10-Q 1 g72361e10-q.txt QUINTILES TRANSNATIONAL CORP. Securities and Exchange Commission Washington, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended September 30, 2001 Commission file number 000-23520 QUINTILES TRANSNATIONAL CORP. ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) North Carolina 56-1714315 ---------------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 4709 Creekstone Dr., Suite 200 Durham, NC 27703-8411 ---------------------------------------- ------------------------------------ (Address of principal executive offices) (Zip Code) (919) 998-2000 ------------------------------------------------------------------------------- (Registrant's telephone number, including area code) N/A ------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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. [X] Yes No [ ] The number of shares of Common Stock, $.01 par value, outstanding as of September 30, 2001 was 119,612,095. QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Index
Page ---- Part I. Financial Information Item 1. Financial Statements (unaudited) Condensed consolidated balance sheets - September 30, 2001 and December 31, 2000 3 Condensed consolidated statements of operations - Three months ended September 30, 2001 and 2000; nine months ended September 30, 2001 and 2000 4 Condensed consolidated statements of cash flows - Nine months ended September 30, 2001 and 2000 5 Notes to condensed consolidated financial statements - September 30, 2001 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk 26 Part II. Other Information Item 1. Legal Proceedings 26 Item 2. Changes in Securities and Use of Proceeds 27 Item 3. Defaults upon Senior Securities - Not Applicable 27 Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable 27 Item 5. Other Information - Not Applicable 27 Item 6. Exhibits and Reports on Form 8-K 28 Signatures 29 Exhibit Index 30
2 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 DECEMBER 31 2001 2000 ------------ ----------- (unaudited) (Note 1) (In thousands) ASSETS Current assets: Cash and cash equivalents $ 441,912 $ 330,214 Trade accounts receivable and unbilled services, net 450,438 413,992 Investments in debt securities 27,369 31,080 Prepaid expenses 30,169 31,984 Other current assets and receivables 31,158 29,405 ----------- ----------- Total current assets 981,046 836,675 Property and equipment 647,394 602,950 Less accumulated depreciation (260,099) (210,990) ----------- ----------- 387,295 391,960 Intangibles and other assets: Intangibles, net 176,453 194,814 Investments in debt securities 9,502 76,732 Investments in marketable equity securities 204,052 384,040 Deferred income taxes 153,902 29,175 Deposits and other assets 64,350 48,182 ----------- ----------- 608,259 732,943 ----------- ----------- Total assets $ 1,976,600 $ 1,961,578 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Lines of credit $ -- $ 44 Accounts payable and accrued expenses 304,086 255,238 Credit arrangements, current 15,057 20,027 Unearned income 193,916 194,201 Income taxes payable 8,856 51,284 Deferred income taxes 4,399 4,774 Other current liabilities 2,151 2,423 ----------- ----------- Total current liabilities 528,465 527,991 Long-term liabilities: Credit arrangements, less current portion 21,879 18,965 Other liabilities 8,279 9,916 ----------- ----------- 30,158 28,881 ----------- ----------- Total liabilities 558,623 556,872 Shareholders' equity: Preferred stock, none issued and outstanding at September 30, 2001 and December 31, 2000, respectively -- -- Common stock and additional paid-in capital, 119,612,095 and 115,933,182 shares issued and outstanding at September 30, 2001 and December 31, 2000, respectively 913,921 876,407 Retained earnings 516,566 622,985 Accumulated other comprehensive loss (12,510) (94,686) ----------- ----------- Total shareholders' equity 1,417,977 1,404,706 ----------- ----------- Total liabilities and shareholders' equity $ 1,976,600 $ 1,961,578 =========== ===========
The accompanying notes are an integral part of these condensed consolidated statements. 3 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 -------------------------- ----------------------------- 2001 2000 2001 2000 --------- ---------- ----------- ----------- (in thousands, except per share data) Net revenue $ 407,103 $ 412,344 $ 1,215,873 $ 1,250,296 Costs and expenses: Direct 242,745 247,577 724,859 755,887 General and administrative 128,089 141,042 392,208 421,768 Depreciation and amortization 24,597 22,934 71,143 68,805 Restructuring 52,023 -- 54,169 58,592 Write-off of goodwill and other assets 20,120 -- 20,120 -- Disposal of business -- -- -- 17,325 --------- ---------- ----------- ----------- 467,574 411,553 1,262,499 1,322,377 --------- ---------- ----------- ----------- (Loss) income from operations (60,471) 791 (46,626) (72,081) Impairment of investments (341,949) -- (345,048) -- Gain on sale of investments, net 235 1,387 4,702 1,387 Other income 3,580 4,635 14,433 9,776 --------- ---------- ----------- ----------- Total other (expense) income (338,134) 6,022 (325,913) 11,163 --------- ---------- ----------- ----------- (Loss) income from continuing operations before income taxes (398,605) 6,813 (372,539) (60,918) Income tax (benefit) expense (132,694) 2,248 (124,093) (20,102) --------- ---------- ----------- ----------- (Loss) income from continuing operations (265,911) 4,565 (248,446) (40,816) Income from discontinued operation, net of income taxes -- -- -- 16,770 Extraordinary gain from sale of discontinued operation, net of income taxes 142,030 -- 142,030 436,327 --------- ---------- ----------- ----------- Net (loss) income $(123,881) $ 4,565 $ (106,416) $ 412,281 ========= ========== =========== =========== Basic net (loss) income per share: (Loss) income from continuing operations $ (2.22) $ 0.04 $ (2.11) $ (0.35) Income from discontinued operation -- -- -- 0.14 Extraordinary gain from sale of discontinued operation 1.19 -- 1.21 3.77 --------- ---------- ----------- ----------- Basic net (loss) income per share $ (1.03) $ 0.04 $ (0.90) $ 3.56 ========= ========== =========== =========== Diluted net (loss) income per share: (Loss) income from continuing operations $ (2.22) $ 0.04 $ (2.11) $ (0.35) Income from discontinued operation -- -- -- 0.14 Extraordinary gain from sale of discontinued operation 1.19 -- 1.21 3.77 --------- ---------- ----------- ----------- Diluted net (loss) income per share $ (1.03) $ 0.04 $ (0.90) $ 3.56 ========= ========== =========== ===========
The accompanying notes are an integral part of these condensed consolidated statements. 4 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
NINE MONTHS ENDED SEPTEMBER 30 ------------------------------ 2001 2000 --------- ---------- (In thousands) OPERATING ACTIVITIES Net (loss) income $(106,416) $ 412,281 Income from discontinued operation, net of income taxes -- (16,770) Gain on the sale of discontinued operation, net of income taxes (142,030) (436,327) --------- --------- Loss from continuing operations (248,446) (40,816) Adjustments to reconcile loss from continuing operations to net cash provided by (used in) operating activities: Depreciation and amortization 71,143 68,805 Restructuring charge accrual, net 32,872 50,874 Loss on disposal of business -- 17,325 Loss (gain) from impairments and sales of investments, net 340,346 (1,387) Benefit from deferred income taxes (229,256) (8,437) Change in operating assets and liabilities 134,445 (146,299) Other 1,332 1,203 --------- --------- Net cash provided by (used in) operating activities 102,436 (58,732) INVESTING ACTIVITIES Proceeds from disposition of property and equipment 7,460 6,379 Acquisition of property and equipment (59,769) (73,323) Proceeds from disposal of discontinued operation, net of expenses -- 391,500 Acquisition of businesses, net of cash acquired (6,620) (15,169) Proceeds from redemption of (purchases of) debt securities, net 71,882 (2,160) Purchases of equity investments, net (25,836) (6,092) Other -- (3) --------- --------- Net cash (used in) provided by investing activities (12,883) 301,132 FINANCING ACTIVITIES (Decrease) increase in lines of credit, net (44) 10,351 Principal payments on credit arrangements, net (12,466) (156,402) Issuance of common stock, net 46,050 14,394 Repurchase of common stock (7,709) (13,455) Dividend from discontinued operation -- 17,086 Other -- 1 --------- --------- Net cash provided by (used in) financing activities 25,831 (128,025) Effect of foreign currency exchange rate changes on cash (3,686) (6,120) --------- --------- Increase in cash and cash equivalents 111,698 108,255 Cash and cash equivalents at beginning of period 330,214 191,653 --------- --------- Cash and cash equivalents at end of period $ 441,912 $ 299,908 ========= =========
The accompanying notes are an integral part of these condensed consolidated statements. 5 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (unaudited) September 30, 2001 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. The balance sheet at December 31, 2000 has been derived from the audited consolidated financial statements of the Company. For further information, refer to the Consolidated Financial Statements and Notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2000 of Quintiles Transnational Corp. (the "Company"). For an update of the Company's legal proceedings, refer to Item 1 of Part II of this Form 10-Q. 2. Acquisitions During the first quarter of 2001, the Company acquired OEC, SA, a Switzerland-based company that provides drug safety services to the pharmaceutical industry, and Ungerer Laboratory, a laboratory based in Pretoria, South Africa specializing in microbiology, molecular biology and hematology. These transactions were accounted for as purchases with an aggregate purchase price of approximately $7.1 million. 3. Stock Repurchase The authorization by the Board of Directors to repurchase up to $200 million of the Company's Common Stock expired March 1, 2001. The Company did not enter into any agreements to repurchase its Common Stock under this authorization during 2001. On March 13, 2001, the Board of Directors authorized the Company to repurchase up to $100 million of the Company's Common Stock. During the first nine months of 2001, the Company repurchased 520,000 shares of its Common Stock for an aggregate price of approximately $8.6 million. 4. Significant Customers One customer accounted for 10.2%, 10.6% and 10.5% of consolidated net revenue for the three and nine months ended September 30, 2001 and the three months ended September 30, 2000, respectively. No one customer accounted for greater than 10% of consolidated net revenue for the nine months ended September 30, 2000. These revenues were derived from each of the Company's segments. 6 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 5. Restructuring Charges During the third quarter of 2001, the Company adopted a restructuring plan which resulted in the recognition of a restructuring charge of $50.9 million. In addition, the Company recognized a restructuring charge of approximately $1.1 million as a revision of an estimate to a 2000 restructuring plan. The restructuring charge consists of $31.1 million related to severance payments, $8.2 million related to asset impairment write-offs and $12.7 million of exit costs. As part of this restructuring, approximately 1,000 positions worldwide will be eliminated and as of September 30, 2001, 561 individuals have been notified of their termination. Positions will be eliminated in each of our segments. During the second quarter of 2001, the Company recognized a $2.1 million restructuring charge relating primarily to a reorganization of the Internet initiative and the commercialization group in the United States. All of the 40 positions to be eliminated as a part of this restructuring were terminated as of June 30, 2001. As of September 30, 2001, the following amounts were recorded for the 2001 restructurings (in thousands):
Activity Nine-Months Ended September 30, 2001 -------------------------------------------------------------------------- Balance at Write-Offs/ Balance at December 31, 2000 Accruals Payments September 30, 2001 ----------------- -------- ----------- ------------------ Severance and related costs $ -- $ 33,104 $ (6,637) $26,467 Exit costs -- 11,743 (1,306) 10,437 Asset impairment write-offs -- 8,237 (8,237) -- ------- -------- -------- ------- $ -- $ 53,084 $(16,180) $36,904 ======= ======== ======== =======
During 2000, the Company adopted a restructuring plan in January ("January 2000 Plan") and a follow-on restructuring plan later in the year, which resulted in the recognition of an aggregate restructuring charge of $58.6 million. Of the approximately 990 positions that were to be eliminated under these two plans, 909 positions have been terminated as of September 30, 2001, which includes 764 positions under the January 2000 Plan. Activity during the first nine months of 2001 is as follows for the 2000 restructurings (in thousands):
Balance at Write-Offs/ Balance at December 31, 2000 Accruals Payments September 30, 2001 ----------------- -------- ----------- ------------------ Severance and related costs $ 8,867 $ -- $ (7,265) $1,602 Exit costs 5,788 1,085 (3,767) 3,106 ------- -------- -------- ------ $14,655 $ 1,085 $(11,032) $4,708 ======= ======== ======== ======
7 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 6. Write-off of Goodwill and Other Assets In the third quarter of 2001, the Company recognized a $20.1 million charge to write-off goodwill and other operating assets primarily relating to goodwill recorded in four separate acquisitions in the commercialization segment. The goodwill was deemed impaired and written-off due to changing business conditions and strategic direction. 7. Impairment of Investments The Company continually reviews declines in fair value of investments in marketable equity securities for declines that may be other than temporary. In connection with this, the Company recognized a loss of approximately $345.0 million for the nine months ended September 30, 2001 to establish a new cost basis for certain investments, primarily WebMD Corporation ("WebMD"). 8. Discontinued Operation During the third quarter of 2001, the Company completed a tax basis study for ENVOY Corporation ("ENVOY") which was sold to WebMD during 2000. As a result of this study, the Company's tax basis in ENVOY was determined which resulted in an approximate $142.0 million reduction in the income taxes provided on the sale of ENVOY. 9. Net Income Per Share The following table sets forth the computation of the weighted-average shares used when calculating the basic and diluted net income per share (in thousands):
Three Months Ended September 30 Nine Months Ended September 30 ------------------------------- ------------------------------ 2001 2000 2001 2000 ------- ------- ------- ------- Weighted average shares: Basic weighted average shares 119,838 115,702 117,786 115,711 Effect of dilutive securities: Stock options -- 2,437 -- -- ------- ------- ------- ------- Diluted weighted average shares 119,838 118,139 117,786 115,711 ======= ======= ======= =======
The effect of options to purchase approximately 27.7 million shares of common stock outstanding during the three and nine months ended September 30, 2001 were not included in the computation of diluted net income per share because the effect on loss from continuing operations would have been antidilutive. The effect of warrants to purchase 10 million shares of common stock outstanding during the three and nine months ended September 30, 2001 were not included in the computation of diluted net income per share because the effect on loss from continuing operations would have been antidilutive. 8 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 10. Comprehensive Income The following table represents the Company's comprehensive income for the three and nine months ended September 30, 2001 and 2000 (in thousands):
Three Months Ended September 30 Nine Months Ended September 30 ------------------------------- ------------------------------ 2001 2000 2001 2000 --------- -------- --------- --------- Net (loss) income $(123,881) $ 4,565 $(106,416) $ 412,281 Other comprehensive income (loss): Reclassification adjustment, WebMD common stock, net of income taxes 206,155 -- 206,155 -- Unrealized (loss) gain on marketable securities, net of income taxes (89,109) 49,617 (116,354) 116,240 Foreign currency adjustment 13,722 (11,984) (7,622) (31,473) --------- -------- --------- --------- Comprehensive income (loss) $ 6,887 $ 42,198 $ (24,237) $ 497,048 ========= ======== ========= =========
9 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 11. Segments The following table presents the Company's operations by reportable segment. The Company is managed through three reportable segments, namely, the product development service group, the commercialization service group and the informatics service group. Management has distinguished these segments based on the normal operations of the Company. The product development group is primarily responsible for all phases of clinical research. The commercialization group is primarily responsible for sales force deployment and strategic marketing services. The informatics group is primarily responsible for providing market research solutions and strategic analysis to support healthcare decisions. The Company does not include net revenue and expenses relating to the Internet initiative, charges relating to restructurings, write-off of goodwill and other assets and disposal of business, other income (expense) and income tax expense (benefit) in segment profitability. Overhead costs are allocated based upon management's best estimate of efforts expended in managing the segments. There are not any significant intersegment revenues.
Three Months Ended September 30 Nine Months Ended September 30 ------------------------------- --------------------------------- 2001 2000 2001 2000 --------- ----------- ----------- ----------- Net revenue: Product development $ 222,519 $ 201,610 $ 664,151 $ 604,575 Commercialization 171,595 196,167 508,620 602,780 Informatics 12,989 14,339 43,069 42,143 Internet initiative -- 228 33 798 --------- ----------- ----------- ----------- $ 407,103 $ 412,344 $ 1,215,873 $ 1,250,296 ========= =========== =========== =========== Income from operations: Product development $ 10,376 $ 2,220 $ 28,166 $ (11,610) Commercialization 9,007 11,433 24,666 43,813 Informatics (5,433) (4,017) (12,543) (11,784) Internet initiative (2,278) (8,845) (12,626) (16,583) --------- ----------- ----------- ----------- $ 11,672 $ 791 $ 27,663 $ 3,836 ========= =========== =========== ===========
10 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 12. Recently Issued Accounting Standards In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," that requires all business combinations initiated after June 30, 2001 to be accounted for as purchases. The Company adopted SFAS No. 141 as required on July 1, 2001. The adoption did not have a material impact on the Company's financial position or results of operations. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," requiring that all intangible assets without a contractual life no longer be amortized but reviewed at least annually for impairment. The Company will adopt SFAS No. 142 when required to do so on January 1, 2002. The adoption of SFAS No. 142 is expected to reduce the Company's amortization expense before income taxes by approximately $2.0 million per quarter. The Company has not assessed the impact of any impairment under the new tests prescribed by the standard. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets to Be Disposed of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The statement is effective for fiscal years beginning after December 15, 2001. The Company is currently assessing the provisions of this statement to determine their impact on the Company's results of operations and financial position. 13. Subsequent Event On October 12, 2001, the Company jointly announced with WebMD the settlement of litigation and the resolution of the disputes between the companies. As part of the settlement, WebMD agreed to pay the Company $185 million in cash for all 35 million shares of WebMD common stock owned by the Company. The Company will also receive an additional payment from WebMD if, on or before June 30, 2004, WebMD is acquired for a price greater than $4.00 per share or ENVOY is acquired for a price greater than $500 million. In addition, as part of the settlement, the outstanding warrant to purchase up to 10 million shares of the Company's common stock, at $40 per share, held by WebMD, was cancelled. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations CAUTIONARY STATEMENT FOR FORWARD-LOOKING INFORMATION Information set forth in this Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains various "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which statements represent our judgement concerning the future and are subject to risks and uncertainties that could cause our 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," 11 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES "estimate," "believe," or "continue," or the negative thereof or other variations thereof or comparable terminology. We caution you that any such forward looking statements are further qualified by important factors that could cause our actual operating results to differ materially from those in the forward looking statements, including without limitation the risk that the market for our products and services will not grow as we expect, the risk that our PharmaBio transactions will not generate revenues, profits or return on investment at the rate or levels we expect, our ability to efficiently distribute backlog among project management groups and match demand to resources, our actual operating performance, the actual savings and operating improvements resulting from our restructuring activities, our ability to maintain large client contracts or to enter into new contracts, changes in trends in the pharmaceutical industry, and our ability to operate successfully in new lines of business. In addition, our data products business remains subject to state and federal regulations and contracts with data vendors. See "Risk Factors" below for additional factors that could cause actual results to differ. Results of Continuing Operations Three Months Ended September 30, 2001 and 2000 Net revenue for the third quarter of 2001 was $407.1 million, a decrease of $5.2 million or (1.3%) as compared to the third quarter of 2000 net revenue of $412.3 million. Net revenue decreased as a result of large commercialization contracts that were terminated or converted in-house by our customers instead of being renewed. Net revenue was also negatively impacted due to the travel restrictions implemented after the terrorist acts on September 11, 2001 and reduced data management activities as a result of the Nimda virus. The decrease was partially offset by an increase of approximately $2.9 million from our Phase I development services. Net revenue in the Asia Pacific region increased $10.4 million or 31.6% to $43.2 million but decreased $20.8 million or 8.7% to $217.5 million in the Americas region primarily resulting from the decline in the commercialization segment. Net revenue in the Europe and Africa region increased $5.2 million or 3.6% to $146.5 million. The growth in net revenue was negatively impacted by approximately $9.9 million due to the effect of foreign currency fluctuations related to the strengthening of the US Dollar relative to the euro, other European currencies and the Japanese yen. Direct costs, which include compensation and related fringe benefits for billable employees, and other expenses directly related to contracts, were $242.7 million or 59.6% of net revenue for the third quarter of 2001 versus $247.6 million or 60.0% of net revenue for the third quarter of 2000. General and administrative expenses, which include compensation and fringe benefits for administrative employees, non-billable travel, professional services, advertising, computer and facility expenses, were $128.1 million or 31.5% of net revenue for the third quarter of 2001 versus $141.0 million or 34.2% of net revenue for the third quarter of 2000. General and administrative expenses decreased primarily due to the effects of reductions relating to our restructuring activities including a decrease in spending on our Internet initiative. These reductions were partially offset by an increase of $2.5 million in costs associated with the continued implementation of our shared service center initiative and $2.3 million in costs associated with the realignment of business development. 12 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Depreciation and amortization were $24.6 million or 6.0% of net revenue for the third quarter of 2001 versus $22.9 million or 5.6% of net revenue for the third quarter of 2000. Depreciation expense increased $1.6 million due to the increase in our capitalized asset base. During the third quarter of 2001, we announced a strategic plan that we are implementing across each service line and geographic area of our business which we believe will allow us to meet the changing needs of our customers and to increase our opportunity for growth by committing ourselves to innovation, quality and efficiency. We intend to successfully implement this plan through: - partnering structures - leveraging technology and information - realigning business development - hiring and retaining quality employees - creating efficiencies through shared service centers and real time human resource management In connection with this plan, we recognized a $50.9 million restructuring charge. In addition, we recognized a restructuring charge of approximately $1.1 million as a revision of an estimate to a 2000 restructuring plan. The restructuring charge consists of $31.1 million related to severance payments, $8.2 million related to asset impairment write-offs and $12.7 million of exit costs. As part of this restructuring, approximately 1,000 positions will be eliminated and as of September 30, 2001, 561 individuals have been notified of their termination. We are targeting the restructuring to result in annualized cost savings of approximately $50 million to $55 million. Also, in the third quarter of 2001, we recognized a $20.1 million charge to write-off goodwill and other operating assets primarily relating to goodwill recorded in four separate acquisitions in our commercialization segment. The goodwill was deemed impaired and written-off due to changing business conditions and strategic direction. Loss from operations was $60.5 million for the third quarter of 2001 versus income from operations of $791,000 for the third quarter of 2000. Excluding the $52.0 million restructuring charge and $20.1 million write-off of goodwill and other assets, income from operations was $11.7 million for the third quarter of 2001. Other expense was $338.1 million for the third quarter of 2001. Included in other expense for the third quarter of 2001 was a $341.9 million write-down of our cost basis in investments held by us, primarily WebMD Corporation, which management deemed to be an other than temporary decline in their fair value. Excluding this charge, other income for the third quarter of 2001 was $3.8 million versus $6.0 million for the third quarter of 2000. The decrease was primarily the result of a $2.1 million decrease in net interest income, due to a decline in interest rates and a $1.2 million decrease in gains from the sale of investments. The effective income tax rate for the third quarter of 2001 was (33.3%) versus a 33.0% effective income tax rate for the third quarter of 2000. Since we conduct operations on a global basis, our effective income tax rate may vary. 13 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Analysis by Segment: The following table summarizes the operating activities for our three reportable segments for the three months ended September 30, 2001 and 2000. We do not include net revenue and expenses relating to the Internet initiative, charges related to restructurings, write-off of goodwill and other assets and disposal of a business, other income (expense) and income tax expense (benefit) in our segment analysis (dollars in millions).
Net Revenue (Loss)/Income From Operations -------------------------------------- --------------------------------------------------- Growth % of Net % of Net 2001 2000 % 2001 Revenue 2000 Revenue ------ ------ ------ ----- -------- ----- -------- Product development $222.5 $201.6 10.4% $10.4 4.7% $ 2.2 1.1% Commercialization 171.6 196.2 (12.5) 9.0 5.2 11.4 5.8 Informatics 13.0 14.3 (9.4) (5.4) (41.8) (4.0) (28.0) ------ ------ ----- ----- $407.1 $412.1 (1.2)% $14.0 3.4% $ 9.6 2.3% ====== ====== ===== =====
The product development group's financial performance improvement was a result of several factors, including process enhancements and cost reduction efforts in the American operations and growth in our Phase I development services. These improvements were partially offset by the effects of lost revenue, estimated to be approximately $2.2 million, due to the September 11, 2001 terrorist acts and the Nimda virus. The commercialization group's financial performance was negatively impacted during the quarter by the continuing effects of large contracts converted in-house or terminated by our customers instead of being renewed. The decrease in net revenues and operating margins in our informatics group was due, in part, to our restructuring plans and the uncertainty that such plans created among the employees in the informatics group. As a percentage of our total number of employees, the employees in our informatics group represent by far the largest group of our employees impacted by the restructuring plans. As a result, since the announcement of our restructuring plans, the net revenues and operating margins in our informatics group have been negatively impacted more than other segments of our business. The details of the strategic plan and related restructuring, which is being communicated to the employees, are expected to reduce the uncertainty surrounding our overall restructuring plans and the related impact such plans will have on the employees of this group. Nine Months Ended September 30, 2001 and 2000 Net revenue for the nine months ended September 30, 2001 was $1.22 billion, a decrease of $34.4 million or (2.8%) as compared to the nine months ended September 30, 2000 net revenue of $1.25 billion. Net revenue decreased primarily as a result of large commercialization contracts that were terminated or converted in-house by our customers instead of being renewed. The decrease was partially offset by an increase of approximately $10.6 million from our Phase I development services. Net revenue in the Asia Pacific region increased $29.4 million or 33.5% to $117.1 million but decreased $70.2 million or 9.7% to $654.0 million 14 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES in the Americas region primarily resulting from the decline in the commercialization segment. Net revenue in the Europe and Africa region increased $6.5 million or 1.5% to $444.8 million. The growth in net revenue was negatively impacted by approximately $43.4 million due to the effect of foreign currency fluctuations related to the strengthening of the US Dollar relative to the euro, other European currencies and the Japanese yen. Direct costs, which include compensation and related fringe benefits for billable employees, and other expenses directly related to contracts, were $724.9 million or 59.6% of net revenue for the first nine months of 2001 versus $755.9 million or 60.5% of net revenue for the first nine months of 2000. General and administrative expenses, which include compensation and fringe benefits for administrative employees, non-billable travel, professional services, advertising, computer and facility expenses, were $392.2 million or 32.3% of net revenue for the first nine months of 2001 versus $421.8 million or 33.7% of net revenue for the first nine months of 2000. General and administrative expenses decreased primarily due to the effects of reductions relating to our restructuring activities including a decrease in the spending for our Internet initiative. These reductions were partially offset by an increase of $4.9 million in costs associated with the realignment of our internal business development structure and $8.1 million in costs associated with the continued implementation of our shared service center initiative. During 2001, we opened our finance shared service center in Scotland. We anticipate the implementation of the global finance and human resources shared service centers to continue during the remainder of 2001. Depreciation and amortization were $71.1 million or 5.9% of net revenue for the first nine months of 2001 versus $68.8 million or 5.5% of net revenue for the first nine months of 2000. Depreciation expense increased $2.5 million due to the increase in our capitalized asset base. In response to a decrease in demand for our services, we announced a restructuring plan during the nine months ended September 30, 2000, resulting in a $58.6 million restructuring charge. This charge consisted of $33.2 million related to severance payments, $11.3 million related to asset impairment write-offs and $14.0 million in exit costs. As of September 30, 2001, approximately 909 positions have been eliminated and approximately $3.6 million remains to be spent in connection with the restructuring plan. In connection with the aforementioned strategic plan announced during 2001, we recognized $54.2 million of restructuring charges which included approximately $1.1 million relating to a 2000 restructuring plan. The restructuring charges consist of $33.1 million related to severance payments, $8.2 million related to asset impairment write-offs and $12.9 million of exit costs. As part of these restructurings, approximately 1,040 positions will be eliminated, and as of September 30, 2001, approximately 601 individuals have been notified of their termination. For the nine months ended September 30, 2001, we recognized a $20.1 million charge to write-off goodwill and other operating assets. For the nine months ended September 30, 2000, we recognized a $17.3 million loss on the disposal of a business. Loss from operations was $46.6 million for the first nine months of 2001 versus $72.1 million for the first nine months of 2000. Excluding the charges relating to the restructurings, the write-off of goodwill and other 15 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES assets, and the disposal of a business, income from operations was $27.7 million for the first nine months of 2001 versus $3.8 million for the first nine months of 2000. Other expense was $325.9 million for the first nine months of 2001. Included in other expense for the first nine months of 2001 was a $345.0 million write-down of our cost basis in investments held by us, primarily WebMD, which management deemed to be an other than temporary decline in their fair value. Excluding this charge, other income for the nine months ended September 30, 2001 was $19.1 million versus $11.2 million for the first nine months of 2000. The increase was primarily due to a $3.3 million increase in gains from the sale of investments and a $3.9 million increase in net interest income as a result of an increase in investable funds and a decrease in debt which was partially offset by the decline in interest rates. The effective income tax rate for the first nine months of 2001 was (33.3%) versus a (33.0%) effective income tax rate for the first nine months of 2000. Since we conduct operations on a global basis, our effective income tax rate may vary. Analysis by Segment: The following table summarizes the operating activities for our three reportable segments for the nine months ended September 30, 2001 and 2000. We do not include net revenue and expenses relating to the Internet initiative, charges relating to restructurings, write-off of goodwill and other assets and the disposal of a business, other income (expense) and income tax expense (benefit) in our segment analysis (dollars in millions).
Net Revenue (Loss)/Income From Operations --------------------------------------- -------------------------------------------------- Growth % of Net % of Net 2001 2000 % 2001 Revenue 2000 Revenue --------- ---------- ------ -------- ------- -------- -------- Product development $ 664.2 $ 604.6 9.9% $ 28.2 4.2% $ (11.6) (1.9)% Commercialization 508.6 602.8 (15.6) 24.7 4.8 43.8 7.3 Informatics 43.1 42.1 2.2 (12.5) (29.1) (11.8) (28.0) ---------- ---------- -------- -------- $ 1,215.8 $ 1,249.5 (2.7)% $ 40.3 3.3% $ 20.4 1.6% ========== ========== ======== ========
The product development group's financial performance improvement was a result of several factors, including process enhancements and cost reduction efforts in the American and European operations and growth in our Phase I development services. The commercialization group's financial performance was negatively impacted by several factors, including the effects of large contracts converted in-house or terminated by our customers instead of being renewed and the effects of a collection issue with a non-pharmaceutical customer receivable. These were partially offset by the effects of cost reduction efforts, primarily in the United States. The informatics group's financial performance was impacted by the uncertainty created among the employees in this group due to the strategic plan and related restructuring and the costs associated with developing new data products. 16 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Liquidity and Capital Resources Cash provided by operations were $102.4 million for the nine months ended September 30, 2001 versus cash used in operations of $58.7 million for the comparable period of 2000. Included in cash provided by operations for the nine months ended September 30, 2001 was an income tax refund of $47.6 million. Investing activities, for the nine months ended September 30, 2001, consisted primarily of capital asset and equity investment purchases. These expenditures were offset by proceeds from the redemption of debt securities. Capital asset purchases required an outlay of cash of $59.8 million for the nine months ended September 30, 2001 compared to an outlay of $73.3 million for the same period in 2000. In 1999, we acquired substantial assets of Aventis' Kansas City-based Drug Innovation and Approval Facility. Subsequent to September 30, 2001, we paid approximately $58 million, which constitutes the remainder of the purchase price for that facility. Total working capital was $452.6 million as of September 30, 2001, an increase of $143.9 million versus working capital of $308.7 million as of December 31, 2000. Net receivables from customers (trade accounts receivable and unbilled services, net of unearned income) were $256.5 million at September 30, 2001 as compared to $219.8 million at December 31, 2000. As of September 30, 2001, trade accounts receivable were $253.2 million versus $246.3 million at December 31, 2000. Unbilled services were $197.2 million at September 30, 2001 versus $167.7 million at December 31, 2000, offset by unearned income balances of $193.9 million and $194.2 million, respectively. The number of days revenue outstanding in trade accounts receivable and unbilled services, net of unearned income, were 49 days at September 30, 2001, as compared to 43 days at December 31, 2000, as a result of customer payment patterns. Investments in debt securities were $36.9 million at September 30, 2001 as compared to $107.8 million at December 31, 2000. Our investments in debt securities consist primarily of U.S. Government Securities, which are callable by the issuer, at par, and money funds. The $70.9 million decrease is a result of investments being called by the issuer. Investments in strategic marketable equity securities at September 30, 2001 were $204.1 million, a decrease of $180.0 million, as compared to $384.0 million at December 31, 2000. This decrease is primarily due to the decline in the market price of WebMD Corporation common stock. Excluding the decline in the market price of WebMD common stock, investments in marketable equity securities decreased approximately $51.2 million due to unrealized losses on the portfolio as a result of market price declines. In accordance with our policy to continually review declines in fair value of our marketable equity securities for declines that may be other than temporary, we recorded a loss of approximately $345.0 million for the nine months ended September 30, 2001 to establish a new cost basis for certain investments, primarily WebMD common stock. On October 12, 2001, we jointly announced with WebMD the settlement of litigation and the resolution of the disputes between the companies. As part of the settlement, WebMD agreed to pay us $185.0 million in cash for all 35 million shares of WebMD common stock owned by us. We will also receive an additional payment from WebMD if, on or before June 30, 2004, WebMD is acquired for a price greater than $4.00 per share or ENVOY is acquired for a price greater than $500 million. As part of this settlement, we will continue to receive data from WebMD only through February 28, 2002. In addition, as part of the settlement, we have 17 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES terminated our existing contracts with WebMD, which, among other things, absolves us from any obligation to fund WebMD up to $100 million to develop a web-based suite of integrated products. We have available to us a (pound)10.0 million (approximately $14.7 million) unsecured line of credit and a (pound)1.5 million (approximately $2.2 million) general banking facility with a U.K. bank. At September 30, 2001, we did not have any outstanding balances on these facilities. Our $150 million senior unsecured credit facility with a U.S. bank expired in August 2001 in accordance with its terms. In March 2001, the Board of Directors authorized us to repurchase up to $100 million of our common stock until March 1, 2002. During the first nine months of 2001, we entered into agreements to repurchase 520,000 shares for an aggregate price of $8.6 million. Shareholders' equity at September 30, 2001 was $1.42 billion versus $1.40 billion at December 31, 2000. Based on our current operating plan, we believe that our available cash and cash equivalents and investments in marketable securities, together with future cash flows from operations and borrowings under our line of credit agreements will be sufficient to meet our foreseeable cash needs in connection with our operations. As part of our business strategy, we review many acquisition candidates in the ordinary course of business, and in addition to acquisitions already made, we are continually evaluating new acquisition and expansion possibilities. We may from time to time seek to obtain debt or equity financing in our ordinary course of business or to facilitate possible acquisitions or expansion. 18 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES RISK FACTORS In addition to the other information provided in our reports, you should consider the following factors carefully in evaluating our business and us. Additional risks and uncertainties not presently known to us, that we currently deem immaterial or that are similar to those faced by other companies in our industry or business in general, such as competitive conditions, may also impair our business operations. If any of the following risks occur, our business, financial condition, or results of operations could be materially adversely affected. Changes in outsourcing trends in the pharmaceutical and biotechnology industries could adversely affect our operating results and growth rate. 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 over the past decade, and we have benefited from this trend. Some industry commentators believe that the rate of growth of outsourcing will continue to trend downward. If these industries reduce their tendency to outsource those projects, our operations, financial condition and growth rate could be materially and adversely affected. Recently, we also believe we have been negatively impacted by mergers and other factors in the pharmaceutical industry, which appear to have slowed decision making by our customers and delayed certain trials. A continuation of these trends would have an ongoing adverse effect on our business. 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. 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 that 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, we are expanding our pharmaceutical and healthcare information and market research services. These services involve analyzing healthcare information to study aspects of current healthcare products and procedures for use in developing new products and services or in analyzing sales and marketing of existing products. In addition to the other difficulties associated with the development of any new service, our ability to develop these services 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 19 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES successfully. Our inability to develop new products or services or any delay in development may adversely affect our ability to maintain our rate of growth in the future. Our plan to web-enable our product development and commercialization services may negatively impact our results in the short term. We are developing an Internet platform for our product development and commercialization services. We have entered into agreements with certain vendors for them to provide web-enablement services to help us develop this platform. If such vendors fail to perform as required or if there are substantial delays in developing and implementing this platform, we may have to make substantial further investments, internally or with third parties, to achieve our objectives. Meeting our objectives is dependent on a number of factors which may not take place as we anticipate, including obtaining adequate web-enablement services, creating web-enablement services which our customers will find desirable and implementing our business model with respect to these services. Also, these expenditures are likely to negatively impact our profitability, at least until our web-enabled products are operationalized. Over time, we envision continuing to invest in extending and enhancing our Internet platform in other ways to further support and improve our services. We cannot assure you that any improvements in operating income resulting from our Internet capabilities will be sufficient to offset our investments in the Internet platform. Our results could be further negatively impacted if our competitors are able to execute their services on a web-based platform before we can launch our Internet services or if they are able to structure a platform that attracts clients away from our services. Our ability to provide informatics services depends on agreements with third parties to access healthcare data. In order to provide our informatics products and services, we need access to healthcare data. Prior to the sale of our ENVOY subsidiary, we obtained this data directly from ENVOY. Following the sale of ENVOY to WebMD, we entered into a data rights agreement with WebMD to continue to provide us with the ENVOY data, as well as other data collected by WebMD. On October 12, 2001, we entered into a settlement agreement with WebMD which ended the litigation and resolved the disputes between our two companies. In connection with the settlement agreement, we will continue to receive healthcare data from WebMD only through February 28, 2002. As a result, we have begun to seek to obtain similar data from alternate sources. While we believe that we will be able to secure alternative sources prior to February 28, 2002, we cannot assure you that we will be able to do so, or that third parties which provide data will be willing to negotiate or provide terms that are acceptable to us, or will be able to give us access to the quality and timeliness of data that we need to support our informatics products. If we do not have continued access to data on acceptable terms, our informatics service group will not be able to support its contracts with existing customers or continue development projects as currently planned, which would have an adverse effect on our business. 20 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES The potential loss or delay of our large contracts could adversely affect our results. Many 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, but these fees may not be sufficient for us to maintain our margins, and termination may result in lower resource utilization rates. Thus, the loss or delay of a large contract or the loss or delay of multiple contracts could adversely affect our net revenue and profitability. We believe that this risk has potentially greater effect as we pursue larger outsourcing arrangements with global pharmaceutical companies. Also, since 1999 we have observed that customers may be more willing to delay, cancel or reduce contracts more rapidly than in the past. If this trend continues, it could become more difficult for us to balance our resources with demands for our services and our financial results could be adversely affected. Our backlog may not be indicative of future results. We report backlog, $1.93 billion at June 30, 2001, based on anticipated net revenue from uncompleted projects that our customers have 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. Also, if customers delay projects, the projects will remain in backlog, but will not generate revenue at the rate originally expected. Accordingly, historical indications of the relationship of backlog to revenues are not indicative of the future relationship. Underperformance of our risk-sharing and gain-sharing strategies could have a negative impact on our financial performance. As part of our sales strategy, we enter into arrangements with customers in which we take on some of the risk of the potential success or failure of the customer's product. These transactions may include a strategic investment in a customer, providing financing to a customer, or taking an interest in the revenues from a customer's product. For example, we may build a sales organization for a biotechnology customer to commercialize a new product in exchange for a share in the revenues of the product. We must carefully analyze and select the customers and products with which we are willing to structure our risk-based deals. Our financial results would be adversely affected if our customers' products do not achieve the level of success that we anticipate and/or our return or payment from the product, investment or financing is less than our costs of performance, investment or financing. 21 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES If we lose the services of Dennis Gillings, Pamela Kirby 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, and Pamela Kirby, Ph.D., our Chief Executive Officer. 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, Dr. Kirby 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 product development services create a risk of liability from clinical trial participants and the parties with whom we contract. We contract with drug companies to perform a wide range of services to assist them in bringing new drugs to market. Our services include supervising clinical trials, data and laboratory analysis, patient recruitment and other services. The process of bringing a new drug to market is time-consuming and expensive. If we do not perform our services to contractual or regulatory standards, the clinical trial process could be adversely affected. Additionally, if clinical trial services such as laboratory analysis do not conform to contractual or regulatory standards, trial participants could be affected. These events would create a risk of liability to us from the drug companies with whom we contract or the study participants. We also contract with physicians to serve as investigators in conducting clinical trials. 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 tests or performing laboratory analysis, 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. We also could be held liable for errors or omissions in connection with our services. For example, we could be held liable for errors or omissions or breach of contract if one of our laboratories inaccurately reports or fails to report lab results or if our informatics products violate rights of third parties. We maintain insurance to cover ordinary risks but any insurance might not be adequate, and it would not cover the risk of a customer deciding not to do business with us as a result of poor performance. 22 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 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 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 and final laws and regulations may create a risk of liability and along with certain contractual obligations may increase the cost of our business or limit our service offerings. The confidentiality of individually identifiable health information and the circumstances under which such individually identifiable health records may be released for inclusion in our databases or used in other aspects of our business are subject to substantial government regulation both domestically and internationally. Additional U.S. legislation governing the possession, use and dissemination of medical record information and other personal health information has been proposed or adopted at both the state and federal levels. Proposed and final U.S. and international regulations governing individually identifiable health information may (1) require us to implement new security measures that may require substantial expenditures or (2) limit our ability to offer some of our products and services. These regulations may also increase costs by creating new privacy requirements for our informatics business and mandating additional privacy procedures for our clinical research business. Additionally, states in the U.S. may adopt health information legislation or regulations that contain privacy and security provisions that are more burdensome than the proposed U.S. federal regulations. In the recently settled dispute with WebMD, WebMD had opined that a number of state laws in the U.S. could apply which may require modifications to access specifications for particular data elements in de-identified health information. 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. There is a risk of civil or criminal liability if we are found to be responsible for any violations of applicable laws, regulations or duties relating to the privacy or security of individually identifiable health information. In addition, in connection with our settlement agreement with WebMD we have agreed to indemnify WebMD for losses arising out of or in connection with the settlement agreement itself, the cancelled Data Rights Agreement with WebMD, our data business, the collection, accumulation, storage or use of data by ENVOY for the purpose 23 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES of transmitting or delivering data to us, any transmission or delivery by ENVOY of data to us, or violations of law or contract attributable to any such event, action or circumstance. Under the terms of our agreement, our indemnification obligation for the first $20 million in aggregate losses is limited to 50%. Industry regulation may restrict our ability to analyze and disseminate pharmaceutical and healthcare data. We are directly subject to certain restrictions on the collection and use of data. Laws relating to the collection and use of data are evolving, as are contractual rights. We cannot assure you that contractual restrictions imposed by our customers, legislation or regulations will not, now or in the future, directly or indirectly restrict the analysis or dissemination of the type of information we gather and therefore materially adversely affect our operations. We also have certain obligations to indemnify parties which provide us data for losses they may incur arising from claims that they have provided us data in violation of contract or other rights. Our services are subject to evolving industry standards and rapid technological changes. The markets for our services, particularly our informatics services, which include our data analysis services, are characterized by rapidly changing technology, evolving industry standards and frequent introduction of new and enhanced services. To succeed, we must continue to: - enhance our existing services; - introduce new services on a timely and cost-effective basis to meet evolving customer requirements; - achieve market acceptance for new services; and - respond to emerging industry standards and other technological changes. 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 44.0% of our 2000 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 and any trends associated with the transition to the euro, 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. 24 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 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 or options. Although we may hedge our transaction risk, there were no open foreign exchange contracts or options relating to service contracts at September 30, 2001. 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. We may be adversely affected by customer concentration. We have one customer that accounted for 10.2% and 10.6% of our net revenues for the three and nine months ended September 30, 2001, respectively. These revenues resulted from services provided by each of our three service groups. If any large customer decreases or terminates its relationship with us, our business, results of operations or financial condition could be materially adversely affected. New healthcare legislation or regulation could restrict our informatics business. On December 28, 2000, the Secretary of Health and Human Services, also referred to as HHS, issued the final rule on Standards for Privacy of Individually Identifiable Health Information to implement the privacy requirements for HIPAA. This rule generally (1) imposes standards for covered entities transmitting or maintaining protected data in an electronic, paper or oral form with respect to the rights of individuals who are the subject of protected health information; and (2) establishes limitations on and procedures for (a) the exercise of those individuals' rights, (b) the uses and disclosures of protected health information and (c) language in contractual agreements between covered entities and their business associates with regards to protected health information. The effective date of the final rule was April 14, 2001 and the compliance date is April 14, 2003. HHS' Office for Civil Rights, the enforcement office for the rule, issued guidance in the form of questions and answers on the rule in July 2001 and according to the Secretary, further modifications and/or guidelines to the regulation will be forthcoming in the next few months. If state or federal legislation or a more restrictive rule is adopted, it could inhibit third party processors in using, transmitting or disclosing health data (even if they have been de-identified) for purposes other than facilitating payment or performing other clearinghouse functions which would restrict our ability to obtain data for use in our informatics services (any such state law may be subject to enforceability challenges based on constitutional and federal preemption issues). In addition, it could require us to establish uniform specifications for obtaining de-identified data, so that de-identified data obtained from different sources could be aggregated. While the impact of developments in legislation, regulations or the demands of third party processors is difficult to predict, each could materially adversely affect our informatics business. If we are unable to submit electronic records to the FDA according to FDA regulations, our ability to service our clients during the FDA approval process could be adversely affected. The United States Food and Drug Administration, also referred to as the FDA, published 21 CFR Part 11 "Electronic Records; Electronic Signatures; Final Rule" ("Part 11") in 1997. Part 11 became effective in August 1997 and defines the regulatory requirements that must be met for FDA acceptance of electronic records and/or electronic signatures in place of the paper equivalents. Part 11 requires that those utilizing such electronic records and/or signatures employ procedures and controls designed to ensure the authenticity, 25 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES integrity and, as appropriate confidentiality of electronic records and, in certain circumstances, Part 11 requires those utilizing electronic records to ensure that a person appending an electronic signature cannot readily repudiate the signed record. Pharmaceutical and biotechnology companies are increasing their utilization of electronic records and electronic signatures and are requiring their service providers and partners to do likewise. Many of our customers, or potential customers, are targeting 2003 for full compliance of all their affected systems. Becoming compliant with Part 11 involves considerable complexity and cost. Our ability to provide services to our customers in full compliance with applicable regulations includes a requirement that, over time, we become compliant with the requirements of Part 11. If we are unable to achieve this objective, our ability to provide services to our customers which meet FDA requirements may be adversely affected. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company did not have any material changes in market risk from December 31, 2000. PART II. Other Information Item 1. Legal Proceedings Beginning on September 30, 1999, several purported class action lawsuits were filed in the United States District Court for the Middle District of North Carolina against us and several of our executive officers and directors on behalf of all persons who purchased or otherwise acquired shares of our common stock between July 16, 1999, and September 15, 1999. These actions were subsequently consolidated and plaintiffs filed an amended complaint purporting to represent a class of purchasers of our stock or call options, and sellers of put options, during the period between April 21, 1999, and September 15, 1999. The amended complaint alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Plaintiffs seek unspecified damages, plus costs and expenses, including attorneys' fees and experts' fees. We believed the claims to be without merit and intended to defend the suit vigorously. Accordingly, we and the named officers and directors filed a motion to dismiss the amended complaint. Immediately prior to the hearing scheduled on February 6, 2001, on the motion to dismiss, the parties agreed to settle the lawsuit. On October 5, 2001, the district court judge approved the settlement, ending the dispute. On January 26, 2001, a purported class action lawsuit was filed in the State Court of Richmond County, Georgia, naming Novartis Pharmaceuticals Corp., Pharmed Inc., Debra Brown, Bruce I. Diamond and Quintiles Laboratories Limited, one of our subsidiaries, on behalf of 185 Alzheimer's patients who participated in drug studies involving an experimental drug manufactured by defendant Novartis and their surviving spouses. The complaint alleges claims for breach of fiduciary duty, civil conspiracy, unjust enrichment, misrepresentation, Georgia RICO violations, infliction of emotional distress, battery, negligence and loss of consortium as to class member spouses. The complaint seeks unspecified damages, plus costs and expenses, including attorneys' fees and experts' fees. We believe the claims to be without merit and intend to defend the suit vigorously. On February 25, 2001, we initiated a lawsuit in Superior Court of Wake County, North Carolina against WebMD Corporation. Our complaint alleged that WebMD's suspension of the delivery of data to us on February 24, 2001 was a material breach of the Data Rights Agreement we entered into with WebMD in May 2000, and we requested a preliminary injunction to require WebMD to continue providing the data to us 26 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES pending final resolution of the action. We obtained a temporary restraining order on February 25, 2001 requiring WebMD to continue the delivery of data to us pursuant to the Data Rights Agreement. WebMD removed the suit to the United States District Court for the Eastern District of North Carolina on March 1, 2001 and moved to dissolve the temporary restraining order. On March 5, 2001, the court denied the defendant's motion to dissolve the temporary restraining order and, subsequently extended the temporary restraining order through March 16, 2001. On March 16 and March 21, the court entered a preliminary injunction requiring WebMD to continue the unaltered and uninterrupted flow of data, which WebMD appealed to the United States Court of Appeals for the Fourth Circuit on April 16, 2001. On October 12, 2001, we entered into a settlement agreement with WebMD which settled the litigation and resolved our dispute. The United States District Court for the Eastern District of North Carolina approved the conditional voluntary dismissal on October 17, 2001. Additionally, the United States Court of Appeals for the Fourth Circuit dismissed the appeal on October 18, 2001. We are also a party in certain other pending litigation arising in the normal course of our business. While the final outcome of such litigation cannot be predicted with certainty, it is the opinion of management, based on consultation with legal counsel, that the outcome of these matters would not materially affect our consolidated financial position or results of operations. Item 2. Changes in Securities and Use of Proceeds During the three months ended September 30, 2001, options to purchase 8,512 shares of our common stock were exercised at an average exercise price of $2.2258 per share in reliance on Rule 701 under the Securities Act of 1933. We granted such options prior to becoming subject to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, pursuant to our Non-qualified Employee Incentive Stock Option Plan. Item 3. Defaults upon Senior Securities -- Not applicable Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable Item 5. Other Information -- Not applicable 27 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.01 Settlement Agreement, dated October 12, 2001, between Quintiles Transnational Corp. and WebMD Corporation (b) During the three months ended September 30, 2001, the Company filed two reports on Form 8-K. The Company filed a Form 8-K, dated July 19, 2001, including its press release announcing the Company's earnings information for the period ended June 30, 2001. The Company filed a Form 8-K, dated September 11, 2001, including its press release announcing the Company's operational and earnings targets for 2002. No other reports on Form 8-K were filed during the three months ended September 30, 2001. 28 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES SIGNATURES Pursuant to the requirements 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. Quintiles Transnational Corp. --------------------------------------- Registrant Date November 1, 2001 /s/ Dennis B. Gillings ------------------------- ---------------------------------- Dennis B. Gillings, Chairman Date November 1, 2001 /s/ Pamela J. Kirby ------------------------- ---------------------------------- Pamela J. Kirby, Chief Executive Officer Date November 1, 2001 /s/ James L. Bierman ------------------------- ---------------------------------- James L. Bierman, Chief Financial Officer
29 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES EXHIBIT INDEX
Exhibit Description ------- ----------- 10.01 Settlement Agreement, dated October 12, 2001, between Quintiles Transnational Corp. and WebMD Corporation
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