ITEM 1. BUSINESS
INTRODUCTION
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.
As the Company continues to build on improving fundamentals, we have the following strategy and goals:
o To grow to significant profitability and improved return on investment for our shareholders.
o To be appreciated as the listening, understanding and reliable partner in creative compound development and safety assessment and to be the first choice for the industries we serve.
o To provide our employees with the opportunity for individual development in a caring, rewarding and safe working environment.
o To be recognized positively in the local communities in which we operate.
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 is a newly formed company 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 agreed to make a best effort to repay within twelve months.
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 FASB Interpretation No. 46R (FIN 46R), the Company will reflect the consolidation of Alconbury as long as it is considered the "primary beneficiary" of Alconbury's variable interests. The Company will not record the gain and loss associated with the sale of the properties, nor recognize the associated changes in depreciation, interest, and rent expenses, until FIN 46R consolidation accounting no longer applies. At that time, the Company will record a non-cash loss of approximately $44 million for the sale of the UK properties, and a gain of approximately $6 million, amortized over the term of the lease, for the US property. In addition, the Company anticipates a net reduction in its annual depreciation charge of approximately $2.7 million, offset by a net increase of $0.5 million in interest and rent expenses. The Company anticipates that it will no longer be the primary beneficiary of Alconbury when the $10 million subordinated promissory note has been repaid.
LSR's executive office is based at the Princeton Research Center in East Millstone, New Jersey.
HISTORY
Huntingdon was originally incorporated in the UK in 1951 as a limited liability company to provide contract research services to the UK pharmaceutical, agrochemical and food industries. In 1964 it was acquired by the US company, Becton Dickinson. Over the next 20 years it successfully established itself as a leading Contract Research Organization (CRO) with business across a number of sectors and with a number of leading pharmaceutical and agrochemical companies. In April 1983, Huntingdon was re-registered as a public limited company and in 1988 it was floated on the London Stock Exchange. In early 1989 Huntingdon obtained a listing for its ADR's on the New York Stock Exchange.
In 1995, it acquired the toxicology business of APBI, which included laboratories near Princeton, New Jersey and Newcastle and Eye, Suffolk in the UK for a total consideration of $43 million. Immediately upon acquisition, the toxicology business of APBI in the UK was merged with that of Huntingdon Research Center Limited and the name of that company changed to Huntingdon Life Sciences Limited. The US business acquired operates as Huntingdon Life Sciences Inc.
In the first half of 1997, allegations were made relating to animal care and Good Laboratory Practice (GLP) against Huntingdon's operating subsidiaries in the UK and US. Those allegations and the UK Government's subsequent statement in the House of Commons in July 1997 about its investigation into those allegations caused the cancellation of booked orders and a decline in new orders. Significant trading losses and cash outflows resulted during the period from mid 1997 through 1998. Given the medium to long term element of many of Huntingdon's activities and the reluctance of clients to place new work until its finances were stabilized, Huntingdon required a substantial injection of finance to both initially restore confidence and then to fund operations during the period until it returned to profitability.
On September 2, 1998 a group of new investors, led by Andrew Baker, subscribed (pound)15 million ($25 million) for 120 million ordinary shares while existing shareholders and institutional investors took up a further 57 million shares, contributing (pound)7.1 million ($11.8 million). After expenses of (pound)1.7 million ($2.9 million), the issue of shares raised (pound)20.4 million ($33.9 million). On the same date Huntingdon's bankers agreed to continue Huntingdon's credit facilities at (pound)24.5 million ($40.8 million) until August 31, 2000 and this amount remained fully drawn down. This debt was refinanced on January 20, 2001 by means of a loan from HLSF LLC, a subsidiary company of the Stephens Group Inc., a related party at the time, which subsequently transferred the debt to an unrelated third party. That debt was paid in full on June 14, 2005 from the proceeds of the Sale/Leaseback Transaction plus cash on hand.
Since the involvement of the new investor group in 1998, the management team, led by Brian Cass, believes that LSR has successfully addressed many of the Company's past difficulties. Relationships with customers have been restored and sales are growing at an encouraging rate.
In November 1999, a new so called "animal rights" group known as "Stop Huntingdon Animal Cruelty" (SHAC) was formed in the UK with Huntingdon as its target. Since then, activists in both the UK and the US have continued focusing on Huntingdon (now LSR), its staff and directors, but also many other stakeholders in the business, including shareholders, financial institutions, suppliers and customers. For further details see Other Information Pertaining to the Company - Animal Rights Activism, below.
In October 2001, LSR commenced the Offer for Huntingdon, which was completed in March 2002 with Huntingdon becoming a wholly owned subsidiary of LSR. The effect of the Offer was to re-domicile Huntingdon's corporate and legal existence to the US. As a US company incorporated in Maryland, LSR benefits from a more hospitable corporate environment, including corporate governance and privacy rules and regulations that benefit LSR security holders. Moreover, the investment community in the US is more familiar with the CRO industry, since most publicly traded CRO's are domiciled in the US.
In March 2002, LSR completed a private placement of approximately 5.1 million shares of Voting Common Stock at a per share subscription price of $1.50 per share.
In April 2002, LSR began trading its common stock on the US Over the Counter Bulletin Board (OTCBB). Since February 6, 2006 it has traded on the Other OTC Market (Pink Sheets).
DESCRIPTION OF BUSINESS
The Company provides pre-clinical and non-clinical biological safety evaluation research services to most of the world's leading pharmaceutical, biotechnology, agrochemical and industrial chemical companies. The purpose of this safety evaluation is to identify risks to humans, animals or the environment resulting from the use or manufacture of a wide range of chemicals, which are essential components of our clients' products. The Company's services are designed to meet the regulatory requirements of governments around the world.
The Company's aim is to develop its business within these markets, principally in the pharmaceutical sector, and through organic growth. In doing so, the Company expects to benefit from strong drug pipelines in the pharmaceutical industry and a growing trend towards greater outsourcing as clients focus more internal resources on research and increasingly look to variabilize their development costs.
The Company's sales and marketing functions are specifically focused on two main groups, pharmaceutical and non-pharmaceutical customers. As much of the research activity conducted for these two customer groups is similar, the Company believes it is appropriate, operationally, to view this as one business.
Pharmaceuticals and Biopharmaceuticals
The pharmaceutical research and development pathway is shown below:
[GRAPHIC OMITTED]
The Company performs non-clinical testing in support of the drug development process, primarily work outsourced from the bio-pharmaceutical industry. Over 80% of the Company's orders are derived from this pharmaceutical sector. Essentially all of this work is performed as a result of regulatory requirements that seek to minimize the risks associated with the ultimate testing and use of these compounds in humans.
Pre-clinical testing helps to evaluate both how the drug affects the body as well as how the body affects the drug. Utilizing advanced laboratory and toxicological evaluations, this work helps assess safe and appropriate dose regimens. Other non-clinical testing can focus on identifying and avoiding the longer-term cancer implications of exposure to the compound, or relating to the potential of possible reproductive implications, as well as assessing the stability of pharmaceuticals under a variety of storage conditions.
The Company views its non-clinical market as extending all the way beyond marketing authorization, although the core market extends to "proof of concept" in man (Phase 2A). Since 1999, the Company has had collaborative relationships with a number of Phase I clinical trial units and offers centralized clinical laboratory services in support of clinical trials. The Company's market is further extended beyond pre-clinical with analytical chemistry support for clinical trials, establishing the stability of pharmaceuticals under varied storage conditions and the batch testing of marketed pharmaceuticals for product release.
The Company has also actively pursued opportunities to extend its range of capabilities supporting late stage drug discovery, focused around in vitro and in vivo models for lead candidate drug characterization and optimization. This growing range of biological services is intended to position the Company to take advantage of the increasing demand for a greater understanding of the physical, chemical and biological properties of intended therapeutics prior to the commencement of pre-clinical and clinical testing.
The outsourced market for the late stage clinical trials (Phase 3 and beyond) is also relevant to the Company. While the Company does not preclude entering this market in the future, it has no plan to do so in the foreseeable future, as it is a very different business and one in which a number of major companies are already firmly established.
Market Growth
It is estimated that the pharmaceutical industry annual research and development (R & D) spending is over $50 billion per year and is growing at around 10% per annum. Approximately 20% of this is devoted solely to pre-clinical testing and a further 10% to central laboratory services. The Company believes that approximately 20-25% of the pre-clinical is outsourced and almost all the central laboratory which means that the Company is today competing in a market which exceeds $3 billion. It is widely believed that this market will continue to grow for the foreseeable future, both in absolute dollar amount and in the percentage of pre-clinical work that is outsourced.
The market for these services is growing, among other things, due to the following:
o New drug discovery is growing fueled by new technologies and strong profits. The information obtained from the Human Genome Project has led to the greater understanding of the pathways underlying the mechanism of disease. This has, in turn, led to a growth in the use and understanding of the `omics (genomics, proteomics, etc.) and increased focus on target receptor based discovery.
o Preclinical development services should experience the higher growth first, as they are at the front end to receive the anticipated wave of new drug candidates generated by advances in drug discovery technologies.
o The need to replace earnings from drugs coming off patent, and anticipated decreasing price flexibility in key markets, is driving an increase in the number of drugs being put into development.
o It is estimated there has been a 30% increase in the numbers of projects in pre-clinical development since 2000.
o There is also a growing trend towards the outsourcing of development work as clients focus more internal resource on discovery research in the search for new lead compounds.
o The biotechnology industry has become a significant source of business for the Company. The number of drugs produced by the biotechnology industry, which require US Food and Drug Administration (FDA) approval has grown substantially over the past decade. Many biotechnology companies have strategically chosen not to invest in asset intensive development and regulatory safety evaluation, but rather to outsource major areas of R & D and utilize CROs to perform these services. This frees them from the capital-intensive requirement to establish and staff their own in-house facilities and then the inefficient utilization of those capabilities due to their sporadic and varied demand.
o The process of consolidation within the pharmaceutical industry is also accelerating the move towards outsourcing. While there is some short-term negative impact from mergers, with development pipelines being rationalized and a focus on integration rather than development, longer-term resources are increasingly invested in in-house facilities for discovery and lead optimization rather than development and regulatory safety evaluation. The Company's own research, supported by comments from the major competitors in this space, suggest that none of the major global pharmaceutical companies are currently investing in significant new safety evaluation facilities. Undertaking development work and safety evaluation is the Company's core business.
As a result of these, amongst other factors, it is believed that the overall market for outsourced services is estimated to be growing at a rate at least equal to the growth of research and development expenditure by the pharmaceutical industry.
Non-Pharmaceuticals
The Company currently generates approximately 20% of its orders from safety and efficacy testing of compounds for the agrochemical, industrial chemical, and veterinary and food industries. During 2005 non-pharmaceutical revenues were approximately the same as the prior year and a declining percent of total revenues, which is predicted to continue. The work involved has many similarities and often uses many of the same facilities, equipment, and scientific disciplines to those employed in pre-clinical testing of pharmaceutical compounds.
The Company's business in these areas is again driven by governmental regulatory requirements. The Company's services address safety concerns surrounding a diverse range of products, spanning such areas as agricultural herbicides and other pesticides, medical devices, veterinary medicines, and specialty chemicals used in the manufacture of pharmaceutical intermediates, and manufactured foodstuffs and products. The Company believes it is a clear market leader in programs designed to assess the safety, environmental impact and efficacy of agricultural chemicals as well as in programs to take new specialty chemicals to market.
Market Growth
It is estimated that the worldwide market for outsourced contract research from non-pharmaceutical industries is approximately $300 million. The growth in the non-pharmaceutical business is driven both by the introduction of novel compounds, and by legislation concerning the safety and environmental impact of existing products.
The Company believes that this segment is likely to experience relatively low growth in the next few years, although a number of market segments included in this broad area of business have the potential for some growth in the future due to the following:
o Continued implementation of testing requirements for `high production volume' (HPV) chemical products in Europe and the US.
o Introduction of new legislation for the notification of new and existing chemicals that are in use within the European Union (REACH).
o Safety testing of specific formulations of crop protection products on a country-by-country basis within the European Union (91/414).
o More stringent regulations affecting compounds, which have the potential to adversely affect the environment, (e.g. biocides and endocrine disrupters).
o Growth in concerns over food safety, (e.g. additives and genetically modified foods, and the introduction of `nutraceuticals').
o Developments of new markets such as China and the EU accession countries.
Safety testing in these industries is also more likely to be outsourced as, unlike the pharmaceutical industry, fewer companies have comprehensive internal laboratory facilities. While overall R & D is not growing, we believe that increased outsourcing could provide business opportunities in this market.
Customers
The Company offers worldwide pre-clinical and non-clinical testing for biological safety evaluation research services to human and veterinary pharmaceutical, biotechnology, agrochemical, industrial chemical and food companies. In 2005 the Company received orders from companies ranging from the largest in their industries to small and start-up organizations. 37 clients placed over $1 million of orders with the Company and the ten largest clients accounted for approximately 44% of orders. No single client accounted for more than 10% of net revenues for 2005.
For net revenues from clients, assets attributable to each of the Company's business segments, other segment information and a geographical analysis of revenues from clients (based on the location of the client) for each of the last three fiscal years, see note 13 to the audited consolidated financial statements included elsewhere in this Annual Report.
Backlog
The majority of the Company's net revenues are earned under contracts, which generally range in duration from a few months to three years. Revenue from these contracts is generally recognized over the term of the contract as services are rendered. The Company maintains an order backlog to track anticipated net revenues for work that has yet to be earned. Aggregate backlog at December 31, 2005 was $122 million compared to $119 million at December 31, 2004, which represents an increase of 7% exclusive of the impact of foreign exchange.
Segment Information
For a discussion of geographic segment information please see "Segment Analysis" beginning on page 32 and "Geographical Analysis" beginning on page 73.
COMPETITION
Competition in both the pharmaceutical and non-pharmaceutical market segments ranges from:
o in-house R&D divisions of large pharmaceutical, agrochemical and industrial chemical companies who perform their own safety assessments; to
o "full service" providers - CROs like LSR, who provide a full range of non-clinical safety services to the industries (such as Covance Inc., and Charles River Laboratories International, Inc.); and
o "niche" suppliers focusing on specific services, geographic areas, or industries (such as MDS, WIL Research, or SafePharm Labs).
GOVERNMENT REGULATION OF OPERATIONS
Regulatory agencies
Since the services provided by the Company are used to support pharmaceutical, biotechnological, chemical or agrochemical product approval applications, its laboratories are subject to both formal and informal inspections by appropriate regulatory and supervisory authorities, as well as by representatives from client companies. The Company is regularly inspected by US, Japan and UK governmental agencies because of the number and complexities of the studies it undertakes. In 1979, the US Food and Drug Administration (FDA) promulgated the Good Laboratory Practice (GLP) regulations, defining the standards under which biological safety evaluations are to be conducted. Other governmental agencies such as the Environmental Protection Agency (EPA), the Japanese Ministry Of Health and Welfare, the Japanese Ministry of Agriculture, Forestry and Fisheries, and the UK Department of Health, have introduced compliance-monitoring programs with similar GLP standards. During 2005 the Company in the UK had 2 GLP inspections; and in the US an FDA inspection. The Company has had numerous such inspections since 1995.
The Company's laboratory in the US is subject to the United States Department of Agriculture (USDA) Animal Welfare Regulations (Title 9, Code of Federal Regulations, Subchapter A). The laboratory is regularly inspected by USDA officials for compliance with these regulations. Compliance is assured through an Institutional Animal Care and Use Committee, comprising staff from a broad range of disciplines within the Company and including external representation. Furthermore, in the US there is a voluntary certification program run by an independent and internationally recognized organization, the Association for Assessment and Accreditation of Laboratory Animal Care (AAALAC). The Company's laboratories in both the US and UK are accredited under this program. The Company's pre-clinical services are subject to industry standards for the conduct of research and development studies that are embodied in the regulations for GLP. The FDA and other regulatory authorities require the test results submitted to such authorities be based on studies conducted in accordance with GLP. The Company must also maintain reports for each study for specified periods for auditing by the study sponsor and by FDA or other regulatory authorities.
The Company's operations in the UK are regulated by the Animals (Scientific Procedures) Act 1986. This legislation, administered by the UK Home Office, provides for the control of scientific procedures carried out on animals and regulation of their environment. Personal licenses (the Company has approximately 225 licensees) are issued by the UK Home Office to personnel who are competent to perform regulated procedures and each program of work must be authorized in advance by a Project Licensee. Premises where procedures are carried out must also be formally designated by the UK Home Office. Consultations and inspections are regularly undertaken in order to ensure continued compliance with regulatory and legislative requirements, the Company had 20 such visits in 2005.
At each of its research centers, the Company ensures the availability of suitably experienced and qualified veterinary staff backed by a 24-hour call out system.
COMPLIANCE WITH ENVIRONMENTAL REGULATIONS
While the Company conducts its business to comply with certain environmental regulations, compliance with such regulations does not impact significantly on its earnings or competitive position. Management believes that its operations are currently in material compliance with all applicable environmental regulations.
OTHER INFORMATION PERTAINING TO THE COMPANY
Human Resources
The Company's most important resource is its people. They have created the Company's knowledge base, its expertise and its excellent scientific reputation. Scientists from the Company are represented at the highest levels on several US, UK and international committees on safety and toxicity testing. Several staff members are considered leaders in their respective fields. They frequently lecture at scientific seminars and regularly publish articles in scientific journals. This recognition has resulted in frequent assignments from clients for consultation services. Some of the Company's staff serve by invitation or election on a number of scientific and industrial advisory panels and groups of certain organizations and agencies such as the FDA, the EPA, the UK Department of Health, and the World Health Organization.
To ensure that this experience and expertise is transmitted throughout the organization, the Company conducts training programs. For example, the Company's study director training programs train graduate staff in all phases of toxicology. Also, in conjunction with the Institute of Animal Technology, the Company maintains what it believes to be one of the largest animal technician training programs in the world. The Company employs approximately 240 licensed personnel.
The number of employees in the Company at December 31, 2005 and 2004 were as follows:
2005 2004 US ........................ 268 247 UK ........................ 1,128 1,129 Japan ..................... 11 11 ----------- ----------- 1,407 1,387 ----------- -----------
Management and Labor Relations
The Company's labor force is non-union and there has never been any disruption of the business through strikes or other employee action. The Company regularly reviews its pay and benefits packages and believes that its labor relations, policies and practices and management structure are appropriate to support its competitive position.
Acquisition of Huntingdon Life Sciences KK (HLS KK)
HLSKK has acted as the Company's marketing representative in Japan since 1996. This Company was a joint venture, 50% of which was owned by Huntingdon. On July 1, 2003, the remaining 50% of the shares in HLS KK, not previously owned by Huntingdon, was purchased, resulting in HLS KK becoming a wholly owned subsidiary of Huntingdon. The purchase price is payable over a three year period, and is equal to the greater of (a) $1 million or (b) the commission which would have been paid if the purchase had not happened at rates of between 2.5% and 4.5% of billings generated. Payments during that three year period shall be made at the rate which had been in effect for commissions prior to the acquisition, and is payable semi-annually. The amount paid in 2005 was $666,000, 2004 $577,000.
Prior to July 1, 2003, the shares owned by Huntingdon in HLS KK were held as an investment, as the day to day control of HLS KK was not exercised by the Company.
Research and Development
In addition to experience gained through research activities performed for clients, the Company engages in research in order to respond to the changing needs of clients and to maintain competitiveness within the industries in which it operates. Most of the research undertaken, however, is an inherent part of the research carried out on behalf of clients in completing studies and as such it is not identified separately.
Know-how and Patents
The Company believes that its proprietary know-how plays an important role in the success of its business. Where the Company considers it appropriate, steps are taken to protect its know-how through confidentiality agreements and protection through registration of title or use. However the Company has no patents, trademarks, licenses, franchises or concessions which are material and upon which any of the services offered are dependent.
Quality Assurance
The Company maintains extensive quality assurance programs, designed to ensure that all testing programs meet client requirements, as well as all relevant codes, standards and regulations. Based on a Master Schedule, periodic inspections are conducted as testing programs are performed to assure adherence to project specifications or protocols and final reports are extensively inspected to ensure consistency with data collected.
Animal Rights Activism
During the last decade there was an escalation in animal rights activity that targeted biomedical research internationally including academic, government and commercial organizations. As part of this increase a new campaign group (Stop Huntingdon Animal Cruelty, SHAC) was formed in the UK in November 1999. SHAC's broad aim is to end all animal research, while its immediate and publicly stated goal at that time was to "shut HLS down within three years". During 2000 this campaign broadened and intensified with a range of Huntingdon's stakeholders becoming potential targets; including staff, directors, institutional and personal shareholders, customers, financial institutions and other suppliers. The protest activities took many forms, both legal and illegal, such as demonstrations outside the Company's facilities and in local towns; distribution of propaganda; abuse, intimidation and threats directed at many of the stakeholders listed above; and, in occasional cases, acts of violence.
During 2001 and 2002 the incidents of violent protest in the UK appeared to diminish. However, activists focused their protest activities on the Company's financial institutions in unsuccessful attempts to deprive Huntingdon of its bank financing and to stop the US re-domiciling transaction. During this period, due in large part to the successful US re-domiciling, the activities of SHAC and other animal rights groups expanded to and intensified in the US, focusing on a similar range of stakeholders as had been targeted in the UK.
To counter this animal rights campaign the Company adopted a strategy of openness and direct co-operation with all its stakeholders, the media and the local communities. The Company has taken every opportunity to promote the value of the work it does in helping its customers bring to market safe and effective new medicines and other products. Members of the media, national bodies, schools and local groups have visited the Company, toured the laboratories and animal facilities, and talked with staff. These visitors have been consistently impressed with the Company's ethics, its standards of animal welfare and the professionalism of its staff. As a consequence of the Company's constructive, high profile, public relations activities and the irrationality of the animal rights messages, media coverage has become increasingly positive. Additionally, both in the US and the UK, the media has consistently condemned the illegal protest actions of the SHAC campaign.
Initiated by, and in conjunction with, the Company's leadership on this issue, there has been a marked increase in communication campaigns designed to inform the general public. These have focused on the essential nature of animal based research, the high standards of animal welfare demanded, the commitment to developing non-animal alternatives and the benefits of such research to society. Our clients' recognition of our scientific and professional integrity and leadership was evident in the granting of the prestigious UK Pharma Industry Individual Achievement Award to Brian Cass, the Company's President and Managing Director, in October 2001. In further recognition of his contribution to science and professional achievements, Mr. Cass was appointed as a Commander in the Most Excellent Order of the British Empire (CBE) in June 2002. The highly prestigious CBE is awarded on merit, for exceptional achievement or service; it is recommended by the Prime Minister of England, but is approved by the Queen.
In the UK the Company has successfully lobbied politicians and the British parliament, with great support from industry trade bodies such as the Association of the British Pharmaceutical Industry, Bioindustry Association, and Research Defence Society. As a result, the British Government has made very positive statements in support of the Company specifically and of biomedical research using animals in general. It has also been extremely critical of the illegal activities of some animal rights supporters. The Government has introduced legislation to offer more protection to those targeted and is encouraging the police and courts to ensure the law is enforced. This national initiative continues to develop, particularly as the government and police deal with protecting an increasing range of animal rights targets in the UK. Of particular note, in April 2005 the Serious Organised Crime and Police Act was introduced with new powers to deal with protests outside homes, harassment and economic damage. Moreover in July 2005 that Act was further amended to introduce the new offense of "interference with business contracts so as to damage an animal research organization", commonly referred to as the "economic terrorism law". These new measures are designed to tackle secondary and tertiary targeting by animal rights extremists, this is the intimidation of businesses doing business with animal research facilities. Additionally, legislation has been proposed by the Government to create an offense of "glorifying terrorism". There have been public statements made by the UK Home Secretary indicating the Government's intention to apply such legislation, if passed, to animal rights extremists.
Running in parallel with the introduction of new legislation the Company has used the civil route to protect itself and its staff. In April 2003 the Company obtained a groundbreaking legal injunction from the London High Court of Justice protecting its employees against harassment from SHAC and similar animal rights activists. This order, obtained under the Protection from Harassment Act, bans protesters from approaching within 50 yards of employees' homes and sets up similar exclusion zones around the Company's two UK research centers. Several months later, a group of five international Japanese pharmaceutical companies followed a similar course, obtaining protective injunctions for their employees who were being harassed. Since then approximately twenty other organizations similarly targeted by animal rights extremists have obtained injunctions of this type. Notably, during 2004, Oxford University became the target of animal rights extremists attempting to halt the construction of an animal research facility. The University also successfully obtained a broad-ranging injunction against such protests.
Although the animal rights movement is less developed in the US and appears to enjoy less public support than in the UK, the Company is addressing it proactively with actions similar to those it has utilized in the UK. These steps include a strategy of openness and media co-operation; legislative and regulatory lobbying in association with industry trade bodies such as Americans for Medical Progress, National Association for Biomedical Research and the Foundation for Biomedical Research; and legal actions including close co-operation with law enforcement authorities at all levels. For example, following incidents of vandalism associated with home protests against the Company's US employees, the Company obtained orders of the New Jersey Superior Court, the New York Supreme Court and the California Supreme Court placing restrictions on both home protests and protests at the Company's Princeton Research Center by animal rights activists. During 2002 criminal indictments were brought against SHAC extremists in New York City and Boston. In the New York prosecution, felony convictions, including prison terms, have been handed down. In Washington D.C., legislation was enacted in May 2002 which significantly increased the penalties under the Animal Enterprise Terrorism Act for acts of vandalism against medical research and animal based research facilities. In October 2005, legislation was introduced to expand the Animal Enterprise Terrorism Act to address secondary and tertiary targeting.
In May 2004, seven leading US animal rights extremists, including Kevin Kjonas, the President of SHAC-USA, were arrested and criminally indicted by the New Jersey US Attorney's Office on federal charges of animal enterprise terrorism, interstate stalking and conspiracy to engage in interstate stalking. Each of the charges carries a maximum penalty of three to five years in federal prison and a $250,000 fine for each count. An additional criminal charge of conspiracy to anonymously utilize a telecommunications device to abuse, threaten and harass persons was added to the indictment in September 2004. On March 2, 2006, SHAC-USA and the six individual defendants remaining in the case were convicted on all counts. Sentencing is scheduled for June 7, 2006, and the Government has indicated an intention to request prison sentences for the individual defendants of up to seven years.
Management recognizes that there are, and expects that there will always be, individuals with strong views on animal rights. Such people believe that animals should not be used for the betterment of humanity, including biomedical research. Regardless of whether this political issue directly impacts the Company's business, the Company remains committed to its strategy of informing the public of the value of biomedical research using animals, of advancing animal welfare, and of supporting our clients' desire to maximize the safety of vital new medicines and other products being developed for the benefit of society.
Available Information
The Company's Internet website is located at http://www.lsrinc.net. The Company posts on its website its filings with the Securities and Exchange Commission (SEC) including those on Form 10-K, Form 10-Q and Form 8-K. The reference to the Company's Internet website does not constitute incorporation by reference of the information contained on or hyperlinked from the Internet website and should not be considered part of this document.
The public may read and copy any materials the Company files with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Rooms by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The SEC's Internet website is located at http://www.sec.gov.
ITEM 1A.
ITEM 1A. RISK FACTORS
This section discusses various risk factors that are attendant to the Company's business and the provision of its services. If the events outlined below were to occur individually or in the aggregate, the Company's business, results of operations, financial condition, and cash flows could be materially adversely affected.
Changes in government regulation or in practices relating to the pharmaceutical industry could decrease the need for the services the Company provides
Governmental agencies throughout the world, but particularly in the United States, strictly regulate the drug development process. The Company's business involves helping pharmaceutical and biotechnology companies navigate the regulatory drug approval process. Changes in regulation, such as a relaxation in regulatory requirements or the introduction of simplified drug approval procedures, or an increase in regulatory requirements that the Company has difficulty satisfying or that make its services less competitive, could eliminate or substantially reduce the demand for the Company's services. Also, if government were to introduce measures to contain drug costs or pharmaceutical and biotechnology company profits from new drugs, the Company's customers may spend less, or reduce their growth in spending on research and development.
Failure to comply with applicable governmental regulations could harm the Company's business
As a company in the contract research industry, the Company is subject to a variety of governmental regulations, both in the US and the UK, relating to animal welfare and the conduct of its business. Failure by it to comply with such laws and regulations could result in material liabilities, the suspension of licenses or a material adverse effect on its business or financial condition. In addition, these laws and regulations could significantly restrict the Company's ability to expand its facilities or require it to acquire costly equipment or incur other material costs to comply with regulations.
The Company depends on the pharmaceutical and biotechnology industries
The Company's revenues depend greatly on the expenditures made by the pharmaceutical and biotechnology industries in research and development. Accordingly, economic factors and industry trends that affect the Company's clients in these industries also affect its business. For example, if health insurers were to change their practices with respect to reimbursements for pharmaceutical products, the Company's customers may spend less, or reduce their growth in spending on research and development.
Pharmaceutical industry consolidation may negatively impact revenues
The process of consolidation within the pharmaceutical industry should accelerate the move towards outsourcing work to contract research organizations such as the Company in the longer term as resources are increasingly invested in in-house facilities for discovery and lead optimization, rather than development and regulatory safety evaluation. However, in the short term, there is a negative impact with development pipelines being rationalized and a focus on integration rather than development. This can have a material adverse impact on the Company's net revenues and net income.
The Company competes in a highly competitive market
Competition in both the pharmaceutical and non-pharmaceutical market segments ranges from in-house research and development divisions of large pharmaceutical, agrochemical and industrial chemical companies, who perform their own safety assessments, to contract research organizations like the Company who provide a full range of services to the industries and niche suppliers focusing on specific services or industries.
Providers of outsourced drug development services compete on the basis of many factors, including the following:
- - reputation for on-time quality performance; - - expertise, experience and stability; - - scope of service offerings; - - how well services are integrated; - - strength in various geographic markets; - - technological expertise and efficient drug development processes; and - - ability to acquire, process, analyze and report data in a time-saving, accurate manner.
The Company has traditionally competed effectively in the above areas, but there can be no assurance that it will be able to continue to do so. If the Company fails to compete successfully, its business could be seriously harmed.
The Company may not be able to successfully develop and market or acquire new services
The Company may seek to develop and market new services that complement or expand its existing business or expand its service offerings through acquisition. If the Company is unable to develop new services and/or create demand for those newly developed services, or expand its service offerings through acquisition, its future business, results of operations, financial condition, and cash flows could be adversely affected.
The Company may expand its business through acquisitions
The Company may expand its business through acquisitions. Factors which may affect its ability to grow successfully through acquisitions include:
o difficulties and expenses in connection with integrating the acquired companies and achieving the expected benefits; o diversion of management's attention from current operations; o the possibility that the Company may be adversely affected by risk factors facing the acquired companies; o acquisitions could be dilutive to earnings, or in the event of acquisitions made though the issuance of the Company's common stock to the shareholders of the acquired company, dilutive to the percentage of ownership of the Company's existing stockholders; o potential losses resulting from undiscovered liabilities of acquired companies not covered by the indemnification the Company may obtain from the seller; o risks of not being able to overcome differences in foreign business practices, language and other cultural barriers in connection with the acquisition of foreign companies; and o loss of key employees of the acquired companies.
The Company's non-US locations account for a majority of its revenues, making the Company exposed to risks associated with operating internationally
Approximately 80% of the Company's revenues are generated by its facilities outside the United States. As a result of these foreign sales and facilities, the Company's operations are subject to a variety of risks unique to international operations, including the following:
o adverse changes in value of foreign currencies against the US dollar in which results are reported; o import and export duties and value-added taxes; o import and export regulation changes that could erode profit margins or restrict exports; o potential restrictions on the transfer of funds; and o the burden and cost of complying with foreign laws.
The Company is exposed to exchange rate fluctuations and exchange controls
The Company's Convertible Capital Bonds are 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 the debt as a function of relative changes in foreign exchange rates.
The Company operates on a world-wide 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.
As the Company operates on an international basis, movements in exchange rates, particularly against sterling, can have a significant impact on its price competitiveness vis a vis competitors who trade in currencies other than sterling or dollars.
The Company's quarterly operating results may vary
The Company's operating results may vary significantly from quarter to quarter and are influenced by factors over which it has little control such as:
o exchange rate fluctuations; o the commencement, completion or cancellation of large contracts; o the progress of ongoing contracts; o changes in the mix of its services.
Management believes that operating results for any particular quarter are not necessarily a meaningful indication of future results. While fluctuations in the Company's quarterly operating results could negatively or positively affect the market price of its common stock, these fluctuations may not be related to the Company's future overall operating performance.
The Company's contracts are generally terminable on little or no notice. Termination of a large contract for services or multiple contracts for services could adversely affect the Company's revenue and profitability
In general, the Company's clients may terminate the agreements that they enter into with the Company or reduce the scope of services under these contracts upon little or no notice. Contracts may be terminated for various reasons, including:
- - unexpected or undesired study results; - - production problems resulting in shortages of the drug being tested; - - adverse reactions to the drug being tested; - - regulatory restrictions placed on the drug or compound being tested; or - - the client's decision to forego or terminate a particular study
Because most of the Company's pre-clinical revenues are from fixed price contracts, these contracts may be subject to under-pricing and cost overruns
The majority of the Company's contracts with its clients are fixed price contracts creating the risk of cost overruns under these contracts. The Company typically has some flexibility under these contracts to adjust the price to be charged under these contracts if it is asked to provide additional services. If the Company did have to bear significant costs of under-pricing or cost-overruns under these contracts, its business, financial condition and operating results could be adversely affected.
The Company depends on its senior management team, and the loss of any member may adversely affect its business
The Company believes its success will depend on the continued employment of its senior management team, especially Andrew Baker (Chairman and CEO) and Brian Cass (President and Managing Director). If one or more members of the senior management team were unable or unwilling to continue in their present positions, those persons could be difficult to replace and the Company's business could be harmed. If any of the Company's key employees were to join a competitor or to form a competing company, some of the Company's clients might choose to use the services of that competitor or new company instead of the Company. Furthermore, clients or other companies seeking to develop in-house capabilities may hire away some of the Company's senior management or key employees. The loss of one or more of these key employees could adversely affect the Company's business.
The Company must recruit and retain qualified personnel
Because of the specialized scientific nature of the Company's business, it is highly dependent upon qualified scientific, technical and managerial personnel. There is intense competition for qualified personnel in the pharmaceutical and biotechnology fields. Therefore, although traditionally the Company has experienced a relatively low turnover in its staff, in the future it may not be able to attract and retain the qualified personnel necessary for the conduct and further development of its business. The loss of the services of existing personnel, as well as the failure to recruit additional key scientific, technical and managerial personnel in a timely manner, could have a material adverse effect on the Company's ability to expand its businesses and remain competitive in the industries in which it participates.
Reliance on transportation
The Company's central laboratories operation, to a lesser extent, its other businesses, are heavily reliant on transport for the movement of clinical trial kits and other material and a significant disruption to the transport systems could have a material adverse effect on the Company's business.
The Company relies on third parties for important services
The Company depends on third parties to provide it with services critical to its business. The failure of any of these third parties to adequately provide the needed services could have a material adverse effect on the Company's business.
Actions of animal rights extremists may affect the Company's business
The Company's development services utilize animals (predominantly rodents) to test the safety and efficacy of drugs. Such activities are required for the development of new medicines and medical devices under regulatory regimes in the United States, Europe, Japan and other countries. The Company is targeted by extreme animal rights activists who oppose all testing on animals, for whatever purpose, including the Company's animal testing activities in support of its safety and efficacy testing for clients. These groups, which include Stop Huntingdon Animal Cruelty (SHAC) and the Animal Liberation Front (ALF), among others, have publicly stated that the goal of their campaign is to "shut Huntingdon". Acts of vandalism and other acts by these animal rights extremists who object to the use of animals in drug development could have a material adverse effect on the Company's business.
Animal rights extremists have targeted, and may continue to target, the US financial community that trades LSR Voting Common Stock, which has caused and may continue to cause illiquidity and a lower market price of the Voting Common Stock.
The animal rights extremists have in the past harassed the financial community that trades in LSR shares, including market makers and stockbrokers. As a result, LSR has had difficulty identifying market makers to make a market in the Voting Common Stock, which has greatly reduced liquidity in those shares. The liquidity and market price of the shares of LSR Voting Common Stock could be adversely affected in the future by such actions.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
N/A
ITEM 2.
ITEM 2. PROPERTIES
The Company's head office is situated within the Princeton Research Center in New Jersey.
The Company believes that its facilities, described below, are adequate for its operations and that suitable additional space will be available if and when needed.
The following table shows the location of the facilities of the Company, approximate size, based on occupancy, and the principal activities conducted at such facilities.
On June 14, 2005 the Company entered into and consummated the Sale/Leaseback Transaction with Alconbury, a newly formed company wholly owned by LSR's Chairman and CEO, Andrew Baker.
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. Base aggregate annual rent for the facilities is $4.9 million (approximately $1.8 million in the US and approximately $3.1 million in the UK) which amount will increase by 3% each 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 will be required at such time that Alconbury refinances its current financing arrangements. Additionally, because the leases are "triple net" leases, LSR will also pay for all of the costs associated with the operation of the facilities, including costs such as insurance, taxes and maintenance.
The proceeds from the Sale/Leaseback Transaction (plus additional cash in hand) were used by the Company to pay in full its (pound)22.6 million non-bank debt (approximately $41.4 million).
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is party to certain legal actions arising out of the normal course of its business. In management's opinion, none of these actions will have a material effect on the Company's operations, financial condition or liquidity. No form of proceedings has been brought, instigated or is known to be contemplated against the Company by any governmental agency.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year ended December 31, 2005, to a vote of the stock holders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
LSR's Voting Common Stock trades on the Other OTC Market (Pink Sheets) under the symbol "LSRI". The closing market price of the Voting Common Stock on March 10, 2006 was $10.00 per share.
Until January 24, 2002 Huntingdon's Ordinary Shares were listed on the London Stock Exchange Ltd., under the Stock Exchange Automated Quotation symbol "HTD". The company completed its re-domiciling from the UK to the US on March 26, 2002 with a conversion ratio of 50:1 for the HTD common shares to LSR common shares (or a ratio of 2 HTD ADRs per 1 LSR common share). LSR common stock commenced trading on the Over the Counter Bulletin Board (OTCBB) Market on April 8, 2002.
The Company's common stock traded on the OTCBB up until February 6, 2006. Since that time it has traded on the Other OTC Market (Pink Sheets). The high and low quarterly sales price of LSR's common stock on the OTCBB for the two years to December 31, 2005 were as follows:
HIGH SALES LOW SALES QUARTER ENDED PRICE PRICE - ------------- ------------------ ----------------- $ $ March 31, 2004 2.80 1.75 June 30, 2004 5.00 1.60 September 30, 2004 7.15 4.00 December 31, 2004 12.50 6.95 March 31, 2005 13.25 10.50 June 30, 2005 13.25 11.00 September 30, 2005 18.30 11.75 December 31, 2005 15.60 8.00
In August 2005, the New York Stock Exchange (the "NYSE") approved the Company's Voting Common Stock for listing on the NYSE and agreed to commence trading in that stock on September 7, 2005 under the ticker symbol "LSR". However on September 7, 2005, the NYSE postponed that commencement of trading without official explanation. Since that date the Company has received no specific information from the NYSE about the status of that postponement. A NYSE representative publicly stated at a US Senate Committee hearing in October 2005, that "we continue to consider the application". The Company does not know when, or whether, the postponement will be lifted and the Voting Common Stock will commence trading on the NYSE.
The Company has not paid any cash dividends in the two most recent fiscal years and does not expect to declare or pay cash dividends on the Company's Voting Common Stock in the near future. The Board of Directors will determine the extent to which legally available funds will be used to pay dividends. In making decisions regarding dividends, the Board will exercise its business judgment and will take into account such matters as results of operations and financial condition and any then-existing or proposed commitments for the use of available funds.
Life Sciences Research Limited, the UK holding company for the two main operating companies Huntingdon Life Sciences Limited and Huntingdon Life Sciences Inc. has a deficit on shareholders equity of (pound)34.6 million. Until this deficit is cleared, under UK company law it is not permitted to pay dividends to its parent company, LSR. This may effect the payment of dividends by LSR.
As of March 13, 2006 LSR had 2,123 holders of record of Voting Common Stock
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. $128,000 of such promissory notes have been repaid to the end of 2005.
Equity Incentive Plans
LSR 2001 Equity Incentive Plan (the "LSR 2001 Equity Incentive Plan")
The LSR Board has adopted the LSR 2001 Equity Incentive Plan. Adoption of the LSR 2001 Equity Incentive Plan enables LSR to use stock options (and other stock-based awards) as a means to attract, retain and motivate key personnel. This stock option plan was approved by the shareholders of LSR, prior to the acquisition of Huntingdon.
Awards under the LSR 2001 Equity Incentive Plan (which has designated the Compensation Committee for such purpose) may be granted by a committee designated by the LSR Board pursuant to the terms of the LSR 2001 Equity Incentive Plan and may include: (i) options to purchase shares of LSR Voting Common Stock, including incentive stock options ("ISOs"), non-qualified stock options or both; (ii) stock appreciation rights ("SARs"), whether in conjunction with the grant of stock options or independent of such grant, or stock appreciation rights that are only exercisable in the event of a change in control or upon other events; (iii) restricted stock consisting of shares that are subject to forfeiture based on the failure to satisfy employment-related restrictions; (iv) deferred stock, representing the right to receive shares of stock in the future; (v) bonus stock and awards in lieu of cash compensation; (vi) dividend equivalents, consisting of a right to receive cash, other awards, or other property equal in value to dividends paid with respect to a specified number of shares of LSR Voting Common Stock or other periodic payments; or (vii) other awards not otherwise provided for, the value of which are based in whole or in part upon the value of the LSR Voting Common Stock. Awards granted under the LSR 2001 Equity Incentive Plan are generally not assignable or transferable except pursuant to a will and by operation of law.
The flexible terms of the LSR 2001 Equity Incentive Plan are intended to, among other things, permit the Compensation Committee to impose performance conditions with respect to any award, thereby requiring forfeiture of all or part of any award if performance objectives are not met or linking the time of exercisability or settlement of an award to the attainment of performance conditions. For awards intended to qualify as "performance-based compensation" within the meaning of Section 162(m) of the United States Internal Revenue Code such performance objectives shall be based solely on (i) annual return on capital; (ii) annual earnings or earnings per share; (iii) annual cash flow provided by operations; (iv) changes in annual revenues; (v) stock price; and/or (vi) strategic business criteria, consisting of one or more objectives based on meeting specified revenue, market penetration, geographic business expansion goals, cost targets, and goals relating to acquisitions or divestitures.
LSR's Compensation Committee, which administers the 2001 LSR Equity Incentive Plan, has the authority, among other things, to: (i) select the directors, officers and other employees and independent contractors entitled to receive awards under the 2001 LSR Equity Incentive Plan; (ii) determine the form of awards, or combinations of awards, and whether such awards are to operate on a tandem basis or in conjunction with other awards; (iii) determine the number of shares of LSR Voting Common Stock or units or rights covered by an award; and (iv) determine the terms and conditions of any awards granted under the 2001 LSR Equity Incentive Plan, including any restrictions or limitations on transfer, any vesting schedules or the acceleration of vesting schedules, any forfeiture provision or waiver of the same and including any terms and conditions necessary or desirable to ensure the optimal tax result for participating personnel and the Company including by way of example to ensure that there is no tax on the grant of the rights and that such tax only arises on the exercise of rights or otherwise when the LSR Voting Common Stock unconditionally vests and is at the disposal of such participating personnel. The exercise price at which shares of LSR Voting Common Stock may be purchased pursuant to the grant of stock options under the 2001 LSR Equity Incentive Plan is to be determined by the option committee at the time of grant in its discretion, which discretion includes the ability to set an exercise price that is below the fair market value of the shares of LSR Voting Common Stock covered by such grant at the time of grant.
The number of shares of LSR Voting Common Stock that may be subject to outstanding awards granted under the 2001 LSR Equity Incentive Plan (determined immediately after the grant of any award) may not exceed 20 percent of the aggregate number of shares of LSR Voting Common Stock then outstanding.
The 2001 LSR Equity Incentive Plan may be amended, altered, suspended, discontinued, or terminated by the LSR Board without LSR Voting Common Stockholder approval unless such approval is required by law or regulation or under the rules of any stock exchange or automated quotation system on which LSR Voting Common Stock is then listed or quoted. Thus, LSR Voting Common Stockholder approval will not necessarily be required for amendments, which might increase the cost of the plan or broaden eligibility. LSR Voting Common Stockholder approval will not be deemed to be required under laws or regulations that condition favorable tax treatment on such approval, although the LSR Board may, in its discretion, seek LSR Voting Common Stockholder approval in any circumstances in which it deems such approval advisable.
The LSR Board has designated the Compensation Committee of the Board to serve as the stock option committee. LSR made grants under the LSR 2001 Equity Incentive Plan on March 1, 2002 to certain directors and key employees at the time.
Grants to Directors ======================================================= Name Number Granted - ---- -------------- Gabor Balthazar 20,000 John Caldwell 20,000 Kirby Cramer 40,000
Grants to Named Executive Officers - ---------------------------------- Name Number Granted - ---- -------------- Andrew Baker 200,000 Mark Bibi 50,000 Brian Cass 200,000 Julian Griffiths 60,000 Richard Michaelson 90,000
All such options have ten-year terms; 50% of the shares subject to grant are immediately exercisable with the remaining 50% exercisable one year after the grant date (meaning all such options fully vested as of March 1, 2003); and all have an exercise price of $1.50 per share, the price at which the Company sold shares of Common Stock in the Private Placement. Options to purchase an aggregate of 1,188,000 shares of LSR Common Stock (including those specified above) were granted during the two years 2002 and 2003 to employees and directors, on the terms set forth above, are listed below.
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- March 1, 2002 1,142,000 $1.50 September 3, 2002 20,000 $2.40 October 21, 2002 15,000 $2.03 February 14, 2003 11,000 $1.80
In 2004, in addition to the options granted under the 2004 LTIP referred to below, options to purchase an aggregate of 67,100 shares of LSR Common Stock were issued, all at exercise prices equal to the market price at the date of grant, on the terms set forth in the previous paragraph, are listed below.
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- April 12, 2004 37,100 $1.85 October 28, 2004 17,400 $7.70 December 15, 2004 12,600 $9.52
In 2005, options to purchase an aggregate of 23,600 shares of LSR Common Stock were issued, all at exercise prices equal to the market price at the date of grant, or the terms set forth above, are listed below:
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- May 23, 2005 3,600 $12.00 June 27, 2005 20,000 $11.00
2004 Long Term Incentive Plan
Effective June 1, 2004 the Company adopted the 2004 Long Term Incentive Plan ("2004 LTIP"), pursuant to the terms of the 2001 Equity Incentive Plan. The 2004 LTIP has two components: a grant of stock options, with a vesting date of March 31, 2007, and a cash bonus to be awarded in 2007 based on 2006 Company financial performance.
Options to purchase an aggregate of 362,663 shares of common stock were granted to 32 key employees of the Company as of June 1, 2004 under the 2004 LTIP; 55,500 of such options were granted to Andrew Baker, the Company's Chairman and CEO, 55,500 of such options were granted to Brian Cass, the Company's Managing Director and President, 30,303 of such options were granted to Richard Michaelson, the Company's CFO, 27,750 of such options were granted to Julian Griffiths, the Company's Vice President of Operations and 20,545 were granted to Mark Bibi, the Company's General Counsel and Secretary. The exercise price of all such options is $3.30, the market price of LSR common stock on June 1, 2004. All such options have ten-year terms and are exercisable in full on March 31, 2007. At December 31, 2005, 356,419 shares under the 2004 LTIP option plan were outstanding and none were exercisable.
The following table summarizes stock option activity under the Company's option plans.
Huntingdon Life Sciences Group plc Stock Option Plans
Huntingdon Life Sciences Group plc issued options prior to December 31, 1997 pursuant to several stock option plans. However, the ability to exercise options under all such Huntingdon plans lapsed on March 26, 2002 in connection with LSR's acquisition of Huntingdon, except for those granted under the Unapproved Stock Option Plan (the "Unapproved Plan"). Under the Unapproved Plan, some options technically remain outstanding. However, such options are exercisable only for shares of Huntingdon, a 100% wholly owned subsidiary of LSR, and as such are considered to have no value.
Warrants
On October 9, 2001, on behalf of Huntingdon, LSR issued to Stephens Group Inc. warrants to purchase up to 704,425 shares of LSR Voting Common Stock at a purchase price of $1.50 per share. Stephens Group Inc. subsequently sold the warrants to independent third parties. 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., (Stephens' Loan) 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 warrants were exercised in 2005.
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. The 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. None of these warrants have been exercised as of December 31, 2005.
On October 24, 2003, 100,000 warrants were issued at the market price on the day of $2.05. On January 4, 2005 100,000 warrants were issued at the market price on the day of $10.70. 50,000 are exercisable from January 4, 2007 and 50,000 from January 4, 2008. In all cases, these warrants were issued to independent consultants in connection with financial and strategic advice.
On November 9, 2005 625,000 warrants were issued to a third party advisory/lobbying firm at the closing market price on the day of $10.46. These warrants will vest upon the successful completion of specific goals outlined in the engagement letter with such firm, and will expire on November 9, 2010.
On November 9, 2005 300,000 warrants were issued to an independent third party financial advisor as partial consideration for providing financial advisory services to the Company in obtaining financing. These were issued at an exercise price of $10.46 per share, the closing market price on the date the Company engaged the financial advisor. Such warrants will vest upon closing of said financing, and will expire on November 9, 2005.
See Note 16 - Subsequent Events
In accordance with Emerging Issues Task Force No. 96-18, the Company has recorded the value of the November 2005, performance-based warrant issuances, at their lowest aggregate market value, which is zero. When the performance conditions have been met, the Company will record these issuances based upon the fair value of the warrants on the date of performance completion.
A summary of warrants outstanding at December 31, 2005 is as follows:
Date of Issue Warrants Exercise Price Expiration Date - -------------- -------- -------------- --------------- October 9, 2001 550,000 $1.50 October 9, 2011 June 11, 2002 410,914 $1.50 June 11, 2012 October 24, 2003 100,000 $2.05 October 24, 2013 January 4, 2005 100,000 $10.70 January 4, 2015 November 9, 2005 625,000 $10.46 November 9, 2010 November 9, 2005 300,000 $10.46 November 9, 2015
Share purchase loan
Brian Cass, President and Managing Director of LSR, acquired 400,000 shares of LSR Common Stock in the Private Placement. Mr. Cass acquired such shares through the delivery of two promissory notes. Both such promissory notes, each in the amount of (pound)211,679 ($363,411), are due on March 28, 2007; bear interest at the rate of 5% per annum; and are secured by the 200,000 shares of LSR Common Stock purchased with the proceeds of each such loan. The due date of each promissory note would be accelerated if Mr. Cass voluntarily resigned from his employment with LSR or had his employment terminated. Repayment of one of the promissory notes will be made by automatic deduction of (pound)44,000 ($75,539) per year from the (pound)66,000 ($113,309) per year pension contribution made by the Company to a pension plan established by Mr. Cass. The other note is further collateralized by the (pound)214,500 ($368,254) accrued in such pension account. In addition, one-third of any yearly bonus received by Mr. Cass will be used to reduce the principal of the promissory notes. Total amount of this loan as of December 31, 2005 is (pound)120,000 ($205,000 at year-end foreign exchange rates).
Julian Griffiths, a former director of LSR and current Vice President of Operations, acquired 50,000 shares of LSR Common Stock in the Private Placement. Mr. Griffiths acquired such shares through the delivery of a promissory note in the principal amount of (pound)52,817 ($90,676), which was due on March 28, 2007; bore interest at the rate of 5% per annum; and was secured by the 50,000 shares of LSR Common Stock purchased with the proceeds of the loan. This loan was paid in full in 2003.
Repurchase of equity securities
The Company did not repurchase any equity securities during 2005.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below as of and for each of the years ended December 31, 2005, 2004, 2003, 2002 and 2001 has been derived from LSR's audited consolidated financial statements on Form 10-K.
The selected consolidated financial data should be read in conjunction with LSR's audited consolidated statements and accompanying notes included elsewhere in this Annual Report. See also "Management's Discussion and Analysis of Financial Conditions and Results of Operations". Historical consolidated financial data may not be indicative of the Company's future performance.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following should be read in conjunction with the consolidated financial statements of LSR as presented in "Item 8, Financial Statements and Supplementary Data".
The Company is a global provider of pre-clinical and non-clinical safety testing services to the pharmaceutical, agrochemical and industrial chemical industries. The Company provides those services under contracts, which may range from one day to three years. Income from these contracts is recognized as services are rendered towards the preparation of the final report. Contracts are generally terminable upon notice by the client with the client being responsible for reimbursing the Company for the value of work performed through the date of cancellation plus the value of work required to wind down a study on an orderly basis.
The Company's business is characterized by high fixed costs, in particular staff and facility related costs. Such a high proportion creates favorable conditions for the Company as excess capacity is utilized, such as has been the case during the last three years. However, during periods of declining revenue, careful planning is required to reduce costs without impairing revenue-generating activities.
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 generally recognized over the term of the contracts as services are rendered. Contracts may contain provisions for re-negotiation in the event of cost overruns due to changes in the level of work scope. Renegotiated amounts are included in net revenue when earned and realization is assured. Provisions for losses to be incurred on contracts are recognized in full in the period in which it is determined that a loss will result from performance of the contractual arrangement. Most service contracts may be terminated for a variety of reasons by the Company's customers, either immediately or upon notice of a future date. The contracts generally require payments to the Company to recover costs incurred, including costs to wind down the study, and payment of fees earned to date, and in some cases to provide the Company with a portion of the fees or income that would have been earned under the contract had the contract not been terminated early.
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).
If the Company does not accurately estimate the resources required or the scope of work to be performed, or does not manage its projects properly within the planned periods of time or satisfy its obligations under the contracts, then future margins may be significantly and negatively affected or losses on existing contracts may need to be recognized. While such errors have not historically been significant, any such resulting reductions in margins or contract losses could be material to the Company's results of operations.
Use of estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of the financial statements and the results of operations during the reporting periods. These also include management estimates in the calculation of pension liabilities covering discount rates, return on plan assets and other actuarial assumptions. 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 ("SFAS") 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. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. Likewise, should the Company determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax assets would increase income in the period such determination was made.
Consolidation of Alconbury
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 is a newly formed company 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 agreed to make a best effort to repay within twelve months.
In accordance with the provisions of FASB Interpretation No. 46R (FIN 46R), the Company will reflect the consolidation of Alconbury as long as it is considered the "primary beneficiary" of Alconbury's variable interests. The Company will not record the gain and loss associated with the sale of the properties, nor recognize the associated changes in depreciation, interest, and rent expenses, until FIN 46R consolidation accounting no longer applies. At that time, the Company will record a non-cash loss of approximately $44 million for the sale of the UK properties, and a gain of approximately $10 million, amortized over the term of the lease, for the US property. In addition, the Company anticipates a net reduction in its annual depreciation charge of approximately $2.7million, offset by a net increase of $0.5 million in interest and rent expenses. The Company anticipates that it will no longer be the primary beneficiary of Alconbury when the $10 million subordinated promissory note has been repaid.
RESULTS OF OPERATIONS
Year ended December 31, 2005 compared with year ended December 31, 2004
Revenues in the year ended December 31, 2005 were $172.0 million, an increase of 9.2% on revenues of $157.6 million for the year ended December 31, 2004. The underlying increase, after adjusting for the impact of the movement in exchange rates was 9.7%; with the UK showing a 6.9% increase and the US a 21.6% increase. The growth in revenues reflects the increase in orders and, consequently, backlog over the last 18 months, principally from the pharmaceutical industry. Orders for the year ended December 31, 2005, of $182.7 million at constant exchange rates were 3% above the previous year. At December 31, 2005 backlog (booked-on work) amounted to approximately $122 million, an increase of 3% above the level at December 31, 2004 (7% net of foreign currency effect). The growth in revenues in the UK was lower than that in the US, in part because the UK includes a higher proportion of non-pharmaceutical business, a market that is not growing.
Cost of sales in the year ended December 31, 2005 were $124.8 million (72.6% of revenue), an increase of 6.6% on cost of sales of $117.1 million (74.3% of revenue) for the year ended December 31, 2004. The underlying increase after adjusting for the impact of the movement in exchange rates was 7.3%. In the UK cost increases in sterling were only 4.7%, which is lower than the revenue growth as capacity is filled without the corresponding increase in fixed costs, the main increase being in labour and direct study costs. Increases in costs in the US were 18.6%, mainly due to increases in labor costs and direct study costs reflecting the growth in revenues.
Selling, general and administrative expenses rose by 6.1% to $26.2 million for the year ended December 31, 2005 (15.2% of revenue) from $24.7 million (15.7% of revenue) in the year ended December 31, 2004. The underlying increase after adjusting for the impact of the movement in exchange rates was 2.9%.
Net interest expense increased by 22.6% to $8.0 million for the year ended December 31, 2005 from $6.5 million in the year ended December 31, 2004. Approximately $1.1 million of this increase was due to higher rates of interest as a result of the Sale/Leaseback transaction and a further $0.2 million represented additional expense associated with the warrants.
Other expense of $7.4 million for the year ended December 31, 2005 comprised $5.1 million from the non-cash foreign exchange remeasurement loss on the Convertible Capital Bonds denominated in US dollars (the functional currency of the financing subsidiary that holds the bonds is UK sterling), finance arrangement fees of $2.8 million, offset by other exchange gains $0.5 million. In the year ended December 31, 2004 there was other income of $2.9 million which was comprised of a non-cash foreign exchange remeasurement gain on the Capital Bonds of $3.3 million offset by $0.4 million relating to the cost of a currency hedge contract.
Taxation expense on income for the year ended December 31, 2005 was $4.1 million representing an expense at 73% compared to a taxation benefit of $5.4 million representing a benefit at 44% for the year ended December 31, 2004. A reconciliation between the US statutory tax rate and the effective rate of income tax benefit on losses before income taxes for the year ended December 31, 2005 and December 31, 2004 is shown below:
% of income before income taxes 2005 2004 % %
US statutory rate 35 35 Foreign rate differential 24 (6) US property sale gain 59 - UK R & D credit and non-deductible items (45) (36) State taxes 8 1 Change in estimate (8) (38) --------------- -------------- Effective tax rate 73 (44) --------------- --------------
The US leaseback gain has arisen from the sale of the US property as part of the sale and leaseback deal. The gain on the sale of the UK assets has been offset against brought forward capital losses resulting in a deferred tax movement.
The losses before tax of the British Virgin Islands represents the Alconbury balances which have been consolidated in accordance with the provisions of FASB Interpretation No. 46R.
The main reason for the change in estimate in 2004 relates to the Huntingdon 2003 tax provisions. The UK government from April 1, 2002 introduced a new tax allowance, `Research and Development (R & D) Tax Credit', for large companies. At the end of 2002, it was not certain how this would apply to Huntingdon. When submitting Huntingdon's 2002 corporation tax computation, and following discussions with the UK Inland Revenue, Huntingdon made a claim for the R & D Tax Credit, which has now been accepted. The 2003 provision has been included in the 2004 change in estimate. The 2004 and 2005 claims are part of the non-deductible items above.
The overall net income for the year ended December 31, 2005 was $1.5 million compared to $17.6 million in the year ended December 31, 2004. The diluted income per share for the year ended December 31, 2005 was $0.10 compared to $1.29 for the year ended December 31, 2004.
Earnings before interest, taxes, depreciation and amortization, other income/(expense) and other operating expenses in 2005 ("EBITDA") was $30.6 million, or 17.8% of revenues, compared with $25.4 million, or 16.1% of revenues for 2004.
The Company believes that EBITDA information, which for this Company excludes other income/(expense) and other operating expenses, enhances an investor's understanding of our financial performance and our ability to satisfy principal and interest obligations with respect to our indebtedness. However, EBITDA should not be considered in isolation or viewed as a substitute for net income, cash flow from operations or other measures of performance as defined by generally accepted accounting principles in the United States. We understand that while securities analysts, lenders and others in their evaluation of companies frequently use EBITDA, EBITDA as used herein is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation. Our management uses EBITDA to assess financial performance and debt service capabilities. In assessing financial performance, our management reviews EBITDA as a general indicator of economic performance compared to prior periods. Because EBITDA excludes interest, income tax, depreciation and amortization, other income/(expense) and other operating expenses, EBITDA provides an indicator of general economic performance that is not affected by changes in debt levels, fluctuations in interest rates or effective tax rates, levels of depreciation and amortization, exchange rate movements on the Convertible Capital Bonds or one off operating expenses. Our management believes this type of measurement is useful for comparing general operating performance from period to period and making certain management decisions. Nevertheless, our management recognizes that there are material limitations associated with the use of EBITDA as compared to n et income, which reflects overall financial performance, including the effects of interest, taxes, depreciation, amortization, other income/(expense) and other operating expenses.
Year ended December 31, 2004 compared with the year ended December 31, 2003
Revenues in the year ended December 31, 2004 were $157.6 million, an increase of 19% on revenues of $132.4 million for the year ended December 31, 2003. The underlying increase, after adjusting for the impact of the movement in exchange rates was 8.5%; with the UK showing a 8.6% increase and the US an 8.4% increase. Orders for the year ended December 31, 2004, at constant exchange rates of $179.4 million were 24% above the previous year. At December 31, 2004 backlog (booked-on work) amounted to approximately $119 million, an increase of 27% above the level at December 31, 2003 (14% net of foreign currency effect). This reflected strong demand in the industry as companies invested in their early stage pipelines together with LSR's success in winning new studies due to its scientific expertise and focus on customer service.
Cost of sales in the year ended December 31, 2004 were $117.1 million (74.3% of revenue), an increase of 11.7% on cost of sales of $104.8 million (79.1% of revenue) for the year ended December 31, 2003. This increase was partly due to exchange rate movements, which increased cost of sales in the year by $10.0 million. Without these movements cost of sales would have increased by 2.2%. In the UK cost increases in sterling were only 2%, which is lower than the revenue growth as capacity is filled without the corresponding increase in fixed costs. The main increase was in direct material costs reflecting the higher revenues, offset by a reduction in labor costs as a result of the restructuring completed in the first quarter. Increases in costs in the US were 3.3%, mainly due to increases in labor costs offset by a reduction in direct material costs compared to the previous year.
Selling, general and administrative expenses rose by 18.2% to $24.7 million for the year ended December 31, 2004 (15.7% of revenue) from $20.9 million (15.8% of revenue) in the year ended December 31, 2004. Of this increase, $2.1 million related to exchange rate movements. This growth was due to a continuation of the build-up of the sales activity during the year and higher labor costs, including bonuses paid or accrued to senior employees.
Other operating expenses in the year ended December 31, 2003 were $3.5 million. These comprised $0.6 million in connection with specific legal actions taken against animal rights groups and $3.5 million in respect of a restructuring of the business. These restructuring costs comprise redundancy (severance) payments and asset write downs in the UK arising from a consolidation of duplicate facilities in response to changes in the market, particularly for non pharmaceutical services and a closure of excess and outdated toxicology capacity. This restructuring was effected to improve the efficiency of the Company's operations without impairing its ability to service clients' needs. These expenses were offset by income of $0.2 million representing the Group's share of an associated company's income (recognized following its acquisition in June 2003) and $0.4 million from the recovery of funds, written off in 2001 following the bankruptcy of an exchange broker.
Net interest expense increased by 8.9% to $6.5 million for the year ended December 31, 2004 from $6.0 million in the year ended December 31, 2003. Excluding the effect of exchange rate movements, there was a net decline of $0.2 million, reflecting the full year impact of loans and bonds repaid during 2003.
Other income of $2.9 million for the year ended December 31, 2004 comprised $3.3 million from the non-cash foreign exchange remeasurement gain on the Convertible Capital Bonds denominated in US dollars (the functional currency of the financing subsidiary that holds the bonds is UK sterling), offset by $0.4 million relating to the cost of a currency hedge contract. In the year ended December 31, 2003 there was other income of $5.4 million which was comprised of a non-cash foreign exchange remeasurement gain on the Convertible Capital Bonds of $4.8 million and a $0.6 million gain made on the partial repurchase of the Convertible Capital Bonds.
Taxation benefit on income for the year ended December 31, 2004 was $5.4 million representing a benefit at 44% compared to a taxation benefit of $1.1 million representing a benefit at 42% for the year ended December 31, 2003. A reconciliation between the US statutory tax rate and the effective rate of income tax benefit on losses before income taxes for the year ended December 31, 2004 and December 31, 2003 is shown below:
% of income before income taxes 2004 2003 % % US statutory rate 35 35 Foreign rate differential (6) (3) UK R & D credit and non-deductible items (36) 13 State taxes 1 2 Change in estimate (38) (89) ---------------- -------------- Effective tax rate (44) (42) ---------------- --------------
The main reason for the change in estimate above relates to the Huntingdon 2002 and 2003 tax provisions. The UK government from April 1, 2002 introduced a new tax allowance, `Research and Development (R & D) Tax Credit', for large companies. At the end of 2002, it was not certain how this would apply to Huntingdon. When submitting Huntingdon's 2002 corporation tax computation, and following discussions with the UK Inland Revenue, Huntingdon made a claim for the R & D Tax Credit, which has now been accepted. The 2003 provision has been included in the current year benefit as a change in estimate. The 2004 claim is part of the non-deductible items above.
The overall net income for the year ended December 31, 2004 was $17.6 million compared to $3.7 million in the year ended December 31, 2003. The diluted income per share for the year ended December 31, 2004 was $1.29 compared to $0.29 for the year ended December 31, 2003.
Earnings before interest, taxes, depreciation and amortization, other income/(expense) and other operating expenses in 2004 ("EBITDA") was $25.4 million, or 16.1% of revenues, compared with $14.6 million, or 11.0% of revenues for 2003.
The Company believes that EBITDA information, which for this Company excludes other income/(expense) and other operating expenses, enhances an investor's understanding of our financial performance and our ability to satisfy principal and interest obligations with respect to our indebtedness. However, EBITDA should not be considered in isolation or viewed as a substitute for net income, cash flow from operations or other measures of performance as defined by generally accepted accounting principles in the United States. We understand that while securities analysts, lenders and others in their evaluation of companies frequently use EBITDA, EBITDA as used herein is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation. Our management uses EBITDA to assess financial performance and debt service capabilities. In assessing financial performance, our management reviews EBITDA as a general indicator of economic performance compared to prior periods. Because EBITDA excludes interest, income tax, depreciation and amortization, other income/(expense) and other operating expenses, EBITDA provides an indicator of general economic performance that is not affected by changes in debt levels, fluctuations in interest rates or effective tax rates, levels of depreciation and amortization, exchange rate movements on the Convertible Capital Bonds or one off operating expenses. Our management believes this type of measurement is useful for comparing general operating performance from period to period and making certain management decisions. Nevertheless, our management recognizes that there are material limitations associated with the use of EBITDA as compared to n et income, which reflects overall financial performance, including the effects of interest, taxes, depreciation, amortization, other income/(expense) and other operating expenses.
SEGMENT ANALYSIS
The analysis of the Company's revenues and operating loss between segments for the three years ended December 31, 2005 is as follows:
The performance of each segment is measured by revenues and operating income/(loss) before other operating expenses.
UK
2005 v 2004
Revenues increased by 6.2% in the year ended December 31, 2005 compared with the year ended December 31, 2004. After allowing for the effect of exchange rate movements the increase was 6.9%. The growth in revenues reflects the increase in orders and, consequently, backlog over the last eighteen months, principally from the pharmaceutical industry. Orders for the year ended December 31, 2005 at constant exchange rates were 2.2% above the previous year.
Costs increased 6.5% in the year ended December 31, 2005 compared with the year ended December 31, 2004. After allowing for the effect of exchange rate movements, the increase was 6.5%. The main increases were in labour and direct material costs, and reflected the increase in revenues.
The operating income for the year ended December 31, 2005 was $22.5 million compared with $18.7 million in the previous year.
2004 v 2003
Revenues increased by 21.9% in the year ended December 31, 2004 compared with the year ended December 31, 2003. After allowing for the effect of exchange rate movements the increase was 8.6%. Orders for the year ended December 31, 2004 at constant exchange rates were 23.7% above the previous year and 11.7% above revenues for the year.
Costs increased by 14.0% in the year ended December 31, 2004 compared with the year ended December 31, 2003. After allowing for the effect of exchange rate movements, the increase was 2.8%. The main increase was in direct material costs reflecting the increase in revenues; however, this was offset by a reduction in labor as a result of the restructuring undertaken in the first quarter.
The operating income before other operating expenses for the year ended December 31, 2004 was $18.7 million compared with $9.3 million in the year to December 31, 2003.
In the year ended December 31, 2003, other operating expenses of $3.2 million comprised $3.5 million in respect of a restructuring of the business. These restructuring costs comprise redundancy (severance) payments and asset write downs arising from a consolidation of duplicate facilities in response to changes in the market, particularly for non pharmaceutical services, and a closure of excess and outdated toxicology capacity. These expenses were offset by income of $0.3 million from the recovery of funds, written off in 2001, following the bankruptcy of an exchange broker.
The operating income for the year ended December 31, 2004 was $18.7 million compared with $6.1 million in the previous year.
US
2005 v 2004
Revenues increased by 21.6% in the year ended December 31, 2005 as compared to the year ended December 31, 2004. The growth in revenues reflects the increase in orders and consequently, backlog, over the last 18 months, principally from the pharmaceutical industry. Orders for the year ended December 31, 2005 were 0.7% above the previous year .
Costs increased by 16.8% in the year ended December 31, 2005 as compared with the year ended December 31, 2004. This cost increase was mainly due to higher labour and direct materials, and reflected the increase in revenues.
The operating income for the year ended December 31, 2005 was $5.2 million compared with an operating income of $3.9 million in the previous year.
2004 v 2003
Revenues increased by 8.4% in the year ended December 31, 2004 as compared to the year ended December 31, 2003. Orders for the year ended December 31, 2004 were 25.1% above the previous year and 21.5% above revenues for the year.
Costs increased by 2% in the year ended December 31, 2004 as compared with the year ended December 31, 2003. This cost increase was mainly due to higher direct materials as a result of the higher revenues.
The operating income for the year ended December 31, 2004 was $3.9 million compared with an operating income of $2.1 million in the previous year.
Corporate
2005 v 2004
Corporate costs for the year ended December 31, 2005 were $6.8 million, an increase of 0% on corporate costs for the year ended December 31, 2004 of $6.8 million. Increases in labour and general expenses were offset by lower bonuses accrued for senior employees.
The operating loss for the year ended December 31, 2005 was $6.8 million compared with an operating loss for the year ended December 31, 2004 of $6.8 million.
2004 v 2003
Corporate costs for the year ended December 31, 2004 were $6.8 million, an increase of 47% on corporate costs for the year ended December 31, 2003 of $4.6 million. Excluding the effects of exchange rate movements the increase was 42%. The main reasons for the increase are the discretionary bonus plan relating to those senior employees in the Company's corporate headquarters of $1.5 million, together with general increases in labor costs and legal and professional fees.
In the year ended December 31, 2003, other operating expenses were $0.4 million for specific legal action taken against animal rights groups.
The operating loss for the year ended December 31, 2004 was $6.8 million compared with an operating loss for the year ended December 31, 2003 of $5.0 million.
LIQUIDITY AND 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 were made in 2005.
On June 14, 2005, the Company entered into and consummated the Sale/Leaseback Transaction with Alconbury. Alconbury is a newly formed company 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 has agreed to make a best effort to repay within twelve months. The Company agreed to pay the expenses incurred by Alconbury in the Sale/Leaseback Transaction of approximately $4.8 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.
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. Base aggregate annual rent for the facilities is $4.9 million (approximately $1.8 million in the US and approximately $3.1 million in the UK) which amount will increase by 3% each 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 will be required at such time that Alconbury refinances its current financing arrangements. Additionally, because the leases are "triple net" leases, LSR will also pay 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 FASB Interpretation No. 46R (FIN 46R), the Company will reflect the consolidation of Alconbury as long as it is considered the "primary beneficiary" of Alconbury's variable interests. The Company will not record the gain and loss associated with the sale of the properties, nor recognize the associated changes in depreciation, interest, and rent expenses, until FIN 46R consolidation accounting no longer applies. At that time, the Company will record a non-cash loss of approximately $44 million for the sale of the UK properties, and a gain of approximately $6 million, amortized over the term of the lease, for the US property. In addition, the Company anticipates a net reduction in its annual depreciation charge of approximately $2.7 million offset by a net increase of $0.5 million in interest and rent expenses. The Company anticipates that it will no longer be the primary beneficiary of Alconbury when the $10 million subordinated promissory note has been repaid.
Due to the consolidation resulting from the Company's adoption of FIN 46R, the Company's financial statements reflect a loan by an unrelated third party in the aggregate principal amount of $30 million. This loan has a maturity date of June 14, 2006, with the right to extend the term one additional year. Alconbury intends to refinance this debt on a long-term basis prior to the maturity date of June 14, 2006. However, if the long term financing is not available, Alconbury has advised the Company that it intends to exercise the one-year renewal option, and accordingly, has classified the loan as long-term debt. The loan, which carries an annual interest rate of 15%, has been secured by first priority lien on all the assets, including the facilities, of Alconbury, and is also personally guaranteed by the owner of Alconbury. This loan is currently payable in twelve monthly installments of interest only, with a balloon payment of $30 million due on June 14, 2006.
Convertible Capital Bonds
The remainder of the Company's long term financing is provided by Convertible Capital Bonds repayable in September 2006. At the time of the issue in 1991, these bonds were for $50 million par and at December 31, 2005, $46.2 million were outstanding. They carry interest at a rate of 7.5% per annum, payable biannually in March and September. During 2002, the Company repurchased and cancelled $2,410,000 principal amount of such bonds resulting in a $1.2 million gain recorded in other income/expense. In 2003 the Company further repurchased and cancelled $1,345,000 principal amount of such bonds resulting in a gain of $0.6 million recorded in other income/expense. At the current conversion rate, the number of shares of Voting Common Stock to be issued on conversion and exchange of each unit of $10,000 comprised in a bond would be 49. The conversion rate is subject to adjustment in certain circumstances.
As indicated in Note 16 - Subsequent Events, these bonds are being redeemed with the proceeds from the New Financing, which occurred in March 2006.
Related Party Loans
Financing which totaled $5.7 million was provided to the company in 2000 and 2001 and was fully repaid in 2002. This financing had been provided in part by a $2.9 million loan facility made available on September 25, 2000 by the Company's Chairman and CEO, Mr. Baker. In connection with this financing, the company authorized, subject to shareholder approval, the issuance of warrants to purchase 410,914 shares of LSR Voting Common Stock at a purchase price of $1.50 per share to FHP, a company controlled by Mr. Baker. Such shareholder approval was granted on June 12, 2002. Additionally, other financing also included a $2.8 million facility from the Stephens Group Inc. made available on July 19, 2001. Effective February 11, 2002 the Stephens Group Inc. debt was transferred to an unrelated third party. $550,000 of the loan from Mr. Baker was transferred to and assumed by FHP in March 2001. On March 28, 2002, $2.1 million of Mr. Baker's loan was converted into 1,400,000 shares of LSR Voting Common Stock and $300,000 of FHP's loan was converted into 200,000 shares of LSR Voting Common Stock; in each case as part of LSR's private placement of approximately 5.1 million shares of Voting Common Stock. The remaining principal amounts were repaid in full to Mr. Baker and FHP, inclusive of 10% interest, respectively, in 2002. The other $2.8 million facility was also repaid in full as of October 1, 2002.
As noted above, 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 January 10, 2002, LSR issued 99,900 shares of Voting Common Stock and 900,000 shares of Non-Voting Common Stock at a price of $1.50 per share (or an aggregate of $1.5 million). Effective July 25, 2002, all of the 900,000 shares of the Non-Voting Common Stock were converted into 900,000 shares of Voting Common Stock.
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. $128,000 of such promissory notes have been repaid through December 31, 2004.
Cash flows
During the year ended December 31, 2005 funds used were $17.9 million, decreasing cash on hand and on short-term deposit from $33.3 million at December 31, 2004 to $15.4 million at December 31, 2005. The cash used by operating, investing and financing activities was as follows (in millions):
The movement in working capital for the year ended December 31, 2005 was due to a decline in net days sales outstanding (DSOs) and the Sale/Leaseback transaction expenses paid on behalf of Alconbury, offset by an increase in the current portion of the pension liability.
Net days sales outstanding (DSOs) at December 31, 2005 were 16 days, a decline from the 4 days at December 31, 2004. DSO is calculated as a sum of accounts receivable, unbilled receivables and fees in advance over total revenue. The impact on liquidity from a one-day change in DSO is approximately $377,000.
Loan repayments for the year ended December 31, 2005 represented the additional cash on hand used in the Sale/Leaseback transaction used to repay the Company's (pound)22.6 million ($41.1 million) non-bank debt.
At December 31, 2005, the Company had a working capital deficit of $56.5 million as the Convertible Capital Bonds repayable in September 2006 are now classified as a current liability. The Company believes that projected cash flow from operations will satisfy its other contemplated cash requirements for at least the next 12 months. See Note 16 - Subsequent Events.
Commitment and Contingencies
Commitments
The Company leases certain equipment under various non-cancelable operating and capital leases. The Company is also obligated under purchase agreements, including long term power contracts. Finally Life Sciences Research Limited is obliged to make contributions to its defined pension plan of (pound)2.7 million ($4.6 million) per year, plus expenses estimated at (pound)0.3 million ($0.5 million) a year for the next 5 years. These commitments are set out in the table below:
Contingencies
The Company is party to certain legal actions arising in the normal course of its business. In management's opinion, none of these actions will have a material effect on the Company's operations, financial condition or liquidity. No form of proceedings has been brought, instigated or is known to be contemplated against the Company by any government agency.
ORDERS
New business signings totaled $183 million for the year ended December 31, 2005, an increase of 3% exclusive of the impact of movements in exchange rates from the prior year. 2004 saw a rapid growth in business from the Pharmaceutical industry and this growth in business was maintained in 2005, with particularly strong order growth in toxicology testing as companies invested in their early stage pipelines. However there was a decline in the amount of work outsourced from the Agrochemical industry, both on new chemical entities and as registration work under European Directive 91/414/EEC diminished.
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 the Company 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. Such fluctuations also have an impact on the translation of the 7.5% Convertible Capital Bonds payable in September 2006.
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. 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 December 31, 2005.
Finally, the consolidated financial statements of LSR are denominated in US dollars. Changes in exchange rates between the UK pound 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 equity accounts are translated at historical exchange rates. Translation of the balance sheet in this manner affects the stockholders' equity account referred to as the accumulated other comprehensive loss account. 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 Average Rate (1) -------------- ---------------- 2002 1.6099 1.5039 2003 1.7857 1.6354 2004 1.9199 1.8321 2005 1.7168 1.8195
(1) Based on the average daily exchange rates during the period.
On March 13, 2006 the noon buying rate for sterling was (pound)1.00 = $1.7310.
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 December 31, 2005:
INFLATION
While most of the Company's net revenues are earned under fixed price contracts, the effects of inflation do not generally have a material adverse effect on its operations or financial condition as only a minority of the contracts have duration in excess of one year.
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, Share-Based Payment, which is a revision of SFAS No. 123. SFAS No. 123R supersedes APB 25 and amends SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123R is similar to the approach described in SFAS No. 123. However, SFAS No. 123R requires all share-based payments to employees and non-employee directors, including grants of stock options, to be recognized in the income statement based on their fair values and requires the use of an option pricing model for estimating fair value, which is amortized to expense over the service periods. Pro forma disclosure is no longer an alternative. SFAS No. 123R will be effective for the first annual period beginning after June 15, 2005. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on the amounts of share-based payments granted in the future. The Company adopted SFAS 123R effective January 1, 2006.
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 Annual Report on Form 10-K (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 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 set forth in the Company's filings with the Securities and Exchange Commission, including without limitation this Annual Report on Form 10-K.
ITEM 7A.
ITEM 7A. 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. 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 December 31, 2005.
Non-Bank Loans
The Company's (pound)22.6 million (approximately $41.1 million on June 14, 2005) non-bank loan was UK pound sterling denominated and did not contribute to transaction gains and losses on the income statement. Interest on all outstanding borrowings on this non-bank loan was based upon LIBOR plus a margin, approximately 6.66% per annum for the period ended June 14, 2005. On June 14, 2005 this non-bank loan was fully repaid using the proceeds from the Sale/Leaseback Transaction and cash on hand.
Revenue
For the year ended December 31, 2005, approximately 73% of the Company's net revenues were from outside the US.
Convertible Capital Bonds
The Company's $46.2 million principal amount of Convertible Capital Bonds are US dollar denominated, but are held by a non-US subsidiary of the Company. As a result, with respect to these bonds, the Company experiences exchange related gains and losses which only has a non-cash impact on the financial statements, based on the movement of exchange rates. The Company is unable to predict whether it will experience future gains or future losses from such exchange-related risks on the bonds.
These bonds are being redeemed with the proceeds from the New Financing received in March 2006. Please see Note 16 - Subsequent Events.
See Management's Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Managements' Report on Consolidated Financial Statements and Internal Control
The management of Life Sciences Research, Inc. (the "Company") has prepared, and is responsible for, the Company's consolidated financial statements and related footnotes. These consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles.
The Company's management is responsible for establishing and maintaining effective internal control over financial reporting and for assessing the effectiveness of internal control over financial reporting. The purpose of this system of internal accounting controls over financial reporting is to provide reasonable assurance that assets are safeguarded, that transactions are executed in accordance with management's authorization and are properly recorded, and that accounting records may be relied upon for the preparation of accurate and complete consolidated financial statements. The design, monitoring and revision of internal accounting control systems involve, among other things, management's judgment with respect to the relative cost and expected benefits of specific control measures. The Company also maintains an internal audit function that evaluates and reports on the adequacy and effectiveness of internal controls, policies and procedures.
The Company's management concluded that its internal control over financial reporting as of December 31, 2005 was effective and adequate to accomplish the objectives described above. Management's assessment was based upon the criteria in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's consolidated financial statements and the effectiveness of control over financial reporting have been audited by an independent registered public accounting firm, Hugh Scott, P.C., as stated in their reports which are included elsewhere herein.
/ S / Andrew Baker Chairman and Chief Executive Officer - Principal Executive Officer
/ S / Richard Michaelson Chief Financial Officer - Principal Financial and Accounting Officer
East Millstone, New Jersey
February 17, 2006
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Shareholders of Life Sciences Research, Inc.
We have audited management's assessment, included in Managements' Report on Consolidated Financial Statements and Internal Control, that Life Sciences Research, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Life Sciences Research, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Life Sciences Research, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Life Sciences Research, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Life Sciences Research, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders equity (deficit) and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2005 and our report dated February 17, 2006 expressed an unqualified opinion thereon.
/s/ Hugh Scott, P.C.
Lakewood, New Jersey February 17, 2006
Report of Independent Registered Public Accounting Firm on financial statements The Board of Directors and Shareholders of Life Sciences Research, Inc.
We have audited the accompanying consolidated balance sheets of Life Sciences Research, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders equity (deficit) and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Life Sciences Research, Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Life Sciences Research, Inc.'s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 17, 2006 expressed an unqualified opinion thereon.
/s/ Hugh Scott, P.C.
Lakewood, New Jersey February 17, 2006, except for Note 16 which is dated March 2, 2006
1. THE COMPANY AND ITS OPERATIONS
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, it tests the effect of such compounds on the environment and also performs work on assessing the safety and efficacy of veterinary products.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies, is set out below:
Basis of Presentation and Principles of Consolidation
The consolidated financial statements incorporate the accounts of LSR and each of its subsidiaries. All inter-company balances have been eliminated upon consolidation.
On June 14, 2005, the Company entered into and consummated purchase and sale agreements with Alconbury Estates Inc. and subsidiaries and its successors (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 is a newly formed company 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 agreed to make a best effort to repay within twelve months.
In accordance with the provisions of FASB Interpretation No. 46R (FIN 46R), the Company will reflect the consolidation of Alconbury as long as it is considered the "primary beneficiary" of Alconbury's variable interests. The Company will not record the gain and loss associated with the sale of the properties, nor recognize the associated changes in depreciation, interest, and rent expenses, until FIN 46R consolidation accounting no longer applies. At that time, the Company will record a non-cash loss of approximately $44 million for the sale of the UK properties, and a gain of approximately $10 million, amortized over the term of the lease, for the US property. In addition, the Company anticipates a net reduction in its annual depreciation charge of approximately $2.7 million offset by a net increase of $0.5 million in interest and rent expenses. The Company anticipates that it will no longer be the primary beneficiary of Alconbury when the $10 million subordinated promissory note has been repaid.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid investments with an original maturity date of three months or less at the date of purchase.
Allowance for Uncollectible Accounts
The Company establishes an allowance for uncollectible accounts which it believes is adequate to cover anticipated losses on the collection of all outstanding trade receivable balances. The adequacy of the uncollectible account allowance is based on historical information, a review of customer accounts and related receivable balances, and management's assessment of current economic conditions. The Company reassesses the allowance for uncollectible accounts annually.
Inventories
Inventories are valued on a FIFO (first-in, first out) method at the lower of cost, or market value. They comprise materials and supplies.
Property, Plant and Equipment
Property, plant and equipment, stated at cost, is depreciated over the estimated useful lives of the assets on a straight-line basis. Estimated useful lives are as follows:
Buildings and facilities 15 - 50 years Plant and equipment 4 - 25 years Vehicles 5 years Computers and software 3 - 5 years
Amounts spent to repair and maintain these assets arising out of the normal course of business are expensed in the period incurred.
Concentration of Credit Risk
The Company maintains cash and cash equivalents in US financial institutions, which, at times, may exceed federally insured limits. Based on the nature of the financial instruments and/or historical realization of these instruments, the Company believes they bear minimal risk.
Income Taxes
The Company accounts for income taxes under the provisions of SFAS 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.
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).
Foreign Currencies
Transactions in currencies other than the functional currency of the entity are recorded at the rates of exchange at the date of the transaction. Monetary assets and liabilities in currencies other than the functional currency are translated at the rates of exchange at the balance sheet date and the related transaction gains and losses are reported in the statements of operations. Exchange gains and losses on foreign currency transactions are recorded as other income or expense. Certain intercompany loans are determined to be of a long-term investment nature. The Company records gains and losses from re-measuring such loans as a component of other comprehensive income.
Upon consolidation, the results of operations of subsidiaries and associates whose functional currency is other than the US dollar are translated into US dollars at the average exchange rate and assets and liabilities are translated at year-end exchange rates and capital accounts are translated at historical exchange rates, and retained earnings are translated at the weighted average of historical rates. Translation adjustments are presented as a separate component of other accumulated comprehensive loss in the financial statements.
Goodwill and Other Intangible Assets
Effective 2003, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which establishes financial accounting and reporting standards for acquired goodwill and other intangible assets (Note 4). In accordance with SFAS No. 142, goodwill and indefinite-lived intangible assets are no longer amortized but are reviewed at least annually for impairment. Separate intangible assets that have finite useful lives continue to be amortized over their estimated useful lives.
SFAS No. 142 requires that goodwill be tested annually for impairment using a two-step process. The first step is to identify a potential impairment. The second step of the impairment test measures the amount of the impairment loss. The Company, after completing the first step of the process, concluded there was no impairment of goodwill at December 31, 2005 or 2004.
Impairment of Long-Lived Assets
The Company adopted the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets". The Company evaluates long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposal are less than its carrying amount. In such instances, the carrying value of long-lived assets is reduced to the estimated fair value, as determined using an appraisal or discounted cash flows, as appropriate.
Restructuring Costs
The Company recognizes obligations associated with restructuring activities in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The Company adopted the provisions of SFAS No. 146 as of the beginning of fiscal 2003, which generally requires a liability for costs associated with an exit or disposal activity be recognized and measured initially at its fair value in the period in which the liability is incurred. The overall purpose of the Company's restructuring actions is to lower overall operating costs and improve profitability by reducing excess capacities. Restructuring costs (Note 8) are typically recorded in other operating expenses in the period in which the plan is approved by the Company's senior management and, where material, the Company's Board of Directors, and when the liability is incurred.
Leased Assets
Assets held under the terms of capital leases are included in property and equipment and are depreciated on a straight-line basis over the lesser of the useful life of the asset or the term of the lease. Obligations for future lease payments, less attributable finance charges are shown within liabilities and are analyzed between amounts falling due within and after one year. Operating lease rentals are charged to the Consolidated Statement of Operations as incurred.
Pension Costs
During the year the Company had two defined contribution plans. One of the defined contribution pension plans covers all employees in the US; the other, employees in the UK. Prior to December 31, 2002, a defined benefit pension plan provided benefits to employees in the UK based on their final pensionable salary. As of December 31, 2002, the defined benefit pension plan was curtailed. The gain on curtailment was recognized in the Statement of Operations according to SFAS No. 88, "Employees' Accounting for Settlements and Curtailments of Deferred Benefit Pension Plan and for Termination Benefits". The pension cost of the plan is accounted for in accordance with SFAS No. 87, "Employers' Accounting For Pensions". Pension information is presented in accordance with the currently required provisions of SFAS No. 132, "Employers' Disclosures About Pensions And Other Post Retirement Benefits". The net asset at transition, prior service cost and net (loss)/gain subject to amortization, outside the corridor, are being amortized on a straight-line basis over periods of 15 years, 10 years and 10 years respectively. The Company recognized all actuarial gains and losses immediately for the purposes of its minimum pension liability.
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.
Income Per Share
Income per share is computed in accordance with SFAS No. 128, "Earnings Per Share". Basic income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year. The computation of diluted income per share is similar to the computation of basic income per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Diluted income per share reflects the potential dilution that could occur if dilutive securities and other contracts to issue common stock were exercised or converted into common shares or resulted in the issuance of common shares that then shared in the income of the Company.
Segment Analysis
In accordance with the Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" (SFAS 131), the Company discloses financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available and regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
Loans and Warrants
In accordance with Accounting Principles Board ("APB") Opinion No. 14 "Accounting for Convertible Debt and Debt issued with Share Purchase Warrants", loans and warrants are recorded at their pro-rata fair values in relation to the proceeds received with the portion allowable to the warrants accounted for as paid-in-capital. The costs of raising long-term financing are capitalized as an asset and are amortized, using the effective interest method, over the term of the debt.
Stock-Based Compensation
The Company accounts for its stock option and stock-based compensation arrangements plans using the intrinsic-value method. Under the intrinsic value method, the difference between the amount the employee will pay the Company for stock acquired under the Company's incentive plans and the stock's fair value on the date of grant is charged to expense. Since employees must pay the Company the grant date fair value for stock options, no expense is recorded for stock options. (Alternatively, if employees did not have to pay for stock issued for deferred stock units granted, their grant date fair value would be recorded as expense).
The following table reconciles net income and earnings per common stock (EPS), as reported, to pro forma net income and EPS, as if the Company had expensed the grant date fair value of both stock options and deferred stock units as permitted by SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"). These pro forma amounts may not be representative of the initial impact of adopting SFAS 123 since, as amended, it permits alternative methods of adoption.
The weighted average fair value at the date of grant for options granted during 2005, 2004 and 2003 was $7.74, $3.44 and $1.03 respectively. The options granted prior to 2002 are considered to have no value. These fair values were estimated using the Black-Scholes option-pricing model, based on the following assumptions:
2005 2004 2003 Dividend yield 0% 0% 0% Volatility 56% 135% 40% Risk-free interest rate 3.93% 4.63% 3.72% Expected term of options (in years) 10 years 10 years 10 years
Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, Share-Based Payment, which is a revision of SFAS No. 123. SFAS No. 123R supersedes APB 25 and amends SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123R is similar to the approach described in SFAS No. 123. However, SFAS No. 123R requires all share-based payments to employees and non-employee directors, including grants of stock options, to be recognized in the income statement based on their fair values and requires the use of an option pricing model for estimating fair value, which is amortized to expense over the service periods. Pro forma disclosure is no longer an alternative. SFAS No. 123R will be effective for the first annual period beginning after June 15, 2005. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on the amounts of share-based payments granted in the future. The Company adopted SFAS 123R effective January 1, 2006.
3. PROPERTY, PLANT AND EQUIPMENT
Depreciation expense aggregated $9,581,000, $9,530,000 and $9,049,000 for 2005, 2004 and 2003 respectively.
The net book value of assets held under capital leases and included above is as follows:
Cost Depreciation Net book Value $000 $000 $000 At December 31, 2005 1,995 246 1,749 At December 31, 2004 981 114 867
Depreciation on these capital leases and included above, amounted to $140,000, $192,000, and $68,000 for the years ended at December 31, 2005, 2004 and 2003, respectively.
4. GOODWILL AND INTANGIBLE ASSETS
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations", which eliminates the pooling of interests method of accounting for business combinations and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets", or SFAS No. 142. The Company adopted SFAS No. 142 as of January 1, 2003. SFAS No. 142 addresses the financial accounting and reporting standards for the acquisition of intangible assets outside of a business combination, and for goodwill and other intangible assets subsequent to their acquisition. This statement requires that goodwill be separately disclosed from other intangible assets in the statement of financial position, and no longer be amortized but tested for impairment on a periodic basis.
On July 1, 2003, the remaining 50% of the shares in HLS KK, not previously owned by Huntingdon, was purchased, resulting in HLS KK becoming a wholly owned subsidiary of Huntingdon. The purchase price is payable over a three year period, and is equal to the greater of (a) $1 million or (b) the commission which would have been paid if the purchase had not happened. Payments during that three year period shall be made at the rate which had been in effect for commissions prior to the acquisition, and is payable semi-annually. At December 31, 2005 and 2004, goodwill on purchase was Japanese Yen 132,000,000 and 99,500,000 ($1,195,000 and $901,000 at year end rates) respectively.
Prior to this date, the shares owned by Huntingdon in HLS KK were held as an investment, as the day to day control of HLS KK was not exercised by the Company.
Other intangible assets represent finance costs of $922,000, associated with the sale/leaseback transaction, net of amortization of $21,000. These costs are being amortized over the period of the lease.
5. INCOME TAXES
The components of income before taxes and the related benefit/(expense) for tax for the years ended December 31 are as follows:
Reconciliation between the US statutory rate and the effective rate is as follows:
The US leaseback gain has arisen from the sale of the US property as part of the Sale/Leaseback Transaction. The gain on the sale of the UK assets has been offset against brought forward capital losses resulting in a deferred tax movement.
The losses before tax of the British Virgin Islands represents the Alconbury balances which have been consolidated in accordance with the provisions of FASB Interpretation No. 46R.
The main reason for the change in estimate in 2004 relates to the Huntingdon 2002 and 2003 tax provisions. The UK government introduced a new tax allowance, `Research and Development (R & D) Tax Credit, for large companies from April 1, 2002. At the end of 2002, it was not certain how this would apply to Huntingdon. When submitting Huntingdon's 2002 corporation tax computation, and following discussions with the UK Inland Revenue, Huntingdon has made a claim for the R & D Tax Credit, which has now been accepted and the 2003 provision included in the 2004 change in estimate. The 2004 and 2005 claims are part of the non-deductible items above. The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of December 31 are as follows:
In accordance with SFAS No. 109, the Company nets all current and non-current assets and liabilities by tax jurisdiction.
Of the gross amount of net operating losses in the US of $1,244,000 expires in 2018, $523,000 expires in 2019, $1,087,000 expires in 2021, $492,000 expires in 2022, $3,000 expires in 2023, $1,815,000 expires in 2024, and $495,000 expires in 2025. The gross amount of net operating losses in the UK of $61,255,000 have no expiration date. The Company has not provided a valuation allowance on the net operating loss carry forwards because it believes that it is more likely than not that those amounts will be realized through taxable income from future operations. A full valuation allowance has been recorded for the total benefit of capital losses incurred in prior years, as the Company does not anticipate that the benefit will be realized in the foreseeable future through the recognition of capital gains.
6. LONG-TERM DEBT AND RELATED PARTY LOANS
2005 2004 $000 $000 Non-bank loans - 43,424 Alconbury loan 30,000 - Warrants (389) (310) Capital leases, net of current 819 376 portion Convertible Capital Bonds - 46,195
-------------- ---------------
$30,430 $89,685
----------------- ---------------
Bank Loans and Non-Bank Loans
On January 20, 2001, the Company's non-bank loan of (pound)22.6 million ($41.4 million approximately), 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 the 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 up to 704,425 shares of LSR Voting Common Stock at a purchase price of $1.50 per share. These 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 and treated as a debt discount. The value of the warrants was $430,000. 154,425 of such warrants were exercised in 2004. No additional exercises were made in 2005.
On June 14, 2005, the Company entered into and consummated the Sale/Leaseback Transaction with Alconbury. Alconbury is a newly formed company 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 agreed to make a best effort to repay within twelve months. The Company agreed to pay the expenses incurred by Alconbury in the Sale/Leaseback Transaction of approximately $4.8 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.
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. Base aggregate annual rent for the facilities is $4.9 million (approximately $1.8 million in the US and approximately $3.1 million in the UK) which amount will increase by 3% each 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 will be required at such time that Alconbury refinances its current financing arrangements. Additionally, because the leases are "triple net" leases, LSR will also pay 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).
Due to the consolidation resulting from the Company's adoption of FIN 46R, the Company's financial statements reflect a loan by an unrelated third party in the aggregate principal amount of $30 million. This loan has a maturity date of June 14, 2006, with the right to extend the term one additional year. Alconbury intends to refinance this debt on a long-term basis prior to the maturity date of June 14, 2006. However, if the long term financing is not available, Alconbury has advised the Company that it intends to exercise the one-year renewal option, and accordingly, has classified the loan as long-term debt. The loan, which carries an annual interest rate of 15%, has been secured by first priority lien on all the assets, including the facilities, of Alconbury, and is also personally guaranteed by the owner of Alconbury. This loan is currently payable in twelve monthly installments of interest only, with a balloon payment of $30 million due on June 14, 2006.
Convertible Capital Bonds
The remainder of the Company's long term financing is provided by Convertible Capital Bonds repayable in September 2006. At the time of the issue in 1991, these bonds were for $50 million par and at December 31, 2005 and 2004 $46.2 million was outstanding. They carry interest at a rate of 7.5% per annum, payable biannually in March and September. During 2002, the Company repurchased and cancelled $2,410,000 principal amount of such bonds resulting in a $1.2 million gain recorded in other income/expense. In 2003 the Company further repurchased and cancelled $1,345,000 principal amount of such bonds resulting in a gain of $0.6 million recorded in other income/expense. At the current conversion rate, the number of shares of Voting Common Stock to be issued on conversion and exchange of each unit of $10,000 comprised in a bond would be 49. The conversion rate is subject to adjustment in certain circumstances.
These bonds are currently being redeemed with the proceeds from the New Financing, as disclosed in Note 16 - Subsequent Events.
Related Party Transactions
On June 11, 2002 LSR issued to Focused Healthcare Partners ("FHP"), an entity controlled by Andrew Baker, the Company's Chairman and CEO, warrants to purchase up to 410,914 shares of LSR Voting Common Stock at a purchase price of $1.50 per share. The LSR warrants are exercisable at any time and will expire on June 11, 2012. These warrants arose out of negotiations regarding the provision of a $2.9 million loan facility made available to the Company on September 25, 2000 by Mr. Baker. This loan was paid in full in 2002. 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.
On June 14, 2005, the Company completed the Sale/Leaseback Transaction with Alconbury, a company controlled by Mr. Baker, LSR's Chairman and CEO. The Company agreed to pay the expenses incurred by Alconbury in the Sale/Leaseback Transaction of approximately $4.8 million, subject to Alconbury's obligation to reimburse those expenses in the future. Such reimbursement shall be made in equal instalments 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.
Alconbury has received an interest free loan of $250,000, which has been included in accrued expenses and other liabilities, from Andrew Baker, LSR's Chairman and CEO.
Brian Cass, President and Managing Director of LSR, acquired 400,000 shares of LSR Common Stock in the Private Placement. Mr. Cass acquired such shares through the delivery of two promissory notes. Both such promissory notes, each in the amount of (pound)211,679 ($363,411), are due on March 28, 2007; bear interest at the rate of 5% per annum; and are secured by the 200,000 shares of LSR Common Stock purchased with the proceeds of each such loan. The due date of each promissory note would be accelerated if Mr. Cass voluntarily resigned from his employment with LSR or had his employment terminated. Repayment of one of the promissory notes will be made by automatic deduction of (pound)44,000 ($75,539) per year from the (pound)66,000 ($113,309) per year pension contribution made by the Company to a pension plan established by Mr. Cass. The other note is further collateralized by the (pound)214,500 ($368,254) accrued in such pension account. In addition, one-third of any yearly bonus received by Mr. Cass will be used to reduce principal of the promissory notes. Total amount of this loan as of December 31, 2005 is (pound)120,000 ($205,000 at year-end foreign exchange rates).
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's principal financial instruments comprise cash and cash equivalents, accounts receivables, unbilled receivables and long-term debt. The Company does not hold financial instruments for trading purposes.
The estimated fair value of the Company's financial instruments as of December 31, 2005 and 2004 is summarized below. Certain estimates and judgments were required to develop the fair value amounts. The fair value amounts shown below are not necessarily indicative of the amounts that the Company would realize upon disposition nor do they indicate the Company's intent or ability to dispose of the financial instrument.
The following methods and assumptions were used by the Company in estimating its fair value disclosure for financial instruments:
Cash and cash equivalents, capital leases - short term, accounts payable and fees invoiced in advance: The estimated fair value of these financial instruments approximates their carrying values due to their short maturities.
Accounts receivables: The estimated fair value of these financial instruments approximates their carrying value due to their short maturities, less any provision for bad debt.
Long-term debt: The carrying value of these financial instruments approximates the fair value due to their variable interest rates.
Convertible Capital Bonds: The estimated fair value of the Company's Convertible Capital Bonds is based on market prices at year-end.
8. RESTRUCTURING COSTS
During the fourth quarter of 2003, the Company recorded restructuring charges of $3,551,000 including impairment of fixed assets of $2,014,000, and employee severance of $1,537,000 associated with the UK facilities. These charges arose from the consolidation of duplicate facilities in response to changes in the market, particularly for non-pharmaceutical services, and the closure of excess and outdated toxicology capacity. This restructuring will improve the efficiency of the Company's operations and did not impair its ability to service clients' needs.
9. OTHER INCOME/(EXPENSE)
10. COMMITMENTS AND CONTINGENCIES
Commitments
The Company leases certain equipment under various non-cancelable operating and capital leases. The Company is also obligated under purchase agreements, including long term power contracts. These commitments are set out in the table below:
Capital lease payments are as follows: $000 Total payments due $1,524 Less amounts representing interest (241) ---------------- Present value of net minimum lease payments 1,283 Less current portion of capital lease obligations (464) ---------------- Non-current portion of capital lease obligations $819
================
Depreciation on these capital leases amounted to $140,000, for the year ended December 31, 2005.
Operating lease expenses were as follows:
2005 2004 2003 $000 $000 $000 Plant and equipment 441 291 451 Other operating leases 418 405 410
Contingencies
The Company is party to certain legal actions arising out of the normal course of its business. In management's opinion, none of these actions will have a material effect on the Company's operations, financial condition or liquidity. No form of proceedings has been brought, instigated or is known to be contemplated against the Company by any government agency.
11. SHAREHOLDERS' EQUITY
Common Stock
As of December 31, 2005 and 2004 LSR had outstanding 12,553,251 and 12,441,281 shares of Voting Common Stock of par value of $0.01 each respectively.
Share option plans
LSR 2001 Equity Incentive Plan (the "LSR 2001 Equity Incentive Plan")
The LSR 2001 Equity Incentive Plan was adopted effective October 4, 2001. Adoption of the LSR 2001 Equity Incentive Plan enables LSR to use stock options (and other stock-based awards) as a means to attract, retain and motivate key personnel. This stock option plan was approved by the shareholders of LSR, prior to the acquisition of Huntingdon.
Awards under the LSR 2001 Equity Incentive Plan may be granted by a committee designated by the LSR Board pursuant to the terms of the LSR 2001 Equity Incentive Plan (which has designated the Compensation Committee for such purpose) and may include: (i) options to purchase shares of LSR Voting Common Stock, including incentive stock options ("ISOs"), non-qualified stock options or both; (ii) stock appreciation rights ("SARs"), whether in conjunction with the grant of stock options or independent of such grant, or stock appreciation rights that are only exercisable in the event of a change in control or upon other events; (iii) restricted stock consisting of shares that are subject to forfeiture based on the failure to satisfy employment-related restrictions; (iv) deferred stock, representing the right to receive shares of stock in the future; (v) bonus stock and awards in lieu of cash compensation; (vi) dividend equivalents, consisting of a right to receive cash, other awards, or other property equal in value to dividends paid with respect to a specified number of shares of LSR Voting Common Stock or other periodic payments; or (vii) other awards not otherwise provided for, the value of which are based in whole or in part upon the value of the LSR Voting Common Stock. Awards granted under the LSR 2001 Equity Incentive Plan are generally not assignable or transferable except pursuant to a will and by operation of law.
The flexible terms of the LSR 2001 Equity Incentive Plan are intended to, among other things, permit the Compensation Committee to impose performance conditions with respect to any award, thereby requiring forfeiture of all or part of any award if performance objectives are not met or linking the time of exercisability or settlement of an award to the attainment of performance conditions. For awards intended to qualify as "performance-based compensation" within the meaning of Section 162 (m) of the United States Internal Revenue Code such performance objectives shall be based solely on (i) annual return on capital; (ii) annual earnings or earnings per share; (iii) annual cash flow provided by operations; (iv) changes in annual revenues; (v) stock price; and/or (vi) strategic business criteria, consisting of one or more objectives based on meeting specified revenue, market penetration, geographic business expansion goals, cost targets, and goals relating to acquisitions or divestitures.
LSR's Compensation Committee, which administers the 2001 LSR Equity Incentive Plan, has the authority, among other things, to: (i) select the directors, officers and other employees and independent contractors entitled to receive awards under the 2001 LSR Equity Incentive Plan; (ii) determine the form of awards, or combinations of awards, and whether such awards are to operate on a tandem basis or in conjunction with other awards; (iii) determine the number of shares of LSR Voting Common Stock or units or rights covered by an award; and (iv) determine the terms and conditions of any awards granted under the 2001 LSR Equity Incentive Plan, including any restrictions or limitations on transfer, any vesting schedules or the acceleration of vesting schedules, any forfeiture provision or waiver of the same and including any terms and conditions necessary or desirable to ensure the optimal tax result for participating personnel and the Company including by way of example to ensure that there is no tax on the grant of the rights and that such tax only arises on the exercise of rights or otherwise when the LSR Voting Common Stock unconditionally vests and is at the disposal of such participating personnel. The exercise price at which shares of LSR Voting Common Stock may be purchased pursuant to the grant of stock options under the 2001 LSR Equity Incentive Plan is to be determined by the Compensation Committee at the time of grant in its discretion, which discretion includes the ability to set an exercise price that is below the fair market value of the shares of LSR Voting Common Stock covered by such grant at the time of grant.
The number of shares of LSR Voting Common Stock that may be subject to outstanding awards granted under the 2001 LSR Equity Incentive Plan (determined immediately after the grant of any award) may not exceed 20 percent of the aggregate number of shares of LSR Voting Common Stock then outstanding.
The 2001 LSR Equity Incentive Plan may be amended, altered, suspended, discontinued, or terminated by the LSR Board without LSR Common Stockholder approval unless such approval is required by law or regulation or under the rules of any stock exchange or automated quotation system on which LSR Voting Common Stock is then listed or quoted. Thus, LSR Common Stockholder approval will not necessarily be required for amendments, which might increase the cost of the plan or broaden eligibility. LSR Common Stockholder approval will not be deemed to be required under laws or regulations that condition favorable tax treatment on such approval, although the LSR Board may, in its discretion, seek LSR Common Stockholder approval in any circumstances in which it deems such approval advisable.
The LSR Board has designated the Compensation Committee of the Board to serve as the Stock Option Committee. LSR made grants under the LSR 2001 Equity Incentive Plan on March 1, 2002 to certain directors and key employees at that time.
Grants to Directors Name Number Granted - ---- -------------- Gabor Balthazer 20,000 John Caldwell 20,000 Kirby Cramer 40,000
Grants to Named Executive Officers Name Number Granted - ---- -------------- Andrew Baker 200,000 Mark Bibi 50,000 Brian Cass 200,000 Julian Griffiths 60,000 Richard Michaelson 90,000
All such options have ten-year terms; 50% of the shares subject to grant are immediately exercisable with the remaining 50% exercisable one year after the grant date (meaning all such options fully vested as of March 1, 2003); and all have an exercise price of $1.50 per share, the price at which the Company sold shares of Common Stock in the Private Placement. Options to purchase an aggregate of 1,188,000 shares of LSR Common Stock (including those specified above) were granted during the two years 2002 and 2003 to employees and directors, on the terms set forth above, are listed below:
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- March 1, 2002 1,142,000 $1.50 September 3, 2002 20,000 $2.40 October 21, 2002 15,000 $2.03 February 14, 2003 11,000 $1.80
In 2004, in addition to the options granted under the 2004 LTIP referred to below, options to purchase an aggregate of 67,100 shares of LSR Common Stock were issued, all at exercise prices equal to the market price at the date of grant, on the terms set forth in the previous paragraph, are listed below.
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- April 12, 2004 37,100 $1.85 October 28, 2004 17,400 $7.70 December 15, 2004 12,600 $9.52
In 2005, options to purchase an aggregate of 23,600 shares of LSR Common Stock were issued, all at exercise prices equal to the market price at the date of grant, or the terms set forth above, are listed below:
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- May 23, 2005 3,600 $12.00 June 27, 2005 20,000 $11.00
2004 Long Term Incentive Plan
Effective June 1, 2004 the Company adopted the 2004 Long Term Incentive Plan ("2004 LTIP"), pursuant to the terms of the 2001 Equity Incentive Plan. The 2004 LTIP has two components: a grant of stock options, with a vesting date of March 31, 2007, and a cash bonus to be awarded in 2007 based on 2006 Company financial performance.
Options to purchase an aggregate of 362,663 shares of common stock were granted to 32 key employees of the Company as of June 1, 2004 under the 2004 LTIP; 55,500 of such options were granted to Andrew Baker, the Company's Chairman and CEO, 55,500 of such options were granted to Brian Cass, the Company's Managing Director and President, 30,303 of such options were granted to Richard Michaelson, the Company's CF0, 27,750 of such options were granted to Julian Griffiths, the Company's Vice President of Operations and 20,545 were granted to Mark Bibi the Company's General Counsel and Secretary. The exercise price of all such options is $3.30, the market price of LSR common stock on June 1, 2004. All such options have ten-year terms and are exercisable in full on March 31, 2007. At December 31, 2005, 356,419 shares under the 2004 LTIP option plan were outstanding and none were exercisable.
The following table summarizes stock option activity under the Company's option plans.
Huntingdon Life Sciences Group plc Stock Option Plan
Huntingdon Life Sciences Group plc issued options prior to December 31, 1997 pursuant to several stock option plans. However, the ability to exercise options under all such Huntingdon plans lapsed on March 26, 2002 in connection with LSR's acquisition of Huntingdon, except for those granted under the Unapproved Stock Option Plan (the "Unapproved Plan"). Under the Unapproved Plan, some options technically remain outstanding. However, such options are exercisable only for shares of Huntingdon, a 100% wholly owned subsidiary of LSR, and are therefore considered to have no value.
Warrants
On October 9, 2001, on behalf of Huntingdon, LSR issued to Stephens Group Inc. warrants to purchase up to 704,425 shares of LSR Voting Common Stock at a purchase price of $1.50 per share. Stephens Group Inc. subsequently sold the warrants to independent third parties. 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 warrants were exercised in 2005.
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. The 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. None of these warrants have been exercised as of December 31, 2005.
On October 24, 2003, 100,000 warrants were issued at the market price on the day of $2.05. On January 4, 2005 100,000 warrants were issued at the market price on the day of $10.70. 50,000 are exercisable from January 4, 2007 and 50,000 from January 4, 2008. In all cases, these warrants were issued to independent consultants in connection with financial and strategic advice.
On November 9, 2005 625,000 warrants were issued to a third party advisory/lobbying firm at the closing market price on the day of $10.46. These warrants will vest upon the successful completion of specific goals outlined in the engagement letter with such firm, and will expire on November 9, 2010.
On November 9, 2005 300,000 warrants were issued to an independent third party financial advisor as partial consideration for providing financial advisory services to the Company in obtaining financing. These were issued at an exercise price of $10.46 per share, the closing market price on the date the Company engaged the financial advisor. Such warrants will vest upon closing of said financing, and will expire on November 9, 2005.
See Note 16 - Subsequent Events
In accordance with Emerging Issues Task Force No. 96-18, the Company has recorded the value of the November 2005, performance-based warrant issuances, at their lowest aggregate market value, which is zero. When the performance conditions have been met, the Company will record these issuances based upon the fair value of the warrants on the date of performance completion.
A summary of warrants outstanding at December 31, 2005 is as follows:
Date of issue Warrants Exercise price Expiration Date October 9, 2001 550,000 $1.50 October 9, 2011 June 11, 2002 410,914 $1.50 June 11, 2012 October 24, 2003 100,000 $2.05 October 24, 2013 January 4, 2005 100,000 $10.70 January 4, 2015 November 9, 2005 625,000 $10.46 November 9, 2010 November 9, 2005 300,000 $10.46 November 9, 2015
12. EMPLOYEE BENEFITS
Prior to December 31, 2002, the Company operated the Huntingdon Life Sciences Pension and Life Assurance Scheme (the "HLS Defined Benefit Pension Plan") a funded pension plan providing benefits, based on final pensionable salary, for certain Company employees in the UK. The Plan had been closed to new entrants from April 5, 1997 and as of December 31, 2002, the accumulation of plan benefits of employees in the plan was permanently suspended, and therefore, the HLS Defined Benefit Pension Plan was curtailed. This suspension of benefits resulted in a gain on curtailment of $8.4 million at December 31, 2002, which has been recorded as a reduction of the Company's unrecognized net actuarial loss.
The components of the net periodic benefit cost of the HLS Defined Benefit Pension Plan for the years ended December 31, are as follows:
The major assumptions used in calculating the pension expense were:
2005 2004 2003 Discount rate 5.5% 5.5% 5.5% Rate of increase of future compensation N/A N/A N/A Long-term rate of return on plan assets 8.0% 8.0% 8.0%
The overall expected return on plan assets for 2005 was the average of 5.5% per annum expected for debt securities and 9.0% per annum for equity securities and other assets held. The expected returns were based on market yields at the measurement date. Expected returns on the equity and `other' assets allowed for expected economic growth.
A reconciliation of the projected benefit obligation for the HLS Defined Benefit Pension Plan to the accrued pension expense recorded as of December 31 is as follows:
The accumulated benefit obligation is the same as the projected benefit obligation as the pension plan has been curtailed.
The Trustees of the pension plan aim to invest with a broad split of 60/40 between their two fund managers. The first manager invests in unit funds that hold portfolios of shares (76%), hedge funds (16%) and property funds (8%). The second manager invests in funds holding predominantly index-linked bonds, gilts and corporate bonds (67% in total) and in a fund of UK equities designed to track the FTSE All-Share Index (33%). These percentages are approximate and kept under review.
The pension plan target split of investment types is as follows:
Equity Securities 59% Debt Securities 27% Real Estate 5% Other 9% ----------- Total 100% ===========
The asset allocation is weighted towards equity investment whilst the liability profile contains a greater proportion of monetary liabilities. The investment stance has been undertaken in expectation of higher long-term returns, but is kept under review by the Trustees. Over the year the Trustees have reduced their exposure to equities in stages, to introduce commercial property and `absolute return' products, so as to increase the range of investments used by the scheme. In principle, this wider range of assets should help maintain the overall portfolio return, but should reduce variability (and hence reduce the risk to the scheme).
The pension plan weighted average asset allocations at December 31, 2005 and 2004, by asset category are as follows:
2005 2004 Equity Securities 59% 61% Debt Securities 29% 30% Real Estate 4% 4% Other 8% 5% ------------- ------------- Total 100% 100% ============= =============
The company expects to contribute $4,635,000 ((pound)2,700,000) plus expenses to its pension plan in 2006. The following benefit payments are expected to be paid in each of the next five years, and in aggregate for the following five years thereafter.
Pension Benefits $000's 2006 3,535 2007 3,707 2008 3,798 2009 3,937 2010 4,084 2011 - 2015 24,758
On April 6, 1997 the Company established a defined contribution plan, the Group Personal Pension Plan, for Company employees in the UK. Additionally, a defined contribution plan (401-K plan) is also available for employees in the US. The retirement benefit expense for these plans for the year ended December 31, 2005, 2004 and 2003 were $3.3 million, $2.5 million and $2.5 million respectively.
13. GEOGRAPHICAL ANALYSIS
During each of the years ended December 31, 2005, 2004 and 2003, the Company operated from within two segments based on geographical markets, the United Kingdom and the United States. The Company had one continuing activity, Contract Research, throughout these periods.
The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. Transactions between segments, which are immaterial, are carried out on an arms-length basis. Interest income, interest expense and income taxes are also not reported on an operating segment basis because they are not considered in the performance evaluation by the Company's chief operating decision-maker. Geographical segment information is as follows:
Revenues from customers (based on location of customers)
2005 2004 2003 $000 $000 $000 United States $46,758 $44,530 $38,820 Europe 87,520 78,277 61,110 Rest of World 37,735 34,744 32,504 -------------- ------------- ------------ $172,013 $157,551 $132,434
-------------- ------------- ------------
14. ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
15. UNAUDITED QUARTERLY FINANCIAL INFORMATION
The following is a summary of unaudited quarterly financial information for the 12 months ended December 31, 2005 and December 31, 2004.
16 SUBSEQUENT EVENTS
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 determined by a premium formula based on LSR's recent closing market prices). 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). Certain customary registration rights were granted in connection with these warrants. The warrants are subject to customary anti-dilution provisions.
In addition, the 300,000 warrants that were issued to an independent third party financial advisor on November 9, 2005 became fully vested on the closing date of the loan, March 2, 2006.
Net proceeds from the loan of approximately $63 million will be used to redeem the $46.2 million outstanding principal amount of the Company's 7.5% Convertible Capital Bonds, which are due to mature in September 2006, and for general corporate purposes.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. The Company's Principal Executive Officer (the CEO) and Principal Financial Officer (the CFO) have reviewed and evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered in this report. Based on that evaluation, the Principal Executive Officer and the Principal Financial Officer have concluded that the Company's current disclosure controls and procedures are effective. There have been no significant changes in the Company's internal controls or in the other factors that significantly affect those controls.
Internal control over financial reporting. Please refer to pages 44-45 of this Form 10-K for Management's Report on Consolidated Financial Statements and Internal Control, and the Internal Control Reports of the Company's Auditors.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below sets forth certain information with respect to the current directors and executive officers of LSR.
(a) Identification of Directors and Executive Officers
Andrew Baker became a director and Chairman and Chief Executive Officer of LSR on January 10, 2002. He was appointed to the Board of Huntingdon as Executive Chairman in September 1998. He is a chartered accountant and has operating experience in companies involved in the delivery of healthcare ancillary services. He spent 18 years until 1992 with Corning Incorporated ("Corning") and held the posts of President and CEO of MetPath Inc., Corning's clinical laboratory subsidiary, from 1985 to 1989. He became President of Corning Laboratory Services Inc. in 1989, which at the time controlled MetPath Inc. (now trading as part of Quest Diagnostics Inc.), and Hazleton Corporation, G.H.Besselaar Associates and SciCor Inc., all three now trading as part of Covance Inc. Since leaving Corning in 1992, Mr. Baker has focused on investing in and developing companies in the healthcare sector including Unilab Corporation, a clinical laboratory services provider in California, and Medical Diagnostics Management, a US based provider of radiology and clinical laboratory services to health care payers. In 1997, he formed Focused Healthcare Partners ("FHP"), an investment partnership that acts as general partner for healthcare startup and development companies.
Gabor Balthazar became a director of LSR on January 10, 2002. He was appointed to the Board of Huntingdon as the Senior Independent Non-Executive Director in March 2000. He has been active in international marketing and management consulting for almost 30 years. He was a founding Board member of Unilab Corporation, serving as President from 1989 to 1992, and continuing to sit on Unilab's Board until November 1999. From 1985 to 1997, Mr. Balthazar served as a consultant to Frankfurt Consult, the merger/acquisition subsidiary of BHF-Bank, Frankfurt, Germany and to Unilabs Holdings SA, a Swiss clinical laboratory testing holding company, from 1987 to 1992. He is a graduate of the Columbia Law School and the Columbia Business School in New York City.
Mark Bibi became Secretary and General Counsel of LSR effective July 28, 2005. Prior thereto he served as General Counsel of LSR and Huntingdon Life Sciences Inc. from April 1, 2002. He served as Executive Vice President, Secretary and General Counsel of Unilab Corporation, a clinical laboratory testing company based in Los Angeles, California from May 1998 to November 1999 and as Vice President, Secretary and General Counsel of Unilab from June 1993 to May 1998. Prior thereto, Mr. Bibi was affiliated with the New York City law firms, Schulte Roth & Zabel and Sullivan & Cromwell.
Brian Cass, FCMA, CBE, became a director and Managing Director/President of LSR on January 10, 2002. He was appointed to the Board of Huntingdon as Managing Director/Chief Operating Officer in September 1998. Prior to joining Huntingdon he was a Vice President of Covance Inc. and Managing Director of Covance Laboratories Ltd., (previously Hazleton Europe Ltd) for nearly 12 years, having joined the company in 1979 as Controller. Brian Cass worked at Huntingdon Research Center between 1972 and 1974 and has previous experience with other companies in the electronics and heavy plant industries. He has also held directorships with North Yorkshire Training & Enterprise Council Ltd and Business Link North Yorkshire Ltd. In June 2002, Mr. Cass was also appointed as a Commander in the Most Excellent Order of the British Empire (CBE).
Julian Griffiths MA, FCA, has served as Vice President of Operations of LSR since July 28, 2005. Prior thereto he was Director of Operations of Huntingdon from April 2003. He was appointed to the Huntingdon Board as Finance Director in April 1999 and Secretary in February 2000. He served as a director of LSR from January 10, 2002 to June 11, 2002. Prior to joining Huntingdon he was most recently Vice President of Analytical Services in the European pre-clinical division of Covance Inc., having spent nine years as Vice President of Finance in the same organization. Prior to that he held various positions with KPMG.
Afonso Junqueiras became a director of LSR on January 15, 2003. He is a civil engineer and has been President and a director of a South American private civil engineering firm since 1997.
Richard Michaelson became Chief Financial Officer and Secretary of LSR effective January 10, 2002. Mr. Michaelson was Director of Strategic Finance of Huntingdon from September 1998 to December 2001. He served as Senior Vice President of Unilab Corporation, a clinical laboratory testing company based in Los Angeles, California, from September 1997 to December 1997, Senior Vice President-Finance, Treasurer and Chief Financial Officer of Unilab from February 1994 to September 1997, and Vice President-Finance, Treasurer and Chief Financial Officer of Unilab from November 1993 to February 1994. Mr. Michaelson also served as Vice President of Unilab beginning in October 1990. Mr. Michaelson joined MetPath, Inc., the clinical laboratory subsidiary of Corning Incorporated, in 1980 and served as Vice President of MetPath from 1983 and Treasurer of Corning Lab Services, Inc. from 1990 through, in each case, September 1992.
Yaya Sesay, served as a senior government official of an African nation for approximately 25 years, culminating in his service as Financial Secretary of the Ministry of Finance for three years. For the past five years, Mr. Sesay has been an international businessman with an interest in the development of pharmaceutical products.
The Articles of Amendment and Restatement of LSR provide that the directors shall be not less than one in number and there shall be no maximum number of directors. Any director appointed by the board of directors holds office only until the next following annual meeting, at which time he shall be eligible for re-election by the stockholders. Directors may be removed from office only for cause.
No director or executive officer has a family relationship with any other director or executive officer.
(b) Code of Ethics
The Company has adopted a Senior Officer and Financial Personnel Code of Ethics. A copy of such Code of Ethics is filed as Exhibit 14 in this Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
In the 12 months ended December 31, 2005 and 2004 the aggregate compensation of the Executive Officers and key employees as a group, paid or accrued, was $3,442,958 and $3,322,247 respectively.
Employment Agreements
Andrew Baker
The services of Mr. Baker are provided for not less than 100 days per year through a management services contract between Huntingdon and FHP. Mr. Baker controls FHP. Under the contract, FHP agrees to provide the services of Mr. Baker as Chairman and CEO of the Company. The management services contract will continue until terminated on 12 months' written notice from either party.
Under the management services contract FHP is paid an annual fee of (pound)330,000. Mr. Baker receives health and medical insurance benefits from the company. He is also entitled to a non-pensionable car allowance of up to (pound)1,000 per month. Mr. Baker receives contributions to his private pension arrangements, equivalent to 33 percent of this basic annual fee. He is also entitled to a non-pensionable car allowance of (pound)1,000 gross per month and (pound)2,000 per month as relocation allowance. The management services contract may be terminated if either FHP or Mr. Baker is guilty of serious misconduct or is in material breach of the terms of the contract, among other reasons. In the event of termination without "cause" following a "change in control", as defined, FHP would receive a payment equal to 2.99 times this annualized fee plus an amount equal to 2.99 times all incentive compensation earned or received by FHP or Mr. Baker during the 12 months prior to termination.
Both FHP and Mr. Baker are bound by confidentiality restrictions and a restriction preventing Mr. Baker from holding any interests conflicting with those of the Company, without the Company's consent. Mr. Baker has undertaken to the Company that, during the continuance of the management services contract, he will not without the prior consent of the Company, be concerned or interested in any business, which competes, or conflicts with the business of the Company.
Mark Bibi
The services of Mark Bibi are provided through a service agreement between him and Huntingdon Life Sciences Inc. (a wholly owned subsidiary of Huntingdon). The service agreement appointed Mr Bibi as General Counsel and Secretary of Huntingdon Life Sciences Inc. and he now also serves as the Company's General Counsel and Secretary. Mr Bibi's service agreement will continue until terminated by Mr Bibi on thirty days' written notice or by Huntingdon Life Sciences Inc. on 12 months' written notice. In the event of termination without "cause" following a "change in control", as defined, Mr Bibi would receive a payment equal to 2.99 times his annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr Bibi during the 12 months prior to termination.
Mr Bibi receives an annual salary of $300,000 gross and is entitled to health insurance, life insurance, personal accident insurance, medical expenses insurance and participation in the 401(k) Plan of Huntingdon Life Sciences Inc. Mr Bibi's service agreement also provides for the payment of a bonus to Mr Bibi in the absolute discretion of the Company's Board.
In addition, Mr Bibi is entitled to a car allowance of $1,000 gross per month.
The agreement may be terminated if Mr Bibi is guilty of serious misconduct or is in material breach of the terms of the service agreement, amongst other reasons.
Mr Bibi is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business conflicting with the business of the Company or any subsidiary unless the Board otherwise consents or the interest is limited to a holding or other interest of no more than 5 percent of the total amount of shares or securities of any company quoted on a recognized investment exchange.
Brian Cass
The services of Mr. Cass are provided through a service agreement between Huntingdon Life Sciences Limited (a wholly owned subsidiary of Huntingdon) and Mr. Cass, which appoints Mr. Cass as President/Managing Director of the Company. Mr. Cass' service agreement can be terminated on two years' written notice from either party.
Mr. Cass receives a gross salary of (pound)330,000 per annum. Under the service agreement, Mr. Cass is also entitled to health insurance, life insurance, personal accident insurance and medical expenses insurance. Mr. Cass receives contributions to his private pension arrangements, equivalent to 33 percent of his basic annual salary. He is also entitled to a non-pensionable car allowance of (pound)1,000 gross per month and (pound)2,000 per month as relocation allowance. Mr. Cass' service agreement also provides for payment to Mr. Cass of a bonus, at the absolute discretion of the Company's Board. In the event of termination without "cause" following a "change in control", as defined, Mr. Cass would receive a payment equal to 2.99 times his annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr. Cass during the 12 months prior to termination.
Mr. Cass' service agreement may be terminated if Mr. Cass is guilty of serious misconduct or is in material breach of the terms of the service agreement or is in breach of the model code for securities transactions by directors of listed companies, among other reasons.
Mr. Cass is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business that conflicts with the business of the Company or any subsidiary unless either the Company's Board otherwise consents or the interest is limited to a holding or other interest of no more than 5 percent of the total amount of shares or securities of any company quoted on a recognized investment exchange.
Julian Griffiths
The services of Mr Griffiths are provided through a service agreement between him and Huntingdon Life Sciences Limited (a wholly owned subsidiary of Huntingdon). The service agreement appointed Mr Griffiths as Finance Director of Huntingdon and he now holds the position of Vice President of Operations. Mr Griffiths' service agreement will continue until terminated by Mr Griffiths on six months' written notice or by Huntingdon Life Sciences Limited on 12 months' written notice. In the event of termination without "cause" following a "change in control", as defined, Mr Griffiths would receive a payment equal to 2.99 times is annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr Griffiths during the 12 months prior to termination.
Mr Griffiths received an annual salary of (pound)165,000 gross and is entitled to permanent health insurance, life insurance, personal accident insurance, medical expenses insurance and pension benefits. Mr Griffiths' service agreement also provides for the payment of a bonus to Mr Griffiths in the absolute discretion of the Huntingdon Board.
In addition, Mr Griffiths is entitled to a non-pensionable car allowance of (pound)750 gross per month.
The agreement may be terminated if Mr Griffiths is guilty of serious misconduct or is in material breach of the terms of the service agreement, amongst other reasons.
Mr Griffiths is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business conflicting with the business of the Company or any subsidiary unless either the Company's Board otherwise consents or the interest is limited to a holding or other interest of no more than 5 percent of the total amount of shares or securities of any company quoted on a recognized investment exchange.
Richard Michaelson
The services of Mr. Michaelson are provided through a service agreement between him and Huntingdon Life Sciences Inc. (a wholly owned subsidiary of Huntingdon). The service agreement appoints Mr. Michaelson as Chief Financial Officer of the Company. Mr. Michaelson's service agreement will continue until terminated by Mr. Michaelson on thirty days' written notice or by Huntingdon Life Sciences Inc. on 12 months' written notice. In the event of termination without "cause" following a "change in control", as defined, Mr. Michaelson would receive a payment equal to 2.99 times his annual salary plus an amount equal to 2.99 times all incentive compensation earned or received by Mr. Michaelson during the 12 months prior to termination.
Mr. Michaelson receives an annual salary of $300,000 gross and is entitled to health insurance, life insurance, personal accident insurance, medical expenses insurance and participation in the 401(k) Plan of Huntingdon Life Sciences Inc. Mr. Michaelson's service agreement also provides for the payment of a bonus to Mr. Michaelson in the absolute discretion of the Company's Board.
In addition, Mr. Michaelson is entitled to a car allowance of $1,000 gross per month.
The agreement may be terminated if Mr. Michaelson is guilty of serious misconduct or is in material breach of the terms of the service agreement, amongst other reasons.
Mr. Michaelson is bound by confidentiality restrictions and a restriction preventing him from being engaged, concerned or interested in any business conflicting with the business of the Company or any subsidiary unless the Board otherwise consents or the interest is limited to a holding or other interest of no more than 5 percent of the total amount of shares or securities of any company quoted on a recognized investment exchange.
Discretionary bonus plan
The Company operates a discretionary bonus plan for executive officers and key managers based upon improvements to operating income and achievement of pre-defined targets. No bonus awards were made in respect of 2003. In accordance with the Company performance provisions established in June 2004 by the Compensation Committee, aggregate bonus awards of $1,910,000 were paid to 31 senior employees of the Company in respect of 2004. Bonus awards of $1,245,497 are expected to be paid to 32 senior employees of the Company in March 2006 as a result of the Company's achievement of specified fiscal year 2005 performance goals established by the Compensation Committee.
The following table shows the remuneration of Executive Officers and key employees in the 12 months ended December 31, 2005, 2004, and 2003:
Messrs. Baker, Bonner, Cass and Griffiths are paid in UK pounds sterling. The amounts have been converted at the rate of 2005: $1.8195, 2004: $1.8321, and 2003: $1.6354, to (pound)1.00 for the purposes of the above table.
The Officers' pension contributions are privately invested.
EQUITY INCENTIVE PLANS
LSR 2001 Equity Incentive Plan (the "LSR 2001 Equity Incentive Plan")
The LSR Board has adopted the LSR 2001 Equity Incentive Plan. Adoption of the LSR 2001 Equity Incentive Plan enables LSR to use stock options (and other stock-based awards) as a means to attract, retain and motivate key personnel. This stock option plan is approved by the shareholders.
Awards under the LSR 2001 Equity Incentive Plan may be granted by a committee designated by the LSR Board pursuant to the terms of the LSR 2001 Equity Incentive Plan (which has designated the Compensation Committee for such purpose) and may include: (i) options to purchase shares of LSR Voting Common Stock, including incentive stock options ("ISOs"), non-qualified stock options or both; (ii) stock appreciation rights ("SARs"), whether in conjunction with the grant of stock options or independent of such grant, or stock appreciation rights that are only exercisable in the event of a change in control or upon other events; (iii) restricted stock consisting of shares that are subject to forfeiture based on the failure to satisfy employment-related restrictions; (iv) deferred stock, representing the right to receive shares of stock in the future; (v) bonus stock and awards in lieu of cash compensation; (vi) dividend equivalents, consisting of a right to receive cash, other awards, or other property equal in value to dividends paid with respect to a specified number of shares of LSR Voting Common Stock or other periodic payments; or (vii) other awards not otherwise provided for, the value of which are based in whole or in part upon the value of the LSR Voting Common Stock. Awards granted under the LSR 2001 Equity Incentive Plan are generally not assignable or transferable except pursuant to a will and by operation of law.
The flexible terms of the LSR 2001 Equity Incentive Plan are intended to, among other things, permit the Compensation Committee to impose performance conditions with respect to any award, thereby requiring forfeiture of all or part of any award if performance objectives are not met or linking the time of exercisability or settlement of an award to the attainment of performance conditions. For awards intended to qualify as "performance-based compensation" within the meaning of Section 162(m) of the United States Internal Revenue Code such performance objectives shall be based solely on (i) annual return on capital; (ii) annual earnings or earnings per share; (iii) annual cash flow provided by operations; (iv) changes in annual revenues; (v) stock price; and/or (vi) strategic business criteria, consisting of one or more objectives based on meeting specified revenue, market penetration, geographic business expansion goals, cost targets, and goals relating to acquisitions or divestitures.
LSR's Compensation Committee, which will administer the 2001 LSR Equity Incentive Plan, will have the authority, among other things, to: (i) select the directors, officers and other employees and independent contractors entitled to receive awards under the 2001 LSR Equity Incentive Plan; (ii) determine the form of awards, or combinations of awards, and whether such awards are to operate on a tandem basis or in conjunction with other awards; (iii) determine the number of shares of LSR Voting Common Stock or units or rights covered by an award; and (iv) determine the terms and conditions of any awards granted under the 2001 LSR Equity Incentive Plan, including any restrictions or limitations on transfer, any vesting schedules or the acceleration of vesting schedules, any forfeiture provision or waiver of the same and including any terms and conditions necessary or desirable to ensure the optimal tax result for participating personnel and the Company including by way of example to ensure that there is no tax on the grant of the rights and that such tax only arises on the exercise of rights or otherwise when the LSR Voting Common Stock unconditionally vests and is at the disposal of such participating personnel. The exercise price at which shares of LSR Voting Common Stock may be purchased pursuant to the grant of stock options under the 2001 LSR Equity Incentive Plan is to be determined by the option committee at the time of grant in its discretion, which discretion includes the ability to set an exercise price that is below the fair market value of the shares of LSR Voting Common Stock covered by such grant at the time of grant.
The number of shares of LSR Voting Common Stock that may be subject to outstanding awards granted under the 2001 LSR Equity Incentive Plan (determined immediately after the grant of any award) may not exceed 20 per cent of the aggregate number of shares of LSR Voting Common Stock then outstanding.
The 2001 LSR Equity Incentive Plan may be amended, altered, suspended, discontinued, or terminated by the LSR Board without LSR Voting Common Stockholder approval unless such approval is required by law or regulation or under the rules of any stock exchange or automated quotation system on which LSR Voting Common Stock is then listed or quoted. Thus, LSR Voting Common Stockholder approval will not necessarily be required for amendments, which might increase the cost of the plan or broaden eligibility. LSR Voting Common Stockholder approval will not be deemed to be required under laws or regulations that condition favorable tax treatment on such approval, although the LSR Board may, in its discretion, seek LSR Voting Common Stockholder approval in any circumstances in which it deems such approval advisable.
The LSR Board has designated the Compensation Committee of the Board to serve as the stock option committee.
LSR made grants under the LSR 2001 Equity Incentive Plan on March 1, 2002 to certain directors as of that date, and employees, including the Named Executive Officers:
Grants to Directors - ------------------- Name Number Granted - ---- -------------- Gabor Balthazar 20,000 John Caldwell 20,000 Kirby Cramer 40,000
Grants to Named Executive Officers - ---------------------------------- Name Number Granted - ---- -------------- Andrew Baker 200,000 Mark Bibi 50,000 Brian Cass 200,000 Julian Griffiths 60,000 Richard Michaelson 90,000
All such options have ten-year terms; 50% of the shares subject to grant are immediately exercisable with the remaining 50% exercisable one year after the grant date (meaning all such options, fully vested as of March 1, 2003); and all have an exercise price of $1.50 per share, the price at which the Company sold shares of Common Stock in the Private Placement. Options to purchase an aggregate of 1,188,000 shares of LSR Common Stock (including those specified above) were granted in the two years 2002 and 2003 to employees and directors, on the terms set forth above, are listed below:
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- March 1, 2002 1,142,000 $1.50 September 3, 2002 20,000 $2.40 October 21, 2002 15,000 $2.03 February 14, 2003 11,000 $1.80
In 2004, in addition to the options granted under the 2004 LTIP referred to below, options to purchase an aggregate of 67,100 shares of LSR Common Stock were issued, all at exercise prices equal to the market price at the date of grant, on the terms set forth in the previous paragraph, are listed below.
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- April 12, 2004 37,100 $1.85 October 28, 2004 17,400 $7.70 December 15, 2004 12,600 $9.52
In 2005, options to purchase an aggregate of 23,600 shares of LSR Common Stock were issued, all at exercise prices equal to the market price at the date of grant, or the terms set forth above, are listed below:
Date of Grant Numbers Granted Exercise Price - ------------- --------------- -------------- May 23, 2005 3,600 $12.00 June 27, 2005 20,000 $11.00
2004 Long Term Incentive Plan
Effective June 1, 2004 the Company adopted the 2004 Long Term Incentive Plan ("2004 LTIP"), pursuant to the terms of the 2001 Equity Incentive Plan. The 2004 LTIP has two components: a grant of stock options, with a vesting date of March 31, 2007, and a cash bonus to be awarded in 2007 based on 2006 Company financial performance.
Options to purchase an aggregate of 362,663 shares of common stock were granted to 32 key employees of the Company as of June 1, 2004 under the 2004 LTIP; 55,500 of such options were granted to Andrew Baker, the Company's Chairman and CEO, 55,500 of such options were granted to Brian Cass, the Company's Managing Director and President, 30,303 of such options were granted to Richard Michaelson, the Company's CFO, 27,750 of such options were granted to Julian Griffiths, the Company's Vice President of Operations and 20,545 were granted to Mark Bibi, General Counsel and Secretary. The exercise price of all such granted options is $3.30, the market price of LSR common stock on June 1, 2004. All such options have ten-year terms and are exercisable in full on March 31, 2007. At December 31, 2005, 356,419 shares under the 2004 LTIP option plan were outstanding and none were exercisable.
The following table summarizes stock option activity under the Company's option plans:
Huntingdon Life Sciences Group plc Stock Option Plans
Huntingdon Life Sciences Group plc issued options prior to December 31, 1997 pursuant to several stock option plans. However, the ability to exercise options under all such Huntingdon plans lapsed on March 26, 2002 in connection with LSR's acquisition of Huntingdon, except for those granted under the Unapproved Stock Option Plan (the "Unapproved Plan"). Under the Unapproved Plan, some options technically remain outstanding. However, such options are exercisable only for shares of Huntingdon, a 100% wholly owned subsidiary of LSR, and as such are considered to have no value.
Warrants
On October 9, 2001, on behalf of Huntingdon, LSR issued to Stephens Group Inc. warrants to purchase up to 704,425 shares of LSR Voting Common Stock at a purchase price of $1.50 per share. Stephens Group Inc. subsequently sold the warrants to independent third parties. 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., (Stephens' Loan) 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 warrants were exercised in 2005.
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. The 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. None of these warrants have been exercised as of December 31, 2005.
On October 24, 2003, 100,000 warrants were issued at the market price on the day of $2.05. On January 4, 2005 100,000 warrants were issued at the market price on the day of $10.70. 50,000 are exercisable from January 4, 2007 and 50,000 from January 4, 2008. In all cases, these warrants were issued to independent consultants in connection with financial and strategic advice.
On November 9, 2005 625,000 warrants were issued to a third party advisory/lobbying firm at the closing market price on the day of $10.46. These warrants will vest upon the successful completion of specific goals outlined in the engagement letter with such firm, and will expire on November 9, 2010.
On November 9, 2005 300,000 warrants were issued to an independent third party financial advisor as partial consideration for providing financial advisory services to the Company in obtaining financing. These were issued at an exercise price of $10.46 per share, the closing market price on the date the Company engaged the financial advisor. Such warrants will vest upon closing of said financing, and will expire on November 9, 2005.
See Note 16 - Subsequent Events
In accordance with Emerging Issues Task Force No. 96-18, the Company has recorded the value of the November 2005, performance-based warrant issuances, at their lowest aggregate market value, which is zero. When the performance conditions have been met, the Company will record these issuances based upon the fair value of the warrants on the date of performance completion.
A summary of warrants outstanding at December 31, 2005 is as follows:
Date of Issue Warrants Exercise price Expiration Date October 9, 2001 550,000 $1.50 October 9, 2011 June 11, 2002 410,914 $1.50 June 11, 2012 October 24, 2003 100,000 $2.05 October 24, 2013 January 4, 2005 100,000 $10.70 January 4, 2015 November 9, 2005 625,000 $10.46 November 9, 2010 November 9, 2005 300,000 $10.46 November 9, 2015
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth, as of March 13, 2006, certain information regarding the beneficial ownership of the shares of LSR common stock, by (a) each person or entity who is known by LSR to own beneficially 5% or more of its outstanding shares of Common Stock (none other than Mr. Baker, who is a Director and Executive Officer of LSR); (b) each Director or Executive Officer of LSR or principal subsidiary; and (c) all Directors and Executive Officers as a group.
Number Percent of Name of Shares Outstanding Shares
Andrew Baker 2,311,060 (1) 17.5% Gabor Balthazar 20,000 (2) * Mark Bibi 148,409 (5) 1.2% Brian Cass 620,000 (3) 4.9% Julian Griffiths 110,000 (6) * Afonso Junqueiras -- -- Richard Michaelson 330,390 (4) 2.6% Yaya Sesay -- -- All Directors and Executive Officers as a Group 3,539,859 26.0%
* Signifies less than 1%. All percentages calculated on the basis of 12,553,251 outstanding shares of Voting Common Stock outstanding at December 31, 2005. Shares subject to issuance upon presently exercisable options or warrants are included in the number of outstanding shares for purposes of calculating that holder's percentage interest, as well as the aggregate percentage interest of all Directors and Executive Officers as a group.
(1) Includes presently exercisable options to purchase 200,000 shares and presently exercisable warrants to purchase 410,914 shares. 1,604,001 of such shares are beneficially owned by Focused Healthcare Partners Ltd, a Bahamas corporation that is controlled by Mr. Baker. 490,914 of such shares (including the 410,914 shares subject to presently exercisable warrants noted above) are beneficially owned by Focused Healthcare Partners LLC, a New Jersey limited liability company that is controlled by Mr. Baker.
(2) Includes presently exercisable options to purchase 20,000 shares
(3) Includes presently exercisable options to purchase 200,000 shares
(4) Includes presently exercisable options to purchase 90,000 shares
(5) Includes presently exercisable options to purchase 50,000 shares
(6) Includes presently exercisable options to purchase 60,000 shares
From time to time US depositary institutions hold shares on behalf of their clients to enable a market to be made in the LSR's shares. No holdings of 5% or more have been reported by those institutions at March 13, 2006.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(1) On January 20, 2001 the Company's bank loan was refinanced by means of a loan from HLSF, LLC a subsidiary company of the Stephens Group Inc., a related party at the time, and the other two banks that were part of the original loan syndicate. That loan was transferred to an unrelated third party effective February 11, 2002. The loan is now repayable on June 30, 2006 and interest is payable in quarterly breaks at a rate of "LIBOR" plus 1.75% per annum. The loan is secured by guarantees from LSR, Inc., LSR Ltd, Huntingdon Life Sciences Limited and Huntingdon Life Sciences Inc., collateralized by all the assets of those companies. As a result of the Sale/Leaseback entered into on June 14, 2005 the loan was fully repaid in June 2005.
(2) Brian Cass, President and Managing Director of LSR, acquired 400,000 shares of LSR Common Stock in the Private Placement. Mr. Cass acquired such shares through the delivery of two promissory notes. Both such promissory notes, each in the amount of (pound)211,679 ($363,411), are due on March 28, 2007; bear interest at the rate of 5% per annum; and are secured by the 200,000 shares of LSR Common Stock purchased with the proceeds of each such loan. The due date of each promissory note would be accelerated if Mr. Cass voluntarily resigned from his employment with LSR or had his employment terminated. Repayment of one of the promissory notes will be made by automatic deduction of (pound)44,000 ($75,539) per year from the (pound)66,000 ($113,309) per year pension contribution made by the Company to a pension plan established by Mr. Cass. The other note is further collateralized by the (pound)214,500 ($368,254) accrued in such pension account. In addition, one-third of any yearly bonus received by Mr. Cass will be used to reduce principal of the promissory notes. Total amount of this loan as of December 31, 2005 is (pound)120,000 ($205,000 at year-end foreign exchange rates).
(3) 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 is a newly formed company 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 agreed to make a best effort to repay within twelve months.
(4) Alconbury has received an interest free loan of $250,000, which has been included in accrued expenses and other liabilities, from Andrew Baker, LSR's Chairman and CEO.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
Fees for audit services totaled approximately $366,000 in 2005 and $377,000 in 2004, including fees associated with the annual audit and the audit of internal control over financial reporting and the reviews of the Company's quarterly reports on Form 10-Q.
Audit-Related Fees
Fees for audit-related services totaled approximately $92,000 in 2005 and zero in 2004. Audit-related services principally include consultation on tax and accounting issues related to a sale leaseback transaction, consultation on other accounting and internal control matters, including Sarbanes-Oxley requirements and other attest services.
Tax Fees
Fees for tax services, including tax compliance, tax advice and tax planning, totaled approximately $25,000 in 2005 and $27,000 in 2004.
All Other Fees
Hugh Scott, P.C. did not provide any services not described above in 2005 and 2004.
Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors
The Audit Committee pre-approves all audit and permissible non-audit services provided by the independent auditors. These services may include audit services, audit-related services, tax services and other services. The Audit Committee has adopted a policy for the pre-approval of services provided by the independent auditors.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
1. List of documents filed as part of this report
2. Index to Financial Statements Life Sciences Research, Inc.
Management Report on Consolidated Financial Statements and Internal Control
Independent Auditors Report on Internal Control over Financial Reporting
Independent Auditors' Report
Consolidated Statements of Operations- Years ended December 31, 2005, 2004, and 2003
Consolidated Balance Sheets - December 31, 2005 and 2004
Consolidated Statements of Changes in Shareholders' (Deficit)/Equity and Comprehensive Income/(Loss) Years ended December 31, 2005, 2004, and 2003
Consolidated Statements of Cash Flows - Years ended December 31, 2005, 2004, and 2003
Notes to Consolidated Financial Statements
3. Financial Statement Schedules
Schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
List of Exhibits
Exhibit No. Description of Exhibit
2.1 Letter of Intent, dated August 27, 2001, between the Registrant and HLS. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION NUMBER 333-71408.
3.1 Articles of Amendment and Restatement of the Registrant adopted on November 7, 2001. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION NUMBER 333-71408.
3.2 Bylaws of the Registrant. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION NUMBER 333-71408.
4.1 Subscription Agreement dated August 1, 1991 among HIH Capital Limited ("HCL"), HLS, Chase Manhattan Bank Luxembourg S.A. (the "Custodian"), J Henry Schroder Wagg & Co. Limited and Others. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1991.
4.2 Trust Deed, dated August 12, 1991 among HCL, HLS and The Law Debenture Trust Corporation plc INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1991.
4.3 Deed Poll, dated August 12, 1991, executed by HLS. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1991.
4.4 Custodian Agreement, dated August 1, 1991 among the Custodian, HCL, and HLS. INCORPORATED BY REFERENCE TO HLS'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1991.
4.5 Deed Poll, dated October 16, 2001, executed by Registrant. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION NO. 333-71408.
10.1 A Management Services Agreement dated August 7, 1998 between HLS and Focused Healthcare Partners. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 20-F FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
10.2 A Deed of Undertaking between HLS and Andrew Baker. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 20-F FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
10.3 Amendment dated January 26, 2000 to the Management Services Agreement dated August 7, 1999 between HLS and Focused Healthcare Partners. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999.
10.4 Service Contract dated April 29, 1999 between Huntingdon Life Sciences Ltd and Mr. B Cass INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 20-F FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
10.5 Service Contract dated April 29, 1999 between Huntingdon Life Sciences Ltd and Mr. J Griffiths. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 20-F FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
10.6 Service Contract dated April 29, 1999 between Huntingdon Life Sciences Ltd and Dr F Bonner. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 20-F FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
10.7 A letter of appointment dated March 21, 2000 between HLS and Mr. G Balthazar. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999.
10.8 Option Deed dated September 2, 1998 between HLS and Andrew Baker INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 20-F FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
10.9 Rules of the Huntingdon Life Sciences Group Unapproved Share Option Scheme as amended on June 3, 1998. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999.
10.10 Rules of the Huntingdon Life Sciences Group Incentive Option Plan INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999.
10.11 Registrant's 2001 Equity Incentive Plan. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION NUMBER 333-71408.
10.12 Loan Facility Letter, dated September 25, 2000, between HLS and Andrew Baker. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000.
10.13 Amendment No. 1 to Loan Facility Letter, dated as of February 22, 2001, between HLS and Andrew Baker. INCORPORATED BY REFERENCE TO HLS' ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000.
10.14 Amendment No. 2 to Loan Facility Letter, dated as of March 20, 2001, by and among Andrew Baker, HLS and Focused Healthcare Partners. INCORPORATED BY REFERENCE TO REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
10.15 Subscription and Investor Rights Agreement, dated October 9, 2001, between LSR and Walter Stapfer. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION STATEMENT NUMBER 333-71408.
10.16 Subscription and Investor Rights Agreement, dated October 9, 2001, between LSR and the persons named therein as Investors. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION STATEMENT NUMBER 333-71408.
10.17 Warrant, dated October 9, 2001, issued by the Registrant. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION STATEMENT NUMBER 333-71408.
10.18 Form of Director's Irrevocable Undertaking. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION STATEMENT NUMBER 333-71408.
10.19 Inducement Agreement, dated October 9, 2001 between the Registrant and HLS. INCORPORATED BY REFERENCE TO REGISTRANT'S REGISTRATION STATEMENT ON FORM S-4, REGISTRATION STATEMENT NUMBER 333-71408.
10.20 Warrant, dated June 11, 2002, issued by the Registrant. INCORPORATED BY REFERENCE TO REGISTRANT'S PROXY STATEMENT ON SCHEDULE 14A, DATED MAY 10, 2002.
10.21 Service Agreement, dated as of April 1, 2000, between Huntingdon Life Sciences, Inc. and Richard Michaelson. INCORPORATED BY REFERENCE TO REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
10.22 Service Agreement, dated as of April 1, 2000, between Huntingdon Life Sciences, Inc. and Mark Bibi INCORPORATED BY REFERENCE TO REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
10.23 Amendment No. 1 to Service Agreement between Huntingdon Life Sciences, Inc. and Richard Michaelson, dated as of April 15, 2002. INCORPORATED BY REFERENCE TO REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
10.24 Amendment No. 1 to Service Agreement between Huntingdon Life Sciences Limited and Brian Cass, dated as of April 15, 2002 INCORPORATED BY REFERENCE TO REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
10.25 Amendment No. 1 to Service Agreement between Huntingdon life Sciences Limited and Julian Griffiths, dated as of April 15, 2002 INCORPORATED BY REFERENCE TO REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
10.26 Amendment No. 2 to Management Services Agreement between Huntingdon Life Sciences Group plc and Focused Healthcare Partners, dated as of April 15, 2002 INCORPORATED BY REFERENCE TO REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002.
10.27 Financing Agreement between Huntingdon Life Sciences Limited and the Lenders thereto, dated as of March 1, 2006 INCORPORATED BY REFERENCE TO REGISTRANT'S CURRENT REPORT ON FORM 8-K DATED MARCH 7, 2006.
14 Code of Ethics - FILED HEREWITH
21.1 Subsidiaries - FILED HEREWITH
31.1 Certification of Chief Executive Officer pursuant to SEC Rule 13(a) - 14(a). FILED HEREWITH
31.2 Certification of Chief Financial Officer pursuant to SEC Rule 13(a) - 14(a). FILED HEREWITH
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.Section 1350. FILED HEREWITH
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.Section 1350. FILED HEREWITH
99.1 Press Release dated March 14, 2006, announcing fourth quarter and full year 2005 results. FILED HEREWITH
SIGNATURE
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Life Sciences Research Inc. (Registrant)
By: /s/ Andrew Baker Name: Andrew Baker Title: Chairman and Chief Executive Officer and Director Principal Executive Officer Date: March 16, 2006
By: /s/ Richard Michaelson Name: Richard Michaelson Title: CFO - Principal Financial and Accounting Officer Date: March 16, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Gabor Balthazar Director March 16, 2006 Gabor Balthazar
/s/ Brian Cass Director March 16, 2006 Brian Cass
/s/ Afonso Junqueiras Director March 16, 2006 Afonso Junqueiras
/s/ Yaya Sesay Director March 16, 2006 Yaya Sesay