Business context and reporting period
Filing: Form 10-Q for the quarter ended September 30, 2016, filed by Quintiles IMS Holdings, Inc. (formerly Quintiles Transnational Holdings Inc.). The results cover legacy Quintiles only: the merger with IMS Health closed on October 3, 2016, after quarter-end, so IMS Health’s results are excluded from the reported financial statements. The company expected to report in three segments after the merger.
Financial results and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Service revenue | $1,136.4m | $1,093.5m | $3,411.5m | $3,197.8m |
| Total revenue, including reimbursed expenses | $1,497.2m | $1,424.8m | $4,539.9m | $4,215.9m |
| Income from operations | $167.8m | $167.0m | $497.3m | $468.6m |
| Net income attributable to Quintiles IMS | $99.2m | $111.3m | $292.6m | $282.6m |
| Diluted EPS | $0.82 | $0.89 | $2.41 | $2.24 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $412.9m | $269.4m |
Reimbursed expenses are pass-through items, with corresponding costs, and generally carry little or no profit. Service revenue increased 3.9% in Q3 and 6.7% for the first nine months; management reported constant-currency growth of 3.6% and 6.6%, respectively. Q3 operating income was nearly flat, while attributable net income fell about 11%. Nine-month attributable net income rose about 3.5%.
- Margins: Service costs were 61.9% of service revenue in Q3 versus 62.5% a year earlier, and 62.9% for nine months versus 63.4%. Calculated operating income as a percentage of service revenue was approximately 14.8% in Q3 and 14.6% for nine months. Product Development segment operating margin rose to 23.7% in Q3 from 22.4%; Integrated Healthcare Services margin was 8.7% versus 8.5%.
- Cash and liquidity: Cash and cash equivalents were $1,209.7m at September 30, 2016, including $328.9m in the United States, versus $977.2m at year-end 2015. Nine-month investing cash use was $81.9m and financing cash use was $78.1m. Management said available cash, operating cash flows, and credit facilities were expected to cover operating needs, capital spending, and debt service for at least 12 months.
- Debt: September 30 balance-sheet debt and capital lease obligations totaled approximately $2.44bn carrying value; management reported $2.5bn of indebtedness and $532m of available revolver capacity, with no revolving borrowings during the first nine months. The company reported covenant compliance. Post-merger financing and refinancing increased stated principal debt to approximately $7.50bn as of October 3; the $500m 6% notes were redeemed November 1, 2016.
- Balance sheet: Total assets were $4.13bn and total liabilities $4.21bn at September 30; stockholders’ deficit was $81.9m. The company repurchased $97.6m of common stock in the first nine months.
Material changes and operating developments
- Product Development service revenue grew 7.9% in Q3 and 10.9% for nine months, benefiting from clinical services volume and, year to date, the Q2 Solutions contribution. Integrated Healthcare Services revenue declined 7.5% in Q3 and 5.0% for nine months, reflecting lower commercial-services and payer-provider activity; real-world and late-phase research partially offset declines.
- Q3 included $27.9m of impairment charges: $23.1m against Encore goodwill and $4.8m against identifiable intangible assets, following weaker-than-expected performance and declining service revenue. No impairment was recorded in the comparable 2015 periods.
- Nine-month restructuring costs were $27.8m, compared with $23.5m in 2015; Q3 included a $0.5m net reversal. Management estimated annualized savings of approximately $90m–$100m from restructuring plans, with actions continuing through 2016 and 2017.
- Merger-related costs were $12.7m for the first nine months, including $3.7m in Q3. Foreign currency translation and derivative activity also affected comprehensive income.
Outlook, commentary, risks and contingencies
- Backlog and bookings: Product Development backlog was $9.4bn at September 30, with $2.7bn expected to convert to revenue in the next 12 months. Rolling 12-month contracted net new business was $4.4bn versus $4.0bn a year earlier. Management said Q3 contracted net new business was softer than usual, partly due to a significant project cancellation after a client reprioritized its pipeline. Backlog is subject to cancellation, delay, scope changes, and conversion uncertainty.
- Merger: The merger was accounted for as a business combination, with purchase accounting still preliminary. Estimated consideration was approximately $10.4bn, and valuations of acquired assets and assumed liabilities were incomplete. Management described potential synergies and an expanded end-to-end offering, but warned that integration, realization of savings and revenue benefits, client retention, and timing were uncertain. Illustrative pro forma results exclude anticipated synergies and integration costs and are not forecasts.
- Financing and taxes: The merger was followed by new unsecured notes and refinanced term and revolving facilities. The company was evaluating combined domestic and foreign cash needs; repatriating indefinitely reinvested foreign earnings could trigger up to an estimated $175m of additional tax. The Board increased repurchase authorization by $1.5bn on November 1, bringing available authorization to approximately $1.547bn.
- Key risks: Management highlighted client contract cancellations and delays, execution and pricing risk, competition, foreign-exchange exposure, substantial indebtedness and restrictive covenants, data privacy and cybersecurity, regulatory and clinical-trial liability, and the challenges of integrating the merger. Approximately 33% of legacy Quintiles’ first-nine-month service revenue was denominated in currencies other than the U.S. dollar.
- Legal and unusual matters: The company said incidental legal proceedings were not expected to have a material adverse effect. Separately, its risk disclosures describe a South Korean civil lawsuit and 2015 indictments involving its IMS Health Korea subsidiary and alleged handling of sensitive health information; the filing does not establish the outcomes. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Post-merger financial statements, purchase-price allocation, goodwill, integration charges, and evidence of realized synergies against management’s expectations.
- Combined-company debt, interest costs, covenant headroom, refinancing terms, and the effect of buybacks and any foreign-cash repatriation taxes on liquidity.
- Whether contracted backlog converts as expected, and whether the Q3 booking softness or client cancellation signals a sustained change.
- Recovery or further deterioration in Integrated Healthcare Services, alongside the causes and performance trends underlying the Encore impairment.
- Developments and financial exposure in the South Korean privacy matter, as well as broader data-protection, cybersecurity, and regulatory risks.