LIFE SCIENCES RESEARCH, INC. AND SUBSIDIARIES
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
- --------------------------------------------------------------------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2006
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-33505
------------------------
LIFE SCIENCES RESEARCH, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND
(JURISDICTION OF INCORPORATION OR ORGANIZATION)
52-2340150
IRS Employer Identification No.
PO BOX 2360, METTLERS ROAD, EAST MILLSTONE, NJ 08875-2360
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 732 649-9961
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or Section 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No __
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer __ Accelerated filer X Non-accelerated filer __
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes _ No X
Indicate the number of outstanding shares of each of the Issuer's classes of
common stock as of the latest practicable date.
12,675,120 shares of Voting Common Stock of $0.01 par value as of
November 3, 2006
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION Page
Item 1 Financial Statements (Unaudited).
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 2006 and 2005. 3
Condensed Consolidated Balance Sheets at September 30, 2006 and
December 31, 2005. 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2006 and 2005. 5
Notes to Condensed Consolidated Financial Statements. 6 - 13
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations. 14 - 22
Item 3 Quantitative and Qualitative Disclosures about Market Risk. 23
Item 4 Controls and Procedures. 23
PART II OTHER INFORMATION
Item 1 Legal Proceedings 24
Item 6 Exhibits 24
Signature 24
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
Three months ended Nine months ended
September 30 September 30
(Dollars in thousands, except per share data) 2006 2005 2006 2005
Revenues $49,460 $43,758 $139,766 $131,993
Cost of sales (36,388) (31,673) (103,271) (95,214)
------------- ------------ ----------- -----------
Gross profit 13,072 12,085 36,495 36,779
Selling, general and administrative expenses (7,334) (6,410) (21,886) (20,496)
------------- ------------ ----------- -----------
Operating income 5,738 5,675 14,609 16,283
Interest income 437 21 968 66
Interest expense (3,162) (2,138) (10,057) (5,855)
Other (expense)/income (913) (1,760) 350 (5,195)
------------- ------------ ----------- -----------
Income before income taxes 2,100 1,798 5,870 5,299
Income tax benefit/(expense) 579 (649) (1,584) (3,288)
------------- ------------ ----------- -----------
Income before cumulative effect of accounting
change $2,679 $1,149 $4,286 2,011
Cumulative effect of accounting change (net of
income tax benefit of $22,218) - - (20,656) -
------------- ------------ ----------- -----------
Net income/(loss) $2,679 $1,149 $(16,370) $2,011
------------- ------------ ----------- -----------
Basic income/(loss) per share
Income before cumulative effect of accounting
change $0.21 $0.09 $0.34 $0.16
Cumulative effect of accounting change - - (1.64) -
------------- ------------ ----------- -----------
Basic income/(loss) per share $0.21 $0.09 $(1.30) $0.16
------------- ------------ ----------- -----------
Diluted income/(loss) per share:
Income before cumulative effect of accounting
change $0.18 $0.08 $0.29 $0.14
Cumulative effect of accounting change - - (1.42) -
------------- ------------ ----------- -----------
------------- ------------ ----------- -----------
Diluted income/(loss) per share $0.18 $0.08 $(1.13) $0.14
------------- ------------ ----------- -----------
Weighted average number of common stock
- - Basic (000's) 12,669 12,542 12,627 12,506
- - Diluted (000's) 14,534 14,601 14,506 14,521
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) September 30, December 31,
2006 2005
ASSETS Unaudited Audited
Current assets:
Cash and cash equivalents $38,315 $15,420
Accounts receivable, net of allowance of $768 and $618 in
2006 and 2005 respectively 30,519 26,810
Unbilled receivables 16,360 11,981
Inventories 2,354 1,992
Prepaid expenses and other current assets 12,263 7,062
---------------- ----------------
Total current assets 99,811 63,265
Property and equipment, net 59,169 105,605
Goodwill 1,445 1,195
Other assets 9,195 901
Unamortized capital bonds issue costs - 70
Deferred income taxes 35,259 13,333
---------------- ----------------
Total assets $204,879 $184,369
---------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities:
Accounts payable $15,018 $15,742
Accrued payroll and other benefits 3,647 3,655
Accrued expenses and other liabilities 14,200 15,862
Pension liabilities 5,044 4,635
Short-term debt 706 46,946
Fees invoiced in advance 38,214 32,920
---------------- ----------------
Total current liabilities 76,829 119,760
Long-term debt 91,131 30,430
Deferred gain on disposal of US property 9,187 -
Pension liabilities, less short-term portion 53,038 48,747
---------------- ----------------
Total liabilities $230,185 $198,937
---------------- ----------------
Commitments and contingencies
Stockholders' equity/(deficit)
Preferred Stock, $0.01 par value. Authorized 5,000,000
Issued and outstanding: None - -
Non-Voting Common Stock, $0.01 par value. Authorized 5,000,000
Issued and outstanding: None - -
Voting Common Stock, $0.01 par value. Authorized 50,000,000
Issued and outstanding at September 30, 2006: 12,670,020
(December 31, 2005: 12,553,251) 127 126
Paid in capital 82,249 75,848
Less: Promissory notes for the issuance of common stock (44) (205)
Accumulated other comprehensive loss (50,320) (49,389)
Accumulated deficit (57,318) (40,948)
---------------- ----------------
Total stockholders' equity /(deficit) (25,306) (14,568)
---------------- ----------------
Total liabilities and stockholders' equity /(deficit) $204,879 $184,369
---------------- ----------------
<FN>
See Notes to Condensed Consolidated Financial Statements
</FN>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
Nine months ended September 30
(Dollars in thousands) 2006 2005
Cash flows from operating activities:
Net (loss)/income $(16,370) $2,011
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 7,221 7,229
Amortisation of gain on disposal of US property (81) -
Non-cash compensation expense associated with employee stock
compensation plans 407 -
Cumulative effect of accounting change 42,874 -
Foreign exchange (gain)/loss on Capital Bonds and New Financing (4,005) 3,765
Foreign exchange gain on intercompany balances (203) -
Deferred income tax (benefit)/expense (20,635) 3,288
Provision for losses on accounts receivable 150 79
Amortization of warrants 1,048 260
Amortization of Capital Bonds issue costs 70 137
Amortization of Financing Costs 3,116 1,420
Changes in operating assets and liabilities:
Accounts receivable, unbilled receivables and prepaid expenses 1,183 (13,880)
Inventories (211) 131
Accounts payable, accrued expenses and other liabilities (4,712) 2,063
Fees invoiced in advance 2,380 (2,876)
----------------- ----------------
Net cash provided by operating activities $12,232 $3,627
----------------- ----------------
Cash flows used in investing activities:
Purchase of property and equipment (8,152) (12,084)
Sale of property, plant and equipment 6 -
----------------- ----------------
Net cash used in investing activities $(8,146) $(12,084)
----------------- ----------------
Cash flows provided by/(used in) financing activities:
Proceeds from issuance of Voting Common Stock 5,345 629
Proceeds from long-term borrowings 70,000 30,000
Increase in deferred finance/other assets (8,145) -
Repayments of long-term borrowings (71) (41,106)
Repayments of short-term borrowings (46,553) (684)
----------------- ----------------
Net cash provided by/(used in) financing activities $20,576 $(11,161)
----------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (1,767) (1,562)
----------------- ----------------
Increase/(decrease) in cash and cash equivalents 22,895 (21,180)
Cash and cash equivalents at beginning of period 15,420 33,341
----------------- ----------------
Cash and cash equivalents at end of period $38,315 $12,161
----------------- ----------------
Supplementary Disclosures
Interest paid in the period $8,127 $5,392
Taxes paid in the period
Japan $123 $18
US $333 $298
Supplementary Disclosures of non-cash financing activity:
Issuance of warrants to lender $2,528 -
Issuance of warrants to financial advisor $1,749 -
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
LIFE SCIENCES RESEARCH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006 and 2005
Unaudited
1. THE COMPANY AND ITS OPERATIONS
Business
Life Sciences Research, Inc. ("LSR") and subsidiaries (collectively, the
"Company") is a global contract research organization, offering worldwide
pre-clinical and non-clinical testing for biological safety evaluation research
services to pharmaceutical, biotechnology, agrochemical and industrial chemical
companies. The Company serves the rapidly evolving regulatory and commercial
requirements to perform safety evaluations on new pharmaceutical compounds and
chemical compounds contained within the products that humans use, eat and are
otherwise exposed to. In addition, the Company tests the effect of such
compounds on the environment and also performs work on assessing the safety and
efficacy of veterinary products.
Organization
LSR was incorporated on July 19, 2001 as a Maryland corporation. It was formed
specifically for the purpose of making a recommended all share offer (the
"Offer") for Life Sciences Research Ltd (LSR Ltd) formerly Huntingdon Life
Sciences Group plc ("Huntingdon"). The Offer was made on October 16, 2001 and
was declared unconditional on January 10, 2002, at which time LSR acquired
approximately 89% of the outstanding ordinary shares of Huntingdon in exchange
for approximately 5.3 million shares of LSR Voting Common Stock. The subsequent
offer period expired on February 7, 2002, by which time approximately 92% of the
outstanding ordinary shares had been offered for exchange. LSR completed its
compulsory purchase under UK law of the remaining outstanding ordinary shares of
Huntingdon on March 26, 2002 at which time Huntingdon became a wholly owned
subsidiary of LSR, in exchange for a total of approximately 5.9 million shares
of LSR Voting Common Stock (the "Exchange Offer").
Under accounting principles generally accepted in the United States ("US GAAP"),
the Company whose stockholders retain the majority interest in a combined
business must be treated as the acquirer for accounting purposes. Accordingly,
the Exchange Offer is accounted for as a reverse acquisition for financial
reporting purposes. The reverse acquisition is deemed a capital transaction and
the net assets of Huntingdon (the accounting acquirer) are carried forward to
LSR (the legal acquirer and the reporting entity) at their carrying value before
the combination. Although Huntingdon was deemed to be the acquiring corporation
for financial accounting and reporting purposes, the legal status of LSR as the
surviving corporation does not change. The relevant acquisition process utilizes
the capital structure of LSR and the assets and liabilities of Huntingdon are
recorded at historical cost. The equity of LSR is the historical equity of
Huntingdon, retroactively restated to reflect the number of shares issued in the
Exchange Offer.
On June 14, 2005, the Company entered into and consummated purchase and sale
agreements with Alconbury Estates Inc. and subsidiaries (collectively
"Alconbury") for the sale and leaseback of the Company's three operating
facilities in Huntingdon and Eye, England and East Millstone, New Jersey (the
"Sale/Leaseback Transaction"). Alconbury was newly formed in June 2005 and
controlled by LSR's Chairman and CEO, Andrew Baker. The total consideration paid
by Alconbury for the three properties was $40 million, consisting of $30 million
in cash and a five year, $10 million variable rate subordinated promissory note,
which Alconbury paid in full on June 30, 2006, together with accrued interest of
$0.6 million.
The proceeds from the Sale/Leaseback Transaction (plus additional cash on hand)
were used by the Company to pay in full its (pound)22.6 million non-bank debt
(approximately $41.1 million).
In accordance with the provisions of Financial Accounting Standards Board (FASB)
Interpretation No. 46R (FIN 46R), the Company has reflected the consolidation of
Alconbury from June 14, 2005 through June 29, 2006, the period in which the
Company was considered the "primary beneficiary" of Alconbury's variable
interests. Effective June 30, 2006, the requirement under FIN46R to include
Alconbury in the Consolidated Financial Statements no longer applied and the
Company has therefore reflected the "deconsolidation" of this entity in the
financial statements. This deconsolidation required the Company to record the
gain and loss associated with the sale of the properties, and recognize the
associated changes in depreciation, interest, and rent expenses. The Company has
recorded a non-cash loss of $48.9 million for the sale of the UK properties, and
a gain of $9.6 million for the US property, which is being amortized over the
term of the lease. Please refer to Note 6 for additional detail of the impact of
this deconsolidation.
On March 2, 2006, the Company entered into a $70 million loan (the "New
Financing") under the terms of a Financing Agreement dated March 1, 2006 with a
third party lender. Net proceeds from the loan were approximately $63 million
and a portion of these proceeds were used to redeem the $46.2 million
outstanding principal amount of the Company's 7.5% Convertible Capital Bonds,
which were due to mature in September 2006. The balance of the proceeds was held
for general corporate purposes.
LSR's executive office is based at the Princeton Research Center in New Jersey.
2. SIGNIFICANT ACCOUNTING POLICIES
i) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements reflect
all adjustments of a normal recurring nature, which are, in the opinion of
management, necessary for a fair statement of the results of operations for the
interim periods presented. The condensed consolidated financial statements are
unaudited and are subject to such year-end adjustments as may be considered
appropriate and should be read in conjunction with the historical consolidated
financial statements of LSR for the years ended December 31, 2005, 2004 and 2003
included in LSR's Annual Report on Form 10-K for the fiscal year ended December
31, 2005. The December 31, 2005 condensed consolidated balance sheet data was
derived from audited financial statements but does not include all disclosures
required by accounting principles generally accepted in the United States of
America. Operating results for the three and nine month periods ended September
30, 2006 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2006.
These financial statements have been prepared in accordance with US GAAP and
under the same accounting principles as the financial statements included in the
Annual Report on Form 10-K. Certain information and footnote disclosures related
thereto normally included in the financial statements prepared in accordance
with US GAAP have been omitted in accordance with Rule 10-01 of Regulation S-X.
ii) Stock-Based Compensation
The Company has stock option and stock-based compensation plans, which are
described in detail in the audited consolidated financial statements included in
the Annual Report on Form 10-K for the year ended December 31, 2005. Under the
Long Term Incentive Plan (LTIP), the Company granted 362,663 ten-year stock
options to executives on June 1, 2004. All such options were granted with an
exercise price equal to the market price of the underlying stock on the date of
the grant. These options will vest 100% on March 31, 2007 for those executives
who remain employed with the Company through that date. As at September 30,
2006, options totaling 6,244 from this issuance have been forfeited, leaving the
remaining balance of 356,419 to vest through March 31, 2007.
In May and June 2005, options totaling 23,600 were issued to employees. 11,800
of these 10-year options vested immediately, and the remaining 11,800 of these
options became fully vested in May and June of 2006, respectively.
In May and June 2006, options totaling 56,400 were issued to employees. 3,750 of
these 10-year options vested immediately and the remaining shares of 24,450,
3,750 and 24,450 will become fully vested in May 2007, June 2007 and May 2008
respectively. In addition in June 2006, a total of 7,500 shares of the Company's
common stock were issued to non-management directors of the Company.
Effective January 1, 2006, the Company adopted Financial Accounting Standards
(FAS) No. 123R, "Share-Based Payment," utilizing the "modified prospective"
method as described in FAS No. 123R. FAS No. 123R is a revision of FAS No. 123,
"Accounting for Stock Based Compensation".
In the "modified prospective" method, compensation cost is recognized for all
share-based payments granted after the effective date and for all unvested
awards granted prior to the effective date. In accordance with FAS No. 123R,
prior period amounts were not restated. FAS No. 123R also requires the tax
benefits associated with these share-based payments to be classified as
financing activities in the Condensed Consolidated Statements of Cash Flows,
rather than as operating cash flows as required under previous regulations.
At September 30, 2006, the Company had two stock-based compensation plans with
total unvested stock-based compensation expense of $0.5 million and a total
weighted average remaining term of 7.93 years. Total stock-based compensation
expense, recognized in Cost of Sales and Selling, General and Administrative
expenses, aggregated $0.2 million and $0.4 million during the three and nine
month periods ended September 30, 2006, respectively. 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 United
States and the deduction is disallowed in that taxing jurisdiction. Accordingly,
no tax benefit will be realized by the Company.
The recognition of total stock-based compensation expense impacted Basic Net
Income Per Common Share and Diluted Net Income Per Common Share by $0.01 and
$0.01, respectively, during the third quarter of 2006.
Prior to the effective date, the stock-based compensation plans were accounted
for under Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Pro-forma information
regarding the impact of total stock-based compensation on net income and income
per share for prior periods is required by FAS No. 123R.
Such pro-forma information, determined as if the Company had accounted for its
employee stock options under the fair value method during the three and nine
month periods ended September 30, 2005, is illustrated in the following table:
Three months Nine months
ended September 30 ended September 30
2005 2005
(Dollars in thousands, except per share data)
Net income, as reported $1,149 $2,011
Deduct: total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects $(73) $(254)
----------------- ----------------
Pro forma net income $1,076 $1,757
----------------- ----------------
Income per share:
Basic - as reported $0.09 $0.16
Basic - pro forma $0.09 $0.14
Diluted - as reported $0.08 $0.14
Diluted - pro forma $0.07 $0.12
The per share weighted average exercise price of the stock options granted for
both the three and nine months ended September 30, 2006 was $9.45, while the
weighted average exercise price of the stock options granted for both the three
and nine months ended September 30, 2005 was $11.15. The per share weighted
average fair value (Black-Scholes value) of the stock options granted for both
the three and nine months ended September 30, 2006 was $8.29, while the weighted
average fair value price of the stock options granted for both the three and
nine months ended September 30, 2005 was $7.74. The Huntingdon options granted
prior to 2002 (effective date of the "Exchange Offer") are considered to have no
value. The fair values of the Company's employee stock options were estimated at
the date of grant of each issuance using a Black-Scholes option-pricing model,
with the following weighted average assumptions for all options
expensed/proforma calculated during the three and nine month periods ended
September 30, 2006 and 2005:
Three months ended September 30 Nine months ended September 30
FAS No. 123R FAS No. 123 FAS No. 123R FAS No. 123
Expense Pro Forma Expense Pro Forma
2006 2005 2006 2005
Expected dividend yield of stock 0% 0% 0% 0%
Expected volatility of stock, range 49.4% - 88.8% 47.1% - 55.9% 49.4% - 88.8% 47.1% - 55.9%
Risk-free interest rate, range 4.71% - 5.10% 3.90% - 4.71% 3.90% - 5.10% 3.90% - 4.71%
Expected term of options 10 years 10 years 10 years 10 years
As partial consideration for the new loan obtained on March 2, 2006, LSR has
issued to the lender 10 year warrants to acquire 500,000 shares of LSR's common
stock at an exercise price of $12.00 per share (such exercise price was
determined by a premium formula based on LSR's recent closing market prices).
These warrants were fully vested on the closing date of the loan, March 2, 2006.
Accordingly, the fair value of these warrants ($2,528,000) has been recorded as
a deferred debt premium and is being amortized to interest expense over the term
of the loan. For financial statement presentation purposes, the unamortized
amount of these warrants has been netted against the loan in long-term debt.
In addition, as partial consideration for providing financial advisory services
to assist the Company in obtaining the loan, LSR issued to its independent third
party financial advisor 10 year warrants to acquire 300,000 shares of LSR common
stock at an exercise price of $10.46 per share (the closing market price on the
date the Company engaged the financial advisor). These warrants became fully
vested on March 2, 2006, the closing date of the loan. The fair value of these
warrants ($1,749,000) has been recorded as deferred financing costs and is being
amortized to other expense over the term of the loan. For financial statement
presentation purposes, the unamortized amount of these warrants has been
classified as other assets (non-current). Certain customary registration rights
were granted in connection with these warrants. The warrants are subject to
customary anti-dilution provisions.
iii) Recently Issued Accounting Standards
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) an
interpretation of FASB Statement No. 109, Accounting for Income Taxes, which
clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. The Interpretation requires that the Company recognize in the
financial statements, the impact of a tax position, if that position is more
likely than not of being sustained on audit, based on the technical merits of
the position. FIN 48 also provides guidance on de-recognition of a previously
recognized tax position, classification, interest and penalties, accounting in
interim periods and disclosures. The provisions of FIN 48 are effective
beginning January 1, 2007 with the cumulative effect of the change in accounting
principle recorded as an adjustment to the opening balance of retained earnings.
The Company is assessing the potential impact the adoption of this
Interpretation may have on its financial position or results of operations.
In September 2006, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106 and 132(R), ("SFAS 158"). SFAS 158 requires an
employer to recognize the over-funded or under-funded status of a defined
benefit postretirement plan -- measured as the difference between the fair value
of plan assets and the projected benefit obligation -- as an asset or liability,
respectively, in its balance sheet and to recognize changes in the funded status
of the plan in the year in which such changes occur through other comprehensive
income. The financial statement recognition and disclosure provisions of SFAS
158 are effective for fiscal years ending after December 15, 2006, which will
result in The Company recording the over-funded or under-funded of its plans as
a liability or asset, respectively, with a corresponding decrease or increase,
net of tax, in the accumulated other comprehensive income equity account on its
balance sheet at December 31, 2006 and recognizing future changes in the funded
status of its plans in other comprehensive income beginning with the year ending
December 31, 2007. SFAS 158 also requires, effective for fiscal years ending
after December 15, 2008, that the measurement of the over-funded or under-funded
status of the plan be made as of the employer's fiscal year end and not as of an
earlier measurement date. The Company is currently in the process of evaluating
SFAS 158, and has not yet determined the impact, if any; SFAS 158 will have on
its consolidated results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, ("SFAS
157"). SFAS 157, which applies whenever other standards require (or permit) fair
value measurement, defines fair value and provides guidance for using fair value
to measure assets and liabilities. SFAS 157 also requires expanded disclosures
about the extent to which companies measure assets and liabilities at fair
value, the information used in those measurements and the effect of fair value
measurements on earnings. The Company will be required to adopt SFAS 157, which
is effective for fiscal years beginning after November 15, 2007, no later than
the quarter beginning January 1, 2008. The Company is currently in the process
of evaluating SFAS 157, and has not yet determined the impact, if any; SFAS 157
will have on its consolidated results of operations or financial position.
3. SEGMENT ANALYSIS
The Company operates within two segments based on geographical markets, the
United Kingdom and the United States, and incurs corporate administrative
expenses. The Company has one continuing activity, Contract Research.
The analysis of the Company's net revenues and operating income by segment for
the three and nine month periods ended September 30, 2006 and September 30, 2005
is as follows:
Three months ended Nine months ended
September 30 September 30
2006 2005 2006 2005
(Dollars in thousands)
Net revenues
UK $40,114 $33,673 $110,754 $103,763
US
9,346 10,085 29,012 28,230
Corporate - - - -
----------- ----------- ----------- -------------
$49,460 $43,758 $139,766 $131,993
=========== =========== =========== =============
Operating income
UK $6,640 $5,183 $16,786 $16,905
US 1,150 1,792 3,522 4,437
Corporate (2,052) (1,300) (5,699) (5,059)
----------- ----------- ----------- -------------
$5,738 $5,675 $14,609 $16,283
=========== =========== =========== =============
4. REFINANCING
On March 28, 2002, LSR closed the sale in a private placement of an aggregate of
5,085,334 shares of Voting Common Stock at a price of $1.50 per share. Of the
aggregate proceeds of approximately $7.6 million, $4.4 million was in cash, $2.4
million represented conversion into equity of debt owed to Mr. Baker ($2.1
million) and Focused Healthcare Partners ("FHP") ($0.3 million) and $825,000 was
paid with promissory notes. A net $492,000 of such promissory notes was repaid
to the end of 2005, and a further net $177,000 was repaid to the end of
September 2006.
On June 14, 2005, the Company entered into and consummated the Sale/Leaseback
Transaction with Alconbury. Alconbury was newly formed in June 2005 and
controlled by LSR's Chairman and CEO, Andrew Baker. The total consideration paid
by Alconbury for the three properties was $40 million, consisting of $30 million
cash and a five year, $10 million variable rate subordinated promissory note,
which Alconbury paid in full on June 30, 2006, together with accrued interest of
$0.6 million. The Company agreed to pay the expenses incurred by Alconbury in
the Sale/Leaseback Transaction of $4.6 million, subject to Alconbury's
obligation to reimburse those expenses in the future. Such reimbursement shall
be made in equal installments in each year of the five-year period beginning on
June 14, 2008, the third anniversary of the closing date of the Sale/Leaseback
Transaction. Interest has been imputed on this loan at 15% and a discount
(expense) of $2.4 million was recorded by the Company on June 14, 2005. This
$2.4 million is being ratably recorded as interest income over the seven year
term of the loan.
As part of the Sale/Leaseback Transaction, the Company (through subsidiaries)
entered into thirty-year leases with Alconbury for each facility, with two
five-year renewal options. The initial base aggregate annual rent for the
facilities was $4.9 million (approximately $1.8 million in the US and
approximately $3.1 million in the UK) which increases by 3% each subsequent year
for the UK facilities and by an amount equal to the annual US consumer price
index for the US facility. Under the terms of the leases, no security deposit
was initially required, but a three-month security deposit was paid at the time
that Alconbury refinanced its financing arrangements. Additionally, because the
leases are "triple net" leases, LSR also pays for all of the costs associated
with the operation of the facilities, including costs such as insurance, taxes
and maintenance.
Since the Sale/Leaseback Transaction was with a related party (Mr. Baker, LSR's
Chairman and CEO and the controlling owner of Alconbury), an Independent
Committee of LSR's Board of Directors (the "Committee") was formed to analyze
and consider the proposed Sale/Leaseback Transaction. The Committee was
comprised of the three independent directors of LSR: Gabor Balthazar, Afonso
Junqueiras and Yaya Sesay. The Committee retained independent legal and
financial advisors to assist in its analysis. The Committee and LSR's senior
management (other than Mr. Baker) negotiated the key terms and provisions of the
Sale/Leaseback Transaction with Alconbury. The Committee also obtained
appraisals of the facilities from independent real estate appraisal firms.
The proceeds from the Sale/Leaseback Transaction (plus additional cash on hand)
were used by the Company to pay in full its (pound)22.6 million non-bank debt
(approximately $41.1 million).
In accordance with the provisions of Financial Accounting Standards Board (FASB)
Interpretation No. 46R (FIN 46R), the Company has reflected the consolidation of
Alconbury from June 14, 2005 through June 29, 2006, the period in which the
Company was considered the "primary beneficiary" of Alconbury's variable
interests. Effective June 30, 2006, the requirement under FIN46R to include
Alconbury in the Consolidated Financial Statements no longer applied and the
Company has therefore reflected the "deconsolidation" of this entity in the
financial statements. This deconsolidation required the Company to record the
gain and loss associated with the sale of the properties, and recognize the
associated changes in depreciation, interest, and rent expenses. The Company has
recorded a non-cash loss of $48.9 million for the sale of the UK properties, and
a gain of $9.6 million for the US property, which is being amortized over the
term of the lease. Please refer to Note 6 for additional detail of the impact of
this deconsolidation.
Due to the consolidation resulting from the Company's adoption of FIN 46R, for
the period of June 14, 2005 through June 29, 2006, the Company's financial
statements reflected a loan payable to an unrelated third party in the aggregate
principal amount of $30 million. This loan had a maturity date of June 14, 2006,
with the right to extend the term one additional year. The loan, carried an
annual interest rate of 15%, was secured by first priority lien on all the
assets, including the facilities, of Alconbury, and was also personally
guaranteed by the owner of Alconbury. This loan was payable in twelve monthly
installments of interest only, with a balloon payment of $30 million due on June
14, 2006. Alconbury refinanced this debt on a long-term basis on June 13, 2006
with an interest rate of 12%. However, due to the June 30, 2006 deconsolidation
of Alconbury (see Note 6), the Company is not reflecting this new loan on the
Condensed Consolidated Balance Sheet as at September 30, 2006.
On March 2, 2006, the Company entered into a $70 million loan (the "New
Financing") under the terms of a Financing Agreement dated March 1, 2006 with a
third party lender. The borrower under the Financing Agreement is Huntingdon
Life Sciences Limited and LSR and substantially all of LSR's other subsidiaries
guarantee all of the borrower's obligations thereunder. The loan matures on
March 1, 2011 and has an interest rate of 8.25% over LIBOR (which may be reduced
to 8.00% over LIBOR upon the Company meeting certain financial tests). The
Financing Agreement contains standard financial and business covenants,
including, without limitation, reporting requirements, limitations on the
incurrence of additional indebtedness, events of default, limitations on
dividends and other payment restrictions and various financial ratio
requirements. The loan is secured by substantially all of the assets of the
Company and the Company has in connection therewith entered into a customary
Security Agreement and a customary Pledge and Security Agreement.
As partial consideration for the loan, LSR has issued to the lender 10 year
warrants to acquire 500,000 shares of LSR's common stock at an exercise price of
$12.00 per share (such exercise price was determined by a premium formula based
on LSR's closing market prices on the date of issuance). These warrants were
fully vested on the closing date of the loan, March 2, 2006. In addition, as
partial consideration for providing financial advisory services to assist the
Company in obtaining the loan, LSR issued to its independent third party
financial advisor 10 year warrants to acquire 300,000 shares of LSR common stock
at an exercise price of $10.46 per share (the closing market price on the date
the Company engaged the financial advisor). These 300,000 warrants became fully
vested on the closing date of the loan, March 2, 2006. Certain customary
registration rights were granted in connection with these warrants. The warrants
are subject to customary anti-dilution provisions.
Net proceeds from the loan were approximately $63 million and a portion of these
proceeds were used to redeem the $46.2 million outstanding principal amount of
the Company's 7.5% Convertible Capital Bonds, which were due to mature in
September 2006. The balance of the proceeds was held for general corporate
purposes.
5. COMMITMENTS AND CONTINGENCIES
(i) On August 22, 2005, the Company announced that its listing application had
been accepted by the New York Stock Exchange ("NYSE") and that trading of
the Company's common stock on the NYSE was expected to begin on September
7. On September 7, 2005, the NYSE postponed commencement of trading of the
Company's stock on the NYSE. On April 4, 2006, the Company's legal counsel
sent a letter to the NYSE enclosing a draft complaint alleging breach of
agreements between the Company and the NYSE, including to list LSR stock,
and seeking specific performance, damages and other relief. The letter
expressed the Company's interest in resolving the matter without
litigation. The ultimate resolution of this matter cannot reasonably be
determined at this time.
The Company is otherwise 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.
(ii) The Compensation Committee approved as of June 1, 2004 a performance based
cash bonus award for executives. This award, issued under the Long Term
Incentive Plan (LTIP), will award cash compensation to select individuals
if certain performance goals relating to operations are reached by December
31, 2006. The amount of the award varies based upon the level of
performance, with a complete default of the award if minimum operating
levels are not achieved.
Management is ratably accruing, as compensation expense, an amount equal to
the currently estimated cash bonus over the performance period. Management
will re-evaluate this estimate periodically throughout the performance
period and, if applicable, will adjust the estimate accordingly.
6. CUMULATIVE EFFECT OF ACCOUNTING CHANGE
As described in Note 1, and in compliance with FIN 46R, the Company has included
Alconbury in its Condensed Consolidated Financial Statements for the period of
June 14, 2005 through June 29, 2006. Effective June 30, 2006, the Company
determined that it was no longer the Primary Beneficiary of Alconbury, and
therefore, was no longer required to include Alconbury in its consolidations
from June 30, 2006 forward. In addition to excluding Alconbury from its
consolidations, the Company was required to effectively remove or
"deconsolidate" the June 14, 2005 through June 29, 2006 activity of Alconbury on
June 30, 2006. This deconsolidation of activity is referred to as the
"Cumulative effect of accounting change" in these Condensed Consolidated
Financial Statements.
The "Cumulative effect of accounting change" is presented in both the Condensed
Consolidated Statement of Operations and Condensed Consolidated Statement of
Cash Flows at September 30, 2006 and is comprised of the following components:
Reversal of Alconbury activity:
(Dollars in thousands)
Income:
Rental income $(5,128)
Discount on intercompany note (2,376)
Interest income (23)
-----------
(7,527)
-----------
Expense:
Interest expense on third party loan 4,806
Interest expense on intercompany loan 628
Interest expense - amortization of discount on intercompany note 360
Amortization of loan closing costs 4,624
General and administrative expenses (bank charges fees etc.) 134
-----------
10,552
-----------
-----------
Net reversal of Alconbury activity $3,025
-----------
Impact on remaining Consolidated Statement of Operations
(Previously eliminated in consolidation):
(Dollars in thousands)
Income:
Amortization of gain on sale of assets to Alconbury (US) $336
Reversal of depreciation recorded on assets sold to Alconbury 3,418
-----------
3,754
-----------
Expense:
Loss on sale of assets to Alconbury (UK) (48,869)
Depreciation on capitalized assets (784)
-----------
(49,653)
-----------
-----------
Net impact on remaining Consolidated Statement of Operations $(45,899)
-----------
Cumulative effect of accounting change - before income taxes (42,874)
Income tax benefit (deferred tax on sale of assets to Alconbury (UK)) 22,218
-----------
Cumulative effect of accounting change $(20,656)
===========
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
1. RESULTS OF OPERATIONS
a) Three months ended September 30, 2006 compared with three months ended
September 30, 2005.
Net revenues for the three months ended September 30, 2006 were $49.5 million,
an increase of 13% on net revenues of $43.8 million for the three months ended
September 30, 2005. The underlying increase, after adjusting for the impact of
the movement in exchange rates was 8.7%; with the UK showing a 12.4% increase
and the US a 3.5% decrease.
Cost of sales for the three months ended September 30, 2006 were $36.4 million
(73.6% of revenue), an increase of 14.9% on cost of sales of $31.7 million
(72.4% of revenue) for the three months ended September 30, 2005. The underlying
increase, after adjusting for the impact of the movement in exchange rates was
10.6%. The increase in cost of sales as a percentage of revenue was due to an
increase in direct study costs as a percentage of revenues and overheads as a
percentage of revenues. These contributed 100 basis points and 60 basis points
respectively to the increase in cost of sales as a percentage of revenues. The
increase in direct study costs was due to a change in study mix, while increased
power costs and depreciation contributed to the increase in overheads. There was
a reduction of 40 basis points in Labor costs as a percentage of revenue due to
the improved Labor efficiency as revenues increased offset in part by higher
pension costs.
Selling, general and administrative expenses (SG&A) increased by 14.4% to $7.3
million for the three months ended September 30, 2006 from $6.4 million in the
corresponding period in 2005. The underlying increase, after adjusting for the
impact of the movement in exchange rates was 18.9%. Of the total increase of
$0.9 million, $0.4 million was due to a reduction in exchange gains and a
further $0.4 million due to higher professional fees.
Net interest expense increased by 28.7% to $2.7 million for the three months
ended September 30, 2006 from $2.1 million for the three months ended September
30, 2005. This increase was due to the additional principal being borrowed and
the higher rates of interest associated with the New Financing.
Other expenses of $0.9 million for the three months ended September 30, 2006
comprised, finance arrangement fees of $0.5 million, the non-cash cost of $0.7
million associated with the 100,000 warrants granted in January 2005 for
advisory services, offset by $0.3 million from the non-cash foreign exchange
re-measurement gain on the New Financing denominated in US dollars (the
functional currency of the financial subsidiary that holds the bonds is UK
sterling). In the three months ended September 30, 2005 there was other expense
of $1.8 million which was comprised of finance arrangement fees of $1.2 million,
and $0.6 million from the non-cash foreign exchange re-measurement loss on the
Convertible Capital Bonds.
Income tax benefit for the three months ended September 30, 2006 was $0.6
million. The income tax expense for the three months ended September 30, 2005,
was $0.6 million. Research and development tax credits in the UK increased the
tax benefit for the three months ended September 30, 2006 by $1.3 million and
reduced the tax expense for the three months ended September 2005 by $1.0
million. For the three months ended September 30, 2005 this benefit was offset
by non tax deductible finance expenses of $0.5 million and the effects of the
consolidation of Alconbury of $0.7 million. Net operating losses are $77.4
million at September 30, 2006; with net operating losses in the US of $10.6
million and net operating losses in the UK of $66.8 million.
The net income for the three months ended September 30, 2006 was $2.7 million
compared to $1.1 million for the three months ended September 30, 2005. The
increase in the net income of $1.6 million is due to a $0.1 million increase in
operating income, an increase in non-cash foreign exchange re-measurement gain
of $0.9 million, and an increase in the income tax benefit of $1.2 million,
offset by an increase in the net interest expense of $0.6 million.
Basic income per common share for the three months ended September 30, 2006 was
21 cents, compared to 9 cents income in the same period last year, on the
weighted average common shares outstanding of 12,669,068 and 12,541,912
respectively. Diluted income per diluted share for the three months ended
September 30, 2006 was 18 cents, compared to 8 cents in the same period last
year.
Excluding the Other Expense items described above related to the finance
arrangement fees, the non-cash foreign exchange losses, and related tax effect,
non-GAAP net income for the three months ended September 30, 2006 was $2.7
million, or $0.19 per fully diluted share (non-GAAP), compared with $3.2 million
or $0.22 per fully diluted share for the same period in the prior year.
Earnings before interest, taxes, depreciation and amortization, and other
income/(expense) ("EBITDA") was $7.8 million for the three months ended
September 30, 2006, or 15.9% of revenues, compared with $8.1 million, or 18.6%
of revenues for the same period in the prior year.
This Quarterly Report on Form 10-Q contains non-GAAP financial measures,
including EBITDA and non-GAAP earnings per share which exclude, among other
items, gains or losses associated with the non-cash foreign exchange
remeasurement losses pertaining to the Company's Convertible Capital Bonds and
one time charges. We exclude these items in the non-GAAP financial measures
because they are outside our normal operations. We believe that the inclusion of
non-GAAP financial measures in this Quarterly Report on Form 10-Q helps
investors to gain a meaningful understanding of our core operating results and
future prospects, and is consistent with how management measures and forecasts
the Company's performance and debt service capabilities, especially when
comparing such results to prior periods or forecasts. Non-GAAP results also
allow investors to compare the Company's operations against the financial
results of other companies in the industry who similarly provide non-GAAP
results. The non-GAAP financial measures included in this Quarterly Report on
Form 10-Q are not meant to be considered superior to or a substitute for results
of operations prepared in accordance with GAAP. Reconciliations of the non-GAAP
financial measures used in this Quarterly Report on Form 10-Q to the most
directly comparable GAAP financial measures are set forth in the text of this
Quarterly Report on Form 10-Q and other public filings, and can also be found on
the Company's website at www.lsrinc.net.
b) Nine months ended September 30, 2006 compared with nine months ended
September 30, 2005.
Net revenues for the nine months ended September 30, 2006 were $139.8 million,
an increase of 5.9% on net revenues of $132.0 million for the nine months ended
September 30, 2005. The underlying increase, after adjusting for the impact of
the movement in exchange rates was 6.9%; with the UK showing a 8.1% increase and
the US a 2.6% increase.
Cost of sales for the nine months ended September 30, 2006 were $103.3 million
(73.9% of revenue), an increase of 8.5% on cost of sales of $95.2 million (72.1%
of revenue) for the nine months ended September 30, 2005. The underlying
increase, after adjusting for the impact of the movement in exchange rates was
9.6%. The increase in the cost of sales as a percentage of revenue was due to an
increase in direct study costs as a percentage of revenue and overheads as a
percentage of revenue. These contributed 100 basis points and 80 basis points
respectively to the increase in cost of sales as a percentage of revenues. The
increase in direct study costs was due to a change in study mix, while increased
power costs and depreciation contributed to the increase in overheads. Labor as
a percentage of revenues was the same as last year with improvements in Labor
efficiency as revenues increased being offset by higher pension costs.
Selling, general and administrative expenses (SG&A) increased by 6.8% to $21.9
million for the nine months ended September 30, 2006 from $20.5 million in the
corresponding period in 2005. The underlying increase, after adjusting for the
impact of the movement in exchange rates was 7.8%. Of the total increase of $1.4
million, $0.5 million was due to the expense of issuing shares to directors and
senior management as part of remuneration packages and incentive schemes, $0.2
million related to employee stock option expenses, a further $0.4 million
related to higher professional fees and $0.3 million to increased insurance
costs.
Net interest expense increased by 57.0% to $9.1 million for the nine months
ended September 30, 2006 from $5.8 million for the nine months ended September
30, 2005. This increase was due to higher rates of interest as a result of the
Sale/Leaseback transaction, duplicate financing in place for one month in
preparation of the early redemption of the Convertible Capital Bonds, the
additional principal being borrowed under the New Financing and the higher rates
of interest as a result of the New Financing.
Other income of $0.4 million for the nine months ended September 30, 2006
comprised $4.0 million from the non-cash foreign exchange re-measurement gain on
the Convertible Capital Bonds and New Financing denominated in US dollars (the
functional currency of the financial subsidiary that holds the bonds is UK
sterling) and other exchange gains of $0.2 million, offset by finance
arrangement fees of $3.1 million and the non-cash costs of $0.7 million
associated with 100,000 warrants granted in January 2005 for advisory services.
In the nine months ended September 30, 2005 there was other expense of $5.2
million which was comprised of finance arrangement fees of $1.4 million and $3.8
million of a non-cash foreign exchange re-measurement loss on the Convertible
Capital Bonds.
Income tax expense for the nine months ended September 30, 2006 was $1.6
million. The income tax expense for the nine months ended September 30, 2005,
was $3.3 million. Research and development tax credits in the UK decreased the
tax expense for the nine months ended September 30, 2006 by $3.7 million and
reduced the tax expense in the nine months ended September 2005 by $3.1 million.
For the nine months ended September 30, 2006 this benefit was offset by non tax
deductible finance expenses of $0.3 million and the effects of consolidation of
Alconbury of $2.9 million. For the nine months ended September 30, 2005 this
benefit was offset by non tax deductible finance expenses of $1.3 million and
the effects of consolidation of Alconbury of $3.1 million.
The net income before the cumulative effect of the accounting change for the
nine months ended September 30, 2006 was $4.3 million compared to $2.0 million
for the nine months ended September 30, 2005. The increase in the net income of
$2.3 million is due to a decrease in operating income of $1.7 million, an
increase in finance arrangement fees of $2.4 million and an increase in net
interest expense of $3.3 million; offset by an increase in non-cash foreign
exchange re-measurement gain of $7.8 million, exchange gain on intercompany
balances of $0.2 million and a decrease in the income tax expense of $1.7
million.
Basic income before the cumulative effect of the accounting change per common
share for the nine months ended September 30, 2006 was 34 cents, compared to 16
cents income in the same period last year, on the weighted average common shares
outstanding of 12,627,048 and 12,505,798 respectively. Diluted income before the
cumulative effect of the accounting change per diluted share for the nine months
ended September 30, 2006 was 29 cents, compared to 14 cents income in the same
period last year.
Excluding the Other Expense items described above related to the finance
arrangement fees, the non-cash foreign exchange losses, and related tax effect,
non-GAAP net income before the cumulative effect of the accounting change for
the nine months ended September 30, 2006 was $5.0 million, or $0.34 per fully
diluted share (non-GAAP), compared with $9.4 million or $0.65 per fully diluted
share for the same period in the prior year.
Earnings before interest, taxes, depreciation and amortization, and other
income/(expense) ("EBITDA") was $21.8 million for the nine months ended
September 30, 2006, or 15.6% of revenues, compared with $23.5 million, or 17.8%
of revenues for the same period in the prior year.
2. LIQUIDITY & CAPITAL RESOURCES
Bank Loan and Non-Bank Loans
On January 20, 2001, the Company's net non-bank loan of (pound)22.6 million
(approximately $43.4 million), was refinanced by Stephens Group Inc. and other
parties. The loan was transferred from Stephens Group Inc., to an unrelated
third party effective February 11, 2002. It was repayable on June 30, 2006 and
interest was payable quarterly at LIBOR plus 1.75%. At the same time the Company
was required to take all reasonable steps to sell off such of its real estate
assets through sale/leaseback transactions and/or obtaining mortgage financing
secured by the Company's real estate assets to discharge this loan. The loan was
held by LSR Ltd., and was secured by the guarantees of wholly owned subsidiaries
of the Company including, LSR Ltd, Huntingdon Life Sciences Ltd, and Huntingdon
Life Sciences Inc., and collateralized by all the assets of these companies. On
June 14, 2005 this non-bank loan was fully repaid using the proceeds from the
Sale/Leaseback Transaction and cash on hand.
On October 9, 2001, on behalf of Huntingdon, LSR issued to Stephens Group Inc.
warrants to purchase 704,425 shares of LSR Voting Common Stock at a purchase
price of $1.50 per share. The warrants were subsequently transferred to an
unrelated third party. The LSR warrants are exercisable at any time and will
expire on October 9, 2011. These warrants arose out of negotiations regarding
the refinancing of the bank loan by the Stephens Group Inc. in January 2001. In
accordance with APB Opinion No. 14, Accounting for Convertible Debt and Debt
Issued with Stock Purchase Warrants ("APB 14"), the warrants were recorded at
their pro rata fair values in relation to the proceeds received on the date of
issuance. As a result, the value of the warrants was $430,000. 154,425 of such
warrants were exercised in 2004. No additional exercises have been made to date.
On June 14, 2005, the Company entered into and consummated the Sale/Leaseback
Transaction with Alconbury. Alconbury was newly formed in June 2005 and
controlled by LSR's Chairman and CEO, Andrew Baker. The total consideration paid
by Alconbury for the three properties was $40 million, consisting of $30 million
cash and a five year, $10 million variable rate subordinated promissory note,
which Alconbury paid in full on June 30, 2006, together with accrued interest of
$0.6 million. The Company agreed to pay the expenses incurred by Alconbury in
the Sale/Leaseback Transaction of $4.6 million, subject to Alconbury's
obligation to reimburse those expenses in the future. Such reimbursement shall
be made in equal installments in each year of the five-year period beginning on
June 14, 2008, the third anniversary of the closing date of the Sale/Leaseback
Transaction. Interest has been imputed on this loan at 15% and a discount
(expense) of $2.4 million was recorded by the Company on June 14, 2005. This
$2.4 million is being ratably recorded as interest income over the seven year
term of the loan.
As part of the Sale/Leaseback Transaction, the Company (through subsidiaries)
entered into thirty-year leases with Alconbury for each facility, with two
five-year renewal options. The initial base aggregate annual rent for the
facilities was $4.9 million (approximately $1.8 million in the US and
approximately $3.1 million in the UK) which increases by 3% each subsequent year
for the UK facilities and by an amount equal to the annual US consumer price
index for the US facility. Under the terms of the leases, no security deposit
was initially required, but a three-month security deposit was paid at the time
that Alconbury refinanced its financing arrangements. Additionally, because the
leases are "triple net" leases, LSR also pays for all of the costs associated
with the operation of the facilities, including costs such as insurance, taxes
and maintenance.
Since the Sale/Leaseback Transaction was with a related party (Mr. Baker, LSR's
Chairman and CEO and the controlling owner of Alconbury), an Independent
Committee of LSR's Board of Directors (the "Committee") was formed to analyze
and consider the proposed Sale/Leaseback Transaction. The Committee was
comprised of the three independent directors of LSR: Gabor Balthazar, Afonso
Junqueiras and Yaya Sesay. The Committee retained independent legal and
financial advisors to assist in its analysis. The Committee and LSR's senior
management (other than Mr. Baker) negotiated the key terms and provisions of the
Sale/Leaseback Transaction with Alconbury. The Committee also obtained
appraisals of the facilities from independent real estate appraisal firms.
The proceeds from the Sale/Leaseback Transaction (plus additional cash on hand)
were used by the Company to pay in full its (pound)22.6 million non-bank debt
(approximately $41.1 million).
In accordance with the provisions of Financial Accounting Standards Board (FASB)
Interpretation No. 46R (FIN 46R), the Company has reflected the consolidation of
Alconbury from June 14, 2005 through June 29, 2006, the period in which the
Company was considered the "primary beneficiary" of Alconbury's variable
interests. Effective June 30, 2006, the requirement under FIN46R to include
Alconbury in the Consolidated Financial Statements no longer applied and the
Company has therefore reflected the "deconsolidation" of this entity in the
financial statements. This deconsolidation required the Company to record the
gain and loss associated with the sale of the properties, and recognize the
associated changes in depreciation, interest, and rent expenses. The Company has
recorded a non-cash loss of $48.9 million for the sale of the UK properties, and
a gain of $9.6 million for the US property, which is being amortized over the
term of the lease. Please refer to Note 6 for additional detail of the impact of
this deconsolidation.
Due to the consolidation resulting from the Company's adoption of FIN 46R, for
the period of June 14, 2005 through June 29, 2006, the Company's financial
statements reflected a loan payable to an unrelated third party in the aggregate
principal amount of $30 million. This loan had a maturity date of June 14, 2006,
with the right to extend the term one additional year. The loan, carried an
annual interest rate of 15%, was secured by first priority lien on all the
assets, including the facilities, of Alconbury, and was also personally
guaranteed by the owner of Alconbury. This loan was payable in twelve monthly
installments of interest only, with a balloon payment of $30 million due on June
14, 2006. Alconbury refinanced this debt on a long-term basis on June 13, 2006
with an interest rate of 12%. However, due to the June 30, 2006 deconsolidation
of Alconbury (see Note 6), the Company is not reflecting this new loan on the
Condensed Consolidated Balance Sheet as at September 30, 2006.
On March 2, 2006, the Company entered into the $70 million New Financing under
the terms of a Financing Agreement dated March 1, 2006 with a third party
lender. The borrower under the Financing Agreement is Huntingdon Life Sciences
Limited and LSR and substantially all of LSR's other subsidiaries guarantee all
of the borrower's obligations thereunder. The loan matures on March 1, 2011 and
has an interest rate of 8.25% over LIBOR (which may be reduced to 8.00% over
LIBOR upon the Company meeting certain financial tests). The Financing Agreement
contains standard financial and business covenants, including, without
limitation, reporting requirements, limitations on the incurrence of additional
indebtedness, events of default, limitations on dividends and other payment
restrictions and various financial ratio requirements. The loan is secured by
substantially all of the assets of the Company and the Company has in connection
therewith entered into a customary Security Agreement and a customary Pledge and
Security Agreement.
As partial consideration for the new loan obtained on March 2, 2006, LSR has
issued to the lender 10 year warrants to acquire 500,000 shares of LSR's common
stock at an exercise price of $12.00 per share (such exercise price was
determined by a premium formula based on LSR's recent closing market prices).
These warrants were fully vested on the closing date of the loan, March 2, 2006.
Accordingly, the fair value of these warrants ($2,528,000) has been recorded as
a deferred debt premium and is being amortized to interest expense over the term
of the loan. For financial statement presentation purposes, the unamortized
amount of these warrants has been netted against the loan in long-term debt.
In addition, as partial consideration for providing financial advisory services
to assist the Company in obtaining the loan, LSR issued to its independent third
party financial advisor 10 year warrants to acquire 300,000 shares of LSR common
stock at an exercise price of $10.46 per share (the closing market price on the
date the Company engaged the financial advisor). These warrants became fully
vested on March 2, 2006, the closing date of the loan. The fair value of these
warrants ($1,749,000) has been recorded as deferred financing costs and is being
amortized to other expense over the term of the loan. For financial statement
presentation purposes, the unamortized amount of these warrants has been
classified as other assets (non-current). Certain customary registration rights
were granted in connection with these warrants. The warrants are subject to
customary anti-dilution provisions.
Net proceeds from the loan were approximately $63 million and a portion of these
proceeds were used to redeem the $46.2 million outstanding principal amount of
the Company's 7.5% Convertible Capital Bonds, which were due to mature in
September 2006. The balance of the proceeds was held for general corporate
purposes.
Related Party Transactions
On June 11, 2002 LSR issued to FHP warrants to purchase up to 410,914 shares of
LSR Voting Common Stock at a purchase price of $1.50 per share. These LSR
warrants are exercisable at any time and will expire on June 11, 2012. These
warrants arose out of negotiations regarding the provision of the $2.9 million
loan facility made available to the Company on September 25, 2000 by Mr. Baker,
who controls FHP. In accordance with APB 14 the loan and warrants were recorded
at their pro rata fair values in relation to the proceeds received. As a result,
the value of the warrants was $250,000.
Common Shares
On March 28, 2002, LSR closed the sale in a private placement of an aggregate of
5,085,334 shares of Voting Common Stock at a price of $1.50 per share. Of the
aggregate proceeds of approximately $7.6 million, $4.4 million was in cash, $2.4
million represented conversion into equity of debt owed to Mr. Baker ($2.1
million) and FHP ($0.3 million) and $825,000 was paid with promissory notes. A
net $492,000 of such promissory notes have been repaid through December 31,
2005, and a further net $177,000 was repaid to the end of September 2006.
Cash flows
During the three months ended September 30, 2006 funds used were $4.5 million,
decreasing cash and cash equivalents from $42.8 million at June 30, 2006 to
$38.3 million at September 30, 2006. Approximately $1.7 million of this related
to the increase in DSOs, $1.3 million related to the payment of Alconbury rent
deposits and the balance reflected the higher capital expenditure in the
quarter.
During the nine months ended September 30, 2006 funds generated were $22.9
million, increasing cash and cash equivalents from $15.4 million at December 31,
2005 to $38.3 million at September 30, 2006. The majority of the increase in
cash was due to the $70 million New Financing which generated net proceeds of
approximately $63 million, of which $46.2 million were used to redeem the
outstanding principal amount of the Convertible Capital Bonds. A further $10.6
million was generated from the repayment of the Alconbury subordinated
promissory note.
Net days sales outstanding ("DSOs") at September 30, 2006 were 15 days, an
increase from the 12 days at June 30, 2006, (21 days at September 30, 2005 and
16 days at December 31, 2005). DSOs are calculated as a sum of accounts
receivables, unbilled receivables and fees in advance over total revenue. Since
January 1999, DSOs at the quarter end have varied from 4 day to 47 days so they
are currently at a low range level. The impact on liquidity from a one-day
change in DSO is approximately $566,000.
3. CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's consolidated financial statements, which have
been prepared in accordance with US GAAP. The Company considers the following
accounting policies to be critical accounting policies.
Revenue recognition
The majority of the Company's net revenues have been earned under contracts,
which generally range in duration from a few months to three years. Revenue from
these contracts is recognized over the term of the contracts as services are
rendered. Contracts may contain provisions for renegotiation 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 profits that would have been earned under the contract had the contract
not been terminated early. Unbilled receivables are recorded for 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 which 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).
Use of estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 financial
statements and the results of operations during the reporting periods. Although
these estimates are based upon management's best knowledge of current events and
actions, actual results could differ from those estimates.
Taxation
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting For Income Taxes" ("SFAS
109"). SFAS 109 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 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.
Consolidation of Alconbury
In accordance with the provisions of FASB Interpretation No. 46R (FIN 46R), the
Company has reflected the consolidation of Alconbury from June 14, 2005 through
June 29, 2006, the period in which the Company was considered the "primary
beneficiary" of Alconbury's variable interests. Effective June 30, 2006, the
requirement under FIN46R to include Alconbury in the Condensed Consolidated
Financial Statements no longer applied and the Company has therefore reflected
the "deconsolidation" of this entity in the financial statements. This
deconsolidation required the Company to record the gain and loss associated with
the sale of the properties, and recognize the associated changes in
depreciation, interest, and rent expenses. The Company has recorded a non-cash
loss of $48.9 million for the sale of the UK properties, and a gain of $9.6
million, amortized over the term of the lease, for the US property. Please refer
to Note 6 for additional detail of the impact of this deconsolidation.
Exchange rate fluctuations and exchange controls
The Company operates on a worldwide basis and generally invoices its clients in
the currency of the country in which it operates. Thus, for the most part,
exposure to exchange rate fluctuations is limited as sales are denominated in
the same currency as costs. Trading exposures to currency fluctuations do occur
as a result of certain sales contracts, performed in the UK for US clients,
which are denominated in US dollars and contribute approximately 6% of total
revenues. Management has decided not to hedge against this exposure.
Also, exchange rate fluctuations may have an impact on the relative price
competitiveness of the Company vis a vis competitors who trade in currencies
other than sterling or dollars.
The Company has debt denominated in USD whereas the Company's functional
currency is the UK pound sterling, which results in the Company recording other
income/loss associated with USD debt as a function of relative changes in
foreign exchange rates. To manage the volatility relating to these exposures,
from time to time, the Company may enter into certain derivative transactions.
The Company holds and issues derivative financial instruments for economic
hedging purposes only. There were no derivative financial instruments in place
on September 30, 2006.
Finally, the consolidated financial statements of LSR are denominated in US
dollars. Changes in exchange rates between the UK pounds sterling and the US
dollar will affect the translation of the UK subsidiary's financial results into
US dollars for the purposes of reporting the consolidated financial results. The
process by which each foreign subsidiary's financial results are translated into
US 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 period exchange rates; and capital accounts are translated
at historical exchange rates and retained earnings are translated at weighted
average of historical rates. Translation of the balance sheet in this manner
affects the stockholders' equity account, referred to as the accumulated
comprehensive loss. Management has decided not to hedge against the impact of
exposures giving rise to these translation adjustments as such hedges may impact
upon the Company's cash flow compared to the translation adjustments which do
not affect cash flow in the medium term.
Exchange rates for translating sterling into US dollars were as follows:
At December 31 At September 30 3 months to September 30 9 months to September 30
Average rate (1) Average rate (1)
2004 1.9199 1.8096 1.8192 1.8209
2005 1.7168 1.7691 1.7854 1.8437
2006 - 1.8680 1.8751 1.8184
<FN>
(1) Based on the average of the exchange rates on each day of each month during
the period.
</FN>
On November 3, 2006 the noon buying rate for sterling was (pound)1.00 = $1.9011
The Company has not experienced difficulty in transferring funds to and
receiving funds remitted from those countries outside the US or UK in which it
operates and Management expects this situation to continue.
While the UK has not at this time entered the European Monetary Union, the
Company has ascertained that its financial systems are capable of dealing with
Euro denominated transactions.
The following table summarizes the financial instruments denominated in
currencies other than the US dollar held by LSR and its subsidiaries as of
September 30, 2006:
Expected Maturity Date
2006 2007 2008 2009 2010 Thereafter Total Fair
Value
(In US Dollars, amounts in thousands)
Cash - Pound Sterling 12,324 - - - - - 12,324 12,324
- Euro 489 - - - - - 489 489
- Japanese Yen 1,791 - - - - - 1,791 1,791
Accounts
receivable - Pound Sterling 20,965 - - - - - 20,965 20,965
- Euro 1,180 - - - - - 1,180 1,180
- Japanese Yen 2,358 - - - - - 2,358 2,358
Recently Issued Accounting Standards
The Company adopted FAS No. 123R, "Share-Based Payments," effective January 1,
2006, utilizing the "modified prospective" method as described in the standard.
Under the "modified prospective" method, compensation cost is recognized for all
share-based payments granted after the effective date and for all unvested
awards granted prior to the effective date. Prior to adoption, the Company
accounted for share-based payments under the recognition and measurement
principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. The Company recognized $0.2
million and $0.4 million in total stock-based compensation expense during the
three and nine month periods ended September 30, 2006, respectively. Total
unvested stock-based compensation expense was $0.5 million at September 30, 2006
and had a total weighted average remaining term of 7.93 years.
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) an
interpretation of FASB Statement No. 109, Accounting for Income Taxes, which
clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. The Interpretation requires that the Company recognize in the
financial statements, the impact of a tax position, if that position is more
likely than not of being sustained on audit, based on the technical merits of
the position. FIN 48 also provides guidance on de-recognition of a previously
recognized tax position, classification, interest and penalties, accounting in
interim periods and disclosures. The provisions of FIN 48 are effective
beginning January 1, 2007 with the cumulative effect of the change in accounting
principle recorded as an adjustment to the opening balance of retained earnings.
The Company is assessing the potential impact the adoption of this
Interpretation may have on its financial position or results of operations.
In September 2006, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106 and 132(R), ("SFAS 158"). SFAS 158 requires an
employer to recognize the over-funded or under-funded status of a defined
benefit postretirement plan -- measured as the difference between the fair value
of plan assets and the projected benefit obligation -- as an asset or liability,
respectively, in its balance sheet and to recognize changes in the funded status
of the plan in the year in which such changes occur through other comprehensive
income. The financial statement recognition and disclosure provisions of SFAS
158 are effective for fiscal years ending after December 15, 2006, which will
result in The Company recording the over-funded or under-funded of its plans as
a liability or asset, respectively, with a corresponding decrease or increase,
net of tax, in the accumulated other comprehensive income equity account on its
balance sheet at December 31, 2006 and recognizing future changes in the funded
status of its plans in other comprehensive income beginning with the year ending
December 31, 2007. SFAS 158 also requires, effective for fiscal years ending
after December 15, 2008, that the measurement of the over-funded or under-funded
status of the plan be made as of the employer's fiscal year end and not as of an
earlier measurement date. The Company is currently in the process of evaluating
SFAS 158, and has not yet determined the impact, if any; SFAS 158 will have on
its consolidated results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, ("SFAS
157"). SFAS 157, which applies whenever other standards require (or permit) fair
value measurement, defines fair value and provides guidance for using fair value
to measure assets and liabilities. SFAS 157 also requires expanded disclosures
about the extent to which companies measure assets and liabilities at fair
value, the information used in those measurements and the effect of fair value
measurements on earnings. The Company will be required to adopt SFAS 157, which
is effective for fiscal years beginning after November 15, 2007, no later than
the quarter beginning January 1, 2008. The Company is currently in the process
of evaluating SFAS 157, and has not yet determined the impact, if any; SFAS 157
will have on its consolidated results of operations or financial position.
There have been no significant changes in critical accounting policies or
management estimates since the year ended December 31, 2005 other than the
adoption of FAS No. 123R as described above. A comprehensive discussion of the
Company's critical accounting policies and management estimates is included in
Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Company's Annual Report on Form 10-K for the year ended
December 31, 2005.
4. LEGAL PROCEEDINGS
On August 22, 2005, the Company announced that its listing application had been
accepted by the NYSE and that trading of the Company's common stock on the NYSE
was expected to begin on September 7. On September 7, 2005, the NYSE postponed
commencement of trading of the Company's stock on the NYSE. On April 4, 2006,
the Company's legal counsel sent a letter to the NYSE enclosing a draft
complaint alleging breach of agreements between the Company and the NYSE,
including to list LSR stock, and seeking specific performance, damages and other
relief. The letter expressed the Company's interest in resolving the matter
without litigation. The ultimate resolution of this matter cannot reasonably be
determined at this time.
The Company is otherwise 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.
5. FORWARD LOOKING STATEMENTS
Statements in this management's discussion and analysis of financial condition
and results of operations, as well as in certain other parts of this Quarterly
Report on Form 10-Q (as well as information included in oral statements or other
written statements made or to be made by the Company) that look forward in time,
are forward looking statements made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Forward looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance, expectations, predictions, and assumptions and other
statements which are other than statements of historical facts. Although the
Company believes such forward-looking statements are reasonable, it can give no
assurance that any forward-looking statements will prove to be correct. Such
forward-looking statements are subject to, and are qualified by, known and
unknown risks, uncertainties and other factors that could cause actual results,
performance or achievements to differ materially from those expressed or implied
by those statements. These risks, uncertainties and other factors include, but
are not limited to the Company's ability to estimate the impact of competition
and of industry consolidation and risks, uncertainties and other factors more
fully described in the Company's filings with the SEC, including its
Registration Statement on Form S-1, dated July 12, 2002, and Annual Report on
Form 10-K for the year ended December 31, 2005, each as filed with the
Securities and Exchange Commission.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
LSR is subject to market risks arising from changes in interest rates and
foreign currency exchange rates.
The Company has debt denominated in US dollars, whereas the Company's functional
currency is the UK pound sterling, which results in the Company recording other
income/loss associated with US dollars debt as a function of relative changes in
foreign exchange rates. The Company is unable to predict whether it will
experience future gains or future losses from such exchange-related risks on the
debt. To manage the volatility relating to these exposures, from time to time,
the Company might enter into certain derivative transactions. The Company holds
and issues derivative financial instruments for economic hedging purposes only.
There were no derivative financial instruments in place at September 30, 2006.
LIBOR
In the three and nine months ended September 30, 2006, a 1% change in LIBOR
would have resulted in a fluctuation in interest expense of $175,000 and
$524,000 respectively.
Revenue
For the three and nine months ended September 30, 2006, approximately 73% of the
Company's net revenues were from outside the US.
See Management's Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM 4 CONTROLS AND PROCEDURES
As of September 30, 2006 an evaluation was carried out, under the supervision
and with the participation of management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
effective as of the quarter ended September 30, 2006 in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in our periodic SEC filings. During the
quarter ended September 30, 2006 there were no significant changes in internal
controls or in other factors that have materially affected, or are reasonably
likely to materially affect, internal controls over financial reporting.
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
On August 22, 2005, the Company announced that its listing application had been
accepted by the NYSE and that trading of the Company's common stock on the NYSE
was expected to begin on September 7. On September 7, 2005, the NYSE postponed
commencement of trading of the Company's stock on the NYSE.
On April 4, 2006, the Company's legal counsel sent a letter to the NYSE
enclosing a draft complaint alleging breach of agreements between the Company
and the NYSE, including to list LSR stock, and seeking specific performance,
damages and other relief. The letter expressed the Company's interest in
resolving the matter without litigation. The ultimate resolution of this matter
cannot reasonably be determined at this time.
ITEM 6 EXHIBITS
Exhibit 31.1 Certification of the Chief Executive Officer
Exhibit 31.2 Certification of the Chief Financial Officer
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 of the Chief Executive Officer
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 of the Chief Financial Officer
Exhibit 99.1 Press Release, dated November 7, 2006 announcing the
third quarter earnings results for 2006.
SIGNATURE
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, this Quarterly Report on Form 10-Q has been signed below by the
following person on behalf of the Registrant and in the capacities and on the
dates indicated.
Life Sciences Research Inc.
(Registrant)
By: /s/ Richard Michaelson
Name: Richard Michaelson
Title: CFO
Date: November 8, 2006