advisory boards of the Hambrecht & Quist Healthcare Investors Fund and the Hambrecht & Quist Life Sciences Fund. Mr. Lewin received an M.B.A. from Harvard Business School. ITEM 2. PROPERTIES As of February 25, 1999, the Company had approximately 133 offices located in 30 countries. The Company's executive headquarters is located adjacent to Research Triangle Park, North Carolina. The Company maintains substantial offices serving its Product Development Group in Durham, North Carolina; Bracknell, England; Irene, South Africa; Tokyo, Japan; and Singapore. The Company also maintains substantial offices serving its Commercialization Group in Parsippany, New Jersey; Marlow, England and Egham, England. The Company recently added PMSI's principal office facilities in Newtown, Pennsylvania, and ENVOY's principal office facilities in Nashville, Tennessee. The Company owns facilities that serve its Product Development Group in Ledbury, England; Lenexa, Kansas; Riccarton, Scotland; Bathgate, Scotland and Freiburg, Germany. The Lenexa, Kansas facility also serves the Commercialization Group. Additionally, the Company owns a corporate office in London, England. All other offices of the Company are leased. Quintiles believes that its facilities are adequate for the Company's operations and that suitable additional space will be available when needed. ITEM 3. LEGAL PROCEEDINGS On February 12, 1999, Kenneth Hodges ("Plaintiff") filed a civil lawsuit in the State Court of Fulton County Georgia naming as defendants Richard L. Borison, Bruce I. Diamond, BASF Corporation, Pfizer, Inc., Merck & Company, Inc., Wyeth-Ayerst Laboratories Company, Zeneca, Inc., Janssen Pharmaceutica Inc., Smithkline Beecham Corporation, Hoechst Marion Roussel, Inc., Glaxo Wellcome, Inc., Abbott Laboratories, Bristol-Myers Squibb Company, Warner-Lambert Company, Monsanto Company, Novartis Pharmaceuticals Corporation and Quintiles Laboratories Limited, a subsidiary of the Company. The complaint alleges that certain drug trials conducted by Drs. Borison and Diamond in which Plaintiff alleges he participated between 1988 and 1996 were not properly conducted or supervised, that Plaintiff had violent adverse reactions to many of the drugs and that his schizophrenia was aggravated by the drug trials. Consequently, Plaintiff alleges that he was subject to severe mortification, injured feelings, shame, public humiliations, victimization, emotional turmoil and distress. The complaint alleges claims for battery, fraudulent inducement to participate in the drug experiments, medical malpractice, negligence in conducting 17 20 the experiments, and intentional infliction of emotional distress. Plaintiff seeks to recover his actual damages in unspecified amounts, medical expenses, litigation costs, and punitive damages. Nowhere in the complaint are found any specific allegations against Quintiles Laboratories Limited nor any specific factual connection between the Company and the Plaintiff's claims. The Company believes the claims alleged against it are vague and meritless, and the recovery sought is baseless. The Company intends to vigorously defend against these claims. Class action complaints were filed on each of August 20, 1998, August 21, 1998 and September 15, 1998, in the United States District Court, Middle District of Tennessee, Nashville Division, against ENVOY and certain of its executive officers. On December 28, 1998, the plaintiffs filed, pursuant to the Court's instructions, a Consolidated Class Action Complaint, consolidating the three cases into a single action. The complaint alleges, among other things, that from February 12, 1997 to August 18, 1998 (the "Class Period") the defendants issued materially false and misleading statements about the Company, its business, operations and financial position and failed to disclose material facts necessary to make defendants' statements not false and misleading in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, and also asserts additional claims under Tennessee common law for fraud and negligent misrepresentation. The complaint alleges that ENVOY failed to disclose that its financial statements were not prepared in accordance with generally accepted accounting principles due to the improper write-off of certain acquired in-process technology, resulting in ENVOY's stock trading at allegedly artificially inflated prices during the Class Period. The plaintiffs in this action seek unspecified compensatory damages, attorney's fees and other relief. ENVOY believes that these claims are without merit and intends to defend the allegations vigorously. Neither the likelihood of an unfavorable outcome nor the amount of the ultimate liability, if any, with respect to these claims can be determined at this time. The Company also is a party in certain other pending litigation arising in the course of its business. While the final outcome of such litigation cannot be predicted with certainty, it is the opinion of management that the outcome of these matters would not materially affect the consolidated financial position or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 18 21 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET PRICES The Company's Common Stock is traded on The Nasdaq Stock Market under the symbol "QTRN." The following table shows, for the periods indicated, the high and low sale prices per share on The Nasdaq Stock Market, based on published financial sources. The Company's share prices below have been adjusted to reflect a two-for-one stock split on December 1, 1997.
CALENDAR PERIOD HIGH LOW - --------------- ------- ------- Quarter ended March 31, 1997................................ $39.000 $26.625 Quarter ended June 30, 1997................................. 35.000 21.500 Quarter ended September 30, 1997............................ 43.688 35.032 Quarter ended December 31, 1997............................. 43.500 31.000 Quarter ended March 31, 1998................................ $52.428 $34.000 Quarter ended June 30, 1998................................. 53.500 42.250 Quarter ended September 30, 1998............................ 52.000 33.375 Quarter ended December 31, 1998............................. 56.875 41.000
As of January 21, 1999, there were approximately 32,700 beneficial owners of the Company's Common Stock, including 692 holders of record. DIVIDEND POLICIES The Company has never declared or paid any cash dividends on its Common Stock. The Company does not anticipate paying any cash dividends in the foreseeable future, and it intends to retain future earnings for the development and expansion of its business. RECENT SALES OF UNREGISTERED SECURITIES On October 8, 1998 the Company completed the acquisition of Simirex, which provides clinical packaging services for the pharmaceutical industry. The Company issued 383,273 shares of its Common Stock, par value $0.01 per share, in connection with the acquisition, which shares were received by the holders of all of the outstanding share capital of Simirex in exchange for such interests. The shares were issued in reliance on a claim of exemption pursuant to Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended. On October 12, 1998 the Company completed the acquisition of Serval, a French contract sales and marketing company. The Company issued 77,876 shares of its Common Stock, par value $0.01 per share, in connection with the acquisition, which shares were received by the holders of all of the outstanding share capital of Serval in exchange for such interests. The shares were issued in reliance on a claim of exemption pursuant to Section 4(2) of the Securities Act of 1933, as amended. On October 12, 1998, the Company completed the acquisition of Q.E.D., a New York-based provider of integrated product marketing and communication services for pharmaceutical companies in the United States market. The Company issued 523,520 shares of its Common Stock, par value $0.01 per share, in connection with the acquisition, which shares were received by the holders of all of the outstanding share capital of Q.E.D. in exchange for such interests. The shares were issued in reliance on a claim of exemption pursuant to Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended. During the three months ended December 31, 1998, options to purchase 27,000 shares of the Company's Common Stock were exercised at an average exercise price of $2.8473 per share in reliance on Rule 701 under the Act. Such options were issued by the Company prior to becoming subject to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, pursuant to its Nonqualified Employee Incentive Stock Option Plan. 19 22 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected Consolidated Statement of Income Data set forth below for each of the years in the three-year period ending December 31, 1998 and the Consolidated Balance Sheet Data set forth below as of December 31, 1998 and 1997 are derived from the audited consolidated financial statements of the Company and notes thereto included elsewhere herein. The selected Consolidated Statement of Income Data set forth below for the years ended December 1995 and 1994, and the Consolidated Balance Sheet Data set forth below as of December 31, 1996, 1995 and 1994 are derived from the audited consolidated financial statements of the Company. The consolidated financial statements of the Company have been restated to reflect material acquisitions by the Company in transactions accounted for as poolings of interests. However, the consolidated financial statements have not been restated to reflect certain other acquisitions accounted for as pooling of interests where the Company determined that the consolidated financial data would not have been materially different if the pooled companies had been included. For such immaterial pooling of interests transactions, which include five transactions in 1998, one transaction in 1997 and two transactions in 1996, the Company's financial statements for the year of each transaction have been restated to include the pooled companies from January 1 of that year, but the financial statements for years prior to the year of each transaction have not been restated because the effect of such restatement would be immaterial. The selected consolidated financial data presented below should be read in conjunction with the Company's audited consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein.
YEAR ENDED DECEMBER 31, -------------------------------------------------------- 1998 1997 1996(1)(3) 1995(1) 1994(1) ---------- -------- ---------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenue............................... $1,188,012 $852,900 $601,126 $368,056 $230,583 Income from operations.................... 125,862 88,812 44,106 25,900 17,456 Income before income taxes................ 122,538 86,535 24,496 24,655 16,567 Net income available for common shareholders............................ 83,679 55,683 7,879 14,626 10,598 Basic net income per share................ 1.08 0.76 0.11 0.23 0.18 Diluted net income per share.............. $ 1.06 $ 0.74 $ 0.11 $ 0.23 $ 0.18 Weighted average shares outstanding(2): Basic................................... 77,520 73,739 69,253 63,171 58,128 Diluted................................. 79,015 75,275 71,888 64,946 58,512
AS OF DECEMBER 31, ------------------------------------------------------ 1998 1997 1996(1) 1995(1) 1994(1) ---------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT EMPLOYEES) Cash and cash equivalents.................. $ 124,729 $ 80,247 $ 74,479 $ 84,569 $ 52,011 Working capital............................ 195,252 164,987 99,772 72,102 48,245 Total assets............................... 1,014,751 814,027 554,737 352,277 208,944 Long-term debt including current portion... 190,831 185,511 185,493 52,662 21,386 Shareholders' equity....................... $ 502,598 $388,639 $150,626 $165,943 $ 90,193 Employees.................................. 15,076 11,540 7,904 4,835 3,115
- --------------- (1) Prior to the Company's November 29, 1996 share exchange with Innovex Limited ("Innovex"), Innovex had a fiscal year end of March 31 and the Company had (and continues to have) a fiscal year end of December 31. As a result, the pooled data presented above for 1994 and 1995 include Innovex's March 31 fiscal year data in combination with the Company's December 31 fiscal year data. In connection with the share exchange, Innovex changed its fiscal year end to December 31. Accordingly, the pooled data presented above for 1996 include both Innovex's and the Company's data on a December 31 year end basis. Because of the difference between Innovex's fiscal year end in 1995 compared with 1996, Innovex's quarter ended March 31, 1996 data are included in the Company's pooled data for both 1995 and 1996. (2) Restated to reflect the two-for-one stock splits of the Company's Common Stock effected as a 100% stock dividend in November 1995 and December 1997. (3) Excluding non-recurring costs, the 1996 basic and diluted net income per share (unaudited) were $0.51 and $0.50, respectively. 20 23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is a market leader in providing full-service contract research, sales, marketing and healthcare policy consulting and health information management services to the global pharmaceutical, biotechnology, medical device and healthcare industries. Based on industry analyst reports, the Company is the largest company in the pharmaceutical outsourcing services industry as ranked by 1998 net revenue; the net revenue of the second largest company was over $450 million less than the Company's 1998 net revenue. During 1998, the Company completed a number of strategic acquisitions. Specifically: On February 2, 1998, the Company acquired Pharma Networks N.V. ("Pharma"), a leading contract sales organization in Belgium. The Company acquired Pharma in exchange for 132,000 shares of the Company's Common Stock. The acquisition of Pharma was accounted for as a pooling of interests, and as such, all historical financial data have been restated to include the historical financial data of Pharma. On February 4, 1998, the Company acquired TAG, a California-based international health outcomes assessment firm that specializes in patient registries and in evaluating the economic, quality-of-life and clinical effects of drug therapies and disease management programs. The Company acquired TAG in exchange for 460,366 shares of the Company's Common Stock. The acquisition of TAG was accounted for as a purchase. On February 26, 1998, the Company acquired T2A S.A. ("T2A"), a leading French contract sales organization. The Company acquired T2A in exchange for 311,899 shares of the Company's Common Stock. The acquisition of T2A was accounted for as a pooling of interests, and as such, all historical financial data have been restated to include the historical financial data of T2A. On February 27, 1998, the Company acquired More Biomedical Contract Research Organization Ltd. ("More Biomedical"), a contract research organization based in Taiwan. The Company acquired More Biomedical in exchange for 16,600 shares of the Company's Common Stock. The acquisition was accounted for as a pooling of interests. On May 31, 1998, the Company acquired Crossbox Limited t/a Cardiac Alert ("Cardiac Alert"), a U.K.-based company which provides a centralized electrocardiogram monitoring service for international clinical trials. The Company acquired Cardiac Alert in exchange for 70,743 shares of the Company's Common Stock. The acquisition of Cardiac Alert was accounted for as a pooling of interests. On May 31, 1998, the Company acquired ClinData International Pty Limited ("ClinData"), a leading biostatistics and data management company in South Africa. The Company acquired ClinData in exchange for 123,879 shares of the Company's Common Stock. The acquisition of ClinData was accounted for as a pooling of interests. On August 24, 1998, the Company acquired The Royce Consultancy, Limited ("Royce"), a leading pharmaceutical sales representative recruitment and contract sales organization in the U.K. The Company acquired Royce in exchange for 664,194 shares of the Company's Common Stock. The acquisition of Royce was accounted for as a pooling of interests and as such, all historical financial data have been restated to include the results of Royce. On September 9, 1998, the Company acquired DAS, a New Jersey-based leader in sales force planning and territory organization systems for the pharmaceutical industry. The Company acquired DAS in exchange for 358,897 shares of the Company's Common Stock. The acquisition of DAS was accounted for as a pooling of interests and as such, all historical financial data have been restated to include the results of DAS. On October 8, 1998, the Company acquired Simirex, a New Jersey-based provider of clinical packaging services for the U.S. pharmaceutical industry. The Company acquired Simirex in exchange for 21 24 383,273 shares of the Company's Common Stock. The acquisition of Simirex was accounted for as a pooling of interests. On October 12, 1998, the Company acquired Serval, a Paris-based French contract sales and marketing company. The Company acquired Serval in exchange for 77,876 shares of the Company's Common Stock. The acquisition of Serval was accounted for as a purchase. On October 12, 1998, the Company acquired QED, a New York-based provider of integrated product marketing and communication services for pharmaceutical companies in the U.S. market. The Company acquired QED in exchange for 523,520 shares of the Company's Common Stock. The acquisition of QED was accounted for as a pooling of interests. The Company's 1998 financial statements have been restated to include More Biomedical, Cardiac Alert, ClinData, Simirex and QED from January 1, 1998, but the financial statements for 1997 and prior years have not been restated because the effect of such restatement would be immaterial. CONTRACT REVENUE The Company considers net revenue, which excludes reimbursed costs, its primary measure of revenue growth. Substantially all net revenue is earned by performing services under contracts with various pharmaceutical, biotechnology, medical device and healthcare companies. Many of the Company's contracts are fixed price, with some variable components, and range in duration from a few months to several years. The Company is also party to fee-for-service and unit-of-service contracts. The Company recognizes net revenue based upon (1) labor costs expended as a percentage of total labor costs expected to be expended (percentage of completion) for fixed price contracts, (2) contractual per diem or hourly rate basis as work is performed for fee-for-service contracts or (3) completion of units of service for unit-of-service contracts. The Company's contracts generally provide for price negotiation upon scope of work changes. The Company recognizes revenue related to these scope changes when the underlying services are performed and realization of revenue is assured. Most contracts are terminable upon 15 -- 90 days' notice by the customer. In the event of termination, contracts typically require payment for services rendered through the date of termination, as well as subsequent services rendered to close out the contract. Any anticipated losses resulting from contract performance are charged to earnings in the period identified. Each contract specifies billing and payment procedures. Generally, the procedures require a portion of the contract fee to be paid at the time the project is initiated with subsequent contract billings and payments due periodically over the length of the project's term in accordance with contractual provisions. Revenue recognized in excess of billings is classified as unbilled services, while billings in excess of revenue are classified as unearned income. The Company reports backlog based on anticipated net revenue from uncompleted projects which have been authorized by the customer through a written contract or otherwise. Using this method of reporting backlog, at December 31, 1998, 1997 and 1996 the backlog was approximately $1.9 billion, $1.09 billion and $727 million, respectively. The Company believes that backlog may not be a consistent indicator of future results because backlog can be affected by a number of factors, including the variable size and duration of projects, many of which are performed over several years, loss or significant delay of contracts, or a change in the scope of a project during the course of a study. 22 25 RESULTS OF OPERATIONS Year Ended December 31, 1998 Compared with Year Ended December 31, 1997 Net revenue for the year ended December 31, 1998 was $1.2 billion, an increase of $335.1 million or 39.3% over fiscal 1997 net revenue of $852.9 million. Growth occurred across each of the Company's geographic regions and each of its major service groups. Factors contributing to the growth included an increase of contract service offerings, the provision of increased services rendered under existing contracts and the initiation of services under contracts awarded subsequent to January 1, 1998. Direct costs, which include compensation and related fringe benefits for billable employees and other expenses directly related to contracts, were $623.3 million or 52.5% of 1998 net revenue versus $448.9 million or 52.6% of 1997 net revenue. General and administrative expenses, which include compensation and fringe benefits for administrative employees, non-billable travel, professional services, advertising, computer and facility expenses, were $383.3 million or 32.3% of 1998 net revenue versus $277.2 million or 32.5% of 1997 net revenue. The $106.1 million increase in general and administrative expenses was primarily due to an increase in personnel, facilities and locations and outside services resulting from the Company's growth. Depreciation and amortization were $55.5 million or 4.7% of 1998 net revenue versus $37.9 million or 4.4% of 1997 net revenue. The $17.6 million increase is primarily due to the increase in the capitalized asset base of the Company. In 1998, the Company recognized approximately $2.8 million of depreciation expense associated with the first full year of operation for the facility in Bathgate, Scotland and related assets. Income from operations was $125.9 million or 10.6% of 1998 net revenue versus $88.8 million or 10.4% of 1997 net revenue. Other expense, which consists primarily of transaction costs and interest, increased to $3.3 million in 1998 from $2.3 million in 1997. Transaction costs included in other expense were $3.5 million in 1998 versus $2.2 million in 1997. The effective tax rate for 1998 was 31.7% versus a 35.7% rate in 1997. The effective tax rate reduction resulted from the reversal of prior year valuation allowances relating to certain net operating loss carryforwards that the Company now believes are more likely than not to be utilized and profits generated in countries with favorable tax rates. Since the Company conducts operations on a global basis, its effective tax rate may vary. See "--Taxes." Year Ended December 31, 1997 Compared with Year Ended December 31, 1996 Net revenue for the year ended December 31, 1997 was $852.9 million, an increase of $251.8 million or 41.9% over fiscal 1996 net revenue of $601.1 million. Growth occurred across each of the Company's geographic regions and each of its major service groups. Factors contributing to the growth included an increase of contract service offerings, the provision of increased services rendered under existing contracts and the initiation of services under contracts awarded subsequent to January 1, 1997. Direct costs, which include compensation and related fringe benefits for billable employees and other expenses directly related to contracts, were $448.9 million or 52.6% of 1997 net revenue versus $309.0 million or 51.4% of 1996 net revenue. The increase in direct costs as a percentage of net revenue was primarily attributable to the increase in net revenue generated from the commercialization segment, which incur a higher level of direct costs (but lower general and administrative expenses) relative to net revenue than the product development segment. General and administrative expenses, which include compensation and fringe benefits for administrative employees, non-billable travel, professional services, advertising, computer and facility expenses, were $277.2 million or 32.5% of 1997 net revenue versus $206.9 million or 34.4% of 1996 net revenue. The $70.4 million increase in general and administrative expenses was primarily due to an increase in personnel, facilities and locations and outside services resulting from the Company's growth. 23 26 Depreciation and amortization were $37.9 million or 4.4% of 1997 net revenue versus $25.7 million or 4.3% of 1996 net revenue. Income from operations was $88.8 million or 10.4% of 1997 net revenue versus $44.1 million or 7.3% of 1996 net revenue. Excluding non-recurring costs of $15.4 million incurred in 1996, the 1996 income from operations was $59.5 million or 9.9% of net revenue. Other expense decreased to $2.3 million in 1997 from $19.6 million in 1996. Excluding acquisition costs and non-recurring transaction costs, other expense was $85,000 in 1997 and $2.5 million in 1996. The $2.4 million change was primarily due to decreases in net interest expense of approximately $2.2 million and other expense of approximately $200,000. The effective tax rate for 1997 was 35.7% versus a 60.5% rate in 1996. Excluding non-recurring transaction and restructuring costs which were not deductible for tax purposes, the 1996 effective tax rate would have been 34.4%. Since the Company conducts operations on a global basis, its effective tax rate may vary. See "-- Taxes." LIQUIDITY AND CAPITAL RESOURCES Cash flows generated from operations were $124.4 million in 1998 versus $79.1 million and $41.9 million in 1997 and 1996, respectively. Cash flows used in investing activities in 1998 were $74.4 million, versus $154.8 million and $145.1 million in 1997 and 1996, respectively. Of these investing activities, capital asset purchases required $95.6 million in 1998 versus $79.3 million and $40.7 million in 1997 and 1996, respectively. Capital asset expenditures in 1997 and 1996 included L15.8 million (approximately $26.5 million) and L2.7 million (approximately $5.0 million), respectively, related to the Company's purchase of land and construction of a facility in Bathgate, Scotland. The remaining capital expenditures were predominantly incurred in connection with the expansion of existing operations, the enhancement of information technology capabilities and the opening of new offices. Total working capital increased $30.3 million to $195.3 million at December 31, 1998 from $165.0 million at December 31, 1997. Including long-term investments of $65.5 million and $69.1 million at December 31, 1998 and 1997, respectively, in total working capital, the increase was $26.7 million. Total accounts receivable and unbilled services increased 43.4% to $314.7 million at December 31, 1998 from $219.4 million at December 31, 1997, as a result of the growth in net revenue. Accounts receivable and unbilled services, net of unearned income, increased 30.2% to $169.8 million at December 31, 1998 from $130.4 million at December 31, 1997. The number of days revenue outstanding in accounts receivable and unbilled services, net of unearned income, were 41 and 42 days at December 31, 1998 and December 31, 1997, respectively. During 1998, the Company acquired a clinical trial production and warehouse facility in Livingston, Scotland for a purchase commitment valued at L1.75 million (approximately $2.9 million), with payment due in May, 2001. During 1995, the Company acquired a drug development facility in Edinburgh, Scotland. Related to this acquisition, the Company entered into a purchase commitment valued at L12.5 million (approximately $20.9 million) with payment due in December 1999. The Company has hedged a portion of this commitment by purchasing forward contracts. The Company's forward contracts mature on December 29, 1999, and as of December 31, 1998, the Company had committed to purchasing approximately L2.4 million (approximately $3.5 million) under such contracts. The Company is obligated to purchase up to an additional L2.9 million through December 28, 1999 in varying amounts as the daily dollar-to-pound exchange rate ranges between $1.5499 and $1.6800. In connection with its March 1999 acquisition of PMSI, the Company agreed to pay contingent value payments to former PMSI stockholders who defer receipt of one-half of the shares of the Company's Common Stock they were entitled to receive in the transaction until June 14, 1999. For each deferred share of the Company's Common Stock, the contingent value payment, if any, will be calculated based on the difference between $38.71875 and the average closing price of the Company's Common Stock for 10 days 24 27 selected at random out of the 20 trading days ending on June 11, 1999. The Company plans to make the contingent value payments, if any, from cash from operations or borrowings under existing lines of credit. The Company has available to it a L15.0 million (approximately $25.1 million) unsecured line of credit with a U.K. bank and a L5.0 million (approximately $8.4 million) unsecured line of credit with a second U.K. bank. At December 31, 1998, the Company had L19.8 million (approximately $33.1 million) available under these credit agreements. During 1998, the Company entered into a $150 million senior unsecured credit facility ("$150 million facility") with a U.S. bank. At December 31, 1998, the Company had $150 million available under this facility. Based upon its current financing plan, the Company believes the $150 million facility would be available to retire long-term credit arrangements and obligations, if necessary. All foreign currency denominated amounts due, subsequent to December 31, 1998, have been translated using the Thursday, December 24, 1998 foreign exchange rates as published in the December 28, 1998 edition of the Wall Street Journal. Based on its current operating plan, the Company believes that its available cash and cash equivalents, together with future cash flows from operations and borrowings under its line of credit agreements will be sufficient to meet its foreseeable cash needs in connection with its operations. As part of its business strategy, the Company reviews many acquisition candidates in the ordinary course of business, and in addition to acquisitions already made, the Company is continually evaluating new acquisition and expansion possibilities. The Company may from time to time seek to obtain debt or equity financing in its ordinary course of business or to facilitate possible acquisitions or expansion. TAXES Since the Company conducts operations on a global basis, the Company's effective tax rate has depended and will continue to depend on the amount of profits in locations with varying tax rates. The Company's results of operations will be impacted by changes in the tax rates of the various jurisdictions and by changes in any applicable tax treaties. In particular, as the portion of the Company's non-U.S. business varies, the Company's effective tax rate may vary significantly from period to period. The Company's effective tax rate may also depend upon the extent to which the Company is allowed (and is able to use under applicable limitations) U.S. foreign tax credits in respect of taxes paid on its foreign operations. INFLATION The Company believes the effects of inflation generally do not have a material adverse impact on its operations or financial condition. IMPACT OF YEAR 2000 ISSUE State of Readiness The Company has established a Year 2000 Program to address the Year 2000 issue, which results from computer processors and software failing to process date values correctly, potentially causing system failures or data corruption. The Year 2000 issue could cause disruptions of the Company's operations, including, among other things, a temporary inability to process information; receive information, services or products from third parties; interface with customers in the performance of contracts; or operate or communicate in some or all of the regions in which it operates. The Company's computing infrastructure is based on industry standard systems. The Company does not depend on large legacy systems and does not use mainframes. Rather, the scope of its Year 2000 Program includes unique software systems and tools in each of its service groups, especially its product development service group, embedded systems in its laboratory and manufacturing operations, facilities such as elevators and fire alarms in over 133 offices (which also involve embedded technology) and numerous supplier and other business relationships. The Company has identified critical systems within each service group and is devoting its resources to address these items first. 25 28 The Company's Year 2000 Program is directed by the Year 2000 Executive Steering Team, which is comprised of the Company's Chief Information Officer and representatives from regional business units, together with legal, quality assurance and information technology personnel. The Company has established a Year 2000 Program Management Office, staffed by consultants, which develops procedures and instructions at a centralized level and oversees performance of the projects that make up the program. Project teams organized by service group and geographic region are responsible for implementation of the individual projects. The framework for the Company's Year 2000 Program prescribes broad inventory, assessment and planning phases which generally guide its projects. Each project generally includes launch, analysis, remediation, testing and deployment phases. The Company is in the process of assessing those systems, facilities and business relationships which it believes may be vulnerable to the Year 2000 issue and which it believes could impact its operations. Although the Company cannot control whether and how third parties will address the Year 2000 issue, its assessment also will include a limited evaluation of certain services on which it is substantially dependent, and the Company plans to develop contingency plans for possible deficiencies in those services. For example, the Company believes that among its most significant third party service providers are physician investigators who participate in clinical studies conducted through its contract research services; consequently, the Company is developing a specialized process to assess and address Year 2000 issues arising from these relationships. The Company does not plan to assess how its customers, such as pharmaceutical and large biotechnology companies, are dealing with the Year 2000 issue. As the Company completes the assessment of its systems, it is developing plans to renovate, replace or retire them, as appropriate, if they are affected by the Year 2000 issue. Such plans generally include testing of new or renovated systems upon completion of the remedial actions. The Company will utilize both internal and external resources to implement these plans. The Company's strategic healthcare communications services are less dependent on information technology than its other services. With the exception of recent acquisitions, the Company's Year 2000 Program with respect to those services is substantially complete, with validation expected to be completed in the first quarter of 1999. The Company addressed most systems relating to its healthcare consulting services in 1998, with completion expected in the first half of 1999. The Company also addressed most of its contract sales systems in 1998, and expects to have substantially completed this program during mid-1999. The Company's product development services utilize numerous systems, which it must address individually on disparate schedules, depending on the magnitude and complexity of the particular system. The Company anticipates that remediation or replacement of these systems will be substantially complete by mid-1999, with migration occurring primarily in the second half of 1999. The Company is in the process of evaluating the state of readiness of its recent acquisitions, particularly ENVOY and PMSI, and plans to integrate these acquisitions into its Year 2000 Program during the second quarter of 1999. The Company expects to complete the core components of its Year 2000 Program before there is a significant risk that internal Year 2000 problems will have a material impact on its operations. COSTS The Company estimates that the aggregate costs of its Year 2000 Program, excluding recent acquisitions, will be approximately $14 million, including costs already incurred. A significant portion of these costs, approximately $6 million, are not likely to be incremental costs, but rather will represent the redeployment of existing resources. This reallocation of resources is not expected to have a significant impact on the Company's day-to-day operations. The Company incurred total Year 2000 Program costs of $3.5 million through December 31, 1998, of which approximately $2.6 million represented incremental expense. ENVOY previously estimated its Year 2000 costs to be between $3.0 and $4.0 million and PMSI previously estimated that its Year 2000 costs would not be material. The Company is in the process of assessing these valuations as part of the integration of these acquisitions into its Year 2000 Program. The Company's estimates regarding the cost, timing and impact of addressing the Year 2000 issue are based on numerous assumptions of future events, including the continued availability of certain resources, its ability to meet deadlines and the cooperation of third parties. The Company cannot provide assurance that its assumptions will be correct and that these estimates will be achieved. Actual results could differ materially from the Company's expectations 26 29 as a result of numerous factors, including the availability and cost of personnel trained in this area, unforeseen circumstances that would cause the Company to allocate its resources elsewhere and similar uncertainties. YEAR 2000 RISKS The Company faces both internal and external risks from the Year 2000 issue. If realized, these risks could have a material adverse effect on the Company's business, results of operations or financial condition. The Company's primary internal risk is that its systems will not be Year 2000 compliant on time. The magnitude of this risk depends on the Company's ability to achieve compliance of both internally and externally developed systems or to migrate to alternate systems in a timely fashion. The decentralized nature of the Company's business may compound this risk if it is unable to coordinate efforts across its global operations on a timely basis. The Company believes that its Year 2000 Program will successfully address these risks, however, the Company cannot provide assurance that this program will be completed in a timely manner. Notwithstanding its Year 2000 Program, the Company also faces external risks that may be beyond its control. The Company's international operations and its relationships with foreign third parties create additional risks for the Company, as many countries outside the United States have been less attuned to the Year 2000 issue. These risks include the possibility that infrastructural systems, such as electricity, water, natural gas or telephony, will fail in some or all of the regions in which the Company operates, as well as the danger that the internal systems of its foreign suppliers, service providers and customers will fail. The Company's business also requires considerable travel, and its ability to perform services under its customer contracts could be negatively affected if air travel is disrupted by the Year 2000 issue. In addition, the Company's business depends heavily on the healthcare industry, particularly on third party physician investigators. The healthcare industry, and physicians' groups in particular, to date may not have focused on the Year 2000 issue to the same degree as some other industries, especially outside of major metropolitan centers. As a result, the Company faces increased risk that its physician investigators will be unable to provide it with the data that the Company needs to perform under its contracts on time, if at all. Thus, the clinical study involved could be slowed or brought to a halt. Also, the failure of its customers to address the Year 2000 issue could negatively impact their ability to utilize the Company's services. While it intends to develop contingency plans to address certain of these risks, the Company cannot assure you that any developed plans will sufficiently insulate it from the effects of these risks. Any disruptions resulting from the realization of these risks would affect the Company's ability to perform its services. If the Company is unable to receive or process information, or if third parties are unable to provide information or services to it, the Company may not be able to meet milestones or obligations under its customer contracts, which could have a material adverse effect on its business and financial results. CONTINGENCIES Until it has completed its remediation, testing and deployment plans, the Company believes it is premature to develop contingency plans to address what would happen if its execution of these plans were to fail to address the Year 2000 issue. CONVERSION TO THE EURO CURRENCY On January 1, 1999, a new currency, the euro, became the legal currency for 11 of the 15 member countries of the European Economic Community. Between January 1, 1999 and January 1, 2002, governments, companies and individuals may conduct business in the member countries in both the euro and existing national currencies. On January 1, 2002, the euro will become the sole currency in the member countries. The Company conducts business in the member countries. The Company is reviewing the issues involved with the introduction of the euro. The more important issues the Company is reviewing include: (1) whether the Company may have to change the prices of its services in the different countries and (2) whether the Company will have to change the terms of any financial instruments in connection with its hedging activities. Based on current information and its initial evaluation, the Company believes that the use of the euro will not have a significant impact on the Company's business or operations. Accordingly, the Company does not 27 30 expect the conversion to the euro to have a material effect on the Company's financial condition or results of operations. RECENT EVENTS On January 1, 1999, the Company acquired substantial assets of Hoechst Marion Roussel's ("HMR") Kansas City-based Drug Innovation and Approval facility for approximately $93 million in cash, most of which is expected to be paid in the second half of 1999 when the acquisition of the physical facility is completed. As part of this transaction, the Company was awarded a $436 million contract for continued support and completion of ongoing HMR development projects over a five year period. In addition, HMR will offer the Company the opportunity to provide all U.S. outsourcing services up to an additional $144 million over the same period. On February 17, 1999, the Company acquired Oak Grove Technologies, Inc. ("Oak Grove"), a leader in providing current Good Manufacturing Practice compliance services to the pharmaceutical, biotechnology and medical device industries. The Company acquired Oak Grove in exchange for 87,948 shares of the Company's Common Stock. The acquisition of Oak Grove is expected to be accounted for as a purchase. On March 29, 1999, the Company acquired Pharmaceutical Marketing Services Inc. ("PMSI") and its core company, Scott-Levin, a leader in pharmaceutical market information and research services located in the United States ("U.S."). The Company acquired PMSI in exchange for approximately 4,993,787 shares of the Company's Common Stock. Outstanding PMSI options became options to acquire approximately 440,426 shares of the Company's Common Stock. In addition, the Company agreed to pay contingent value payments to former PMSI stockholders who defer receipt of one-half of the shares of the Company's Common Stock they were entitled to receive in the transaction until June 14, 1999. For each deferred share of the Company's Common Stock, the contingent value payment, if any, will be calculated based on the difference between $38.71875 and the average closing price of the Company's Common Stock for 10 days selected at random out of the 20 trading days ending on June 11, 1999. The acquisition of PMSI will be accounted for as a purchase. On March 30, 1999, the Company acquired ENVOY Corporation ("ENVOY"), a Tennessee-based provider of healthcare electronic data interchange and data mining services. The Company acquired ENVOY in exchange for approximately 28,465,160 shares of the Company's Common Stock. Outstanding ENVOY options became options to acquire approximately 3,914,583 shares of the Company's Common Stock. The acquisition of ENVOY will be accounted for as a pooling of interests. RECENTLY ISSUED ACCOUNTING STANDARD In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement No. 133"). Statement No. 133 requires that upon adoption, all derivative instruments be recognized in the balance sheet at fair value, and that changes in such fair values be recognized in earnings unless specific hedging criteria are met. Changes in the values of derivatives that meet these hedging criteria will ultimately offset related earnings effects of the hedged items; effects of certain changes in fair value are recorded in other comprehensive income pending recognition in earnings. The Company will adopt Statement No. 133 when required to do so on January 1, 2000. Because of its limited use of derivatives, the Company does not expect the application of Statement No. 133 to have a significant impact on its financial position or results of operations. MARKET RISK Market risk is the potential loss arising from adverse changes in the market rates and prices, such as foreign currency rates, interest rates, and other relevant market rate or price changes. In the ordinary course of business, the Company is exposed to various market risks, including changes in foreign currency exchange rates, interest rates and equity price changes and the Company regularly evaluates its exposure to such changes. The Company's overall risk management strategy seeks to balance the magnitude of the exposure 28 31 and the cost and availability of appropriate financial instruments. From time to time, the Company has utilized forward exchange contracts to manage its foreign currency exchange rate risk. The Company does not hold or issue derivative instruments for trading purposes. The following analyses present the sensitivity of the Company's financial instruments to hypothetical changes in interest and foreign currency exchange rates that are reasonably possible over a one-year period. Foreign Currency Exchange Rates Approximately 51.0%, 51.7% and 58.0% of the Company's net revenue for the years ended December 31, 1998, 1997, and 1996, respectively, were derived from the Company's operations outside the United States. The Company does not have significant operations in countries in which the economy is considered to be highly-inflationary. The Company's financial statements are denominated in U.S. dollars, and accordingly, changes in the exchange rate between foreign currencies and the U.S. dollar will affect the translation of such subsidiaries' financial results into U.S. dollars for purposes of reporting the Company's consolidated financial results. Accumulated currency translation adjustments recorded as a separate component (reduction) of shareholders' equity were ($5.0) million at December 31, 1998 as compared to ($7.5) million at December 31, 1997. The Company may be subject to foreign currency transaction risk when the Company's service contracts are denominated in a currency other than the currency in which the Company earns fees or incurs expenses related to such contracts. At December 31, 1998, the Company's most significant foreign currency exchange rate exposures were in the British pound, German mark and French franc. The Company limits its foreign currency transaction risk through exchange rate fluctuation provisions stated in its contracts with customers, or the Company may hedge its transaction risk with foreign currency exchange contracts or options. The Company recognizes changes in value in income only when foreign currency exchange contracts or options are settled or exercised, respectively. There were several foreign exchange contracts relating to service contracts open at December 31, 1998, all of which are immaterial to the Company. As of December 31, 1998, the Company has a long-term obligation denominated in a foreign currency (approximately L1.8 million) and a short-term obligation denominated in a foreign currency (approximately L12.5 million). Assuming a hypothetical change of 10% in year-end exchange rates (a weakening of the US dollar), the fair value of these instruments would increase by approximately $2.4 million. Interest Rates At December 31, 1998, the Company has $143.75 million of 4.25% Convertible Subordinated Notes ("Notes") due May 31, 2000. The fair value of long-term fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The carrying value of the Notes at December 31, 1998 approximates the fair value. A 10% increase in prevailing interest rates at December 31, 1998 would not result in a material decrease in the fair value of the Notes due to the short maturity. Currently, the Company does not hold any derivative instruments to manage interest rate risk. The Company's investment portfolio consists primarily of U.S. Government Securities and money funds. The portfolio is primarily classified as available-for-sale and therefore these investments are recorded at fair value in the financial statements. These securities are exposed to market price risk which also takes into account interest rate risk. As of December 31, 1998, the fair value of the investment portfolio was $97.9 million, based on quoted market prices. The potential loss in fair value resulting from a hypothetical decrease of 10% in quoted market price is approximately $9.8 million. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This information is included under Item 7 of this report under the caption "Market Risk" beginning on page 28. 29 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, -------------------------------- 1998 1997 1996 ---------- -------- -------- Net revenue................................................. $1,188,012 $852,900 $601,126 Costs and expenses: Direct.................................................... 623,301 448,920 308,993 General and administrative................................ 383,323 277,238 206,870 Depreciation and amortization............................. 55,526 37,930 25,726 Non-recurring costs: Restructuring.......................................... -- -- 13,102 Special pension contribution........................... -- -- 2,329 ---------- -------- -------- 1,062,150 764,088 557,020 ---------- -------- -------- Income from operations...................................... 125,862 88,812 44,106 Other income (expense): Interest income........................................... 11,603 8,472 7,206 Interest expense.......................................... (11,460) (8,764) (9,716) Non-recurring transaction costs........................... -- -- (17,118) Other..................................................... (3,467) (1,985) 18 ---------- -------- -------- (3,324) (2,277) (19,610) ---------- -------- -------- Income before income taxes.................................. 122,538 86,535 24,496 Income taxes................................................ 38,859 30,852 14,832 ---------- -------- -------- Net income.................................................. 83,679 55,683 9,664 Non-equity dividend......................................... -- -- (1,785) ---------- -------- -------- Net income available for common shareholders................ $ 83,679 $ 55,683 $ 7,879 ========== ======== ======== Basic net income per share.................................. $ 1.08 $ 0.76 $ 0.11 Diluted net income per share................................ $ 1.06 $ 0.74 $ 0.11 Shares used in computing net income per share: Basic..................................................... 77,520 73,739 69,253 Diluted................................................... 79,015 75,275 71,888
The accompanying notes are an integral part of these consolidated statements. 30 33 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, --------------------- 1998 1997 ---------- -------- ASSETS Current assets: Cash and cash equivalents................................. $ 124,729 $ 80,247 Accounts receivable and unbilled services................. 314,705 219,438 Investments............................................... 32,241 44,372 Prepaid expenses.......................................... 26,000 22,276 Other current assets...................................... 17,713 24,456 ---------- -------- Total current assets............................... 515,388 390,789 Property and equipment: Land, buildings and leasehold improvements................ 93,599 83,383 Equipment and software.................................... 197,007 116,065 Furniture and fixtures.................................... 39,078 29,124 Motor vehicles............................................ 46,455 39,875 ---------- -------- 376,139 268,447 Less accumulated depreciation............................. (125,271) (81,481) ---------- -------- 250,868 186,966 Intangibles and other assets: Intangibles............................................... 74,710 72,395 Investments............................................... 65,456 69,089 Deferred income taxes..................................... 71,401 68,651 Deposits and other assets................................. 36,928 26,137 ---------- -------- 248,495 236,272 ---------- -------- Total assets....................................... $1,014,751 $814,027 ========== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Lines of credit........................................... $ 921 $ 10,485 Accounts payable.......................................... 57,478 36,385 Accrued expenses.......................................... 78,309 62,818 Unearned income........................................... 144,932 89,069 Income taxes payable...................................... 4,487 132 Current portion of obligations held under capital leases.................................................. 12,421 15,019 Current portion of long-term debt and obligation.......... 20,978 23 Other current liabilities................................. 610 11,871 ---------- -------- Total current liabilities.......................... 320,136 225,802 Long-term liabilities: Obligations held under capital leases, less current portion................................................. 12,280 8,269 Long-term debt and obligation, less current portion....... 145,152 162,200 Deferred income taxes..................................... 30,414 25,963 Other liabilities......................................... 4,171 3,154 ---------- -------- 192,017 199,586 ---------- -------- Total liabilities.................................. 512,153 425,388 Commitments and contingencies Shareholders' Equity: Preferred stock, none issued and outstanding.............. -- -- Common Stock and additional paid-in capital, 78,018,958 and 75,304,156 shares issued and outstanding at December 31, 1998 and 1997, respectively......................... 368,406 336,144 Retained earnings......................................... 143,629 60,684 Accumulated other comprehensive income.................... (5,622) (7,588) Other equity.............................................. (3,815) (601) ---------- -------- Total shareholders' equity......................... 502,598 388,639 ---------- -------- Total liabilities and shareholders' equity......... $1,014,751 $814,027 ========== ========
The accompanying notes are an integral part of these consolidated statements. 31 34 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------- 1998 1997 1996 --------- --------- --------- Operating activities: Net income................................................ $ 83,679 $ 55,683 $ 9,664 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization........................... 55,526 37,930 26,343 Non-recurring transaction costs......................... -- -- 17,118 Net loss on sale of property and equipment.............. 534 665 21 Provision for (benefit from) deferred income taxes...... (1,728) 10,296 916 Change in operating assets and liabilities: Accounts receivable and unbilled services............. (84,254) (30,270) (72,598) Prepaid expenses and other assets..................... (5,979) (16,108) (12,371) Accounts payable and accrued expenses................. 26,587 11,555 30,557 Unearned income....................................... 50,955 815 47,816 Income taxes payable and other current liabilities.... (992) 9,023 3,810 Change in fiscal year of pooled entity.................. -- (581) (9,378) Other................................................... 83 60 (41) --------- --------- --------- Net cash provided by operating activities................. 124,411 79,068 41,857 Investing activities: Proceeds from disposition of property and equipment..... 6,297 4,642 2,284 Purchase of investments held-to-maturity................ -- -- (95,939) Maturities of investments held-to-maturity.............. 10,593 35,579 43,345 Purchase of investments available-for-sale.............. (125,413) (137,597) (19,020) Proceeds from sale of investments available-for-sale.... 130,422 51,278 8,960 Purchase of other investments........................... -- (12,011) -- Acquisition of property and equipment................... (95,593) (79,283) (40,741) Acquisition of businesses, net of cash acquired......... 2,738 (11,756) (35,108) Payment of non-recurring transaction costs.............. -- (5,648) (11,440) Change in fiscal year of pooled entity.................. -- (17) 2,606 Loan to ESOP, net....................................... (3,429) -- -- --------- --------- --------- Net cash used in investing activities................... $ (74,385) $(154,813) $(145,053)
Financing activities: Increase (decrease) in lines of credit, net............... $ (8,597) $ 660 $ 2,544 Proceeds from issuance of debt............................ -- -- 139,650 Repayment of debt......................................... (23) (7,727) (57,271) Principal payments on capital lease obligations........... (18,656) (16,778) (9,627) Issuance of common stock.................................. 21,499 108,834 3,683 Issuance of debt for capitalization of pooled entity...... -- -- 45,197 Recapitalization of pooled entity......................... -- -- (29,230) Non-equity dividend....................................... -- -- (1,756) Dividend paid by pooled entity............................ (1,307) (1,632) (1,528) Change in fiscal year of pooled entity.................... -- 58 1,399 Other..................................................... 827 (56) (295) --------- --------- --------- Net cash provided (used in) by financing activities......... (6,257) 83,359 92,766 Effect of foreign currency exchange rate changes on cash.... 713 (1,846) 340 --------- --------- --------- Increase (decrease) in cash and cash equivalents............ 44,482 5,768 (10,090) Cash and cash equivalents at beginning of year.............. 80,247 74,479 84,569 --------- --------- --------- Cash and cash equivalents at end of year.................... $ 124,729 $ 80,247 $ 74,479 ========= ========= ========= Supplemental Cash Flow Information Interest paid............................................. $ 11,536 $ 8,891 $ 9,415 Income taxes paid......................................... 22,161 16,774 12,740 Non-cash Investing and Financing Activities Capitalized leases........................................ 19,531 23,027 13,210 Equity impact of mergers and acquisitions................. 5,046 1,134 (23,253) Equity impact from exercise of non-qualified stock options................................................. 5,498 24,049 2,920 Tax effect of pooled transactions........................... $ -- $ 62,700 $ --
The accompanying notes are an integral part of these consolidated statements. 32 35 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
EMPLOYEE STOCK OWNERSHIP ACCUMULATED PLAN OTHER ADDITIONAL LOAN COMPREHENSIVE RETAINED COMPREHENSIVE COMMON PAID-IN GUARANTEE INCOME EARNINGS INCOME STOCK CAPITAL & OTHER TOTAL ------------- -------- ------------- ------ ---------- --------- -------- Balance, December 31, 1995............... $ -- $ 32,618 $ 1,700 $342 $132,778 $(1,495) $165,943 Issuance of common stock................. -- -- -- 15 3,838 -- 3,853 Principal payments on ESOP loan.......... -- -- -- -- -- 420 420 Common stock issued for acquisitions..... -- 608 -- 3 516 -- 1,127 Issuance of common stock for other than cash................................... -- -- -- 1 135 -- 136 Effect due to change in fiscal year of pooled entity.......................... -- 324 -- -- -- -- 324 Recapitalization of pooled entity........ -- (29,028) -- -- (202) -- (29,230) Tax benefit from the exercise of non-qualified stock options............ -- -- -- -- 2,920 -- 2,920 Dividends paid by pooled entity.......... -- (1,519) -- -- -- -- (1,519) Non-equity dividend...................... -- (1,785) -- -- -- -- (1,785) Other equity transactions................ -- 18 -- -- 15 (62) (29) Comprehensive income: Net income............................... 9,664 9,664 -- -- -- -- 9,664 Unrealized gain on marketable securities, net of tax................. 45 -- 45 -- -- -- 45 Foreign currency adjustments............. (1,243) -- (1,243) -- -- -- (1,243) ------- Comprehensive income..................... 8,466 ======= -------- ------- ---- -------- ------- -------- Balance, December 31, 1996............... 10,900 502 361 140,000 (1,137) 150,626 Issuance of common stock................. -- -- -- 22 112,738 -- 112,760 Principal payments on ESOP loan.......... -- -- -- -- -- 536 536 Common stock issued for acquisitions..... -- (455) -- -- 244 -- (201) Issuance of common stock for other than cash................................... -- -- -- 1 19 -- 20 Effect due to change in fiscal year of pooled entity.......................... -- (3,775) 117 -- -- -- (3,658) Tax effect of pooling of interests....... -- -- -- -- 62,700 -- 62,700 Tax benefit from the exercise of non-qualified stock options............ -- -- -- -- 20,118 -- 20,118 Dividend paid by pooled entity........... -- (1,679) -- -- (72) -- (1,751) Two-for-one stock split.................. -- -- -- 369 (369) -- -- Other equity transactions................ -- -- -- -- 13 -- 13 Comprehensive income: Net income............................... 55,683 55,683 -- -- -- -- 55,683 Unrealized loss on marketable securities, net of tax................. (104) -- (104) -- -- -- (104) Foreign currency adjustments............. (8,103) -- (8,103) -- -- -- (8,103) ------- Comprehensive income..................... 47,476 ======= -------- ------- ---- -------- ------- -------- Balance, December 31, 1997............... 60,684 (7,588) 753 335,391 (601) 388,639 Issuance of Common Stock................. -- -- -- 10 21,489 -- 21,499 Principal payments on ESOP loan.......... -- -- -- -- -- 215 215 Loan to ESOP............................. -- -- -- -- -- (3,429) (3,429) Common stock issued for acquisitions..... -- 480 -- 17 4,549 -- 5,046 Tax benefit from the exercise of non-qualified stock options............ -- -- -- -- 5,498 -- 5,498 Dividend paid by pooled entity........... -- (1,307) -- -- -- -- (1,307) Other equity transactions................ -- 93 -- -- 699 -- 792 Comprehensive income: Net income............................... 83,679 83,679 -- -- -- -- 83,679 Unrealized loss on marketable securities, net of tax................. (572) -- (572) -- -- -- (572) Foreign currency adjustments............. 2,538 -- 2,538 -- -- -- 2,538 ------- Comprehensive income..................... $85,645 ======= -------- ------- ---- -------- ------- -------- Balance, December 31, 1998............... $143,629 $(5,622) $780 $367,626 $(3,815) $502,598 ======== ======= ==== ======== ======= ========
The accompanying notes are an integral part of these consolidated statements. 33 36 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY The Company is a leader in providing full-service contract research, sales, marketing and healthcare policy consulting and health information management services to the worldwide pharmaceutical, biotechnology, medical device and healthcare industries. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts and operations of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. FOREIGN CURRENCIES Assets and liabilities recorded in foreign currencies on the books of foreign subsidiaries are translated at the exchange rate on the balance sheet date. Revenues, costs and expenses are recorded at average rates of exchange during the year. Translation adjustments resulting from this process are charged or credited to equity. Gains and losses on foreign currency transactions are included in other income (expense). REVENUE RECOGNITION Many of the Company's contracts are fixed price, with some variable components, and range in duration from a few months to several years. The Company is also party to fee-for-service and unit-of-service contracts. The Company recognizes net revenue based upon (1) labor costs expended as a percentage of total labor costs expected to be expended (percentage of completion) for fixed price contracts, (2) contractual per diem or hourly rate basis as work is performed under fee-for-service contracts or (3) completion of units of service for unit-of-service contracts. The Company's contracts provide for price renegotiation upon scope of work changes. The Company recognizes revenue related to these scope changes when the underlying services are performed and realization is assured. Most contracts are terminable upon 15-90 days' notice by the customer. In the event of termination, contracts typically require payment for services rendered through the date of termination, as well as for subsequent services rendered to close out the contract. Any anticipated losses resulting from contract performance are charged to earnings in the period identified. CONCENTRATION OF CREDIT RISK Substantially all net revenue is earned by performing services under contracts with various pharmaceutical, biotechnology, medical device and healthcare companies. The concentration of credit risk is equal to the outstanding accounts receivable and unbilled services balances, less the unearned income related thereto, and such risk is subject to the financial and industry conditions of the Company's customers. The Company does not require collateral or other securities to support customer receivables. Credit losses have been immaterial and consistently within management's expectations. One customer accounted for 11.3% of consolidated net revenue in 1996. These revenues were derived from both the Company's product development and commercialization segments. 34 37 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) UNBILLED SERVICES AND UNEARNED INCOME In general, prerequisites for billings and payments are established by contractual provisions including predetermined payment schedules, submission of appropriate billing detail or the achievement of contract milestones, depending on the type of contract. Unbilled services arise when services have been rendered but customers have not been billed. Similarly, unearned income represents prebillings for services that have not yet been rendered. CASH EQUIVALENTS AND INVESTMENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The Company does not report in the accompanying balance sheets cash held for customers for investigator payments in the amount of $7.3 million and $9.5 million at December 31, 1998 and 1997, respectively, that pursuant to agreements with these customers, remains the property of the customers. The Company's investments in debt and marketable equity securities are classified as either held-to-maturity or available-for-sale. Investments classified as held-to-maturity are recorded at amortized cost. Investments classified as available-for-sale are measured at market value and net unrealized gains and losses are recorded as a component of shareholders' equity until realized. In addition, the Company has recorded $19.2 million and $13.1 million in deposits and other assets at December 31, 1998 and 1997, respectively, that represents investments in equity securities of and advances to companies for which there are not readily available market values; such investments are accounted for using the cost method. Any gains or losses on sales of investments are computed by specific identification. PROPERTY AND EQUIPMENT Property and equipment are carried at historical cost and are depreciated using the straight-line method over the shorter of the asset's estimated useful life or the lease term as follows: Buildings and leasehold improvements........................ 3 - 50 years Equipment and software...................................... 3 - 10 years Furniture and fixtures...................................... 5 - 10 years Motor vehicles.............................................. 3 - 5 years
INTANGIBLE ASSETS Intangibles consist principally of the excess cost over the fair value of net assets acquired ("goodwill") and are being amortized on a straight-line basis over periods from 10 to 40 years. Accumulated amortization totaled $10.9 million and $12.8 million at December 31, 1998 and 1997, respectively. The carrying values of intangible assets are reviewed if the facts and circumstances suggest impairment. If this review indicates that carrying values will not be recoverable, as determined based on undiscounted cash flows over the remaining amortization period, the Company would reduce carrying values by the estimated shortfall of discounted cash flows. NET INCOME PER SHARE In February 1997, the FASB issued Statement No. 128, "Earnings per Share" which established new standards for computing and presenting net income per share information. As required, the Company adopted the provisions of Statement No. 128 in its 1997 financial statements and has restated all prior year net income per share information. Basic net income per share was determined by dividing net income available for common shareholders by the weighted average number of common shares outstanding during each year. 35 38 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Diluted net income per share reflects the potential dilution that could occur assuming conversion or exercise of all convertible securities and issued and unexercised stock options. A reconciliation of the net income available for common shareholders and number of shares used in computing basic and diluted net income per share is in Note 4. INCOME TAXES Income tax expense includes U.S. and international income taxes. Certain items of income and expense are not reported in tax returns and financial statements in the same year. The tax effects of these differences are reported as deferred income taxes. Tax credits are accounted for as a reduction of tax expense in the year in which the credits reduce taxes payable. RESEARCH AND DEVELOPMENT COSTS Research and development costs relating principally to new software applications and computer technology are charged to expense as incurred. These expenses totaled $3.4 million, $2.8 million and $2.3 million in 1998, 1997 and 1996, respectively. EMPLOYEE STOCK COMPENSATION The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation", requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. FOREIGN CURRENCY HEDGING The Company uses foreign exchange contracts and options to hedge the risk of changes in foreign currency exchange rates associated with contracts in which the expenses for providing services are incurred in one currency and paid for by the customer in another currency. The Company recognizes changes in value in income only when contracts are settled or options are exercised. There were several foreign exchange contracts relating to service contracts open at December 31, 1998, all of which are immaterial to the Company. RECENTLY ADOPTED ACCOUNTING STANDARDS As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("Statement No. 130"). Statement No. 130 establishes new rules for the reporting and display of comprehensive income and its components. Statement No. 130 requires foreign currency translation adjustments and unrealized gains or losses on the Company's available-for-sale securities to be included in other comprehensive income. Prior to the adoption of Statement No. 130, the Company reported such adjustments and unrealized gains or losses separately in shareholders' equity. Amounts in prior year financial statements have been reclassified to conform to Statement No. 130. In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The Company adopted the provisions of SOP No. 98-1 in fiscal 1998. The adoption of SOP No. 98-1 did not have a material impact on the Company's consolidated financial statements. 36 39 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) RECENTLY ISSUED ACCOUNTING STANDARD In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." Statement No. 133 requires that upon adoption, all derivative instruments be recognized in the balance sheet at fair value, and that changes in such fair values be recognized in earnings unless specific hedging criteria are met. Changes in the values of derivatives that meet these hedging criteria will ultimately offset related earnings effects of the hedged items; effects of certain changes in fair value are recorded in other comprehensive income pending recognition in earnings. The Company will adopt Statement No. 133 when required to do so on January 1, 2000. Because of its limited use of derivatives, the Company does not expect the application of Statement No. 133 to have a significant impact on its financial position or results of operations. 2. SHAREHOLDERS' EQUITY The Company is authorized to issue 25 million shares of preferred stock, $.01 per share par value. At December 31, 1998, 200 million common shares of $.01 par value were authorized. In October 1997, the Board of Directors authorized a two-for-one split of the Company's Common Stock in the form of a 100% stock dividend. A total of 36,920,627 shares of Common Stock were issued in connection with the split. The stated par value of each share was not changed from $.01. A total of $369,000 was reclassified from additional paid-in capital to Common Stock. All references in the financial statements to number of shares, per share amounts, stock option data and market prices of Common Stock have been restated to reflect the stock split. In March 1997, the Company completed a stock offering of 11,040,000 shares of its Common Stock. Of the shares sold, 2,830,000 shares were sold by the Company and 8,210,000 shares by certain selling shareholders. The offering provided the Company with approximately $84.3 million, net of expenses. 3. MERGERS AND ACQUISITIONS On February 2, 1998, the Company acquired Pharma in exchange for 132,000 shares of the Company's Common Stock. On February 26, 1998, the Company acquired T2A in exchange for 311,899 shares of the Company's Common Stock. On August 24, 1998, the Company acquired Royce in exchange for 664,194 shares of the Company's Common Stock. On September 9, 1998, the Company acquired DAS in exchange for 358,897 shares of the Company's Common Stock. These transactions were accounted for by the pooling of interests method and prior period financial statements have been restated. The following is a summary of the net revenue and net income available for common shareholders from the beginning of the year through the date of combination for companies acquired in transactions accounted for as poolings of interests in 1998 (in thousands):
PHARMA T2A ROYCE DAS OTHERS ------ ------ ------ ------ ------- Net revenue.................................. $388 $3,836 $7,319 $5,182 $14,471 Net income available for common shareholders............................... $ 31 $ 163 $ 372 $ 386 $ 1,744
On June 2, 1997, the Company acquired Butler Communications, Inc. in exchange for 428,610 shares of the Company's Common Stock. On June 11, 1997, the Company acquired 100% of the stock of Medical Action Communications Limited for 1,131,394 shares of the Company's Common Stock. On July 2, 1997, the Company acquired CerebroVascular Advances, Inc. ("CVA") through an exchange of 100% of CVA's stock for 467,936 shares of the Company's Common Stock. On August 29, 1997, the Company acquired Intelligent Imaging, Inc. ("Intelligent Imaging") in exchange for 171,880 shares of the Company's Common Stock. On August 29, 1997, the Company acquired Clindepharm International (Pty) Limited in exchange for 477,966 shares of the Company's Common Stock. These transactions were accounted for by the pooling of interests 37 40 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) method and were previously included in the Company's historical financial statements, with the exception of Intelligent Imaging as described below. On November 29, 1996, the Company acquired 100% of the outstanding stock of Innovex Limited ("Innovex"), an international contract pharmaceutical organization based in Marlow, U.K., for 18,428,478 shares of the Company's Common Stock and the exchange of options to purchase 1,572,452 shares of the Company's Common Stock. On November 22, 1996, the Company acquired BRI International, Inc. ("BRI"), a global contract research organization, through an exchange of 100% of BRI's stock for 3,229,724 shares of the Company's Common Stock. Related to the Innovex and BRI transactions, the Company recognized approximately $17.1 million in non-recurring transaction costs and approximately $10.7 million in non-recurring restructuring costs. These transactions were accounted for by the pooling of interests method and were previously included in the Company's historical financial statements. On May 13, 1996, the Company acquired the operating assets of Lewin-VHI, Inc., a healthcare consulting company, for approximately $30 million in cash. The Company recorded approximately $20 million related to the excess cost over the fair value of net assets acquired. The acquisition was accounted for as a purchase and accordingly, the financial statements include the results of operations of the business from the date of acquisition. In connection with the preparation of its 1998 financial statements, the Company determined that the 1996 financial statements should be restated to account for the acquisition of Intelligent Imaging. Intelligent Imaging had not previously been considered material to the 1996 financial statements; however, certain acquisitions occurring in the fourth quarter of 1998 required the Company to reassess its evaluation of materiality. The following is a reconciliation of net revenue and net income available for common shareholders previously reported by the Company, in Form 8-K dated January 27, 1999, for the year ended December 31, 1996, with the amounts currently presented in the financial statements for that year (in thousands):
AS PREVIOUSLY INTELLIGENT CONSOLIDATED REPORTED IMAGING AS RESTATED ------------- ----------- ------------ Net revenue......................................... $600,100 $1,026 $601,126 Net income available for common shareholders........ $ 7,648 $ 231 $ 7,879
In addition to the above mergers and acquisitions, the Company has completed other mergers and acquisitions all of which are immaterial to the financial statements. For such immaterial pooling of interests transactions, the Company's financial statements for the year of the transaction have been restated to include the pooled companies from January 1 of that year, but the financial statements for years prior to the year of the transaction have not been restated because the effect of such restatement would be immaterial. 38 41 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 4. NET INCOME PER SHARE The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share data):
YEAR ENDED DECEMBER 31, --------------------------- 1998 1997 1996 ------- ------- ------- Net income available for common shareholders: Net income.............................................. $83,679 $55,683 $ 9,664 Non-equity dividend..................................... -- -- (1,785) ------- ------- ------- Net income available for common shareholders -- basic and diluted net income per share..................... $83,679 $55,683 $ 7,879 ======= ======= ======= Weighted average shares: Basic net income per share -- weighted average shares... 77,520 73,739 69,253 Effect of dilutive securities: Stock options........................................ 1,495 1,536 2,635 ------- ------- ------- Diluted net income per share -- adjusted weighted-average shares and assumed conversions...... 79,015 75,275 71,888 ======= ======= ======= Basic net income per share.............................. $ 1.08 $ 0.76 $ 0.11 ======= ======= ======= Diluted net income per share............................ $ 1.06 $ 0.74 $ 0.11 ======= ======= =======
Options to purchase 1.5 million shares of common stock with exercise prices ranging between $46.75 and $56.25 per share were outstanding during 1998 but were not included in the computation of diluted net income per share because the options' exercise price was greater than the average market price of the common shares and, therefore, the effect would be antidilutive. The conversion of the Company's 4.25% Convertible Subordinated Notes ("Notes") into approximately 3.5 million shares of common stock was not included in the computation of diluted net income per share because the effect would be antidilutive. For additional disclosures regarding the outstanding stock options and the Notes, see "Employee Benefit Plans" and "Credit Arrangements and Obligations." 5. CREDIT ARRANGEMENTS AND OBLIGATIONS On May 31, 1998, the Company acquired a clinical trial supply production and warehouse facility in Livingston, Scotland for a purchase commitment valued at L1.75 million (approximately $2.9 million), with payment due in May, 2001. On May 23, 1996, the Company completed a private placement of $143.75 million of 4.25% Convertible Subordinated Notes ("Notes") due May 31, 2000. Net proceeds to the Company amounted to approximately $139.7 million. The Notes are convertible into 3,474,322 shares of Common Stock, at the option of the holder, at a conversion price of $41.37 per share, subject to adjustment under certain circumstances, at any time after August 21, 1996. The Notes are redeemable, at the option of the Company, beginning May 31, 1999. Interest is payable on the notes semi-annually on May 31 and November 30 each year. The Company has a $150 million senior unsecured credit facility with a U.S. bank. At the option of the Company, interest is charged at either the bank's prime rate (7.75% at December 31, 1998) or LIBOR rate (5.06563% at December 31, 1998) plus an applicable rate (.2% at December 31, 1998). No balance was outstanding as of December 31, 1998. 39 42 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company has a L15.0 million (approximately $25.1 million) line of credit which is guaranteed by certain of the Company's U.K. subsidiaries. Interest is charged at the bank's base rate (7.25% at December 31, 1998), plus 1%, with a minimum of 5.5%. The line of credit had an outstanding balance of L0 and L1.5 million (approximately $2.5 million) at December 31, 1998 and 1997, respectively. The Company has a L5.0 million (approximately $8.4 million) unsecured line of credit with a second U.K. bank. The line of credit is charged interest at the bank's published base rate (6.25% at December 31, 1998) plus 1.5%. The line of credit had an outstanding balance of L.2 million (approximately $.4 million) and L4.7 million (approximately $7.8 million) at December 31, 1998 and 1997, respectively. In March 1995, Quintiles Scotland Limited, a wholly-owned subsidiary of the Company, acquired assets of a drug development facility in Edinburgh, Scotland from Syntex Pharmaceuticals Limited, a member of the Roche group based in Basel, Switzerland for a purchase commitment valued at L12.5 million (approximately $20.9 million), with payment due in December 1999. In connection with this commitment, the Company has committed to purchasing at December 31, 1998 approximately L2.4 million (approximately $3.5 million) under foreign exchange contracts. The Company is obligated to purchase up to an additional L2.9 million through December 28, 1999 in varying amounts as the daily dollar-to-pound exchange rate ranges between $1.5499 and $1.6800. Long-term debt and obligation consist of the following (in thousands):
DECEMBER 31, ------------------- 1998 1997 -------- -------- 4.25% Convertible Subordinated Notes due 2000............... $143,747 $143,750 Other notes payable......................................... 222 23 Long-term obligations....................................... 23,830 20,985 -------- -------- 167,799 164,758 Less: current portion..................................... 20,978 23 unamortized issuance costs......................... 1,669 2,535 -------- -------- $145,152 $162,200 ======== ========
Maturities of long-term debt and obligation at December 31, 1998 are as follows (in thousands): 1999........................................................ $ 20,978 2000........................................................ 143,824 2001........................................................ 2,989 2002........................................................ 8 -------- $167,799 ========
The fair value of the Company's long-term debt approximates carrying value. 40 43 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 6. INVESTMENTS The following is a summary as of December 31, 1998 of held-to-maturity securities and available-for-sale securities by contractual maturity where applicable (in thousands):
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET HELD-TO-MATURITY SECURITIES: COST GAINS LOSSES VALUE - ---------------------------- --------- ---------- ---------- ------ U.S. Government Securities -- Maturing in one year or less.................. $2,990 $ 15 $-- $3,005 Other........................................... 2,333 217 -- 2,550 ------ ---- --- ------ $5,323 $232 $-- $5,555 ====== ==== === ======
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET AVAILABLE-FOR-SALE SECURITIES: COST GAINS LOSSES VALUE - ------------------------------ --------- ---------- ---------- ------- U.S. Government Securities -- Maturing between one and three years......... $ 6,506 $ 2 $ (9) $ 6,499 Maturing between three and five years........ 43,584 9 (298) 43,295 Maturing between five and seven years........ 13,000 13 (39) 12,974 State and Municipal Securities -- Maturing in one year or less................. 2,000 -- -- 2,000 Maturing between one and three years......... 1,568 27 -- 1,595 Equity Securities.............................. 556 -- (63) 493 Money Funds.................................... 25,512 -- (594) 24,918 Other.......................................... 605 -- (5) 600 ------- --- ------- ------- $93,331 $51 $(1,008) $92,374 ======= === ======= =======
The following is a summary as of December 31, 1997 of held-to-maturity and available-for-sale securities by contractual maturity where applicable (in thousands):
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET HELD-TO-MATURITY SECURITIES: COST GAINS LOSSES VALUE - ---------------------------- --------- ---------- ---------- ------- U.S. Government Securities -- Maturing in one year or less................. $ 5,892 $ 15 $ -- $ 5,907 Maturing between one and three years......... 2,814 16 -- 2,830 State and Municipal Securities -- Maturing in one year or less................. 2,688 9 -- 2,697 Maturing between one and three years......... 2,329 17 -- 2,346 Other.......................................... 2,312 97 -- 2,409 ------- ---- ----- ------- $16,035 $154 $ -- $16,189 ======= ==== ===== =======
41 44 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET AVAILABLE FOR SALE SECURITIES: COST GAINS LOSSES VALUE - ------------------------------ --------- ---------- ---------- ------- U.S. Government Securities -- Maturing in one year or less................. $ 2,499 $ -- $ -- $ 2,499 Maturing between one and three years......... 52,061 -- (57) 52,004 Maturing between three and five years........ 7,000 5 -- 7,005 State and Municipal Securities -- Maturing in one year or less................. 3,060 -- -- 3,060 Maturing between three and five years........ 2,595 30 -- 2,625 Money Funds.................................... 30,301 -- (68) 30,233 ------- ---- ----- ------- $97,516 $ 35 $(125) $97,426 ======= ==== ===== =======
The gross realized gains and losses on sales of available-for-sale securities were $81,000 and $210,000, respectively, in 1998. The net adjustment to unrealized holding gains (losses) on available-for-sale securities included as a separate component of shareholders' equity was ($572,000), ($104,000) and $45,000 in 1998, 1997 and 1996, respectively. 7. ACCOUNTS RECEIVABLE AND UNBILLED SERVICES Accounts receivable and unbilled services consist of the following (in thousands):
DECEMBER 31, ------------------- 1998 1997 -------- -------- Trade: Billed.................................................... $174,344 $129,397 Unbilled services......................................... 127,848 80,108 -------- -------- 302,192 209,505 Other....................................................... 14,122 11,753 Allowance for doubtful accounts............................. (1,609) (1,820) -------- -------- $314,705 $219,438 ======== ========
Substantially all of the Company's accounts receivable and unbilled services are due from companies in the pharmaceutical, biotechnology, medical device and healthcare industries and are a result of contract research, sales, marketing, healthcare consulting and health information management services provided by the Company on a global basis. The percentage of accounts receivable and unbilled services by region is as follows:
DECEMBER 31, ------------ REGION 1998 1997 - ------ ---- ---- Americas: United States............................................. 52% 46% Other..................................................... 2 1 --- --- Americas............................................... 54 47 Europe and Africa: United Kingdom............................................ 31 36 Other..................................................... 13 15 --- --- Europe and Africa...................................... 44 51 Asia -- Pacific............................................. 2 2 --- --- 100% 100% === ===
42 45 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 8. ACCRUED EXPENSES Accrued expenses consist of the following (in thousands):
DECEMBER 31, ----------------- 1998 1997 ------- ------- Compensation and payroll taxes.............................. $46,453 $30,754 Transaction and restructuring costs......................... 943 2,751 Other....................................................... 30,913 29,313 ------- ------- $78,309 $62,818 ======= =======
9. LEASES The Company leases certain office space and equipment under operating leases. The leases expire at various dates through 2049 with options to cancel certain leases at five-year increments. Some leases contain renewal options. Annual rental expenses under these agreements were approximately $35.8 million, $25.4 million and $22.6 million for the years ended December 31, 1998, 1997 and 1996, respectively. The Company leases certain assets, primarily vehicles, under capital leases. Capital lease amortization is included with depreciation and amortization expenses and accumulated depreciation in the accompanying financial statements. The following is a summary of future minimum payments under capitalized leases and under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 1998 (in thousands):
CAPITAL OPERATING LEASES LEASES ------- --------- 1999........................................................ $13,703 $ 38,309 2000........................................................ 12,682 31,962 2001........................................................ 157 23,491 2002........................................................ 136 19,050 2003........................................................ 2 14,196 Thereafter.................................................. 1 52,137 ------- -------- Total minimum lease payments...................... 26,681 $179,145 ======== Amounts representing interest............................... 1,980 ------- Present value of net minimum payments....................... 24,701 Current portion............................................. 12,421 ------- Long-term capital lease obligations......................... $12,280 =======
43 46 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 10. INCOME TAXES The components of income tax expense are as follows (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 1998 1997 1996 ------- ------- ------- Current: Federal................................................ $26,640 $11,201 $ 5,209 State.................................................. 3,995 2,655 1,735 Foreign................................................ 11,671 6,783 6,582 ------- ------- ------- 42,306 20,639 13,526 Deferred expense (benefit): Federal................................................ (1,068) 7,717 (632) Foreign................................................ (2,379) 2,496 1,938 ------- ------- ------- (3,447) 10,213 1,306 ------- ------- ------- $38,859 $30,852 $14,832 ======= ======= =======
The Company has allocated directly to additional paid-in capital approximately $5.5 million in 1998, $20.1 million in 1997 and $2.9 million in 1996 related to the tax benefit from non-qualified stock options exercised. The differences between the Company's consolidated tax expense and the expense computed at the 35% U.S. statutory tax rate were as follows (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 1998 1997 1996 ------- ------- ------- Federal taxes at statutory rate.......................... $42,888 $30,288 $ 8,574 State and local income taxes, net of federal benefit..... 2,597 1,745 1,101 Non-deductible transaction costs......................... -- -- 4,761 Foreign earnings taxed at different rates................ (1,988) 608 226 Valuation allowance reduction............................ (2,194) (636) -- Non-taxable income....................................... (590) (1,521) -- Other.................................................... (1,854) 368 170 ------- ------- ------- $38,859 $30,852 $14,832 ======= ======= =======
Income before income taxes from foreign operations was approximately $32 million, $4.4 million and $24.9 million for the years 1998, 1997 and 1996, respectively. Income from foreign operations was approximately $64 million, $35.5 million and $26.1 million for the years 1998, 1997 and 1996, respectively. The difference between income from operations and income before income taxes is due primarily to intercompany charges which eliminate in consolidation. Undistributed earnings of the Company's foreign subsidiaries amounted to approximately $79 million at December 31, 1998. Those earnings are considered to be indefinitely reinvested, and accordingly, no U.S. federal and state income taxes have been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various countries. 44 47 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The tax effects of temporary differences that give rise to significant portions of deferred tax (assets) liabilities are presented below (in thousands):
YEAR ENDED DECEMBER 31, ----------------------- 1998 1997 --------- --------- Deferred tax liabilities: Depreciation and amortization............................ $ 27,523 $ 24,031 Prepaid expenses......................................... 3,389 1,335 Other.................................................... 2,940 2,733 --------- --------- Total deferred tax liabilities................... 33,852 28,099 Deferred tax assets: Net operating loss carryforwards......................... (24,348) (17,532) Accrued expenses and unearned income..................... (13,434) (7,104) Goodwill net of amortization............................. (94,432) (101,095) Other.................................................... (5,306) (4,783) --------- --------- Total deferred tax assets........................ (137,520) (130,514) Valuation allowance for deferred tax assets................ 52,685 54,879 --------- --------- Net deferred tax assets.................................... (84,835) (75,635) --------- --------- Net deferred tax (assets) liabilities...................... $ (50,983) $ (47,536) ========= =========
The decrease in the Company's valuation allowance for deferred tax assets to $52.7 million at December 31, 1998 from $54.9 million at December 31, 1997 is primarily due to the reduction of prior year valuation allowances relating to net operating loss carryforwards that the Company now believes are more likely than not to be utilized. In connection with the Innovex acquisition, the Company established an initial deferred tax asset of $108 million to reflect the tax benefits arising from the deductibility of goodwill recorded for tax purposes. The Innovex business combination was accounted for as a pooling of interests for financial reporting purposes, and no goodwill was recorded. In addition, the Company recorded a $45.3 million valuation allowance related to this taxable goodwill to reflect uncertainties that might affect the realization of this deferred tax asset. These uncertainties include the projection of future taxable and foreign source income, the interplay of U.S. tax statutes and the Company's ability to minimize foreign tax credit limitations. Based on its analysis, the Company believes it is more likely than not that a portion of the deferred tax asset related to this taxable goodwill will not be recognized. The resulting net asset of $62.7 million was recorded as an increase to additional paid-in capital. The Company's deferred income tax expense (benefit) results from the following (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 1998 1997 1996 ------- ------- ------- Excess (deficiency) of tax over financial reporting: Depreciation and amortization.......................... $10,326 $14,936 $ 9,414 Net operating loss carryforwards....................... (6,816) (6,057) (1,907) Valuation allowance reduction.......................... (2,194) (636) -- Accrued expenses and unearned income................... (6,611) (874) (4,368) Other items, net....................................... 1,848 2,844 (1,833) ------- ------- ------- $(3,447) $10,213 $ 1,306 ======= ======= =======
The U.K. subsidiaries qualify for Scientific Research Allowances (SRAs) for 100% of capital expenditures on certain assets under the Inland Revenue Service guidelines. For 1998, 1997 and 1996, these allowances were $23 million, $28 million and $11 million, respectively, which helped to generate net operating 45 48 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) loss carryforwards of $7 million to be used to offset taxable income in that country. Assuming the U.K. subsidiaries continue to invest in qualified capital expenditures at an adequate level, the portion of the deferred tax liability relating to the U.K. subsidiaries may be deferred indefinitely. The Company recognizes a deferred tax benefit for foreign generated operating losses at the time of the loss, as the Company believes it is more likely than not that the benefit will be realized. The Company has net operating loss carryforwards of approximately $55 million in various entities within the United Kingdom which have no expiration date and has over $10 million of net operating loss carryforwards from various foreign jurisdictions which have different expiration periods. In addition, the Company has approximately $7 million of U.S. state operating loss carryforwards which expire through 2002 and has approximately $3 million of U.S. federal operating loss carryforwards which begin to expire in 2005. 11. EMPLOYEE BENEFIT PLANS The Company has numerous employee benefit plans which cover substantially all eligible employees in the countries in which the plans are offered. Contributions are primarily discretionary, except in some countries where contributions are contractually required. Plans include Approved Profit Sharing Schemes in the U.K. and Ireland which are funded with Company stock, a defined contribution plan funded by Company stock in Australia, Belgium and Canada, defined contribution plans in Belgium, Holland, Sweden, and Great Britain, a profit sharing scheme in France, and defined benefit plans in Germany and the U.K. The defined benefit plan in Germany is an unfunded plan which is provided for in the balance sheet. In addition, the Company sponsors a supplemental non-qualified deferred compensation plan, covering certain management employees. The Company sponsors a leveraged Employee Stock Ownership Plan (the "ESOP") for all eligible employees. In 1992, the Company loaned the ESOP approximately $2.0 million to purchase 413,222 shares of Company common stock. As of December 31, 1997, the loan was repaid. In connection with its acquisition of BRI, the Company merged the existing BRI ESOP, also a leveraged plan, into the Company's ESOP effective September 1, 1997. During 1998, the ESOP borrowed approximately $4.0 million from the Company to purchase 100,000 shares of Company common stock. The ESOP's trustee holds such shares in suspense and releases them for allocation to participants as the loan is repaid. The Company's contributions to the ESOP are used to repay the loan principal and interest. Compensation expense for the Company's contributions to the ESOP totaled $1,743,000, $568,000, and $585,000 in 1998, 1997, and 1996, respectively. As of December 31, 1998 and 1997, 1,520,950 and 1,773,000 shares, respectively, were allocated to participants. Shares unallocated and held in suspense as of December 31, 1998, totaled 172,740 and had a fair value of $9.2 million. The Company has an employee savings and investment plan (401(k) Plan) available to all eligible employees meeting certain specified criteria. The Company matches employee deferrals at varying percentages, set at the discretion of the Board of Directors. For the years ended December 31, 1998, 1997, and 1996, the Company expensed $2.7 million, $1.5 million, and $539,000, respectively, as matching contributions. On July 25, 1996, the Company's Board of Directors adopted the Quintiles Transnational Corp. Employee Stock Purchase Plan (the "Purchase Plan") which is intended to provide eligible employees an opportunity to acquire the Company's Common Stock. Participating employees have the option to purchase shares at 85 percent of the lower of the closing price per share of common stock on the first or last day of the calendar quarter. The Purchase Plan is intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code of 1986, as amended. The Board of Directors has reserved 500,000 shares of common stock for issuance under the Purchase Plan. During 1998, 1997 and 1996, 124,237 shares, 81,024 shares and 9,576 shares, respectively, were purchased under the Purchase Plan. At December 31, 1998, 285,163 shares were available for issuance under the Purchase Plan. 46 49 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company has stock option plans to provide incentives to eligible employees, officers, and directors in the form of incentive stock options, non-qualified stock options, stock appreciation rights, and restricted stock. The Board of Directors determines the option price (not to be less than fair market value for incentive options) at the date of grant. Options, including those granted or exchanged as a result of acquisitions, have various vesting schedules and expiration periods. The majority of options granted under the Executive Compensation Plan typically vest 25 percent per year over four years expiring ten years from the date of grant. Stock option activity during the periods indicated is as follows:
WEIGHTED AVERAGE NUMBER EXERCISE PRICE ---------- ---------------- Outstanding at December 31, 1995.......................... 2,574,306 $ 8.09 Granted................................................. 4,146,568 34.27 Exercised............................................... (1,334,836) 2.49 Canceled................................................ (416,264) 35.92 ---------- Outstanding at December 31, 1996.......................... 4,969,774 15.52 Granted................................................. 2,234,387 36.82 Exercised............................................... (1,565,827) 7.78 Canceled................................................ (269,550) 24.34 ---------- Outstanding at December 31, 1997.......................... 5,368,784 26.21 Granted................................................. 2,177,942 48.34 Exercised............................................... (874,420) 19.00 Canceled................................................ (465,737) 26.43 ---------- Outstanding at December 31, 1998.......................... 6,206,569 $35.05 ==========
Pro forma information regarding net income and net income per share is required by Statement No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement No. 123. The per share weighted-average fair value of stock options granted during 1998, 1997 and 1996 was $15.34, $13.37, and $4.41 per share, respectively, on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
EMPLOYEE STOCK PURCHASE EMPLOYEE STOCK OPTIONS PLAN ----------------------- ----------------------- 1998 1997 1996 1998 1997 1996 ----- ----- ----- ----- ----- ----- Expected dividend yield................ 0% 0% 0% 0% 0% -- Risk-free interest rate................ 4.9% 6.0% 6.0% 4.9% 5.1% -- Expected volatility.................... 40.0% 40.0% 40.0% 40.0% 34.4% -- Expected life (in years from vest)..... 1.25 1.00 1.00 0.25 0.25 --
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are transferable. All available option pricing models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options and changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 47 50 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company's pro forma information follows (in thousands except for net income per share information):
YEAR ENDED DECEMBER 31, -------------------------- 1998 1997 1996 ------- ------- ------ Pro forma net income available for common shareholders.... $70,400 $46,845 $1,162 Pro forma basic net income per share...................... 0.91 0.64 0.02 Pro forma diluted net income per share.................... $ 0.89 $ 0.62 $ 0.02
Selected information regarding stock options as of December 31, 1998 follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ---------------------------------------------------------------- ---------------------------- NUMBER OF EXERCISE PRICE WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE OPTIONS RANGE EXERCISE PRICE REMAINING LIFE OPTIONS EXERCISE PRICE - --------- -------------- ---------------- ---------------- --------- ---------------- 860,094 $ 0.20-$14.64 $ 7.24 4.9 739,465 $ 6.57 1,668,244 $14.75-$33.91 29.48 7.0 866,879 30.15 1,851,535 $34.06-$38.25 37.88 8.5 901,977 38.08 595,341 $38.38-$49.75 44.29 8.1 121,444 40.28 1,231,355 $50.13-$56.25 53.32 10.0 500 50.13 - --------- --------- 6,206,569 $35.05 7.9 2,630,265 $26.71 ========= =========
12. OPERATIONS BY GEOGRAPHIC LOCATION The table below presents the Company's operations by geographical location. The Company attributes revenues to geographical locations based upon (1) customer service activities, (2) operational management, (3) business development activities and (4) customer contract coordination. The Company's operations within each geographical region are further broken down to show each country which accounts for 10% or more of the totals. (in thousands)
1998 1997 1996 ---------- -------- -------- Net revenue: Americas: United States.................................... $ 582,667 $412,324 $252,504 Other............................................ 15,078 7,325 2,908 ---------- -------- -------- Americas.................................... 597,745 419,649 255,412 Europe and Africa: United Kingdom...................................... 340,345 250,608 200,658 Other............................................... 221,118 159,950 132,345 ---------- -------- -------- Europe and Africa................................ 561,463 410,558 333,003 Asia-Pacific:......................................... 28,804 22,693 12,711 ---------- -------- -------- $1,188,012 $852,900 $601,126 ========== ======== ======== Long-lived assets: Americas: United States.................................... $ 75,760 $ 52,711 $ 34,348 Other............................................ 1,544 1,130 460 ---------- -------- -------- Americas.................................... 77,304 53,841 34,808
48 51 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1998 1997 1996 ---------- -------- -------- Europe and Africa: United Kingdom................................... 148,384 116,846 79,367 Other............................................ 19,806 14,226 10,687 ---------- -------- -------- Europe and Africa........................... 168,190 130,712 90,054 Asia-Pacific:......................................... 5,374 2,414 1,947 ---------- -------- -------- $ 250,868 $186,966 $126,809 ========== ======== ========
13. SEGMENTS The following table presents the Company's operations by reportable segment. The Company is managed through two reportable segments, namely, the commercialization service group and the product development service group. Management has distinguished these segments based on the normal operations of the Company. The commercialization group is primarily responsible for sales force deployment and strategic marketing services. The product development group is primarily responsible for all phases of clinical research and outcomes research consulting. The Company does not include non-recurring costs, interest income (expense) and income tax expense (benefit) in segment profitability. Overhead costs are allocated based on management's best estimate of efforts expended in managing the segments. There are not any significant intersegment revenues.
1998 1997 1996 (in thousands) ---------- -------- -------- Net revenue: Commercialization................................... $ 496,178 $350,968 $195,619 Product development................................. 691,834 501,932 $405,507 ---------- -------- -------- $1,188,012 $852,900 $601,126 ========== ======== ======== Income from operations: Commercialization................................... $ 47,298 $ 36,913 $ 17,541 Product development................................. 78,564 51,899 41,996 ---------- -------- -------- $ 125,862 $ 88,812 $ 59,537 ========== ======== ======== Total assets: Commercialization................................... $ 267,091 $209,737 $148,561 Product development................................. 747,660 604,290 406,176 ---------- -------- -------- $1,014,751 $814,027 $554,737 ========== ======== ======== Expenditures to acquire long-lived assets: Commercialization................................... $ 18,349 $ 11,353 $ 9,406 Product development................................. 77,244 67,930 31,335 ---------- -------- -------- $ 95,593 $ 79,283 $ 40,741 ========== ======== ======== Depreciation and amortization expense: Commercialization................................... $ 22,681 $ 17,824 $ 11,145 Product development................................. 32,845 20,106 14,581 ---------- -------- -------- $ 55,526 $ 37,930 $ 25,726 ========== ======== ========
49 52 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 14. QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of unaudited quarterly results of operations (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31, 1998 ------------------------------------------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ---------------- ---------------- ---------------- ---------------- Net revenue...................... $ 263,874 $ 289,991 $ 308,064 $ 326,083 Income from operations........... 28,153 30,576 32,634 34,499 Net income available for common shareholders................... 18,902 20,371 21,449 22,957 Basic net income per share....... 0.25 0.26 0.28 0.29 Diluted net income per share..... 0.24 0.26 0.27 0.29 Range of stock prices............ $34.000 - 52.428 $42.250 - 53.500 $33.375 - 52.000 $41.000 - 56.875
YEAR ENDED DECEMBER 31, 1997 ------------------------------------------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ---------------- ---------------- ---------------- ---------------- Net revenue.............................. $ 188,635 $ 203,490 $ 216,311 $ 244,464 Income from operations................... 19,201 21,392 22,794 25,425 Net income available for common shareholders........................... 11,600 12,974 14,288 16,821 Basic net income per share............... 0.16 0.18 0.19 0.22 Diluted net income per share............. 0.16 0.17 0.19 0.22 Range of stock prices.................... $26.625 - 39.000 $21.500 - 35.000 $35.032 - 43.688 $31.000 - 43.500
15. SUBSEQUENT EVENTS On January 1, 1999, the Company acquired substantial assets of HMR's Kansas City-based Drug Innovation and Approval facility for approximately $93 million in cash, most of which is expected to be paid in the second half of 1999 when the acquisition of the physical facility is completed. As a part of this transaction, the Company was awarded a $436 million contract for continued support and completion of ongoing HMR development projects over a five year period. In addition, HMR will offer the Company the opportunity to provide all U.S. outsourcing services up to an additional $144 million over the same period. On February 12, 1999, Kenneth Hodges ("Plaintiff") filed a civil lawsuit naming as defendants Richard L. Borison, Bruce I. Diamond, 14 pharmaceutical companies and Quintiles Laboratories Limited, a subsidiary of the Company. The complaint alleges that certain drug trials conducted by Drs. Borison and Diamond in which Plaintiff alleges he participated between 1988 and 1996 were not properly conducted or supervised, that Plaintiff had violent adverse reactions to many of the drugs and that his schizophrenia was aggravated by the drug trials. Consequently, Plaintiff alleges that he was subject to severe mortification, injured feelings, shame, public humiliations, victimization, emotional turmoil and distress. The complaint alleges claims for battery, fraudulent inducement to participate in the drug experiments, medical malpractice, negligence in conducting the experiments, and intentional infliction of emotional distress. Plaintiff seeks to recover his actual damages in unspecified amounts, medical expenses, litigation costs, and punitive damages. Nowhere in the complaint are found any specific allegations against Quintiles Laboratories Limited nor any specific factual connection between the Company and the Plaintiff's claims. The Company believes the claims alleged against it are vague and meritless, and the recovery sought is baseless. The Company intends to vigorously defend against these claims. On February 17, 1999, the Company acquired Oak Grove, a leader in providing current Good Manufacturing Practice compliance services to the pharmaceutical, biotechnology and medical device industries. The Company acquired Oak Grove in exchange for 87,948 shares of the Company's Common Stock. The acquisition of Oak Grove is expected to be accounted for as a purchase. On March 29, 1999, the Company acquired PMSI and its core company, Scott-Levin, a leader in pharmaceutical market information and research services in the U.S. The Company acquired PMSI in 50 53 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) exchange for approximately 4,993,787 shares of the Company's Common Stock. Outstanding PMSI options became options to acquire approximately 440,426 shares of the Company's Common Stock. In addition, the Company agreed to pay contingent value payments to former PMSI stockholders who defer receipt of one-half of the shares of the Company's Common Stock they were entitled to receive in the transaction until June 14, 1999. For each deferred share of the Company's Common Stock, the contingent value payment, if any, will be calculated based on the difference between $38.71875 and the average closing price of the Company's Common Stock for 10 days selected at random out of the 20 trading days ending on June 11, 1999. The acquisition of PMSI will be accounted for as a purchase. On March 30, 1999, the Company acquired ENVOY, a Tennessee-based provider of healthcare electronic data interchange and data mining services. The Company acquired ENVOY in exchange for approximately 28,465,160 shares of the Company's Common Stock. Outstanding ENVOY options became options to acquire approximately 3,914,583 shares of the Company's Common Stock. The acquisition of ENVOY will be accounted for as a pooling of interests. Unaudited proforma results of operations for the Company for the years ended December 31, 1998, 1997 and 1996 reflecting the ENVOY transaction are as follows (in thousands, except per share data):
UNAUDITED COMPANY ENVOY PROFORMA CONSOLIDATED ---------- -------- --------------------- YEAR ENDED DECEMBER 31, 1998 Net revenue................................. $1,188,012 $184,773 $1,372,785 Net income available for common shareholders.............................. 83,679 4,244 87,923 Basic net income per share.................. 1.08 0.86 Diluted net income per share................ $ 1.06 $ 0.81 YEAR ENDED DECEMBER 31, 1997 Net revenue................................. $ 852,900 $137,605 $ 990,505 Net income (loss) available for common shareholders.............................. 55,683 (9,198) 46,485 Basic net income per share.................. 0.76 0.48 Diluted net income per share................ $ 0.74 $ 0.45 YEAR ENDED DECEMBER 31, 1996 Net revenue................................. $ 601,126 $ 90,572 $ 691,698 Net income (loss) available for common shareholders.............................. 7,879 (37,217) (29,338) Basic net income (loss) per share........... 0.11 (0.33) Diluted net income (loss) per share......... $ 0.11 $ (0.33)
Three class action complaints were filed in 1998, and later consolidated into a single action, against ENVOY and certain of its executive officers. The complaint alleges, among other things, that from February 12, 1997 to August 18, 1998 the defendants issued materially false and misleading statements about ENVOY, its business, operations and financial position and failed to disclose material facts necessary to make defendants' statements not false and misleading in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, and also asserts additional claims under Tennessee common law for fraud and negligent misrepresentation. The complaint alleges that ENVOY failed to disclose that its financial statements were not prepared in accordance with generally accepted accounting principles due to the improper write-off of certain acquired in-process technology, resulting in ENVOY's stock trading at allegedly artificially inflated prices. The plaintiffs in this action seek unspecified compensatory damages, attorney's fees and other relief. ENVOY believes that these claims are without merit and intends to defend the allegations vigorously. Neither the likelihood of an unfavorable outcome nor the amount of the ultimate liability, if any, with respect to these claims can be determined at this time. 51 54 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Quintiles Transnational Corp.: We have audited the accompanying consolidated balance sheet of Quintiles Transnational Corp. (a North Carolina corporation) and subsidiaries as of December 31, 1998, and the related consolidated statements of income, shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Quintiles Transnational Corp. and subsidiaries as of December 31, 1998, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Arthur Andersen LLP Raleigh, North Carolina, January 25, 1999 (except with respect to the matters discussed in Note 15, as to which the date is March 30, 1999) 52 55 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders of Quintiles Transnational Corp. We have audited the accompanying consolidated balance sheet of Quintiles Transnational Corp. and subsidiaries as of December 31, 1997, and the related consolidated statements of income, shareholders' equity, and cash flows for the years ended December 31, 1997 and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Quintiles Transnational Corp. and subsidiaries at December 31, 1997, and the consolidated results of their operations and their cash flows for the years ended December 31, 1997 and 1996, in conformity with generally accepted accounting principles. Ernst & Young LLP Raleigh, North Carolina January 26, 1998, except for Note 3, as to which the date is January 25, 1999 53 56 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information on the Company's directors is incorporated by reference from the Company's definitive proxy statement to be filed with respect to the Annual Meeting of Shareholders to be held June 14, 1999. Information on the Company's executive officers is included under the caption "Executive Officers of the Registrant" on page 16 of this report. ITEM 11. EXECUTIVE COMPENSATION This information is incorporated by reference from the Company's definitive proxy statement to be filed with respect to the Annual Meeting of Shareholders to be held June 14, 1999. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This information is incorporated by reference from the Company's definitive proxy statement to be filed with respect to the Annual Meeting of Shareholders to be held June 14, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This information is incorporated by reference from the Company's definitive proxy statement to be filed with respect to the Annual Meeting of Shareholders to be held June 14, 1999. 54 57 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) Financial Statements. The following financial statements and supplementary data are included in Item 8 of this report.
FINANCIAL STATEMENTS FORM 10-K PAGE -------------------- -------------- Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996.......................... 30 Consolidated Balance Sheets as of December 31, 1998 and 1997...................................................... 31 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996.......................... 32 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996.............. 33 Notes to Consolidated Financial Statements.................. 34 Report of Independent Public Accountants.................... 52 Report of Independent Auditors.............................. 53
(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been included in the Notes to the Consolidated Financial Statements. (a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below.
EXHIBIT DESCRIPTION - ------- ----------- 3.01(1) -- Amended and Restated Articles of Incorporation, as amended 3.02(2) -- Amended and Restated Bylaws 4.01(3) -- Indenture, dated as of May 17, 1996, between the Company and Marine Midland Bank, as Trustee, with respect to the Company's 4.25% Convertible Subordinated Notes due May 31, 2000 4.02 -- Amended and Restated Articles of Incorporation, as amended (see Exhibit 3.01) 4.03 -- Amended and Restated Bylaws (see Exhibit 3.02) 4.04(4) -- Specimen certificate for Common Stock, $0.01 par value per share 4.05(1) -- Form of the Company's 4.25% Convertible Subordinated Notes in Unrestricted Global Form 4.06(1) -- Form of the Company's 4.25% Convertible Subordinated Notes in Certificated Form. 10.01(4)(5) -- Employment Agreement, dated February 22, 1994, by and between Dr. Dennis B. Gillings and the Company 10.02(4)(5)(6) -- Employment Agreement, dated February 22, 1994, by and between Santo J. Costa and the Company, as amended on November 4, 1994 10.03(5)(6) -- Employment Agreement, dated January 1, 1995, by and between Rachel R. Selisker and the Company 10.04(4)(5) -- Employment Agreement, dated January 15, 1988, by and between Dr. Ludo Reynders and Quintiles (UK) Limited 10.05(5)(7) -- Employment Agreement, dated May 13, 1996, by and between Lawrence S. Lewin and The Lewin Group, Inc. (a wholly-owned subsidiary of the Company) 10.06(5)(7) -- Service Agreement, dated September 2, 1994, between Innovex Holdings Limited and David F. White
55 58
EXHIBIT DESCRIPTION - ------- ----------- 10.07(5)(7) -- Deed of Non-Competition, dated November 29, 1996, between David F. White and the Company 10.08(2)(5) -- Employment letter agreement, dated May 31, 1994, by and between Gregory D. Porter and the Company 10.09(4)(5) -- Quintiles Transnational Corp. Non-Qualified Employee Incentive Stock Option Plan 10.10(4)(5) -- Quintiles Transnational Corp. Equity Compensation Plan 10.11 -- Amendments to Quintiles Transnational Corp. Equity Compensation Plan. 10.12(5)(12) -- Quintiles Transnational Corp. Elective Deferred Compensation Plan 10.13(2)(5) -- Quintiles Transnational Corp. Group Executive Share Option Scheme 10.14(5)(9) -- Quintiles Transnational Corp. Employee Stock Purchase Plan 10.15(5)(9) -- Innovex Limited 1996 Unapproved Executive Share Option Scheme 10.16(5)(10) -- Quintiles/Lewin Non-Qualified Stock Option Plan 10.17(5)(11) -- Quintiles Transnational Corp. Nonqualified Stock Option Plan 10.18(7) -- Sublease, dated January 18, 1996, by and between Legent Corporation and Innovex, Inc. 10.19(12) -- Underlease, dated November 28, 1997, by and between PDFM Limited and Quintiles (UK) Limited and guaranteed by the Company 10.20(2)(5) -- Consulting Agreement dated as of March 15, 1995 between the Company and A.M. Pappas & Associates, L.L.C. 10.21(13) -- Agreement for the Provision of Research Services and Lease of Business Assets dated as of March 3, 1995, between Syntex Pharmaceuticals Limited, Quintiles Scotland Limited, Quintiles (UK) Limited, and Roche Products Limited. 10.22(14) -- Merger Agreement, dated as of December 14, 1998, among Quintiles Transnational Corp., QTRN Acquisition Corp., and Pharmaceutical Marketing Services Inc. 10.23(15) -- Amended and Restated Agreement and Plan of Merger, dated December 15, 1998, among Quintiles Transnational Corp., QELS Corp., and ENVOY Corporation 10.24(16) -- Credit Agreement dated as of August 7, 1998 21 -- Subsidiaries of the Company 23.01 -- Consent of Arthur Andersen LLP 23.02 -- Consent of Ernst & Young LLP 24.01 -- Power of Attorney (included on the signature page hereto) 27.01 -- Financial Data Schedule (for SEC use only) 27.02 -- Financial Data Schedule (for SEC use only) 99.01 -- Risk Factors relating to the Company
- --------------- (1) Exhibit to the Company's Registration Statement on Form S-3, as amended, as filed with the Securities and Exchange Commission (File No. 333-19009) effective February 21, 1997 and incorporated herein by reference. (2) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, as filed with the Securities and Exchange Commission on March 25, 1996, as amended on May 16, 1996, and incorporated herein by reference. (3) Exhibit to the Company's Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission on August 15, 1996, and incorporated herein by reference. 56 59 (4) Exhibit to the Company's Registration Statement on Form S-1, as amended, as filed with the Securities and Exchange Commission (File No. 33-75766) effective April 20, 1994, and incorporated herein by reference. (5) Executive compensation plans and arrangements. (6) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as filed with the Securities and Exchange Commission on March 30, 1995, and incorporated herein by reference. (7) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, as filed with the Securities and Exchange Commission on March 25, 1997, and incorporated herein by reference. (8) Exhibit to the Company's Registration Statement on Form S-3, as filed with the Securities and Exchange Commission (File No. 333-38181) effective October 21, 1997, and incorporated herein by reference. (9) Exhibit to the Company's Registration Statement on Form S-8, as filed with the Securities and Exchange Commission (File No. 333-16553) effective November 21, 1996, and incorporated herein by reference. (10) Exhibit to the Company's Registration Statement on Form S-8, as filed with the Securities and Exchange Commission (File No. 333-03603) effective May 13, 1996, and incorporated herein by reference. (11) Exhibit to the Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission (File No. 333-40493) effective November 18, 1997, and incorporated herein by reference. (12) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, as filed with the Securities and Exchange Commission on March 30, 1998, and incorporated herein by reference. (13) Exhibit to the Company's Current Report on Form 8-K dated March 6, 1995, as filed with the Securities and Exchange Commission on March 20, 1995, and incorporated herein by reference. (14) Exhibit to the Company's Current Report on Form 8-K dated December 16, 1998, as filed with the Securities and Exchange Commission on December 17, 1998, and incorporated herein by reference. (15) Exhibit to the Company's Registration Statement on Form S-4 (File No. 333-72495), as filed with the Securities and Exchange Commission on February 17, 1999 and declared effective on February 24, 1994, and incorporated herein by reference. (16) Exhibit to the Company's Quarterly Report on Form 10-Q dated November 16, 1998, as filed with the Securities and Exchange Commission on November 16, 1998, and incorporated herein by reference. (b) Reports on Form 8-K. The Company filed a Current Report on Form 8-K dated October 20, 1998, including as an exhibit a press release regarding its financial results for the three month period ended September 30, 1998. The Company filed a Current Report on Form 8-K dated December 16, 1998, reporting (i) the execution of a letter of intent to negotiate a definitive agreement to acquire substantial assets of Hoechst Marion Roussel's Kansas City-based Drug Innovation and Approval organization and open a Kansas City contract research facility and (ii) the execution of a Merger Agreement between the Company, the Company's wholly-owned subsidiary, QTRN Acquisition Corp., and PMSI. The Company filed a Current Report on Form 8-K dated December 17, 1998, reporting that it had entered into an Agreement and Plan of Merger with QELS Corp., a wholly-owned subsidiary of the Company, and ENVOY. 57 60 FORWARD-LOOKING STATEMENTS Information set forth in this Annual Report on Form 10-K contains various "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements represent the Company's judgment concerning the future and are subject to risks and uncertainties that could cause the Company's actual operating results and financial position to differ materially. Such forward looking statements can be identified by the use of forward looking terminology such as "may", "will", "expect", "anticipate", "estimate", "believe", or "continue", or the negative thereof or other various thereof or comparable terminology. The Company cautions that any such forward looking statements are further qualified by important factors that could cause the Company's actual operating results to differ materially from those in the forward looking statements, including without limitation, the Company's dependence on certain industries and customers, the risks associated with acquisitions, development and commercialization of potential new services, competition, the Year 2000 issue, the loss or delay of large contracts, dependence on key personnel, potential effects of government regulation, and the other Risk Factors described in Exhibit 99.01 attached to this report. 58 61 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Durham, North Carolina, on the 31st day of March, 1999. QUINTILES TRANSNATIONAL CORP. By: /s/ DENNIS B. GILLINGS, PH.D. ------------------------------------ Dennis B. Gillings, Ph.D. Chairman of the Board of Directors and Chief Executive Officer SIGNATURES AND POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dennis B. Gillings and Rachel R. Selisker and each of them, each with full power to act without the other, his true and lawful attorneys-in-fact and agents, with full powers of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully for all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and as of the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ DENNIS B. GILLINGS, PH.D. Chairman of the Board of March 31, 1999 - ----------------------------------------------------- Directors and Chief Executive Dennis B. Gillings, Ph.D. Officer /s/ RACHEL R. SELISKER Chief Financial Officer, March 31, 1999 - ----------------------------------------------------- Executive Vice President Rachel R. Selisker Finance and Director /s/ ROBERT C. BISHOP, PH.D. Director March 31, 1999 - ----------------------------------------------------- Robert C. Bishop, Ph.D. /s/ E. G. F. BROWN Director March 31, 1999 - ----------------------------------------------------- E. G. F. Brown /s/ VAUGHN D. BRYSON Director March 31, 1999 - ----------------------------------------------------- Vaughn D. Bryson President, Chief Operating - ----------------------------------------------------- Officer and Director Santo J. Costa /s/ CHESTER W. DOUGLASS, PH.D. Director March 31, 1999 - ----------------------------------------------------- Chester W. Douglass, Ph.D.
59 62
SIGNATURE TITLE DATE --------- ----- ---- /s/ LAWRENCE S. LEWIN Chief Executive Officer, The March 31, 1999 - ----------------------------------------------------- Lewin Group, and Director Lawrence S. Lewin Director - ----------------------------------------------------- Arthur M. Pappas /s/ LUDO J. REYNDERS, PH.D. Chief Executive Officer, March 31, 1999 - ----------------------------------------------------- Quintiles CRO, and Director Ludo J. Reynders, Ph.D. Director - ----------------------------------------------------- Eric J. Topol, M.D. /s/ VIRGINIA V. WELDON, M.D. Director March 31, 1999 - ----------------------------------------------------- Virginia V. Weldon, M.D. /s/ DAVID F. WHITE Chief Executive Officer, March 31, 1999 - ----------------------------------------------------- Innovex Limited, and Director David F. White
60 63 EXHIBIT INDEX
EXHIBIT DESCRIPTION ------- ----------- 3.01 (1) -- Amended and Restated Articles of Incorporation, as amended 3.02 (2) -- Amended and Restated Bylaws 4.01 (3) -- Indenture, dated as of May 17, 1996, between the Company and Marine Midland Bank, as Trustee, with respect to the Company's 4.25% Convertible Subordinated Notes due May 31, 2000 4.02 -- Amended and Restated Articles of Incorporation, as amended (see Exhibit 3.01) 4.03 -- Amended and Restated Bylaws (see Exhibit 3.02) 4.04 (4) -- Specimen certificate for Common Stock, $0.01 par value per share 4.05 (1) -- Form of the Company's 4.25% Convertible Subordinated Notes in Unrestricted Global Form 4.06 (1) -- Form of the Company's 4.25% Convertible Subordinated Notes in Certificated Form. 10.01 (4)(5) -- Employment Agreement, dated February 22, 1994, by and between Dr. Dennis B. Gillings and the Company 10.02 (4)(5)(6) -- Employment Agreement, dated February 22, 1994, by and between Santo J. Costa and the Company, as amended on November 4, 1994 10.03 (5)(6) -- Employment Agreement, dated January 1, 1995, by and between Rachel R. Selisker and the Company 10.04 (4)(5) -- Employment Agreement, dated January 15, 1988, by and between Dr. Ludo Reynders and Quintiles (UK) Limited 10.05 (5)(7) -- Employment Agreement, dated May 13, 1996, by and between Lawrence S. Lewin and The Lewin Group, Inc. (a wholly-owned subsidiary of the Company) 10.06 (5)(7) -- Service Agreement, dated September 2, 1994, between Innovex Holdings Limited and David F. White 10.07 (5)(7) -- Deed of Non-Competition, dated November 29, 1996, between David F. White and the Company 10.08 (2)(5) -- Employment letter agreement, dated May 31, 1994, by and between Gregory D. Porter and the Company 10.09 (4)(5) -- Quintiles Transnational Corp. Non-Qualified Employee Incentive Stock Option Plan 10.10 (4)(5) -- Quintiles Transnational Corp. Equity Compensation Plan 10.11 -- Amendments to Quintiles Transnational Corp. Equity Compensation Plan. 10.12 (5)(12) -- Quintiles Transnational Corp. Elective Deferred Compensation Plan 10.13 (2)(5) -- Quintiles Transnational Corp. Group Executive Share Option Scheme 10.14 (5)(9) -- Quintiles Transnational Corp. Employee Stock Purchase Plan 10.15 (5)(9) -- Innovex Limited 1996 Unapproved Executive Share Option Scheme 10.16 (5)(10) -- Quintiles/Lewin Non-Qualified Stock Option Plan 10.17 (5)(11) -- Quintiles Transnational Corp. Nonqualified Stock Option Plan 10.18 (7) -- Sublease, dated January 18, 1996, by and between Legent Corporation and Innovex, Inc. 10.19 (12) -- Underlease, dated November 28, 1997, by and between PDFM Limited and Quintiles (UK) Limited and guaranteed by the Company 10.20 (2)(5) -- Consulting Agreement dated as of March 15, 1995 between the Company and A.M. Pappas & Associates, L.L.C.
61 64
EXHIBIT DESCRIPTION ------- ----------- 10.21 (13) -- Agreement for the Provision of Research Services and Lease of Business Assets dated as of March 3, 1995, between Syntex Pharmaceuticals Limited, Quintiles Scotland Limited, Quintiles (UK) Limited, and Roche Products Limited. 10.22 (14) -- Merger Agreement, dated as of December 14, 1998, among Quintiles Transnational Corp., QTRN Acquisition Corp., and Pharmaceutical Marketing Services Inc. 10.23 (15) -- Amended and Restated Agreement and Plan of Merger, dated December 15, 1998, among Quintiles Transnational Corp., QELS Corp., and ENVOY Corporation 10.24 (16) -- Credit Agreement dated as of August 7, 1998 21 -- Subsidiaries of the Company 23.01 -- Consent of Arthur Andersen LLP 23.02 -- Consent of Ernst & Young LLP 24.01 -- Power of Attorney (included on the signature page hereto) 27.01 -- Financial Data Schedule (for SEC use only) 27.02 -- Financial Data Schedule (for SEC use only) 99.01 -- Risk Factors relating to the Company
- --------------- (1) Exhibit to the Company's Registration Statement on Form S-3, as amended, as filed with the Securities and Exchange Commission (File No. 333-19009) effective February 21, 1997 and incorporated herein by reference. (2) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, as filed with the Securities and Exchange Commission on March 25, 1996, as amended on May 16, 1996, and incorporated herein by reference. (3) Exhibit to the Company's Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission on August 15, 1996, and incorporated herein by reference. (4) Exhibit to the Company's Registration Statement on Form S-1, as amended, as filed with the Securities and Exchange Commission (File No. 33-75766) effective April 20, 1994, and incorporated herein by reference. (5) Executive compensation plans and arrangements. (6) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as filed with the Securities and Exchange Commission on March 30, 1995, and incorporated herein by reference. (7) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, as filed with the Securities and Exchange Commission on March 25, 1997, and incorporated herein by reference. (8) Exhibit to the Company's Registration Statement on Form S-3, as filed with the Securities and Exchange Commission (File No. 333-38181) effective October 21, 1997, and incorporated herein by reference. (9) Exhibit to the Company's Registration Statement on Form S-8, as filed with the Securities and Exchange Commission (File No. 333-16553) effective November 21, 1996, and incorporated herein by reference. (10) Exhibit to the Company's Registration Statement on Form S-8, as filed with the Securities and Exchange Commission (File No. 333-03603) effective May 13, 1996, and incorporated herein by reference. (11) Exhibit to the Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission (File No. 333-40493) effective November 18, 1997, and incorporated herein by reference. (12) Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, as filed with the Securities and Exchange Commission on March 30, 1998, and incorporated herein by reference. 62 65 (13) Exhibit to the Company's Current Report on Form 8-K dated March 6, 1995, as filed with the Securities and Exchange Commission on March 20, 1995, and incorporated herein by reference. (14) Exhibit to the Company's Current Report on Form 8-K dated December 16, 1998, as filed with the Securities and Exchange Commission on December 17, 1998, and incorporated herein by reference. (15) Exhibit to the Company's Registration Statement on Form S-4 (File No. 333-72495), as filed with the Securities and Exchange Commission on February 17, 1999 and declared effective on February 24, 1999, and incorporated herein by reference. (16) Exhibit to the Company's Quarterly Report on Form 10-Q dated November 16, 1998, as filed with the Securities and Exchange Commission on November 16, 1998, and incorporated herein by reference. 63 EX-10.11 2 AMENDMENTS TO EQUITY COMPENSATION PLAN 1 EXHIBIT 10.11 AMENDMENTS TO QUINTILES TRANSNATIONAL CORP. EQUITY COMPENSATION PLAN 1. FEBRUARY 1, 1996 - AMENDMENT PERMITTING DELEGATION OF COMMITTEE'S POWERS Effective February 1, 1996, the Board of Directors of Quintiles Transnational Corp. (the "Board") amended the Quintiles Transnational Corp. Equity Compensation Plan (the "Plan") as follows: Section 3.1 shall be amended by deleting the third sentence in its entirety and inserting in lieu thereof the following two sentences: The Committee, in its discretion, may delegate to one or more of its members, or to one or more officers of the Corporation, all or part of the Committee's authority and duties with respect to grants and awards to individuals who are not subject to the reporting and other provisions of Section 16 of the Act; provided, however, that such persons must exercise any authority so delegated to them within any guidelines established by the Committee. The Committee may revoke or amend the terms of a delegation at any time but such action shall not invalidate any prior actions of the Committee's delegate or delegates that were consistent with the terms of the Plan. 2. OCTOBER 24, 1996 - AMENDMENT ALLOWING COMMITTEE TO SET TIMES AND CONDITIONS UPON WHICH A NONQUALIFIED STOCK OPTION WILL TERMINATE UPON TERMINATION OF EMPLOYMENT Effective October 24, 1996, the Board amended the Plan as follows: Article V shall be amended by deleting Section 5.3 in its entirety and inserting in lieu thereof a new Section 5.3 substantially in the form that follows: 5.3 The times and conditions upon which a Nonqualified Stock Option and its related Stock Right, if any, will terminate where a Participant to whom such an option and related right has been granted under the Plan terminates, or the Corporation terminates, his or her employment, consultant, or service relationship with the Corporation shall be determined by the Committee when the option and related right are granted; provided, however, that in no event 2 shall an option or related right be exercisable more than ten (10) years from the date it was granted. Nothing in the Plan or in any option or related right granted pursuant to the Plan shall (a) confer on any individual any right to continue in the employ of the Corporation or to continue any consultant or service relationship with the Corporation or (b) interfere in any way with the Corporation's right to terminate such individual's employment, consultant or service relationship at any time. 3. JANUARY 1, 1998 - AMENDMENT DELETING ARTICLE REGARDING NONDISCRETIONARY AWARDS Effective January 1, 1998, the Board amended the Plan in response to changes in securities rules that made it unnecessary to make formula awards of stock options to outside directors in order to avoid potential short-swing liability associated with such awards. The amendment deleted Article IX of the Plan, which provided for formula awards, in its entirety. EX-21 3 LIST OF SUBSIDIARIES 1 EXHIBIT 21 SUBSIDIARY JURISDICTION - -------------------------------------------------------------------------- Action International Marketing Services Limited England Alchemy Pharmaceuticals Pty. Limited Australia AR-MED Limited England BCA Corp. (a/k/a Butler Recruitment) North Carolina Benefit B.V. Netherlands Benefit Canada Medico-Economic Studies, Inc. Canada Benefit Holding, Inc. North Carolina Benefit International SNC France Benefit Research Italia S.r.l. Italy Benefit Transnational Holding Corp. North Carolina Benefit, Inc. North Carolina BRI International Holdings N.V. Belgium BRI International Limited England BRI International N.V. Belgium BRI International S.A.R.L. France ClinData International (PTY) Limited South Africa G.D.R.U. Limited England H2V S.A. France HCR ZVG Switzerland Health Care Research U.K. Limited England Histological Services Limited England Innovex (Australia) Pty Limited Australia Innovex (Benelux) BV Holland Innovex (Biodesign) GmbH Germany Innovex (DCCG) Holdings Pty. Limited Australia Innovex (France) SARL France Innovex (North America) Inc. Delaware Innovex Spain S.L. Spain Innovex (UK) Limited England Innovex Belgium NV Belgium Innovex DAS, Inc. North Carolina Innovex GmbH Germany Innovex Holdings Limited England Innovex Istanbul Turkey Innovex Limited England Innovex Merger Corp. North Carolina Innovex Nordic AB Sweden Innovex Overseas Holdings, Ltd./Limited England Innovex S.r.l. Italy Innovex South Africa PTY Limited [f/k/a PPMS] South Africa Innovex Staff Services. S.r.l. Italy Intelligent Imaging, Inc. Delaware International Clinical Research Limited England Lewin-TAG, Inc. California Medical Action Communications Limited England Medical Action Publishing Limited England Medical Action Research Limited England Medical Alliances Pty. Limited Australia Medical Technology Consultants England MTCE France S.A.R.L. France Novex Pharma Limited England Penderwood Limited England 2 Pharm OTC SARL France PharmaBio Development, Inc. North Carolina Phytotherapy Pty. Ltd. South Africa Presta Medica SARL France Q98 Corp. (d/b/a/ Biotext, Inc.) North Carolina QED International, Inc. New York QELS Corp. Tennessee QTRN Acquisition Corp. North Carolina Quintiles (Israel) Ltd. Israel Quintiles (UK) Limited England Quintiles AB Sweden Quintiles Asia, Inc. North Carolina Quintiles Australia Pty. Limited Australia Quintiles Canada, Inc. Canada Quintiles Cardiac Alert Limited England Quintiles Chile Chile Quintiles Clindepharm (Pty.) Limited South Africa Quintiles CVA, Inc. North Carolina Quintiles East Asia Pte. Limited Singapore Quintiles England Limited England Quintiles European Holdings Limited England Quintiles GesmbH Ltd. Austria Quintiles Brasil Ltda. Brazil Quintiles GmbH Germany Quintiles Holdings Limited England Quintiles Holdings SNC France Quintiles Hong Kong Limited Hong Kong Quintiles, Inc. North Carolina Quintiles Ireland (Finance) Limited Ireland Quintiles Ireland Limited Ireland Quintiles Transnational Japan KK Japan Quintiles Laboratories Limited North Carolina Quintiles Latin America, Inc. North Carolina Quintiles Mexico, S. de R.L. de C.V. Mexico Quintiles Mauritius Holdings, Inc. Mauritius Quintiles NV/SA Belgium Quintiles Oak Grove, Inc. North Carolina Quintiles Oy Finland Quintiles Pacific, Inc. North Carolina Quintiles Poland Sp. Zoo Poland Quintiles Quality Regulatory Alliance, Inc. Virginia Quintiles S.A. France Quintiles s.l. Spain Quintiles, S.r.l. Italy Quintiles Scotland Limited England Quintiles South Africa (Pty.) Limited South Africa Quintiles Spectral ltd. India Quintiles Taiwan Limited Taiwan Quintiles Technologies, Inc. North Carolina Quintiles Transnational Corp. North Carolina Royce Recruitment Limited England Serval SA France Serval Recruitement SARL France Servicios Clinicos, S.A. de C.V. Mexico Simirex Inc. New Jersey Simirex International New Jersey 3 Speci Plus SARL France Strategic Medical Publishing Limited England Synapse Pharmaceuticals Pty. Limited Australia T2A - Techniques de Aide aux Affaires SA France T2A Marketing SARL France T2A Promotion SARL France T2A Recruitement SARL France The Clinical Research Foundation (UK) Ltd. England The Lewin Group, Inc. North Carolina The MSM Group, Inc. Delaware The Royce Consultancy Limited Scotland Transforce, S.A. de C.V. Mexico Envoy Corporation Tennessee Healthcare Data Interchange Delaware National Electronic Information Corporation Delaware Professional Office Systems, Inc. Washington, D.C. Envoy/ExpressBill, Inc. Tennessee Synergy Health Care, Inc. Delaware Automated Revenue Management, Inc. Ohio (a wholly owned subsidiary of Envoy/ExpressBill, Inc.) Quintiles Scott-Levin, Inc. North Carolina PMSI Holdings Limited Delaware PMSI Scott-Levin Inc. New Jersey PMSI Finance Limited Delaware PMSI Database Services Inc. Delaware Source Informatics European Holdings, Inc. Delaware Source Informatics European Holdings LLC Delaware Source Informatics European Finance Inc. Delaware Pharma Informatics Inc. Delaware Medical Informatics KK Japan PMSI Ltd. England EX-23.01 4 CONSENT OF ARTHUR ANDERSEN 1 EXHIBIT 23.01 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS To Quintiles Transnational Corp: As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statement Nos. 33-91026 on Form S-8, 333-03603 on Form S-8, 333-16553 on Form S-8, 333-40493 on Form S-8, 333-60797 on Form S-8, 333-19009 on Form S-3, 333-28919 on Form S-3, 333-38181 on Form S-3, 333-40497 on Form S-3, 333-48403 on Form S-3, 333-65743 on Form S-3, 333-72495 on Form S-4, 333-72545 on Form S-4, and 333-75183 on Form S-8. /s/ ARTHUR ANDERSEN LLP Raleigh, North Carolina March 30, 1999 EX-23.02 5 CONSENT OF ERNST & YOUNG 1 EXHIBIT 23.02 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-91026, 333-16553, 333-03603, 333-40493, 333-60797 and 333-75183) and the Registration Statements on Form S-3 (Nos. 333-19009, 333-28919, 333-38181, 333-40497, 333-48403 and 333-65743) of our report dated January 26, 1998, except for Note 3, as to which the date is January 25, 1999, with respect to the consolidated financial statements included in this Annual Report (Form 10-K) of Quintiles Transnational Corp. for the year ended December 31, 1998. /s/ Ernst & Young LLP Raleigh, North Carolina March 30, 1999 EX-27.01 6 FINANCIAL DATA SCHEDULE 1998
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 124,729 32,241 316,314 1,609 0 515,388 376,139 125,271 1,014,751 320,136 157,432 0 0 780 501,818 1,014,751 0 1,188,012 0 1,062,150 (8,136) 0 11,460 122,538 38,859 83,679 0 0 0 83,679 1.08 1.06
EX-27.02 7 RESTATED FINANCIAL DATA SCHEDULE 1996
5 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 74,479 37,623 195,392 2,046 0 320,519 182,941 56,132 554,737 220,747 171,346 0 0 701 149,925 554,737 0 601,126 0 557,020 9,894 0 9,716 24,496 14,832 7,879 0 0 0 7,879 .11 .11
EX-99.01 8 RISK FACTORS RELATING TO THE COMPANY 1 EXHIBIT 99.01 RISK FACTORS CHANGES IN OUTSOURCING TRENDS IN THE PHARMACEUTICAL AND BIOTECHNOLOGY INDUSTRIES COULD ADVERSELY AFFECT OUR OPERATING RESULTS Economic factors and industry trends that affect our primary customers, pharmaceutical and biotechnology companies, also affect our business. For example, the practice of many companies in these industries has been to hire outside organizations like us to conduct large clinical research and sales and marketing projects. This practice has grown substantially in the 1990s, and we have benefited from this trend. If this trend were to change and companies in these industries reduced their tendency to outsource those projects, our operations and financial condition could be materially and adversely affected. In addition, numerous governments have undertaken efforts to control growing healthcare costs through legislation, regulation and voluntary agreements with medical care providers and pharmaceutical companies. If future regulatory cost containment efforts limit the profits which can be derived on new drugs, our customers may reduce their research and development spending which could reduce the business they outsource to us. We cannot predict the likelihood of any of these events or the effects they would have on our business, results of operations or financial condition. WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE PMSI AND ENVOY INTO OUR BUSINESS We may not achieve the intended benefits of the mergers with PMSI and ENVOY if we are unable to integrate these businesses with our own successfully. We could encounter a number of difficulties as a result of the mergers, such as: - retaining PMSI's and ENVOY's customers; - maintaining and increasing PMSI's and ENVOY's competitive presence in the healthcare industry; - continuing to operate PMSI's and ENVOY's businesses efficiently; or - retaining key PMSI and ENVOY employees. For example, if either acquired company's current customers are uncertain about our commitment to support their existing products and services, they could cancel or refuse to renew current contracts. In addition, the combined company may be unsuccessful in expanding or retaining its competitive position in the healthcare industry as a result of factors such as its inability to properly market either acquired company's services and products. Furthermore, the successful integration of PMSI and ENVOY depends on the contribution of certain key PMSI 2 and ENVOY employees. The loss of any key personnel could result in less efficient business operations for the combined company and could seriously harm its business. IF COMPANIES WE ACQUIRE DO NOT PERFORM AS EXPECTED OR IF WE ARE UNABLE TO MAKE STRATEGIC ACQUISITIONS, OUR BUSINESS COULD BE ADVERSELY AFFECTED A key element of our growth strategy depends on our ability to complete acquisitions that complement or expand our business and successfully integrate the acquired companies into our operations. If we are unable to successfully execute our acquisition strategy, there could be a material adverse effect on our business, results of operations and financial condition. In the past, some of our acquisitions performed below our expectations in the short term, but we experienced no impact to our expectations for our overall results, due in part to the size of such acquisitions and the performance of other areas of our business. In the future, if we are unable to operate the business of an acquired company so that our results meet our expectations, those results could have a negative impact on our results as a whole. The risk that our results may be affected if we are unable to successfully operate the businesses we acquire may increase in proportion with (1) the size of the businesses we acquire, (2) the lines of business we acquire and (3) the number of acquisitions we complete in any given time period. In 1998, we completed 11 acquisitions. As of March 31, 1999, we have completed another four acquisitions, including PMSI and ENVOY. The PMSI and ENVOY acquisitions have expanded our lines of business and thus involve new risks. ENVOY is the largest acquisition we have completed to date, and PMSI is one of the largest we have ever completed. If either of these acquisitions fails to meet our performance expectations, our results of operation and financial condition could be materially adversely affected. In addition, we are currently reviewing many acquisition candidates and continually evaluating and competing for new acquisition opportunities. Other risk factors we face as a result of our aggressive acquisition strategy include the following: - the ability to achieve anticipated synergies from combined operations; - integrating the operations and personnel of acquired companies, especially those in lines of business that differ from our current lines of business; - the ability of acquired companies to meet anticipated revenue and net income targets; - potential loss of the acquired companies' key employees; - the possibility that we may be adversely affected by risk factors present at the acquired companies, including Year 2000 risks; - potential losses resulting from undiscovered liabilities of acquired companies that are not covered by the indemnification we may obtain from the sellers; -2- 3 - the ability to expand the data analyses portion of ENVOY's business; - risks of assimilating differences in foreign business practices and overcoming language barriers (for acquisitions of foreign companies); and - risks experienced by companies in general that are involved in acquisitions. Due to these risks, we may not be able to successfully execute our acquisition strategy. IF WE ARE UNABLE TO SUCCESSFULLY DEVELOP AND MARKET POTENTIAL NEW SERVICES, OUR GROWTH COULD BE ADVERSELY AFFECTED Another key element of our growth strategy is the successful development and marketing of new services which complement or expand our existing business. If we are unable to succeed in (1) developing new services and (2) attracting a customer base for those newly developed services, we will not be able to implement this element of our growth strategy, and our future business, results of operations and financial condition could be adversely affected. For example, as a result of our acquisition of ENVOY, we are considering expanding our pharmaceutical and healthcare information and market research services. Providers of these services manipulate healthcare information to analyze aspects of current healthcare products and procedures for use in producing new products and services or in analyzing sales and marketing of existing products. These types of services are also known as data mining. We believe that the healthcare information ENVOY processes in its current business could be utilized to create new data mining services. In addition to the other difficulties associated with the development of any new service, our ability to develop this line of service may be limited further by contractual provisions limiting our use of the healthcare information or the legal rights of others that may prevent or impair our use of the healthcare information. Due to these and other limitations, we cannot assure you that we will be able to develop this type of service successfully. Our inability to develop new products or services or any delay in the development of them may adversely affect our ability to realize some of the synergies we anticipate from the acquisition of ENVOY. OUR RESULTS COULD BE ADVERSELY AFFECTED BY THE POTENTIAL LOSS OR DELAY OF OUR LARGE CONTRACTS Most of our customers can terminate our contracts upon 15-90 days notice. In the event of termination, our contracts often provide for fees for winding down the project. Still, the loss or delay of a large contract or the loss or delay of multiple contracts could adversely affect our future net revenue and profitability. -3- 4 OUR BACKLOG MAY NOT BE INDICATIVE OF FUTURE RESULTS We report backlog based on anticipated net revenue from uncompleted projects that a customer has authorized. We cannot assure you that the backlog we have reported will be indicative of our future results. A number of factors may affect our backlog, including: - the variable size and duration of projects (some are performed over several years); - the loss or delay of projects; and - a change in the scope of work during the course of a project. WE FACE RISKS CONCERNING THE YEAR 2000 ISSUE If We or Our Vendors Do Not Adequately Prepare for the Year 2000 Issue, Our Operations Could Be Disrupted We have established a Year 2000 Program to address the Year 2000 issue, which results from computer processors and software failing to process date values correctly, potentially causing system failures or data corruption. The Year 2000 issue could cause disruptions of our operations, including, among other things, a temporary inability to process information; receive information, services or products from third parties; interface with customers in the performance of contracts; or operate or communicate in some or all of the regions in which we do business. Our computing infrastructure is based on industry standard systems. We do not depend on large legacy systems and do not use mainframes. Rather, the scope of our Year 2000 Program includes unique software systems and tools in each of our service groups, especially our Product Development Group, embedded systems in our laboratory and manufacturing operations, facilities such as elevators and fire alarms in over 70 offices (which also involve embedded technology) and numerous supplier and other business relationships. We have identified critical systems within each service group and are devoting our resources to address these items first. Our Year 2000 Program is directed by the Year 2000 Executive Steering Team, which is comprised of our Chief Information Officer and representatives from regional business units, together with legal, quality assurance and information technology personnel. We have established a Year 2000 Program Management Office, staffed by consultants, which develops procedures and instructions at a centralized level and oversees performance of the projects that make up the program. Project teams organized by service group and geographic region are responsible for implementation of the individual projects. The framework for our Year 2000 Program prescribes broad inventory, assessment and planning phases which generally guide its projects. Each project generally includes launch, analysis, remediation, testing and deployment phases. We are in the process of assessing those systems, facilities and business relationships which we believe may be vulnerable to the Year 2000 issue and which we believe could impact our operations. Although we cannot control -4- 5 whether and how third parties will address the Year 2000 issue, our assessment also will include a limited evaluation of certain services on which we are substantially dependent, and we plan to develop contingency plans for possible deficiencies in those services. For example, we believe that among our most significant third party service providers are physician investigators who participate in clinical studies conducted through our contract research services; consequently, we are developing a specialized process to assess and address Year 2000 issues arising from these relationships. We do not plan to assess how our customers, such as pharmaceutical and large biotechnology companies, are dealing with the Year 2000 issue. As we complete the assessment of our systems, we are developing plans to renovate, replace or retire them, as appropriate, if they are affected by the Year 2000 issue. Such plans generally include testing of new or renovated systems upon completion of the remedial actions. We will utilize both internal and external resources to implement these plans. Our strategic healthcare communications services are less dependent on information technology than our other services. With the exception of recent acquisitions, our Year 2000 Program with respect to those services is substantially complete, with validation expected to be completed in the first quarter of 1999. We addressed most systems relating to our healthcare consulting services in 1998, with completion expected in the first half of 1999. We also addressed most of our contract sales systems in 1998, and expect to have substantially completed this program during mid-1999. Our contract research services utilize numerous systems, which we must address individually on disparate schedules, depending on the magnitude and complexity of the particular system. We anticipate that remediation or replacement of these systems will be substantially complete by mid-1999, with migration occurring primarily in the second half of the year. We are in the process of evaluating the state of readiness of our recent acquisitions, particularly ENVOY and PMSI, and plan to integrate these acquisitions into our Year 2000 Program during the second quarter of 1999. We expect to complete the core components of our Year 2000 Program before there is a significant risk that internal Year 2000 problems will have a material impact on our operations. If Our Costs of Addressing the Year 2000 Issue Exceed Our Estimates, Our Net Income Could Be Adversely Affected We estimate that the aggregate costs of our Year 2000 Program, excluding recent acquisitions, will be approximately $14 million, including costs already incurred. A significant portion of these costs, approximately $6 million, are not likely to be incremental costs, but rather will represent the redeployment of existing resources. This reallocation of resources is not expected to have a significant impact on our day-to-day operations. We incurred total Year 2000 Program costs of $3.5 million through December 31, 1998, of which approximately $2.6 million represented incremental expense. ENVOY previously estimated its Year 2000 costs to be between $3.0 and $4.0 million, and PMSI previously estimated that its Year 2000 costs would not be material. We are in the process of assessing these valuations as part of the integration of these acquisitions into our Year 2000 Program. Our estimates regarding the cost, timing and impact of addressing the Year 2000 issue are based on numerous assumptions of future events, including the continued availability of certain resources, our ability to meet deadlines and the cooperation of third parties. We cannot guarantee that our assumptions will be correct and that -5- 6 these estimates will be achieved. Actual results could differ materially from our expectations as a result of numerous factors, including the availability and cost of personnel trained in this area, unforeseen circumstances that would cause us to allocate our resources elsewhere and similar uncertainties. Our Business Could Be Adversely Affected if Year 2000 Issues Are Not Adequately Addressed In Other Parts of the World or by Companies With Which We Do Business We face both internal and external risks from the Year 2000 issue. If realized, these risks could have a material adverse effect on our business, results of operations or financial condition. Our primary internal risk is that our systems will not be Year 2000 compliant on time. The magnitude of this risk depends on our ability to achieve compliance of both internally and externally developed systems or to migrate to alternate systems in a timely fashion. The decentralized nature of our business may compound this risk if we are unable to coordinate efforts across our global operations on a timely basis. We believe that our Year 2000 Program will successfully address these risks; however, we cannot assure you that this program will be completed in a timely manner. Notwithstanding our Year 2000 Program, we also face external risks that may be beyond our control. Our international operations and our relationships with foreign third parties create additional risks for us, as many countries outside the United States have been less attuned to the Year 2000 issue. These risks include the possibility that infrastructural systems, such as electricity, water, natural gas or telephone, will fail in some or all of the regions in which we operate, as well as the danger that the internal systems of our foreign suppliers, service providers and customers will fail. Our business also requires considerable travel, and our ability to perform services under our customer contracts could be negatively affected if air travel is disrupted by the Year 2000 issue. In addition, our business depends heavily on the healthcare industry, particularly on third party physician investigators. The healthcare industry, and physicians' groups in particular, to date may not have focused on the Year 2000 issue to the same degree as some other industries, especially outside of major metropolitan centers. As a result, we face increased risk that our physician investigators will be unable to provide us with the data that we need to perform under our contracts on time, if at all. Thus, the clinical study involved could be slowed or brought to a halt. Also, the failure of our customers to address the Year 2000 issue could negatively impact their ability to utilize our services. While we intend to develop contingency plans to address certain of these risks, we cannot assure you that any developed plans will sufficiently insulate us from the effects of these risks. Any disruptions resulting from the realization of these risks would affect our ability to perform our services. If we are unable to receive or process information, or if third parties are unable to provide information or services to us, we may not be able to meet milestones or obligations under our customer contracts, which could have a material adverse effect on our business, results of operations and financial condition. Until we have completed our remediation, testing and deployment plans, we believe it is premature to develop contingency plans to address what would happen if our execution of these plans were to fail to address the Year 2000 issue. -6- 7 IF WE LOSE THE SERVICES OF DENNIS GILLINGS OR OTHER KEY PERSONNEL, OUR BUSINESS COULD BE ADVERSELY AFFECTED Our success substantially depends on the performance, contributions and expertise of our senior management team, led by Dennis B. Gillings, Ph.D., our Chairman of the Board of Directors and Chief Executive Officer. We maintain key man life insurance on Dr. Gillings in the amount of $3 million. Our performance also depends on our ability to attract and retain qualified management and professional, scientific and technical operating staff, as well as our ability to recruit qualified representatives for our contract sales services. The departure of Dr. Gillings, or any key executive, or our inability to continue to attract and retain qualified personnel could have a material adverse effect on our business, results of operations or financial condition. OUR CONTRACT RESEARCH SERVICES CREATE A RISK OF LIABILITY FROM CLINICAL TRIAL PARTICIPANTS We contract with physicians to serve as investigators in conducting clinical trials to test new drugs on human volunteers. Such testing creates risk of liability for personal injury to or death of volunteers, particularly to volunteers with life-threatening illnesses, resulting from adverse reactions to the drugs administered during testing. It is possible third parties could claim that we should be held liable for losses arising from any professional malpractice of the investigators with whom we contract or in the event of personal injury to or death of persons participating in clinical trials. We do not believe we are legally accountable for the medical care rendered by third party investigators, and we would vigorously defend any such claims. Nonetheless, it is possible we could be found liable for those types of losses. In addition to supervising such tests, we also own a number of labs where Phase I clinical trials are conducted. Phase I clinical trials involve testing a new drug on a limited number of healthy individuals, typically 20 to 80 persons, to determine the drug's basic safety. We also could be liable for the general risks associated with ownership of such a facility. These risks include, but are not limited to, adverse events resulting from the administration of drugs to clinical trial participants or the professional malpractice of Phase I medical care providers. RELAXATION OF GOVERNMENT REGULATION COULD DECREASE THE NEED FOR THE SERVICES WE PROVIDE Governmental agencies throughout the world, but particularly in the United States, highly regulate the drug development/approval process. A large part of our business involves helping pharmaceutical and biotechnology companies through the regulatory drug approval process. Any relaxation in regulatory approval standards could eliminate or substantially reduce the need for our services, and, as a result our business, results of operations and financial condition could be materially adversely affected. Potential regulatory changes under consideration in the United States and elsewhere include mandatory substitution of generic drugs for patented drugs, relaxation in the scope of regulatory requirements or the introduction of simplified drug approval -7- 8 procedures. These and other changes in regulation could have an impact on the business opportunities available to us. FAILURE TO COMPLY WITH EXISTING REGULATIONS COULD RESULT IN A LOSS OF REVENUE Any failure on our part to comply with applicable regulations could result in the termination of ongoing clinical research or sales and marketing projects or the disqualification of data for submission to regulatory authorities, either of which could have a material adverse effect on us. For example, if we were to fail to verify that informed consent is obtained from patient participants in connection with a particular clinical trial, the data collected from that trial could be disqualified, and we could be required to redo the trial under the terms of our contract at no further cost to our customer, but at substantial cost to us. PROPOSED REGULATIONS MAY INCREASE THE COST OF OUR BUSINESS OR LIMIT OUR SERVICE OFFERINGS Certain of our current services relate to the diagnosis and treatment of disease. The confidentiality of patient-specific information and the circumstances under which such patient-specific records may be released for inclusion in our databases or used in other aspects of our business, are subject to substantial government regulation. Additional legislation governing the possession, use and dissemination of medical record information has been proposed at both the state and federal levels. This legislation may (1) require us to implement security measures that may require substantial expenditures or (2) limit our ability to offer some of our products and services. These and other changes in regulation could limit our ability to offer some of our products or have an impact on the business opportunities available to us. EXCHANGE RATE FLUCTUATIONS MAY AFFECT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION We derive a large portion of our net revenue from international operations; for example, we derived approximately 51.0% of our 1998 net revenue from outside the United States. Our financial statements are denominated in U.S. dollars; thus, factors associated with international operations, including changes in foreign currency exchange rates could significantly affect our results of operations and financial condition. Exchange rate fluctuations between local currencies and the U.S. dollar create risk in several ways, including: - Foreign Currency Translation Risk. The revenue and expenses of our foreign operations are generally denominated in local currencies. - Foreign Currency Transaction Risk. Our service contracts may be denominated in a currency other than the currency in which we incur expenses related to such contracts. We try to limit these risks through exchange rate fluctuation provisions stated in our service contracts, or we may hedge our transaction risk with foreign currency exchange contracts -8- 9 or options. Despite these efforts, we may still experience fluctuations in financial results from our operations outside the United States, and we cannot assure you that we will be able to favorably reduce our currency transaction risk associated with our service contracts. On January 1, 1999, a new currency, the euro, became the legal currency for 11 of the 15 member countries of the European Economic Community. Between January 1, 1999 and January 1, 2002, governments, companies and individuals may conduct business in these countries in both the euro and existing national currencies. On January 1, 2002, the euro will become the sole currency in these countries. We are evaluating the impact conversion to the euro will have on our business. In particular we are reviewing (1) whether we may have to change the prices of our services in the different countries because they will now be denominated in the same currency in each country and (2) whether we will have to change the terms of any financial instruments in connection with our hedging activities described above. Based on current information and our initial evaluation, we do not expect the cost of any necessary corrective action to seriously harm our business. However, we will continue to evaluate the impact of these and other possible effects of the conversion to the euro on our business. We cannot assure you that the costs associated with the conversion to the euro will not in the future seriously harm our business, results of operations or financial condition. INDUSTRY REGULATION MAY RESTRICT OUR ABILITY TO DISSEMINATE PHARMACEUTICAL DATA As described above, the pharmaceutical industry is subject to extensive regulations, including limitations on the prices drug companies may charge. Such regulations may cause our pharmaceutical company clients to revise or reduce their marketing programs. In addition, we are directly subject to certain restrictions on the collection and use of data. While we do not believe that any such current legislation will have a material adverse effect on our operations, we cannot assure you that future legislation or regulations will not directly or indirectly restrict the dissemination of the type of information we gather and therefore materially adversely affect our operations. ENVOY MAY BE ADVERSELY AFFECTED BY CUSTOMER CONCENTRATION ENVOY has one customer, Aetna U.S. Healthcare, Inc. ("AUSHC"), that accounted for 17% of its 1998 revenues and 12% of its 1997 revenues. ENVOY and AUSHC entered into a ten-year services agreement that requires AUSHC to use ENVOY as its single source clearinghouse and EDI network for all of AUSHC's electronic healthcare transactions. The fees under the AUSHC services agreement have been negotiated for the first three years. The AUSHC services agreement also requires ENVOY to maintain minimum transaction volumes and services levels and to perform marketing services that are designed to encourage AUSHC providers to use ENVOY's services. If either ENVOY or AUSHC fail to comply with a material term of the services agreement, the other party can terminate the services agreement upon 180 days' notice. ENVOY believes that it is currently complying with all material terms of the AUSHC services agreement. -9- 10 ENVOY receives medical EDI transactions from practice management system vendors and other claims clearinghouses. These vendors and claims clearinghouses collect transactions from healthcare providers and send ENVOY these transactions to complete the processing of the transactions with the payors. ENVOY receives revenue from the payors for processing these transactions and, in turn, pays rebates to exclusive and preferred vendors based on the volume of transactions delivered to ENVOY. If consolidation in the healthcare industry results in fewer vendors and clearinghouses that gather medical EDI transactions from healthcare providers, then ENVOY's medical EDI business will be more dependent on a smaller number of vendors and clearinghouses. To illustrate the foregoing risk, ENVOY currently processes batch transactions for Medic Computer Systems, a practice management system vendor. ENVOY and Medic have an exclusive relationship for processing these transactions through June 1999. ENVOY's revenues for such processing represented 3.5% of ENVOY's revenues for the year ended December 31, 1998. Medic recently announced that it has entered into a processing and development agreement with one of ENVOY's competitors. Subsequently, both ENVOY and Medic have alleged that the other party has breached the parties' current agreement, and a lawsuit is pending to resolve the parties' allegations. If ENVOY is not able to resolve the parties' allegations and maintain a relationship with Medic, or other companies like Medic, its business may be adversely affected. As another illustration, before NEIC was acquired by ENVOY, it generated most of our revenues from five insurance companies who were shareholders of NEIC. These insurance companies have continued to use NEIC's services following ENVOY's acquisition of NEIC, but they are not required to continue to use NEIC's services in the future. If one or more of the insurance companies decreases or ceases its use of NEIC's services, then ENVOY's business could be adversely affected. ENVOY RELIES ON SPECIFIC DATA CENTERS ENVOY relies on its host computer system to perform real-time EDI transaction processing. This host computer system is contained in a single data facility. The host computer system does not have a remote backup data center. Although the host computer system is insured, if there is a fire or other disaster at the data facility, ENVOY's business could be materially adversely affected. ENVOY also relies on a data center operated by a third party to perform many of its other healthcare EDI transaction processing services. The facility is located in Tampa, Florida and is operated by GTE Data Services Incorporated, with whom ENVOY has contracted for such processing services. ENVOY relies primarily on this facility to process its batch claims and other medical EDI transaction sets. ENVOY's contract with GTE requires GTE to maintain continuous processing capability and a "hot site" disaster recovery system. This contract expires in December 2003. If the GTE facility's services are disrupted or delayed, ENVOY's business could be materially adversely affected. -10- 11 ENVOY CANNOT PREDICT THE NEED FOR INDEPENDENT HEALTHCARE EDI PROCESSING ENVOY's business strategy anticipates that providers of healthcare services and payors will increase their use of electronic processing of healthcare transactions in the future. The development of the business of electronically transmitting healthcare transactions is affected, and somewhat hindered, by the complex nature and types of transactions that must be processed. Furthermore, while the wide variety of processing forms used by different payors has fostered the need for healthcare EDI and transaction processing clearinghouses such as ENVOY to date, if such forms become standardized, through consolidation of payors or otherwise, then the need for independent third party healthcare EDI processing could become less prevalent. We cannot assure you that the electronic processing of healthcare transactions will increase or that ENVOY's business will grow. ENVOY FACES A VARIETY OF COMPETITORS ENVOY faces different types of competition in the healthcare EDI and transaction processing business. Some of its competitors are similarly specialized, such as former regional partners of ENVOY that have direct provider relationships, and others are involved in more highly developed areas of the business. In addition, some vendors of provider information management systems include or may include, in their offered products, their own electronic transaction processing systems. If electronic transaction processing becomes the standard method of processing healthcare claims and information, other companies with significant capital resources could enter the industry. Competition from any or all of these sources could force ENVOY to reduce, or even eliminate, per transaction fees, which could adversely affect its business. DIRECT LINKS MAY BYPASS NEED FOR ENVOY'S SERVICES Some third party payors provide electronic data transmission systems to healthcare providers, thereby directly linking the payor to the provider. Such direct links bypass third party processors such as ENVOY. An increase in the use of direct links between payors and providers would materially adversely affect ENVOY's business. ENVOY FACES AN UNCERTAIN REGULATORY ENVIRONMENT The operations of companies in the healthcare industry are affected by changes in political, economic and regulatory influences. Federal and state legislatures periodically consider legislation that would change the federal and state healthcare programs. Such legislation may include increased government involvement in healthcare, lower reimbursement rates, or other changes. The uncertainty surrounding these proposed or actual changes could cause companies in the healthcare industry to curtail or defer investments in ENVOY's services and products. -11- 12 CONSOLIDATION IN THE HEALTHCARE INDUSTRY MAY ADVERSELY AFFECT ENVOY'S BUSINESS Many healthcare providers and payors are consolidating to create larger healthcare organizations. This consolidation reduces the number of potential customers for ENVOY's services, and the increased bargaining power of these organizations could lead to reductions in the amounts paid for ENVOY's services. Industry developments are increasing the amount of capitation-based care and reducing the need for providers to make claims or reimbursements for products or services. Payors and other healthcare information companies, such as billing services and practice management vendors, which currently utilize ENVOY's services, have developed or acquired transaction processing and networking capabilities and may cease utilizing ENVOY's services in the future. The impact of these developments in the healthcare EDI and transaction processing industry is difficult to predict and could materially adversely affect ENVOY's business. NEW HEALTHCARE LEGISLATION COULD RESTRICT ENVOY'S BUSINESS The Health Insurance Portability and Accountability Act of 1996 requires the use of standard transactions, standard identifiers, security and other administrative simplification provisions and instructs the Secretary of Health and Human Services to promulgate regulations regarding these standards. The Act also requires the Secretary of Health and Human Services to develop recommendations regarding the privacy of individually identifiable health information. On September 11, 1997, the Secretary presented her recommendations, which, among other things, advise that patient information should not be disclosed except when authorized by the patient. This Act further establishes an August 1999 deadline for Congress to enact privacy legislation. If Congress does not meet this deadline, the Secretary is directed to issue regulations setting privacy standards to protect health information that is transmitted electronically. Such changes could occur as early as the year 2000, and their impact cannot be predicted. Such legislation or regulations could materially affect ENVOY's business. This Act also specifically names clearinghouses as the compliance facilitators for providers and payors, and permits clearinghouses to convert non-standard transactions to standard transactions on behalf of their clients. ENVOY is preparing to comply with the mandated standards within three to six months after they are published. Whether ENVOY is successful in complying with these standards may depend on whether providers, payors and others are also successful in complying with the standards. In addition, broad-based health information privacy legislation restricting third party processors from using, transmitting or disclosing certain patient data without specific patient consent has recently been introduced in the United States Congress. If this legislation is adopted, it could prevent third party processors from using, transmitting or disclosing certain treatment and clinical data. It is difficult to predict the impact of the legislation described above, but such legislation could materially adversely affect ENVOY's business. -12- 13 ENVOY FACES EVOLVING INDUSTRY STANDARDS AND RAPID TECHNOLOGICAL CHANGES The market for ENVOY's business is characterized by rapidly changing technology, evolving industry standards and frequent introduction of new and enhanced products and services. To succeed, ENVOY must continue to: - enhance its existing products and services; - introduce new products and services on a timely and cost-effective basis to meet evolving customer requirements; - achieve market acceptance for new products and services; and - respond to emerging industry standards and other technological changes. PROTECTING ENVOY'S TECHNOLOGY IS IMPORTANT TO ITS SUCCESS ENVOY believes that its technology is important to its success and competitive position. Accordingly, ENVOY has devoted substantial resources to the establishment and protection of the intellectual property rights associated with its technology. These actions, however, may be inadequate to prevent a third party from imitating or using ENVOY's technology or asserting certain rights in ENVOY's technology and intellectual property rights. Additionally, ENVOY's competitors may independently develop technologies that are substantially equivalent or superior to ENVOY's technology. Although ENVOY is currently not aware of any pending or threatened infringement claims, a third party also may claim that ENVOY's products and services are infringing on its intellectual property rights. Such claims could require ENVOY to enter into license arrangements in order to use such products and services. ENVOY may not be able to obtain such licenses. Furthermore, litigation may be necessary to enforce or defend ENVOY's intellectual property rights or defend against any infringement claims. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on ENVOY's business and financial results. ENVOY INCREASINGLY DEPENDS ON MEDICAL EDI AND PATIENT STATEMENT TRANSACTION REVENUES ENVOY's medical EDI and patient statement transaction revenues constituted approximately 75% of ENVOY's total revenues in 1998. Although pharmacy EDI transactions currently represent a majority of ENVOY's total transactions, pharmacy EDI revenue constituted less than 15% of ENVOY's total revenues in 1998 as a result of lower per transaction prices on pharmacy transactions. In 1998, the number of transactions processed in ENVOY's pharmacy EDI business grew at approximately half the rate experienced in ENVOY's other businesses. Because of the significant penetration and lower per transaction prices already existing in the -13- 14 more mature pharmacy EDI sector, ENVOY believes that the percentage of total revenue contributed by its pharmacy EDI business as presently conducted will continue to decrease. Accordingly, ENVOY will have an increasing dependence on medical EDI and patient statement transaction revenues. Any decline in growth rates associated with these businesses could have a material adverse effect on ENVOY's business and financial results. ENVOY FACES RISKS CONCERNING UNAUTHORIZED ACCESS TO DATA CENTERS Unauthorized access to ENVOY's data centers and misappropriation of ENVOY's proprietary information could have a material adverse effect on ENVOY's business and financial results. While ENVOY believes its current security measures and the security measures used by third parties for whom ENVOY processes or transmits healthcare information are adequate, such unauthorized access or misappropriation could occur. -14- -----END PRIVACY-ENHANCED MESSAGE-----