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Executives

Jill L. Baker - Vice President of Investor Relations

Josef H. von Rickenbach - Chairman and Chief Executive Officer

James F. Winschel - Senior Vice President and Chief Financial Officer

Analysts

Dave Windley – Jefferies

John Kreger - William Blair

Eric Coldwell – Robert W. Baird

Alex Alvarez - Goldman Sachs

Todd Van Fleet - First Analysis

Douglas Tsao - Lehman Brothers

Sandy Draper - Raymond James

Glenn Garmont - Broadpoint Capital

PAREXEL International Corporation (PRXL) F2Q08 Earnings Call January 24, 2008 10:00 AM ET

Operator

Welcome to the PAREXEL International second quarter Fiscal 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to our host, Ms. Jill Baker.

Jill L. Baker

Good morning everyone. The purpose of this call is to review the financial results for PAREXEL’s second quarter of fiscal year 2008. With me on the call today is Josef von Rickenbach, our Chairman and Chief Executive Officer; and James Winschel, Senior Vice President and Chief Financial Officer. Thank you for joining us.

We would like to begin by stating our standard Safe Harbor disclosure language. Various remarks that we may make about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors. These factors are discussed more fully in the section entitled Risk Factors of the company’s quarterly report on Form 10-Q, for the quarter ended September 30th, 2007, as filed with the Securities and Exchange Commission on November 7, 2007.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, and therefore you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

During this call, we may refer to certain financial measures, which have not been prepared in accordance with Generally Accepted Accounting Principles. When discussing numbers or margins related to direct costs, selling, general and administrative expenses, income from operations, income taxes, net income and earnings per share, we may refer to pro forma results. These pro forma results may exclude the impact of unusual positive or negative items and/or charges, including those related to special charges, restructuring reserves and adjustments to restructuring reserves.

As always, our discussions today concerning growth rates and margins will be based upon service revenue and related costs, and will not include revenue and costs related to reimbursable out-of-pocket amounts. A reconciliation of the non-GAAP financial measures with the most directly comparable GAAP measures is available in the Investor Relations section of our website at PAREXEL.com or will be discussed during the course of this teleconference.

I would now like to turn the call over to Mr. von Rickenbach.

Josef H. von Rickenbach

Thank you, Jill. I would like to review some of the details for the quarter, and then Jim will provide more information on the financials. After that we will open the call to any questions you may have.

For the quarter ended December 31st 2007, service revenue was a record $238.7 million, compared with $180.5 million in the same quarter of the prior year, an increase of approximately 32%. Excluding the positive impact of foreign exchange of $14.2 million in the quarter, revenue increased 24.4%.

The CCT and APEX acquisitions added a total of $14.2 million to revenue in the quarter. To get to a year-over-year same-store growth rate, partial quarter CCT revenue of $4.4 million should be deducted form the second quarter revenue last year. The result is a same-store growth rate of 27.4%.

Excluding the positive impact of both foreign exchange and acquisitions revenue grew 19.4%. On a sequential basis, revenue in the December 2007 quarter was up 14.7% from the September 2007 quarter.

The primary reason why second quarter revenue exceeded the top end of our guidance range, related to better than anticipated progress on the execution of projects. This resulted in a faster burn rate on certain contracts, which in turn led to a slightly higher conversion of backlog into revenue than we had originally projected. While we are pleased with this result, I felt that the variance deserved some explanation.

During the second quarter, Clinical Research Services or CRS represented approximately 76% of the company’s total revenue, versus 73% in the same quarter of the prior year.

PAREXEL Consulting & Medical Communications Services or PCMS comprised approximately 14%, compared with 16% in the prior year quarter and Perceptive Informatics was approximately 10% of the total, versus 11% one year ago.

With regard to the geographic breakout of revenue for the December 2007 quarter, 39% of revenue was generated in the Americas, the same as the December quarter one year ago. Europe, the Middle East and Africa represented 54% of revenue versus 56% one year ago. And Asia-Pacific represented 7% versus 5% one year ago.

During the quarter, the largest client represented 9% of revenue, up from 8% in the December quarter one year ago. The top five clients represented 35%, up from 29% one year ago. And the top 20 comprised 58% of the total, which was up from 53% last year.

Our second quarter operating income increased a robust 47.7% year-over-year to $20.5 million. As a percentage of total company revenue, the operating margin was 8.6%, an improvement of 90 basis points year-over-year. This was driven more or less equally by an improved gross margin and SG&A leverage.

SG&A expense declined as a percent of revenue, both year-over-year and sequentially in the December quarter. We are pleased with our progress in improving margins and fully expect to further improve this important metric in future quarters.

With regard to the tax rate, you may recall that the first quarter benefited from a significant reduction in the term tax rate, which pushed the corporate tax rate to an unusually low level. We anticipated that our second quarter tax rate would significantly increase, but at 41.3% it came in even higher than we had planned. We do expect the tax rate to even out for the remainder of the year and Jim will provide more specific commentary and guidance on this complex topic in just a moment.

In the second quarter, diluted earnings per share came in at $0.40 versus $0.32 in the second quarter one year ago, an increase of 25%. The increase in the tax rate eroded EPS growth substantially, especially in light of the healthy growth in operating income.

I would now like to walk you through the new business and backlog performance for the quarter. Backlog as of September 30, 2007 was $1.57 billion, adding record gross new business wins of $486.8 million in the December quarter and then subtracting $238.7 million of revenue that was recognized during the quarter. And cancellations of $40.1 million left us with an ending backlog on December 31, 2007 of approximately $1.78 billion.

I’d like to note that the cancellation rate, which equated to 2.6% of the prior’s quarter-ending backlog, was very low and below our expected range. As we have consistently indicated cancellations can fluctuate significantly, I have no doubt that the rate will eventually come back into the range of 3.5% to 5% of the prior quarter’s ending backlog, which is the range we also use in our internal models. Indeed, if you look at cancellations on a 12-month and 6-month basis, the average quarterly cancellation rate amounted to 4% and 3.9% respectively.

The net book-to-burn ratio for the quarter was a very strong 1.87, and we are obviously very happy with this performance. As mentioned on last quarter’s call, we had a couple of contracts in the first quarter which carried over into this quarter’s new business numbers. Our experience indicates that the second quarter’s book-to-burn ratio is unusually high and that the ratio will likely come down going forward.

I believe that over the long run, average book-to-burn levels of 1.3 to 1.4 should be considered as quite good. That being said, we believe that the overall market conditions continue to be favorable at the present time. Demand for our services is strong and our new business outlook remains very positive.

With regard to the APEX acquisition which we completed in the first quarter, the integration continues to be on track. We are excited about the many opportunities that we now have to further grow our business in the Asia-Pacific region, which is becoming increasingly important to our clients and to our company.

Unlike some of our competitors, who are only now focusing on establishing a more global presence, this has been our focus for the last 15 years. We are very comfortable with the size and scope of our global footprint. Our focus now, is to maximize the competitive benefits of our global infrastructure to the benefit of our clients as well as for our own purposes.

In our operations in the United States, we generated a small operating profit this quarter. We expect to see steady increased profitability in this important geography over the remainder of the year and in fact beyond.

In our PCMS business, both revenue and gross margin grew year-over-year and sequentially. In this context, I would like to highlight the performance of our Medical Communications business, which contributed more than half of the 7.5-point year-over-year margin improvement.

While MedCom is making good progress, we still expect further improvements as a result of operational initiatives that are currently underway in that business unit. Additionally, we anticipate an uptick in product approvals for the biopharma industry. In the past, this has correlated well to increased levels of new business for MedCom.

I would like to now make some comments about our Perceptive and our technology strategy. We believe that technology is an integral and in fact pivotal component of our business, as we work to deliver high quality products and services to clients, reliably and cost effectively.

As you all know, Perceptive sells a number of exciting eClinical technologies. One of our specific initiatives is to introduce these systems across the board in our clinical research operations. We also plan to extend the scope of our products and services and to add further scale to Perceptive. Collectively, these measures are designed to drive growth and improve profitability for this rapidly growing business unit.

So at this point I’d like to turn the call over to Jim, who will provide more detail on our financial results.

James F. Winschel

Thanks Joe and good morning everyone, first, a few comments about our three reporting segments. During the second quarter, CRS service revenue totaled a $182.7 million, up 38% compared with the prior year quarter, driven by strength in Phases II through IV. On a sequential basis, CRS increased 14.7%. Excluding the CCT and APEX acquisitions, which contributed $14.2 million combined, and the $12 million positive impact of foreign exchange movements, same-store constant currency service revenue growth was 22.1%.

During the quarter, service growth in the Clinical Pharmacology portion of the CRS business was negatively impacted by cancellations and delays, as well as a temporary disruption in our Berlin unit which moved into a new facility during the quarter. The Berlin unit is now back to normal operations.

CRS gross margin was 32.9% during the second quarter, down 0.4 of a point from 33.3% one year ago. On a sequential basis, gross margin was down 1.7 points due in part to the ClinPharm challenges I just described.

The remainder of the decline occurred in the Phase II through IV portion of business, due to catch up adjustments recorded for bonus accruals and increased hiring and training costs in light of the ongoing significant increases in backlog and service revenue. Going forward we expect to see a rebound in CRS gross margin.

Quarterly service revenue of $32.5 million in PCMS increased by 15% year-over-year and by approximately 7% on a sequential basis. I am pleased to report that both PARAXEL Consulting and Medical Communications contributed to the growth.

During the quarter, PCMS gross margin at 34.2% increased by a very healthy 7.5 points compared with last year and by 2.8 points sequentially. Again, both businesses contributed to the improvement, although as Joe noted, MedCom was the larger contributor.

Quarterly service revenue of $23.4 million in Perceptive Informatics was up approximately 19% year-over-year and up approximately 28% on a sequential basis, with strength in Medical Imaging and IVRS.

Perceptive’s gross margin in the quarter was 44.7%, down 1.7 points from the prior year quarter, but up 4.6 points on a sequential basis. The year-over-year decline was caused by a less favorable revenue mix. The sequential improvement was driven mainly by increases in Medical Imaging and IVRS.

On an overall company basis, gross margin for the quarter was 34.2%, compared with 33.7% one year ago, up 0.5 of a point. On a sequential basis, gross margin was down 0.4 of a point for the reasons I have already covered. We expect gross margin to increase in the third quarter, driven by improvements in the CRS business segment.

SG&A spending in the second quarter stood at 21.5% of revenue, down from 21.8% in the December quarter one year ago, and down from 22.6% in the September quarter. In dollar terms, SG&A spending was up 30.6%, compared with the December quarter one year ago, versus service revenue growth, 32.2%.

The primary drivers of the increases included increased facilities and information systems costs, the impact of the CCT and APEX acquisitions, and foreign exchange movements. We expect SG&A to continue to decrease as a percent of revenue over the remainder of the fiscal year.

For the quarter, depreciation expense equated to 3.5% of service revenue, down from 3.7% during the second quarter of last year. Amortization expense was 0.6, 1% of service revenue in the quarter, the same as one year ago. On a dollar basis, amortization expense increased year-over-year and sequentially, driven primarily by the APEX acquisition. The year-over-year increase was partly offset by a decrease with regard to CCT.

Operating margin in the second quarter was 8.6% of service revenue, up 0.9 of a percentage point from 7.7% in the December quarter one year ago. We expect operating margin to be in the 8.8% to 9% range during the third quarter. On a full year basis, we expect operating margin to be in the range of 8.8% to 9.1%.

Other income was a negative $329,000 in the quarter, driven by interest expense, partially offset by foreign exchange gains. We are currently forecasting other income to be a loss of about $800,000 in the third quarter.

During the December quarter, we had an effective tax rate of 41.3%, compared with 37.3% one year ago. We are now projecting the full fiscal year tax rate to be 35.1%, up from our expectations of 33.9% back in October, including the various one-time net tax benefits, for example, the German statutory tax rate reduction. The projected full year rate excluding those one-time net benefits is now 40%, up from our expectations of 38.7% back in October.

At this time, we are projecting third and fourth quarter tax rates to be 40%. Taxes continue to be a challenging area. There are several reasons why our tax rate is so high including one, the need accrue potential liabilities associated with FIN 48 related tax reserves; two, U.S taxation of non-US earnings, so called Subpart F income; and three, other non-deductible expenses.

We’re currently in the middle of making some major changes to our tax structure and approach, which we would expect, will mitigate these types of issues. However the issues by their nature are highly complex and will require some time to resolve. When we complete all the steps, we believe we can have a sustainable tax rate in the mid to low thirties.

Net income in the quarter was $11.5 million, an increased of 27% year-over-year. Moving on to the balance sheet, net receivables stood at $184.6 million at the end of December, taking into account gross revenue of $284.3 million for the quarter.

DSO stood at 52 days, a decrease of one day from the December quarter one year ago, and a decrease of five days from the September quarter. Cash collections have been very strong during the month of January, so we’re off to a great start for the March quarter.

During the quarter, we generated cash flow from operations of $18.2 million. Other cash inflows included $5 million from the additional drawdown on the company’s credit line, $4 million in proceeds from the issuance of common stock in conjunction with the company’s employee stock purchase and stock option plans, and $300,000 from other sources.

Cash outflows included $13.3 million for capital expenditures, mostly related to hardware and software purchases and leasehold improvements; and acquisition expenditures accounted for $1.7 million. Netting the inflows and outflows resulted in an overall increase in cash of $12.5 million from the end of September, leaving us with a balance of $62.9 million. During fiscal year 2008, we now expect capital expenditures to total approximately $45 million.

Finally, with regard to the earnings guidance, which is contained within our press release, we’ve increased the low and high ends of both revenue and EPS guidance, taking into account actual second quarter results for revenue, EPS and net new business wins, recent exchange rate movements, and a current strong outsourcing market environment.

Operator, at this point we are ready to begin to the question-and-answer period.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Dave Windley – Jefferies.

Dave Windley – Jefferies

I wanted to focus first on the CRS gross margin. Jim, you mentioned hiring, training, catch-up adjustments for bonus accrual and I think you also said that Phase I of business impacted that a little bit. You said you expect that to rebound.

Can you put an order of magnitude on that rebound, I mean back to Q1 levels or in excess of that. I know in your guidance comments from the last conference call, you said you expected 2Q gross margin to actually improve, and that obviously didn’t happen. I’m just wondering how much of a bounce-back can we expect there?

James F. Winschel

David, in the second quarter the Clinical Pharmacology piece of the deterioration probably accounted for half of the impact. And then the other parts of the CRS business segment accounted for the other piece of that. Certainly we know that a large chunk of the issue, with respect to the Clinical Pharmacology business, is not going to be repeated.

But of course you’ve also seen the very strong new business wins that we reported this quarter, which is going to continue to require us to add some hiring and training costs during the third quarter. So we will certainly see an improvement, but probably not quite back up to those prior levels.

Dave Windley – Jefferies

It’s not back up that Q1 level?

James F. Winschel

Not quite back up to the Q1 level, that’s right.

Dave Windley – Jefferies

It’s not immediately, right?

James F. Winschel

Not immediately, sure.

Dave Windley – Jefferies

In the Perceptive business, obviously in the other two segments both of those, the gross margin was pretty attractive and certainly the improvement was impressive. In Perceptive in particular, you’ve hit that 44% level a few times. I am wondering if we are now getting to a point where something in the mid-40s might be sustainable, or conversely could you describe what continues to make that pretty lumpy?

James F. Winschel

Well, David, the lumpiness in Perceptive is certainly caused by software sales. And to the extent that we have a high proportion of software sales in a particular quarter, you would see a much higher gross margin, because the cost of R&D to develop that software is all included down in SG&A, number one.

And number two, that piece of the business has a very high gross margin. So, that’s what’s going to drive the things up or down in any particular quarter for us, I guess over time.

Dave Windley – Jefferies

Is that business broadening in a way that would tend to smooth out the quarterly performance, or is it just, by its very nature, going to continue to be lumpy regardless of what you do?

Josef H. von Rickenbach

Well, as I pointed out in my commentary, we believe that with increased scale the probability will improve in that business. And also, I think it will be a little less lumpy. Partly because in all likelihood, the license sales that Jim was alluding to as an overall proportion of the business, is probably going to be less, or to say it differently, the more service-oriented parts of the business are probably going to increase faster.

Dave Windley – Jefferies

Around new business, which is obviously very strong, is the proportion of your new business coming from big pharma versus mid-tiers or small biopharma clients?

Josef H. von Rickenbach

As always, we had a pretty good mix in terms of the client segments. Although I would say, this quarter specifically, it probably was a little more driven by the large pharma companies.

I want to highlight that this is not a trend. It is just a one-off kind of a thing in this quarter. And we certainly have very good traction with the small companies and the emerging companies as well.

Operator

Our next question comes from the line of John Kreger - William Blair.

John Kreger - William Blair

As a follow-up to David’s last question, are you seeing any changes in the duration, in the contracts in your backlog? As we think about that 41% increase, can we expect that to continue to tug up your revenue growth rate or are the contracts continuing to get longer?

Josef H. von Rickenbach

John, this is of course difficult to call, exactly, meaning especially as we look towards the future. But as of right now, actually in this quarter we have seen, if anything flattening out of the conversion, which is to say that would imply that the average duration probably has stayed the same compared to the last quarter.

Whether that’s going to hold for future quarters is yet to be seen. In our modeling and our forecasting we still expect a slight deterioration in backlog conversion, which would also imply that we would expect still somewhat of a lengthening of the average contract.

John Kreger - William Blair

What are your current thoughts on the sustainable revenue growth that your infrastructure can support? You’ve had a pretty dramatic acceleration in revenue growth over the last two or three years. As you look across the organization, what do you think you can sustain and still have a high degree of quality for your clients?

Josef H. von Rickenbach

As we have pointed out many times in the past, we felt that our infrastructure was ready for growth. And this has now started to occur. And in fact as I pointed out, especially if you take into account our global footprint, we are comfortable with that and I think that still has a fair ways to go in terms of our growing revenue into that.

And if you specifically look at the U.S., I think we have a long way to go as a matter of fact. I am happy to say by the way at this time that metrics in the U.S. are starting to really go where we want them to go. It’s very nice to see a little black there in our operating income.

Finally, I am very confident that this is going to continue, both the growth and the improvement in profitability. And so therefore as Jim points out in his commentary, the percentage cost of SG&A as a percent of revenue, I think will gradually continue to come down a little bit and we get some margin expansion from that.

John Kreger - William Blair

Your perspective on your improved revenue growth rate, as you kind of step back, how much of this was would you attribute to a healthy market environment, and how much would you attribute to gaining share for PAREXEL?

Josef H. von Rickenbach

Well as I pointed out David, this quarter was really a great quarter for us any which way you put it. Having said that you have to also take into account the last quarter, and as you remember we have a little bit of a perspective of let’s say two quarters. If you take two quarters together, it was still a great performance, in my opinion.

Any way you put it, when I say any way you put it we would be above 1.6, any way you put it, even if you take into account foreign exchange or any other sort of negative metric if you want to that would offset that. So obviously we are pleased with that. We believe that the market continues to grow well, that we have a very good environment at the same time we still believe that sort of the overall market is probably growing in the mid-teens.

Our company at this time on a fully adjusted basis, I mean the same-store foreign exchange just is clearly growing substantially above that. Our new business intake is even above that. So I would have to say we are taking share somewhere.

Operator

And our next question comes from the line of Eric Coldwell – Robert W. Baird.

Eric Coldwell – Robert W. Baird

I was hoping you could quantify for us the impact on operating profitability from foreign currency in the quarter.

James F. Winschel

Yes, Eric, I believe that the number was somewhere north of a half of a point in the quarter.

Eric Coldwell – Robert W. Baird

It’s about 50 bits and more than 50 bits?

James F. Winschel

Yes.

Eric Coldwell – Robert W. Baird

And on Perceptive Informatics, I think last quarter there was a comment that you may be had some change order delays and the signatures were likely to come in the December quarter and that would boost performance in December I should say. How much of those came through and what impact did they have on the quarter?

James F. Winschel

Are you talking about the new business or you talking about the contract signatures?

Eric Coldwell – Robert W. Baird

Contract signatures.

James F. Winschel

It was about $1 million dollars in the Perceptive Informatics business I believe that we talked about last quarter. Interestingly we ended this quarter with about $1 million as well. So we signed everything that we had not been able to sign at the end of September but ended up with a new group of about $1 million in the current quarter.

Eric Coldwell – Robert W. Baird

And that would be a million of revenue and a million of gross profit, correct, in terms of the treatment?

James F. Winschel

Yes, more or less that’s right. If that was in there, the bonus accruals were up a little bit, and this, that and three other things, but yes.

Eric Coldwell – Robert W. Baird

So the 460 depth improvement in gross margin really is a kind of a clean number here because you had an additional million go into the next quarter?

James F. Winschel

That’s correct.

Eric Coldwell – Robert W. Baird

In terms of the bookings the last quarter there was some commentary about backlog getting an adjustment due to the foreign currency moves. I didn’t hear you say anything about that this period. Were there any FX adjustments that impacted the gross bookings and the backlog growth?

Josef H. von Rickenbach

Every quarter there are some of those. Actually in this quarter they were very nominal, barely in the double digit millions.

Eric Coldwell – Robert W. Baird

$0 million, $12 million?

Josef H. von Rickenbach

Very close.

Operator

And our next question from the line of Alex Alvarez - Goldman Sachs.

Alex Alvarez - Goldman Sachs

In terms of the services that customers are asking you to provide in the contracts that you are bidding whether you’ve seen any change over the last 12 to 24 months.

Josef H. von Rickenbach

Did we see any changes? I’d say we are continuing to see basically good momentum across the board. That’s what I would say, which is to say the following, we talked a little bit about the segments before, across the board there is a healthy market. We actually did, specifically a little bit of analysis in terms of large contracts versus small contracts. There are a fair number of very sizeable opportunities but on the whole actually the medium size contract has not moved that much, over time.

This is to say its not just a few large contracts; it’s actually fairly evenly distributed across the spectrum. And there are, at the high end, contracts that are getting to be actually quite sizeable where the scope of services are big and which take a long time and we talked about that a second ago with I believe John, in terms of the length of contract.

And maybe the only other thing I would also say is that, I seem to feel that in some instances, some of our clients, especially some of our larger clients, seem to be a little more strategic about how they go about working with us and how they outsource.

Alex Alvarez - Goldman Sachs

You’ve mentioned some of the improved project execution that benefited the backlog conversion. Is this something that you think is sustainable going forward or were there specific factors in the quarter that you will take advantage of?

Josef H. von Rickenbach

Obviously, if we had anticipated that this would occur we would have guided to that. So I would say the same thing this time, if we believed that this would happen we would have guided to that. So, there is always a little uncertainty and in the end, I guess it comes down to that conversion rate.

You are all familiar with the curve that has been trending down now for a long time. And at some point of course it has to even out or even make a pick up. Are we at that point right now? I don’t know. I have called that number multiple times the wrong way so I’m not going to call it again. But at some time it will have to happen.

Perhaps, however, to put the damper on the forecast, which is to say that the curve may still continue to decline a little bit. Some of these larger contracts are big and take a long time and take time to put in place. And so, right now as I have pointed out before, we are forecasting still basically a continuation of the trends that we’ve been seeing in the past. If it gets to be better, it’s better, obviously.

Operator

And our next question comes from the line of Todd Van Fleet - First Analysis.

Todd Van Fleet - First Analysis

I wanted to ask you first on the growth rates for the various geographies, revenue growth rates. It looked that the Americas were up pretty solidly year-over-year, about 31% by our calcs and then EMEA was about 27%. I wonder if you could talk about the regions that are really propelling the growth in those particular segments. Is it Latin America for the Americas? Is it Europe for EMEA? If you could talk a little about that, that would be great?

Josef H. von Rickenbach

Obviously the most rapidly growing region right now for us is Asia but that is also on a small base. And so other than that, in terms of revenue growth, and I’m contrasting that to bookings growth or bank lot growth.

We have a pretty even picture actually if you strip out foreign exchange and same-store effect. Indirectly of course I am saying also that the growth in the U.S. is actually starting to become normal, which is to say the same as the rest of the company still. It ticks just below the rest and so therefore by implication you know we still are growing a little faster in Europe right now. Eastern Europe is very strong growth. Africa is also doing well so we’ll kind of leave at that.

Todd Van Fleet - First Analysis

As you grow larger into these newer geographies, does the seasonality become less of an issue or more of an issue in terms of your forecasting?

Josef H. von Rickenbach

Difficult to say, maybe Jim can add something to that. But from my perspective first of all the more diversified you are, the less this makes a difference in terms of seasonality. Seasonality has an effect mainly into holiday patterns in various parts of the world. The more global you are the more diversifying you are, as far as that goes.

For instance the Chinese New Year is in a completely different quarter, let’s say, than some of the holidays in other parts of the world. And maybe there is a little bit less of a lumpiness but I am sure the September quarter will always be, if anything, the most affected by seasonality.

James F. Winschel

Yes, I guess in all of my projections I don’t see a change from our pattern, which is that the June quarter tends to be the strongest quarter for the company and the September quarter tends to be the weakest quarter for the company. No signals yet that is changing either way.

I mean we have other issues. For example, the Easter holiday has a big impact in Europe and last year that was in the June quarter; this year it’s in the March quarter and those kinds of things. So we are always having to deal with those kinds of things and make sure we know where things are falling in the calendar in a particular year.

Todd Van Fleet - First Analysis

Jim, could you tell us kind of directionally, from an operating margin standpoint, where did each of the three geographies move on a sequential basis? That is the Americas, the EMEA, Asia-Pacific. Can you tell us stock magnitudes of operating margin for each of the three geographies in the quarter, where they moved kind of on a sequential basis?

James F. Winschel

Well we got an improvement in the U.S., obviously, and then we saw an improvement in Asia. And I think Europe, Europe, Middle East and Africa was relatively flat.

Todd Van Fleet - First Analysis

As you think about the suite of services that PARAXEL offers, in particular I am thinking CRS and Perceptive, and the relationship between your services offering and your technology offering. Have there been improvements in the attachment rate for the technology piece to the services piece over the past several quarters? Has there been a focus internally on improving that attachment rate or how do you think about that? Has it been a focus of the organization?

Josef H. von Rickenbach

Yes, actually that is a good question to be at exactly what we are focusing on right now quite a bit. The suite of products and services that we have in Perceptive originally was geared primarily for outside clients. Having said that, we are now, first of all seeing more technologies, broadly speaking, incorporated into our services overall. And secondly we want to really be in the lead as far as that goes.

So we are making a big effort right now to incorporate all those great technologies into our own processes and into our own ways of working. And so that’s ongoing right now in our clinical operations. And also I would say broadly speaking in the market there is more interest and there is a more competitive environment, more competitive traction in the technology component than there used to be.

Operator

And our next question comes from the line of Douglas Tsao - Lehman Brothers.

Douglas Tsao - Lehman Brothers

Jim, I was just wondering if you could provide some color on the geographic distribution of revenues for the both the PCMS as well as the Perceptive businesses?

James F. Winschel

Doug, we have not historically provided that information for competitive reasons and I think we’re going to decline to do it again today.

Douglas Tsao - Lehman Brothers

Following up on Perceptive, I was wondering if you could give perhaps, I doubt you’ll give us the absolute dollar, but perhaps a sense of the scale of the R&D investment that you are making in the Perceptive technology solutions. And a sense of whether those investments have been flat or increasing as the business grows?

James F. Winschel

Well, I guess we don’t want to talk about the absolute dollar amount, but over time those amounts are going up certainly as the business grows.

Douglas Tsao - Lehman Brothers

So these are not something that you have been holding flat at a basic level. I mean, those have been increasing steadily over the last couple of years.

James F. Winschel

Yes, there can be little up and down here and certainly a little variation in the quarters and things like that. But I would say the general trend over time has been some increase.

Douglas Tsao - Lehman Brothers

When you think of your competitive differentiation or competitive strengths the international business clearly stands out. How much of your improvement in the U.S. is tied to studies getting done in the U.S. that also have an international component?

Josef H. von Rickenbach

I would say the vast majority of the business that we win in terms of clinical research has international components. In other words, business you win in Europe, very likely also has legs in the U.S. That business you win in the U.S. almost certainly has some arms outside of the U.S. as well. And so, it clearly, it’s very rare that you have, especially for the largest study, where you would have only one geography.

Douglas Tsao - Lehman Brothers

And so do you account for, as we see increased globalization, one of the reasons the U.S. business has picked up over the last two years, in particular this last quarter?

Josef H. von Rickenbach

I will answer the question in general as a broader trend, yes, would be the answer. The broader trend basically is more globalization, more internationalization. And as I pointed out in my commentary you have been anticipating this and we’re building into it and investing into it, may be a little bit ahead of the curve at times. But nevertheless absolutely getting the trend right, I would say this is going to continue if anything even more briskly and certainly was, all of the case this quarter, very strongly actually.

Douglas Tsao - Lehman Brothers

How much in your U.S. Phase I business you made the CCT acquisition last year. Have those two businesses been completely integrated, and are you conducting many studies that utilize facilities both in California as well as your original Baltimore location?

Josef H. von Rickenbach

Phase I contracts tend to be much smaller in terms of average size. And so they are more location oriented and we have multiple Phase I units and each one of these units has a little bit of a distinct profile from a competitive point of view.

So for argument’s sake, one of the reasons why CCT was attractive to us is because they have a great strength in the CNS area from the therapeutic area point of view. So there’s actually not that much competition between our units and clients generally have a preference, a pretty distinct preference actually, for one or the other.

Douglas Tsao - Lehman Brothers

Well, I wasn’t asking a question of competition between the units. I was just wondering because I’ve certainly heard and seen evidence that while Phase I studies tend to be smaller, there is some evidence, that there is a use of many facilities in order to speed up enrollment and tap into different populations and different regions. So I was wondering if that was something that you as a company were focusing on.

Josef H. von Rickenbach

Sure, there is no question about it, absolutely. And so the geography that we have in our clinical pharmacology business is absolutely in part driven by exactly what you said. The dynamics of the business are actually considerably different from the Phase II and III business.

James F. Winschel

And before we go on to another question, I would like to correct a misstatement that I made earlier in response to Todd Van Fleet’s question on geographic operating margin.

We actually saw a tidy decline in geographic operating margin with respect to Asia and this is directly related to the increase in spending as we go forward with the integration of the APEX acquisition; that’s on a sequential basis. And so we saw an improvement in the U.S; Europe, Middle East and Africa were essentially flat; and then a decline in Asia-Pacific. Operator, we can go to the next question, I guess.

Operator

Our next question comes from the line of Sandy Draper - Raymond James.

Sandy Draper - Raymond James

Just maybe a little bit more color on the revenue upside, Joe, you talked about in your prepared comments. Did either the acquisition revenue or strength of currency, was that any source of surprise or was it really just simply that improvement in some of the projects getting completed faster than you expected?

Josef H. von Rickenbach

Well, Jim can give you a little more detail exactly on the impact on the two specifics you asked. But, generally speaking it was basically project driven and milestone driven. But Jim, do you want to add some commentary on the specifics.

James F. Winschel

I guess with respect to currency, we probably got a benefit of approximately $2 million from where we were back in October when we last guided to the numbers.

Sandy Draper - Raymond James

A follow-up on that, when looking at the third quarter and full year numbers, what’s built into your model in terms of currency impact? What type of numbers there?

James F. Winschel

What we are looking at there is using rates that were in effect in the early part of January. So the pound has substantially weakened versus the dollar coming from the second quarter to the early part of January. And the euro I think is, relatively speaking flat although maybe in the last couple of days has weakened just a little bit against the dollar as well. Those are the two major currencies that we have to focus on.

Sandy Draper - Raymond James

You certainly wouldn’t expect another double-digit benefit from currency in the third quarter.

James F. Winschel

Well I think that the benefit from currency, you have to be careful as to which periods you are talking about. If you are looking at year-over-year, in the second quarter I think it was about 8 points of benefit that we got, and I think that’s probably the highest that it has been in some period of time. I would certainly not expect based on what our rates were at the beginning of January that we would have that big a currency benefit this coming quarter.

Sandy Draper - Raymond James

On the acquisition side, CCT now that gets fully cycled, so you are really just looking at APEX. What type of revenue would APEX be expected to do in the second half of the year?

James F. Winschel

We are looking at a run rate that’s somewhere in the $5 million range per quarter at the moment.

Operator

And our next question comes from the line of Glenn Garmont - Broadpoint Capital.

Glenn Garmont - Broadpoint Capital

Joe I was a little surprise by that strength in the MedCom business, I guess particularly given that the slower pace of product approvals. Can you drill down a little bit more about, into what’s driving the improved results there? Is it new business? Are you taking business from a competitor?

And then secondarily what’s the company’s appetite for M&A on a go-forward basis. Do you need there are some therapeutic area where you feel you need to be stronger or maybe you don’t have the geographic presence?

Josef H. von Rickenbach

On MedCom obviously I am pleased with the development there. We have been working on this business for quite a while. And I think I mentioned in the last quarter or even the quarter before that we probably had seen the bottom at that point and as it looks like right now we have.

So as of right now I would say that improvements are coming primarily from actions that we have taken, in other words operational improvements, a number of which are still underway, by the way. Okay, so I don’t think we have seen the full benefit of everything that is going on there.

The market is still I would say it’s a little better certainly and maybe we are starting to see some growth in the market overall, after about two years of essentially declines and pretty hefty declines in some cases.

Now having said all that and from a strategic position point of view I think we are in a very good position there in the sense that, as I pointed out in the past multiple times we are really getting the business ready for real growth. And at some point the four, 500 compounds that are currently in Phase III clinical trials are going to get filed and many of those are going to get approved. And somebody is going to help launch those projects and I want to be there when that happens, and I think we’ll be ready with our MedCom unit at that point.

So generally speaking I am pleased with where this is going. I think in the short term, gradually, we’ll probably still see some benefits coming out. But eventually once the real growth starts to set in we should really see operating some improvements a little out. Okay, this is not going to be in the near term.

And in terms of M&A, we have made a couple of acquisitions in the recent past. I am very pleased with those acquisitions, I think they were strategically highly relevant and also financially attractive overall as far as our global footprint is concerned right now. I think we are basically global. At some point you are global in our strategic thrust eventually. From our global footprint perspective, we are now focusing much more on the operational optimization of that footprint versus actually expanding it.

So the hurdle rate in terms of adding other geographies in my view has gone up quite a bit. And so in terms of focus, therapeutic areas, I think we’re also well covered. So I’d certainly say that the technology area is interesting to us at the moment. I think scale in that business is very important.

We talked a little bit before about R&D. And the more you can spread those R&D costs in terms of revenue obviously the more your margins go up. And right now I think our R&D costs as a percent of revenue are relatively high, just in terms of scale, which is also to say that the minimum critical scale of that business is probably higher than one would anticipate. So it gives you a little bit of direction in terms of what we’re thinking.

Glenn Garmont - Broadpoint Capital

With regard to the new business that you reported in the quarter, what are the dominant therapeutic areas there?

Josef H. von Rickenbach

It hasn’t particularly changed if you look at the top five or six categories. By far, the most important one is oncology. There is really a lot happening there. CNS is a very important category as well. Pretty perennially, the other important ones would be anti-infective, anti-viral, muscular, skeletal is another important one and endocrine, pulmonology is another important one, cardiology is an important one always.

The top five or six change from quarter to quarter a little bit. But over time, I’d have to say you probably would have expected to see virtually all the ones I mentioned on every list pretty much.

Operator

And our last question comes from the line of Dave Windley with Jefferies and Company.

Dave Windley – Jefferies

Jim, on the tax rate, I understand that there is a lot of moving parts here. But just from the higher level, I believe you still have this significant NOL. For a while we were talking about as you moved into profitability in the U.S., that would it be reflected in a declining and an effective tax rate on early basis. So I think we’ve now moved away from that.

But I just wanted to understand as you move into profitability in the U.S., how should we expect to see the company monetize that NOL?

James F. Winschel

Well David, in fact that’s not correct. The NOL has more or less been converted into a foreign tax credit at this stage of the game. As I said, there are a lot of different changes going on. And I think back in the Investor Day meeting that we held in June and I talked about Subpart F income and how that was going to become a bigger part of life here at PAREXEL.

And that has certainly happened and so we have a number of changes that we need to make. Which in the end of the day will, we believe make all of our entities profitable, including the U.S. And drive that tax rate down, our expectations would be that we could drive it down to the mid to low-30s.

Dave Windley – Jefferies

So, eventually the effect will be that you’ll have a reasonably sustainable lower tax rate by 500 basis points or more.

James F. Winschel

Right. and we have somewhat cautious as we go forward and do this, because we don’t want to lose the foreign tax credits that we have available to us. And so, we’re being very careful in this process to get there. And of course the other point is that we have this big valuation reserve on our deferred tax assets and it looks to me like we’ll probably be reversing that some time in fiscal year 2009.

Dave Windley – Jefferies

And you will reverse that in one fell swoop?

James F. Winschel

In one fell swoop, more or less yes.

Dave Windley – Jefferies

Back in new business a little bit and I guess the flipside of new business, the cancellations, Joe, you mentioned in your prepared remarks that they have been low; you do expect those to revert back to the norm. Is your expectation there based on just, the normal attrition rates and failures of science, or are you expecting cancellations from other sources as well?

And maybe where I’m digging around a little bit to show you my hand is I am wondering as equity markets get more volatile in and maybe biotech funding might come under some higher levels of scrutiny, is there a potential for cancellation for lack of funding from the smallest of the clients?

Josef H. von Rickenbach

My comments were purely analytical. In other words I certainly I don’t have any foresight or any knowledge that we would expect an increase in cancellations. We may well have another quarter with very low cancellations right now. And also specifically to your comments about the equity markets, of course this is something we pay lot of attention to. But as of right now we have not seen any of that.

The funding has been relatively good actually a number of, in fact pretty much if not all, many of our clients have pretty strong balance sheets and it would be relatively short-term disruption. I don’t think it would matter that much actually. Of course if it’s an extended drought it will have an impact, but as of right now that has certainly not shown up.

I’m just basically tempering expectations. I mean in the end the cancellation rate has pretty much always come into this band and there are also no indications that will not happen again.

And by the way while I am on this topic, I just want to make sure that people also understand that if we should have a large cancellation that this is coming out of a very large backlog as well now, so 3% to 5% of backlog that is approaching, $2 billion is a pretty big number and I think we could absorb that now.

Operator

And there are no additional questions, please continue.

Josef H. von Rickenbach

Okay, so thank you very much for attending our conference call. And your interest in our company and we look forward to updating you on our next call. Bye-bye.

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Source: PAREXEL International Corporation F2Q08 (Qtr End 12/31/07) Earnings Call Transcript
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