10-Q 1 g76143e10-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 March 31, 2002 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 March 31, 2002 was 118,703,665 Index Page ---- Part I. Financial Information Item 1. Financial Statements (unaudited) Condensed consolidated balance sheets - March 31, 2002 and December 31, 2001 3 Condensed consolidated statements of operations - Three months ended March 31, 2002 and 2001 4 Condensed consolidated statements of cash flows - Three months ended March 31, 2002 and 2001 5 Notes to condensed consolidated financial statements - March 31, 2002 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 3. Quantitative and Qualitative Disclosure about Market Risk 30 Part II. Other Information Item 1. Legal Proceedings 31 Item 2. Changes in Securities and Use of Proceeds 31 Item 3. Defaults upon Senior Securities - Not Applicable 31 Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable 31 Item 5. Other Information - Not Applicable 32 Item 6. Exhibits and Reports on Form 8-K 32 Signatures 33 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS MARCH 31 DECEMBER 31 2002 2001 ----------- ----------- (unaudited) (Note 1) (In thousands) ASSETS Current assets: Cash and cash equivalents $ 579,623 $ 565,063 Trade accounts receivable and unbilled services, net 400,718 426,954 Investments in debt securities 27,333 27,489 Prepaid expenses 28,173 28,085 Other current assets and receivables 34,628 32,147 ----------- ----------- Total current assets 1,070,475 1,079,738 Property and equipment 467,630 469,919 Less accumulated depreciation (199,951) (196,144) ----------- ----------- 267,679 273,775 Intangibles and other assets: Goodwill 169,724 163,651 Other identifiable intangibles, net 136,840 123,999 Investments in debt securities 9,821 9,510 Investments in marketable equity securities 76,435 77,992 Investments in non-marketable equity securities and loans 40,174 37,590 Deferred income taxes 140,020 136,686 Deposits and other assets 50,170 44,799 ----------- ----------- 623,184 594,227 ----------- ----------- Total assets $ 1,961,338 $ 1,947,740 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 232,843 $ 223,573 Credit arrangements, current 17,062 16,116 Unearned income 203,416 205,783 Income taxes 19,226 14,811 Other current liabilities 1,342 1,903 ----------- ----------- Total current liabilities 473,889 462,186 Long-term liabilities: Credit arrangements, less current portion 21,625 21,750 Other liabilities 5,585 8,716 ----------- ----------- 27,210 30,466 ----------- ----------- Total liabilities 501,099 492,652 Shareholders' equity: Preferred stock, none issued and outstanding at March 31, 2002 and December 31, 2001, respectively -- -- Common stock and additional paid-in capital, 118,703,665 and 118,623,669 shares issued and outstanding at March 31, 2002 and December 31, 2001, respectively 894,251 897,075 Retained earnings 606,338 589,142 Accumulated other comprehensive loss (40,350) (31,129) ----------- ----------- Total shareholders' equity 1,460,239 1,455,088 ----------- ----------- Total liabilities and shareholders' equity $ 1,961,338 $ 1,947,740 =========== =========== 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 MARCH 31 ------------------------------- 2002 2001 --------- --------- (in thousands) Revenues: Gross service revenues $ 474,320 $ 463,265 Commercial rights and royalties 14,194 2,647 Investment 4,782 (902) --------- --------- Total gross revenues 493,296 465,010 Less: reimbursed service costs 95,153 61,442 --------- --------- 398,143 403,568 Costs of revenues: Service 211,515 238,905 Commercial rights and royalties 14,279 2,561 Investment 158 30 --------- --------- 225,952 241,496 --------- --------- Contribution 172,191 162,072 General, administrative and other: General and administrative 127,233 134,509 Depreciation and amortization 21,389 22,401 Interest (income) expense, net (3,262) (5,848) Other expense (income), net 1,069 (618) --------- --------- 146,429 150,444 --------- --------- Income before income taxes 25,762 11,628 Income tax expense 8,501 3,837 --------- --------- Net income $ 17,261 $ 7,791 ========= ========= Net income per share: Basic $ 0.15 $ 0.07 Diluted 0.14 0.06 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) THREE MONTHS ENDED MARCH 31 --------------------------- 2002 2001 --------- ---------- (In thousands) OPERATING ACTIVITIES Net income $ 17,261 $ 7,791 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 21,793 22,653 Restructuring charge payments, net (8,414) (7,100) (Gain) loss from sales of investments, net (4,782) 902 Benefit from deferred income tax expense (2,233) (105) Change in operating assets and liabilities 32,637 36,506 Other (1,121) (224) --------- --------- Net cash provided by operating activities 55,141 60,423 INVESTING ACTIVITIES Proceeds from disposition of property and equipment 2,336 2,279 Acquisition of property and equipment (10,703) (24,019) Acquisition of businesses, net of cash acquired (25,248) (6,522) (Purchases of) proceeds from debt securities, net (215) 32,667 Proceeds from (purchases of) equity investments 162 (13,576) --------- --------- Net cash used in investing activities (33,668) (9,171) FINANCING ACTIVITIES Decrease in lines of credit, net -- (26) Principal payments on credit arrangements, net (2,490) (4,370) Issuance of common stock, net 1,964 6,033 Repurchase of common stock (4,781) (471) --------- --------- Net cash (used in) provided by financing activities (5,307) 1,166 Effect of foreign currency exchange rate changes on cash (1,606) (4,686) --------- --------- Increase in cash and cash equivalents 14,560 47,732 Cash and cash equivalents at beginning of period 565,063 330,214 --------- --------- Cash and cash equivalents at end of period $ 579,623 $ 377,946 ========= ========= 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) March 31, 2002 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 notes 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 three month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. 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, 2001 of Quintiles Transnational Corp. (the "Company"). The balance sheet at December 31, 2001 has been derived from the audited consolidated financial statements of the Company. Certain amounts in the 2001 financial statements have been reclassified to conform with the 2002 financial statement presentation. The reclassifications had no effect on previously reported net income, shareholders' equity or net income per share. For an update of the Company's legal proceedings, refer to Item 1 of Part II of this Form 10-Q. 2. Commercial Rights and Royalties The Company has entered into financial transactions and other arrangements with customers and other parties in which a portion of the Company's revenues and operating income depends on the performance of a specific pharmaceutical product. These transactions may include providing product development and/or commercialization services to customers, as well as the funding of such services, in return for royalties or commissions based on the sales of the customer's product. Below is a brief description of these agreements: In May 1999, the Company entered into an agreement with CV Therapeutics, Inc. ("CVTX") to commercialize Ranolazine for angina in the United States and Canada. Under the terms of this agreement, the Company purchased 1,043,705 shares of CVTX's common stock for $5 million of which the Company owns 581,705 shares as of March 31, 2002, and has made available a $10 million credit line for pre-launch sales and marketing activities. Once Ranolazine, which is currently in Phase III studies, is approved, the Company will provide a $10 million milestone payment to CVTX which will be used to pay off any outstanding balances on the credit line. The Company will also make available an additional line of credit to help fund a portion of the first year sales and marketing expenses. Additionally, the Company has committed to provide a minimum of approximately $14.4 million per year of commercialization services and to fund a minimum of $7.8 million per year of marketing activities, for a period of five years. In return it will 6 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES receive payment for services rendered by the Company in year one and royalties based on the net sales of Ranolazine in years two through five subject to a cap not to exceed 300% of funding by the Company in any year or over the life of the contract. In addition, the Company will also receive royalties in years six and seven. In December 1999, the Company obtained the distribution rights to market four pharmaceutical products in the Philippines from a large pharmaceutical customer in exchange for providing certain commercialization services amounting to approximately $5.1 million during the two-year period ending December 31, 2001. As of March 31, 2002, the Company has capitalized 251.8 million philippino pesos (approximately $4.9 million) related to these commercialization rights, and is amortizing these costs over seven years. Under the terms of the agreement, the customer has the option to reacquire the rights to the four products from the Company after seven years for a price to be determined at the exercise date. In January 2001, the Company entered into an agreement with Scios Inc. ("SCIO") to market Natrecor(R) for acute congestive heart failure in the United States and Canada. Under the terms of the agreement, the Company agreed to provide $30 million in funding over a two and one-half year period for sales and marketing activities following product launch, of which $13.75 million has been funded by the Company as of March 31, 2002. The Company also received warrants to purchase 700,000 shares of SCIO's common stock at $20 per share, exercisable in installments over two and one-half years. In addition to receiving payments on a fee for service basis for providing commercialization services, the Company will receive royalties based on net sales of the product from 2002 through 2008. The royalty payments are subject to minimum and maximum amounts of $50 million and $65 million, respectively, over the life of the agreement. In June 2001, the Company entered into an agreement with Pilot Therapeutics, Inc.'s ("PLTT") to commercialize a natural therapy for asthma, AIROZIN(TM), in the United States and Canada. Under the terms of the agreement, the Company will provide commercialization services for AIROZIN(TM) and a milestone-based $6 million line of credit which is convertible into PLTT's common stock, of which $4 million was funded by the Company as of March 31, 2002. Further, the Company has committed to funding 50% of sales and marketing activities for AIROZIN(TM) over five years with a $6 million limit per year. Following product approval and launch, the Company will receive royalties based on the net sales of AIROZIN(TM). The royalty percentage will vary to allow the Company to achieve a minimum rate of return. In December 2001, the Company entered into an agreement with Discovery Laboratories, Inc. ("DSCO") to commercialize, in the United States, DSCO's humanized lung surfactant, Surfaxin(R), which is currently in Phase III studies. Under the terms of the agreement, the Company acquired 791,905 shares of DSCO's common stock and a warrant to purchase 357,143 shares of its common stock at $3.48 per share for a total of $3 million, and has agreed to make available a line of credit up to $10 million for pre-launch commercialization services as certain milestones are achieved by DSCO. In addition, the Company will receive additional warrants to purchase approximately 38,000 shares of DSCO common stock at an exercise price of $3.03 per share for each million dollars made available by the Company under the line of credit as milestones are achieved. The Company has agreed to fund the sales and marketing activities of this product up to $10 million per year for seven years. In return, the Company will receive commissions based on net sales of Surfaxin(R) for meconium aspiration syndrome, infant respiratory distress syndrome and all "off-label" 7 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES uses for 10 years. In December 2001, the Company acquired the license to market SkyePharma's Solaraze(TM) skin treatment in the United States, Canada and Mexico for 15 years from Bioglan Pharma Plc for a total consideration of $26.7 million. The Company will amortize the rights ratably over 15 years. The Company has a commitment to pay royalties to SkyePharma based on a percentage of net sales of Solaraze(TM). Pursuant to the license, the Company may pursue additional indications for the compound, which will be facilitated through the Company's ownership rights in the Solaraze(TM) New Drug Application and Investigational New Drug. In March 2002, the Company acquired certain assets of Bioglan Pharma, Inc. ("Bioglan") for a total consideration of approximately $26.4 million. The assets included distribution rights to market ADOXA(TM) in the United States for 10 years along with other products and product rights that Bioglan had previously marketed, as well as approximately $1.6 million in cash. Under the purchase method of accounting, the results of operations of Bioglan are included in the Company's results of operations as of March 22, 2002 and the assets and liabilities of Bioglan were recorded at their respective fair values. The fair values are preliminary and are subject to refinement as information relative to the fair values as of March 22, 2002 becomes available. The acquisition did not have a material impact on the financial position or results of operations for the Company. The acquisition resulted in total goodwill and intangible assets of $26.0 million. The Company will amortize the rights ratably over the lives of these products. Under certain of the contracts acquired, the Company has commitments to pay royalties based on a percentage of net sales of the acquired products. In January 2002, the Company entered into an agreement with Kos Pharmaceuticals, Inc. ("KOSP") to commercialize, in the United States, KOSP's treatments for cholesterol disorders, Advicor(R) and Niaspan(R). Advicor(R) was launched in January 2002 and Niaspan(R) is also on the market. Under the terms of the agreement, the Company will provide a dedicated sales force of 150 cardiovascular-trained representatives who, in combination with KOSP's sales force of 300 representatives, will commercialize Advicor(R) and Niaspan(R) for two years. In return, the Company also received warrants to purchase 150,000 shares of KOSP's common stock at $32.79 per share, exercisable in installments over two years. Further, the Company will receive commissions based on net sales of the product from 2002 through 2006. The commission payments are subject to minimum and maximum amounts of $45 million and $75 million, respectively, over the life of the agreement. During the first quarter of 2002, the Company has entered into a letter of intent with a large pharmaceutical customer to market four pharmaceutical products within Europe. The Company will provide sales and marketing resources over five years in return for a royalty on the sales of the products above certain baselines. In addition to a minimal royalty on the baseline sales targets for these products, the Company is entitled to receive a share of incremental net sales above these baselines. Revenues are recognized as they are earned under the terms of the letter of intent. The Company currently estimates that the projected incremental revenue will exceed the operating costs of this arrangement and, therefore, has deferred approximately $0.9 million in direct operating costs. If the projected incremental sales for these products do not exceed the operating costs, the Company will recognize the deferred costs through earnings in the period it becomes reasonably estimable. 8 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES The Company has firm commitments under the above arrangements, excluding the letter of intent discussed in the preceding paragraph for which the commitments are not finalized, to provide funding of approximately $117.5 million in exchange for various commercial rights. As of March 31, 2002, the Company has funded approximately $65.7 million of these commitments. Further, the Company has future funding commitments that are contingent upon satisfaction of certain milestones being met by the third party such as receiving the United States Food and Drug Administration ("FDA") approval, obtaining funding from additional third parties, agreement of a marketing plan and other similar milestones. Due to the uncertainty of the amounts and timing, these contingent commitments are not included in the commitment amounts. Below is a summary of the remaining commitments with pre-determined payment schedules under such arrangements (in thousands): Commitments ----------- 2002 $ 28,511 2003 23,300 ----------- $ 51,811 =========== 3. Investments - Marketable Equity Securities The Company has entered into financial arrangements with various customers and other parties in which the Company provides funding in the form of an equity investment. The equity investments may be subject to certain trading restrictions including "lock-up" agreements. The Company's portfolio in such transactions as of March 31, 2002 is as follows (in thousands except share data): Number of Cost Fair Market Company Trading Symbol Shares Basis Value ------- -------------- ------ ----- ----- Common Stock: CV Therapeutics, Inc. CVTX 581,705 $ 2,833 $ 21,058 The Medicines Company MDCO 2,059,221 8,978 29,364 Triangle Pharmaceuticals Inc. VIRS 3,775,000 15,029 19,253 Other 5,024 6,760 ------- -------- Total Marketable Equity Securities $31,864 $ 76,435 ======= ======== The Company may from time to time acquire equity instruments of companies in which a current market value is not readily available. As such, these investments are included in the Investments - Non-marketable Equity Securities and Loans. 9 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 4. Investments - Non-marketable Equity Securities and Loans The Company has entered into financial arrangements with various customers and other parties in which the Company provides funding in the form of an equity investment in non-marketable securities or loans. These financial arrangements are comprised of direct and indirect investments. The indirect investments are made through six venture capital funds in which the Company is an investor. The Company's portfolio in such transactions as of March 31, 2002 is as follows (in thousands): Remaining Funding Company Cost Basis Commitment ------- ---------- ---------- Venture capital funds $ 21,224 $ 21,237 Equity investments (eight companies) 11,547 -- Convertible loans (five companies) 7,403 2,600 Loans (two companies) -- 20,000 -------- -------- Total non-marketable equity securities and loans $ 40,174 $ 43,837 ======== ======== Below is a table representing management's best estimate as of March 31, 2002 of the amount and timing of the above commitments (in thousands): Total ----- 2002 $ 20,505 2003 18,332 2004 5,000 ---------- $ 43,837 ========== The Company also has future loan commitments that are contingent upon satisfaction of certain milestones by the third party such as receiving FDA approval, obtaining funding from additional third parties, agreement of a marketing plan and other similar milestones. Due to the uncertainty of the amounts and timing, these contingent commitments are not included in the commitment amounts described above. The Company has determined that it is not practicable at each reporting date to estimate the fair value of its investments in non-marketable equity securities. 5. Goodwill and Identifiable Intangible Assets On January 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." As such, all goodwill and indefinite-lived intangible assets are no longer amortized but reviewed at least annually for impairment. Other intangible assets continue to be amortized over their useful lives. During the second quarter of 2002, the Company will perform the required impairment tests and therefore, as of March 31, 2002 has not yet assessed the impact of any impairment under these tests. 10 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES As of March 31, 2002, the Company had approximately $169.7 million of goodwill. Through December 2001, goodwill was amortized on a straight-line basis over periods from five to 40 years. The following is a summary of reported net income and net income per share, as adjusted to exclude goodwill amortization expense (in thousands, except per share amounts): Three Months Ended March 31, 2001 --------------------------------- Net income $ 7,791 Add: goodwill amortization 1,934 Less: income tax benefit (638) ------------ Adjusted net income $ 9,087 ============ Adjusted net income per share: Basic $ 0.08 Diluted 0.08 In accordance with SFAS No. 142, the Company has reclassed capitalized software and related accumulated amortization to other identifiable intangible assets from property and equipment for all periods presented. Identifiable assets consist primarily of software, which are amortized over the estimated useful life ranging from three to five years, and commercial rights, which are amortized ratably, based on estimated cash flows, over the life of the rights ranging from five to 15 years. Amortization expense associated with identifiable intangible assets was $6.0 million and $5.2 million for the three months ended March 31, 2002 and 2001, respectively. The following is a summary of identifiable intangible assets (in thousands):
As of March 31, 2002 As of December 31, 2001 ----------------------------------- ---------------------------------- Gross Accumulated Net Gross Accumulated Net Amount Amortization Amount Amount Amortization Amount -------- ------------ -------- -------- ------------ -------- Identifiable intangible assets: Software and related assets $157,377 $ 69,381 $ 87,996 $156,806 $ 63,938 $ 92,868 Commercial rights 51,228 2,384 48,844 33,475 2,344 31,131 -------- -------- -------- -------- -------- -------- $208,605 $ 71,765 $136,840 $190,281 $ 66,282 $123,999 ======== ======== ======== ======== ======== ========
Estimated amortization expense for existing identifiable intangible assets is approximately $25 million to $26.5 million per year for each of the years in the five-year period ended December 31, 2006, respectively. Estimated amortization expense will be affected by various factors including future acquisitions of product and/or commercial rights. 11 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 6. Stock Repurchase The Company was authorized by its Board of Directors to repurchase up to $100 million of the Company's Common Stock until March 1, 2002. On February 7, 2002, the Board of Directors extended this authorization until March 1, 2003. During the three months ended March 31, 2002, the Company entered into agreements to repurchase 290,000 shares of its Common Stock for an aggregate price of approximately $4.8 million. 7. Significant Customers One customer accounted for 12.8 % and 11.4% of consolidated gross service revenues less reimbursed service costs for the three months ended March 31, 2002 and 2001, respectively. The revenues were derived from the product development, commercial services and informatics groups. 8. Investment Revenues The following table is a summary of investment revenues for the three months ended March 31, 2002 and 2001(in thousands): Three months ended March 31 ------------------------------ 2002 2001 ------- ------- Marketable equity securities: Gross realized gains $ 4,724 $ -- Impairment losses -- (3,099) Non-Marketable equity securities and loans: Gross realized gains -- 2,197 Gross realized losses (400) -- Other 458 -- ------- ------- $ 4,782 $ (902) ======= ======= 12 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 9. Restructuring Charge 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. Of the approximately 1,000 positions to be eliminated under this plan, 749 individuals have been terminated as of March 31, 2002. Activity during the first three months of 2002 was as follows for the 2001 restructuring plan (in thousands): Balance at Write-Offs/ Balance at December 31, 2001 Payments March 31, 2002 ----------------- ----------- -------------- Severance and related costs $ 19,323 $ (6,060) $13,263 Exit costs 8,806 (1,264) 7,542 -------- -------- ------- $ 28,129 $ (7,324) $20,805 ======== ======== ======= The Company adopted a restructuring plan in January 2000 ("January 2000 Plan") and a follow-on restructuring plan which resulted in the recognition of a restructuring charge of $58.6 million. During the third quarter of 2001, the Company recognized an additional restructuring charge of approximately $1.1 million as a revision of an estimate to the January 2000 Plan. Of the approximately 990 positions that were to be eliminated under these plans, 916 positions have been terminated as of March 31, 2002, which includes 770 positions under the January 2000 Plan. Activity during the first three months of 2002 was as follows for the 2000 restructurings (in thousands): Balance at Write-Offs/ Balance at December 31, 2001 Payments March 31, 2002 ----------------- ----------- -------------- Severance and related costs $ 894 $ (312) $ 582 Exit costs 1,714 (778) 936 -------- -------- ------- $ 2,608 $ (1,090) $ 1,518 ======== ======== ======= As a result of the restructuring plans, the Company has approximately 500,000 square feet of abandoned leased facilities as of March 31, 2002. A portion of these facilities has been subleased and the Company is pursuing disposition of the remaining abandoned facilities. Below is a summary of the total lease obligations for the abandoned facilities (in thousands): Remainder of 2002 $ 6,768 2003 6,229 2004 3,782 2005 2,818 2006 2,712 Thereafter 6,515 --------- Gross abandoned lease obligations 28,824 Less: sublease/restructuring (12,000) --------- Total obligation in excess of subleases and related restructuring accrual balances $ 16,824 ========= 13 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 10. 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 March 31 --------------------------- 2002 2001 ---- ---- Weighted average shares: Basic weighted average shares 118,685 116,338 Effect of dilutive securities: Stock options 1,542 3,726 ------- ------- Diluted weighted average shares 120,227 120,064 ======= ======= Options to purchase approximately 14.4 million shares of the Company's Common Stock were outstanding during the three months ended March 31, 2002, but were not included in the computation of diluted net income per share because the option's exercise price was greater than the average market price of the Company's Common Stock and, therefore, the effect would be antidilutive. 11. Comprehensive Income The following table represents the Company's comprehensive income for the three months ended March 31, 2002 and 2001, respectively (in thousands): Three Months Ended March 31 --------------------------- 2002 2001 ---- ---- Net income $ 17,261 $ 7,791 Other comprehensive income (loss): Unrealized gain (loss) on marketable securities, net of income taxes 1,650 (82,964) Reclassification adjustment, net of income taxes (3,153) -- Foreign currency adjustment (7,786) (13,946) -------- --------- Comprehensive income (loss) $ 7,972 $ (89,119) ======== ========= 14 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 12. Segments The following table presents the Company's operations by reportable segment. The Company is managed through four reportable segments, namely, the product development group, the commercial services group, the informatics group and the PharmaBio 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 and outcomes research consulting. The commercial services 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 PharmaBio group is primarily responsible for facilitating non-traditional customer alliances and consists primarily of product revenues, royalties and commissions and investment revenues relating to the financial arrangements with customers and other third parties. During 2002, the Late Phase, primarily Phase IV, operations included in the commercial services group were reclassified to the product development group in order to consolidate the operational and business development activities. These changes are reflected in all periods presented. The Company does not include general and administrative expenses, depreciation and amortization except amortization of commercial rights, interest income (expense), other income (expense) and income tax expense (benefit) in segment profitability. Significant intersegment revenues have been eliminated. (In thousands)
Three months ended March 31, 2002 ---------------------------------------------------------------------------------------- Product Commercial Development Services Informatics PharmaBio Eliminations Consolidated ----------- ---------- ----------- --------- ------------ ------------ Net services: External $ 230,457 $ 136,020 $ 12,690 $ -- $ -- $ 379,167 Intersegment -- 11,212 -- -- (11,212) -- ----------- ---------- ----------- --------- ------------ ------------ Total net services 230,457 147,232 12,690 -- (11,212) 379,167 Commercial rights and royalties -- -- -- 14,194 -- 14,194 Investment -- -- -- 4,782 -- 4,782 ----------- ---------- ----------- --------- ------------ ------------ Total net revenues $ 230,457 $ 147,232 $ 12,690 $ 18,976 $ (11,212) $ 398,143 =========== ========== =========== ========= ============ ============ Contribution $ 112,413 $ 50,768 $ 4,470 $ 4,540 $ -- $ 172,191 =========== ========== =========== ========= ============ ============ Three months ended March 31, 2001 ---------------------------------------------------------------------------------------- Product Commercial Development Services Informatics PharmaBio Eliminations Consolidated ----------- ---------- ----------- --------- ------------ ------------ Net services: External $ 225,242 $ 161,117 $ 15,464 $ -- $ -- $ 401,823 Intersegment -- -- -- -- -- -- ----------- ---------- ----------- --------- ------------ ------------ Total net services 225,242 161,117 15,464 -- -- 401,823 Commercial rights and royalties -- -- -- 2,647 -- 2,647 Investment -- -- -- (902) -- (902) ----------- ---------- ----------- --------- ------------ ------------ Total net revenues $ 225,242 $ 161,117 $ 15,464 $ 1,745 $ -- $ 403,568 =========== ========== =========== ========= ============ ============ Contribution $ 105,069 $ 50,305 $ 7,543 $ (845) $ -- $ 162,072 =========== ========== =========== ========= ============ ============
15 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 13. Recently Adopted Accounting Pronouncements In July 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment on Disposal of Long-Lived Assets." This statement supersedes SFAS No. 121, "Accounting for 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 Company adopted SFAS No. 144 as required to do so on January 1, 2002. The adoption of SFAS No. 144 did not have a material impact on the Company's results of operations and financial position. In November 2001, the Emerging Issues Task Force ("EITF") released EITF Issue 01-14, "Income Statement Characterization of Reimbursements Received for "Out-of-Pocket" Expenses Incurred," requiring companies to report reimbursed costs as part of gross revenues. The Company adopted the provisions of EITF 01-14 as required to do so on January 1, 2002 and, as such, reimbursed service costs have been reclassified to gross service revenues for all periods presented. However, it was impracticable to identify and reclassify certain prior period commercialization reimbursed service costs and, accordingly, historical results have not been restated for these costs. During the quarter ended March 31, 2002, these commercialization reimbursed service costs totaled approximately $19.6 million. 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, as amended, and Section 21E of the Securities Act of 1934, as amended. Forward looking statements represent our judgment 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," "estimate," "believe," "continue," or "target" 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, our ability to 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 customer contracts or to enter into new contracts, changes in trends in the pharmaceutical industry, the risk that our PharmaBio transactions will not generate revenues, profits or return on investment at the rate or levels we expect, risks associated with entering into a new line of business such as those being entered into by PharmaBio, the risk that our informatics business will not be able to operate as expected using new and multiple data sources, the risk that our proposed joint venture with McKesson Corporation relating to the informatics business will not be consummated, or if consummated, will not be successful, liability risks associated with our business which could result in losses 16 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES or indemnity to others not covered by insurance and risks associated with data use and use of our data products which are regulated by state and federal laws and contracts. See "Risk Factors" below for additional factors that could cause actual results to differ. Results of Continuing Operations Three Months Ended March 31, 2002 and 2001 ------------------------------------------ Gross service revenues, which are total service fees accrued to our customers including reimbursed service costs, for the first quarter of 2002 were $474.3 million versus $463.3 million for the first quarter of 2001. Reimbursed service expenses, which are pass-through expenses that are to be reimbursed by our customers, were $95.2 million for the first quarter of 2002 as compared to $61.4 million for the first quarter of 2001. We adopted Emerging Issues Task Force Issue 01-14 on January 1, 2002, as required. This new accounting guidance requires us to report reimbursed service costs as part of gross service revenues. Our reimbursed service costs include such items as payments to investigators and travel expenses for our clinical monitors and sales representatives. Historically, we have not reported these reimbursed service costs as service revenues since we do not earn a profit on these costs. In accordance with this new accounting guidance, we have reclassified reimbursed service costs to gross service revenues for all periods presented. However, it was impracticable to identify and reclassify certain prior period commercialization reimbursed service costs and, accordingly, historical results have not been restated for these costs. During the first quarter of 2002, these commercialization reimbursed service costs totaled approximately $19.6 million. Gross service revenues accrued to our customers less reimbursed service costs, or net service revenues, for the first quarter of 2002 were $379.2 million, a decrease of $22.7 million or 5.6% over the first quarter of 2001 net service revenues of $401.8 million. However, there was a negative impact of approximately $12.0 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; therefore, using a constant exchange rate for each period, net service revenues decreased $10.7 million or (2.7%). Net service revenues increased in the Asia Pacific region $7.5 million or 21.9% to $41.9 million. Net service revenues decreased $29.0 million or (13.4%) to $187.5 million in the Americas region primarily as a result of the decline in the commercial services group and $1.2 million or (0.8%) to $149.8 million in the Europe and Africa region as a result of a negative impact of $7.6 million due to the effect of foreign currency fluctuations. Commercial rights and royalties revenues, which include product revenues, royalties and commissions, for the first quarter of 2002 were $14.2 million, an increase of $11.5 million over the first quarter of 2001 commercial rights and royalties revenues of $2.6 million. These revenues include products for which we have acquired the rights, such as the dermatology products, Solaraze(TM) and ADOXA(TM). Also included are product revenues that we receive in exchange for providing commercial or product development services. The $11.5 million increase is primarily the result of our contracts with Scios Inc. and Kos Pharmaceuticals, Inc. Investment revenues, which include gains and losses on the sale of equity securities and impairment of investment instruments, for the first quarter of 2002 were $4.8 million versus a loss of $902,000 for the first 17 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES quarter of 2001. The first quarter of 2001 included a $3.1 million impairment loss on securities whose decline in fair value was other than temporary. Total net revenues decreased $5.4 million or (1.3%) to $398.1 million for the first quarter of 2002 from $403.6 million for the first quarter of 2001. Service costs, which include compensation and fringe benefits for billable employees, and other expenses directly related to service contracts, were $211.5 million or 55.8% of net service revenues for the first quarter of 2002 versus $238.9 million or 59.5% of net service revenues for the first quarter of 2001. This reduction is primarily a result of the continued effect of our process enhancements and cost reduction efforts. Commercial rights and royalties costs, which include compensation and related fringe benefits for employees, amortization of commercial rights, infrastructure costs of the PharmaBio group and other expenses directly related to commercial rights and royalties, were $14.3 million versus $2.6 million for the first quarter of 2001. These costs include services and products provided by third parties, as well as services provided by our other service groups, totaling approximately $11.2 million for the first quarter of 2002. The profit for these internal services is reported within the service group providing the services. The first quarter of 2002 also includes costs to launch and market Solaraze(TM) and ADOXA(TM). Investment costs, which include costs directly related to direct and indirect investments in our customers or other third parties as part of the financing arrangements, were $158,000 for the first quarter of 2002 versus $30,000 for the first quarter of 2001. Revenue less associated direct costs, or contribution, was $172.2 million or 43.2% of total net revenues for the first quarter of 2002 versus $162.1 million or 40.2% of total net revenues for the first quarter of 2001. General and administrative expenses, which include compensation and fringe benefits for administrative employees, non-billable travel, professional services, and expenses for advertising, information technology and facilities, were $127.2 million or 32.0% of total net revenues for the first quarter of 2002 versus $134.5 million or 33.3% of total net revenues for the first quarter of 2001. General and administrative expenses decreased $7.3 million primarily due to the effects of reductions relating to our restructurings. Depreciation and amortization, which include depreciation of our property and equipment, and amortization of our definite-lived intangible assets except commercial rights, decreased to $21.4 million for the first quarter of 2002 versus $22.4 million for the first quarter of 2001. This decrease is primarily due to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," which requires all goodwill and indefinite-lived intangible assets no longer be amortized but reviewed at least annually for impairment. Net interest income, which represents interest income received from bank balances and investments in debt securities net of interest expense incurred on lines of credit, notes and capital leases, was $3.3 million for the 18 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES first quarter of 2002 versus $5.8 million for the first quarter of 2001. The $2.6 million decrease was due to a decline in interest rates. Other expense was $1.1 million for the first quarter of 2002 versus other income of $618,000 for the first quarter of 2001. The $1.7 million variation was a result of several factors, including effects of foreign currency translations, disposal of assets and transaction costs associated with the pending joint venture with McKesson Corporation. Income before income taxes was $25.8 million or 6.5% of total net revenues for the first quarter of 2002 versus $11.6 million or 2.9% of total net revenues for the first quarter of 2001. The effective income tax rate was 33.0% for the first quarter of 2002 and 2001, respectively. Since we conduct operations on a global basis, our effective income tax rate may vary. Analysis by Segment: During the three months ended March 31, 2002, we transferred the portion of the operations of our Late Phase, primarily Phase IV, clinical group that was in the commercial services group to the product development group. All historical information presented has been restated to reflect this change. The following table summarizes the operating activities for our four reportable segments for the three months ended March 31, 2002 and 2001, respectively. We do not include general and administrative expenses, depreciation and amortization except amortization of commercial rights, interest income (expense), other income (expense) and income tax expense (benefit) in our segment analysis. Significant intersegment revenues have been eliminated, (dollars in millions). Total Net Revenues Contribution ------------------------- --------------------------------- % of Net % of Net 2002 2001 Growth % 2002 Revenues 2001 Revenues ------- ------- -------- ------- -------- ------- -------- Product development $ 230.5 $ 225.2 2.3% $ 112.4 48.8% $ 105.1 46.6% Commercial services 147.2 161.1 (8.6) 50.8 34.5 50.3 31.2 Informatics 12.7 15.5 (17.9) 4.5 35.2 7.5 48.8 PharmaBio 19.0 1.7 987.4 4.5 23.9 (0.8) (48.4) Eliminations (11.2) -- -- -- -- -- -- ------- ------- -------- ------- -------- ------- -------- $ 398.1 $ 403.6 (1.3%) $ 172.2 43.2% $ 162.1 40.2% The product development group's financial performance improvement was a result of several factors, including an increase in revenues and the continued effect of process enhancements. The commercial services group's financial performance was negatively impacted by difficult business conditions for large fee-for-service contracts in the United States, as well as the completion of several contracts in the United States. This trend is anticipated to continue into the next quarter. The negative impact was offset by the effects of our cost reduction efforts. 19 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES The informatics group's performance was negatively impacted by the pending transaction to transfer this group into a joint venture with McKesson Corporation. We are targeting this transaction to be completed during the second quarter of 2002. The PharmaBio group's increase in net revenues, which consist of commercial rights and royalties and investments, was primarily the result of our contracts with Scios Inc. and Kos Pharmaceuticals, Inc. This group was negatively impacted by the costs associated with the launch and marketing of Solaraze(TM) and ADOXA(TM). We believe the costs of marketing these products will exceed the revenues during the first year. Liquidity and Capital Resources Cash and cash equivalents were $579.6 million at March 31, 2002 as compared to $565.1 million at December 31, 2001. Cash from operations were $55.1 million for the three months ended March 31, 2002 versus $60.4 million for the comparable period of 2001. Included in cash provided by operations for the three months ended March 31, 2001 was an income tax refund of $47.6 million. Investing activities consisted primarily of capital asset purchases. Capital asset purchases required an outlay of cash of $10.7 million for the three months ended March 31, 2002 compared to an outlay of $24.0 million for the same period in 2001. On March 22, 2002, we acquired certain assets of Bioglan, including approximately $1.6 million in cash, for approximately $26.4 million. As part of the agreement, we also acquired Bioglan's rights to certain dermatology products already on the market in the United States, including ADOXA(TM). The following table is a summary of our net service receivables outstanding (in thousands, except days): March 31, 2002 December 31, 2001 -------------- ----------------- Trade service accounts receivable $ 240,992 $ 258,917 Unbilled services 155,658 166,754 Unearned income (203,016) (205,783) --------- --------- Net service receivables outstanding $ 193,634 $ 219,888 ========= ========= Number of days of service revenues outstanding 37 43 The decrease in the number of days of service revenues outstanding is a result of our continued focus on the fundamentals of our business and efficiencies generated by our shared service centers. Investments in debt securities were $37.2 million at March 31, 2002 as compared to $37.0 million at December 31, 2001. Our investments in debt securities consist primarily of U.S. Government Securities, which are callable by the issuer at par, and money funds. Investments in marketable equity securities at March 31, 2002 were $76.4 million, a decrease of $1.6 million, as compared to $78.0 million at December 31, 2001. This decrease is due primarily to sales of marketable equity securities partially offset by unrealized gains on the portfolio as a result of stock price increases and purchases. 20 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Investments in non-marketable equity securities and loans at March 31, 2002 were $40.2 million, an increase of $2.6 million, as compared to $37.6 million at December 31, 2001. We have available to us a (pound)10.0 million (approximately $14.3 million) unsecured line of credit and a (pound)1.5 million (approximately $2.1 million) general banking facility with a U.K. bank. At March 31, 2002, we did not have any outstanding balances on these facilities. In March 2001, the Board of Directors authorized us to repurchase up to $100 million of our common stock until March 1, 2002. In February 2002, the Board extended this authorization until March 1, 2003. During the first three months of 2002, we entered into agreements to repurchase 290,000 shares for an aggregate price of $4.8 million. Shareholders' equity at March 31, 2002 was $1.460 billion versus $1.455 billion at December 31, 2001. Based on our current operating plan, we believe that our available cash and cash equivalents, 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. In addition, as part of our business strategy going forward, we intend to review and consider opportunities to acquire additional product rights, as appropriate. 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. 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 21 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 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 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 currently 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 customers away from our services. 22 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Our ability to provide informatics services depends on agreements with third parties to access healthcare data. In order to provide our informatics 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 services agreement with WebMD to continue to provide us with the ENVOY data, as well as other data collected by WebMD. On February 24, 2001, WebMD unilaterally stopped the transmission of data to us in violation of our rights under the data rights agreement which resulted in litigation. 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 continued to receive healthcare data from WebMD, but only through February 28, 2002. While we have been able to secure agreements for similar data from alternate sources, we cannot assure you that access to such data will not be more costly than in the past or that we will have continuous access to the data that we need to support our informatics products. Furthermore, we must aggregate the volume of data from a variety of sources, and we do not have a track record for being able to process and use the data we receive from different sources effectively. On March 15, 2002, we entered into a joint venture agreement with McKesson Corporation pursuant to which we agreed to form a joint venture company designed to leverage the operational strengths of the healthcare information business of each company. Several major data providers are to contribute de-identified prescription and medical data to the joint venture company. There can be no assurances, however, that any of the data providers with which we currently are in discussions will join the joint venture company or otherwise provide data to the joint venture company. If continued access to data is not available on acceptable terms, our informatics 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. The consummation of our proposed joint venture with McKesson may not occur and, if consummated, the joint venture may not succeed. The consummation of our joint venture with McKesson may not occur and, even if consummated, the joint venture's success will be subject to the risks of our informatics business as well as new risks applicable to its operation as a stand-alone entity. The proposed joint venture with McKesson is important to our business and, if the transaction fails to close or the closing is delayed, we may not be able to derive the benefits we hoped to achieve by leveraging our informatics business with outside resources. If the conditions to closing are not satisfied or the agreement is otherwise terminated prior to closing, we will continue to own our informatics business and be subject to the risks associated with that business. If the joint venture company is formed as contemplated, we may not achieve the intended benefits of the joint venture if it is not able to secure additional data in exchange for equity. Although we and McKesson currently are in discussions with several major data providers to participate in the joint venture company, it is possible that these or other data providers will prefer to receive cash as payment for data, instead of equity in the joint 23 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES venture company, or will not want to participate at all. Such a trend could have a material adverse effect on the joint venture's operations and financial condition. The joint venture also could encounter other difficulties, including: o its ability to aggregate the volume of data received from data providers; o its ability to attract customers, besides Quintiles and McKesson, to purchase its products and services; o the risk of changes in healthcare information privacy regulations that could have an adverse impact on the joint venture's operations; o the risk that it will not be able to effectively and cost-efficiently replace services previously provided to the contributed businesses by the former parent corporations; and o other risks currently faced by our informatics business and described elsewhere in these risk factors. Although we will have a license to the joint venture company's data products for use by our product development and commercial services groups, if the joint venture is unable to provide us with the quality and character of data products that we need to support those services, we will not be able to fully realize the benefits of the joint venture and will need to seek other strategic alternatives to achieve our goals. Also, if the joint venture company is not successful, it could have a material adverse effect on our results of operation and financial condition because it is a pass-through entity and, as such, its results will be reflected in our financial statements to the extent of our interest in the joint venture. 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, over the past two years 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. Underperformace of our commercial rights strategies could have a negative impact on our financial performance. As part of our PharmaBio Development business 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 24 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 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 customer or its 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. Our rights to market and sell certain pharmaceutical products expose us to product risks typically associated with pharmaceutical companies. Our recent acquisition of the rights to market and sell Solaraze(TM) and the rights to other dermatology products acquired from Bioglan, as well as any other product rights we may hold at any time, subject us to a number of risks typical to the pharmaceutical industry. For example, we could face product liability claims in the event users of these products, or of any other pharmaceutical product we may license in the future, experience negative reactions or adverse side effects or in the event it causes injury, is found to be unsuitable for its intended purpose or is otherwise defective. While we believe we currently have adequate insurance in place to protect against these risks, we may nevertheless be unable to satisfy any claims for which we may be held liable as a result of the use or misuse of products which we manufacture or sell, and any such product liability claim could adversely affect our business, operating results or financial condition. In addition, like pharmaceutical companies, our commercial success in this area will depend in part on our obtaining, securing and defending our intellectual property rights covering our pharmaceutical products. These risks may be augmented by certain risks relating to our outsourcing of the manufacturing and distribution of these products or any pharmaceutical product we may license in the future. For example, as a result of our decision to outsource the manufacturing and distribution of Solaraze(TM), we are unable to directly monitor quality control in the manufacturing and distribution processes. Our plans to market and sell Solaraze(TM) and other pharmaceutical products also subject us to risks associated with entering into a new line of business. We have limited experience operating in this line of business. If we are unable to operate this new line of business as we expect, the financial results from this new line of business could have a negative impact on our results of operations as a whole. The risk that our results may be affected if we are unable to successfully operate our pharmaceutical operations may increase in proportion with (1) the number of products we license in the future, (2) the applicable stage of the drug approval process of the products and (3) the levels of outsourcing involved in the development, manufacture and commercialization of such products. 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 J. 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 25 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 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. Similar risks apply to our product development services relating to medical devices. 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. For example, we are among the defendants named in a purported class action by participants in an Alzheimer's study seeking to hold us liable for alleged damages to the participants arising from the study. 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. Although, we maintain insurance to cover ordinary risks, insurance would not cover the risk of a customer deciding not to do business with us as a result of poor performance. 26 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Our insurance may not cover all of our indemnification obligations and other liabilities associated with our operations. We maintain insurance designed to cover ordinary risks associated with our operations and our ordinary indemnification obligations. This insurance might not be adequate coverage or may be contested by our carriers. For example, our insurance carrier, to whom we paid premiums to cover risks associated with our product development services, has filed suit against us seeking to rescind the insurance policies or to have coverage denied for some or all of the claims arising from class action litigation involving an Alzheimer study. The availability and level of coverage provided by our insurance could have a material impact on our profitability if we suffer uninsured losses or are required to indemnify third parties for uninsured losses. 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 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 27 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 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 U.S. federal regulations. In recent litigation, a party took the position that various state laws could be construed to require modifications to access specifications for particular data elements in de-identified health information that we receive. These laws or further changes to existing laws having similar effects could limit our ability to offer some of our products or have an impact on the business opportunities 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 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 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%, except that this limitation does not apply to indemnity obligations we may have to WebMD arising from the sale of ENVOY, including a class action lawsuit filed against ENVOY prior to its purchase by us and subsequent sale to WebMD. 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. 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: o enhance our existing services; o introduce new services on a timely and cost-effective basis to meet evolving customer requirements; o integrate new services with existing services; o achieve market acceptance for new services; and o respond to emerging industry standards and other technological changes. 28 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Exchange rate fluctuations may affect our results of operations and financial condition. We derive a large portion of our net revenue from international operations. 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. 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 March 31, 2002. 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 12.8% of our net service revenues for the three months ended March 31, 2002. These revenues resulted from services provided by the product development, commercial services and informatics 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 (April 14, 2004 for small health plans). 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 on March 27, 2002 issued a proposed modification to the privacy rule (NPRM). 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 29 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES 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 customers during the FDA approval process could be adversely affected. If we were unable to submit electronic records to the United States Food and Drug Administration, also referred to as the FDA, according to FDA regulations, our ability to service our customers during the FDA approval process could be adversely affected. 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, 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 Disclosure about Market Risk The Company did not have any material changes in market risk from December 31, 2001. 30 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES PART II. Other Information Item 1. Legal Proceedings 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 January 22, 2002, Federal Insurance Company and Chubb Custom Insurance Company filed suit against us and two of our subsidiaries, Quintiles Pacific, Inc. and Quintiles Laboratories Limited, in the United States District Court for the Northern District of Georgia. In the suit, Chubb, our primary commercial general liability carrier, and Federal, our excess liability carrier, seek to rescind the policies issued to us for coverage years 2000-2001 and 2001-2002 based on an alleged misrepresentation by us on our policy application. We deny these allegations; contending that the information was material to their determination to accept the risk of coverage. Alternatively, Chubb and Federal seek a declaratory judgment that there is no coverage under the policies for some or all of the claims asserted against us and our subsidiaries in the litigation described in the prior paragraph, and, if one or more of such claims is determined to be covered, Chubb and Federal request an allocation of the defense costs between the claims they contend are covered and non-covered claims. We believe these allegations are without merit and intend to defend this case vigorously. We are also a party to 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 other 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 March 31, 2002, options to purchase 9,000 shares of our common stock were exercised at an average exercise price of $3.0525 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 31 QUINTILES TRANSNATIONAL CORP. AND SUBSIDIARIES Item 5. Other Information - Not applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - Not applicable (b) During the three months ended March 31, 2002, the Company filed or furnished two reports on Form 8-K. The Company filed a Form 8-K, dated January 23, 2002, including its press release announcing the Company's earnings information for the period ended December 31, 2001. The Company furnished a Form 8-K to the Securities and Exchange Commission, dated March 5, 2002, disclosing that the Board of Directors approved an extension of the Company's share repurchase program through March 1, 2003. Under the repurchase program, the Company is authorized to repurchase up to $100 million of its Common Stock. The report on Form 8-K dated, March 5, 2002 was furnished pursuant to Regulation FD. This report shall not be deemed to be incorporated by reference into this Form 10-Q or filed hereunder for purposes of liability under the Securities Exchange Act of 1934. No other reports on Form 8-K were filed or furnished during the three months ended March 31, 2002. 32 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 May 10, 2002 /s/ Dennis B. Gillings -------------------- ----------------------------------------- Dennis B. Gillings, Chairman Date May 10, 2002 /s/ Pamela J. Kirby --------------------- ----------------------------------------- Pamela J. Kirby, Chief Executive Officer Date May 10, 2002 /s/ James L. Bierman --------------------- ----------------------------------------- James L. Bierman, Chief Financial Officer 33