Statements of Cash Flows
- Cash flows related to excess tax benefits are no longer separately classified as a financing activity apart from other income tax cash flows. The Company adopted this component of the standard on a prospective basis.
Earnings Per Share
- The Company uses the treasury stock method to compute diluted earnings per share, unless the effect would be anti-dilutive. Under this method, the Company is no longer required to estimate the tax rate and apply it to the dilutive share calculation for determining the dilutive earnings per share. The Company adopted this component of the standard on a prospective basis.
In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows Classification of Certain Cash Receipts and Cash Payments,” which clarifies existing guidance related to accounting for cash receipts and cash payments and classification on the statement of cash flows. In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash,” which requires restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption permitted. The guidance for both standards requires application using a retrospective transition method.
The Company early adopted both ASUs during the fourth quarter of 2016. As a result of the retrospective application of ASU No. 2016-15, $17.8 million of payments of debt prepayment and debt extinguishment costs originally recorded as operating cash outflows were reclassified to financing outflows in the consolidated condensed statement of cash flows for the three months ended March 31, 2016. The retrospective application of ASU No. 2016-18 resulted in restricted cash being reclassified as a component of cash, cash equivalents, and restricted cash in the consolidated condensed statement of cash flows for all periods presented.
Recently Issued
Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers.” The new revenue standard establishes a single revenue recognition model for recognizing contracts from customers. Under the new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has issued several amendments to the standard, including clarification on principal versus agent considerations, identifying performance obligations, and accounting for licenses of intellectual property.
The new standard is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The standard permits the use of either the retrospective or modified retrospective (cumulative effect) transition method.
The Company plans to adopt the new revenue guidance as of January 1, 2018 and is currently evaluating the transition methods and the potential impact to the its consolidated financial statements. The Company has established an implementation team that consists of both internal resources and external advisors to assist with the adoption of the new standard. During the first quarter of 2017, the Company completed its preliminary review of a representative sample of contracts from its contract portfolio and is currently evaluating and documenting the key qualitative judgments associated with the adoption of the new revenue standard. The evaluation and implementation process is ongoing and is expected to continue throughout 2017 as the Company performs an analysis on its contract portfolio to identify potential differences from its current accounting policies, and as it reviews the business processes, systems and controls required to support recognition and disclosure under the new standard.
In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which revises the accounting related to lessee accounting. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases with terms greater than 12 months. Leases will be classified as either finance or operating, with classification
(7) Long-Term Debt
Long-term debt consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
December 31,
|
|
|
|
2017
|
|
2016
|
|
Term loans, first lien
|
|
$
|
617,187
|
|
$
|
625,000
|
|
Senior notes
|
|
|
91,441
|
|
|
91,441
|
|
Accounts receivable financing agreement
|
|
|
120,000
|
|
|
120,000
|
|
|
|
|
828,628
|
|
|
836,441
|
|
Less debt issuances costs and discount
|
|
|
(7,746)
|
|
|
(8,139)
|
|
|
|
|
820,882
|
|
|
828,302
|
|
Less current portion
|
|
|
(35,156)
|
|
|
(31,250)
|
|
Total long-term debt, net
|
|
$
|
785,726
|
|
$
|
797,052
|
|
Principal payments on long-term debt are due as follows (in thousands):
|
|
|
|
|
2017 (remaining)
|
|
$
|
23,437
|
|
2018
|
|
|
46,875
|
|
2019
|
|
|
166,875
|
|
2020
|
|
|
62,500
|
|
2021
|
|
|
437,500
|
|
2022 and thereafter
|
|
|
91,441
|
|
Total
|
|
$
|
828,628
|
|
2016 Credit Facilities
As collateral for borrowings under the senior secured credit facilities, or 2016 Credit Facilities, the Company granted a pledge on primarily all of its assets, and the stock of wholly‑owned U.S. restricted subsidiaries. The Company is subject to certain financial covenants, which require the Company to maintain certain debt‑to‑EBITDA and interest expense-to-EBITDA ratios. The 2016 Credit Facilities also contain covenants that, among other things, restrict the Company’s ability to create any liens, make investments and acquisitions, incur or guarantee additional indebtness,
enter into mergers or consolidations and other fundamental changes, conduct sales and other dispositions of property or assets, enter into sale-leaseback transactions or hedge agreements, prepay subordinated debt, pay dividends or make other payments in respect of capital stock, change the line of business, enter into transactions with affiliates, enter into burdensome agreements with negative pledge clauses and clauses restriction, and make subsidiary distributions. After giving effect to the applicable restrictions on the payment of dividends under the 2016 Credit Facilities, subject to compliance with applicable law, as of March 31, 2017 and December 31, 2016, all amounts in retained earnings were free of restriction and were available for the payment of dividends. The Company does not expect to pay dividends in the foreseeable future. The Company does not expect these covenants to restrict its liquidity, financial condition or access to capital resources in the foreseeable future. The 2016 Credit Facilities also contains customary representations, warranties, affirmative covenants, and events of default. For the three months ended March 31, 2017, the weighted average interest rate on the first lien term loan was 2.75%.
Revolving Credit Facilities
The Company’s revolving credit facilities provide for $125.0 million of potential borrowings and expire on December 6, 2021. The interest rate on the revolving credit facilities is based on the LIBOR with a 0% LIBOR floor or ABR rate, at the election of the Company, plus an applicable margin, based on the leverage ratio of the Company. The Company, at its discretion, may elect interest periods of 1, 2, 3 or 6 months. The Company is required to pay to the lenders a commitment fee ranging from 0.2% to 0.4% based on the Company’s debt-to-EBITDA ratio. At March 31, 2017 and December 31, 2016, the Company had no outstanding borrowings under the revolving credit facilities. In addition, at March 31, 2017 and December 31, 2016, the Company had $3.7 million and $7.0 million, respectively, in letters of credit outstanding, which are secured by the revolving credit facilities.
Senior Notes
On March 17, 2016, the Company repaid $133.6 million aggregate principal amount of its 9.5% senior notes due 2023, or Senior Notes, as part of a cash tender offer. In accordance with the guidance in the FASB’s Accounting Standards Codification, or ASC, 470-50, "Debt—Modifications and Extinguishments," the debt repayment was accounted for as a partial debt extinguishment. The repayment resulted in a $21.5 million loss on extinguishment of debt, which consists of a $17.4 million early tender premium, a $3.7 million write-off of unamortized debt issuance costs and $0.4 million of fees associated with the transaction for the three months ended March 31, 2016.
The Senior Notes agreement contains certain provisions that restrict the payment of dividends from the Company’s subsidiaries to the parent company. As a result, there are no material balances present within the parent company that are available for the payment of dividends as the parent company did not have any net income during 2016 or the three months ended March 31, 2017, that was free of restrictions. The Company does not expect to pay dividends in the foreseeable future.
Accounts Receivable Financing Agreement
In March 2016, the Company entered into a $140.0 million accounts receivable financing agreement, of which $120.0 million was outstanding as of March 31, 2017 and December 31, 2016. The borrowings were used to repay amounts outstanding on the Company’s revolving credit facility that were used to fund the cash tender offer for the Senior Notes.
Loans under the accounts receivable financing agreement accrue interest at either a reserve-adjusted LIBOR or a base rate, plus 1.6%. The Company may prepay loans upon one business day prior notice and may terminate the accounts receivable financing agreement with 15 days’ prior notice. For the three months ended March 31, 2017, the weighted average interest rate on the accounts receivable financing agreement was 2.60%.
The accounts receivable financing agreement contains various customary representations and warranties and covenants, and default provisions which provide for the termination and acceleration of the commitments and loans under the agreement in circumstances including, but not limited to, failure to make payments when due, breach of representations, warranties or covenants, certain insolvency events or failure to maintain the security interest in the trade receivables, and defaults under other material indebtedness.
The accounts receivable financing agreement terminates on March 22, 2019, unless terminated earlier pursuant to its terms. At March 31, 2017 and December 31, 2016, there was $20.0 million of remaining capacity available under the accounts receivable financing agreement.
Fair Value of Debt
The estimated fair value of the Company’s debt was $837.7 million and $844.2 million at March 31, 2017 and December 31, 2016, respectively. The fair value of the Senior Notes, which totaled $100.5 million and $99.2 million at March 31, 2017 and December 31, 2016, respectively, was determined based on Level 2 inputs using the market approach, which is primarily based on rates at which the debt is traded among financial institutions. The fair value of the term loans, borrowings under credit facilities, and accounts receivable financing agreement which totaled $737.2 million and $745.0 million at March 31, 2017 and December 31, 2016, respectively, was determined based on Level 3 inputs, which is primarily based on rates at which the debt is traded among financial institutions adjusted for the Company's credit standing.
options during the three months ended March 31, 2016, which is included in transaction-related costs in the accompanying consolidated condensed statement of operations.
In December 2013, the Company granted certain employees market-based options under the Plan that vest only upon the achievement of a specified internal rate of return from a liquidity event (“2.0x Options”). At the time of grant, no compensation expense was recorded as the 2.0x Options vest upon a liquidity event, which is not considered probable until the date it occurs. On January 20, 2016, the Compensation Committee of the Board of Directors adopted a resolution to adjust the vesting criteria for all 2.0x Options granted and still outstanding on such date. Under the revised vesting criteria, the 2.0x Options vest upon the announcement of a secondary offering. This modification resulted in Type IV Improbable-to-Improbable modification. Since the secondary offering was deemed improbable due to the fact that it is outside of the Company’s control and cannot be considered probable until the date it occurs, no compensation expense was recognized on the January 20, 2016 modification date. On March 2, 2016, the Company announced a secondary offering of shares by KKR and certain management stockholders, and it became probable that the 2.0x Options would vest. In total, 835,551 2.0x Options held by current employees were modified. As a result of this modification, and the modification associated with the transfer restrictions releases noted above, the Company incurred approximately $23.8 million of incremental compensation expense associated with the 2.0x Options during the three months ended March 31, 2016, which is included in transaction-related costs in the accompanying consolidated condensed statement of operations.
(10) Income Taxes
The Company’s effective income tax rate was 23.8% and 25.4% for the three months ended March 31, 2017 and 2016, respectively. The variation between the Company’s effective income tax rate and the U.S. statutory rate of 35% for the three months ended March 31, 2017 is primarily due to (i) income from foreign subsidiaries being taxed at rates lower than the U.S. statutory rate and (ii) the favorable impact of research and development tax credits.
GAAP requires a two-step approach when evaluating uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence demonstrates that it is more likely than not that the position will be sustained upon audit, including resolution of any related appeals or litigation processes. The second step is to quantify the amount of tax benefit to recognize as the amount that is cumulatively more than 50% likely to be realized upon ultimate settlement with the taxing authorities.
As of March 31, 2017, the Company’s liability for unrecognized tax benefits was $12.5 million. If any portion of this $12.5 million is recognized that impacts the effective tax rate, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution of audits is highly uncertain, the Company believes it is reasonably possible that approximately $3.9 million of gross unrecognized tax benefits will change in the next 12 months as a result of pending audit settlements or statute of limitations expirations.
The Company files U.S. federal, U.S. state, and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for years ended December 31, 2012 and prior. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for years prior to 2012. For foreign purposes, the Company is generally no longer subject to examination for tax periods 2009 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination and adjustment.
(11) Commitments and Contingencies
Legal Proceedings
The Company is involved in legal proceedings from time to time in the ordinary course of its business, including employment claims and claims related to other business transactions. Although the outcome of such claims is uncertain, management believes that these legal proceedings will not have a material adverse effect on the financial condition or results of future operations of the Company.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated condensed financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q, with our audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and with the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
We use the terms “we,” “us,” “our,” or the “Company” in this report to refer to PRA Health Sciences, Inc. and its subsidiaries.
Overview
We are one of the world’s leading global contract research organizations, or CROs, by revenue, providing outsourced clinical development services to the biotechnology and pharmaceutical industries. We believe we are one of a select group of CROs with the expertise and capability to conduct clinical trials across major therapeutic areas on a global basis. Our therapeutic expertise includes areas that are among the largest in pharmaceutical development, and we focus in particular on oncology, central nervous system, inflammation, respiratory, cardiometabolic and infectious diseases. We believe that we further differentiate ourselves from our competitors through our investments in medical informatics and clinical technologies designed to enhance efficiencies, improve study predictability and provide better transparency for our clients throughout their clinical development processes.
Contracts define the relationships with our clients and establish the way we earn revenue. Three types of relationships are most common: a fixed-price contract, a time and materials contract and fee-for-service arrangements. In cases where the contracts are fixed price, we may bear the cost of overruns for the contracted scope, or we may benefit if the costs are lower than we anticipated for the contracted scope. In cases where our contracts are fee-for-service, the contracts contain an overall budget for contracted resources. If actual resources used are lower than anticipated, the client generally keeps the savings and we may be responsible for covering the cost of the unused resource if we are unable to redeploy the resource. For time and material contracts, we bill the client only for the actual hours we spend to complete the contracted scope based upon stated hourly rates by position. The duration of our contracts range from a few months to several years. Revenue for services is recognized only after persuasive evidence of an arrangement exists, the sales price is determinable, services have been rendered, and collectability is reasonably assured. Once these criteria have been met, we recognize revenue for the services provided on fixed-fee contracts based on the proportional performance methodology, which determines the proportion of outputs or performance obligations, which have been completed or delivered compared to the total contractual outputs for performance obligations. To measure performance, we compare the contract costs incurred to estimated total contract costs through completion. As part of the client proposal and contract negotiation process, we develop a detailed project budget for the direct costs based on the scope of the work, the complexity of the study, the geographical locations involved and our historical experience. We then establish the individual contract pricing based on our internal pricing guidelines, discount agreements, if any, and negotiations with the client. The estimated total contract costs are reviewed and revised periodically throughout the lives of the contracts, with adjustments to revenue resulting from such revisions being recorded on a cumulative basis in the period in which the revisions are first identified. Our costs consist of expenses necessary to carry out the clinical development project undertaken by us on behalf of the client. These costs primarily include the expense of obtaining appropriately qualified labor to administer the project, which we refer to as direct cost headcount. Other costs we incur are attributable to the expense of operating our business generally, such as leases and maintenance of information technology and equipment. Revenue from time and materials contracts is recognized as hours are incurred. Revenues and the related costs of fee-for-service contracts are recognized in the period in which services are performed.
How We Assess the Performance of Our Business
In addition to our U.S. generally accepted accounting principles, or GAAP, financial measures, we review various financial and operational metrics, including new business awards, cancellations, and backlog. Many of our current contracts include clinical trials covering multiple geographic locations. We utilize the same management systems
and reporting tools to monitor and manage these activities on the same basis worldwide. For this reason, we consider our operations to be a single business segment, and we present our results of operations as a single reportable segment.
Our gross new business awards for the three months ended March 31, 2017 and 2016 were $647.6 million and $534.0 million, respectively. New business awards arise when a client selects us to execute its trial and is documented by written or electronic correspondence, or for our Strategic Solutions offering when the amount of revenue expected to be recognized is measurable. The number of new business awards can vary significantly from year to year, and awards can have terms ranging from several months to several years. For our Strategic Solutions offering, the value of a new business award is the anticipated service revenue to be recognized in the corresponding quarter of the next fiscal year. For the remainder of our business, the value of a new award is the anticipated service revenue over the life of the contract, which does not include reimbursement activity or investigator fees.
In the normal course of business, we experience contract cancellations, which are reflected as cancellations when the client provides us with written or electronic correspondence that the work should cease. During the three months ended March 31, 2017 and 2016 we had $82.8 million and $57.8 million, respectively, of cancellations for which we received correspondence from the client. The number of cancellations can vary significantly from year to year. The value of the cancellation is the remaining amount of unrecognized service revenue, less the estimated effort to transition the work back to the client.
Our backlog consists of anticipated service revenue from new business awards that either have not started or are in process but have not been completed. Backlog varies from period to period depending upon new business awards and contract modifications, cancellations, and the amount of service revenue recognized under existing contracts. Our backlog at March 31, 2017 and 2016 was $3.1 billion and $2.6 billion, respectively.
Sources of Revenue
Total revenues are comprised of service revenue and reimbursement revenue, each of which is described below.
Service Revenue
We generally enter into contracts with customers to provide services with payments based on either fixed-fee, time and materials, or fee-for-service arrangements. Revenue for services is recognized only after persuasive evidence of an arrangement exists, the sales price is determinable, services have been rendered, and collectability is reasonably assured.
Once these criteria have been met, we recognize revenue for the services provided on fixed-fee contracts based on the proportional performance methodology, which determines the proportion of outputs or performance obligations which have been completed or delivered compared to the total contractual outputs for performance obligations. To measure performance, we compare the contract costs incurred to estimated total contract costs through completion. As part of the client proposal and contract negotiation process, we develop a detailed project budget for the direct costs based on the scope of the work, the complexity of the study, the geographical location involved and our historical experience. We then establish the individual contract pricing based on our internal pricing guidelines, discount agreements, if any, and negotiations with the client. The estimated total contract costs are reviewed and revised periodically throughout the lives of the contracts, with adjustments to revenue resulting from such revisions being recorded on a cumulative basis in the period in which the revisions are first identified. Revenue from time and materials contracts is recognized as hours are incurred. Billable hours typically fluctuate during the terms of individual contracts, as services we provide generally increase at the beginning of a study and decrease toward the end of a study. Revenues and the related costs of fee-for-service contracts are recognized in the period in which services are performed.
A majority of our contracts undergo modifications over the contract period and our contracts provide for these modifications. During the modification process, we recognize revenue to the extent we incur costs, provided client acceptance and payment is deemed reasonably assured.
We often offer volume discounts to our large customers based on annual volume thresholds. We record an estimate of the annual volume rebate as a reduction of revenue throughout the period based on the estimated total rebate to be earned for the period.
Most of our contracts can be terminated by the client either immediately or after a specified period, typically 30 to 60 days, following notice. In the case of early termination, these contracts typically require payment to us of fees earned to date, and in some cases, a termination fee or some portion of the fees or profit that we could have earned under the contract if it had not been terminated early. Based on ethical, regulatory, and health considerations, this wind-down activity may continue for several quarters or years. Therefore, revenue recognized prior to cancellation generally does not require a significant adjustment upon cancellation.
Increases in the estimated total direct costs to complete a contract without a corresponding proportional increase to the total contract price result in a cumulative adjustment to the amount of revenue recognized in the period the change in estimate is determined.
Our service revenue was $427.1 million and $372.3 million during the three months ended March 31, 2017 and 2016, respectively. Changes in service revenue from period to period are driven primarily by changes in backlog at the beginning of a period, as well as new business awards during such period. Additionally, service revenue and billable hours will generally be impacted by the mix of studies that are active during a period, as different studies have different staffing requirements, as well as the life cycles of projects that are active during a period.
Reimbursement Revenue and Reimbursable Out-of-Pocket Costs
We incur out-of-pocket costs, which are reimbursable by our customers. We include these out-of-pocket costs as reimbursement revenue and reimbursable out-of-pocket expenses in our consolidated condensed statement of operations.
As is customary in our industry, we also routinely enter into separate agreements on behalf of our clients with independent physician investigators in connection with clinical trials. We also receive funds from our clients for investigator fees, which are netted against the related costs, since such fees are the obligation of our clients, without risk or reward to us. We are not obligated either to perform the service or to pay the investigator in the event of default by the client. In addition, we do not pay the independent physician investigator until funds are received from the client. Accordingly, unlike reimbursable out-of-pocket costs, we do not recognize these investigator fees in revenue.
Reimbursement costs and investigator fees are not included in our backlog because they are pass-through costs to our clients.
We believe that the fluctuations in reimbursement costs and reimbursement revenue from period to period are not meaningful to our underlying performance.
Costs and Expenses
Our costs and expenses are comprised primarily of our direct costs, selling, general and administrative costs, depreciation and amortization and income taxes. In addition, we incur reimbursable out-of-pocket expenses; however, as noted above, our reimbursable out-of-pocket expenses are directly offset by our reimbursement revenue. Since reimbursement revenue is offset by our out-of-pocket reimbursable expenses, we monitor and measure costs as a percentage of service revenue rather than total revenue as we believe this is a more meaningful comparison and better reflects the operations of our business.
Direct Costs
Our direct costs consist primarily of labor-related charges. They include elements such as salaries, benefits and incentive compensation for our employees. In addition, we utilize staffing agencies to procure primarily part time individuals to perform work on our contracts. For the three months ended March 31, 2017 and 2016, the labor-related
charges were 96.4% and 97.0% of our total direct costs, respectively. The cost of labor procured through staffing agencies is included in these percentages and represented 5.6% and 5.4% of total direct costs for the three months ended March 31, 2017 and 2016, respectively. Our remaining direct costs are items such as travel, meals, postage and freight, patient costs, medical waste and supplies. The total of all these items was 3.6% and 3.0% of total direct costs for the three months ended March 31, 2017 and 2016, respectively.
Historically, direct costs have increased with an increase in service revenues. The future relationship between direct costs and service revenues may vary from historical relationships. Several factors will cause direct costs to decrease as a percentage of service revenues. Deployment of our billable staff in an optimally efficient manner has the greatest impact on our ratio of direct cost to service revenue. The most effective deployment of our staff is when they are fully engaged in billable work and are accomplishing contract related activities at a rate that meets or exceeds budgeted targets. We also seek to optimize our efficiency by performing work using the employee with the lowest cost. Generally, the following factors may cause direct costs to increase as a percentage of service revenues: our staff are not fully deployed, as is the case when there are unforeseen cancellations or delays, or when our staff are accomplishing tasks at levels of effort that exceed budget, such as rework, as well as pricing pressure from increased competition.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of administration payroll and benefits, marketing expenditures, and overhead costs such as information technology and facilities costs. These expenses also include central overhead costs that are not directly attributable to our operating business and include certain costs related to insurance, professional fees and property.
Loss on Extinguishment of Debt
Loss on extinguishment of debt for the three months ended March 31, 2016 consists of an early tender premium, the write-off of unamortized debt issuance costs and miscellaneous costs incurred as a result of our repayment of $133.6 million of our 9.5% senior notes due 2023, or Senior Notes.
Transaction-Related Costs
Transaction-related costs for the three months ended March 31, 2016 consists of expenses incurred with our secondary offering, transaction-related stock based compensation and the closing of our accounts receivable financing agreement.
Depreciation and Amortization
Depreciation represents the depreciation charged on our fixed assets. The charge is recorded on a straight-line method, based on estimated useful lives of three to seven years for computer hardware and software and five to seven years for furniture and equipment. Leasehold improvements are depreciated over the lesser of the life of the lease term or the useful life of the improvements.
Amortization expense consists of amortization recorded on acquisition-related intangible assets. Customer relationships, backlog and finite-lived trade names are amortized on an accelerated basis, which coincides with the period of economic benefit we expect to receive. All other finite-lived intangibles are amortized on a straight-line basis. In accordance with GAAP, we do not amortize goodwill and indefinite-lived intangible assets.
Income Taxes
Because we conduct operations on a global basis, our effective tax rate has and will continue to depend upon the geographic distribution of our pre-tax earnings among several different taxing jurisdictions. Our effective tax rate can also vary based on changes in the tax rates of the different jurisdictions. Our effective tax rate is also impacted by tax credits and the establishment or release of deferred tax asset valuation allowances and tax reserves, as well as significant non-deductible items such as portions of transaction-related costs.
Foreign subsidiaries are taxed separately in their respective jurisdictions. We have foreign net operating loss carryforwards in some jurisdictions. The carryforward periods for these losses vary from five years to an indefinite carryforward period depending on the jurisdiction. Our ability to offset future taxable income with the net operating loss carryforwards may be limited in certain instances, including changes in ownership.
Exchange Rate Fluctuations
The majority of our foreign operations transact in the Euro, or EUR, or British Pound, or GBP. As a result, our revenue and expenses are subject to exchange rate fluctuations with respect to these currencies. We have translated these currencies into U.S. dollars using the following average exchange rates:
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2017
|
|
2016
|
U.S. dollars per:
|
|
|
|
|
Euro
|
|
1.07
|
|
1.10
|
British Pound
|
|
1.24
|
|
1.43
|
Results of Operations
Three Months Ended March 31, 2017 Compared to the Three Months Ended March 31, 2016
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2017
|
|
2016
|
|
(in thousands)
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
Service revenue
|
|
$
|
427,080
|
|
$
|
372,320
|
|
Reimbursement revenue
|
|
|
60,680
|
|
|
57,903
|
|
Total revenue
|
|
|
487,760
|
|
|
430,223
|
|
Operating expenses
|
|
|
|
|
|
|
|
Direct costs
|
|
|
287,512
|
|
|
243,487
|
|
Reimbursable out-of-pocket costs
|
|
|
60,680
|
|
|
57,903
|
|
Selling, general and administrative
|
|
|
74,268
|
|
|
63,990
|
|
Transaction-related costs
|
|
|
—
|
|
|
28,916
|
|
Depreciation and amortization
|
|
|
15,192
|
|
|
16,953
|
|
Loss on disposal of fixed assets
|
|
|
82
|
|
|
28
|
|
Income from operations
|
|
|
50,026
|
|
|
18,946
|
|
Interest expense, net
|
|
|
(9,527)
|
|
|
(15,366)
|
|
Loss on extinguishment of debt
|
|
|
—
|
|
|
(21,485)
|
|
Foreign currency losses, net
|
|
|
(7,254)
|
|
|
(2,790)
|
|
Other expense, net
|
|
|
(180)
|
|
|
—
|
|
Income (loss) before income taxes and equity in income (loss) of unconsolidated joint ventures
|
|
|
33,065
|
|
|
(20,695)
|
|
Provision for (benefit from) income taxes
|
|
|
7,883
|
|
|
(5,264)
|
|
Income (loss) before equity in income (loss) of unconsolidated joint ventures
|
|
|
25,182
|
|
|
(15,431)
|
|
Equity in income (loss) of unconsolidated joint ventures, net of tax
|
|
|
42
|
|
|
(538)
|
|
Net income (loss)
|
|
$
|
25,224
|
|
$
|
(15,969)
|
|
Service revenue increased by $54.8 million, or 14.7%, from $372.3 million during the three months ended March 31, 2016 to $427.1 million during the three months ended March 31, 2017. Service revenue for the three months ended March 31, 2017 benefited from an increase in billable hours, offset by an unfavorable impact of $1.5 million from foreign currency exchange rate fluctuations. The growth in service revenue and the increase in billable hours were due largely to the increase in our backlog as we entered the year, the type of services we are providing on our active studies, which was driven by the life cycles of projects that were active during the period, the growth in new business awards as a
result of higher demand for our services across the industries we serve, and more effective sales efforts and the growth in the overall CRO market. New business awards arise when a client selects us to execute its trial. The number of awards can vary significantly from period to period and our studies have terms ranging from several months to several years.
Direct costs increased by $44.0 million, or 18.1%, from $243.5 million during the three months ended March 31, 2016 to $287.5 million during the three months ended March 31, 2017. The increase in direct costs is primarily due to an increase in salaries and related benefits of $43.1 million, as we continue to hire billable staff to support our current projects and as we hire additional staff in anticipation of our growing portfolio of studies, offset by a favorable impact of $2.0 million from foreign currency exchange rate fluctuations. Direct costs as a percentage of service revenue increased from 65.4% during the three months ended March 31, 2016 to 67.3% during the three months ended March 31, 2017.
Selling, general and administrative expenses increased by $10.3 million, or 16.1%, from $64.0 million during the three months ended March 31, 2016 to $74.3 million during the three months ended March 31, 2017. Selling, general and administrative expenses as a percentage of service revenue increased from 17.2% during the three months ended March 31, 2016 to 17.4% during the three months ended March 31, 2017. The increase in selling, general and administrative expenses is primarily due to an increase in salaries and related benefits, as we continue to hire staff to support our growing business, and increased facility costs as we add office space as we continue to grow.
During the three months ended March 31, 2016, we incurred transaction-related expenses of $28.9 million. These costs consist of $3.0 million of stock-based compensation expense associated with the release of the transfer restrictions on a portion of shares issuable upon exercise of vested service-based options in connection with the announcement of our March secondary offering. These costs also include $23.8 million of stock-based compensation expense related to the vesting and release of the transfer restrictions of certain performance-based stock options. In addition, we incurred $2.1 million of third-party fees associated with the secondary offering and the closing of our accounts receivable financing agreement. No transaction-related expenses were incurred for the three months ended March 31, 2017.
Depreciation and amortization expense decreased by $1.8 million, or 10.4%, from $17.0 million during the three months ended March 31, 2016 to $15.2 million during the three months ended March 31, 2017. Depreciation and amortization expense as a percentage of service revenue was 4.6% during the three months ended March 31, 2016 and 3.6% during the three months ended March 31, 2017. The decrease in depreciation and amortization expense as a percentage of service revenue is primarily due to the continued amortization of our acquired intangibles which are amortized on an accelerated basis.
Interest expense, net, decreased by $5.8 million, or 38%, from $15.4 million during the three months ended March 31, 2016 to $9.5 million during the three months ended March 31, 2017. The cash tender on our senior notes and refinancing of our variable rate first lien term loans contributed to a 2.1% decrease in the weighted average interest rate on our outstanding debt as compared to the three months ended March 31, 2016; this resulted in a $5.5 million reduction in interest expense. Additionally, interest expense decreased by $0.7 million due to lower amortization of debt issuance costs, which was offset by an increase of $0.5 million related to the amortization of our terminated interest rate swaps and interest expense on our current interest rate swap.
Loss on extinguishment of debt was $21.5 million during the three months ended March 31, 2016 and there were no losses on extinguishment of debt during the three months ended March 31, 2017. The loss on extinguishment of debt incurred during the three months ended March 31, 2016 was associated with our cash tender offer on our senior notes. The loss consists of the $17.4 million early tender premium, the write-off of $3.7 million of unamortized debt issuance costs, and $0.4 million of other costs associated with the transaction.
Foreign currency losses, net, increased by $4.5 million from $2.8 million during the three months ended March 31, 2016 to $7.3 million during the three months ended March 31, 2017. Foreign exchange gains and losses are due to fluctuations in the U.S. dollar, gains or losses that arise in connection with the revaluation of short-term inter-company balances between our domestic and international subsidiaries, and gains or losses from foreign currency transactions, such as those resulting from the settlement of third-party accounts receivables and payables denominated in
a currency other than the local currency of the entity making the payment. During the three months ended March 31, 2017, foreign currency losses were primarily due to the U.S. dollar weakening against the GBP, EUR, Canadian dollar, or CAD, and Russian Ruble, or RUB, by 1.6%, 1.5%, 1.0% and 8.6%, respectively. During the three months ended March 31, 2016, foreign currency losses were primarily due to the U.S. dollar weakening against the the EUR, CAD, and RUB, by 3.5%, 6.5%, and 7.4%, respectively, partially offset by a strengthening against the GBP by 3.0%.
Provision for income taxes increased by $13.1 million from a benefit of $5.3 million during the three months ended March 31, 2016 to a provision of $7.9 million during the three months ended March 31, 2017. Our effective tax rate was 25.4% and 23.8% during the three months ended March 31, 2016 and 2017, respectively. The decrease in the effective tax rate of 1.6% was primarily attributable to the change in our overall distribution of projected income among our domestic and foreign subsidiaries which are typically taxed at a lower rate.
Seasonality
Although our business is not generally seasonal, we typically experience a slight decrease in our revenue growth rate during the fourth quarter due to holiday vacations and a similar decrease in new business awards in the first quarter due to our clients’ budgetary cycles and vacations during the year-end holiday period.
Liquidity and Capital Resources
We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Our principal source of liquidity is operating cash flows. As of March 31, 2017, we had approximately $123.5 million of cash and cash equivalents of which $44.2 million was held by our foreign subsidiaries. Our expected primary cash needs on both a short and long-term basis are for capital expenditures, expansion of services, geographic expansion, debt repayments, and other general corporate purposes. We have historically funded our operations and growth, including acquisitions, with cash flow from operations, borrowings, and issuances of equity securities. We expect to continue expanding our operations through internal growth and strategic acquisitions and investments. We expect these activities will be funded from existing cash, cash flow from operations and, if necessary or appropriate, borrowings under our existing or future credit facilities. Our sources of liquidity could be affected by our dependence on a small number of industries and clients, compliance with regulations, international risks, and personal injury, environmental or other material litigation claims.
Cash Collections
Cash collections from accounts receivable were $496.4 million during the three months ended March 31, 2017, including $62.7 million of funds received from customers to pay independent physician investigators, or investigators, as compared to $481.2 million during the three months ended March 31, 2016, including $53.5 million of funds received from customers to pay investigators. The increase in cash collections during the three months ended March 31, 2017 is related to our increase in revenue, driven by an increase in new business awards and an increase in our backlog.
Discussion of Cash Flows
Cash Flow from Operating Activities
During the three months ended March 31, 2017, net cash used in operations was $10.8 million, compared to net cash provided by operations of $20.4 million for the same period of 2016. Cash provided by operating activities decreased over the prior year primarily due to an increase in cash outflows from working capital, which was partially offset by increased cash flows from our operating performance. The changes in working capital were driven by changes in our accounts receivable, unbilled services, and advanced billings accounts, as a result of an increase in our days sales outstanding during the three months ended March 31, 2017, as compared to the same period of 2016.
Cash Flow from Investing Activities
Net cash used in investing activities was $8.3 million during the three months ended March 31, 2017, compared to $12.6 million for the same period of 2016. The decrease in cash outflows was primarily due to the $4.1 million in cash flows related to the acquisition of Nextrials, Inc. during the three months ended March 31, 2016.
Cash Flow from Financing Activities
Net cash used in financing activities was $6.8 million during the three months ended March 31, 2017 compared to $31.3 million for the same period of 2016. During the three months ended March 31, 2017, we repaid $7.8 million principal amount of our term loan. During the three months ended March 31, 2016, we borrowed $120.0 million under our accounts receivable financing agreement and we repaid $133.6 million aggregate principal amount of our senior notes and $17.8 million related to debt prepayment and debt extinguishment costs as part of the cash tender offer.
Indebtedness
As of March 31, 2017, we had $828.6 million of total indebtedness. Additionally, our senior secured credit agreement provides for a $125.0 million revolving credit facilities. There were no amounts drawn on this revolving credit facilities as of March 31, 2017. In addition, at March 31, 2017, we had $3.7 million in letters of credit outstanding, which are secured by the revolving credit facilities. Our long-term debt arrangements contain usual and customary restrictive covenants, and, as of March 31, 2017, we were in compliance with these covenants.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Liquidity and Capital Resources” and Note 9 to our audited consolidated financial statements, each included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, for additional details regarding our credit arrangements.
Contractual Obligations and Commercial Commitments
We have various contractual obligations, which are recorded as liabilities in our consolidated condensed financial statements. Other items, such as operating lease obligations, are not recognized as liabilities in our consolidated condensed financial statements but are required to be disclosed.
There have been no material changes, outside of the ordinary course of business, to our contractual obligations as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Critical Accounting Policies and Estimates
There have been no material changes to our critical accounting policies as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Disclosure Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition to historical consolidated condensed financial information, this Quarterly Report on Form 10-Q contains forward-looking statements that reflect, among other things, our current expectations and anticipated results of operations, all of which are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements, market trends, or industry results to differ materially from those expressed or implied by such forward-looking statements. Therefore, any statements contained herein that are not statements of historical fact may be forward-looking statements and should be evaluated as such. Without limiting the foregoing, the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “should,” “targets,” “will” and the negative thereof and similar words and expressions are intended to identify forward-looking statements. Unless legally required, we assume no obligation to update any such forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information.
We caution you that any such forward-looking statements are further qualified by important factors that could cause our actual operating results to differ materially from those in the forward-looking statements, including without limitation, that most of our contracts may be terminated on short notice, and we may be unable to maintain large customer contracts or to enter into new contracts; our financial results may be adversely affected if we underprice our contracts, overrun our cost estimates or fail to receive approval for or experience delays in documenting change orders; the historical indications of the relationship of our backlog to revenues may not be indicative of their future relationship; we may be unable to maintain our information systems or effectively update them; customer or therapeutic concentration could harm our business; our business is subject to risks associated with international operations, including economic, political and other risks, such as compliance with a myriad of laws and regulations, complications from conducting clinical trials in multiple countries simultaneously and changes in exchange rates; the market for our services may not grow as we expect; government regulators or our customers may limit the scope of prescription or withdraw products from the market, and government regulators may impose new regulatory requirements or may adopt new regulations affecting the biopharmaceutical industry; we may be unable to successfully develop and market new services or enter new markets; our failure to perform services in accordance with contractual requirements, regulatory standards and ethical considerations may subject us to significant costs or liability, which could also damage our reputation and cause us to lose existing business or not receive new business; our services are related to treatment of human patients, and we could face liability if a patient is harmed; we may be unable to successfully identify, acquire and integrate businesses, services and technologies; and we have substantial indebtedness and may incur additional indebtedness in the future, which could adversely affect our financial condition. For a further discussion of the risks relating to our business, see “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Website and Social Media Disclosure
We use our website (www.prahs.com) and our corporate Twitter account (@PRAHSciences) as channels of distribution of company information. The information we post through these channels may be deemed material. Accordingly, investors should monitor these channels, in addition to following our press releases, Securities and Exchange Commission, or SEC, filings and public conference calls and webcasts. The contents of our website and social media channels are not, however, a part of this report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes to our quantitative and qualitative disclosures about market risk as compared to the quantitative and qualitative disclosures about market risk described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Item 4. Controls and Procedures
As of March 31, 2017, we carried out an evaluation under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Regulations under the Exchange Act require public companies, including us, to maintain “disclosure controls and procedures,” which are defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required or necessary disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to accomplish their objective of a reasonable assurance level.
There were no changes in our internal control over financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
We are party to legal proceedings incidental to our business. While the outcome of these matters could differ
from management’s expectations, we do not believe that the resolution of these matters is reasonably likely to have a material adverse effect to our financial statements.
Item 1A. Risk Factors
For a discussion of our potential risks and uncertainties, see the information under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, or Annual Report. There have been no significant changes from the risk factors previously disclosed in our Annual Report.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits
The exhibits in the accompanying Exhibit Index following the signature page are filed or furnished as a part of this report and are incorporated herein by reference.
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.
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PRA HEALTH SCIENCES, INC.
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/s/ Linda Baddour
|
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Linda Baddour
|
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Executive Vice President and Chief Financial Officer
|
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(Authorized Signatory)
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Date: April 26, 2017
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EXHIBIT INDEX
Exhibit
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Number
|
|
Description of Exhibit
|
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31.1*
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Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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31.2*
|
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Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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32.1*
|
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Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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32.2*
|
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Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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101
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The following financial information from PRA Health Sciences, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017 formatted in XBRL: (i) Consolidated Condensed Balance Sheets as of March 31, 2017 and December 31, 2016, (ii) Consolidated Condensed Statements of Operations for the three months ended March 31, 2017 and 2016, (iii) Consolidated Condensed Statements of Comprehensive Income (Loss) for the three months ended March 31, 2017 and 2016, (iv) Consolidated Condensed Statements of Cash Flows for the three months ended March 31, 2017 and 2016, and (v) Notes to Consolidated Condensed Financial Statements.
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