BPAL Holdings, Inc.
ANNUAL REPORT
For the Year ended December 31, 2014
401 Hackensack Avenue Hackensack, NJ 07601 March 24, 2015
BPAL Holdings, Inc. Annual Report for Year Ended December 31, 2014
This Annual Report is prepared pursuant to: (1) Section 4.03(2) of those certain Indentures, dated as of March 15, 2012, among BPA Laboratories, Inc. (“BPA”) and each of the Guarantors party thereto and US Bank National Association as Trustee and Collateral Trustee for the 12.25% Senior Secured Notes (the “Notes”) due 2017 and 15.00% Third Lien Debt due 2020, each as supplemented by supplemental indentures thereto, (2) Section 5.01(b) of that certain First Lien Credit Agreement, dated as of April 29, 2014 (the “First Lien Credit Agreement”) among BPA, the several Guarantors from time to time party thereto, the Lenders from time to time party thereto and Wilmington Trust, National Association (“Wilmington”) as Administrative Agent and Collateral Agent to the First Lien Credit Agreement, (3) Section 5.01(b) of that certain Second Lien Credit Agreement, dated as of April 29, 2014 (the “Second Lien Credit Agreement”) among BPA, the several Guarantors from time to time party thereto, the Lenders from time to time party thereto and Wilmington as Administrative Agent and Collateral Agent to the Second Lien Credit Agreement, and (4) Section 5.01(b) of that certain Second Lien Liquidity Facility Credit Agreement, dated as of April 29, 2014 (the “Second Lien Liquidity Facility Credit Agreement” and together with the First Lien Credit Agreement and Second Lien Credit Agreement the “Credit Agreements”) among BPA, the several Guarantors from time to time party thereto, the Lenders from time to time party thereto and Wilmington as Administrative Agent and Collateral Agent to the Second Lien Liquidity Facility Credit Agreement.
BPAL Holdings, Inc. was incorporated in the state of Delaware on February 6, 2012 in connection with the offering of the Notes. It was organized for the sole purpose of holding 100% ownership interest of Life Sciences Research, Inc. All information contained in this Annual Report for the year ended December 31, 2014 relates to BPAL Holdings, Inc., and subsidiaries. BPAL Holdings, Inc. and subsidiaries is referred to as the Company throughout this Annual Report.
TABLE OF CONTENTS
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Business ...... 1 Risk Factors ...... 13 Management ...... 23 Management’s Discussion and Analysis of Financial Condition and Results of Operations ...... 25 Index to Financial Statements ...... 37 Certain Relationships And Related Party Transactions 76
IMPORTANT INFORMATION ABOUT THIS ANNUAL REPORT This Annual Report is highly confidential. We prepared it solely for use by holders and potential purchasers of the 12.25% Senior Secured Notes due 2017 and 15.00% Third Lien Debt due 2020 issued by BPA Laboratories, Inc. (collectively, the “notes”) and by lenders under the credit agreements. You may not reproduce or distribute this Annual Report, in whole or in part, and you may not disclose any of the contents of this Annual Report or use any information herein for any purpose other than an investment in the notes or participation as lender under the credit agreements. By accessing this Annual Report, you expressly agree to the foregoing and expressly agree to maintain the disclosed information contained in this Annual Report in confidence. You may not distribute this Annual Report or disclose its contents to anyone, other than persons you have retained to advise you in connection with your investment in the notes, without our prior written consent.
The information in this Annual Report is current only as of the date on its cover. For any time after the cover date of this Annual Report, the information, including information concerning our business, financial condition, results of operations and prospects, may have changed. You expressly agree, by accessing this Annual Report, that: • this Annual Report contains highly confidential information concerning us; • you will hold the information contained or referred to in this Annual Report in confidence; and • you will not make copies of this Annual Report or any documents referred to inside. The 12.25% Senior Secured Notes are listed on the Channel Islands Stock Exchange (CISX).
Neither the Securities and Exchange Commission (“SEC”) nor any securities commission of any other jurisdiction has determined that this Annual Report is truthful or complete. Any representation to the contrary is a criminal offense.
If you have any questions relating to this Annual Report, or if you require additional information in connection with your investment in the notes or your participation as a vendor under the credit agreements, you should direct your questions to us. BPAL Holdings, Inc. (“Holdings”) is a Delaware corporation and BPA Laboratories, Inc. (“BPA”) is a Nevada corporation, in each case with principal offices at 401 Hackensack Avenue, Floor 9, Hackensack, NJ, 07601. We can be reached at (866) 524- 0378 and at [email protected]. NON-GAAP FINANCIAL MEASURES This Annual Report has not been prepared in accordance with, and does not contain all of the information that is required by, the rules and regulations of the SEC that would apply if the Annual Report was being filed with the SEC.
EBITDA and Adjusted EBITDA information presented in this Annual Report are supplemental measures of our ability to service debt that are not required by, or presented in accordance with, generally accepted accounting principles in the United States of America (“GAAP”). EBITDA and Adjusted EBITDA are not measurements of our financial performance under GAAP and neither should be considered as an alternative to net income, operating income or any other performance measures derived in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity.
EBITDA represents income before interest expense, income taxes, depreciation and amortization. We believe this measure is frequently used by securities analysts, investors and other interested parties in the evaluation of high yield issuers, many of which present EBITDA when reporting their lenders’ results. Adjusted EBITDA represents EBITDA plus non-cash employee compensation, Sale-Leaseback operating lease expenses, certain identified items that we believe to be non-recurring, non-cash purchase accounting adjustments in accordance with GAAP, and management fees and expenses paid to certain of our indirect equity investors. Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or nonrecurring items.
EBITDA and Adjusted EBITDA each have limitations as an analytical tool, and you should not consider them in isolation, or as a substitute for analysis of our operating results or cash flows as reported under GAAP. Some of these limitations are: • they do not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments; • they do not reflect changes in, or cash requirements for, our working capital needs; • they do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our debt; • although depreciation is a non-cash charge, the assets being depreciated will often have to be replaced in the future,
and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; • they are not adjusted for all non-cash income or expense items that are reflected in our statements of cash flows; and • other companies in our industry may calculate these measures differently than we do, limiting their usefulness as comparative measures.
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Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA and Adjusted EBITDA only for supplemental purposes. Please see our consolidated financial statements contained in this Annual Report.
The SEC has adopted rules to regulate the use in filings with the SEC and public disclosures and press releases of non- GAAP financial measures, such as EBITDA and Adjusted EBITDA and the ratios related thereto. These rules are not being applied to this Annual Report. They govern the manner in which non-GAAP financial measures are publicly presented and require, among other things: • a presentation, with equal or greater prominence, of the most directly comparable financial measure calculated and presented in accordance with GAAP; • a reconciliation of the differences between the non-GAAP measure and the most comparable financial measure calculated and presented in accordance with GAAP; • a statement disclosing the reasons a company’s management believes that presentation of the non-GAAP financial measure provides useful information to investors regarding a company’s financial condition and results of operations; and • to the extent material, a statement disclosing the additional purposes, if any, for which a company’s management uses the non-GAAP financial measure. The rules prohibit the following, among other things, in filings with the SEC: • exclusion of charges or liabilities that require, or will require, cash settlement or would have required cash settlement, absent an ability to settle in another manner, from non-GAAP liquidity measures; • adjustment of a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it has occurred in the past two years or is reasonably likely to recur within the next two years; and • presentation of non-GAAP financial measures on the face of any pro forma financial information.
The non-GAAP financial measures presented in this Annual Report may not comply with the SEC’s rules governing the presentation of non-GAAP financial measures. For example, some of the adjustments to Adjusted EBITDA as presented in this Annual Report may not be allowed if Adjusted EBITDA were considered a liquidity or performance measure. In addition, our measurements of EBITDA and Adjusted EBITDA may not be comparable to those of other companies. INDUSTRY AND MARKET DATA TERMINOLOGY This Annual Report includes estimates of market share and industry data and forecasts that we obtained from industry publications, securities analyst research reports and internal company sources. Industry publications and other third party materials generally state that the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of the included information. We have not independently verified any of the data from third-party sources nor have we ascertained the underlying economic assumptions relied upon therein. Statements as to our market position are based on market data currently available to us. Our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading “Risk Factors” in this Annual Report.
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FORWARD-LOOKING STATEMENTS Any statements made in this Annual Report that are not statements of historical fact, including statements about our beliefs and expectations, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, and should be evaluated as such. Forward-looking statements include information concerning possible or assumed future results of operations, including descriptions of our business plan and strategies. These statements often include words such as “anticipate,” “expect,” “suggests,” “plan,” “believe,” “intend,” “estimates,” “targets,” “projects,” “should,” “could,” “would,” “may,” “will,” “forecast,” and other similar expressions. These forward-looking statements are contained throughout this Annual Report, including the sections entitled “Business,” “Risk Factors,” “Capitalization,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. We base these forward-looking statements or projections on our current expectations, plans and assumptions that we have made in light of our experience in the industry, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances and at such time. As you read and consider this Annual Report, you should understand that these statements are not guarantees of performance or results. The forward-looking statements and projections are subject to and involve risks, uncertainties and assumptions and you should not place undue reliance on these forward-looking statements or projections. Although we believe that these forward-looking statements and projections are based on reasonable assumptions at the time they are made, you should be aware that many factors could affect our actual financial results or results of operations and could cause actual results to differ materially from those expressed in the forward-looking statements and projections. Factors that may materially affect such forward-looking statements and projections include, without limitation: • changes in government regulation of the pharmaceutical, contract research services (“CRS”) or research models and services (“RMS”) industries; • failure to comply with applicable governmental regulations; • the financial condition of and negative industry trends in the pharmaceutical and biotechnology industries; • changes in aggregate spending, research and development budgets and outsourcing trends in the pharmaceutical and biotechnology industries; • competition in the CRS or RMS industries; • development, validation and increase in use of new technologies used in biomedical research; • liabilities relating to errors or omissions from our contract research studies; • disease within our animal populations; • costs or liabilities relating to environmental, health and safety laws and regulations; • our ability to develop or acquire new services; • our ability to successfully integrate the businesses and operations of companies that we have acquired, and those we may acquire in the future, including, without limitation, our acquisition of Harlan Laboratories Holdings Corp. and its subsidiaries (“Harlan”); • risks associated with our global operations, including economic instability and political conditions; • our exposure to exchange rate fluctuations and our US dollar denominated indebtedness; • our backlog may not be indicative of future results; • our ability to collect on our backlog of revenues from awards, contracts and letters of intent; • the termination of our service contracts;
• contract under-pricing and project cost overruns; • our dependence on our senior management team; • our ability to attract and retain executive officers and qualified personnel; • actions of animal rights activists; • uncertainties related to general economic conditions; • disruptions to our supply chain; • the impact of changes in tax laws in the US, UK and other jurisdictions where we provide services; • our reliance on our facilities; • levels of our outstanding indebtedness; • our incurrence of additional amounts of debt; • restrictions contained in our debt agreements that limit the flexibility in our operations; • our ability to comply with the covenants and restrictions contained in the agreements relating to our indebtedness and those agreements related to indebtedness we may enter into in the future;
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• our ability to generate cash or raise or continue the financing required to service our indebtedness and finance our operations or future acquisitions; • our reliance on cash balances to finance our business; • liability risks associated with our business not covered by insurance; • other factors disclosed in this Annual Report under the caption “Risk Factors;” and • various other factors beyond our control.
These cautionary statements should not be construed by you to be exhaustive and are made only as of the date of this Annual Report. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. If we do update one or more forward-looking statements, there should be no inference that we will make additional updates with respect to those or other forward-looking statements.
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BUSINESS
Corporate History The Company, which began operations in 1931, is one of the world’s leading early stage Contract Research Organizations (“CRO” or “CROs”). BPAL Holdings, Inc. (“Holdings”) was incorporated in 2012 for the purpose of holding the equity interests of Life Sciences Research, Inc. (“LSR”). LSR was founded in 1951 in England and subsequently listed on the London Stock Exchange, and latterly the New York Stock Exchange Arca until being taken private in 2009. LSR has historically provided services that focused on helping customers around the world better understand the safety and efficacy profiles of the products they develop, and in the process, support both their decision making processes and their ability to satisfy the world’s regulators as they strive to bring their products to market. In April 2014, we acquired Harlan Laboratories Holdings Corp. (“Harlan”), a leading provider of research model and contract research services, which added further depth to our capabilities in non-clinical testing services, as well as broadening our offering to also supply research models and services and laboratory diets and bedding, that are used not just within our industry, but by researchers across the globe.
Overview Our customer base includes global pharmaceutical companies, biotechnology companies, leading agrochemical and chemical companies, government agencies, leading hospitals and academic institutions and other contract research organizations around the world. We currently operate approximately 38 facilities in 12 countries worldwide. For the year ended December 31, 2014, our net revenues from continuing operations and Adjusted EBITDA, including pro forma cost savings, as defined elsewhere in this Annual Report, were approximately $351.0 million and approximately $70.8 million respectively.
We provide our pharmaceutical customers with research models and services and non-clinical testing of compounds in support of the drug development process. We support customers from the earliest in vivo discovery stages of drug development through ‘first-in-man’ studies (Phase I) to marketing authorization and commercial product release (Phase IV).
The last decade has seen a rise in the amount of work that is outsourced to CROs by the pharmaceutical industry, as companies look to become more efficient and convert some of the fixed research and development (R&D) expenditures into variable costs. While this has been an emerging trend, and we believe is a sustainable long term view of how pharmaceutical companies will increasingly outsource, 2008 to 2013 actually saw total outsourced work decrease due to two main reasons. Firstly, large pharmaceutical companies decreased the amount of their R&D spend that had been focused on early, or preclinical, development as they preferentially funded their later stage assets in an attempt to accelerate their progress to market and generate new revenue streams to replace products coming to the end of their patent protection. We considered this under-investment in early drug development unsustainable for the industry, and over recent times we have seen these large companies begin to increase the numbers of molecules that are entering early development. Secondly, the global credit crunch of late 2008 reduced the amount of cash available to the smaller biotechnology companies that rely on public and venture capital financing to fund their product development. Again, increasingly positive capital markets over recent times have made it possible for an increasing amount of development to be funded by these smaller companies.
We believe that the trend to increased outsourcing will continue in the future, driven by the improved environment for biotech financing and larger companies reinvesting in their early stage portfolios. In addition, larger companies should increasingly outsource as they look to increase the speed, and reduce the cost, of drug development through increasingly strong partnerships with CROs. Further, they have been reducing the number of suppliers they use, and therefore are increasingly partnering with CROs who can provide the services and specialist expertise that they require on a global basis.
We believe we are well positioned as one of only four global non-clinical CROs who can credibly meet large pharmaceutical customers evolving needs and, consequently, have benefitted from this increased outsourcing as compared to smaller competitors. Based on revenues, we believe we are the third largest CRO globally within the growing $3.9 billion non- clinical CRO industry, with an approximate 9% market share.
We provide our crop protection, agrochemical and chemical customers with research models and services and end-to-end regulatory and testing service in support of both new product registrations and existing product re-registrations under various legislations worldwide, including the European REACH program. We believe we are the leading, if not only, CRO that can perform all the regulatory strategy, product safety and dossier preparation and submission work for a new crop protection active ingredient.
We consider that global regulators are increasingly concerned with the potential impact of chemicals on man and the environment, whether through defined exposure (as in the case of the spraying of crop protection products) or accidental exposure (for example, workers exposed to chemicals in their work environment). Coupled with this, the science and technology used in safety testing has advanced greatly in the last 50 years, yet many chemicals in use today were tested for safety decades ago. We believe these factors drive a strong regulatory environment that generates demand for our services and will continue to do so for the foreseeable future.
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We believe we are strongly positioned as the market leader serving crop protection and chemical customers. We consider our well-integrated, full service offering, including a very strong regulatory support infrastructure, to be unique in this market segment.
The Company has approximately 3,500 employees based in state-of the art research facilities in North America, Europe and Asia. We have a global customer base for our service offerings and provide services to companies in the major research centers of the United States, Europe and Asia. Our biopharmaceutical customers include more than 30 of the 50 largest (by sales) pharmaceutical and biotechnology companies in the world. Our non-pharmaceutical customers (who operate primarily in the crop protection and industrial chemical industries) include many significant and long-standing customers. Our research models and services business further serves approximately 4,800 customers worldwide.
The Company has two operational business segments: Contract Research Services (“CRS”) and Research Models and Services (“RMS”).
Through our CRS segment we offer laboratory-based, non-clinical testing services for biological safety evaluation research predominantly to the pharmaceutical, crop protection and industrial chemical industries. The purpose of this safety evaluation is to identify risks to humans, animals or the environment resulting from the use or manufacture of a wide range of compounds which are essential components of our customers’ products. Safety testing is mandated by governments around the world before products can be brought to market, therefore our customers are required to perform the safety evaluations we offer to develop their products. CRS accounted for approximately 60% of our total revenue from continuing operations and approximately 2,100 of our employees.
Our RMS segment, which has been added as part of the Harlan acquisition in 2014, has been supplying research models, services and diets and bedding to the research community since 1931. We offer a wide range of research models, animal diets and related products, including many of the most widely used rodent research model stock and strains. We also provide a variety of related services including contract breeding, custom diets and bedding, health monitoring and surgical services. The Company maintains production centers, including barrier rooms and/or isolator production centers, in multiple facilities located on three continents (North America, Europe and Asia). RMS accounted for approximately 40% of our total revenue from continuing operations and approximately 1,300 of our employees.
Contract Research Services (CRS). Our CRS segment provides customers with a wide variety of testing services to support them in product development and registration. Services range from in silico (or computer-based) modeling used to predict the potential properties of a compound (e.g. it is likely to be toxic), through in vitro (or cell-culture based) and in vivo (or animal- based) testing to determine the potential safety and efficacy of a compound.
Most of our scientific and technological services can be utilized across all of our different customer segments.
The following table summarizes the services we provide:
Service Description Safety Assessment Safety evaluation programs (e.g., toxicology studies) assess the impact of chemicals and biological compounds when they are exposed to living systems. Metabolism Studies the impact of living systems on the chemicals they are exposed to, for example understanding how the body breaks down and excretes medicines. Environmental Testing Assesses the potential hazards of compounds exposed in the environment, and also the efficacy of compounds used in the field to protect food crops. Analytical Support Provides chemistry and biological analytical support to Safety Assessment and also provides stand-alone analytical services for clinical trials Chemistry, Manufacturing and Provides compound storage stability and lot-release services for compounds during Control (“CMC”) Services development and for manufactured products Regulatory Consultancy Provides advice, guidance and full regulatory support to customers through all compound development phases and regulatory compliance and registration
Research Models and Services (RMS). Our RMS segment is comprised of (1) Research Models, (2) Laboratory Animal Diets, Bedding and Enrichment, and (3) Research Model Services.
Research Models. We are a leading provider of essential research models, animal diets, animal beddings and enrichments, and model-related services to the pharmaceutical, biotech, medical device, agrochemical, and chemical industries, as well as universities, government, and other contract research organizations. The company's focus is on providing customers with products and services to optimize the discovery and safety of new medicines and compounds. As an industry leading company providing
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these three critical research components (animal models, laboratory animal diets, bedding and enrichment, and preclinical model- related services), we give the global scientific community the ability to work with one vendor to simplify, supply, ensure consistent quality, and have a fully-integrated partner committed to their long-term research success.
We have a global footprint with production facilities strategically located in 9 countries, in close proximity to our customers. This enables us to provide our models to customers around the world in a timely fashion and with the highest level of animal welfare. Our research models are bred and maintained in controlled environments which are designed to breed models that are free of specific viral and bacterial agents and other contaminants that can disrupt research operations and distort results. With our barrier room and isolator production capabilities, we strive to deliver consistently high-quality research models worldwide.
Our research models include standard stocks and strains and disease models, such as those with compromised immune systems, which are in demand as early-stage research tools. At a high level, our research models are categorized as follows:
outbred, which are purposefully bred for heterogeneity; inbred, which are bred to be genetically identical; spontaneous mutant, which contain naturally occurring genetic mutation (such as immune deficiency); hybrid, which are the offspring of two different inbred parents; and other genetically modified research models, including knock-out models with one or more disabled gene and transgenic models
Examples of specific research areas our models support include:
Aging and Behavior: Hair loss, loss of motor skills and sensory perception; Presence of spontaneous tumors; reduced immunologic and physiologic function; loss of vision, e.g., retinal degeneration, development of cataracts Cardiovascular: immunology and neurology: vaccine development, brain function decline Metabolism: obesity, diabetes Oncology and Safety Toxicology: tumor growth and treatment, ADME/Tox testing, xenograft hosting Organ Systems Transgenic Applications
Laboratory Animal Diets, Bedding, and Enrichment: Through our Teklad product line, we produce and sell laboratory animal diets, bedding, and enrichment products. With primary manufacturing operations in the United States (“US”) and a Company-owned and/or managed distribution network throughout the US, United Kingdom (“UK”), and Europe, we are able to distribute our products globally. The Company also maintains contract manufacturing relationships with companies in the UK and Italy.
Teklad has been manufacturing animal diets for over 40 years and offers a full line of off-the-shelf formulations as well as custom diets to meet our customers’ specific research needs. A team of nutritionists works with our customers to determine the best diet for their research objectives. If a custom diet is required, our nutritionists define the appropriate formula and our custom diet manufacturing line produces the feed. Teklad can provide irradiated diet as well. Our manufacturing facilities are ISO 9001:2008 certified.
Teklad diets are manufactured from natural ingredients and using fixed formulas. Fixed Formula diets are diets that are manufactured in accordance with a formula that remains unchanged from one production to the next. In conjunction with strict quality standards for raw materials, this approach ensures quality and consistency by minimizing nutrient variability and the variability of other phytochemicals in the diet which might affect a research study. Many researchers value these diets as a way to avoid the adverse effects that phytoestrogens, chlorophyll, and nitrosamines can have on their studies. Our Teklad Global Diets are specifically designed for biomedical research and as a result, certain diets are made without alfalfa meal and soy meal in order to minimize the resulting adverse effects on study results.
Teklad offers a variety of bedding and enrichment products to support model breeding, weaning, and holding. Our bedding includes all Teklad traditional contact bedding materials, such as corn cobs, hardwood chips, wood shavings, and contact paper bedding materials.
Research Model Services: RMS also offers a variety of services designed to support our customers’ use of research models in screening drug candidates. These services capitalize on the technologies and relationships developed through our research model business, and address the need among pharmaceutical and biotechnology companies to outsource the non-core aspects of their drug discovery activities. These services include those which are related to the maintenance and monitoring of research models, managing research operations for government entities, academic organizations and commercial customers, pre-delivery surgical services, special breeding products and Bio-products and Antibody Production Services. Services include: 3
Colony Management/ Genetic Tes ting/Genetic Breeding Services Surgery Monitori ng Expression Biologics and Antibodies
'Cryopreservation Cannulation Contract colony 'Nucleic acid extraction 'Monoclonal/polyclonal Rederivation Organ removal management Genotyping antibody development Revitalization Telemetry Heath monitoring Zygosity testing Antibody purification Others as requested Quarantine Gene expression analysis Serum, plasma, whole blood, by customers High throughput screening tissue, organs, and glands SNP analysis from a variety of species
Our Role in the Pharmaceutical Development Process Our RMS and CRS business units offer a range of products and services that support the entire drug development process. Essentially all of this work is performed as a result of regulatory requirements that seek to minimize the risks associated with the testing, and ultimately the use, of these compounds in humans. The following illustrates the Company’s role in the research, development and marketing process:
Pre-clinical testing helps to evaluate how the drug affects the body as well as how the body affects the drug. Utilizing advanced in silico, in vitro and in vivo evaluations, this research helps to predict potential harmful effects in humans and assess appropriate safety margins for human dosing regimens. Non-clinical testing, conducted alongside certain late-stage trials, can focus on identifying and avoiding longer-term cancer and other health and safety implications of exposure to certain compounds, such as possible reproductive implications, as well as assessing the stability of pharmaceuticals under a variety of storage conditions.
Although we conduct limited clinical testing directly, we also provide analytical chemistry support for all stages of clinical trials (Phase I through Phase IV), establish the stability of pharmaceuticals under varied storage conditions and undertake batch testing of marketed pharmaceuticals for product release. It is important to note that we perform non-clinical safety studies throughout the entire drug development process from late-stage discovery through to marketing approval.
We also actively pursue opportunities to extend our range of capabilities to support late stage drug discovery. In the late stage drug discovery phase, pharmaceutical companies are still screening their novel therapeutic candidates to determine which are likely to be most effective and least toxic in humans, often referred to as lead optimization. We currently support late stage drug discovery by, utilizing a limited number of in vitro and in vivo models to help our customers choose the best candidates and we believe that this market is likely to grow in the future. We believe that our expertise in early biology and its translation into regulatory development positions us well to capture market share in this evolving area.
The outsourced market for managed late stage clinical trials (late Phase II and beyond) is also relevant to our business, but we do not presently operate in this market. While we may decide to enter this trial management market in the future, we have no plan to do so in the foreseeable future as it is a very different business and one in which a number of major companies are already firmly established.
Our Role in Crop Protection and Industrial Chemicals
We are a world leader in providing safety and efficacy testing services to the crop protection and industrial chemical industries. We believe we are the only CRO globally who can provide the entire range of services required to register a new agrochemical, from regulatory advice through safety and efficacy testing, to dossier preparation and submission. The laboratory testing we perform for our customers in these industries is used in the characterization of potential hazards of exposing humans and the environment to specific chemicals in order to help our customers comply with regulatory requirements. We believe there are three main drivers of this business:
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• New Products: Active substances under development must be tested in a similar manner to new pharmaceutical products to fully characterize any toxic effects the chemical may cause. For example, a new agrochemical product must be formulated and sprayed onto the crops it is intended to be used upon so that potential residues that could be left on foodstuffs can be assessed. • New Regulations: The potential for chemicals to cause environmental and human danger often result in new regulations. One such recent example is the potential of chemicals in the environment (whether from pharmaceutical, agrochemical or industrial chemical manufacture or use) to interfere with the sex hormones of animals, thus affecting fertility (so-called endocrine disruption). To this end, the regulatory authorities have drawn up a list of chemicals they believe have the potential to cause this hazard, and these chemicals must be tested and their results submitted to the regulatory authorities. • Product Re-registrations: Testing technology and standards are improving constantly and, as a result, products that have been on the market for some time may not have been tested to the same standard as new products coming to market. Regulatory authorities are increasingly demanding that existing chemicals be tested to these improved standards. For example, the Registration, Evaluation, Authorization and Restriction of Chemicals (“REACH”) legislation has been enacted in Europe to test all chemicals in use on the market to bring them up to standard. In some cases, new agrochemical licenses are granted for 10 years and safety data must be checked against the standards of the time when the license is renewed.
Industry Overview Pharmaceutical Drug discovery and development are primarily focused on the prevention and/or treatment of human disease. The drug discovery process aims to identify drug candidates for their potential application in humans. The drug development process involves the testing of drug candidates developed in discovery upon animals and humans to find suitable drugs that meet regulatory requirements. The overall drug development process is highly capital intensive. It can typically take 15 years to obtain the necessary approvals for a new prescription drug to become available and, over the course of the development cycle, can cost around $1 billion for each new drug that enters the market. For every approximately 1,000 drug candidates that go through late- stage discovery, around 250 enter into pre-clinical testing and five drug candidates advance to clinical trials, with only 1 gaining
FDA approval. The following table, obtained from securities industry research, illustrates the phases of the pharmaceutical development cycle in the US and the focus of the Company and certain of the key industry players. The quantitative information in the table is an approximation, but is believed by the Company to be a reasonably accurate representation of the drug development funnel. For a more detailed discussion of these development phases, see “Business—Overview of Pharmaceutical Drug Discovery and Development Process.”
Discovery Pre- Phase I Phase II Phase III FDA Total Phase IV clinical Testing Years 4 - 5 2 1 1 - 2 1 - 3 2.5 11.5 - 15.5
Laboratory 20 to 80 100 to 300 1,000 to Test N/A and animal healthy patient 3,000 patient Population studies volunteers volunteers volunteers Verify Additional effectiveness, Identification Assess Evaluate post- Determine monitor Review of drug safety and effectiveness, marketing Purpose File safety and adverse File process / targets and biological look for side testing IND dosage reactions NDA Approval candidates activity effects required by at from long- at FDA FDA term use FDA 5,000-10,000 250 drug 5 enter drug Success Rate candidates clinical 1 approved candidates evaluated trials evaluated BPA, Charles Covance, Covance, BPA, Charles River, Icon, INC, Icon, INC, Representative River, Covance, Parexel, Covance, Icon, INC, Parexel, Parexel,
CROs Covance, MPI, PPD Intl, PPD Intl, PRA, Quintiles PPD Intl, MPI SNBL, PRA, PRA, WIL Quintiles Quintiles Research
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The drug development services industry, which includes CROs, provides outsourced product development services to pharmaceutical companies and government organizations. This industry has evolved over the last four decades from providing limited tactical services in connection with and in support of clinical trials to a full service industry, where CROs partner strategically with their customers at all stages of the drug development process. The 2014 global market for CROs was estimated to be $29.0 billion, of which $3.9 billion was related to outsourced pre-clinical and other non-clinical development. Based on third party research, we expect this non-clinical segment of the CRO market to grow at a compound annual growth rate of approximately 6% over the next five years, driven primarily by a continued shift towards outsourcing, a greater focus on strategic partnerships by big pharmaceutical companies and low single-digit growth in global R&D spending. We believe that larger non- clinical CROs, such as ourselves, will have the opportunity to gain market share from smaller competitors as pharmaceutical companies differentiate outsourced service providers based on global scale and breadth of service offerings. Furthermore, we believe larger CROs are better able to capitalize on strategic partnership arrangements with larger pharmaceutical companies.
We believe the following trends should drive growth in the non-clinical segment of the CRO industry over the next five years: • Outsourcing. We believe that biopharmaceutical companies, including our customers, will outsource a larger component of testing which will result in an increase in the penetration of outsourcing as a percentage of total development spending by pharmaceutical companies. It is estimated that approximately 35%-40% of the pre-clinical development market is currently outsourced, and we believe it will increase to over 50% over the next 5 to 10 years. In an increasingly resource-constrained environment, many biopharmaceutical companies may reduce their investment in the expertise and assets required for non-clinical testing. Some large pharmaceutical companies have been closing their existing facilities. On that basis, it is estimated that the higher level of outsourcing penetration will contribute an incremental revenue growth each year for the next five years to the total CRO market. Expected drivers of increased utilization of outsourcing include: • a desire for flexible cost structures (i.e., converting fixed costs into variable costs) to relieve the expense drag
of a large and inefficient development infrastructure; • a desire to address declining R&D productivity by utilizing more efficient means of conducting pharmaceutical development; • the anticipated lower numbers of blockbuster drugs in the future, which means that pharmaceutical companies would need to bring a higher number of smaller value drugs to market, and would have to do so at a lower cost and speed per new drug; and • an increasing willingness to outsource late-stage discovery and early stage development and the related pre- clinical testing. • Strategic Partnerships. Pharmaceutical companies have been reducing the number of CROs with which they work in order to streamline their costs and simplify internal oversight requirements. Many leading pharmaceutical companies are forming strategic partnerships with a smaller group of select CROs that have the necessary resources, global network, capacity, and expertise to manage the full product development cycle. As a result, we believe that the larger, global CROs that possess these capabilities, such as ourselves, have collectively gained market share over smaller CROs over the past three years, and we expect this trend to continue. • R&D Spending. Despite pressure to reduce costs, pharmaceutical companies must continually invest in drug development in order to create innovative new drugs to address unmet medical needs and replace lost revenues when their currently marketed drugs lose patent protection. We estimate that long term percentage growth rates in R&D expenditure will be in the low single-digits.
Crop Protection and Chemicals.
We believe safety testing in these industries is more likely to be outsourced as, unlike the pharmaceutical industry, fewer companies have comprehensive internal laboratory facilities.
The growth in this business is driven both by the introduction of new compounds, and by legislation concerning the safety and environmental impact of existing products. The work involved for these CROs has many similarities to pharmaceutical CROs, and often uses many of the same facilities, equipment and scientific disciplines, as those employed in non-clinical testing of pharmaceutical compounds.
With the increasing global population as well as urbanization and degradation of usable lands, the agrochemicals market has experienced strong growth. Natural fertilizers and traditional farming methods alone could not support the needs of the world population. Agrochemical companies have invested in research and development of chemical compounds to increase land productivity and reduce loss of crops. As the industry has become increasingly more competitive in recent years, agrochemical companies have continued to invest in additional chemical compounds to increase crop yields. In addition, increasing concerns about pesticide residue in foods has sparked an increase in development of eco-friendly agrochemicals which has also fueled industry growth.
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While beneficial to agricultural yields, agrochemicals can pose environmental and/or health risks. In many countries, the use of agrochemicals is highly regulated. Government bodies typically regulate the approval, usage, storage and labeling, handling, disposal and emergency clean-up procedures of agrochemicals. New agrochemicals often require testing prior to approval to determine environmental impacts as well as health risks to humans. Tests will include toxicology and ecotoxicology, metabolism, pathology and environmental tests. As the industry continues to invest in R&D to develop new agrochemical compounds, the agrochemical testing market is also expected to be positively impacted.
Chemical companies support many other industries such as industrial, life sciences, consumer products and technology companies. The development of new and advanced materials within these industries such as those involving semiconductors, composites, thin films and coatings, medical devices, environmental processes, energy systems and biopharmaceutical products is a driver of growth. In recent years, concerns over the safety of certain polymers and plastics drove chemical companies to invest in development of safer plastics for consumer applications. New industries and technologies also fuel chemical R&D. The emergence of nanotechnology has led to more R&D spends by chemicals and material companies to support the development of nanomaterials.
The European Chemicals regulation (REACH) was adopted in December 2006 and implemented on June 1, 2007. The regulation’s goal is to improve the protection of human health and the environment while maintaining competitiveness, and enhancing the innovative capability of the EU chemicals industry. REACH gives greater responsibility to industry to manage the risks from chemicals and to provide safety information that will be passed down the supply chain. REACH requires a registration of some 30,000 chemical substances in 3 separate phases: 2010, 2013 and 2018. The registration process requires the manufacturers and importers to generate data for all chemicals substances produced or imported into the EU. The registrants must also identify appropriate risk management measures and communicate them to the users.
REACH is a radical step forward in EU chemicals management, shifting the human and environmental safety testing from regulatory authorities to industry participants. In addition, REACH allows the further evaluation of substances where there are grounds for concern and foresees an authorization system for the use of substances of very high concern. This applies to substances that cause cancer, infertility, genetic mutations or birth defects, and to those which are persistent and accumulate in the environment.
Research Models and Services
The use of research models is critical to both the discovery and development of a new drug. The FDA requires that a drug be tested for safety and efficacy on two species of research models, one small and one large, before moving into the clinic for testing on humans. Research model testing is used in order to identify, define, characterize and assess the safety of new drug candidates, to support the development of vaccines, to provide test models for device development and to support chemical and agrochemical testing. Pharmaceutical and biotechnology companies, academic research centers, CROs and government institutions are the primary customers for research models.
The size of the research model and services market is estimated by independent research to be approximately $2.0 billion. Research models represent approximately $700-800 million of the market. The balance of the market comprises (i) related products, such as laboratory diets, SPF eggs and in vitro technologies, and (ii) services, including colony hosting, health & genetic monitoring and cryopreservation. The RMS market is expected to grow annually at low single digits.
Recently, there has been a shift towards higher margin specialty models and disease specific models. The Company expects this trend to continue as research projects are expected to be very targeted given constrained R&D spending. There are a limited number of providers in this space given barriers to entry and there is key customer demand dependability in the areas of animal health, animal genetics, availability, and security of supply.
Our Strengths • Full service capabilities with global reach. We have developed a full service business model that provides a range of products and services that support our customers throughout their research, development and product stewardship needs. We believe this broad offering, plus our global infrastructure provides us with a significant advantage over smaller, more regionally focused CROs. Our expertise and the quality of our products and services, provide us with a significant competitive advantage in the CRO industry. Our full service capabilities and reputation for reliability and timeliness allow us to build long-term relationships with our customers and provide a wide range of services for their research needs worldwide. • Strong market position. We believe we are currently the third largest CRS provider globally by revenue, with a market share of approximately 9% of the growing $3.9 billion non-clinical CRO industry. We expect the non-clinical CRO industry to experience growth from R&D expenditures and increased outsourcing of these expenditures. Given
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our scale and reputation within the non-clinical industry, we believe we are in a strong position to outperform the market over the next five years. We believe we are the second largest RMS provider globally by revenue, with a market share of approximately 17%. We are one of only two global suppliers, and as such are able to offer a global platform to large pharmaceutical and biotech firms who have synchronized their research platforms globally. We utilize our long standing relationships and a broad range of services to retain and enhance the customer value proposition, building and growing our relationships with our largest accounts as their research needs evolve. • Established expertise in specialty toxicology. We believe toxicology services account for approximately 70% of the non-clinical CRO testing market, or approximately $2.5 billion. The specialty toxicology segment currently accounts for approximately 25% of non-clinical CRO studies but represents approximately 35% of our CRS revenues. Within the specialty toxicology segment, we believe we are an established leader in inhalation toxicology, having been one of the first CROs to sign a dedicated space agreement for this discipline. We believe our expertise in this sub-segment and others has allowed us to build a loyal customer base. • Diverse customer base with long-standing relationships. Our CRS business has provided services to more than 35 of the 50 largest (by sales) pharmaceutical companies in the world. Due to the quality of our services and long-standing relationships, over 90% of our orders in 2014 came from repeat customers. Furthermore, we retain a significant share of the market for crop protection and industrial chemical companies, whose business, we believe, is independent of the pharmaceutical R&D cycle. Our RMS business served approximately 4,800 customers in the most recent year and does business with nearly all of the largest pharmaceutical, biotechnology and academic institutions globally. • High barriers to entry. The non-clinical CRO market is a difficult and costly market to enter due to the specialized nature of the assets and requisite employee expertise. In addition, there are significant capital costs associated with building new facilities along with ongoing maintenance investments necessary for maintaining state-of-the-art equipment and laboratories. Also, the non-clinical business is highly dependent on intangible assets, including employee expertise, company reputation, regulatory compliance and approvals, which new entrants would typically find difficult to satisfy. We believe that CRO customers demand expertise and a strong track record with regulators as well as scientific excellence and invaluable background data over a wide range of chemical moieties and therapeutic areas. The RMS segment also has high barriers to entry. The construction of maximum biosecurity barrier production facilities, flexible-film isolator production facilities and the population of these facilities with greater than fifty specific stocks and strains of rodent models requires years of investment, highly developed operating procedures and global harmonization. No new entrants have entered this market in many decades. • Experienced management team and stable, high quality workforce. Our executives have on average over 20 years of industry experience, including over 15 years serving within the Company. Andrew Baker, our Chairman, and Brian Cass, our Chief Executive Officer, have been with us since 1998 and have substantial industry experience. This has allowed them to build an extensive relationship base within the industry. We maintain a staff which includes PhD- level scientists across a variety of disciplines providing our customers with extensive expertise through our service
offerings.
Our Strategy • Strengthen existing and develop new strategic partnerships. We believe our long-term relationships with leading pharmaceutical and crop protection companies are a key driver of our success. In order to expand our market share, we consider further integration into our customers’ businesses to be critical. To date, we have been able to secure multiple, strategic partnerships with leading companies, allowing us to better integrate our products and services with their operations. These leading customers are currently trending towards further outsourcing of their development activities as they seek to reduce their fixed cost base and avoid the investment needed to update and/or replace aging facilities. The addition of Harlan’s pre-clinical CRO capabilities and scientific strength, coupled with the RMS service offering that we can now offer, enhances our position with these strategic partners. We believe our global reach, state-of-the-art facilities and full service capabilities will enable us to capitalize upon this increased outsourcing trend by providing additional services to our existing customers and developing relationships with new ones. . • Maintain market leadership in specialty toxicology. We believe the toxicology market accounts for approximately 70% of non-clinical CRO testing, or approximately $2.5 billion. The specialty toxicology segment currently accounts for approximately 25% of non-clinical CRO testing and represents approximately 35% of our CRS revenues. We have developed an expertise in the specialty toxicology segment with particular expertise in inhalation toxicology. As a premier industry participant from a scientific, technical and engineering viewpoint, we believe we have been able to capture significant market share. Our relatively high specialty toxicology mix provides a favorable balance as compared to those non-clinical CROs more exposed to the typically more volatile general toxicology market, and we are dedicated to maintaining our industry leading position in this segment.
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• Improve margins through focus on operational efficiencies. Our management and operational teams are continuously focused on improving efficiencies and optimizing our cost structure, including the companywide implementation of an enhanced set of operating tools. • Selectively enhance our product and service offerings. As we drive our operations towards further integration with our customers, we have identified the late-stage discovery market as a potential growth opportunity. Given the significant restructuring within the pharmaceutical industry over the past five years, a surplus of available equipment and human capital have become available which should allow us to successfully enter this market at an attractive return. In addition, we believe that we can efficiently further expand our biologics testing given our focus and expertise in immunology and cell biology. We will continue to selectively pursue similar business segments while maintaining our focus on our core services. • Expand our United States CRS operations. We currently maintain a state-of-the art facility in Princeton, N.J. that has provided us with a central location to serve our United States customer base, which is highly concentrated in the Northeastern United States. From 2010 to 2014, our United States operations have comprised approximately 30% of our new orders. Given the concentration of leading pharmaceutical companies within the United States, we continue to view the North American market as a core area for growth. We intend to capitalize upon available capacity at our Princeton facility and will seek to continue to selectively and incrementally expand our CRS business in the US.
Expand RMS in emerging geographies. We believe we can expand our RMS business by serving emerging, high growth research markets. For example, we recently opened a breeding facility in India and believe this market is poised to grow in the low double digits over the next five years. We also believe that we have other similar expansion opportunities to drive strong growth in other markets.
Know-how and Patents The Company believes that its proprietary know-how plays an important role in the success of its business. Where the Company considers it appropriate, steps are taken to protect its know-how through confidentiality agreements and protection through registration of title or use. Whereas the Company has numerous US, European, UK and Chinese trademarks, it has no patents, trademarks, licenses, franchises or concessions which are material and upon which any of the services offered are dependent.
Customers The Company offers worldwide research products and services for biological safety evaluation research services to human and veterinary pharmaceutical and biotechnology companies, other contract research organizations and government entities, as well as crop protection, industrial chemical and food companies. In 2014, the Company received orders from companies ranging from some of the largest in their respective industries to small and start-up organizations, with no single customer accounting for more than 10% of total orders in 2014.
Backlog The Company’s net revenues are earned under contracts ranging in duration from a few days to three years. Net revenue from these contracts is recognized over the term of the contract as services are rendered. The Company maintains an order backlog to track anticipated net revenues for work that has yet to be earned. Aggregate backlog for CRS at December 31, 2014 was approximately $167.2 million.
Backlog includes work to be performed under signed agreements (i.e., contracts). Once work under a signed agreement begins, net revenues are recognized over the life of the project.
We do not report backlog for RMS as the turnaround time from receipt of order to fulfillment, for both products and services is short.
Competition Competition in our market segments includes: in-house R&D divisions of large pharmaceutical, crop protection and industrial chemical companies who perform their own safety assessments and/or build and maintain their own animal breeding stocks; “full service” non-clinical testing providers—CROs like the Company, who globally provide a full range of non- clinical safety services to the industries (such as Covance and Charles River); “niche” non-clinical testing suppliers focusing on specific services, geographic areas, or industries (such as MPI, WIL Research and SNBL); and other research models suppliers, such as Taconic Biosciences and Janvier Labs.
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There is competition for customers on the basis of many factors, including: reputation for on-time quality performance; expertise and experience in specific areas; scope of service offerings; strengths in various geographic markets; price; technological expertise; ability to acquire, process, analyze and report data in a rapid and accurate manner; historic client experience and relationships; quality of facilities; and vendor size.
Research and Development In addition to experience gained through research activities performed for customers, the Company engages in research in order to respond to the changing needs of customers and to maintain competitiveness within the industries in which it operates. Most of the research undertaken, however, is an inherent part of the research carried out on behalf of customers in completing studies and as such it is not identified separately.
Regulatory The Company is subject to a variety of governmental regulations, particularly in the US and the UK, relating to animal welfare and the conduct of its business. Services provided by the Company are used to support pharmaceutical, biotechnology, chemical or agrochemical product approval applications worldwide. Its laboratories are therefore subject to routine formal inspections by appropriate regulatory and supervisory authorities, as well as by representatives from customer companies. The Company is regularly inspected by US and UK governmental agencies because of the number and complexities of the studies it undertakes. In 1979, the US FDA promulgated the Good Laboratory Practice (“GLP”) regulations, defining the standards under which biological safety evaluations are to be conducted. Since that time the Organization for Economic Co-Operation and Development (OECD) and the International Congress on Harmonisation (ICH) have implemented international principles that, together with compliance monitoring and mutual data acceptance programs, are designed to ensure that laboratory and clinical work is conducted to the highest standards.
The Company’s services are subject to these international standards for the conduct of research and development studies embodied in the regulations for GLP, Good Clinical Practice (GCP) and Good Manufacturing Practice (GMP). The FDA and other national and international regulatory authorities require the test results submitted to such authorities, including those conducted by the Company for its customers, to be based on studies conducted in accordance with GLP, GCP or GMP. To ensure that all testing programs meet customer requirements, as well as all relevant codes, standards and regulations, the Company maintains extensive quality assurance programs. Periodic inspections are conducted as testing programs are performed to assure adherence to project specifications or protocols, and final reports are extensively inspected to ensure consistency with data collected. The Company must also maintain records and reports for each study for specified periods for auditing by the study sponsor and by any regulatory authorities.
The Company’s operations in the UK are regulated by a variety of governmental regulations, including the Animals (Scientific Procedures) Act 1986. This legislation, administered by the UK Home Office, provides for the control of scientific procedures carried out on animals and the regulation of their environment. Personal licenses are issued by the UK Home Office to personnel who are competent to perform regulated procedures and each program of work must be authorized in advance by a Project Licensee. Premises where procedures are carried out must also be formally designated by the UK Home Office. Consultations and inspections are regularly undertaken by the UK Home Office in order to ensure continued compliance with regulatory and legislative requirements.
The Company’s laboratory in the US is subject to a variety of governmental regulations, including the United States Department of Agriculture’s (“USDA”) Animal Welfare Regulations. The laboratory is regularly inspected by USDA officials for compliance with these regulations. The Company has formed an internal Institutional Animal Care and Use Committee, comprising staff from a broad range of disciplines within the Company in addition to external representation, to comply with applicable regulations (both in the US and the UK). Furthermore, the Company’s laboratories in both the US and UK are accredited under a voluntary certification program run by an independent and internationally recognized organization, the Association for Assessment and Accreditation of Laboratory Animal Care.
At all of its research centers in the US and the UK, the Company ensures the availability of suitably experienced and qualified veterinary staff backed by a 24-hour call-out system.
While the Company conducts its business to comply with certain environmental and health and safety regulations, compliance with such regulations does not impact significantly on its earnings or competitive position. Management believes that its operations are currently in material compliance with all applicable environmental and health and safety regulations.
Animal Welfare and Research Support We are committed to delivering first-class science, operational performance and customer service. High standards of animal welfare are vital to each of these, and so are integral to our business success. As a consequence we strive to achieve those high standards globally, whilst recognizing that cultural differences and diverse local operating conditions exist across different countries in relation to the breeding, care and use of laboratory animals.
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We have been at the forefront of animal welfare improvements and the humane care of laboratory animals, and are committed to the 3Rs (Reduction, Refinement and Replacement). We provide financial support to the NC3Rs and FRAME in the UK and have been involved in international validation studies. Members of our scientific and technical care staff undertake continuing professional development in the field of laboratory animal science, with special reference to animal welfare and the 3Rs, and they are encouraged to publish and present within the scientific community.
Laboratory animals remain an essential component in the research and development that both we and our customers conduct. They further our knowledge of living systems and help in the discovery and development of products that can make a real difference to people’s lives. We work with the scientific community to improve our understanding and promote best practice in the care and welfare of research animals. As animal carers and researchers as well as providers of research models to the research community, we are responsible to our customers and the public for the health and well-being of the animals in our care.
Environmental Health and Safety We are subject to a variety of federal, state, local and foreign environmental laws, regulations, initiatives and permits that govern, among other things: the emission and discharge of materials, including greenhouse gases, in air, land and water; the remediation of soil, surface water and groundwater contamination; the generation, storage, handling, use, disposal and transportation of regulated materials and wastes, including biomedical and radioactive wastes; and health and safety.
Human Resources The Company’s most important resource is its people. They have created the Company’s knowledge base, its expertise and its excellent scientific reputation. Scientists from the Company are represented at the highest levels on several US, UK and international committees regarding safety and toxicity testing. Several staff members are considered leaders in their respective fields. They frequently lecture at scientific seminars and regularly publish articles in scientific journals. This recognition has resulted in frequent assignments from customers for consultation services. Some of the Company’s staff serve by invitation or election on a number of scientific and industrial advisory panels, as well as groups within certain organizations and agencies such as the FDA, the EPA, the UK Department of Health, and the World Health Organization.
To ensure that this experience and expertise is transmitted throughout the organization, the Company conducts training programs. For example, the Company’s study director training programs train graduate staff in all phases of toxicology. Also, in conjunction with the Institute of Animal Technology, the Company maintains what it believes to be one of the largest animal technician training programs in the world. The number of employees in the Company at December 31, 2014 and 2013 were as follows:
2014 2013 US 977 260 UK 1,708 1,015 Rest of world 860 13
3,545 1,288
The significant increase in the number of employees in 2014 as compared to 2013 is principally as a result of the Harlan acquisition.
The Company’s labor force is non-union and there has never been any disruption of the business through strikes or other employee action. The Company regularly reviews its pay and benefits packages and believes that its labor relations, policies and practices and management structure are appropriate to support its competitive position.
Geographic areas For an analysis of revenues by geographical area (based on the locations of our facilities) and assets attributable to each of the Company’s geographical business areas for each of the last three fiscal years, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Properties We own or lease the land and buildings where we have facilities. We own facilities for our CRS business in the US, UK, Switzerland, Spain, Germany and Israel. We own facilities for our RMS business in the US, UK, Netherlands, France, Italy and Israel for both production and distribution purposes. Where we have leases, none of these are individually material to our business operations. Many of our leases have an option to renew, and we believe that we will be able to renew expiring leases on satisfactory terms. We consider that our facilities are adequate for our operations and we have the capacity to further grow our business. However, as many of our facilities are built for specific purpose, excess capacity may not be used for other purposes without significant investment in renovation.
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In October 2014, we announced the plan to close our CRS facility in Switzerland.
General Corporate Information and Ownership of BPA and Holdings Holdings is a Delaware corporation with principal offices at 401 Hackensack Avenue, Floor 9, Hackensack, NJ, 07601. We can be reached at (866) 524-0378 and at [email protected]. Holdings was formed to serve as a holding company for LSR. LSR was acquired by an investor group led by Andrew Baker, our Chairman, in a November 2009 “going private” transaction. At that time, LSR ceased to be traded on the NYSE Arca. Mr. Baker and our CEO, Brian Cass, have had a leading ownership and management role at the Company since 1998. As a result of limited liability company and shareholder agreements, Mr. Baker has the right to appoint all of the directors of Holdings’ immediate parent company, Lion Holdings, Inc. (“Lion Holdings” or the “Parent”), although the indirect economic interest of Mr. Baker and his affiliates in the Company is approximately 16%. Other members of management own a combined, indirect economic interest of approximately 6.5%. Two of Mr. Baker’s co-investors, Jermyn Street Capital LLC (“Jermyn”) and Savanna Holdings LLC (“Savanna”), possess consensual rights over specified extraordinary matters, such as material sales of assets, acquisitions and change in control transactions. See “Management” and “Certain Relationships and Related Party Transactions— Sale-Leaseback Transactions with Baker Affiliates and Interest of Mr. Baker and his Co-Investors in the Company and the Transactions.”
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RISK FACTORS An investment in the notes or participation as a lender involves a number of risks. Before making a decision to purchase the notes or participate as a lender, you should carefully consider the following risks, as well as the other information contained in this Annual Report. The risks described below are those that we believe are the material risks we face but are not the only ones facing the Company. If any of the following risks occur, our business, financial condition, prospects and results of operations could be materially adversely affected. As a result, the trading price of the notes and/or the value of your participation as a lender could decline and you may lose part or all of your investment.
Risks Related to Our Business Changes in government regulation or in practices relating to the pharmaceutical industry or the contract research industry could decrease the need for the services the Company provides or result in increased costs for the Company. Governmental agencies throughout the world strictly regulate the drug development process. The Company’s business involves, among other things, helping pharmaceutical and biotechnology companies navigate the regulatory drug approval process. Changes in regulation, such as a relaxation in regulatory requirements or the introduction of simplified drug approval procedures, or an increase in regulatory requirements that the Company has difficulty satisfying or that make its services less competitive, could eliminate or substantially reduce the demand for the Company’s services. In addition, if new legislation were to mandate a significant reduction in safety testing procedures which utilize laboratory animals (as has been advocated by certain groups, most recently petitions by anti-vivisection groups for the EU to ban all animal experimentation) certain segments of our business could be materially adversely affected. Also, if the government were to introduce measures to contain drug costs or pharmaceutical and biotechnology company profits from new drugs, the Company’s customers may spend less, or reduce their growth in spending on research and development.
For example, in the United States in March 2010, the US Congress enacted The Patient Protection and Affordable Care Act, health care reform legislation intended to expand, over time, health insurance coverage and impose health industry cost containment measures. This legislation may significantly impact the pharmaceutical and biotechnology industries. Regulations under that Act were promulgated in 2013 and more than eleven million people have enrolled under the new law. Efforts to repeal that law have been introduced in Congress and undertaken in the courts and the success of those efforts cannot be predicted. In addition, the US Congress, various state legislatures and European and Asian governments may consider various types of health care reform in order to control growing health care costs. Implementation of health care reform legislation that contains costs could limit the profits that can be made from the development of new drugs. This could adversely affect research and development expenditures by pharmaceutical and biotechnology companies which could in turn decrease the business opportunities available to us both in the United States and abroad. In addition, new laws or regulations may create a risk of liability, increase our costs or limit our service offerings. We are presently uncertain as to the effects of the recently enacted legislation on our business and are unable to predict what legislative proposals will be adopted in the future, if any.
Failure to comply with applicable governmental regulations could harm the Company’s business. As a company in the contract research industry, the Company is subject to a variety of governmental regulations, particularly in the US, Europe, and the UK, relating to animal welfare and the conduct of its business, including Good Laboratory Practice regulations, the UK Animals (Scientific Procedures) Act 1986 and US USDA Animal Welfare Regulations. Our laboratories are therefore subject to routine formal inspections by appropriate regulatory and supervisory authorities, including the US FDA, the US USDA and the UK Home Office, as well as by representatives from customer companies. The Company is regularly inspected by governmental agencies because of the number and complexities of the studies it undertakes. The Company must also maintain records and reports for each study for specified periods for auditing by the study sponsor and by any regulatory authorities. Failure to comply with applicable laws and regulations could result in material liabilities, the suspension of licenses, disqualification of current trials, the disqualification of data collected by the Company, the termination of ongoing research, harm to relationships with customers or harm to the Company’s reputation and prospects for future work, and could have a material adverse effect on our business or financial condition. For example, if we were to fail to properly monitor compliance by our personnel with study protocols, the data collected from that applicable study and other studies could be disqualified. If this were to happen, we could be contractually required to repeat the study or studies at no further cost to our customer, but at potentially substantial cost to us, or could be exposed to a lawsuit seeking substantial monetary damages. If our operations are found to violate any applicable law or other governmental regulations, we might be subject to civil and criminal penalties, damages and fines and other penalties. Any action against us for violation of applicable laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management’s attention from the operation of our business and damage our reputation. In addition, applicable laws and regulations could significantly restrict the Company’s ability to expand its facilities or require it to acquire costly equipment or incur other material costs to comply with regulations, or otherwise increase costs.
We expend significant resources on compliance efforts. Regulations and guidance worldwide concerning the production and use of laboratory animals for research purposes continue to be updated. For example, the European Directive 2010/63/EU requires new standards for animal housing and accommodations that require implementation by 2017. Similarly, guidance has been and continues to be developed for other areas that impact the biomedical research community on both a national and international basis, including transportation, import and export requirements of biological materials, and animal housing and welfare. Certain of 13
our customers may require us to comply with this new guidance in advance of its implementation as a condition to being awarded contracts. Conforming to these new guidelines may result in increased costs attributable to adding or upgrading facilities, the addition of personnel to address new processes and increased administrative burden.
The Company depends on the pharmaceutical and biotechnology industries. The Company’s net revenues depend greatly on the expenditures made by the pharmaceutical and biotechnology industries in research and development. Accordingly, economic factors and industry trends that affect the Company’s customers in these industries also affect our business. For example, the availability of financing from the capital markets to the biotechnology industry can have a material impact on their ability to fund development of their compounds. Also, at any given time, pharmaceutical customers can choose to allocate their research and development expenditures more heavily towards clinical testing than the non-clinical safety testing that the Company performs. As well, if health insurers were to change their practices with respect to reimbursements for pharmaceutical products, the Company’s customers may spend less, or reduce their growth in spending on research and development.
Several of our product and service offerings are dependent on a limited source of supply, which if interrupted could adversely affect our business.
We depend on a limited international source of supply for certain products, such as large research models. Disruptions to their continued supply may arise from health problems, export or import laws/restrictions or embargoes, international trade regulations, foreign government or economic instability, severe weather conditions, increased competition amongst suppliers for models, disruptions to the air travel system, commercial disputes, supplier insolvency, or other normal-course or unanticipated events. Any disruption of supply could harm our business if we cannot remove disruption or are unable to secure an alternative or secondary supply source on comparable commercial terms.
Changes in aggregate spending, research and development budgets and outsourcing trends in the pharmaceutical and biotechnology industries could adversely affect our operating results. Our ability to continue to grow and win new business is dependent in large part upon the ability and willingness of the pharmaceutical and biotechnology industries to continue to spend on compounds in the pre-clinical phase of research and development and to outsource the products and services we provide. Fluctuations in the expenditure amounts in each phase of the research and development budgets of these industries could have a significant effect on the demand for our products and services. R&D budgets fluctuate due to changes in available resources, mergers of pharmaceutical and biotechnology companies, spending priorities, general economic conditions and institutional budgetary policies. Our business could be adversely affected by any significant decrease in pre-clinical research and development expenditures by pharmaceutical and biotechnology companies. The economic downturn negatively affected us as research and development budgets at our pharmaceutical and biotechnology customers were reduced for their early stage products in favor of their later-stage products.
Even more than the growth in R&D budgets, the practice of many companies in the pharmaceutical and biotechnology industries to hire external organizations such as ours to conduct non-clinical research projects has been critical to our growth. Over the past decade, our industry has grown as a result of the increase in pharmaceutical and biotechnology companies outsourcing their non-clinical research support activities. If these industries reduce their outsourcing of these research projects for any reason, our operations and financial condition could be materially and adversely affected. We also believe we may be negatively impacted by consolidation in the pharmaceutical and biotechnology industries, including business reductions or failures due to a lack of financing, which could result in development pipelines being rationalized, a shift in focus from development to integration, the delay or cancellation of certain existing projects or a decrease in the number of our potential customers. If the number of our potential customers declines, potential customers might be able to negotiate price discounts or other terms for our services that are less favorable to us than has historically been the case.
The Company competes in a highly competitive market. The CRO and RMS industries are highly competitive. Competition in both the pharmaceutical and non-pharmaceutical market segments ranges from in-house research and development divisions of large pharmaceutical, agrochemical and industrial chemical companies, that perform their own safety assessments, to contract research organizations like the Company that provide a full range of services and products to the industries and niche suppliers focusing on specific services, geographies or industries. Some of these competitors have greater capital, technical and other resources than we have, while our competitors that are smaller specialized companies might compete effectively against us based on price and their concentrated size and focus.
Providers of outsourced drug development and research models and services compete on the basis of many factors, including the following: reputation for on-time quality performance; reputation for regulatory compliance;
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expertise, experience and operational stability; scope of service offerings; how well services are integrated; quality of facilities; quality and stability of the animal models; assurance of supply; technical and scientific support; strength in various geographic markets; price; financial stability; technological expertise and efficient drug development processes; and ability to acquire, process, analyze and report data in a time-saving, accurate manner. The Company has traditionally competed effectively in the above areas, but there can be no assurance that it will be able to continue to do so. The biotechnology and pharmaceutical industries generally are subject to increasingly rapid technological changes. Our competitors or others might develop technologies, services or products that are more effective or commercially attractive than our current or future technologies, services or products, or that render our technologies, services or products less competitive or obsolete. If competitors introduce superior technologies, services or products and we cannot make enhancements to ours to remain competitive, we could be materially and adversely affected.
New technologies may be developed, validated and increasingly used in biomedical research that could reduce demand for some of our products and services. For many years, groups within the scientific and research communities have attempted to develop models, methods and systems that would replace or supplement the use of living animals as test subjects in biomedical research. Some companies have developed techniques in these areas that may have scientific merit. In addition, technological improvements to our existing or new processes, such as imaging technology, could result in a refinement in the number of animal research models necessary to conduct the required research. Alternative research methods could decrease the need for research models, and we may not be able to develop new products effectively or in a timely manner to replace any lost sales. In addition, other companies or entities may develop research models with characteristics different than the ones that we produce, and which may be viewed as more desirable by our customers.
Contract research and research model services create a risk of liability. In contracting to work on drug development trials and studies, the Company faces a range of potential liabilities, for example: • risks associated with our possible failure to properly care for our customers’ property, such as samples, study compounds, records, work in progress, other archived materials while in our possession, or goods and materials in transit; • errors or omissions from tests conducted for the agrochemical and industrial chemical industries; • errors and omissions during a study that may undermine the usefulness of a study or data from the study; • errors or omissions that result in harm to study volunteers during a trial or after regulatory approval of the drug to consumers of the drug; and • risks that our research models may be contaminated or infected, which could harm the models or humans coming into contact with them despite our best efforts to implement appropriate protections.
We try to limit these risks. In our RMS business we implement animal testing, quarantine and veterinary measures to control animal disease. In our CRS and RMS businesses while we endeavor to include in our contracts provisions entitling us to be indemnified or entitling us to a limitation of liability, these provisions do not uniformly protect us against liability arising from certain of the Company’s own actions, such as negligence or misconduct. We could be materially and adversely affected if we were required to pay damages or bear the costs of defending any claim which is not covered by a contractual indemnification provision or in the event that a party who must indemnify us does not fulfill its indemnification obligations or which is beyond the level of the Company’s insurance coverage or for which insurance coverage is not available. There can be no assurance that the Company will be able to maintain such insurance coverage on terms acceptable to us.
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Our animal populations may suffer diseases that can damage our inventory, harm our reputation or result in other liability to us.
It is important that the Company’s research products be free of diseases, including infectious diseases. The Company houses in our CRS business a number of different species at close proximity, with new batches being acquired frequently. In our RMS business, our research models in our animal production facilities must similarly remain free of contamination. The presence of diseases or infectious agents has the potential to cause substantial loss of animals in the Company’s inventory, to result in harm to humans or the public if the disease cannot be contained to animals in inventory and/or to distort or damage the quality of the research results. These risks may differ substantially according to species. In rodents most infections are without any apparent clinical signs and pose therefore a risk to the scientific quality of the research performed on the animals rather than to humans. We seek to minimize the risk of these species being infected by one of these agents due to the stringent health monitoring programs in place at the supplier and the Company itself in our RMS facilities. The same applies to a certain degree to primates, where all animals will be serologically tested for specific diseases. The main concern in this species is the potential of any infectious disease causing harm to humans due the close evolutionary proximity. Again, the risk is substantially minimized by efficient quarantine and health monitoring programs at supply and after acquisition. Diseases in cats and dogs bear less risk to the Company as efficient vaccination programs are available and followed in these species. Farm animals may be carriers of diseases, which may cause significant losses in animal numbers and are of particular public interest including foot and mouth disease. A national screening program may mitigate some of the risks of animals carrying these diseases being acquired by the Company, but an animal found to be positive for any notifiable disease would impact the public reputation of the Company. Any significant disease outbreak at the Company has the potential to harm our reputation or have a material adverse effect on our financial condition, results of operations, and cash flows. There is also the risk that disease from research models we produce may affect our customers’ facilities.
We are subject to environmental, health and safety requirements and risks as a result of which we may incur significant costs, liabilities and obligations. We are subject to a variety of federal, state, local and foreign environmental laws, regulations, initiatives and permits that govern, among other things: the emission and discharge of materials, including greenhouse gases, in air, land and water; the remediation of soil, surface water and groundwater contamination; the generation, storage, handling, use, disposal and transportation of regulated materials and wastes, including biomedical and radioactive wastes; and health and safety. Failure to comply with these laws, regulations or permits could result in fines or sanctions, obligations to investigate or remediate existing or potential contamination, third-party property damage claims, personal injury claims, natural resource damages claims, or modification or revocation of operating permits and may lead to temporary or permanent business interruptions. Pursuant to certain environmental laws, we may be held strictly, and under certain circumstances jointly and severally, liable for costs of investigation and remediation of contaminated sites which we currently own or operate, or sites at which we or our predecessor have owned or operated in the past. Further, we could be held liable at sites where we have sent wastes for disposal.
Environmental laws, regulations and permits, and the enforcement thereof, change frequently and have tended to become more stringent over time. Compliance with the requirements of laws and regulations may increase capital costs and operating expenses, or necessitate changes to our production processes.
We endeavor to conduct our operations according to all legal requirements, but we may not be in complete compliance with such laws and regulations at all times. We use, and in the past have used, hazardous materials and generate, and in the past have generated, hazardous wastes. We cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any resulting damages and incur liabilities which exceed our resources. Our costs, liabilities and obligations relating to environmental matters may have a material adverse effect on our business, financial condition, results of operations and cash flows.
The Company may not be able to successfully develop and market or acquire new services. The Company may seek to develop and market new services that complement or expand its existing business or expand its service offerings through acquisition. If the Company is unable to develop new services and/or create demand for those newly developed services, or expand its service offerings through acquisition, its future business, results of operations, financial condition, and cash flows could be adversely affected.
We may have trouble integrating the Harlan acquisition. In April 2014 the Company acquired Harlan. Since that time we have been working to integrate Harlan’s business. Failure by the Company to integrate Harlan’s CRS business with the Company’s pre-existing CRS business could result in operational and financial difficulties. Prior to the acquisition the Company had no prior experience in operating an RMS business. Failure to properly operate the newly acquired RMS business could similarly result in operational and financial difficulties. The Company’s acquisition of Harlan was predicated in part on recognized potential synergies. Failure to achieve these expected synergies could adversely affect the Company’s financial performance. It remains possible that the Company will discover liabilities at Harlan that it was unaware of at the time of acquisition and for which the Company will be responsible. The
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Company has also determined to close certain of the acquired business locations of Harlan and attempt to transfer the business to other locations. The Company may lose customers and business revenues from the closed locations.
Upgrading and integrating newly acquired business systems could result in implementation issues and business disruptions.
We have embarked upon an integration and upgrade, as appropriate, to many of our numerous legacy business systems including Customer Relationship Management and Enterprise Resource Planning (“ERP”) systems. In general, the process of planning and preparing for these types of integrated, wide-scale implementations is extremely complex and we are required to address a number of challenges including data conversion, system cutover and user training issues. Problems in any of these areas could cause operational problems during implementation including delayed shipments, missed sales, billing and accounting errors and other operational issues. There have been numerous, well publicized instance of companies experiencing difficulties with the implementation of ERP systems which resulted in negative business consequences.
If we are unable to identify and complete successfully acquisitions, our business could be adversely affected. The Company may seek to expand its business through acquisitions. However, business and technologies may not be available on terms and conditions we find acceptable. The Company may devote time and resources investigating and negotiating with potential acquisition or alliance partners, but not consummate the transactions. Even if consummated, factors which may affect our ability to grow successfully through acquisitions include: • difficulties and expenses in connection with integrating the acquired companies and achieving the expected benefits; • diversion of management’s attention from current operations; • the possibility that the Company may be adversely affected by risk factors facing the acquired companies; • potential losses resulting from undiscovered liabilities of acquired companies not covered by the indemnification the Company may obtain from the seller;
• difficulties in retaining customers of the acquired business; • risks of not being able to overcome differences in foreign business practices, language and other cultural barriers in connection with the acquisition of foreign companies; and • loss of key employees of the acquired companies.
In the event that an acquired business or technology does not meet our expectations, our results of operations may be adversely affected.
The Company’s non-US locations account for a majority of its revenues, making the Company exposed to risks associated with operating internationally. In 2014, approximately 69% of the Company’s net revenues from continuing operations were generated by its facilities outside the United States. We expect that international revenues will continue to account for a significant percentage of our revenues for the foreseeable future. As a result of these foreign sales and facilities, the Company’s operations are subject to a variety of risks unique to international operations, including the following: • exposure to local economic conditions; • changes in tax law; • potential restrictions on the transfer of funds; • unexpected changes in regulatory requirements; • exposure to liabilities under the US Foreign Corrupt Practices Act or the UK Antibribery Act; • government imposed investment and other restrictions or requirements; • exposure to local social unrest, including any resultant acts of war, terrorism or similar events; • exposure to local public health issues and the resultant impact on economic and political conditions; • currency exchange rate and interest rate fluctuations; • difficulty enforcing agreements and collecting receivables through certain legal systems; • variations in protection of intellectual property and other legal rights; • more expansive legal rights of employees, including specifically those applicable to our European operations; and • export and import restrictions (such as antidumping duties, tariffs or embargoes).
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The Company is exposed to exchange rate fluctuations and its US dollar denominated indebtedness. The Company operates on a world-wide basis and generally invoices its customers in the currency of the country in which it operates. Management has decided not to hedge against this exposure. While exposure to exchange rate fluctuations may be limited since our sales are generally denominated in the same currency as our costs, trading exposures to currency fluctuations may nonetheless occur as a result of certain sales contracts, performed for customers in a different country than the testing site, which are denominated in a currency different from the site’s currency. There can be no assurance we will not suffer more detrimental impacts from currency fluctuations in the future. Moreover, since the Company operates on an international basis, movements in exchange rates, particularly against British pounds, can have a significant impact on our price competitiveness vis a vis competitors who trade in currencies other than British pounds or US dollars. The Company’s indebtedness is denominated in US dollars whereas the Company earns significant revenues (approximately 69% of total net revenues from continuing operations in 2014) in other currencies. This may adversely impact our ability to meet our debt obligations.
Our backlog may not be indicative of future results. Our backlog of approximately $167.2 million as of December 31, 2014 is based on anticipated service CRS revenue from uncompleted projects that our customers have awarded and we believe to be firm commitments. Once work begins on a project, net revenue is recognized over the duration of the project. Backlog is the amount of revenue that remains to be earned and recognized on signed contracts. Contracts included in backlog are generally subject to termination by our customers at any time. In the event that a customer cancels a contract, we typically would be entitled to receive payment for all services performed up to the cancellation date and subsequent customer-authorized services related to terminating the cancelled project. The duration of the projects included in our backlog range from a few days to many years. Our backlog may not be indicative of our future results and we cannot assure you that we will realize all the anticipated future revenue reflected in our backlog. A number of factors may affect backlog, including: • the variable size and duration of the projects; • the loss or delay of projects; • the change in the scope of work during the course of a project; and • the cancellation of such contracts by our customers.
Also, if projects are delayed, the projects will remain in backlog but will not generate revenue at the rate originally expected. Cancellation or delay of a large contract or multiple smaller contracts could result in under-utilized resources and require an adjustment to our backlog, negatively affecting our net revenue and results of operations. The historical relationship of backlog to revenues actually realized by us should not be considered indicative of future results.
The Company’s contracts are generally terminable on little or no notice. Termination of a large contract for services or multiple contracts for services or product purchases could adversely affect the Company’s revenue and profitability. In general, the Company’s customers may terminate the agreements that they enter into with the Company or reduce the scope of services under these contracts upon little or no notice. Contracts may be terminated for various reasons, including: • unexpected or undesired study results; • the loss of funding for the particular research study; • the failure of products to satisfy technical or safety requirements; • production problems resulting in shortages of the drug being tested; • adverse reactions to the drug being tested; • regulatory restrictions placed on the drug or compound being tested; or • the customer’s decision to forego or terminate a particular study.
The loss, reduction in scope or delay of a large contract or the loss or delay of multiple smaller contracts could materially adversely affect our business.
Because most of the Company’s revenues are from fixed price contracts, these contracts may be subject to under-pricing and cost overruns. The majority of the Company’s contracts with its customers are fixed price contracts with set limits on amounts we can charge for our services, creating the risk of cost overruns under these contracts. The Company typically has some flexibility under these contracts to adjust the price to be charged under these contracts if it is asked to provide additional services. If the Company did have to bear significant costs of under-pricing or cost overruns under these contracts, its business, financial condition and operating results could be adversely affected.
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The Company depends heavily on its senior management team, and the loss of any member may adversely affect us. The Company believes its success depends on the continued availability of its senior management team, especially Andrew Baker (Chairman) and Brian Cass (CEO). If one or more members of the senior management team were unable or unwilling to continue in their present positions, those persons would likely be difficult to replace and the Company’s business would likely be harmed. If any of the Company’s key employees were to join a competitor or to form a competing company, some of the Company’s customers might choose to use the services of that competitor or new company instead of the Company. Furthermore, customers or other companies seeking to develop in-house capabilities may hire away some of the Company’s senior management or key employees. The loss of one or more of these key employees could adversely affect the Company’s business. In addition, the death or disability of Mr. Baker would result in Jermyn and Savanna having rights to appoint Lion Holdings’ directors.
The Company must recruit and retain qualified personnel. Because of the specialized scientific nature of the Company’s business, we are highly dependent upon qualified scientific, technical and managerial personnel. There is intense competition for qualified personnel in the pharmaceutical and biotechnology fields. The shortage of qualified scientific, technical and managerial personnel, or other factors, might lead to increased recruiting, relocation and compensation costs for these professionals, which might exceed our forecasts. These increased costs might reduce our profit margins or make hiring new personnel impracticable. Any inability to hire additional qualified scientific, technical and managerial personnel might also require an increase in the workload for both existing and new personnel. Although traditionally the Company has experienced a relatively low turnover in its staff, in the future it may not be able to attract and retain the qualified personnel necessary for the conduct and further development of its business. The loss of the services of existing personnel, as well as the failure to recruit additional key scientific, technical and managerial personnel in a timely manner, could have a material adverse effect on the Company’s ability to expand its businesses and remain competitive in the industries in which it participates.
Actions of animal rights activists may affect the Company’s business and associated persons, our ability to access capital markets and the information that we share. The Company’s development services utilize animals (predominantly rodents) to test the safety and efficacy of drugs. The Company’s RMS business provides animal research models to our customers. Such activities are required for the development of new medicines and medical devices under regulatory regimes in the United States, Europe, Japan and other countries. Many CROs, including the Company, pharmaceutical companies and other research organizations are targeted by animal rights activists who oppose all testing on animals, for whatever purpose, including the animal testing activities in support of safety and efficacy testing for customers. These groups, which include groups directed at the industry and the Company, have publicly stated that the goal of their campaign is to stop animal testing. Acts of vandalism and other acts by animal rights activists who object to the use of animals in drug development could have a material adverse effect on the Company’s business. These groups have targeted not only CROs and pharmaceutical companies, but also third parties that do business with CROs, including customers, suppliers, advisors and investors. For example, animal rights activists have harassed and/or caused the fear of harassment to individuals and entities in the financial community who they believe are associated with the Company, other CROs and pharmaceutical companies, including broker-dealers, stockbrokers, research analysts, auditors, investors, trading platforms and lenders. This has limited our ability to access the capital markets and other financial sources, which could adversely affect our business and our ability to restructure or refinance our indebtedness, including the senior secured notes, and may not permit us to meet our scheduled debt service obligations.
Unfavorable general economic conditions could negatively impact the Company’s operating results and financial condition. Unfavorable global economic conditions could negatively affect our business. While it is difficult for us to predict the impact of general economic conditions on our business, these conditions could reduce customer demand for some of our services, which could cause our revenue to decline. Also, our customers, particularly smaller biotechnology companies which are especially reliant on the credit and capital markets, may not be able to obtain adequate access to credit or equity funding, which could affect their ability to make timely payments to us. If that were to occur, we could be required to increase our allowance for doubtful accounts, and the number of days outstanding for our accounts receivable could increase. For these reasons, among others, if the global economic conditions stagnate or decline, our operating results and financial condition could be adversely affected.
We rely on our facilities and any disruption in their operation could materially and adversely impact us. The Company relies on certain of its facilities. In particular, the Company’s laboratory facilities are highly specialized and would be difficult to replace in a short period of time. Any event that causes a disruption of the operation of these facilities might impact our ability to provide service to our customers and therefore could have a material adverse effect on our financial condition, results of operations and cash flows.
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If we experience a breach of the confidentiality of the information we hold or of the security of our computer systems, it could adversely affect our operating results and financial condition. As a routine element of our business, we collect, analyze and retain substantial amounts of data pertaining to the pre-clinical and non-clinical studies we conduct for our pharmaceutical and non-pharmaceutical customers, much of which is highly sensitive and confidential. As a result, the Company operates large and complex computer systems that contain significant amounts of confidential client and customer data. Our contracts with our customers typically contain provisions that require us to keep confidential the information received from our customers and generated from these studies. Unauthorized persons could attempt to gain entry to this confidential information for the purpose of stealing or otherwise accessing confidential data or other information. We believe that we have taken adequate measures to protect our data and our customers’ confidential information from unauthorized access or intrusion, including, where we consider it to be appropriate, through the implementation of security measures at our research facilities and by entering into confidentiality agreements with employees and consultants. While we continue to monitor, and to improve and enhance where appropriate, our systems in this regard, in the event that our efforts are unsuccessful and the confidentiality of any information is compromised, we could suffer significant harm. In addition, as with all information technology, the Company’s systems could become vulnerable to potential damage or interruptions from fires, blackouts, telecommunications failures and other unexpected events, as well as to break-ins, sabotage or intentional acts of vandalism. Given the extensive reliance of the Company’s business on this technology and the substantial investment that would be required for new technology infrastructure, any substantial disruption or resulting loss of data that is not avoided or corrected by backup measures could adversely affect the Company’s business and operations.
The Company relies on third parties for important services. The Company depends on third parties to provide it with products and services critical to its business, including transportation services for the movement of materials and supplies. In particular, the Company depends on a limited number of suppliers for certain animal populations. In the event of a failure of any of these third parties to adequately provide these products or services, including the activities of animal rights activists, export/import restrictions or embargoes and foreign political or economic instability, the Company could have difficulty in obtaining alternative sources of the products and services, and this could have a material adverse effect on the Company’s business. Potential changes in tax law in the United States, Europe and the United Kingdom could adversely affect our operating results and financial condition. In the US, there are several proposals to reform corporate tax law that are currently under consideration. These proposals include reducing the corporate statutory tax rate, broadening the corporate tax base through the elimination or reduction of deductions, exclusions and credits, implementing a territorial regime of taxation, limiting the ability of US corporations to deduct interest expense associated with offshore earnings, modifying the foreign tax credit rules, and reducing the ability to defer US tax on offshore earnings. These or other changes in the US tax laws could impact our effective tax rate and profitability. The Company has substantial operations in the United Kingdom, which currently benefit from favorable corporate tax arrangements. The Company receives benefits from enhanced deductions and accelerated tax depreciation allowances in the United Kingdom. Any reduction in the availability or amount of these deductions would be likely to have a material adverse effect on profits, cash flow and the Company’s effective tax rate. The UK government introduced a new tax allowance, Research and Development Tax Credit (“UK R&D credit”), for large companies in 2002. This UK R&D credit allowed the UK companies to recover an additional 30% of their research and development expenses in addition to the 100% normally allowed. On July 18, 2013, a change was enacted in UK Tax Legislation in relation to research and development expenditures, giving companies the option of recognizing research and development credits as a reduction of cost of sales. The Company has adopted the new approach effective April 1, 2013 and is no longer able to recover the additional 30% UK R&D credit. The previous UK R&D credit eliminated all UK taxable income of the Company and the Company did not need to utilize its net operating loss carry forwards. Despite the change in legislation, the Company does not anticipate the removal of the R & D tax credit will result in taxable profits in the foreseeable future, and so the Company will maintain a full valuation allowance against the deferred tax assets in the UK until sufficient positive evidence exists to reduce or eliminate the allowance. Some of our customers depend on government funding of research and development and a reduction in that funding may adversely affect our business. A portion of sales in our RMS business is derived from customers at academic institutions and research laboratories whose funding is partially dependent on funding from government sources, including the U.S. National Institutes of Health (NIH). Such funding can be difficult to forecast as it may be subject to the political process. Our sales may be adversely affected if our customers delay purchases as a result of uncertainties surrounding the approval of government budget proposals. A reduction in government funding for the NIH or other government research agencies could adversely affect our business and our financial results. There can be no certainty that NIH funding will be directed towards projects and studies that require use of our products and services.
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Risks Related to Our Indebtedness. Our substantial levels of outstanding indebtedness could adversely affect our financial condition, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under the notes. Effective March 15, 2012, Holdings completed an offering of $120.0 million principal amount of 12.25% Senior Secured Notes due 2017 and approximately $22.4 million principal amount of Third Lien Debt. In addition, on July 11, 2012 the Company secured a $10.0 million Revolving Credit Facility. Effective April 29, 2014, in connection with the acquisition of Harlan, we incurred additional indebtedness of $310.4 million, comprised of $150.0 million of First Lien Notes, $130.4 million of Second Lien Notes and $30.0 million of Second Lien Liquidity Notes. Accordingly, as of December 31, 2014, we had approximately $473.4 million of outstanding indebtedness, consisting of $120.0 million of indebtedness related to the Senior Secured Notes, approximately $32.3 million of indebtedness related to the Third Lien Debt, $10.0 million drawdown on the Revolving Credit Facility, $150.0 million of indebtedness of the First Lien Notes, $130.4 million of indebtedness of the Second Lien Notes and $30.0 million of indebtedness of the Second Lien Liquidity Notes. This debt represents approximately 85% of our total capitalization. Our substantial level of indebtedness increases the risk that we may be unable to generate cash sufficient to pay amounts due in respect of our indebtedness, including the notes. Our substantial indebtedness could have other important consequences to you and significant effects on our business, including: • increasing our vulnerability to adverse changes in general economic, industry and competitive conditions; • requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities; • making it more difficult for us to satisfy our obligations with respect to our indebtedness, including the notes, and any failure to comply with the obligations of any of our debt instruments, including financial or restrictive covenants and borrowing conditions, could result in an event of default under the indenture governing the notes or the agreements governing other indebtedness and result in the acceleration of our outstanding debt; • require us to repatriate cash for debt service from our foreign subsidiaries resulting in dividend tax costs or require us to adopt other disadvantageous tax structures to accommodate debt service payments; • restricting us from making strategic acquisitions or causing us to make non-strategic divestitures; • limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes, including to repurchase the notes from the holders upon a change of control; and • limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to our competitors who have less debt and who, therefore, may be able to take advantage of opportunities that our leverage prevents us from pursuing.
Our liquidity needs could vary significantly and may be affected by general economic conditions, industry trends, performance and many other factors not within our control. If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to refinance all or a portion of our existing debt. However, we may not be able to refinance our debt or obtain any new or additional debt on favorable terms or at all.
We may incur additional amounts of debt, including secured indebtedness, which could further exacerbate the risks associated with our current level of indebtedness and allow holders of the future secured debt to exercise certain rights and remedies with respect to the collateral securing the notes. We may incur additional indebtedness in the future, including secured indebtedness. Although the indentures and Credit Agreements governing the notes and the revolving credit facility contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions, and under certain circumstances, the amount of indebtedness that could be incurred in compliance with these restrictions could be substantial. If new debt is added to our existing debt levels, the related risks that we now face would increase.
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Our debt agreements contain or future debt agreements may contain restrictions that will limit our flexibility in operating our business. The indentures and Credit Agreements governing the notes and the revolving credit facility contains, and future debt agreements may contain, various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things: • incur or guarantee additional indebtedness and issue preferred stock; • pay dividends and make other restricted payments; • enter into agreements restricting the payment of dividends or other distributions from our restricted subsidiaries; • create or incur liens; • make investments; • transfer or sell assets; • engage in transactions with affiliates; and • merge or consolidate with other companies or transfer all or substantially all of our or their assets.
Additionally, the revolving credit facility, as permitted by the indenture governing the notes, requires us to meet specified financial ratios. These restrictions may prevent us from taking actions that we believe would be in the best interest of our business, and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted.
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MANAGEMENT The following is a list of the names and ages of the directors of Holdings and our executive officers, and a brief account of their business experience.
Name Age Position
Andrew Baker 66 Director of Holdings; Chairman Brian Cass 67 Director of Holdings; Chief Executive Officer Richard Michaelson 63 Chief Financial Officer Dr. Adrian Hardy 44 Chief Operating Officer Mark Bibi 56 Secretary and General Counsel Michael Caulfield 56 President, RMS Operations and General Manager, Princeton Research Center Dr. Paul Brooker 57 President, CRS Operations
Andrew Baker became a director and Chairman and Chief Executive Officer of the Company on January 10, 2002. Mr. Baker stepped down from his position as Chief Executive Officer on April 29, 2014. He was appointed to the board of directors of Huntingdon Life Sciences Group plc. (“Huntingdon”), our predecessor, as Executive Chairman in September 1998. He is a chartered accountant and has operating experience in companies involved in the delivery of healthcare ancillary services. He spent 18 years until 1992 with Corning Incorporated and held the posts of President and CEO of MetPath Inc., Corning’s clinical laboratory subsidiary, from 1985 to 1989. He became President of Corning Laboratory Services Inc. in 1989, which at the time controlled MetPath Inc. (now trading as part of Quest Diagnostics Inc.), and Hazleton Corporation, G.H. Besselaar Associates and SciCor Inc., all three now trading as part of Covance Inc. Since leaving Corning in 1992, Mr. Baker has focused on investing in and developing companies in the healthcare sector including Unilab Corporation, a clinical laboratory services provider in California, and Medical Diagnostics Management, a US based provider of radiology and clinical laboratory services to health care payers. In 1997, he formed Focused Healthcare Partners, L.L.C., an investment firm involved with healthcare startup and development companies. Brian Cass, FCMA, CBE, became a director and President and Managing Director of the Company on January 10, 2002. Mr Cass was appointed to the board of directors of Huntingdon as Managing Director in September 1998 and was appointed Chief Executive Officer of Holdings on April 29, 2014. Prior to joining Huntingdon, he was a Vice President of Covance Inc. and Managing Director of Covance Laboratories Ltd. (previously Hazleton Europe Ltd.) for nearly 12 years, having joined the company in 1979 as Controller. Mr. Cass worked at Huntingdon Research Center between 1972 and 1974 and has previous experience with other companies in the electronics and heavy plant industries. He has also held directorships with North Yorkshire Training & Enterprise Council Ltd. and Business Link North Yorkshire Ltd. In recognition of Huntingdon’s scientific and professional integrity and leadership, he was granted the prestigious UK Pharma Industry Individual Achievement Award in October 2001. In further recognition of his, and the Company’s contribution to science and professional achievements, Mr. Cass was appointed as a Commander in the Most Excellent Order of the British Empire (“CBE”) in June 2002. The highly prestigious CBE is awarded on merit, for exceptional achievement or service; it is recommended by the Prime Minister of Great Britain, but is approved by the Queen.
Richard Michaelson resumed his role as Chief Financial Officer in December 2012 having previously held this position from July 28, 2005 to November 24, 2009. Mr. Michaelson was employed to assist the Company with special projects from December 2009 through December 2012. Prior to this, Mr. Michaelson held the position of Chief Financial Officer and Secretary of LSR from January 10, 2002. Mr. Michaelson was Director of Strategic Finance of Huntingdon from September 1998 to December 2001. He served as Senior Vice President of Unilab Corporation, a clinical laboratory testing company based in Los Angeles, California, from September 1997 to December 1997, Senior Vice President-Finance, Treasurer and Chief Financial Officer of Unilab from February 1994 to September 1997, and Vice President-Finance, Treasurer and Chief Financial Officer of Unilab from November 1993 to February 1994. Mr. Michaelson also served as Vice President of Unilab beginning in October 1990. Mr. Michaelson joined MetPath, Inc., the clinical laboratory subsidiary of Corning Incorporated, in 1980 and served as Vice President of MetPath from 1983 and Treasurer of Corning Lab Services, Inc. from 1990 through, in each case, September 1992.
Dr. Adrian Hardy has been with Huntingdon since 2002. He joined initially in the business development team before setting up and running the strategic marketing operation responsible for business and market analysis and competitive intelligence. In 2008 he took on the newly created position of Group Director, Strategic Development with global responsibility for sales, corporate development and strategic marketing. Dr. Hardy was appointed Chief Operating Officer on April 29, 2014, with global responsibility for the operations of the Company. Dr. Hardy has a background in Molecular and Developmental Biology, with a doctorate from University College, London where he also completed his post-doctoral research. After leaving academia, Dr. Hardy spent three years working in product development for a subsidiary of Novartis and a further two years running his own business.
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Mark Bibi became Secretary and General Counsel of the Company effective July 28, 2005. Prior thereto he served as General Counsel of the Company and Huntingdon Life Sciences Inc. from April 1, 2002. He served as Executive Vice President, Secretary and General Counsel of Unilab Corporation, a clinical laboratory testing Company based in Los Angeles, California from May 1998 to November 1999 and as Vice President, Secretary and General Counsel of Unilab from June 1993 to May 1998. Prior thereto, Mr. Bibi was affiliated with the New York City law firms, Schulte Roth & Zabel and Sullivan & Cromwell.
Michael Caulfield became President of RMS operations on August 14, 2014. Mr. Caulfield became VP, Operations in 2000 and Princeton Research Center General Manager in 2002, a role he has continued and, where he has overall site responsibility. He started his career in Research Quality Assurance, and joined Huntingdon in 1996 from BMS as Director of Quality Assurance and Regulatory Compliance. In 1999 he moved into Operations as Vice-President, Toxicology Operations, with responsibilities for Toxicology and Pathology technical study conduct. Mr. Caulfield became VP, Operations in 2000 and General Manager in 2002.
Dr. Paul Brooker became President of CRS Operations, Europe on August 14, 2014. Dr. Brooker joined Huntingdon Life Sciences as a genetic toxicologist in 1983. After subsequent positions in program management and business development he became Group Director, Business Development in 1998, with responsibilities for sales world-wide. In 2001, Dr. Brooker returned to operational and scientific management in the role of Director of Toxicology Operations, responsible for toxicology study management. He became Director of Toxicology in 2003 and, in January 2007, he became Director, UK Operations, responsible for Huntingdon UK’s six scientific Operating Divisions. Dr. Brooker holds a BSc in Biological Sciences from the University of East Anglia, and a PhD in Genetics from University College, London. He is a member of the ABPI pre-clinical drug safety advisory group; the expert forum on in vivo sciences; and of the UK Biosciences Coalition, a group consisting of UK industry and academia set up for lobbying purposes around European and UK legislation on use of animals in scientific interpretation.
The Board of Directors of Holdings is comprised of Messrs. Baker and Cass. Through shareholder and limited liability company agreements, Mr. Baker has been given the sole right to appoint directors of Holdings’ immediate parent company, Lion Holdings. Certain extraordinary actions by the Lion Holdings’ Board are limited by consent rights that he has granted to his co- investors from the 2009 “going private” transaction. In addition to himself, Mr. Baker has also designated as directors or board observers of Lion Holdings, Mr. Cass and representatives of his co-investors, Jermyn and Savanna, and an individual that he considers to be “independent”. As described elsewhere in “Risk Factors—Actions of animal rights activists may affect the Company’s business and associated persons and our ability to access capital markets” and in “Business—Regulatory” in this Annual Report, persons associated with us may be subjected to harassment from animal rights activists. We take measures to protect against the disclosure of the identities of these Lion Holdings’ directors, as well as other persons associated with the Company.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This management’s discussion and analysis of financial condition and results of operations should be read together with the other sections of this Annual Report, including “Business”, “Management” and our consolidated financial statements, including the notes thereto. This management’s discussion and analysis contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the risks and uncertainties described throughout this Annual Report and particularly in “Risk Factors.” Our actual results may differ materially from those estimated or projected in any forward- looking statement.
Overview The Company provides research models and services, laboratory diets and bedding and laboratory-based, non-clinical testing services for biological safety evaluation research to the pharmaceutical, crop protection and industrial chemical industries and to academic and governmental institutions globally. The purpose of our safety evaluation services is to identify risks to humans, animals or the environment resulting from the use or manufacture of a wide range of compounds, which are essential components of our customers’ products. Our customers are required to perform the safety evaluations we offer to develop their products because safety testing is mandated by governments around the world before products can be brought to market.
Critical Accounting Estimates The following is a discussion and analysis of the Company’s consolidated financial statements, which have been prepared in accordance with GAAP. The Company considers the following accounting policies to be critical accounting estimates.
In preparing its consolidated financial statements in accordance with GAAP, the Company makes assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. The Company bases its assumptions, judgments and estimates on historical experience and various other factors that it believes to be reasonable under the circumstances. These assumptions, judgments and estimates are evaluated on a regular basis. Actual outcomes may differ from these assumptions, judgments and estimates and these differences may have a material impact on the consolidated financial statements.
The Company believes that the assumptions, judgments and estimates involved in the accounting for revenue recognition, inventories, discontinued operations, pensions and income taxes have the greatest potential impact on its consolidated financial statements. These areas are key components of the Company’s results of operations and are based on complex rules which require the Company to make judgments and estimates, so it considers these to be its critical accounting estimates. A summary of the significant accounting policies is set out below: Business Acquisitions The Company accounts for acquired businesses using the acquisition method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact net income. Accordingly, for significant items, the Company typically obtains assistance from a third-party valuation expert.
The fair values of the net assets acquired are determined using the market and income approaches. The market approach, which indicates value for a subject asset based on available market pricing for comparable assets, was utilized to estimate the fair value of Harlan’s freehold and leasehold property, plant and equipment and animal inventory. The market approach included prices and other relevant information generated by market transactions, the condition and age of property and the expected proceeds from sale of property and equipment, among other factors. The income approach is used to value intangible assets, including non-contractual customer relationships, trade names and other intellectual property. The income approach indicates a value for a subject asset based on the present value of cash flows projected to be generated or cash expenditures avoided by having the right to use the asset. Projected cash flows are discounted at a weighted average cost of capital that reflects the relative risk of achieving the cash flows and the time value of money.
Estimating the useful life of an intangible asset also requires judgment. For example, different types of intangible assets will have different useful lives, influenced by the nature of the asset, competitive environment, and rate of change in the industry. Certain assets may even be considered to have indefinite useful lives. All of these judgments and estimates can significantly impact the determination of the amortization period of the intangible asset, and thus net income.
Revenue Recognition All of the Company’s CRS segment net revenues have been earned under contractual arrangements, which generally range in duration from a few days to three years. Net revenue from these contracts is generally recognized over the term of the contracts as services are rendered. Contracts may contain provisions for re-negotiation in the event of cost overruns due to changes in the level of work scope. Renegotiated amounts are included in net revenue when earned and realization is assured. Provisions for
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losses to be incurred on contracts are recognized in full in the period in which it is determined that a loss will result from performance of the contractual arrangement. Most service contracts may be terminated for a variety of reasons by the Company’s customers either immediately or upon notice at a future date. The contracts generally require payments to the Company to recover costs incurred, including costs to wind down the study, and payment of fees earned to date, and in some cases to provide the Company with a portion of the fees or income that would have been earned under the contract had the contract not been terminated early. The Company recognizes revenue for the RMS segment in relation to its products, which include research models, research model diets, bedding and biomedical products, when title and risk have been transferred, which usually occurs at the time of delivery to the customer. Product sales are recorded net of discounts to customers. The Company accounts for shipping and handling costs billed to the customer as revenue. Shipping and handling costs incurred are recorded in cost of sales. The Company accounts for the sale of containers used to ship products as revenue. Costs related to containers are recorded in cost of sales.
Unbilled receivables are recorded for net revenue recognized to date that is currently not billable to the customer pursuant to contractual terms. In general, amounts become billable upon the achievement of certain aspects of the contract or in accordance with predetermined payment schedules. Unbilled receivables are billable to customers within one year from the respective balance sheet date. Fees in advance are recorded for amounts billed to customers for whom net revenue has not been recognized at the balance sheet date (such as upfront payments upon contract authorization, but prior to the actual commencement of the study).
If the Company does not accurately estimate the resources required or the scope of work to be performed, or does not manage its projects properly within the planned periods of time or satisfy its obligations under the contracts, then future margins may be significantly and negatively affected or losses on existing contracts may need to be recognized. While such issues have not historically been significant, any such resulting reductions in margins or contract losses could be material to the Company’s results of operations.
Inventories
Inventories consist of research models stock, biomedical products and research model diets and bedding, and are stated at the lower of cost or market using average costing FIFO methodologies. The determination of market value is assessed using the selling price of the products. Provisions are recorded to reduce the carrying value of inventory determined to be unsalable.
Discontinued Operations
The Company accounts for discontinued operations in accordance with ASC 205-20. In October 2014, the Company announced a decision to cease operations in Switzerland and has therefore presented the results as discontinued operations in the Consolidated Statement of Operations and as assets and liabilities of discontinued operations in the Consolidated Balance Sheets.
Pension Costs Prior to December 31, 2002, a defined benefit pension plan provided benefits to employees in the UK based on their final pensionable salary. The defined benefit pension plan closed to new entrants on April 5, 1997, and as of December 31, 2002, the defined benefit pension plan was curtailed. Following the acquisition of Harlan, the Company has additional defined benefit plans in subsidiaries in the UK and Switzerland. In April 2012, the Harlan UK benefit plan was closed and future benefit accruals and the plan were curtailed. In December 2014, following the decision to cease the operations in Switzerland a curtailment of benefits resulted. In Switzerland, the employee’s benefits are paid out of the pension at the time that they leave the plan. The pension cost of the plan is accounted for in accordance with FASB ASC 715, “Compensation—Retirement Benefits”. Pension information is presented in accordance with the currently required provisions of FASB ASC 715-20, “Compensation—Retirement Plans— Defined Benefit Plans—General”. The measurement of the related benefit obligation and net periodic benefit cost recorded each year is based upon actuarial computations which require the use of judgment as to certain assumptions. The more significant of these assumptions are: (a) the appropriate discount rate to use in computing the present value of the benefit obligation; and (b) the expected return on plan assets (for funded plans). Actual results (such as the return on plan assets) will likely differ from the assumptions used. Those differences, along with changes that may be made in the assumptions used from period to period, will impact the amounts reported in the financial statements and footnote disclosures. The net (loss)/gain subject to amortization, outside the corridor, is being amortized on a straight-line basis over periods of 10 to 15 years. The Company recognizes all actuarial gains and losses immediately for the purposes of its minimum pension liability.
Taxation The Company accounts for income taxes under the provisions of FASB ASC 740, “Income Taxes” (“ASC 740”). ASC 740 requires recognition of deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the
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year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of operations in the period in which the enactment rate changes. Deferred tax assets and liabilities are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not that the deferred tax assets will not be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. Likewise, should the Company determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax assets would increase income in the period such determination was made.
The Company accounts for uncertainties in income taxes under the provisions of FASB ASC 740-10-05, “Accounting for Uncertainty in Income Taxes”. The pronouncement clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with ASC 740. The pronouncement provides guidance on recognizing, measuring, presenting and disclosing in the financial statements uncertain tax positions that a company has taken or expects to take on a tax return.
Effective January 1, 2014, the Company adopted ASU No. 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”). ASU 2013-11 is expected to reduce diversity in practice by providing guidance on the presentation of unrecognized tax benefits and will better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. The amendments in this update were adopted on January 1, 2014 and have been applied prospectively. The adoption of ASU 2013-11 did not have a material effect on the Company’s consolidated financial statements.
EBITDA and Adjusted EBITDA EBITDA represents income before interest expense, income taxes, depreciation and amortization. We believe this measure is frequently used by securities analysts, investors, lenders and other interested parties in the evaluation of high yield issuers, many of which present EBITDA when reporting their results. Adjusted EBITDA represents EBITDA plus non-cash employee compensation, foreign exchange, Sale-Leaseback operating lease expenses, certain identified items that we believe to be non- recurring and management fees and expenses paid to certain of our indirect equity investors. Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or nonrecurring items.
Significant events In December 2012, the Company announced a reduction in force at both the UK and US operations. Following a consultation period, 97 UK employees and 29 US employees left the Company during the first quarter of 2013. The reduction in force reduced annualized labor costs by approximately $6.6 million and $2.5 million in the UK and US, respectively. In February 2014, the Company announced a further reduction in force in the US operations resulting in 18 employees leaving the Company. This reduction in force is expected to reduce annualized labor costs by approximately $0.5 million. On April 29, 2014, the Company acquired, pursuant to an Agreement and Plan of Merger, 100 percent of the outstanding common stock and voting interests of Harlan, a long established business offering full service, non-clinical, contract research services (“CRS”) and research models and services (“RMS”) and laboratory animal diets and bedding. The acquisition involved no cash payments to Harlan’s equity holders. The existing Harlan debt of $280.4 million was refinanced pursuant to a Consent and Exchange Agreement, under which the Company delivered new loans and warrants to Harlan lenders in full satisfaction of Harlan’s indebtedness. The fair value of the long term debt issued amounted to $245.9 million including the fair value of warrants issued by the Parent. The transaction has been accounted for using the acquisition method of accounting. On October 21, 2014 the Company announced a decision to close its CRS operations in Switzerland. There will be a gradual reduction in services as customers’ studies are completed over an 18 month period. The Company has determined the operations meet the definition of a discontinued operation in accordance with ASC 205-20 and has therefore been excluded from the continuing operations in the Consolidated Statements of Operations and Balance Sheets respectively. Detailed disclosures are included in Note 18. During the year, the Company conducted a review of its existing trade names and made a decision to adopt a new trade name to reflect the new integrated management structure and the product and service offerings of the combined Huntingdon and Harlan organizations. Accordingly, a review of the useful economic lives and fair values of trade names has been performed, resulting in an impairment of trade names in the year ended December 31, 2014 of $14.2 million.
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Results of Operations
Year ended December 31, 2014 compared with year ended December 31, 2013
Backlog (booked-on-work) at December 31, 2014 amounted to approximately $167.2 million, an increase of 8.9% from the level at December 31, 2013. Although the increase includes the backlog from the Harlan acquisition, this represented a small element due to the shorter term nature of studies as well as some impact from the announced closure of operations in Switzerland.
Revenue from continuing operations for the year ended December 31, 2014 was $351.0 million, an increase of $17.1 million, or 10.0% excluding the Harlan results. The effect of foreign currency translation had a positive impact of 3.9%.
Year ended Dollar change Excluding Harlan results Attributable December December Dollar to Harlan Dollar 31, 2014 31, 2013 change results change % change CRS $ 231,505 $ 170,268 $ 61,237 $ 44,174 $ 17,063 10.0% RMS 123,589 - 123,589 123,589 - - Eliminations (4,095) - (4,095) (4,095) - - $ 350,999 $ 170,268 $ 180,731 $ 163,668 $ 17,063 10.0%
The underlying increase in CRS revenue, excluding Harlan results, reflected the improved orders at the end of 2013.
Cost of sales for the year ended December 31, 2014 was $260.5 million, an increase of $14.9 million, or 12.1% excluding the Harlan results.
Year ended Dollar change % change
Attributable Excluding Excluding December % of December % of Dollar to Harlan Harlan Harlan 31, 2014 revenue 31, 2013 revenue change results results results
CRS $ 164,798 71.2% $ 123,224 72.4% $ 41,574 $ 26,654 $ 14,920 12.1%
RMS 99,803 80.8% - - 99,803 99,803 - -
Eliminations (4,095) - - - (4,095) (4,095) - -
$ 260,506 74.2% $ 123,224 72.4% $137,282 $ 122,362 $ 14,920 12.1% The underlying increase in CRS cost of sales, excluding Harlan results, was due to an increase in direct materials and animal costs of $4.4 million, as well as a general increase in labor costs, offset by the foreign exchange gain of $1.4 million. Excluding the impact of the costs mentions above, the remaining increase in CRS cost of sales was consistent with the increase in revenues.
Selling, general and administrative expenses for the year ended December 31, 2014 was $76.0 million, an increase of $2.2 million or 5.7% excluding the Harlan results.
Year ended Dollar change % change
Attributable Excluding Excluding December % of December % of Dollar to Harlan Harlan Harlan 31, 2014 revenue 31, 2013 revenue change results results results $ CRS $ 33,097 14.3% $ 26,407 15.5% $ 6,690 $ 7,489 (799) (3.0)%
RMS 18,431 14.9% - 0.0% 18,431 18,431 - -
Corporate 24,458 7.0% 11,549 6.8% 12,909 9,949 2,959 25.6%
$ 75,986 21.6% $ 37,956 22.3% $38,030 $ 35,869 $ 2,160 5.7%
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The underlying increase in selling, general and administrative expenses, excluding the Harlan results, was due to the increase in non-cash SAR’s expense of $1.5 million as well as a general increase in labor costs.
Operating income before other operating expenses for the year end December 31, 2014 was $14.5 million, comparable with the prior year excluding the Harlan results from the acquisition date through December 31, 2014.
Year ended Dollar change %change
Attributable Excluding Excluding December % of December % of to Harlan Harlan Harlan 31, 2014 revenue 31, 2013 revenue Total results results results
CRS $ 33,610 14.5% $ 20,637 33.7% $12,973 $ 10,031 $ 2,942 14.3%
RMS 5,355 4.3% - - 5,355 5,355 - -
Corporate (24,458) 597.3% (11,549) 282.0% (12,909) (9,949) (2,960) 25.6%
$ 14,507 4.1% $ 9,088 5.0% $ 5,419 $ 5,437 $ (18) (0.2)%
The underlying decrease in operating income before other operating expense, excluding the Harlan results from the acquisition date through December 31, 2014, was due to the increase in revenue, offset by SAR’s expense of $1.9 million in the year ended December 31, 2014 and a general increase in labor costs.
Consolidated other operating expense for the year end December 31, 2014 of $35.1 million is comprised of costs associated with the reduction in force programs of $1.7 million, transaction related costs of $11.7 million, integration costs of $7.5 million and impairment of trade names of $14.2 million.
Consolidated net interest expense increased by 68.0% to $36.8 million for the year ended December 31, 2014 from $21.9 million for the year ended December 31, 2013. Consolidated net interest expense for the year ended December 31, 2014 includes $22.1 million of cash interest, $4.4 million of PIK interest and $10.3 of non-cash amortization of financing costs and debt discount. The increase of $14.9 million is principally due to the new financing following the acquisition of Harlan, including amortization of related debt discount and deferred financing costs, as well as the increased capital balance on the Third Lien Debt.
Foreign exchange loss of $14.5 million for the year ended December 31, 2014 comprised a $14.5 million non-cash re- measurement loss on intercompany loans. In the year ended December 31, 2013 foreign exchange gain of $1.0 million comprised a $3.0 million non-cash re-measurement gain on intercompany loans offset by other exchange losses of $2.0 million.
Income tax benefit for the year ended December 31, 2014 of $4.8 million includes the utilization of net operating losses from earlier periods. The income tax expense for the year ended December 31, 2013, was $20.1 million. Following a review of the recoverability of deferred tax assets in relation to US and Corporate net operating losses, a valuation allowance of $24.1 million was provided in 2013 as the asset will not be fully realized in the next three years, given the current lack of profitability of the US business. As these losses are available substantially beyond that three year horizon (expiring between 2018 and 2032), they continue to be available when sufficient taxable profits become available. This allowance was offset by additional taxable losses in the period of $4.5 million.
A reconciliation between the US statutory tax rate and the effective rate of tax expense/benefit on income/losses before taxes for the year ended December 31, 2014 and December 31, 2013 is shown below:
% loss before income taxes
2014 2013
US statutory rate 35% 35% Foreign differential rate (13)% (3)% Non-deductible items (8)% 5% Valuation allowance (12)% (162)% State taxes 1% 3% US taxes on unremitted earnings 3% - Losses utilized - 1%
Effective tax rate 6% (121)%
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The Company derives significant benefit from the UK Research and Development Tax Credit for large companies.
Reported EBITDA for the year ended December 31, 2014 was $18.2 million compared to $18.2 million for the year ended December 31, 2013. Adjusted EBITDA for years ended December 31, 2014 and December 31, 2013 was $70.8 million (20.2% of revenue) and $32.5 million (19.1% of revenue), respectively.
2014 2013
Revenues from continuing operations $ 351.0 $ 170.3
Operating (loss) income from continuing operations (20.5) 4.3 Operating (loss) from discontinued operations (3.7) -
Depreciation and amortization 28.2 13.9 Impairment of trade names 14.2 - EBITDA 18.2 18.2
Adjustments: Non-cash compensation1 4.9 3.5 Foreign exchange2 (0.8) 0.3 Non recurring item and restructuring charges3 22.3 8.2 Sponsor management fees and expenses4 1.5 1.5 Purchases accounting (inventory step-up) 4.3 - Adjusted EBITDA excluding pro forma cost savings $ 50.4 $ 31.7
Adjusted pro forma EBITDA excluding pro forma cost savings5 $ 56.7 $ 31.7
Pro forma cost savings6 14.1 0.8
Adjusted EBITDA including pro forma cost savings $ 70.8 $ 32.5
1 Non-cash compensation represents income statement charges arising on the defined benefit pension plan, and changes in the valuation of the stock appreciation rights granted to certain employees.
2 Foreign exchange adjustments represent gains and losses included in operating expense.
3 Non-recurring items and restructuring charges represent expenses associated with reduction in force and restructuring changes ($2.4 million), costs arising on the 101 Mettlers Road site ($1.2 million), non-recurring transaction costs ($11.7 million) and, integration and transition costs ($7.0 million).
4 Sponsor management fees and expenses represent monitoring fees and other advisory fees.
5 Adjusted pro forma EBITDA for the year ended December 31, 2014 presents adjusted EBITDA as if the acquisition had been completed on January 1, 2014.
6 Pro forma cost savings have been given pro forma effect as if they had occurred on the first day of the four-quarter reference period and include adjusted EBITDA from discontinued operations of Switzerland and other cost saving actions.
Net loss for the year ended December 31, 2014 was $69.1 million compared with a net loss of $36.8 million for the year ended December 31, 2013.
Year ended December 31, 2013 compared with year ended December 31, 2012.
During 2013, there was no meaningful improvement or deterioration of market conditions for pharmaceutical companies overall. Increases in preclinical outsourcing from some companies were balanced by others who were either spending proportionately more of their Development budget on late stage assets, or were reprioritizing their portfolios. The decrease in the Company’s backlog for the year was primarily driven by a reduction in work year over year from our European mid-tier pharmaceutical customers. These customers generally do not have pipelines as broad and deep as the larger pharmaceutical companies, and several of them were at phases of development of their current portfolios that did not require preclinical testing.
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These companies are expected to continue through their research and development cycles and resume normalized levels of preclinical outsourcing in the near future.
Backlog (booked-on-work) at December 31, 2013 amounted to approximately $153.6 million, an increase of 15.5% from the level at December 31, 2012 (an increase of 13.8% net of foreign currency effect).
Net revenues for the year ended December 31, 2013 were $170.3 million, a decrease of 9.0% on net revenues of $187.1 million for the year ended December 31, 2012. The effect of foreign currency translation had a positive impact of 0.7%.
Year ended December 31, December 31, Dollar % 2013 2012 change change CRS $ 170,268 $ 187,114 $ (16,846) (9.0)% RMS - - - - Eliminations - - - - $ 170,268 $ 187,114 $ (16,846) (9.0%)
The underlying decrease in revenues was primarily due to continued weakness in our Big Pharma business.
Cost of sales for the year ended December 31, 2013 were $123.2 million, a decrease of 12.2% on cost of sales of $140.4 million for the year ended December 31, 2012, the effect of foreign currency translation had a positive impact of 1.1%.
Year ended
December % of December 31, % of 31, 2013 revenue 2012 revenue Dollar change % change CRS $ 123,224 72.4% $ 140,395 75.0% $(17,171) (12.2)% RMS ------Eliminations ------$ 123,224 72.4% $ 140,395 75.0% $(17,717) (12.2)%
The underlying decrease was impacted by the recognition of above the line research and development credits of $4.0 million following the enactment of UK Tax Legislation in July 2013 and the reduction of costs associated with the removal of waste of $2.0 million. Labor costs, which represented the majority of the remaining decrease in costs in the period, decreased by 13.1% as a result of the reduction in staffing following the reduction in force programs effected by the Company in the third quarter of 2012 and the first quarter of 2013. Selling, general and administrative expenses decreased by 6.8% to $38.0 million for the year ended December 31, 2013 from $40.7 million in the year ended December 31, 2012. The effect of foreign currency translation had a positive impact of 0.4%.
Year ended
December 31, % of December 31, % of 2013 revenue 2012 revenue Dollar change % change CRS $ 26,407 15.5% $ 29,420 15.7% $ (3,013) (10.2)% RMS ------
Corporate $ 11,549 6.8% $ 11,295 6.0% $ 254 2.2% $ 37,956 22.3% $ 40,715 21.8% $ (2,759) (6.8)%
The decrease was primarily due to the elimination in 2013 of the Sale – Leaseback interest of $1.2 million that was classified as remuneration in the year ended December 31, 2012.
Other operating expenses for the year ended December 31, 2013 of $4.8 million is comprised of costs associated with the reduction in force program of $3.7 million and transaction related expenses of $1.1 million. Other operating expense for the year ended December 31, 2012 of $18.9 million related to the reversal of the Sale – Leaseback transaction and comprised the gain on the extinguishment of the capital lease obligation of $21.6 million, the unamortized deferred gain of $7.4 million on the original sale of the US property, the write back of the deferred rent liability of $6.1 million on the two UK properties, offset by the net loss
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of $49.3 million on the disposal of capital leased assets, the expense of the unamortized deferred Sale – Leaseback costs of $2.0 million and the reduction in force program of $2.7 million.
Net interest expense increased by 5.6% to $21.9 million for the year ended December 31, 2013 from $20.8 million for the year ended December 31, 2012. The increase of $1.1 million was primarily due to the increased charges arising on the larger capital balance associated with the issue of Senior Secured Notes and charges arising on the increased Second Lien Debt following the capitalization of interest, of $2.2 million, offset by the savings from the termination of the Sale – Leaseback transaction of $0.6 million and the non-recurring charges arising on the repayment of the first and second Financing Agreements of $1.0 million arising in 2012.
Foreign exchange gains of $1.0 million for the year ended December 31, 2013 comprised a $3.0 million non-cash re- measurement gain on intercompany loans offset by other exchange losses of $2.0 million. In the year ended December 31, 2012 foreign exchange gains of $2.7 million comprised a $5.9 million non-cash re-measurement gain on intercompany loans offset by other exchange losses of $3.2 million.
Income tax expense for the year ended December 31, 2013 was $20.1 million. Following a review of the recoverability of deferred tax assets in relation to US and Corporate net operating losses, a valuation allowance of $24.1 million has been provided as the asset will not be fully realized in the next three years, given the current lack of profitability of the US business. As these losses are available substantially beyond that three year horizon (expiring between 2018 and 2032), they continue to be available when sufficient taxable profits become available. This allowance was offset by additional taxable losses in the period of $4.5 million. The income tax benefit for the year ended December 31, 2012 was $5.9 million.
A reconciliation between the US statutory tax rate and the effective rate of tax expense/benefit on income/losses before taxes for the year ended December 31, 2013 and December 31, 2012 is shown below:
% loss before income taxes
2013 2012
US statutory rate 35% 35% Foreign differential rate (3)% (6)% UK R&D credit and non-deductible items 5% (16)% Valuation allowance (162)% (5)% State taxes 3% 2% Losses utilized 1% - Change in estimate - (19)% Transaction fees - 27% Effective tax rate (121)% 18%
The Company derives significant benefit from the UK Research and Development Tax Credit for large companies.
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Reported EBITDA for the year ended December 31, 2013 was $18.2 million compared to $0.6 million for the year ended December 31, 2012. Adjusted EBITDA for years ended December 31, 2013 and December 31, 2012 was $32.5 million (19.1% of revenue) and $31.7 million (17.0% of revenue), respectively.
2013 2012
Revenues $ 170.3 $ 187.1 Operating income 4.3 (12.9)
Depreciation and amortization 13.9 13.5 EBITDA 18.2 0.6
Adjustments: Non-cash compensation1 3.5 3.4 Foreign exchange2 0.3 0.4 Operating lease expenses relating to the Sale-Leaseback3 - 1.8 Non recurring item and restructuring charges4 8.2 21.0 Sponsor management fees and expenses5 1.5 1.5 Adjusted EBITDA excluding pro forma cost savings 31.7 28.7
Pro forma cost savings6 0.8 3.0
Adjusted EBITDA including pro forma cost savings $ 32.5 $ 31.7
1 Non-cash compensation represents income statement charges arising on the defined benefit pension plan, and changes in the valuation of the stock appreciation rights granted to certain employees.
2 Foreign exchange adjustments represent gains and losses included in operating expense.
3 Operating lease expenses relating to the Sale - Leaseback represent operating lease charges on the UK site, interest charges due to the owner of the UK & US sites, and amortization of the deferred gain arising on the sale of the US property.
4 Non-recurring items and restructuring charges represent expenses associated with the Q1 2013 reduction in force ($3.7 million), reduction in facilities ($0.6 million), non-recurring management consulting costs ($1.8 million), special project costs ($1.1 million), and costs arising on the 101 Mettlers Road site ($1.0 million).
5 Sponsor management fees and expenses represent monitoring fees and other advisory fees.
6 Pro forma cost savings have been given pro forma effect as if they had occurred on the first day of the four-quarter reference period.
Net loss for the year ended December 31, 2013 was $36.8 million compared with net loss of $26.5 million for the year ended December 31, 2012.
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Geographical Analysis
The analysis of the Company’s net revenues from continuing operations and total assets, by location, for the years ended December 31, 2014, 2013 and 2012 is as follows:
2014 2013 2012 $000 $000 $000 Net revenues UK $ 193,310 $ 131,014 $ 141,072 US 108,132 39,254 46,042 Rest of the World 49,557 - - $ 350,999 $ 170,268 $ 187,114
Total assets UK $ 555,824 $ 258,781 $ 268,246 US 69,474 55,969 79,104 Rest of the World 38,353 - - $ 663,651 $ 314,750 $ 347,350
Liquidity and Capital Resources
Cash and cash equivalents at December 31, 2014 were $61.0 million and were held in accounts denominated in the following currencies: Currency (Amounts in USD equivalents) $000 US Dollar $ 28,946 Sterling 10,412 Euro 7,843 Yen 1,312 Swiss Franc 10,075 Israeli New Shekel 1,505 Mexican Peso 150 Indian Rupee 234 Korean Won 252 Canadian Dollar 215 Danish Krona 18 $ 60,962
On March 15, 2012, the Company issued $120.0 million of 12.25% Senior Secured Notes and $22.4 million of 15.00% Second Lien Debt due 2017. The Second Lien Debt was converted to Third Lien Debt on April 29, 2014 and is now due 2020. The proceeds of the issue were used to reacquire assets that were the subject of a Sale-Leaseback Transaction which was terminated on issue of the Senior Secured Notes, repay existing borrowings, pay financing costs and for general corporate purposes.
On July 11, 2012 the Company secured a $10.0 million Revolving Credit Facility. As at December 31, 2014 $10.0 million had been drawn down.
On April 29, 2014, the Company secured $280.4 million of First Lien Term Loan and Second Lien Term loan due 2020. The debt was used to refinance the Harlan debt as part of the acquisition. The Company also secured $30.0 million of Second Lien Liquidity Facility due 2017. If the loans are not repaid in full within 6 months of the maturity date, they will be automatically extended to 2020. The proceeds were to provide funds for transaction costs related to the acquisition and for the integration of the Harlan acquisition.
At December 31, 2014, the Company had $473.4 million of outstanding debt, including $10.0 million of capitalized interest.
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The Company’s expected primary cash needs on both a short-term and a long-term basis are for capital expenditures, expansion of services, possible future acquisitions, integration and restructuring, geographic expansion, working capital and other general corporate purposes.
As of December 31, 2014, the Company had a working capital deficit of $9.4 million, but the Company believes that projected cash flow from operations will satisfy its contemplated cash requirements for at least the next 12 months. Working capital, as stated in the Offering Circular for the 12.25% Senior Secured Notes, is defined as current assets (excluding cash and cash equivalents) less current liabilities (excluding debt classified as short-term).
Net days sales outstanding (DSOs) at December 31, 2014 were 31 days, an increase from the 3 days at December 31, 2013. The increase is primarily as a result of the RMS business from the Harlan acquisition which has a more standard DSO profile. DSO is calculated as a sum of accounts receivable, unbilled receivables and fees in advance over total net revenue. The impact on liquidity from a one-day change in DSO is approximately $1.2 million.
During the year ended December 31, 2014, the Company’s operating activities used $19.7 million after non-recurring expenses relating to the reductions in force of $1.7 million; transaction related costs of $11.7 million and integration and transition related costs of $7.5 million; of this the change in net operating assets and liabilities used $21.2 million. This was mainly caused by a $9.2 million increase in accounts receivable, unbilled receivables and prepaid expenses and a $8.9 million increase in fees invoiced in advance, offset by the $6.2 million research and development credit receivable, introduced in 2013, a $10.1 million decrease in accounts payable and accrued expenses and a $1.8 million increase in inventories.
Investing activities for the year ended December 31, 2014 generated net cash of $10.5 million, which mainly relates to cash acquired in acquisition of $13.8 million and proceeds from sales of assets of $7.9 million, offset by $11.7 million purchase of property, plant and equipment. Net cash generated in financing activities for the year ended December 31, 2014 is $59.2 million, which relates to $39.4 million capital contribution from Parent and $30.0 million proceeds from long term borrowing, offset by $0.3 million repayment of short term borrowings and $9.9 million to repay capital finance leases and finance fees, respectively.
The effect of exchange rate movements on cash for the year ended December 31, 2014 was a decrease of $3.2 million.
Contractual Obligations
The Company leases certain equipment and buildings under various non-cancellable operating leases. The Company is also obligated under purchase agreements, including long term power contracts. Finally the Company is obliged to make contributions to its defined benefit pension plans. These commitments are set out in the table below: Less than More than Total 1 year 1-3 years 3-5 years 5 years Operating leases $ 28,844 $ 7,961 $ 9,918 $ 5,776 $ 5,189 101 Mettlers Road 375 375 - - - Capital leases 66 37 29 - - Purchase obligations 5,835 5,835 - - - Pension plan contributions 110,998 8,282 19,511 23,526 59,679 $ 146,118 $ 22,490 $ 29,458 $ 29,302 $ 64,868 Contingencies
The Company is party to certain legal actions arising in the normal course of its business. In management’s opinion, none of these actions will have a material effect on the Company’s operations, financial condition or liquidity. No form of proceedings has been brought, instigated or is known to be contemplated against the Company by any government agency.
Inflation
While most of the Company’s net revenues are earned under fixed price contracts, the effects of inflation do not generally have a material adverse effect on its operations or financial condition as only a minority of the contracts have a duration in excess of one year.
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Recently Issued Accounting Standards
Management does not believe that any other recently issued, but not yet effective, accounting standard if currently adopted would have a material effect on the accompanying financial statements. See Note 3 (“Recent Accounting Pronouncements”) to the audited consolidated financial statements of Holdings.
Quantitative and Qualitative Disclosures about Market Risk
We are subject to market risks arising from changes in interest rates and foreign currency exchange rates.
Foreign Currency Risks
The Company operates on a global basis and is therefore exposed to various foreign currency risks due to the nature of certain contracts. The Company executes contracts with its customers where the contracts are denominated in a currency different from the local currencies of the subsidiaries performing the work under the contracts. As a result, revenue recognized for services rendered may be denominated in a currency different from the currencies in which the subsidiaries’ expenses are incurred. Fluctuations in exchange rates (from those in effect at the time the contract is executed and pricing is established to the time services are rendered and revenue is recognized) can affect the subsidiary’s net revenues and resultant earnings. This risk is generally applicable only to a portion of the contracts executed by the Company’s subsidiaries providing contract research services. Historically fluctuations in exchange rates from those in effect at the time contracts were executed have not had a material effect upon the consolidated financial results.
We also have other cross-currency contracts executed by subsidiaries where the foreign currency amounts billed are determined by converting local currency revenue amounts to the contract billing currency using the exchange rates in effect at the time services are rendered. These contracts do not give rise to foreign currency denominated revenue and local currency denominated expenses but through the passage of time between the invoicing of customers under both of these types of contracts and the ultimate collection of customer payments against such invoices. Because such invoices are denominated in a currency other than the subsidiary’s local currency, the Company recognizes a receivable at the time of invoicing for the local currency equivalent of the foreign currency invoice amount as of the invoice date. Subsequent changes in exchange rates from the time the invoice is prepared to the time payment from the customer is received will result in the Company receiving either more or less in local currency equivalent of the invoice amount at the time the invoice was prepared and the receivable was recorded. This difference is recognized by the Company as a foreign currency transaction gain or loss, as applicable, in the consolidated statements of operations.
The Company’s consolidated financial statements are denominated in US dollars. Accordingly, changes in exchange rates between the applicable foreign currency and the U.S. dollar will affect the translation of each foreign subsidiary’s financial results into US dollars for purposes of reporting the consolidated financial results. The process by which each foreign subsidiary’s financial results are translated into U.S. dollars is as follows: income statement accounts are translated at average exchange rates for the period; balance sheet asset and liability accounts are translated at end of the period exchange rates; and equity accounts are translated at historical exchange rates. Translation of the balance sheet in this manner affects the stockholders’ equity account, referred to as the cumulative translation adjustment account. This account exists only in the foreign subsidiary’s US dollar balance sheet and is necessary to keep the foreign balance sheet stated in US dollars in balance. At December 31, 2014, accumulated other comprehensive income on the consolidated balance sheet includes the cumulative translation account deficit for the year ended December 31, 2014 of $7.8 million.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None
Legal Proceedings
The Company is party to certain legal actions arising out of the normal course of its business. In management’s opinion, none of these actions will have a material effect on the Company’s operations, financial condition or liquidity. No form of proceedings has been brought, instigated or is known to be contemplated against the Company by any governmental agency.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES TABLE OF CONTENTS
Page
Consolidated Financial Statements
Independent Auditors’ Report on Consolidated Financial Statements 38
Consolidated Statements of Operations for the Years Ended December 31, 2014, 2013 and 2012 39
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2014, 2013 and 2012 40
Consolidated Balance Sheets as of December 31, 2014 and 2013 41
Consolidated Statements of Changes in Stockholder’s Equity for the Years Ended December 31, 2014, 2013 and 2012 42
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012 43
Notes to Consolidated Financial Statements 44
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Independent Auditors’ Report on Consolidated Financial Statements
To the Board of Directors and Stockholder of BPAL Holdings, Inc.
Report on the Consolidated Financial Statements
We have audited the accompanying consolidated financial statements of BPAL Holdings, Inc. and subsidiaries (the "Company"), which comprises the consolidated balance sheets as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, changes in stockholder’s equity and cash flows for the years ended December 31, 2014, 2013 and 2012, and the related notes to the consolidated financial statements.
Management's Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditor's Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for the years ended December 31, 2014, 2013 and 2012 in accordance with accounting principles generally accepted in the United States of America.
Rotenberg Meril Solomon Bertiger & Guttilla, P.C. Saddle Brook, New Jersey March 24, 2015
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BPAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Year ended Year ended Year ended December 31, December 31, December 31,
2014 2013 2012 Net revenues $ 350,999 $ 170,268 $ 187,114 Cost of sales (260,506) (123,224) (140,395) Gross profit 90,493 47,044 46,719 Selling, general and administrative expenses (75,986) (37,956) (40,715) Other operating expenses (35,050) (4,816) (18,919) Operating (expense) income (20,543) 4,272 (12,915) Interest expense, net (32,303) (18,003) (16,657) Interest expense, related parties (4,519) (3,910) (4,101) Loss on extinguishment of debt - - (1,468) Foreign exchange (loss) gain (14,475) 987 2,742 Other income 1,629 - - Loss from continuing operations, before income taxes (70,211) (16,654) (32,399) Income tax benefit (expense) 4,842 (20,147) 5,912 Loss from continuing operations (65,369) (36,801) (26,487) Loss from discontinued operations, net of tax (3,736) - - Consolidated net loss (69,105) (36,801) (26,487) Net loss attributable to non-controlling interests 27 - - Net loss attributable to the stockholder $ (69,078) $ (36,801) $ (26,487)
The accompanying notes are an integral part of these financial statements
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BPAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Year ended Year ended Year ended December 31, December 31, December 31, 2014 2013 2012 Consolidated net loss $ (69,105) $ (36,801) $ (26,487)
Other comprehensive (loss) income, net of tax Foreign currency translation adjustments (7,821) (1,562) (1,431) Defined benefit plans Actuarial gain on plan assets 3,094 7,270 6,990 Actuarial loss on benefit obligations (13,143) (5,038) (16,172) Amortization of actuarial losses included in net periodic benefit cost 3,074 3,309 3,073
Other comprehensive (loss) income, net of tax (14,796) 3,979 (7,540)
Consolidated comprehensive loss (83,901) (32,822) (34,027)
Comprehensive loss attributable to non-controlling interests 156 - -
Comprehensive loss attributable to the stockholder $ (83,745) $ (32,822) $ (34,027)
The accompanying notes are an integral part of these financial statements
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BPAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2014 AND 2013 DOLLARS IN (000's)
ASSETS 2014 2013 Current assets: Cash and cash equivalents $ 60,962 $ 14,093 Accounts receivable (net of doubtful debt provision of $1,326 in 2014 and $1,545 in 2013) 62,169 27,446 Unbilled receivables 18,407 11,048 Inventories 14,656 3,427 Research and development credit receivable, net 2,983 - Prepaid expenses and other current assets 8,648 3,654 Current deferred tax assets 2,372 - Current assets of discontinued operations 19,100 - Total current assets 189,297 59,668
Property, plant and equipment, net 183,703 89,940 Goodwill 163,738 93,708 Intangible assets and financing costs, net 101,235 68,252 Research and development credit receivable, net 5,951 3,182 Other assets 1,408 - Deferred income taxes 473 - Non-current assets of discontinued operations 17,846 - Total assets $ 663,651 $ 314,750 LIABILITIES AND EQUITY Current liabilities: Accounts payable $ 28,632 $ 11,576 Accrued payroll and other benefits 12,940 5,058 Accrued expenses and other liabilities 22,531 17,131 Accrued loan interest (includes related parties of $1,213 in 2014 and $1,050 in 2013) 6,691 4,814 Short-term debt 10,257 100 Fees invoiced in advance 46,479 37,020 Current deferred tax liabilities 266 - Current liabilities of discontinued operations 20,222 - Total current liabilities 148,018 75,699
Long-term debt, net (includes related parties of $32,343 in 2014 and $27,987 in 2013) 419,271 154,541 Other liabilities 3,129 323 Pension liabilities 45,569 39,513 Long term deferred tax liabilities 19,457 - Long term liabilities of discontinued operations 12,162 - Total liabilities 647,606 270,076
Company stockholder’s equity Common stock - - Paid in capital 175,415 121,475 Accumulated deficit (148,270) (79,192) Accumulated other comprehensive (loss) income (12,405) 2,391 Total Company stockholder’s equity 14,740 44,674 Non-controlling interests in subsidiaries 1,305 - Total equity 16,045 44,674 Total liabilities and equity $ 663,651 $ 314,750
The accompanying notes are an integral part of these financial statements
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BPAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER’S EQUITY FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Accumulated Voting Common Stock Other Non- Paid in Accumulated Comprehensive Controlling Shares Amount Capital Deficit (Loss)/Income Interests Total
Balance, January 1, 2012 100 $ - $ 121,475 $ (15,904) $ 5,952 $ - $ 111,523
Consolidated net loss - - - (26,487) - - (26,487) Other comprehensive loss - - - - (7,540) - (7,540) Balance, December 31, 2012 100 - 121,475 (42,391) (1,588) - 77,496
Consolidated net loss - - - (36,801) - - (36,801) Other comprehensive income - - - - 3,979 - 3,979 Balance, December 31, 2013 100 - 121,475 (79,192) 2,391 - 44,674
Capital contribution from parent - - 39,400 - - - 39,400 Warrants in parent issued with debt - - 14,540 - - - 14,540 Acquired non-controlling interests - - - - - 1,488 1,488 Consolidated net loss - - - (69,078) - (27) (69,105) Other comprehensive loss - - - - (14,796) (156) (14,952) Balance, December 31, 2014 100 $ - $ 175,415 $ (148,270) $ (12,405) $ 1,305 $ 16,045
The accompanying notes are an integral part of these financial statements
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BPAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012
DOLLARS IN (000's) Year ended Year ended Year ended December 31, December 31, December 31, 2013 2012 2014 Cash flows from operating activities: Consolidated net loss $ (69,105) $ (36,801) $ (26,487) Adjustments to reconcile consolidated net loss to net cash (used in) provided by operating activities: Depreciation and amortization 28,228 13,895 13,489 Amortization of gain on disposal of US property - - (7,507) Loss (gain) on disposal of property, plant and equipment 195 (27) 49,417 Impairment of trade names 14,208 - - Non-cash compensation expense associated with employee stock compensation plans 1,881 (48) (215) Non-cash movement on inventory associated with purchase accounting 4,325 - - Gain on casualty insurance (1,381) - - Foreign exchange loss (gain) on intercompany balances 14,475 (987) (2,742) Income tax (benefit) expense (4,842) 20,147 (5,912) (Recovery of) provision for losses on accounts receivable (509) 56 680 Gain on extinguishment of capital lease obligation - - (21,631) Loss on extinguishment of debt - - 1,468 Write-off capitalized sale-leaseback costs - - 2,025 Deferred rent - - (6,001) Amortization of debt issue and financing costs included in interest expense 10,282 2,754 2,592 Capitalization of accrued interest 4,357 3,789 1,828
Changes in operating assets and liabilities: Accounts receivable and unbilled receivables (6,859) 2,496 (3,434) Prepaid expenses and other current assets (2,389) 2,953 2,215 Inventories (1,811) (866) 1,503 Research and development credit, net (6,211) (3,182) - Accounts payable, accrued expenses and other liabilities (10,121) (3,398) (1,746) Accrued loan interest 1,908 250 4,162 Fees invoiced in advance 8,856 2,796 (1,726) Defined benefit pension plan liabilities (4,609) (636) (2,437) Net cash (used in) provided by operating activities (19,122) 3,191 (459)
Cash flows from investing activities: Cash from acquisition of business, net 13,762 - - Purchase of property, plant and equipment (11,735) (4,546) (5,487) Proceeds from sale of property, plant and equipment 7,877 - - Payments for property, plant and equipment acquired in prior year - - (4,095) Repurchase of property - - (63,291) Proceeds from casualty insurance 610 - - Net cash provided by (used in) investing activities 10,514 (4,546) (72,873)
Cash flows from financing activities: Capital contribution from Parent 39,400 - - Proceeds from long-term borrowings 30,000 - 125,665 Repayment of long-term borrowings - - (37,217) Repayment of short-term borrowings (282) (44) - Financing fees (9,908) - (12,113) Net cash provided by (used in) financing activities 59,210 (44) 76,335
Effect of exchange rate changes on cash and cash equivalents (3,733) (993) (364) Increase (decrease) in cash and cash equivalents 46,869 (2,392) 2,639 Cash and cash equivalents at beginning of year 14,093 16,485 13,846 Cash and cash equivalents at end of year $ 60,962 $ 14,093 $ 16,485
Supplementary Disclosures: Interest paid $ 20,103 $ 15,050 $ 11,556 Income taxes paid $ 1,165 $ 102 $ 284 Supplementary disclosures of non-cash investing activity: Purchases of property, plant and equipment (2012- financed by capital leases) $ - $ - $ 289 Supplementary disclosures of non-cash financing activity: Finance costs $ - $ - $ 1,636
The accompanying notes are an integral part of these financial statements 43
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
NOTE 1 - THE COMPANY AND ITS OPERATIONS:
BPAL Holdings, Inc. ("Holdings") was incorporated in the State of Delaware on February 6, 2012. The Company is a global contract research organization, providing laboratory-based, non-clinical testing services for biological safety evaluation research to the pharmaceutical, agrochemical and industrial chemical industries. The purpose of this safety evaluation is to identify risks to humans, animals or the environment resulting from the use or manufacture of a wide range of compounds which are essential components of the Company’s customers’ products. The customers are required to perform the safety evaluations offered by the Company because safety testing is mandated by governments around the world before products can be brought to market. In addition, since the acquisition of Harlan Laboratories Holdings Corp. ("Harlan"), the Company also provides research models and services and laboratory animal diets and bedding.
Holdings was organized for the sole purpose of holding a 100% ownership interest in Life Science Research, Inc. ("LSR"). LSR was incorporated in the State of Maryland in July 2001. Holdings is a wholly-owned subsidiary of a US corporation (the "Parent"), which was formed for the purpose of holding the equity interests in LSR. On February 6, 2012, the Parent contributed to Holdings all of the outstanding equity interests of LSR pursuant to a Contribution Agreement. As a result, LSR became a wholly-owned subsidiary of Holdings.
The Parent was formed for the purpose of acquiring LSR and subsidiaries. On November 24, 2009 ("Merger Date"), pursuant to the Agreement and Plan of Merger dated July 8, 2009 among LSR, Parent, a Delaware corporation and a wholly-owned subsidiary of the Parent, the Delaware corporation merged with and into LSR. LSR continued as the surviving corporation of the Merger and became a wholly-owned subsidiary of the Parent.
On April 29, 2014 Holdings acquired Harlan, a global provider of pre-clinical and non-clinical contract research services and research models and services and laboratory animal diets and bedding. The transaction has been accounted for as a business combination under the acquisition method of accounting. The assets and liabilities acquired have been recorded at their estimated fair values at the date of the acquisition, with the excess of the purchase price over these fair values recorded as goodwill.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
A summary of the significant accounting policies is set out below:
Basis of Presentation
The Company's consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP").
The Company accounts for non-controlling interests in accordance with ASC 810 "Consolidation" ("ASC 810"). ASC 810 requires companies with non-controlling interests to disclose such interests clearly as a portion of equity but separate from the Parent’s equity. The non-controlling interests’ portion of net income/loss are clearly presented on the statement of operations.
All intercompany accounts and transactions have been eliminated in the consolidated financial statements.
Certain items in the prior year financial statements have been reclassified to conform to the 2014 presentation.
Business Acquisitions
The Company accounts for acquired businesses using the acquisition method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact net income. Accordingly, the Company typically obtains assistance from a third-party valuation expert for significant items.
The fair values of the net assets acquired are determined using the market and income approaches. The market approach, which indicates value for a subject asset based on available market pricing for comparable assets, was utilized to estimate the fair value of Harlan’s freehold and leasehold property, plant and equipment and animal inventory. The market approach included prices and other relevant information generated by market transactions involving comparable assets as well as industry pricing guides and 44
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's) other sources. The Company considers market comparable transactions, the condition and age of property and the expected proceeds from sale of property and equipment, among other factors. The income approach is used to value intangible assets, including non-contractual customer relationships, trade names and other intellectual property. The income approach indicates a value for a subject asset based on the present value of cash flows projected to be generated or cash expenditures avoided by having the right to use the asset. Projected cash flows are discounted at a weighted average cost of capital that reflects the relative risk of achieving the cash flows and the time value of money.
Estimating the useful life of an intangible asset also requires judgment. For example, different types of intangible assets will have different useful lives, influenced by the nature of the asset, competitive environment, and rate of change in the industry. Certain assets may even be considered to have indefinite useful lives. All of these judgments and estimates can significantly impact the determination of the amortization period of the intangible asset, and thus net income.
Foreign Currencies
Transactions in currencies other than the functional currency of the Company are recorded at the rates of exchange at the date of the transaction. Monetary assets and liabilities in currencies other than the functional currency are translated at the rates of exchange at the balance sheet date and the related transaction gains and losses are reported in the consolidated statements of operations, as other income or expense. Certain intercompany loans are determined to be long-term investments. The Company records gains and losses from re-measuring such loans as a component of other comprehensive income. The Company also has certain intercompany loans not considered long-term investments. The Company records gains and losses from re-measuring such loans as a component of other income or expense.
Upon consolidation, the results of operations of subsidiaries whose functional currency is other than the US dollar are translated into US dollars at the average exchange rate, assets and liabilities are translated at year-end exchange rates, capital accounts are translated at historical exchange rates, and retained earnings are translated at the weighted average of historical rates. Translation adjustments are presented as a separate component of other accumulated comprehensive loss in the consolidated financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of the consolidated financial statements and the results of operations during the reporting periods. These include management estimates in the calculation and timing of revenue recognition, valuation of acquired assets and liabilities, pension liabilities covering discount rates, return on plan assets and other actuarial assumptions, and deferred tax assets and liabilities and the valuation allowance on deferred tax. Although estimates are based upon management's best knowledge of current events and actions, actual results could differ from those estimates.
Revenue Recognition
All of the Company’s CRS net revenues in relation to services have been earned under contractual arrangements, which generally range in duration from a few days to three years. Net revenue from these contracts is generally recognized over the term of the contracts as services are rendered. Contracts may contain provisions for re-negotiation in the event of cost overruns due to changes in the level of work scope. Renegotiated amounts are included in net revenue when earned and realization is assured. Provisions for losses to be incurred on contracts are recognized in full in the period in which it is determined that a loss will result from performance of the contractual arrangement. Most service contracts may be terminated for a variety of reasons by the Company’s customers either immediately or upon notice at a future date. The contracts generally require payments to the Company to recover costs incurred, including costs to wind down the study, and payment of fees earned to date, and in some cases to provide the Company with a portion of the fees or income that would have been earned under the contract had the contract not been terminated early.
The Company recognizes revenue in relation to its products, which include research models, research model diets, bedding and biomedical products, when title and risk have been transferred, which usually occurs at the time of delivery to the customer. Product sales are recorded net of discounts to customers.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The Company accounts for shipping and handling costs billed to the customer as revenue. Shipping and handling costs incurred are recorded in cost of sales. The Company accounts for the sale of containers used to ship products as revenue. Costs related to containers are recorded in cost of sales.
Unbilled receivables are recorded for net revenue recognized to date that is currently not billable to the customer pursuant to contractual terms. In general, amounts become billable upon the achievement of certain aspects of the contract or in accordance with predetermined payment schedules. Unbilled receivables are billable to customers within one year from the respective balance sheet date. Fees in advance are recorded for amounts billed to customers for whom net revenue has not been recognized at the balance sheet date (such as upfront payments upon contract authorization, but prior to the actual commencement of the study).
If the Company does not accurately estimate the resources required or the scope of work to be performed, or does not manage its projects properly within the planned periods of time or satisfy its obligations under the contracts, then future margins may be significantly and negatively affected or losses on existing contracts may need to be recognized. While such issues have not historically been significant, any such resulting reductions in margins or contract losses could be material to the Company’s results of operations.
Accounts Receivables and Allowance for Uncollectible Accounts
The Company records accounts receivables net of an allowance for doubtful accounts. The Company establishes an allowance for uncollectible accounts which it believes is adequate to cover anticipated losses on the collection of all outstanding trade receivables. The adequacy of the uncollectible account allowance is based on historical information, a review of customer accounts and related receivables, and management's assessment of current economic conditions. The Company reassesses the allowance for uncollectible accounts at the end of every quarter. Provisions to the allowance for doubtful accounts were $36 in 2014, $665 in 2013 and $993 in 2012. Recoveries of provisions against the allowance for doubtful accounts were $545 in 2014, $609 in 2013 and $313 in 2012.
Inventories
Inventories consist primarily of research models stock, biomedical products and research model diets and bedding, and are stated at the lower of cost or market using average costing methodology. The determination of market value is assessed using the selling price of the products. Provisions are recorded to reduce the carrying value of inventory determined to be unsalable. Materials and supplies inventories are valued on a FIFO (first-in, first out) method at the lower of cost or market value.
Income Taxes
The Company recognizes deferred tax assets and liabilities for estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of operations in the period in which the enactment rate changes. Deferred tax assets and liabilities are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not the deferred tax assets will not be realized.
The Company accounts for uncertainties in income taxes under the provisions of ASC 740-10-05, "Accounting for Uncertainty in Income Taxes." The ASC clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The ASC prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The ASC provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Effective January 1, 2014, the Company adopted ASU No. 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013- 11"). ASU 2013-11 is expected to reduce diversity in practice by providing guidance on the presentation of unrecognized tax benefits and will better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. The amendments in this update were adopted on January 1, 2014 and have been applied prospectively. The adoption of ASU 2013-11 did not have a material effect on the Company’s consolidated financial statements.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid investments with an original maturity of three months or less at date of purchase and consist primarily of amounts invested in money market funds and bank deposits.
Fair Value of Financial Instruments
Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, the Company considers the principal or most advantageous market in which the Company would transact, and the assumptions that market participants would use when pricing the asset or liability.
The Company’s financial assets are measured and recorded at cost. The Company’s liabilities are measured and recorded at cost or amortized cost.
The Company utilizes the three-level valuation hierarchy for the recognition and disclosure of fair value measurements. The categorization of assets and liabilities within this hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of hierarchy consist of the following:
Level 1 – Inputs to the valuation methodology are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Level 2 – Inputs to the valuation methodology are quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active or inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument. Level 3 – Inputs to the valuation methodology are unobservable inputs based upon management’s best estimate of inputs market participants could use in pricing the asset or liability at the measurement date, including assumptions about risk.
Concentration of Risk The Company maintains cash and cash equivalents with various financial institutions. These financial institutions are located primarily in the US, UK and Switzerland and the Company's policy is designed to limit exposure with any one institution. Balances in these accounts, at times, may be in excess of insured limits. At December 31, 2014 and 2013, the Company had uninsured balances of $56,269 and $15,072, respectively. The Company has not experienced any losses in such accounts.
Financial instruments that also potentially subject the Company to concentrations of credit risk consist primarily of trade receivables from customers in the pharmaceutical chemical, academic, governmental and biotechnology industries. The Company believes its exposure to credit risk is minimal, as the customers are predominantly well established and viable. Additionally, the Company maintains allowances for potential credit losses. Credit losses incurred have not historically exceeded management's expectations. The Company's exposure to credit loss in the event that payment is not received for revenue recognized equals the outstanding accounts receivable and unbilled receivables less fees invoiced in advance.
The Company has a wide range of customers and suppliers and therefore, believes its concentration risk to any one customer or supplier is minimal. In the years ending December 31, 2014, 2013 and 2012 no customer amounted for greater than 10% of sales and no supplier amounted for more than 10% of purchases of goods and services.
An analysis of the Company’s net revenues from continuing operations and total assets are included in Note 19.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Property, Plant and Equipment
Property, plant and equipment are stated at cost and depreciated over its estimated useful lives on a straight-line basis. Leased property is depreciated over the lesser of its useful life or remaining lease term. Estimated useful lives are as follows:
Asset Estimated Useful Lives Leasehold land and buildings Lease term (or estimated useful life if lower) Leasehold improvements 15 years - the remaining lease term Freehold land Not depreciated Land improvements 5 - 13 years Freehold buildings 10 - 45 years Plant and equipment 3 - 25 years Vehicles 3 - 5 years Computers and software 3 - 5 years Large animal breeding stock 5 years Repair and maintenance expenses on these assets arising from the normal course of business are expensed in the period incurred.
Goodwill
Goodwill represents costs in excess of the fair value of net tangible and identifiable net intangible assets acquired in business combinations. The total goodwill amount of $163,738 relates to the merger of LSR, $95,428, and the acquisition of Harlan, $68,310.
Goodwill is not amortized, but is tested for impairment at the reporting unit level. The Company performed the quantitative impairment test by comparing, at the reporting unit level, the carrying value of the reporting unit to its fair value. The Company assesses fair value based upon its estimate of the present value of the future cash flows that it expects to be generated by the reporting unit. The Company tests annually for impairment at each year end and concluded there were no impairments of goodwill at December 31, 2014 and 2013.
In January 2014, the FASB issued ASU No. 2014-02, "Intangibles – Goodwill and Other (Topic 350): Accounting for Goodwill, a consensus of the Private Company Council" ("ASU 2014-02"). ASU 2014-02 allows an accounting alternative for the subsequent measurement of goodwill. An entity within the scope of the amendments that elects the accounting alternative in ASU 2014-02 should amortize goodwill on a straight-line basis over 10 years, or less than 10 years if the entity demonstrates that another useful life is more appropriate. An entity that elects the accounting alternative is further required to make an accounting policy election to test goodwill for impairment at either the entity level or the reporting unit level. Goodwill should be tested for impairment when a triggering event occurs that indicates that the fair value of an entity (or a reporting unit) may be below its carrying amount. When a triggering event occurs, an entity has the option to first assess qualitative factors to determine whether the quantitative impairment test is necessary. If that qualitative assessment indicates that it is more likely than not that goodwill is impaired, the entity must perform the quantitative test to compare the entity's fair value with its carrying amount, including goodwill (or the fair value of the reporting unit with the carrying amount, including goodwill, of the reporting unit). If the qualitative assessment indicates that it is not more likely than not that goodwill is impaired, further testing is unnecessary. The goodwill impairment loss, if any, represents the excess of the carrying amount of the entity over its fair value (or the excess of the carrying amount of the reporting unit over the fair value of the reporting unit). The goodwill impairment loss cannot exceed the entity's (or the reporting unit's) carrying amount of goodwill. The amendments in ASU 2014-02, if elected, should be applied prospectively to goodwill existing as of the beginning of the period of adoption and new goodwill recognized in annual periods beginning after December 15, 2014. Early application is permitted. The Company is not adopting ASU 2014-02.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Long-Lived and Intangible Assets
Long-lived and intangible assets are stated at cost or fair valuation acquired and amortized over their estimated useful lives on a straight line basis. Estimated useful lives are as follows:
Asset Estimated Useful Lives Customer contracts 2 -20 years Customer relationships 11-20 years Trade name 2 years Intellectual property – animal strains 30 years Finance costs associated with the debt financing Loan term
Long-lived and intangible assets subject to amortization to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amount may be impaired. The Company records an impairment loss if the undiscounted future cash flows are found to be less than the carrying amount of the asset group. If an impairment loss has occurred, a charge is recorded to reduce the carrying amount of the asset to fair value. Long-lived and intangible assets subject to amortization to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. No events or changes in circumstances have occurred that caused an evaluation of the recoverability of long-lived and intangible assets subject to amortization at December 31, 2014 and 2013 other than the impairment of trade names (Note 7).
Intangible assets that have indefinite useful lives are not amortized, but are tested at least annually for impairment, or if circumstances change that will more likely than not reduce the fair value of the intangible asset below its carrying amount. This impairment test is performed by comparing the carrying value of the intangible asset to its fair value.
The Company accounts for the potential impairment of intangible assets that have indefinite useful lives under guidance that permit an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. The more likely than not threshold is defined as having a likelihood of more than 50 percent.
The Company assesses fair value based upon its estimate of the present value of the future cash flows that it expects to be generated by the intangible asset. The Company concluded there were no impairments of intangible assets at December 31, 2014 and 2013 other than the impairment of trade names (see Note 7).
Leased Assets
Assets held under the terms of capital leases are included in property and equipment and are depreciated on a straight-line basis over the lesser of the useful life of the asset or the term of the lease. Obligations for future lease payments under capital leases, less attributable finance charges, are shown within liabilities and are presented between amounts falling due within and after one year.
Operating lease rentals are expensed. Escalating rent provisions are recognized on a straight-line basis over the lease term, and the Company records the difference between amounts charged to operations and amounts paid as deferred rent liability.
Pension Costs
The Company has a number of defined contribution plans, as well as three defined benefit plans, of which two are in UK subsidiaries and one in Switzerland.
The projected benefit obligations and funded position of the defined benefit plans are estimated by actuaries and the Company recognizes the funded status of its defined benefit plan on its consolidated balance sheet and recognizes gains, losses and prior service costs or credits that arise during the period that are not recognized as components of net periodic benefit cost as a component of accumulated other comprehensive income (loss), net of tax. The Company measures plan assets and obligations as of the date of the Company's year-end consolidated balance sheet making assumptions to anticipate future events.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition assets or obligations are disclosed in the notes to the consolidated financial statements (see Note 17 - Employee Benefits).
Debt, Issuance Costs and Stock Warrants In accordance with accounting guidance for debt, debt issued with stock warrants are recorded at their pro-rata fair values in relation to the proceeds received with the portion allocable to the warrants accounted for as a debt discount and paid-in-capital. The Company utilizes a Black-Scholes option pricing model to determine the fair value of its warrants.
Costs charged by the lender, including the pro-rata fair value relating to issuance of stock warrants to the lender, are netted against the related debt and are amortized to interest expense using the effective interest method over the term of the debt. Other financing costs, other than costs charged directly by the lender, are capitalized as an asset and reflected in other assets as a deferred cost and are also amortized to interest expense using the effective interest method over the term of the debt.
Comprehensive Loss Comprehensive loss for the years presented is comprised of consolidated net loss plus the change in the cumulative translation adjustment equity account and the adjustments, net of tax, for the current year actuarial gains (losses) and prior service costs in connection with the Company's defined benefit plan.
NOTE 3 - RECENT ACCOUNTING PRONOUNCEMENTS:
Effective January 1, 2014, the Company adopted ASU No. 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income" ("ASU 2013-02"). ASU 2013-02 requires an entity to provide information about the amount reclassified out of the accumulated other comprehensive income by component. The entity is also required to disclose significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting periods. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about these amounts. The objective in ASU 2013-02 is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this update are applied prospectively for reporting periods beginning after December 15, 2013. The adoption of ASU 2013-02 did not have a material effect on the Company’s consolidated financial statements.
Effective January 1, 2014, the Company adopted ASU No. 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013- 11"). ASU 2013-11 is expected to reduce diversity in practice by providing guidance on the presentation of unrecognized tax benefits and will better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. The amendments in this update are applied prospectively. The adoption of ASU 2013-11 did not have a material effect on the Company’s consolidated financial statements.
On April 10, 2014, the FASB issued ASU No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity" ("ASU 2014-08"). The amendments in ASU 2014-08 change the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. This standard is effective for the Company prospectively as follows:
1. All disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015. 2. All businesses or nonprofit activities that, on acquisition, are classified as held for sale that occur within annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015.
Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The Company has evaluated the impact of ASU 2014-08 and has early adopted the disclosure requirements therein.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers" ("ASU 2014-09"). The amendments in ASU 2014-09 affect any entity that either enters into contracts with customers to transfer goods or services or enters into contracts
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's) for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in ASC 605, "Revenue Recognition" and most industry-specific guidance and creates ASC 606, "Revenue from Contracts with Customers."
The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: Step 1: Identify the contract(s) with a customer. Step 2: Identify the performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the performance obligations in the contract. Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
ASU 2014-09 is effective for nonpublic entities for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. A nonpublic entity may elect to apply ASU 2014-09 earlier as defined in the ASU. The Company is currently evaluating the effects of the adoption of ASU 2014-09 on its consolidated financial statements.
In June 2014, the FASB issued ASU 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period" ("ASU 2014-12"). The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition and should not be reflected in the estimate of the grant-date fair value of the award. ASU 2014-12 is effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted. The adoption of ASU 2014-12 is not expected to have an effect on the Company’s financial position or results of operations.
In August 2014, the FASB issued ASU 2014-15, "Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern" ("ASU 2014-09"). The amendments in ASU 2014-15 contain amendments that clarify the principles for management’s assessment of an entity’s ability to continue as a going concern. ASU 2014-15 is effective for annual reporting periods after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. The adoption of ASU 2014-15 is not expected to have an effect on the Company’s financial position or results of operations.
In November 2014, the FASB issued ASU No. 2014-17, "Business Combinations (Topic 805): Pushdown Accounting (a consensus of the FASB Emerging Issues Task Force)" ("ASU 2014-17"). ASU 2014-17 provides guidance on whether and at what threshold an acquired entity that is a business or nonprofit activity may elect to apply pushdown accounting in its separate financial statements upon a change-in-control event in which an acquirer obtains control of the acquired entity. ASU 2014-17 is effective on November 18, 2014. After the effective date, an acquired entity can make an election to apply the guidance to future change-in-control events or to its most recent change-in-control event. However, if the financial statements for the period in which the most recent change-in-control event occurred already have been issued or made available to be issued, the application of this guidance would be a change in accounting principle. The Company anticipates that the adoption of ASU 2014-17 will not have a material effect on the Company’s financial position or results of operations.
In December 2014, the FASB issued ASU No. 2014-18, "Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination, a consensus of the Private Company Council" ("ASU 2014-18"). ASU 2014-18 allows an accounting alternative to recognize or otherwise consider the fair value of intangible assets as a result of any in-scope transactions (as defined) should no longer recognize separately from goodwill (1) customer-related intangible assets unless they are capable of being sold or licensed independently from the other assets of the business and (2) noncompetition agreements. An entity that elects the accounting alternative in ASU 2014-18 must adopt the private company alternative to amortize goodwill as described in ASU No. 2014-02, "Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill" ("ASU2014-02"). However, an entity that elects the accounting alternative in ASU 2014-02 is not required to adopt the amendments in this Update.
The decision to adopt the accounting alternative in ASU 2014-18 must be made upon the occurrence of the first transaction within the scope of this accounting alternative in fiscal years beginning after December 15, 2015, and the effective date of adoption depends on the timing of that first in-scope transaction. If the first in-scope transaction occurs in the first fiscal year beginning after December 15, 2015, the elective adoption will be effective for that fiscal year’s annual financial reporting and all interim and annual periods thereafter. If the first in-scope transaction occurs in fiscal years beginning after December 15, 2016, the elective
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's) adoption will be effective in the interim period that includes the date of that first in-scope transaction and subsequent interim and annual periods thereafter. Early application is permitted for any interim and annual financial statements that have not yet been made available for issuance. The Company is currently evaluating the impact of its pending adoption of ASU 2014-18 on its Company’s consolidated financial statements.
In January 2015, the FASB issued ASU No. 2015-01, "Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary items" ("ASU 2015-01"). ASU 2015-01 eliminates from GAAP the concept of extraordinary items. ASU 2015-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company anticipates that the adoption of ASU 2015-01 will not have a material effect on the Company’s financial position or results of operations.
In February 2015, the FASB issued ASU NO. 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis" ("ASU 2015-02"). The amendments in ASU 2015-02 change the analysis that reporting entity must perform to determine whether it should consolidate certain types of legal entities. The amendments in ASU 2015-02 are effective for nonpublic business entities for fiscal years beginning after December 15, 2016 and for interim period within fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. A reporting entity may apply the amendments in ASU 2015-02 using a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. A reporting entity also may apply the amendments retrospectively. The adoption of ASU 2015-02 is not expected to have a material impact on the Company’s consolidated financial statements.
Management does not believe that any other recently issued but not yet effective accounting standard if currently adopted would have a material effect on the accompanying financial statements.
NOTE 4 – HARLAN ACQUISITION AND RELATED MATTERS:
On April 29, 2014 (the "Acquisition Date"), the Company acquired, pursuant to an Agreement and Plan of Merger, 100 percent of the outstanding common stock and voting interests of Harlan, a long established business offering full service, non-clinical, contract research services ("CRS") and research models and services and laboratory animal diets and bedding ("RMS").
The acquisition involved no cash payments to Harlan’s equity holders. The existing Harlan debt of $280,425 was refinanced pursuant to a Consent and Exchange Agreement, under which the Company delivered new loans and warrants to Harlan lenders in full satisfaction of Harlan’s indebtedness. The fair value of the long term debt issued amounted to $245,910, including the fair value of warrants issued by the Parent.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The transaction has been accounted for using the acquisition method of accounting which requires, among other things, that assets acquired and liabilities assumed be recognized at their fair values as of the Acquisition Date. The following table summarizes the final allocation of assets acquired and liabilities assumed as of the Acquisition Date at estimated fair value:
April 29, 2014 Cash and cash equivalents $ 13,762 Receivables and other current assets 65,634 Inventory 14,574 Property and equipment held for sale 7,050 Property and equipment 136,757 Intangible assets 50,520 Other assets 1,450 Long term deferred income taxes 4,627 Total identifiable assets acquired 294,374 Long term debt and capital leases (598) Long term deferred income taxes (30,510) Retirement benefits (13,606) Current liabilities (70,572) Total liabilities assumed (115,286) Net identifiable assets acquired, excluding goodwill 179,088 Non-controlling interests (1,488) Goodwill 68,310 Net assets acquired $ 245,910
The fair values of the net assets acquired were determined using the market and income approaches. The market approach, which indicates value for a subject asset based on available market pricing for comparable assets, was utilized to estimate the fair value of Harlan’s freehold and leasehold property, plant and equipment and animal inventory. The market approach included prices and other relevant information generated by market transactions involving comparable assets as well as industry pricing guides and other sources. The Company considered market comparable transactions, the condition and age of property and the expected proceeds from sale of the property and equipment, among other factors. The income approach was used to value intangible assets, including non-contractual customer relationships, the Harlan trade name and other intellectual property related to animal strains. The income approach indicates a value for a subject asset based on the present value of cash flows projected to be generated or cash expenditures avoided by having the right to use the asset. Projected cash flows are discounted at a weighted average cost of capital that reflects the relative risk of achieving the cash flows and the time value of money. The fair value of debt has been determined using the market approach, using an appropriately required yield and comparing against the stated interest rate on the debt. The fair value of warrants were determined using the income approach, taking into consideration historical and future earnings, as well as the market prices and stock price volatility of comparable companies, to establish multiples. The purchase price for the acquisition was allocated to the fair value of the assets acquired and liabilities assumed based on the estimates of the fair values at the Acquisition Date, with the amount exceeding the estimated fair values being recorded as goodwill. Harlan’s results of operations have been included in the Company’s operating results for the period subsequent to the acquisition on April 29, 2014. Harlan contributed revenues of $191,019 from the date of acquisition through December 31, 2014 and a net loss attributable to the Company of $12,335 from the date of acquisition through December 31, 2014. Non-controlling interests The Company recognizes non-controlling interests as equity in the consolidated financial statements separate from the parent entity’s equity. The non-controlling interests were recorded at fair value at the date of the acquisition and subsequently adjusted for profit or loss attributable to the non-controlling interest. The amount of net income or loss attributable to non-controlling interests is included in consolidated net income on the face of the condensed consolidated statement of operations. The fair value of non-controlling interests was determined by reference to the fair value of net assets acquired and the proportion attributable to the non-controlling interests.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Inventory The fair value of acquired inventories of $14,574 is valued at the estimated selling price less the cost of disposal and reasonable profit for the selling effort. The fair value write-up of acquired finished goods inventory was $4,342, the amount of which will be amortized over the expected turn of the acquired inventory. Accordingly, a $4,325 incremental cost of sales charge associated with the fair value write-up of inventory acquired in the merger was recorded for the year ended December 31, 2014.
Property, plant and equipment The fair value of acquired property, plant and equipment of $136,757 has been determined by a third-party valuation firm and is valued at its value-in-use, unless there was a known plan to dispose of an asset.
Property and equipment held for sale In connection with the acquisition of Harlan, the Company classified $7,050 of acquired real estate as property and equipment held for sale at the Acquisition Date. The asset was recorded at the estimated fair value less estimated costs to sell.
The property and equipment held for sale comprised of certain land and buildings located in Fullinsdorf, Switzerland. As of the Acquisition Date and through November, 2014, the real estate assets were being marketed for sale. The sale was consummated in December of 2014 resulting in net proceeds of $7,651.
Intangible assets The identifiable intangible assets summarized in the table below have been amortized from the Acquisition Date based on their average useful lives. The aggregate amortization expense for the year ended December 31, 2014, was $1,580. Estimated future amortization expense for each of the years ending December 31, 2015 through December 31, 2019 is $7,400. The fair values and useful lives of the identified intangible assets are as follows:
Fair value Useful life Trade name $ 1,430 2 years Intellectual property – animal strains 28,810 30 years Customer relationships 20,280 20 years $ 50,520
Goodwill Goodwill in the amount of $68,310 has been recorded for the acquisition of Harlan, none of which is expected to be deductible for income tax purposes. Goodwill is calculated as the excess of the consideration transferred over the fair value of net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized such as the Harlan trained and assembled workforce as well as the synergies and other benefits that are expected to result from combining the operations of the two companies. Goodwill will not be amortized but tested for impairment at least annually.
All of the goodwill is allocated to the Company’s RMS segment.
Taxes
The final valuation of tax assets acquired and liabilities assumed has been completed. However, given the size and complexity of the acquisition, and the valuation of certain tax assets and liabilities, though the final valuation is completed, the Company’s estimates may require adjustment. To the extent that the Company's estimates require adjustment, the Company will modify the value.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Leases The acquired leases are recorded at cost, which approximates fair value. The fair value was determined using the income capitalization approach using inputs such as comparable lease contracts in the market, market growth and discount rates. Operating leases, which expire at various dates through 2024, are for equipment, land and buildings, including several leases with related parties, and provide that the Company will bear all of the property taxes, insurance, normal maintenance and utility expenses incurred. Future minimum lease payments consist of the following for the years ended December 31:
2015 $ 7,515 2016 5,676 2017 3,768 2018 3,163 2019 2,391 Thereafter 5,189 Total minimum lease payments $ 27,702
Expenses related to the Harlan acquisition The Company is expected to continue to incur substantial integration and transition expenses in connection with the Harlan acquisition, including the necessary costs associated with integrating the operations of the two companies. While the Company has assumed that a certain level of expense will be incurred, there are many factors that could affect the total amount and timing of these expenses, and many of the expenses that will be incurred are, by their nature, difficult to estimate. These expenses could, particularly in the near term, exceed the financial benefits that the Company expects to achieve from the Harlan acquisition and could result in the Company taking significant charges against earnings. For the year ended December 31, 2014, the Company incurred integration and transition costs of $7,540.
For the year ended December 31, 2014, the Company incurred acquisition related costs of $11,611 respectively, primarily consisting of financial and legal advisory fees and consulting, restructuring and severance costs. These costs have been classified within other operating expenses.
Supplemental pro forma data The following unaudited supplemental pro forma data presents consolidated pro forma information as if the acquisition and financing had been completed as of the beginning of January 1, 2012.
The unaudited pro forma financial information does not reflect the potential realization of revenue synergies or cost savings nor does it reflect other costs relating to the integration of the two companies. Thus, pro forma data should not be considered indicative of the results that would have actually occurred if the acquisition and related financing had been consummated on January 1, 2013, nor are they indicative of future results.
The unaudited supplemental pro forma financial information was calculated by combining the Company’s results with the stand- alone results of Harlan for the pre-acquisition periods, which were adjusted for certain transactions and other costs that would have been incurred during this pre-acquisition period.
Year ended Year ended Year ended
December 31, 2014 December 31, 2013 December 31, 2012 Net revenues $ 477,815 $ 476,029 $ 532,635 Net loss (39,112) $ (61,162) $ (19,401)
The unaudited pro forma financial information above also gives effect to the following:
a) The elimination of transactions between Holdings and Harlan, which upon completion of the merger would be considered intercompany. This reflects the elimination of intercompany net revenues and associated costs and expenses; and
b) Incremental amortization and depreciation expense related to the estimated fair value of identifiable intangible assets and property, plant and equipment from the purchase price allocation.
55
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The unaudited pro forma net loss for the year ended December 31, 2014 excludes the purchase accounting impact of the incremental charge of $4,325 reported in cost of sales.
The unaudited pro forma net loss for the year ended December 31, 2014 excludes $19,151 of acquisition and integration related costs expensed.
NOTE 5 – CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS:
The Company and its subsidiaries are parties to a number of transactions with related parties.
As described in Note 11 – Long-Term Debt, on March 15, 2012, the Company issued $22,389 of Second Lien Debt in a dollar-for dollar exchange with an existing loan (the "Second Financing Agreement") with related entities (including individuals and/or entities who are stockholders of the Parent), for the outstanding principal amount of $21,600 plus capitalized interest of $789. On April 29, 2014, in connection with the acquisition of Harlan, the Second Lien Debt was converted to Third Lien Debt with no modifications to the terms of the agreement other than to extend the maturity to be no earlier than the maturity date of the First and Second Lien Loans by changing the maturity date to July 30, 2020 and to subordinate the Third Lien Debt to the debt issued under the Credit Agreements.
The Third Lien Debt facility matures on July 30, 2020, and is payable in full on this date. This debt bears interest at a rate of 15% per annum, payable semi-annually in arrears. All or a portion of the interest payable on each interest payment date may be capitalized and added to the principal amount of Third Lien Debt depending on the level of consolidated earnings before interest, tax, depreciation, amortization and other expense adjustments in the immediately preceding twelve months. A total of $9,954 and $5,598 of interest arising on the Third Lien Debt was capitalized as of December 31, 2014 and December 31, 2013, respectively. The Third Lien Debt’s security ranks below that of the Senior Secured Notes, First Lien Loan, Second Lien Loan and Second Lien Liquidity Facility.
On April 29, 2014, Hal Harlan, a founder and significant equity holder in Harlan and an equity holder in the Company’s Parent, became a director of the Company’s Parent. Harlan had entered into lease agreements with entities owned by Hal Harlan at certain of its research model facilities under which the Company paid rent of $219 in the year ended December 31, 2014. Hal Harlan receives annual fees of $250 for his services as a director of Parent.
The Company purchases medicated diets and bedding from an entity owned by Hal Harlan. Purchases from this entity were $1,959 during the year ended December 31, 2014. The Company also sold $162 of diets to this entity during the year ended December 31, 2014.
As described in Note 15 – Commitments and Contingencies, the services of the Chairman are provided to the Company via a management services contract with a company controlled by the Chairman, employed under service agreements. These agreements carry rights to termination payments.
In addition, the Company is party to a management agreement (the "Management Agreement") with certain of its indirect shareholders (the "Providers"), under which the Providers are obligated to: (a) provide general monitoring and management services; (b) identify, support, negotiate and analyze acquisitions and dispositions by the Company or its subsidiaries; (c) support, negotiate and analyze financing alternatives including in connection with acquisitions, capital expenditures, refinancing of existing indebtedness and equity issuances; (d) monitor finance functions, including assisting with the preparation of financial projections and compliance with financing agreements; (e) identify and develop growth strategies; and (f) other monitoring services that the Providers and the Company agree upon. In consideration for the above mentioned services, the Providers are entitled to compensation in the aggregate amount of $1,250 per annum, plus expenses. In addition the Providers are entitled to fees and expenses relating to various financing, which amounted to $5,256 in 2014, $0 in 2013 and $2,250 in 2012 respectively.
The Management Agreement remains in full force and effect so long as the Providers and their respective affiliates collectively own at least 20% of the voting membership or other equity interests in the Company; provided that (i) the Management Agreement terminates upon the sale of all or substantially all of the Company’s assets, and (ii) the Providers may terminate the agreement upon 30 days’ notice to the Company. Under the Management Agreement, the Company indemnifies the Providers against all claims, liabilities, losses, damages and expenses as a result of any action, suit, proceeding or demand against the Providers by a third party, other than those resulting from the gross negligence or wilful misconduct of the Providers.
56
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
NOTE 6 – PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consisted of the following as of December 31:
2014 2013 Land $ 40,003 $ 8,676 Freehold buildings 85,910 54,817 Leasehold buildings and improvements 12,362 3,689 Plant, equipment, vehicles, computers and software 126,784 99,564 Assets in the course of construction 9,770 562 Animal breeding stock 475 - 275,304 167,308
Less: accumulated depreciation (91,601) (77,368) Property, plant and equipment, net $ 183,703 $ 89,940
Depreciation expense aggregated $21,704, $8,910 and $8,504 for 2014, 2013 and 2012 respectively. Of the depreciation expense in the year ended December 31, 2014, $2,918 has been included in discontinued operations.
Acquisitions of property, plant and equipment aggregated $11,735, $4,546 and $69,067 in 2014, 2013 and 2012 respectively.
Included within operating income is a (loss) gain on disposal of property, plant and equipment of $(195) in 2014, $27 in 2013 and $nil in 2012.
The net book value of assets held under capital leases and included above is as follows:
2014 2013 Cost Accumulated Net Book Cost Accumulated Net Book Depreciation Value Depreciation Value Other capital leases $ 319 $ (124) $ 195 $ 289 $ (73) $ 216
The assets under capital leases and the associated liabilities are recorded at the lower of the present value of the minimum lease payments or the fair value of the asset.
Depreciation expense on these capital leases and included above, amounted to $51, $47 and $26 for 2014 and 2013 and 2012 respectively.
NOTE 7 - INTANGIBLE ASSETS:
Identifiable intangible assets are amortized over the period of their expected benefit, unless they were determined to have indefinite lives.
57
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The following table summarizes the intangible assets pushed down to the Company, which are reflected in intangibles assets, net on the consolidated balance sheets, as of December 31: 2014 2013 Intangible assets, at cost: Customer contracts $ 5,100 $ 5,100 Customer relationships 82,207 62,800 Trade names 16,968 15,600 Intellectual property – animal strains 27,570 - Finance costs associated with the debt refinancing 24,602 15,667
Total intangible assets, gross 156,447 99,167 Less: accumulated amortization costs (41,004) (30,915) Less: impairment costs on trade names (14,208) - Net carrying value $ 101,235 $ 68,252
Amortization expense for acquired intangibles for 2014, 2013 and 2012 was $6,524, $4,985 and $4,985, respectively.
The Company has assessed the useful life of the trade names as, following the acquisition of Harlan, a decision has been taken to adopt a new trade name for the combined business. Accordingly, the useful lives of the existing trade names have been assessed as two years and an impairment charge has been made based on the present value of future cash flow (see Note 12).
Interest and amortization expense for the Company's intangible assets expected to be recorded for each of the next five years is as follows:
Year Ending Intangible Assets Debt Finance December 31, Amortization Costs 2015 $ 7,118 $ 13,134 2016 6,473 13,601 2017 6,245 11,389 2018 6,245 10,271 2019 6,245 10,271
NOTE 8 – INVENTORIES:
Inventories at December 31, 2014 and December 31, 2013 consist of the following:
2014 2013 Raw materials and consumables $ 3,035 $ 1,889 Finished goods and work progress 4,508 - Animal stock 7,113 1,538 $ 14,656 $ 3,427
NOTE 9 – INCOME TAXES:
An analysis of the components of income/(loss) from operations before income tax benefit (expense) is presented below:
Year ended Year ended Year ended December 31, December 31, December 31,
2014 2013 2012 Loss before taxes: US $ (35,980) $ (12,545) $ (13,518) Non - US (37,930) (4,109) (18,881) (73,910) (16,654) (32,399) Discontinued operations (non- US) (3,699) - - $ (70,211) $ (16,654) $ (32,399)
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The benefit (expense) for income taxes from continuing operations by location of the taxing jurisdiction consisted of the following:
Year ended Year ended Year ended December 31, December 31, December 31,
2014 2013 2012 Current taxation: US - Federal $ (41) $ - $ - US - State 288 - - Non - US (2,386) (136) (136) Total current $ (2,139) $ (136) $ (136)
Deferred Taxation: US - Federal 4,124 (19,743) 5,476 US - State 905 628 674 Non - US 1,952 (896) (102) Total deferred 6,981 (20,011) 6,048
Income tax benefit (expense) $ 4,842 $ (20,147) $ 5,912
Reconciliation between the US statutory rate and the effective rate is as follows:
Year ended Year ended Year ended December 31, December 31, December 31, 2014 2013 2012 US statutory rate 35% 35% 35% Foreign rate differential (13)% (3)% (6)% Non-deductible items (8)% 5% (16)% Valuation allowance (12)% (162)% (5)% State taxes 1% 3% 2% US taxes on unremitted earnings 3% - - Losses utilized - 1% - Change in estimate - - (19)% Transaction fees - - 27% Effective tax rate 6% (121%) 18%
The 2014, 2013 and 2012 effective tax percentages include the valuation allowance adjustment of the UK net operating losses. The 2013 effective tax percentages also include a valuation allowance adjustment of the US net operating losses.
The UK government introduced a new tax allowance, Research and Development Tax Credit ("UK R&D credit"), for large companies in 2002. This UK R&D credit allowed the UK companies to recover an additional 30% of their research and development expenses in addition to the 100% normally allowed.
On July 18, 2013 a change was enacted in UK Tax Legislation in relation to research and development expenditures, giving companies the option of recognizing research and development credits as a reduction of cost of sales. The Company has adopted the new approach effective April 1, 2013 and is no longer able to recover the additional 30% UK R&D credit. The previous UK R&D credit eliminated all UK taxable income of the Company and the Company did not need to utilize its net operating loss carry forwards. Despite the change in legislation, the Company does not anticipate the removal of the R & D tax credit will result in taxable profits in the foreseeable future, and so the Company will maintain a full valuation allowance against the deferred tax assets in the UK until sufficient positive evidence exists to reduce or eliminate the allowance.
Interest and penalty costs related to unrecognized tax benefits, are classified as a component of interest income and other income (expense), net, in the accompanying Consolidated Statements of Operations.
59
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The Company conducts business in various international and domestic tax jurisdictions. As a result, the Company is subject to tax examinations on a regular basis including, but not limited to, such major jurisdictions as the US, UK, Switzerland, Netherlands and Spain. As of the date that these financial statements were available to be issued, tax examinations were occurring in the Netherlands, Israel and US. With few exceptions, the Company is no longer subject to US federal and state income tax examinations for the years prior to 2011. The most significant US jurisdictions in which the Company is required to file income tax returns includes the states of New Jersey, Maryland, Indiana, California and Wisconsin. In addition, with few exceptions, the Company is no longer subject to foreign tax examinations for years prior to 2007.
2014 2013 Deferred tax assets: Accruals and liabilities $ 1,273 $ - Depreciation and amortization 6,415 5,636 Inventory 1,364 - Net operating losses 74,314 57,293 Employee benefits and compensation 11,750 11,047 Unrealized foreign exchange 426 - Valuation allowance 10 - Other 10,436 7,327
Total gross deferred tax assets 105,988 81,303
Deferred tax liabilities: Accruals and liabilities 13 - Depreciation and amortization 45,876 2,074 Inventory 174 3,401 Employee benefits and compensation 13 13,532 Unrealized foreign exchange 79 - Other 1,539 -
Total gross deferred tax liabilities 47,694 19,007
Less valuation allowance 75,172 62,296 Net deferred tax liability $ 16,878 $ -
The Company made cash payments for income taxes in the amount of $1,165 for the year ended December 31, 2014.
At December 31, 2014, the Company has Federal net operating losses in its US entities of $80,881of which $126 expires in 2018, $523 expires in 2019, $1,087 expires in 2021, $414 expires in 2022, $1,784 expires in 2024, $5,892 expires in 2026, $1,504 expires in 2027, $6,841 expires in 2028, $16,241 expires in 2029, $18,673 expires in 2030, $6,934 expires in 2031, $7,667 expires in 2032, $6,627 expires in 2033, and $6,569 expires in 2034. Additionally the Company has State net operating losses in its US entities at December 31, 2014 of $28,280 which will begin to expire in 2017. The utilization of these net operating losses is subject to limitations based on past changes in ownership of the Company pursuant to Internal Revenue Code ("IRC") Section 382. The Company has determined that an ownership change as defined by the IRC occurred on the Merger Date and the Acquisition Date.
The gross amount of net operating losses at December 31, 2014 in the UK is $122,388 and has no expiration date. The Company has provided a valuation allowance on the net operating loss carry forwards because it believes that it is more likely than not that those amounts will not be realized through taxable income in the foreseeable future. A full valuation allowance has been recorded for the total benefit of capital losses incurred in prior years, as the Company does not anticipate that the benefit will be realized in the foreseeable future through the recognition of capital gains. At December 31, 2014, the Company has net operating losses other foreign jurisdictions of $21,409 which will begin to expire in 2017, although many jurisdictions have no expiration date.
During the year ended December 31, 2013, the Company performed a review of the recoverability of the US deferred tax asset in relation to losses. As a result of this review, a valuation allowance of $24,135 was provided as the asset will not be fully realized in the foreseeable future given the current lack of profitability of the US business.
60
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The Company evaluates its deferred income taxes to determine if valuation allowances are required or should just be adjusted. US GAAP requires that valuation allowances should be established against their deferred tax assets based on consideration of all available evidence, both positive and negative, using a "more likely than not" standard.
This assessment considers, among other matters, the nature, frequency and amount of recent losses, the duration of statutory carryforward periods, and tax planning strategies. In making such judgments, significant weight is given to evidence that can be objectively verified.
The Company provides income taxes on the earnings of foreign subsidiaries to the extent those earnings are taxable or expected to be remitted. The Company’s historical policy has been to leave its unremitted foreign earnings invested indefinitely outside the United States and intends to continue this policy. It is not practical to estimate the amount of additional tax that might be payable if such accumulated earnings were remitted. Additionally, if such accumulated earnings were remitted, certain countries impose withholding taxes that, subject to certain limitations, would be available for use as a tax credit against any Federal income tax liability arising from such remittance.
The Company recognizes a tax benefit from uncertain tax positions only if the Company believes it is "more likely than not" to be sustained upon examinations based on the technical merits of the position. The amount of the accrual for which an exposure exists is measured as the largest amount of benefit determined on a cumulative probability basis that the Company believes is "more likely than not" to be realized upon ultimate settlement of the position. The Company accrues interest and penalties in relation to previously unrecognized tax benefits as a component of income tax expense.
As of December 31, 2014, the balance of the reserve for previously unrecognized tax benefits was $707, which is recorded in accrued expenses and other liabilities on the consolidated balance sheet. This balance is comprised entirely of interest and penalty amounts as of December 31, 2014. The Company anticipates no significant increase in the previously unrecognized benefit during the next 12 months. The only changes in this balance during the year ended December 31, 2014 are due to currency fluctuations. All other unrecognized tax benefits as of December 31, 2014, if recognized, would favorably affect the income tax expense in future years.
In accordance with accounting for income taxes, the Company nets all current and non-current assets and liabilities by tax jurisdiction.
NOTE 10 – ACCRUED EXPENSES AND OTHER LIABILITIES:
Accrued expenses and other liabilities consist of the following:
2014 2013 General accruals $ 15,805 $ 11,775 Waste accrual 1,941 1,897 Other creditors 1,871 629 Discounts and commission 2,914 2,830 $ 22,531 $ 17,131
NOTE 11 - LONG-TERM DEBT:
Long-term debt consists of the following:
2014 2013 Long-term financing $ 473,297 $ 157,987 Leases- other 66 137 Warrants and discount costs (43,835) (3,483) 429,528 154,641 Less: current portion (10,257) (100) Long-term debt, net of current portion $ 419,271 $ 154,541
The long-term financing held with related parties and included in the table above amounts to $32,343 and $27,987 as of December 31, 2014 and 2013, respectively. 61
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Minimum future principal payments of long-term debt at December 31, 2014 are as follows:
Total 2015 2016 2017 2018 2019 2020 Long- term financing $473,297 $ 10,220 $ 309 $120,000 $ - $ - $342,768 Leases - other 66 37 21 8 - - - $473,363 $ 10,257 $ 330 $120,008 $ - $ - $342,768
Long Term Financing
Issue of Senior Secured Notes, First Lien Loan, Second Lien Loan and Third Lien Debt
On March 15, 2012, the Company issued $120,000 of Senior Secured Notes and $22,389 of Third Lien Debt (previously Second Lien Debt).
On April 29, 2014 the Company issued $280,425 of First and Second Lien Loans. On issuance, $150,000 has been ranked as First Lien Loan and $130,425 as Second Lien Loan. The ranking was determined by the Senior Leverage Ratio of the Senior Secured Notes Indenture. The Company is required, at each quarter end, to promote Second Lien Loan to First Lien Loan according to the Senior Leverage Ratio. Through December 31, 2014, no such promotions have been made.
The Company’s obligations under the terms of the Senior Secured Notes, First Lien Loan, Second Lien Loan and Third Lien Debt are guaranteed by substantially all of the Company’s subsidiaries located in the US and UK. The terms require the Company to maintain certain financial ratios and covenants. The Senior Secured Notes and First Lien Loan are secured by a first priority lien on substantially all of the assets of the Company and certain of its subsidiaries located in the US and UK, subject to certain exceptions and permitted liens. The Second Lien Loan is secured by a second priority lien on substantially all of the assets of the Company and certain of its subsidiaries located in the US and UK, subject to certain exceptions and permitted liens and the Third Lien Debt is secured by a third priority lien on substantially all of the assets of the Company and certain of its subsidiaries located in the US and UK, subject to certain exceptions and permitted liens.
Senior Secured Notes The issue price of the Senior Secured Notes was 96.388% of their face value, which generated proceeds of $115,666 before expenses. The Senior Secured Notes will mature on April 1, 2017 and are payable in full on that date. This debt bears interest at a rate of 12.25% per annum, payable semi-annually in arrears.
The discount on issue of $4,334 was recorded as a debt discount and is being amortized to interest expense over the term of the loan. For consolidated financial statement presentation purposes, the unamortized debt discount has been offset against long-term debt.
The fees incurred in respect of the issue of the Senior Secured Notes were $10,834 and have been recorded as a deferred financing cost and are being amortized to interest expense using the effective interest method over the term of the loan. For consolidated financial statement presentation purposes, the unamortized amount of capitalized financing cost has been classified as intangible assets and financing costs, net.
First and Second Lien Loans The fair value of the First and Second Lien Loans was $245,910, including the fair value of warrants of $6,610. The loans mature on July 1, 2017, although if not repaid in full within 6 months of that date, the loans will be automatically extended to April 29, 2020. The loans bear interest at 2.5% per annum above LIBOR until the fourth anniversary and thereafter at 5.75% and 7.75% per annum above LIBOR on the First and Second Lien Loans, respectively. At December 31, 2014, LIBOR was 0.25% and interest is payable quarterly in arrears. On a quarterly basis, the principal amount of the First Lien Loan may increase and the Second Lien Loan will correspondingly decrease under the Senior Secured Notes Indenture. As of December 31, 2014, there has been no conversion of Second Lien Loan to First Lien Loan.
The discount of $32,085 on the principal value of the loans was recorded as a debt discount and is being amortized to interest expense using the effective interest method over the term of the loans. For consolidated financial statement presentation purposes, the unamortized debt discount has been offset against long-term debt.
The fees incurred in respect of the issue of the First and Second Lien Loans were $9,070 and have been recorded as a deferred financing cost and will be amortized to interest expense using the effective interest method over the term of the loans. 62
BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
For consolidated financial statement presentation purposes, the unamortized amount of capitalized financing cost has been classified as intangible assets and financing costs, net.
The warrants issued in the Parent in respect of the First and Second Lien Loans of $6,610 will be amortized to interest expense using the effective interest method over the term of the loans. For consolidated financial statement presentation purposes, the unamortized value of the warrant has been offset against long-term debt.
Third Lien Debt On March 15, 2012, the Company issued $22,389 of Second Lien Debt in a dollar-for dollar exchange with an existing loan (the ‘Second Financing Agreement’) with related entities (including individuals and/or entities who are stockholders of the Parent), for the outstanding principal amount of $21,600 plus capitalized interest of $789. On April 29, 2014, in connection with the acquisition of Harlan, the Second Lien Debt was converted to Third Lien Debt with no modifications to the terms of the agreement other than to extend the maturity to be no earlier than the maturity date of the First and Second Lien Loans by changing the maturity date to July 30, 2020 and to subordinate the Third Lien Debt to the debt issued under the Credit Agreements.
The Third Lien Debt matures on July 30, 2020, and is payable in full on this date. This debt bears interest at a rate of 15% per annum, payable semi-annually in arrears. All or a portion of the interest payable on each interest payment date may be capitalized and added to the principal amount of Third Lien Debt depending on the level of consolidated earnings before interest, tax, depreciation, amortization and other expense adjustments in the immediately preceding twelve months. A total of $9,954 and $5,598 of interest arising on the Third Lien Debt was capitalized as of December 31, 2014 and 2013, respectively. The Third Lien Debt’s security ranks below that of the Senior Secured Notes, First Lien Loan, Second Lien Loan, Second Lien Liquidity Facility and Revolver.
The fees incurred in respect of the issue of the Third Lien Debt were $283 and have been recorded as a deferred financing cost and are being amortized to interest expense using the effective interest method over the original term of the loan, along with the deferred financing cost of $1,123 from the existing loan. For consolidated financial statement presentation purposes, the unamortized amount of capitalized financing cost has been classified as intangible assets and financing costs, net.
Revolver On July 11, 2012, the Company secured a $10,000 Revolving Credit Facility (the "Revolver") maturing on March 31, 2015. No principal payments are required until maturity and optional prepayments are allowed without penalty. As of December 31, 2014, $10,000 had been drawn down and is included within short term debt. This debt bears interest at 3.25% per annum above LIBOR, payable quarterly in arrears. At December 31, 2014, LIBOR was 0.25% and the interest rate on the revolver was 3.50%. Additionally, there is a commitment fee of 0.5% charged on the unused credit facility.
The Company’s obligations under the terms of the Revolver are guaranteed by substantially all of the Company’s subsidiaries located in the US and UK. The terms of the Revolver require the Company to maintain certain financial ratios and covenants. Certain of these ratios and covenants were amended by the First Amendment to the Credit Agreement for the Revolver, effective June 30, 2013. On April 29, 2014, certain of the terms were amended by the Second Amendment to the Credit Agreement for the Revolver.
The fees incurred in respect of the arrangement of the Revolver were $988 and have been recorded as a deferred financing cost and are being amortized to interest over the term of the agreement. The fees incurred in respect of the Second Amendment to the Credit Agreement were $215 and have been recorded as a deferred financing cost and are being amortized over the remaining term of the agreement. For consolidated financial statement presentation purposes, the unamortized amount of capitalized financing cost has been classified as intangible assets and financing costs, net.
The Revolver is secured by all property and assets of the Company and certain of its subsidiaries, subject to certain exceptions and permitted liens, but is subordinate to the Senior Secured Notes.
Second Lien Liquidity Facility On April 29, 2014, the Company secured a $30,000 new Second Lien Liquidity Facility maturing on April 29, 2020. No principal payments are required until maturity and optional prepayments are allowed without penalty. This debt bears interest at 7.75% per annum above LIBOR (subject to a minimum of 1.00%), payable quarterly in arrears. At December 31, 2014, LIBOR was 0.25% and the interest on the Second Lien Liquidity Facility was 8.75%.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The Company’s obligations under the terms of the Second Lien Liquidity Facility are guaranteed by substantially all of the Company’s subsidiaries located in the US and UK.
The fees incurred in respect of the arrangement of the Second Lien Liquidity Facility were $624 and have been recorded as a deferred financing cost and are being amortized to interest over the term of the agreement. For consolidated financial statement presentation purposes, the unamortized amount of capitalized financing cost has been classified as intangible assets and financing costs, net.
The Second Lien Liquidity Facility is secured by all property and assets of the Company and certain of its subsidiaries, subject to certain exceptions and permitted liens, but is subordinate to the Senior Secured Notes, Revolver and First and Second Lien Loan.
The warrants issued in the Parent in respect of the Second Lien Liquidity Facility of $7,930 are being amortized to interest expense using the effective interest method over the term of the loan. For consolidated financial statement presentation purposes, the unamortized value of the warrant has been offset against long-term debt.
Financial instruments not recorded at fair value on a recurring basis On a quarterly basis, the Company measures the fair value of its short-term debt and long-term debt carried at amortized cost. The Company’s financial assets would be recorded at fair value only if and when an impairment is recognized. The carrying amounts and fair values of debt not recorded at fair value on a recurring basis at the end of each period were as follows:
December 31, 2014 Carrying Amount Fair Value Measured Using Fair Value (in millions) Level 1 Level 2 Level 3 Short-term debt $ 10,257 $ - $ 10,257 $ - $ 10,257 Long-term debt 419,271 - 419,271 - 419,271 $ 429,528 $ - $ 429,528 $ - $ 429,528
December 31, 2013 Carrying Amount Fair Value Measured Using Fair Value (in millions) Level 1 Level 2 Level 3 Short-term debt $ 100 $ - $ 100 $ - $ 100 Long-term debt 154,541 - 154,541 - 154,541 $ 154,641 $ - $ 154,641 $ - $ 154,641
The book value of the Company’s term and revolving loans, which are variable loans carried at amortized cost, approximate their fair value based on current market pricing of similar debt. As the fair value is based on significant observable inputs, including current interest and foreign currency exchange rates, it is deemed to be level 2.
Related Party Leases
In June 2005, the Company entered into and consummated a Sale-Leaseback transaction with a related party. The Company sold its two UK and US properties for an aggregate consideration of $40,000 and immediately leased back the properties under 30 year leases. The related party is controlled by the Company’s Chairman.
In accordance with accounting guidance for leases, the leases for the UK buildings and US land and buildings were determined to be capital leases, while the leases for the land portion of the UK properties were determined to be operating leases. A gain of approximately $9,600 on the sale of the US property was deferred and was being amortized over the term of the lease. All the leases on these properties expired in 2035 and had two five-year renewal options under the same terms and conditions in effect under the leases immediately prior to the renewal periods.
The annual rental payments on the US leases approximated $2,200 and called for annual CPI increases. The annual rental payments on the UK leases currently approximated $3,100 and had fixed annual increases of 3% per year during the terms of the leases. All of the related party leases were triple net leases and the Company was required to pay for all of the costs associated with the operation of the facilities, including, but not limited to, insurance, taxes and maintenance. The implicit interest rate on the related party capital leases approximated 12.25%, representing the rate required to discount the future stream of rental payments to equal the appraised
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's) value of the properties at the date of the Sale-Leaseback transaction. For consolidated financial statement purposes, interest expense related to the rental payments on the Sale-Leaseback transaction was classified as interest expenses, related parties.
This Sale-Leaseback transaction was terminated on March 15, 2012 when the properties were repurchased by the Company using the proceeds from the refinancing described below, for an aggregate consideration through December 31, 2012 of $63,291.
The Company recorded a net loss of $49,417 on the disposal of capital leased assets and a gain on the extinguishment of the capital lease obligation of $21,631 in connection therewith. The Company also recognized the unamortized deferred gain of $7,427 on the original sale of the US property, wrote off the deferred rent liability of $6,162 on the two UK properties and expensed the unamortized deferred Sale-Leaseback costs of $2,025. These transactions were recorded as other operating expense (Note 12), net on the Consolidated Statements of Operations for the year ended December 31, 2012.
NOTE 12 – OTHER OPERATING EXPENSE:
Other operating expense consists of the following:
Year ended Year ended Year ended December 31, December 31, December 31,
2014 2013 2012
Reduction in force (see Note 13) $ 1,691 $ 3,729 $ 2,697 Transaction related expenses 11,611 1,087 - Integration and transaction expenses 7,540 - - Impairment of trade names (see Note 7) 14,208 - - Termination of Sale -Leaseback transaction - - 16,222 $ 35,050 $ 4,816 $ 18,919
Transaction related expenses for 2014 primarily consist of financial and legal advisory fees and consulting related to the acquisition of Harlan. Integration and transition expenses for 2014 relate to professional fees, restructuring, severance costs and staff travel and meeting costs specific to the integration following the acquisition. For a discussion of the impairment, see Note 7 – Intangible Assets.
NOTE 13 – REDUCTION IN FORCE:
Included within other operating expenses (see Note 12) is an amount of $1,691 in relation to reduction in force programs that have been enacted through the year as part of the integration of Harlan. Included within other operating expenses for the year ended December 31, 2013 is an amount of $3,729 in relation to the UK reduction in force program.
Over the past few years, the Company has focused heavily on cost control and productivity improvement in an attempt to preserve competitiveness. In 2009, staff took compensation cuts to help save jobs, but the continued downturn in the pharmaceutical development market through 2012 has led to reductions in force in certain business areas in the UK where employee skills were non-transferable to other parts of the business that continued to perform well.
In December 2012, the Company announced a reduction in force in both the UK and US operations. Following a consultation period, 97 UK employees and 29 US employees left the Company during the first quarter of 2013. This reduction in force has reduced annualized labor costs by approximately $6,600 and $2,500 in the UK and US, respectively.
In February 2014, the Company announced a further reduction in force in the US operations, resulting in 18 employees leaving the Company. This reduction in force has reduced annualized labor costs by approximately $500. In addition, there have been reduction in force programs associated with the integration of Harlan, which have reduced annualized labor costs by $5,500.
NOTE 14 – OTHER INCOME:
Other income for the year ended December 31, 2014 consists primarily of casualty insurance proceeds as well as other miscellaneous items.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
NOTE 15 - COMMITMENTS AND CONTINGENCIES:
Commitments
The Company leases certain equipment under various non-cancellable operating and capital leases. The Company is also obligated under purchase agreements, including fixed-term utilities contracts. Finally, the Company is obligated to make contributions to its defined benefit pension plan of approximately $8,282 in 2015 and then approximately $102,716 over the following eight years. Minimum commitments in effect at December 31, 2014 are as follows:
Total 2015 2016 2017 2018 2019 Thereafter Operating leases $ 28,844 $ 7,961 $ 5,923 $ 3,995 $ 3,297 $ 2,479 $ 5,189 101 Mettlers Road 375 375 - - - - - Capital leases 66 37 21 8 - - - Purchase obligations 5,835 5,835 - - - - - Pension plan contributions 110,998 8,282 9,318 10,193 11,177 12,349 59,679 $ 146,118 $ 22,490 $ 15,262 $ 14,196 $ 14,474 $ 14,828 $ 64,868
Employment Contracts
The services of the Chairman are provided to the Company via a management services contract with a company controlled by the Chairman. The Company has also entered into service agreements with four other executive officers. In each case, the amount payable by the Company on termination of the contract ‘without cause’ in the event of ‘change of control’ (as defined in the relevant contract) is equivalent to 2.99 times the officer’s annual salary plus all incentive compensation earned in the 12 months prior to termination. The total amount of these executive officers’ remuneration for the years ended December 31, 2014, 2013 and 2012 were $5,412, $3,629 and $5,014, respectively. In addition, the Company has entered into employment agreements with other officers and key employees on substantially similar terms.
Leases
The following is a schedule of future minimum lease payments under capital leases together with the present value of net minimum lease payments as of December 31, 2014:
Total payments due $ 71 Less: amounts representing interest (5) Present value of net minimum lease payments 66 Less: current portion of capital lease obligations (37) Non-current portion of capital lease obligations $ 29
Operating lease expenses were as follows:
Year ended Year ended Year ended December 31, December 31, December 31,
2014 2013 2012 Plant and equipment $ 5,085 $ 588 $ 946 Property leases 5,628 500 500 Other operating leases 69 160 155 Related party operating leases 219 - 622 $ 11,001 $ 1,248 $ 2,223
Contingencies
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The Company is party to certain legal actions arising out of the normal course of its business. In management's opinion, none of these actions will have a material effect on the Company's operations, financial condition or liquidity. No form of proceedings has been brought, instigated or is known to be contemplated against the Company by any government agency.
NOTE 16 – STOCKHOLDER EQUITY:
Common Stock
Holdings is authorized to issue 100 shares of $0.01 par value Voting Common Stock. All of the shares are deemed to be issued and outstanding as of December 31, 2014, 2013 and 2012.
Paid in capital activity consists of the following:
At January 1, 2014 $ 121,475 Capital contribution from Parent 39,400 Warrants in Parent issued with First and Second Lien Loans 6,610 Warrants in Parent issued with Second Lien Liquidity Facility 7,930 At December 31, 2014 $ 175,415
On April 29, 2014, in connection with the issuance of the Second Lien Loan, the Company’s Parent granted 454,695 warrants to purchase its Class A common stock for $.01 per share ("Series A Warrants") and 729,016 warrants to purchase its Class B common stock for $0.01 per share ("Series B Warrants"). In connection with the issuance of the Second Lien Liquidity Facility, the Company’s Parent granted 545,634 warrants to purchase its Class A common stock for $.01 per share ("Liquidity Facility Warrants"). The total fair value of the Series A Warrants, Series B Warrants and Liquidity Facility Warrants was $6,610, $0 and $7,930, respectively, at the date of grant. The fair values were determined using a weighted average of the indicated enterprise values of the Company using the market and income approaches. The market approach assumptions used included using a 10 times multiple of projected weighted average EBITDA. The income approach assumptions used annual revenue growth rates ranging from 1.5% - 7.4% and a discount rate of 10.5%. At December 31, 2014, the aforementioned Series A Warrants and Liquidity Facility Warrants were exercisable. The Series B Warrants are exercisable on April 29, 2018. The fair value of the warrants in the Parent have been accounted for as capital contributions of the Parent to the Company and classified as "equity" and included in Paid in Capital of the Company in the consolidated balance sheets. These warrants in the Parent are fully vested and non-forfeitable but have certain transfer and exercise restrictions. These warrants have a "cashless exercise" provision and "down round" protection as well as certain distribution and registration rights. The warrants have a contractual life of 10 years.
NOTE 17 – EMPLOYEE BENEFITS:
Stock Appreciation Rights
Certain of the Company’s officers and employees have been granted stock appreciation rights ("SARs") in the Parent. Stock compensation expense related to these grants is recognized by the Company. Upon exercise, each SAR entitles the holder to receive an amount in cash equal to the difference between the notional fair market value of one share in the Parent on exercise date and the notional fair market value of one share in the Parent on the grant date.
No of SARs No of SAR’s Number Exercise Date 1st 50% exercisable – Date 2nd 50% exercisable- Date of Grant Granted price Terms became exercisable 1st 50% became exercisable 2nd 50% December 3, 2010 1,397,878 $8.50 10 years November 24, 2011 698,939 November 24, 2011 698,939 May 11, 2011 20,000 $8.50 10 years May 11, 2012 10,000 May 11, 2013 10,000 September 15, 2011 5,000 $8.50 10 years September 15, 2012 2,500 September 15, 2013 2,500 July 31, 2012 20,000 $8.50 10 years July 31, 2013 10,000 July 31, 2014 10,000 July 31, 2012 10,000 $8.50 10 years July 31, 2012 5,000 December 3, 2012 5,000 October 1, 2012 25,000 $8.50 10 years October 1, 2013 12,500 October 1, 2014 12,500 March 1, 2013 20,000 $8.50 10 years March 1, 2014 10,000 March 1, 2015 10,000
15,763 SARs were forfeited in the year ended December 31, 2014, 21,186 SARs were forfeited in the year ended December 31, 2013, and 0 in the year ended December 31, 2012.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The fair market value of the SARs is calculated using The Black-Scholes option pricing model and the following assumptions:
Year ended Year ended Year ended December 31, December 31, December 31,
2014 2013 2012 Expected dividend yield of stock 0% 0% 0% Expected volatility of stock 32.0% 34.4% 43.8% Risk-free interest rate 1.35%-1.66% 1.12% - 2.28% 0.40% - 0.92% Expected term of SAR’s 3.0-5.0 years 3.5 -6.5 years 4.0 – 5.9 years
The expected life is the number of years that the Company estimates, based upon history, that the SARs will be outstanding prior to exercise or forfeiture. Expected life is determined using the "simplified method". The stock volatility factor is based on an average volatility rate of entities providing similar services. The Company did not use the volatility rate for the Company’s common stock, as the Company’s common stock does not trade on an exchange or market.
The SARs generally vest over a two-year period. The value of the SARs is recognized as compensation expense on a straight-line basis over the vesting period. The expense is recalculated at the end of each reporting period until final settlement occurs. The accrued expense of the unexercised SARs is disclosed on the face of the balance sheet as "Other liabilities."
Once vested, the SARs may only be exercised on March 31 and September 30 of each year. The holders may only exercise 50% of the rights granted to them at any one time. The SARs have a term of ten years.
Weighted Average Rights Fair Value per SAR SARs outstanding as of 1/1/2010 - SARs granted 1,397,878 $0.21 SARs outstanding as of 12/31/2010 1,397,878 SARs granted 25,000 $0.28 SARs outstanding as of 12/31/2011 1,422,878 SARs granted 55,000 $0.35 SARs outstanding as of 12/31/2012 1,477,878 SARs granted 20,000 $0.28 SARs forfeited (21,186) SARs outstanding as of 12/31/2013 1,476,692 $0.22 SARs forfeited (15,763) SARs outstanding as of 12/31/2014 1,460,929 $1.51
SARs exercisable as of 12/31/2009 - SARs exercisable as of 12/31/2010 - SARs exercisable as of 12/31/2011 1,397,878 SARs exercisable as of 12/31/2012 1,420,378 SARs exercisable as of 12/31/2013 1,434,192 SARs exercisable as of 12/31/2014 1,445,929
The Company had unvested SARs compensation expense of $19, $12, and $8 at December 31, 2014, 2013 and 2012, respectively, with a total weighted average remaining term of 8.19, 8.91 and 9.41 years for the years ended December 31, 2014, 2013 and 2012, respectively. Stock-based compensation expense totalled $1,881 and $48 for the years ended December 31, 2014 and December 31, 2013 respectively and a gain of $48 and $215 for the years ended December 31, 2013 and 2012, respectively. The exercise price of the SARs was in excess of the market value as of December 31, 2014, 2013 and 2012.
The Company has not recorded any tax benefit relating to this expense as the majority of the compensation will be paid to employees that are located outside of the US and the deduction is disallowed in that taxing jurisdiction. Accordingly, no tax benefit will be realized by the Company.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
During the year ended December 31, 2014, the Company issued a further 775,000 SARs to senior management. The SARs vest on the sooner of January 1, 2018 or sooner if there is a liquidity event, but can only be exercised on a liquidity event, defined as a change of control, an Initial Public Offering with a value greater than $75.0 million or a Dividend Recapitalisation of more than $15 per share. The exercise price for each SAR is $15. The fair value of the SARs has been determined as immaterial at December 31, 2014.
Defined Benefit Plan
The Company operated the LSR Pension and Life Assurance Scheme (the "LSR Plan") through to December 31, 2002. The LSR Plan has been closed to new entrants since April 5, 1997. As of December 31, 2002, the accumulation of plan benefits of employees in the LSR Plan was permanently suspended, and therefore, the LSR Plan was curtailed.
As part of the acquisition of Harlan, the Company has an additional benefit plan in the UK, the Harlan Laboratories UK Scheme (the "Harlan UK Plan") which operated through to April 2012. As of April 30, 2012, the accumulation of plan benefits of employees in the Harlan UK Plan was permanently suspended and therefore the Harlan UK Plan was curtailed. Additionally as part of the Harlan acquisition the Company also operates a defined benefit plan in Switzerland (the "Switzerland Plan").
The accumulated benefit obligation is the same as the projected benefit obligation as the Plans have been curtailed.
The following tables summarize the changes in the benefit obligation funded status of the Company’s defined benefit plans and amounts reflected in the Company’s consolidated balance sheet as of December 31, 2014 and 2013. All assets and liabilities have been converted from British Pounds and Swiss Francs to US Dollars using year-end exchange rates.
2014 LSR Plan Harlan UK Plan Switzerland Plan Total Change in projected benefit obligation: Projected benefit obligation, beginning of period $ 209,700 $ - $ - $ 209,700 Projected benefit obligation, on acquisition - 19,986 84,595 104,581 Service cost - - 1,511 1,511 Interest cost 8,706 573 1,095 10,374 Contributions by plan participants - - 753 753 Benefits paid (6,968) (317) (8,677) (15,962) Foreign currency translation adjustment (13,054) (1,727) (8,986) (23,767) Actuarial loss 13,143 1,964 1,049 16,156
Accumulated benefit obligation at end of year $ 211,527 $ 20,479 $ 71,340 $ 303,346
Change in fair value of plan assets: Fair value of plan assets, beginning of period $ 170,187 $ - $ - $ 170,187 Fair value of plan assets, on acquisition 16,711 74,264 90,975 Actual return on plan assets 12,376 998 188 13,562 Employer contributions 5,234 727 1,333 7,294 Employee contributions - - 753 753 Foreign currency translation adjustment (10,592) (1,419) (7,719) (19,733) Benefits paid-recurring (6,968) (317) (8,677) (15,962) Fair value of plan assets, end of year 170,237 16,700 60,142 247,079
Funded status $ (41,290) $ (3,779) $ (11,198) $ (56,267)
Of the total pension liability $10,698 has been included in discontinued operations (see Note 18). 2013 LSR Plan Harlan UK Plan Switzerland Plan Total Change in projected benefit obligation:
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
2013 LSR Plan Harlan UK Plan Switzerland Plan Total Projected benefit obligation, beginning of year $ 199,364 $ - $ - $ 199,364 Service cost - - - - Interest cost 8,701 - - 8,701 Benefits paid (7,180) - - (7,180) Currency translation adjustment 3,777 - - 3,777 Actuarial loss 5,038 - - 5,038
Projected benefit obligation, end of year 209,700 $ - $ - $ 209,700
Change in fair value of plan assets: Fair value of plan assets, beginning of year $ 154,487 $ - $ - $ 154,487 Actual return on plan assets 15,561 - - 15,561 Employer contributions 4,393 - - 4,393 Currency translation adjustment 2,926 - - 2,926 Benefits paid (7,180) - - (7,180) Fair value of plan assets, end of year 170,187 - - 170,187
Funded status $ 39,513 $ - $ - $ 39,513
The net periodic benefit costs under the Company’s defined benefit plans for the years ended December 31, 2014, 2013 and 2012 were as follows:
LSR Plan 2014 2013 2012 Components of net periodic benefit expense: Interest cost $ 8,760 $ 8,218 $ 8,604 Expected return on assets (9,162) (8,014) (8,013) Amortization of prior loss 2,915 3,309 3,073 Net periodic benefit cost $ 2,513 $ 3,513 $ 3,664
Harlan UK Plan 2014 2013 2012 Components of net periodic benefit expense: Service cost $ - $ - $ - Interest cost 573 -- Expected return on assets (673) -- Amortization of prior loss 15 -- Net periodic benefit cost $ (85) $ - $ -
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Switzerland Harlan 2014 2013 2012 Components of net periodic benefit expense: Service cost $ 1,511 $ - $ - Interest cost 1,095 -- Expected return on assets (1,593) -- Amortization of prior service (credit) (572) -- Net periodic benefit cost $ 441 $ - $ -
The major assumptions used in determining the net periodic benefit costs for the years ended December 31:
LSR Plan Harlan UK Plan Switzerland Plan
2014 2013 2012 2014 2013 2012 2014 2013 2012 Discount rate 4.50% 4.35% 4.95% 3.60% - - 1.40% - - Expected return on plan assets 5.74% 5.42% 5.80% 6.10% - - 2.80% - - Rate of compensation increases ------0.50% - -
The expected returns on plan assets were based on market yields at the measurement date. Expected returns on the equity and other assets allowed for expected economic growth
The weighted-average assumptions used in determining benefit obligations were as follows:
LSR Plan Harlan UK Plan Switzerland Plan
2014 2013 2014 2013 2014 2013 Weighted-average assumptions as of December 31: Discount rate 3.60% 4.50% 3.60% - 1.40% - Rate of compensation increases - - - - 0.00% -
Discount rates were determined for each defined benefit retirement plan at their measurement date to reflect the yield of a portfolio of high quality bonds matched against the timing and amounts of projected future benefit payments.
The Company’s expected long-term return on plan assets assumption is based on a periodic review and modelling of the plans’ asset allocation over a long-term horizon. Expectations of returns for each asset class are the most important of the assumptions used in the review and modelling, based on reviews of historical data and economic/financial market theory. The expected long- term rate of return on assets was selected from within the range of rates determined by (1) historical actual returns, net of inflation, for the asset classes covered by the investment policy, and (2) projections of inflation over the long-term period during which benefits are payable to plan participants.
Switzerland
LSR Plan Harlan UK Plan Plan
2014 2013 2014 2013 2014 2013 Plan assets as of December 31: Equity securities 33% 37% 56% - 28% - Debt securities 57% 53% 40% - 33% - Real estate 10% 9% 0% - 34% - Other - 1% 4% - 5% - Total 100% 100% 100% 100% 100% 100%
The Company maintains target allocation percentages among various asset categories based on an investment policy designed to achieve long-term objectives of return, while mitigating downside risk and considering expected cash flows. The Company’s investment policy is reviewed from time to time to ensure consistency with long-term objectives. The Company’s target allocation percentages were materially consistent with the actual percentages above at December 31, 2014 and 2013.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The fair value of total plan assets as of December 31, 2014 and 2013 by asset category is as follows:
Fair Value measurements at Reporting Date Using: Quoted Prices in Significant Fair value as Active Market Significant Other Unobservable of December for Identical Observable Inputs Inputs Notes 31, 2014 Assets (Level1) (Level 2) (Level 3) Cash $ 797 $ 797 $ - $ - Equity securities: Common stock 1 83,324 83,324 - - Fixed income securities: Investment grade corporate bonds 2 123,274 - 123,274 - Other types of investments: Real estate 3 36,113 - 36,113 - Other 3 3,571 638 2,933 Total $ 247,079 $ 84,759 $ 162,320 $ -
Fair Value measurements at Reporting Date Using: Quoted Prices in Significant Fair value as Active Market Significant Other Unobservable of December for Identical Observable Inputs Inputs Notes 31, 2013 Assets (Level1) (Level 2) (Level 3) Cash $ 891 $ 891 $ - $ - Equity securities: Common stock 1 63,188 63,188 - - Fixed income securities: Investment grade corporate bonds 2 91,332 - 91,332 - Other types of investments: Real estate 3 14,468 - 14,468 - Other 3 308 - - 308 Total $ 170,187 $ 64,079 $ 105,800 $ 308
The following table provides changes in Level 3 assets measured at fair value on a recurring basis for the year ended December 31, 2014 and 2013:
Fair value Measurements Using Unobservable Inputs (Level 3) 2014 2013 Description Beginning balance at December 31, 2013 $ 308 $ 424 Effects of foreign exchange (19) 8 Actual return on plan assets sold during period: - 28 Purchases, sales and settlements (289) (152) Ending balance at December 31, 2014 $ - $ 308
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The following pension benefit payments are expected to be paid in cash in each of the next five years and in aggregate for the following five years thereafter
LSR Plan Harlan UK Plan Switzerland Plan USD in Thousands 2015 $ 5,902 $ 371 $ 2,009 2016 6,951 387 1,980 2017 7,727 430 2,036 2018 8,504 469 2,204 2019 9,280 553 2,516 2020-2024 42,208 4,500 12,971
Defined Contribution Plan On April 6, 1997, the Company established a defined contribution plan, the Group Personal Pension Plan, for Company employees in the UK. Additionally, a defined contribution plan is also available for employees in the US. The retirement benefit expense for 2014, 2013 and 2012 were $2,090, $635 and $731, respectively.
NOTE 18 – DISCONTINUED OPERATIONS
In October 2014, the Company announced a decision to close its CRS operations in Switzerland. Prior to the announcement, the Company evaluated alternatives for the CRS operations in Switzerland including the sale of the business as a whole or in parts. As this was not considered viable, there will be a gradual reduction in services as customer studies are completed over an 18 month period. Certain of the activities being performed in regulatory and archiving will continue to operate and their results and operations have been included in continuing operations.
The CRS operations in Switzerland are classified as discontinued operations in the consolidated statements of operations and presented as assets and liabilities of discontinued operations in the consolidated balance sheets. As the CRS Switzerland operations were acquired during the year ended December 31, 2014 there is no impact on prior years consolidated financial statements.
The discontinued operations of CRS operations in Switzerland are summarized below:
Year ended December 31, 2014
Net revenues $ 27,351 Cost of sales (26,555) Gross profit 796 Selling, general and administrative expenses (4,076) Other operating expense (419) Operating loss (3,699) Income tax expense 37 Loss from discontinued operations, net of income tax $ (3,736)
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
The current and noncurrent assets and liabilities of CRS operations in Switzerland are summarized here:
December 31, 2014
Accounts receivable, net $ 4,147 Unbilled receivables 8,625 Deferred income taxes 1,749 Prepaid expenses and other 4,579 Current assets of discontinued operations $ 19,100
Property, plant and equipment $ 17,812 Other assets 34 Non-current assets of discontinued operations $ 17,846
Accounts payable and accrued expenses $ 6,876 Short term debt 8 Accrued expenses and other liabilities 2,195 Fees invoiced in advance 10,842 Deferred income taxes 301 Current liabilities of discontinued operations $ 20,222
Long term debt $ 16 Deferred income taxes 1,448 Pension liabilities 10,698 Non-current liabilities of discontinued operations $ 12,126
Consolidated Statement of Cash Flows The impact of discontinued CRS operations in Switzerland on the Consolidated Statements of Cash Flows for "Depreciation and amortization" contained in "Cash used in operating activities" was $3,024. The impact on cash flows related to "Property, plant and equipment contained in "cash used in investing activities" was $673 for "Purchase of property, plant and equipment" and $7,752 for "Proceeds from sale of property, plant and equipment".
NOTE 19 - OPERATING SEGMENTS:
Operating segments are components of an enterprise for which separate financial information is available that is evaluated regularly by chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company identifies operating segments based on management responsibility and believes it meets the criteria for aggregating its operating segments into two reporting segments.
Effective with the acquisition of Harlan and beginning with the quarterly report dated June 30, 2014, the Company now has two reportable operating segments consisting of Contract Research Services ("CRS") and Research Models and Services ("RMS"). CRS includes sales of pre-clinical research services to aid in the discovery and development of new drugs, devices and therapies or product-safety testing services. The RMS segment consists of sales and research models, research model services, diets and bedding, and other related services. Prior to the acquisition of Harlan (see Note 4), the Company operated solely in the CRS market. Unallocated corporate costs consisting of executive compensation, executive benefit programs, corporate finance, legal and human resource personnel and certain IT expenditure and certain other reconciling items, such as intercompany sales, are included in the Corporate/Reconciling segment.
The accounting policies of the operating segments are as described in Note 2. Transactions between segments, which are immaterial, are carried out on an arms-length basis. Interest income, interest expense and income taxes are also not reported on an operating segment basis because they are not considered in the performance evaluation by the Company's chief operating decision-makers.
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BPAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012 DOLLARS IN (000's)
Operating segment information is as follows:
Corporate/ Year ended December 31, 2014 CRS RMS Reconciling Total Net revenues $ 231,505 $ 123,589 $ (4,095) $ 350,999 Operating income (expense) before other operating 33,610 5,355 (24,458) 14,507 expense Other operating expense (419) - (34,631) (35,050) Operating income (expense) $ 33,191 $ 5,355 $ (59,089) $ (20,543)
Corporate/ Year ended December 31, 2013 CRS RMS Reconciling Total Net revenues $ 170,268 $ - $ - $ 170,268 Operating income (expense) before other operating 20,637 - (11,549) 9,088 expense Other operating expense - - (4,816) (4,816) Operating income (expense) $ 20,637 $ - $ (16,365) $ 4,272
Corporate/ Year ended December 31, 2012 CRS RMS Reconciling Total Net revenues $ 187,114 $ - $ - $ 187,114 Operating income (expense) before other operating 17,299 - (11,295) 6,004 expense Other operating expense - - (18,919) (18,919) Operating income (expense) $ 17,299 $ - $ (30,214) $ (12,915)
The analysis of the Company’s net revenues from continuing operations and total assets, by location, for the years ended December 31, 2014, 2013 and 2012 is as follows:
2014 2013 2012 $000 $000 $000 Net Revenues UK $ 193,310 $ 131,014 $ 141,072 US 108,132 39,254 46,042 Rest of the world 49,557 - - $ 350,999 $ 170,268 $ 187,114
Total assets UK $ 555,824 $ 258,781 $ 268,246 US 69,474 55,969 79,104 Rest of the world 38,353 - - $ 663,651 $ 314,750 $ 347,350
NOTE 20 – SUBSEQUENT EVENTS:
Subsequent events are defined as those events or transactions that occur after the balance sheet date, but before the financial statements are issued or available to be issued. The Company completed an evaluation of the impact of any subsequent events through March 24, 2015, the date at which the financial statements were available to be issued.
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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS This section describes certain relationships and material transactions that involve the Company, any of the Guarantors or any of their respective subsidiaries and any related party of the Company.
Sale-Leaseback Transactions with Baker Affiliates and Interest of Mr. Baker and his Co-Investors in the Company and the Transactions
In June 2005, the Company entered into and consummated the Sale-Leaseback Transactions with a related party, Alconbury Estates Inc. and its subsidiaries (collectively "Alconbury"). The Company sold to Alconbury its three facilities in Cambridge and Suffolk, England and Princeton, New Jersey for aggregate consideration of $40.0 million and immediately leased back the properties under 30 year leases with aggregate annual rental payments of approximately $5.3 million. Alconbury was controlled by the Company’s Chairman, Andrew Baker. The Company agreed to pay approximately $4.9 million of expenses incurred by the related party, subject to the related party’s obligation to reimburse those expenses in the future in five annual installments beginning in June 2008. Interest was imputed at 15% and a discount (expense) of approximately $2.5 million was recorded by the Company in June 2005. This discount was being ratably recorded as interest income over the term of the loan. Alconbury paid the Company approximately $1.0 million of those expenses in June 2008 in the first annual installment. No additional payments were received by the Company and during the year ended December 31, 2010, the remaining payments and interest due were forgiven by the Company. Effective March 15, 2012, a portion of the proceeds from the notes offering was used to reacquire these properties from Alconbury and terminate the Sale-Leaseback Transactions for an aggregate consideration in the year ended December 31, 2012 of $63.3 million.
As a result of limited liability company and shareholder agreements, Mr. Baker has the right to appoint all of the directors of Lion Holdings, the immediate parent company of Holdings, although the indirect economic interest that he and his affiliates have in the Company is approximately 16%. Certain of Mr. Baker’s indirect co-investors, Jermyn and Savanna, possess consent rights over specified extraordinary matters, such as material sales of assets, acquisitions, a change in control transaction, recapitalizations, certain affiliate transactions and other similarly significant matters. In the event of Mr. Baker’s death or disability, Jermyn and Savanna would have indirect rights to appoint directors of Lion Holdings. Jermyn and Savanna are private investment funds. The Second Lien Debt is held by affiliates of Jermyn and Savanna. See Note 10 ("Long Term Debt") to the audited consolidated financial statements of Holdings appearing elsewhere in this Annual Report.
In addition, in connection with the Transactions, the Company agreed to pay to Jermyn, Savanna and an affiliate of Mr. Baker an aggregate fee equal to 1.5% of the gross proceeds from the issuance of the notes in consideration of their assistance to us in arranging for this financing.
Related Party Loans
On March 15, 2012, the Company issued $22.4 million of Second Lien Debt in a dollar-for dollar exchange with an existing loan (the ‘Second Financing Agreement’) with related entities (including individuals and/or entities who are stockholders of the Parent), for the outstanding principal amount of $21.6 million plus capitalized interest of $0.8 million. On April 29, 2014, in connection with the acquisition of Harlan, the Second Lien Debt was converted to Third Lien Debt with no modifications to the terms of the agreement other than to extend the maturity to be no earlier than the maturity date of the First and Second Lien Loans by changing the maturity date to July 30, 2020 and to subordinate the Third Lien Debt to the debt issued under the Credit Agreements.
The Third Lien Debt matures on July 30, 2020, and is payable in full on this date. This debt bears interest at a rate of 15% per annum, payable semi-annually in arrears. All or a portion of the interest payable on each interest payment date may be capitalized and added to the principal amount of Third Lien Debt depending on the level of consolidated earnings before interest, tax, depreciation, amortization and other expense adjustments in the immediately preceding twelve months. A total of $10.0 million and $5.6 million of interest arising on the Third Lien Debt was capitalized as of December 31, 2014 and 2013, respectively.
Management Agreement
The Company is party to a management agreement (the "Management Agreement") with certain of our indirect shareholders pursuant to which Andrew Baker, Jermyn and Savanna (the "Providers") provide: (a) general monitoring and management services; (b) identify, support, negotiate and analyze acquisitions and dispositions by the Company or its subsidiaries; (c) support, negotiate and analyze financing alternatives including in connection with acquisitions, capital expenditures, refinancing of existing indebtedness and equity issuances; (d) monitor finance functions, including assisting with the preparation of financial projections and compliance with financing agreements; (e) identify and develop growth strategies; and (f) other monitoring services that the Providers and the Company agree upon. In consideration for the above mentioned services, the Providers are
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entitled to compensation in the aggregate amount of $1,250,000 per annum, plus expenses. In addition the Providers are entitled to fees and expenses relating to various financing, which amounted to $5,256,000 in 2014, $0 in 2013 and $2,250,000 in 2012 respectively.
The Management Agreement remains in full force and effect so long as the Providers and their respective affiliates collectively own at least 20% of the voting membership or other equity interests in the Company; provided that (i) the Management Agreement terminates upon the sale of all or substantially all of the Company’s assets, and (ii) the Providers may terminate the agreement upon 30 days’ notice to the Company. Under the Management Agreement, we indemnify the Providers against all claims, liabilities, losses, damages and expenses as a result of any action, suit, proceeding or demand against the Providers by a third party, other than those resulting from the gross negligence or willful misconduct of the Providers.
Employment Agreements Andrew Baker The services of Mr. Baker are provided for not less than 100 days per year through a management services contract between a subsidiary, the Company and Focused Healthcare Partners, L.L.C. ("FHP"), an investment firm controlled by Mr. Baker. Under the contract, FHP agrees to provide the services of Mr. Baker as Chairman of the Company. The management services contract will continue until terminated on 12 months’ written notice from either party. In the event of termination without "cause" following a "change in control", as defined in the management services contract, FHP would receive a payment equal to 2.99 times this annualized fee plus an amount equal to 2.99 times all incentive compensation earned or received by FHP or Mr. Baker during the 12 months prior to termination. Under the management services contract FHP received total payments in 2014 of £712,726. This included health and medical and life insurance benefits from the Company and pension benefits, and also included a non-pensionable car allowance of £1,000 per month and £2,000 per month as a relocation allowance.
The management services contract may be terminated if either FHP or Mr. Baker is guilty of serious misconduct or is in material breach of the terms of the contract, among other reasons.
Both FHP and Mr. Baker are bound by confidentiality restrictions and a restriction preventing Mr. Baker from holding any interests conflicting with those of the Company without the Company’s consent. Mr. Baker has undertaken to the Company that, during the continuance of the management services contract, he will not without the prior consent of the Company, be concerned or interested in any business, which competes or conflicts with the business of the Company.
Brian Cass
The services of Mr. Cass are provided through a service agreement between the Company and Mr. Cass, which appoints Mr. Cass as Chief Executive Officer of the Company. Mr. Cass’ service agreement can be terminated on two years’ written notice from either party. In the event of termination without "cause" following a "change in control", as defined in the service agreement, Mr. Cass would receive a payment equal to 2.99 times his annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr. Cass during the 12 months prior to termination. Mr. Cass’ total remuneration, including bonus, in 2014 was £998,555. This included health insurance, life insurance, personal accident insurance, medical expenses insurance and pension benefits, and also included a non-pensionable car allowance of £1,000 per month and £2,000 per month as a relocation allowance. Mr. Cass’ service agreement also provides for payment to Mr. Cass of a bonus, in the absolute discretion of the Company’s Board.
Mr. Cass’ service agreement may be terminated if Mr. Cass is guilty of serious misconduct or is in material breach of the terms of the service agreement or is in breach of the model code for securities transactions by directors of listed companies, among other reasons.
Mr. Cass is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business that conflicts with the business of the Company or any subsidiary unless either the Company’s Board otherwise consents or the interest is limited to a holding or other interest of no more than five percent of the total amount of shares or securities of any company quoted on a recognized investment exchange.
Adrian Hardy
The services of Mr. Hardy are provided through a service agreement between the Company and Mr. Hardy, which appoints Mr. Hardy as Chief Operating Officer of the Company. Mr. Hardy’s service agreement can be terminated on twelve months written notice from the Company or six months written notice from Mr. Hardy. In the event of termination without "cause" following a "change in control", as defined in the service agreement, Mr. Hardy would receive a payment equal to 2.99 times his annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr. Hardy during the 12 months prior to termination.
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Mr. Hardy’s total remuneration, including bonus, in 2014 was $835,433. This included health insurance, life insurance, personal accident insurance and medical expenses insurance and pension benefits, participation in the 401K plan of Huntingdon Life Sciences Inc., and also a relocation allowance of $19,847. Mr. Hardy’s service agreement also provides for payment to Mr. Hardy of a bonus, in the absolute discretion of the Company’s Board.
Mr. Hardy’s service agreement may be terminated if Mr. Hardy is guilty of serious misconduct or is in material breach of the terms of the service agreement, among other reasons.
Mr. Hardy is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business that conflicts with the business of the Company or any subsidiary unless either the Company’s Board otherwise consents or the interest is limited to a holding or other interest of no more than five percent of the total amount of shares or securities of any company quoted on a recognized investment exchange.
Richard Michaelson
The services of Mr. Michaelson are provided through a service agreement between him and the Company, which appoints Mr. Michaelson as Chief Financial Officer. Mr. Michaelson’s service agreement will continue until terminated by Mr. Michaelson on thirty days’ written notice or by the Company on 12 months’ written notice. In the event of termination without "cause" following a "change in control", as defined in the service agreement, Mr. Michaelson would receive a payment equal to 2.99 times his annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr. Michaelson during the 12 months prior to termination.
Mr. Michaelson’s total remuneration, including bonus, during 2014 was $959,015. This included health insurance, life insurance, personal accident insurance, long-term care insurance, medical expenses insurance, participation in the 401(k) Plan of Huntingdon Life Sciences Inc., and also included a car allowance of $1,000 gross per month.
Mr. Michaelson’s service agreement also provides for the payment of a bonus to Mr. Michaelson in the absolute discretion of the Company’s Board.
The agreement may be terminated if Mr. Michaelson is guilty of serious misconduct or is in material breach of the terms of the service agreement, among other reasons.
Mr. Michaelson is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business conflicting with the business of the Company or any subsidiary unless the Board otherwise consents or the interest is limited to a holding or other interest of no more than five percent of the total amount of shares or securities or any company quoted on a recognized investment exchange.
Mark Bibi
The services of Mr. Bibi are provided through a service agreement between him and the Company, which appoints Mr. Bibi as General Counsel and Secretary. Mr. Bibi’s service agreement will continue until terminated by Mr. Bibi on thirty days’ written notice or by the Company on 12 months’ written notice. In the event of termination without "cause" following a "change in control", as defined in the service agreement, Mr. Bibi would receive a payment equal to 2.99 times his annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr. Bibi during the 12 months prior to termination.
Mr. Bibi’s total remuneration, including bonus, during 2014 was $796,785. This included health insurance, life insurance, personal accident insurance, long-term care insurance, medical expenses insurance, participation in the 401(k) Plan of Huntingdon Life Sciences Inc., and also included a car allowance of $1,000 gross per month.
Mr. Bibi’s service agreement also provides for the payment of a bonus to Mr. Bibi in the absolute discretion of the Company’s Board.
The agreement may be terminated if Mr. Bibi is guilty of serious misconduct or is in material breach of the terms of the service agreement, among other reasons.
Mr. Bibi is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business conflicting with the business of the Company or any subsidiary unless the Board otherwise consents or the interest is limited to a holding or other interest of no more than five percent of the total amount of shares or securities or any company quoted on a recognized investment exchange.
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Other Executive Officers and Key Employees
We have entered into employment agreements with other executive officers and key employees on substantially similar terms. Each employment agreement provides for an annual base salary and entitles each employee to certain insurance benefits. Certain of the agreements provide for performance based bonuses and car allowances. The employment agreements also include customary restrictions with respect to the use of our confidential information and in some cases include non-compete agreements and agreements that all intellectual property developed or conceived by such employee while employed by the Company remains the property of the Company. Certain of the employment agreements include provisions for payments to be made on termination following a change of control of the Company.
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