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Executives

John Climax - Chairman & Co-Founder

Peter Gray - Director & CEO

Ciaran Murray - Company Secretary & CFO

Analysts

John Kreger – William Blair & Company

Eric Caldwell - Badge (ph)

Ross Muken - Deutsche Bank

Bob Jones - Goldman Sachs

Sam Faravin (ph) - Marion Finance Co.

Jack Gorman – Davy Stockbrokers

Greg Baylin - World's Baygate Securities

David Windley - Jefferies & Company

Ian Hunter – Goodbody Stockbrokers

Doug Tosayo (ph) - Barclays Capital

Todd Wensley (ph) - First Analysis

David Windley - Jefferies & Company

Jack Gorman - Davy Stockbrokers

Chris Hans (ph) - Select Equity

ICON plc ADR (ICLR) Q2 2009 Earnings Call July 22, 2009 10:00 AM ET

Operator

Good afternoon, ladies and gentleman, and welcome to the ICON plc Second Quarter 2009 Earnings Conference Call. My name is Fay, and I'll be your coordinator for today's conference. (Operator's Instructions). I'm now handing you over to Ciaran Murray to begin today's conference. Thank you.

Ciaran Murray

Good day, ladies and gentlemen. Thank you for joining us on this call covering the quarter ended June the 30th, 2009. On the call today we have Dr. John Climax, our Chairman, and Mr. Peter Gray, our Chief Executive Officer.

Before I hand the call over to John, I would just like to note that this call is webcast. There are slides available and the comments will follow the slide show. I will now make the customary statement in relation to forward-looking statements.

Certain statements in today's call may constitute forward-looking statements concerning the company's operations, performance, financial condition and prospects. Because such statements involve known and unknown risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Given these uncertainties, investors and prospective investors are cautioned not to place undue reliance on such forward-looking statements. The company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise.

Today's commentary refers to our second quarter ending June the 30th, 2009. Please take note that financials for both current and prior quarters and any reference to margin is after charging stock compensation expense.

In addition, the following commentary specifically excludes one-time net charges taken in Q2 2009, amounting to $4.2 million. These charges relate to lease and asset write-offs, headcount reduction costs, government incentive payments, and one-off tax credits.

On a US GAAP basis, including the above charges, operating profit in the quarter was $20.4 million or 9.3% of revenue. Net income was $18.5 million or 8.4% of revenue, and EPS amounted to $0.31 per share.

As noted, this presentation includes selected non-GAAP financial measures. For a presentation of the most directly comparable GAAP financial measures, please refer to the press release statement headed "Consolidated Income Statements: Unaudited US GAAP." While non-GAAP financial measures are not as superior, are not superior to, or a substitute for the comparable GAAP measures, we believe certain non-GAAP information is more useful to investors for historical comparison purposes.

And having said all of that, I would like to hand the call over to John.

John Climax

Thank you, Ciaran. Good day, ladies and gentlemen. We are very pleased to report another solid performance by ICON in quarter two, 2009. The group's net revenue grew 1% to $220 million in quarter two compared to $218.3 million last year. On a constant currency basis, revenue would have been approximately $230 million, representing constant dollar organic growth of 5%.

Year to date, net revenue was up 5% from $420 million to $440 million. Again, on a constant currency basis, revenue for the first six months would have been $456 million, representing constant dollar organic growth of 9%.

Operating income for the quarter grew 20% to $29.3 million compared with $24.4 million in the same quarter last year. Year to date, operating income grew 23% to $56.2 million. Operating margin for the quarter increased 13.3% compared to 11.2% in the same quarter last year. Year to date, the group operating margin improved to 12.8%, up from 10.9% in the prior year. Group net income rose to $22.8 million from $18.8 million last year, representing a 21% growth. EPS grew 22% from $0.31 per share to $0.38 per share. The effective tax rate for the quarter was 20%.

Year to date, net income increased by 22% to $43.7 million $35.7 million last year. EPS grew from $0.59 per share last year to $0.73 per share, a 24% increase. The effective tax rate for the year to date was 20%, in line with prior year.

DSOs at the end of June were 49 days compared with 59 days compared with the end of March '09, and 69 days at the end of December '08. As a result, cash flow provided by operating activities was a strong $103 million in the quarter. We invested $8.3 million capital expenditure on the maintenance of our global infrastructure and a number of major IT projects.

Year to date, cash flow from operations was $128 million and capital expenditure was $16.3 million. In addition, we invested $17.4 million in the acquisition of the remaining 30% of Beacon Bioscience in quarter one, and a further $6 million primary in relation to earn out payments for (inaudible).

On June 30th, the company's net cash amounted to $83.2 million compared to net debt of $2.2 million at March 31st, 2009. Having said that, I would like to hand you over now to Peter Gray who will give you an update of our business outlook.

Peter Gray

Thanks, John, and good afternoon or good morning to everyone on the call. Gross business awards for the quarter were $317 million. Cancellations were $51 million or 16% of gross awards or 3% of the opening backlog. Accordingly, net business wins were $266 million, and this represents a very solid book-to-bill of 1.2, which should support future growth.

Gross business awards for the year to date were $638 million, cancellations were $107 million, which is 17% of the gross awards on a year-to-date basis, and 3% of the average opening backlog. Net business wins for the six months were $531 million, which again represents a book-to-bill of 1.2.

As a result of all that our backlog at the end of June was $1.86 billion, which is a 14% increase over the same quarter last year. After this backlog we are expecting $679 million to be earned in the next four quarters, which represents a coverage of approximately 75% of the expected revenues in those future four quarters.

Just some commentary on the general marketplace as we see it: while the total sales cycle has remained prolonged and while total RFP values are still lower than last year, the value of opportunities outstanding has continued to strengthen through the quarter and currently stands at over $1.2 billion. It was down as low as $800 million at one stage earlier this year. So we see an improvement overall in the tone of the market. We see our pipeline in our lab business stronger than it's been for some considerable time. We're seeing the pipeline in our phase one business improving. So overall we would say that our experience is that the marketplace is strengthening, albeit from a low base, and certainly not back at the levels it was at a year ago.

We passed the year now complete. We're updating guidance. We expect revenues in 2009 to be in the range of $880 million to $900 million, which is slightly lower than our original guidance, partly impacted by currency factors. We expect earnings per share for 2009, after taking into account the Qualia acquisition which we talked about last quarter as being dilutive, we now expect the EPS in the range of $1.38 to $1.44, which is a slight improvement over the indications we gave in the last quarter post-Qualia.

Before we go to questions I'd like to take the opportunity to thank all of our staff across the globe for their contribution to the continuing success of ICON in this somewhat challenging environment. That concludes the formal part of the call, and maybe we can move to questions.

Question-and-Answer Session

Operator

Thank you. (Operator's Instructions) The first question comes from the line of John Kreger at William Blair. Please go ahead.

John Kreger - William Blair

Hi. Thanks very much. Peter, could you please give us just a bit more clarity on where the restructuring actions impacted the company?

Peter Gray

I've told John, it was pretty broadly based would be the top answer, although the US was more — the higher cost in the restructuring was in the US because we decided to shot a number of offices across the US and allowed the staff in those offices to go home-based, so there are lease termination costs that are a fairly significant part of the $13.4 million of gross costs.

But there are also some costs associated with some reductions in our lab business. There's a restructuring taking place in our Manchester phase one unit, which I think you've all heard us talk about, the fact that that business has been challenging and problematic for some time, so we've taken some strong action there and other small pieces across the other parts of the business, John. So the major spend was in the US in the clinical business, rationalizing our cost base, reflecting the fact that demand in clinical research is not as strong in the United States today as it is outside of the United States. And what we're seeing effectively is some contraction in our business in the US while growth is continuing in Europe, Asia, and Latin America.

John Kreger - William Blair

Great. That's very helpful. A followup to that, I think the change in your revenue guidance at the midpoint was I think about $65 million. How much of that would you say is just foreign currency related versus also some changed market conditions?

Peter Gray

I think, John, I have to say most of it would be changed market conditions. Currency impact might account for about half of that towards the midpoint.

John Kreger - William Blair

Great, and finally, any update on pricing environment, as you perceive it?

Peter Gray

No. No change, John. Our view is that pricing in the marketplace continues to be pretty disciplined. We're not seeing any apparent behavior. It's competitive. As we talked about on the last call, it is competitive, but not foolishly so. And I think what we see, we're reasonably satisfied with the business that we're winning and not feeling as if it's being unduly impacted by that competitive environment.

John Kreger - William Blair

Excellent. Thanks very much.

Operator

Thank you. The next question comes from the line of Eric Caldwell at Badge (ph).

Eric Caldwell - Badge

Thanks very much. I was hoping that we could get an update on progress with the Qualia unit and whether you're actually starting to book revenue in that facility or new contracts in that facility, anything you're seeing there?

Peter Gray

I think we had planned that we would not actually have the units operational until during Q3, and that's still the plan. We expect that it'll be about mid-August by the time the unit has been reconfigured to what we want. We are pre-selling at the moment, although the unit's not ready for clients to come and view it and audit it and so on, so we haven't booked any business yet, I suppose is the short answer. But we are pre-selling and we are encouraged by the response that we're getting.

Eric Caldwell - Badge

That's great. Next question relates to segment mix. I apologize if I missed this; I haven't had the chance to go through the slide deck yet. But the central lab, could we get the operating margin in the quarter and also the bookings profile for central lab?

Peter Gray

Yeah. I suppose a piece of update for you is we're no longer going to be reporting the lab as a separate segment. It being well less than 10% of our revenues, and given that we have now a number of other lab assets, and given that none of our peers who have labs report them as a separate segment, we've decided we're not going to report lab as a separate segment in the future; but nonetheless, as we've always done, we're going to give clarity on how different elements of our business are performing.

So the revenues in the lab were down a little on last quarter. They were just under $18 million in the quarter. The margin was down because of the investments that we've been making and the slightly lower revenues. The margin was between 5 and 6%, which is a bit disappointing but not unexpected given the investments we've been making. And the good news with the quarter was the bookings. The bookings were up in the early 20s, which is back up to where — it's been three quarters since they were anywhere close to that.

And their pipeline, as I said in my opening remarks, their pipeline of opportunities is stronger than we have seen for a considerable length of time, so we're reasonably comfortable with where the lab is going, although in the remainder of 2009 its financial performance is still going to be around mid-single digit margins as the investments we're making are a drag on performance until we get some business in there.

Eric Caldwell - Badge

That's fair. Would it be reasonable for us to maybe go back now and restate central lab into the core operations? Since you won't be reporting this, I assume that's the model going forward?

Peter Gray

That's correct, Eric. Yes.

Eric Caldwell - Badge

Okay, great. Finally, on the other conference call from the sector this morning there was a message that it looks like the market may be returning in the second half and that one of your big peers has seen a bigger RFP pipeline already for the fourth quarter looking ahead a couple of quarters than they've historically seen looking three to six months out. I'm curious if you can confirm that. And they also made a comment that there are a half or dozen or so preferred-provider deals being discussed in the market, and I'm curious whether you're also participating in that level or number of discussions with your client base.

Peter Gray

Yes is the answer, I suppose, to the second one. Obviously you don't know if they're overlapping ones, but there are always things happening in the marketplace, and we're certainly engaged in quite a number of interesting discussions with either existing clients or new clients currently.

Eric Caldwell - Badge

Understanding that there's always guilt out there, I guess the better way to ask the question would be are you seeing incrementally more here in the last few months, or is it a steady state of strong activity?

Peter Gray

I think I'd call it a steady state of strong activity, Eric. I think on the last call — I rue the day that I said it — I mentioned a number of strategic discussions we were having. I always get asked about it now. I think that that in itself was a very strong statement and it indicated a very strong level of discussion. And there have been a couple more come on the agenda since then, so we're pretty comfortable that the tone of the market, not just in RFP terms but in terms of companies really engaging in thinking about how to do outsourcing to a greater extent in a more, if you'll pardon the cliché, strategic way and so on — but that progress continues, and we see that as a pretty positive indicator for the future.

Now I can't say that we are seeing RFPs related to Q4 because we don't get RFPs for Q4 until Q4, but what we are getting indications of is continuing improvement in RFP activity and good indications from our clients that the flow of opportunities in the second half is likely to be stronger than in the first half. So I think we're probably echoing similar sentiments to the other call today.

Eric Caldwell - Badge

Great. Thanks so much, Peter.

Operator

Thank you. The next question comes from the line of Ross Muken at Deutsche Bank. Please go ahead.

Ross Muken - Deutsche Bank

Good morning and afternoon, depending on where you are. In terms of sort of overall market activity, one of the other things your peer said this morning was that there was particular areas of weakness from a therapeutic focus. They noted infectious disease and oncology. Are you seeing any specific areas that are showing any different characteristics, sort of, from the overall core business, or is that something where you think it was probably more specific to their mix?

Peter Gray

I can't comment on their mix, to be honest with you, but you now have asked a question that I will run off and get our business development people to do an analysis and see is there anything in the numbers that says that there's a particular shift in particular therapeutic areas. But there is nothing that I am aware of. Ciaran, if you are aware of — no, we are all shaking our heads here. There is nothing we're aware of any particular weakness in any particular therapeutic area and it's hard — to be honest, it's hard to conceive as to why one particular therapeutic area would be suffering weakness if others weren't.

So nothing we're aware of, but you prompted me now to go ahead and ask the business development folks to do some analysis.

Ross Muken - Deutsche Bank

Well, I'm glad I at least accomplished — (laughter). In terms of uses of cash, obviously, with the very, very strong cash flow in the quarter, your balance sheet profile is quite attractive currently. You've been somewhat active on the M&A front. How would you sort of characterize valuations and sort of what's available? I know for a lot of time last year there was pretty stretch valuations. Obviously that's corrected somewhat. How would you sort of paint that picture?

Peter Gray

I think valuations have changed, obviously, in the public domain. I think in the private domain they have not. It seems to take entrepreneurial and VC or PE owners of emerging or developing businesses longer to adjust to the evaluation realities of the marketplace than it takes the market to adjust or the public markets to adjust. So I would say that it is probably early yet for acquisition activity to pick up because valuation expectations have not adjusted as much as they probably need to.

Ross Muken - Deutsche Bank

Okay, great, thank you very much.

Operator

Thank you. The next question comes from the line of Randall Stanicky at Goldman Sachs. Please go ahead.

Bob Jones - Goldman Sachs

Good morning. Hi. Good morning. This is actually Bob Jones on for Randall. I wanted to talk on the margins for a second. I'm hoping you can provide some detail on what was done on the cost production side, maybe some specific areas that were the source of cost productions, and then how much leverage do you think you have on the cost side going forward?

Peter Gray

I think, first of all, Bob, I would say that the cost production that we've taken in the course of the quarter haven't really had financial effect yet because they were taken, many of them, toward the latter end of the quarter, so we have obviously been taking cost — we've been very cost-conservative through the year so far because of the uncertainty in the marketplace. But the specific cost productions that we've spent money on, as I say, occurred at the back end of the quarter, and therefore we haven't seen the benefit of those yet.

Bob Jones - Goldman Sachs

Now that's helpful; and then just one more follow-up. On the strategic deal that you signed with Lilly in June, I was wondering if you could maybe help us think about how much of that deal is recognized this quarter in bookings, and then maybe how we should think about that business being recognized going forward. Thanks.

Peter Gray

It's obviously a significant piece of business that should have long-term significant revenue value for us, but the value booked in backlog is probably the equivalent of a large phase three program. It's therefore north of $50 million, is what's gone into the backlog. We have earned no revenue on that as yet. There's a consultation period going on with the Lilly employees, and those processes have to go through before we'll actually take on any of the work. Some revenues may flow in Q3, but again, it'll probably be only at the very back end of the quarter, so it won't be until Q4 that revenues begin to flow from that opportunity.

Bob Jones - Goldman Sachs

Thanks for the questions.

Operator

Thank you. The next question comes from the line of Sam Faravin(ph) at Marion. Please go ahead.

Sam Faravin - Marion Finance Co.

Hi, guys. Thanks for taking the questions. Peter, you were talking about RFP value increasing. I was wondering if you could give us some sort of idea of the momentum going from Q1 into where we are now in terms — has it been a steady growth from what you were saying, $800 million up to the 1.2 billion now?

And I was wondering also if you could give us some information about how the new business signings are going. I remember in Q1 you were saying that January and February there was very little sign that all sort of fell through into March, and then we saw a continuation into April-May. I was wondering if you could give us an update how that's gone throughout Q2 and into Q3.

Peter Gray

Okay, the first part first. The RFP momentum is — as I said in my opening comments, RFP values are still pretty significantly lower than last year, so none of us here are jumping up and down and throwing our caps in the air and saying, "Peace in our time." There's still significant progress to be made, as one of the earlier questioners identified. There are indications that RFP activity is going to be increasing in the second half of the year. We're certainly seeing better quality and more, larger RFP opportunities over the last month or so, so it's building nicely. One of the reasons why the pipeline of outstanding opportunities has grown up to 1.2 billion is because the sales cycle remains prolonged, so things are staying longer before the decisions are made. So I don't, again, want to overexcite enthusiasm here, but it's — I think the indicators — what I'm saying here, Sam, is the indicators are encouraging, but we're not calling it the end of the game yet.

And to the second part of the question, if you wouldn't mind repeating it.

Sam Faravin - Marion Finance Co.

Yeah. Sorry, I was just asking about the actual new business signings.

Peter Gray

Oh yeah, yeah. The flow of signings was better all through the quarter. There weren't any big gaps during the quarter where nothing was happening, and the very encouraging thing was the signings in the first couple of weeks of July have been pretty strong so Q3 has started out very well. So overall again the indicators are that the freeze, a bit like the credit markets perhaps, the freeze has been thawing and decisions have been made and business has been signed.

Sam Faravin - Marion Finance Co.

Okay. Thanks for the question.

Operator

Thank you. The next question comes from the line of Jack Gorman at Davy. Please go ahead.

Jack Gorman - Davy Stockbrokers

Thanks for letting me ask some questions. I have some housekeeping questions, really, if I may, albeit very short ones. First of all on Qualia, just wanted to get as sense of what the impact of that was in the quarter in earnings terms, if there was any at all? Second question and just in terms of the margin profile whether FX had an impact on that as there was plenty — a marked increase year-on-year in your margin. Thirdly, should we be reading the cash flow in the quarter as particularly sustainable or indeed the DSO trend as particularly good in the quarter? Is that a sustainable number? And finally, just any sense, Peter, whether on your consolations was there anything particular unusual within the profile of those this quarter around?

Peter Gray

Okay. Maybe Ciaran will your take the first couple of pieces.

Ciaran Murray

I will, yeah. Qualia was one cent. We got a foreign exchange benefit when we retranslated the balance sheet at the end of the quarter which led to the margin from being in the high 12s to 13.3, so looking forward sort of 12.6-12.8 is where we would see the like-for-like margin.

The cash flow was driven by a record 49 days of DSO, which arose from a particular benign set of collection circumstances. Everything just seemed to go right. We still used 60 as being our target DSO as being the long-term average so while we will endeavor to keep the numbers as low as we can, there's a fair chance that we will see a rise over the next quarter or two, so I wouldn't assume 49 was necessarily sustainable.

Peter Gray

And then in relation to the cancellations, I think that what's noticeable, Jack, is the last three quarters the cancellation rate against wins in the quarter was only about 16% or thereabouts, which is higher than the average that we've had over the last couple of years. But when you look at it in terms of opening backlog, it's running about 3%, which is at the upper end of the range. We talk about 2-3% or 2-4%. 3% is a relatively high number historically.

So cancelation activity is a little higher than it's been traditionally, but not worryingly so. There's no particular evidence to say that the world is changed and things are much more likely to be cancelled. I think where some of those cancellations are still fallouts from the financial crisis and people really examining their pipelines and determining whether certain projects that they planned to do they really need to do or not, and I suspect that will work itself out over the next couple of quarters, and I would be hopeful we'd see the cancellation rate begin to come back down into our norm of low teens or thereabouts, against wins, and somewhere between 2-3% against opening backlog.

But there are no particular trends that we see in cancelations other than that rather broad statement that I've just given you.

Jack Gorman - Davy Stockbrokers

Okay. And Peter, maybe if I may, just if you could provide any more additional color on the RFP momentum that you've talked about for a couple of questions, and is there any particular segment of the market, be it biotech, pharma, large, small, that's been particularly driving that momentum?

Peter Gray

I would say large pharma is more in evident than obviously small pharma small biotech. That's not a surprise, I guess. They're the guys who have the most money. But generally, it's mid-sized pharma. It's the companies that have revenues and cash flows to support their R&D activity which are strongest, and the companies that were relying on the financial markets and sponsors to provide them with cash to support programs are the ones that are less obvious in the market today.

Jack Gorman - Davy Stockbrokers

Thank you very much.

Operator

Thank you. The next question comes from the line of Greg Baylin (ph) at World's Baygate Securities (ph). Please go ahead.

Greg Baylin - World's Baygate Securities

Thanks, Peter. So touching on Eric's earlier question, last quarter you talked about three specific conversations you were having with pharma on strategic deals. It looks like obviously one of those was the Lilly deal you signed in the quarter, and congratulations, by the way. Assuming success with other deals, do you expect these strategic deals to follow the same structure as the Lilly deal in that they are kind of outsourced as a specific function?

Peter Gray

No. I think that the types of strategic discussions we have and are having with clients are pretty much unique to each client. Each client has their own approach and way of doing things, and not every one of them is likely to be announced. In fact, the majority of them will never be announced because of the nature of them and because there aren't specific assets or activities that are transferred. But nonetheless they will represent a shift in the way in which the client is approaching outsourcing.

So I don't think you should expect to hear of more announcements of the Lilly type necessarily, but there may be a lot of interesting things going on in the background which we'll allude to in conversation, but we won't be announcing in press releases.

Greg Baylin - World's Baygate Securities

Okay, that's fair. And then excluding the Lilly deal that was signed in the quarter, any bookings in the quarter of note, just in terms of maybe the $30-50 million mark?

Peter Gray

There were one or two other things that were reasonably significant in the quarter, but obviously we don't go into more details other than saying, yeah, there were a couple of things in the 20-30 range.

Greg Baylin - World's Baygate Securities

Okay. And then, Ciaran, just a few housekeeping questions; are you still targeting $46-48 million for CapEx in 2009?

Ciaran Murray

I think we will be lower than that, Greg. We started at that level at the start of the year. We've spent about $16 million or 16.5 in the first two quarters so I would expect that the CapEx would be closer to $35 million.

Greg Baylin - World's Baygate Securities

Okay, all right. And then just last question, looking at the 5% constant currency growth rate in the quarter, does that include the revenue contribution from Prevlair (ph), and then if so, I'm assuming it does, can you break that out if possible?

Ciaran Murray

No. The 5% was a constant dollar organic growth rate.

Greg Baylin - World's Baygate Securities

Okay. And then could you possibly provide what the contribution for Prevlair was?

Ciaran Murray

No. We don't disclose that detail.

Greg Baylin - World's Baygate Securities

Okay, all right. Thank you.

Operator

Thank you. The next question comes from the line of David Windley at Jefferies. Please go ahead.

David Windley - Jefferies & Company

All right, thanks. Ciaran, could you talk a little bit on FX? I think from my notes I had that you were using 1.4 on the US dollar to Euro exchange in your guidance earlier in the year. The dollar is actually a little weaker than that right now. I wanted to make sure I understood the moving parts of the currencies and where your exposures are that would negatively impact revenue forecast as opposed to positively impact that forecast?

Ciaran Murray

Yeah. For the first part of the year, Dave, the dollar was down in the 1.30s so in the actual numbers that we picked up for about five months the dollar was adversely impacting the reported revenue, so that's where most of it comes. And when we look forward to the rest of the year we're forecasting not at 1.40, but in at around 1.35 or 1.36.

And then the actual currency flows that we have is specific to just the nature of contracts and what's been signed and where revenue's coming in, so they're just moving parts there, and when you crunch them all through the model it's coming up that we're about $30-40 million off for the foreign exchange assumptions when we did the guidance.

David Windley - Jefferies & Company

Okay. So part of that is that you are making an assumption that is of a stronger dollar than where it's trading right now?

Ciaran Murray

Yes.

David Windley - Jefferies & Company

Right. Peter, on the new business flows, is ICON's hit rate remaining relatively constant? Are you seeing that actually move up in the market right now?

Peter Gray

Our data would suggest that our hit rate is running a little better than it was running a year ago so a little higher is the answer.

David Windley - Jefferies & Company

And would you attribute that to getting some repeat business from some customers that might have been new a year ago or newer a year ago or just continuing to put the shoulder to the yolk or is there some other factor that might be influencing that hit rate?

Peter Gray

I think you're asking me are we cutting prices, Dave.

David Windley - Jefferies & Company

I didn't say that. I'm going to ask you if others are cutting prices, though.

Peter Gray

Well, the answer is we're not cutting prices. Is it because we're putting it to the shoulder? Yeah, it is. I mean, if you asked our business development team and our operations teams, they would say we've upped our game in our pitches to clients, the amount of effort we're putting in, the teams we're assembling — everything, because it's a tough market. Everything and because it's a more completive market, everything is being looked at, and I think we're just playing the game a little better a little tighter than we were a year ago. And that is a great achievement and I think we're very pleased with that, but we certainly are pretty confident it's not because we are cutting prices.

David Windley - Jefferies & Company

Right. And are you running into different competitors these days in the bake off than you have seen historically or is it pretty much the same mix?

Peter Gray

I think it's pretty much the same mix. We've been playing in — what do we call it — in football in the UK they call it the Premier League. We've been playing in the Premier League now for the last number of years so the people we see are the top CROs and you wouldn't really expect them to disappear. They're all there so we're continuing to see the same people.

David Windley - Jefferies & Company

And are you seeing any of your typical competitive set, which I presume includes both public and private companies — are you seeing any of them and maybe particularly the privates that can hide that activity acting differently from a pricing discipline standpoint?

Peter Gray

No. As I said in my earlier comments, our observation is that there's pretty good pricing discipline in the marketplace. We're not seeing, as we saw back in 1999, some real rogue activity. We're not seeing any evidence of real rogue activity, so I think everyone, public and private, seem to be behaving in a rational way. I think if you go back to 1999, some of the companies that did behave irrationally suffered for several years afterwards because they had to live with the consequence in three and four year duration contracts of very poor pricing. I think everyone remembered that and has learned from that and therefore people are not being foolish.

David Windley - Jefferies & Company

Moving onto the others side of that coin. The cancellation rate, you've commented about that a little bit. Obviously I'm sure you've seen it, I've written about it, these mergers are kind of notorious for creating some shuffling of pipeline of activity, and I guess I'm wondering when we're going to — not if we're going to hear about that reshuffling, but when, and I'm wondering if you have heard or gotten indications from clients of business that they do not intend to continue to pursue as a result of Pfizer Wyeth or Merck sharing.

Peter Gray

Again the quick answer is no. The longer answer is it's probably early yet. I don't think any of those mergers are yet consummated so the actions that you might take as a result of those will not happen until they happen. I think the other thing to remember is in these mergers it's later stage projects, and particularly anything that's in phase three are rarely, in our experience, cancelled. Because if they've got to that stage they presumably have been through a lot of screening and a lot of diligence and they have significant hope associated with them if they are in phase three. So the likelihood that significant chunks of business that are already running will be cancelled, I think is pretty small.

The disruption that typically happens in mergers is the flow of RFPs after the merger or even before the merger slows down, because people are anticipating the actions of the merger are digesting the merger and trying to use their internal resources first and outsourcing less of the pie for a period of time until the cost-reduction exercises kick in and then they need to outsource more.

So I don't think it's going to be a cancellation story. I think it's going to be a lag in business story if there is any sort of story. And again remember, and we have been again open about this, the percentage of our business with any of those companies is pretty small.

David Windley - Jefferies & Company

Right. In your comments to an earlier question kind of referring to PPD's call this morning and talking about the back half improving from the first half, when you look at the back half of '09 and expect some improvement, is that also taking into account the potential lack of flow from those companies, the larger companies?

Peter Gray

I'd love to tell you that we have analyzed it down to that level and we've done it up by company and we haven't. I suppose our business development teams give us reports on what they're expecting from the clients and we amalgamate all of that and we gauge from that what we think the tone of the market is, but it's not a scientific number.

It's like looking into — what is it, in Harry Potter they have a pen thief or something like that is what they look into in Dumbledore's office. That's what we're looking into and hoping that we're seeing the picture of the future, but who the hell knows.

David Windley - Jefferies & Company

And then last question I had was around the coverage ratio. I noticed that you guide in a way that ratcheted that number back up a little bit. Was part of the change in guidance to get to a more conservative position vis-à-vis that coverage outlook?

Peter Gray

Now I think you need to repeat that question. You've got me confused.

David Windley - Jefferies & Company

Well, you're 75% coverage number, I think, is where you're at now and it had dropped down to 71. So that obviously is a more conservative stance. I guess I'm just asking was that a recognition that you wanted to get that number back up into the mid-70s just to position yourself more conservatively on guidance?

Peter Gray

No. Obviously when you bring down the revenue it does push up that percentage number that you are correct there, but it wasn't done in order to bring the percentage back up. It was done because our revenue forecast say that that's what it'll be, and with having done 218 or 220 in each of the last quarters we're at a cumulative of 440 or there, but at this stage it'll be quite a stretch to get to the 930, which is the bottom of the guidance. That would require a blowout, if I can use that term, Q3s and Q4s, and we're not anticipating that. So we had to bring down the revenue guidance number to make sense with the numbers there.

David Windley - Jefferies & Company

Okay, great. Thank you.

Operator

Thank you. The next question comes from the line of Ian Hunter at Goodbody Stockbrokers.

Ian Hunter - Goodbody Stockbrokers

Good afternoon, gentlemen. Given the fact that this quarter you're saying that you had one business — well, the Eli Lilly deal was $50 million towards the backlog and you had a couple of deals in the $20-30 million, and I think you had a $40 million deal in Q1 '09 or that kind of range. I was just if you could give us an update on the client concentration?

Peter Gray

Sure. Largest client is less than 7% of revenues. Let me open my cheat sheet here. The top five clients, 24% of revenue year to date compared to 29% last year. Top 10 clients 39% compared to 48% last year, and the top 25 clients year to date, 59% compared to 68% last year. So the client concentration is continuing to dilute.

Ian Hunter - Goodbody Stockbrokers

Okay. That's great. And I'm just wondering if again can you give us an idea as you've got your cheat sheet there, as you said, Peter, what the indications are that you're seeing the business coming through if you've got an idea or a breakdown on that, and also the size of companies that you're dealing with that are in your backlog.

Peter Gray

Oh, you're really getting into the nitty gritty now (laughter). In terms of the business wins, the concentration of clients, I think alluded to this earlier, are largely large pharma and mid-biotech and small biotech and small pharma, by which we mean companies that make losses or don't have revenue — only represented 6% of our gross awards in the quarter.

And the other anoraks question you ask me, Ian, was what? Oh, therapeutic indications. In the first half of the year oncology was 24% of revenues, cardiovascular was 22%, CNS was 16%, and endocrinology, which would be diabetes and obesity, was 10%. Now that's not awards, that's revenues. I haven't analyzed or don't think we have analyzed the awards by therapeutic area.

But if you look at our backlog overall at the end of the quarter, oncology was 29% of our backlog, cardiovascular was 17%, CNS was 16%, and diabetes in endocrinology was 13%. And the rest — I can go on and on, but too much information.

Ian Hunter - Goodbody Stockbrokers

No. That's why I mean, really, when I was looking at the size of the clients, et cetera, I was going back to my old chestnut of bad debt provisions and just wonder if whether you have a provision in there and whether you've been seeing any difficulty with your smaller clients? And I see your percentage of small biotech and pharma has reduced somewhat from a couple of quarters okay, and I'm just wondering if you're seeing that they're just not coming through with the deals and therefore you're in a better position dealing with the more established pharma now than you were maybe two quarters ago.

Peter Gray

I think, Ian, it would be fair to say if you go back over the years we haven't had much in the way of bad debt issues. In Q4 on a one off basis because of the state of the world we took a provision of $5 million or thereabouts against a number of biotech companies which we had looked at in terms of their ability to continue and their viability and their funding.

We took that charge in Q4. We haven't done anything more significant since then. We took a prudent and hard look at the numbers at the end of the year and nothing much has changed since that time. And as you would expect that small provision is still warranted because some of these small companies are struggling, and there are some programs we're doing where we've slowed down the pace of work because their cash flows can't support the paperwork and so on, and so we're being cautious with those but we think we're well provided.

Ian Hunter - Goodbody Stockbrokers

That's great. Thanks very much.

Operator

Thank you. The next question comes from the line of Doug Tosayo (ph) of Barclays Capital. Please go ahead.

Doug Tosayo - Barclays Capital

Hi. Good morning, guys. You referenced that you took a charge for the Manchester clinic and I believe you indicated that you are moving from the clinic into an inpatient setting at a Manchester hospital. Has that move been completed and how —

Peter Gray

No. That has not been completed. The timing on that is that we have moved out of our old facility, but the new facility in Manchester Royal Infirmary will not be available until April of next year. So at the moment we're continuing to work with our clients, but we are using third party facilities. We've settled partnerships with five or six other units and we are conducting studies in their units using their facilities, but using our staff.

Doug Tosayo - Barclays Capital

And do you anticipate seeing any moderation in terms of your business development efforts for European phase one just given the fact that you are going to be sort of working with third-party providers which might give some clients a little hesitation until you're into your new facility?

Peter Gray

On the contrary, we've been working even harder to convince our clients they should to continue to work with us. We have some unique selling points developed in Manchester and we have some unique models that we've developed in Manchester that we're continuing to have traction with with clients. And we certainly were not going to withdraw from the market, though, because when you withdraw from the market it's very hard to regain your position. So we're fighting hard with all of our existing clients and with some new clients to win business, even in the third-party units.

Obviously, when we modeled the effect of that post the closing of the old unit, we were concerned that not all clients would be receptive, but we've been positively surprised and have been winning higher levels of business than our plan had supposed, so we're very pleased with how that's going.

Doug Tosayo - Barclays Capital

Okay. And then when we think about the operating margin in the quarter, Ciaran referenced there were some balance sheet adjustments which gave, it sounds about 70 basis points in the quarter. How should we suspect about — I suspect your recruiting costs are down just given the moderation of your business wins. And so when I think about the margin gains that we've seen sort of 12.7% range for the year which is probably about 70 basis points up from where we were last year — how much is just lower recruiting cost versus just improved deployment of resources and more efficient operation?

Peter Gray

I mean, it's a combination of a number of factors. We have seen significant margin gains over the past 12 months, and I mean, I wouldn't call it — sort of to just categorize it as recruiting costs would probably be over simplistic, albeit we may be responsible for that nomenclature from what we said in the past. From what we said about growth and when we were growing very rapidly there was some downward pressure at times on margin and we would have categorized that as being gross-related costs, meaning recruitment costs, induction, training, building up the associated infrastructure behind it.

So I think taking all of those things into account in that and a more moderate growth environment. So while we're still posting growth, it is at a more moderate pace therefore — we're all human. There's less suboptimization in the face of the growth rates we have, now rather than the nosebleed 30+% gross rates we had in the past.

So you put all that mix together and we've seen the margin creep up into the high 12-point somethings. I think that's a fair run rate for the rest of the year.

Doug Tosayo - Barclays Capital

Okay. And then, Peter, you've broadly sort of given comment about seeing fewer large opportunities in the marketplace right now. Is your experience, or are you seeing things fairly even across your entire client base or is it uneven in that some clients continue to be fairly strong, some seem to be weaker, and maybe some are strong in some quarters and some are weaker in others, or has it been fairly consistent across all the quarters, across your entire client base, as I think about your key repeat clients, not thinking about the smaller biotech companies who are less often repeat companies?

Peter Gray

There are a number of different points I'd like to make about that. First of all, I'd like to clarify something that you said at the beginning, which is that I said we were seeing less large opportunities. I think that's what I said on the last call, pre-quarter one. What I was indicating, and I obviously didn't communicate it very well today, was we're beginning to see those larger opportunities reappear, which is why our list of outstanding opportunities has grown and is growing and has reached $1.2 billion at this point in time.

So I think that flow, that aspect of the market, is correcting, would be our assessment. Now it's early yet to absolutely call it, but it's certainly better than it was at the end of quarter one.

In terms of repeat business and are there some that are and some that aren't, the answer to that is there are always some that are and some that aren't. If you think about the number of compounds that large pharma companies have in phase three, it is never as large as the threes would like it to be. So therefore there's a finite number of large opportunities any company has.

And once they commit into a large molecule they've committed a significant part of their budget probably for several years to come. So you can see periods — you can see years where we have a lot of activity with one particular client and much less activity with that client in the following years, but we're earning lots of revenue with them because we won some significant project from them in a given year. And another client is in a difference place in its cycle and we see a lot of activity from another client in a year.

So it's very difficult and very misleading to say that one client is more active than another client at a particular point in time. Given the duration of these big projects, you tend to get a staccato flow of business from these companies.

And I think another factor, just during the course of this last quarter I pointed out to people and I think it was even a bit of an aha moment even for myself. Last year we had $865 million of revenues and our largest client was 7-8% of revenues, which means our largest client represented about $60 million of revenue. For companies that are spending four or five or $6 billion plus in research and development, for us only to have $60 million of revenues from them since — we've got a heck of a long way to go before we really penetrate these companies.

So it's not surprising that we might see ups and downs and staccato activity with any one client at any point in time.

Doug Tosayo - Barclays Capital

Okay, great. Thank you very much.

Operator

Thank you. The next question comes from the line of Todd Wensley (ph) at First Analysis. Please go ahead.

Todd Wensley - First Analysis

Hi, guys. I wanted to ask you, is there an annualized savings that you can attach to that $13.4 million in restructuring costs that you incurred in the quarter?

Peter Gray

There are annualized savings that we can attach to it, but we're not disclosing that number. It's just another number in the whole panoply of numbers that go to make up and weave the fabric of the accounts.

Todd Wensley - First Analysis

Is it presumably greater than the $13.4 million restructuring cost?

Peter Gray

No. I mean, a lot of that $13.4 million is attached to where we consolidated certain offices where we had duplicate facilities. There were a number of cities where over the years we ended up with two offices, some as a result of acquisition and other reasons. So some of those lease termination costs would run to leases over the next five or six years. Hence the actual amount that that will go forward in quarterly savings wouldn't be particularly material in the context of our accounts. If it were a material number we might indicate it or disclose it.

Todd Wensley - First Analysis

Okay. Just trying to reconcile a few different things that you've given us regarding your outlook for the back half of the year in the way of EPS, and I think you said you really don't expect the margin run rate ex the Qualia benefit that you got in Q2 to change in the back half of the year. Is there anything apart from Qualia that is a margin headwind on the back half of the year? Perhaps maybe the phase one facility in the UK, but apart from those two, was there anything that's kind of a headwind to margin from your perspective?

Peter Gray

Nothing that springs to mind, Todd, no. As I indicated, the lab margin down a little in quarter two and we're expecting that'll continue to be lower than it had been in the previous three or four quarters. So mid-single digit as opposed to high single-digit in the lab. I wouldn't call it a headwind because again, the numbers aren't that big, but nothing else, Todd.

Todd Wensley - First Analysis

Okay. Anything below the operating line that you'd like to call out for us then in terms of expense in the back half of the year that maybe we didn't see in the first half?

Peter Gray

We don't really have any expense then below the operating line. Interest is the only one that will fluctuate in relation to the various cash pattern and balances. It's really hard to forecast. It's not a significant amount. I think it's just under $1 million in this quarter. It'll go up or down depending on the timing of cash flows and the interest rates and deposits so there's nothing significant there.

Todd Wensley - First Analysis

Okay. Good enough. On the revenue side, then, just you talked about the increase in number of strategic discussions; there has been a lengthening, I guess, in decision cycles that still persist. From your perspective, the reason behind the lengthening of the decision cycle is that because of the general landscape that the pharma companies find themselves in today with respect to health-care reform here in the US, or is it something more specific to perhaps how the customer base is looking at their utilization of outsourcing in general, the types of outsourcing that they want to engage in? If you could provide some thoughts there, that would be helpful, thanks.

Peter Gray

It's a very difficult one to analyze, Todd. Why were they taking an average three months to make a decision last year and they're taking on average about five months to make a decision this year? In different companies probably there are different reasons within them. I think myself it is that the financial crisis was a wakeup call for everyone in every industry in every business around the world. As a consequence, everyone has become more parsimonious, more careful about how they spend money, questioning more about why they're doing certain things, and I think that's affecting the decision cycle even in pharma companies.

Now it's not to say that every decision is delayed, but on average, decisions are taking longer to make because I think getting the commitment to spend is just taking longer because of the conservatism that has been brought to bear in all businesses.

Todd Wensley - First Analysis

Thank you. That's helpful.

Operator

Thank you. The next question comes from the line of Dave Windley at Jefferies. Please go ahead.

David Windley - Jefferies & Company

Hi. I thought I’d come back, and since you’re not going to report the lab, I thought I’d suggest, how about reporting the staffing segment as a separate business?

Peter Gray

It would be under 10% of revenues, Dave, so…

David Windley - Jefferies & Company

I see. How about phase four? (laughter) One segment just seems — not enough excitement with only one segment.

Ciaran Murray

You don’t give anybody else a hard time about it. Why us?

David Windley - Jefferies & Company

Ah, well, I don’t know. Just felt like coming back on here. I’ve got one or two others. So we, I don’t think, have touched on Vida labs as it incorporates into the guidance; was there material? Was there much of an influence or impact from Vida on revenue or earnings?

Ciaran Murray

No, Dave, there wasn’t much. It’s a small facility, based in the UK, and it’s distinguished by some of the talents that it has and its bio market technology. It had about 10 employees, so it’s not a significant number in terms of revenue or earnings, and it hasn’t impacted the guidance at all.

David Windley - Jefferies & Company

Ok. And then, Ciaran, to I think Todd’s question on influence on margin. You said you expect something in the 12%, high 12%, for the balance of the year, and that is — I’m trying to kind of compare that with your answer to my question earlier on using the 1.35 assumption, Euro to dollar. If the dollar is weaker than that, does that have a negative influence on that margin level as revenue and margin move in opposite directions for you guys?

Ciaran Murray

I mean, there are too many moving parts, really, in the whole way the foreign exchange works to oversimplify it. You really have to look at these currency assumptions more by way of an impression, as a painting rather than an architect with blueprints, you know? I mean, broadly, I am comfortable that in that 1.35 to 1.40 range we keep posting margins, and that — we had 12.4% in Q1. We have a 13.3% in this quarter, which, if you took out that one-off benefit — what makes it hard, I’m not being coy with you, but you know, we talk about the average rate for the quarter. If you go back to Q1, our average dollar-Euro rate was 1.31. It was then an average rate of 1.35 for quarter two, albeit it finished up near the 1.40. So it’s not rated actually on the day that you translate your balance sheet that all you stuff comes across, hence, we got a couple of million dollars benefit.

It's very hard to predict to that level, and you know, you can have the rate bounce along at a particular level for 89 days in a quarter, and on that last day, the day you translate your balance sheet, is the one that’s going to swing your margin by that 30 or 40 or 50 cents, so I wouldn’t really be able to go forensic enough for you to be honest with what we’ve said, you know.

David Windley - Jefferies & Company

CSI, Ciaran!

Ciaran Murray

(Laughter) I’m sitting here with my microscope as we speak…

David Windley - Jefferies & Company

Was the FX — there was a specific FX benefit related to Qualia in the second quarter?

Ciaran Murray

No. I don’t know where that came from.

David Windley - Jefferies & Company

Right. I think those were consecutive statements that Ciaran made, but they’re unrelated, right? And that was my interpretation; they are unrelated.

Ciaran Murray

I didn’t refer to Qualia in any sense of foreign exchange, so they must have been separate statements.

David Windley - Jefferies & Company

Okay. Well, I think in Todd’s question, he said something about – and maybe I misunderstood his question - but something about the benefit to margin in the second quarter from Qualia. There wasn’t one, was there?

Ciaran Murray

No, there wasn’t.

David Windley - Jefferies & Company

No. Right.

Ciaran Murray

I think you have misheard something that I said. It might be an accent issue there, Dave. (Laughter)

David Windley - Jefferies & Company

All right. Got you!

Ciaran Murray

Or a telecommunications one, but…

David Windley - Jefferies & Company

Got you! Okay, thank you.

Operator

Thank you. We have no further questions, but please be reminded, if you’d like to ask a question please press seven on your telephone keypad now.

We have a question from the line of Jack Gorman at Davy. Please go ahead.

Jack Gorman - Davy Stockbrokers

Guys, I’ve probably gone over my quota on questions already, but if I can, maybe just one more. Just to go back to the restructuring charge, Ciaran, can you just give us an outline of what the cash costs are on a net basis associated with the three elements of the charge, please?

Ciaran Murray

I don’t have those figures to hand, Jack.

Jack Gorman - Davy Stockbrokers

Okay. But presumably, the tax effect is a non-cash item?

Ciaran Murray

The tax effect — most of the tax effect in this quarter is unrelated to the restructuring costs. The tax effect in those restructuring costs is pretty — it might be about $1 million on the actual restructuring provision.

Jack Gorman - Davy Stockbrokers

Okay. But the credited sales that you note in the statement on the tax side, the tax cut, it would be essentially non-cash, that’s the way we should look at it. Would that be right?

Ciaran Murray

No, that’s a cash tax credit. It involves either the reduction of the payment of tax or the refund of previous tax.

Jack Gorman

Okay. All right. Well, maybe I can take that off the Internet get further details on it. Thank you.

Operator

Thank you. The next question comes from the line of Chris Hans (ph) at Select Equity. Please go ahead.

Chris Hans - Select Equity

My question was answered, thanks.

Operator

Thank you. We have no further questions, so I’ll hand you back to your host to conclude today’s conference.

Ciaran Murray

Thank you very much, ladies and gentlemen. We are very satisfied with ICON’s performance in Q2 ’09. Operating income, net income and margins all grew, and effective working capital management produced excellent cash generation in the quarter. We remain cautiously optimistic as 2009 continues. Thank you again.

Operator

Thank you for joining today’s call. You may now replace your handsets.

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