Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Jill Baker – VP, IR

Josef von Rickenbach – Chairman and CEO

James Winschel – SVP and CFO

Analysts

Todd Van Fleet – First Analysis

Dave Windley – Jefferies & Co.

John Kreger – William Blair

Randall Stanicky – Goldman Sachs

Blake Goodner – Bridger Capital

Cregg Watner – Elm Ridge Capital Management

PAREXEL International Corp. (PRXL) F4Q08 (Qtr End 06/30/08) Earnings Call Transcript August 7, 2008 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the PAREXEL International fourth quarter and fiscal year conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator instructions) And as a reminder, the conference is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Ms. Jill Baker. Please go ahead.

Jill Baker

Good morning everyone. The purpose of this call is to review the financial results for PAREXEL’s fourth quarter and 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 March 31, 2008, as filed with the Securities and Exchange Commission on May 9, 2008, and in our earnings press release issued yesterday.

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 will 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 adjusted results. These adjusted results may exclude the impact of unusual positive or negative items including those related to special charges, restructuring reserves, adjustments to restructuring reserves, and certain tax items.

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 press release we issued yesterday which may be found in the Investor Relations section of our website at parexel.com or will be discussed during the course of this teleconference.

Additionally, the company has posted a spreadsheet of quarterly and full fiscal year 2008 results detailing certain adjustments in the additional financials portion of the Investor Relations section at parexel.com.

I would now like to say a few words about ClinPhone. As publicly announced on June 13, 2008, the Boards of PAREXEL and ClinPhone agreed on the terms of a recommended proposal whereby PAREXEL would acquire the entire issued and to-be-issued ordinary share capital of ClinPhone.

On July 22, 2008, ClinPhone's shareholders approved the scheme of arrangement and other associated matters to implement the acquisition. The implementation of the acquisition remains conditional upon the sanction of the scheme of arrangement and confirmation of the capital reduction by the court, and is expected to be completed during the first quarter of fiscal year 2009. UK law limits the comments that we can make at this time including the detailed anticipated financial impact from the acquisition.

We expect to update guidance in more detail after the completion of the transaction. For additional information, please refer to our press releases and SEC filings which can be found on the PAREXEL website.

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

Josef von Rickenbach

Thank you, Jill. I would like to review some details for the quarter and the fiscal year, 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 June 30, 2008, service revenue was a record $272.2 million compared with $205.2 million in the same quarter of the prior year, an increase of 32.6%. Excluding the positive impact of foreign exchange of $14.8 million in the quarter, revenue increased about 25%. Excluding foreign exchange and the net impact of acquisitions and divestitures which equated to $7.8 million in revenue in the current quarter and $1.7 million in the fourth quarter of the prior year, revenue grew to 22.6%. On a sequential basis, revenue in the quarter was up about 11%.

For the fiscal year, revenue was approximately $964 million compared with $742 million in fiscal year 2007, a year-over-year increase of 30%. Excluding FX of $51.7 million, revenue increase 23% for the year. Excluding the positive impact of foreign exchange and the net impact of acquisitions and divestitures which equated to $38 million in revenue in fiscal year 2008 and $6 million in fiscal year 2007, revenue grew 18.8%.

The depth of our geographic footprint and our ability to offer a broad array of services to clients in 52 countries continues to be a very important competitive differentiator for PAREXEL and a strong selling point in winning new business. For the fiscal year 2008, the Americas represented 39% of service revenue, the same as one year ago; Europe, the Middle East and Africa represented 53% versus 55% fiscal year 2007; and Asia Pacific was 7% of revenue as compared with 5% one year ago. Of course, part of the increase in the Asia Pacific region was due to the acquisition of APEX which was not included in the fiscal year 2007 results.

During the quarter, the largest client represented 11% of revenue, up from 7% in the June quarter one year ago, the top 5 and top 20 clients represented 32% and 58% respectively, both about the same as the June quarter last year. For the full fiscal year, the top client was 9% of service revenue versus 7% one year ago, the top 5 represented 31% versus 28% one year ago, and the top 20 comprised 55% of the total versus 53% one year ago. Although the full year norm [ph] ticked up a bit, we remain comfortable with the diversity of our client base.

During the fourth quarter, we continued to improve operating income, generating strong growth of almost 60% on a year over year basis. As a percentage of total service revenue, operating margin was 9.9%, up from 8.2% in the June quarter one year ago, an improvement of 170 basis points. For the full year, operating income was up almost 50% and operating margin was 8.9%, an increase of 110 basis points.

While we delivered and our commitment to invest is to improve this key profitability metric, there is still more work to be done and we expect to continue to drive operating margin expansion in the course of fiscal year 2009.

As we discussed in our last earnings conference call and during the course of our recent Investor Day, the four areas of greatest opportunity for operating profitability improvement are the Clinical Pharmacology business, the Medical Communications business, Perceptive Informatics, and overall efficiencies in US operations.

For additional detail on some of the initiatives that we are working on each of these areas, I encourage you to review the Investor Day slides and webcast which is available on our website.

In the fourth quarter, diluted earnings per share came in at $0.28 versus $0.18 in the fourth quarter one year ago, an increase of 55.6% year-over-year. For the full year, diluted earnings per share were $0.89 versus $0.66 one year ago, an increase of 34.8%.

I would now like to walk you through the new business and backlog performance for the quarter. Backlog as of March 31, 2008 was $1.907 billion. We added record gross new business wins of $545 million and then subtracted $272.2 million of revenue for the June quarter. Cancellations netted out $120.7 million, which left us with an ending backlog on June 30, 2008, of $2.059 billion.

The net book to burn ratio in the quarter was 1.56. This quarter, the impact of foreign exchange on backlog was de minimis. Cancellations were higher than normal this quarter at 6.3% of the quarter's beginning backlog and outside of the range that we typically project of 3.5% to 5%. However, on an annualized basis, cancellations came in at 19.1% when measured as a percent of the fiscal year 2008 beginning backlog which equates to a quarterly average of 4.8% and is within the expected range. Of course, these cancellations have been incorporated into the forward-looking guidance that we have provided in the press release.

Going forward, we still expect cancellations to fall in the range of 3.5% to 5% of the quarter's beginning backlog. Year-over-year, net new business increased more than 31%, backlog increased almost 37%, and the net book to burn ratio was 1.57 for the year. We're obviously very pleased with this strong performance.

I would now like to mention a few fiscal year 2008 highlights. In addition to strong sales and backlog growth, I was also pleased with the progress that we have made in our Medical Communications business. I believe that we have seen the bottom for Med Com and although the markets still remain challenged, the work that we have done to reposition and streamline the business puts us in a good place in life as the improvement pipeline for the new product approvals.

Given the growth we have achieved, our focus on deepening our talent bench and strengthening our management team have remained a key priority. Along these lines, I was very pleased to promote Mark Goldberg from President of Clinical Research Services and Perceptive Informatics to the position of Chief Operating Officer. Mark is being part of the executive management team of the company for 11 years and helped to establish our Perceptive Informatics technology business in fiscal year 2000. In 2005, he was given the additional responsibility for CRS.

Under his leadership, be drove growth and performance improvements. His proven business management skills combined with the strong technical background has positioned him well for this new leadership role, and I look forward to working with Mark for the many years to come.

Another highlight of the year was our acquisition last September of APEX International, a leading CRO in the Asia Pacific region. During the course of the fiscal year, we made great progress in integrating APEX into the company. The acquisition helped us to effectively round out our global footprint and is meeting our financial and operational expectations.

Looking forward, on the acquisition front as most of you know, we are in the process of acquiring ClinPhone, a UK company. We're still constrained with regard to what we can say on the UK law about this deal. In any case, we continue to believe that the confluence of advances in information technology and the pressure to gain efficiencies in drug development have resulted in a surge in demand for domain specific IT products and services.

This acquisition will move us forward with regard to our e-clinical vision and help to strengthen our position as an innovative leader in the e-clinical space. As we enter our new fiscal year, I continue to believe that our future looks promising. There is concern in some quarters that the flow of money into small biopharma companies may be slowing down. Even if this were the case, I believe that big pharma would step in and utilize its cash flow (inaudible) to make sure that these small biopharma companies have funding to continue the developing of their promising product.

In summary, our proposal pipeline remains strong. We believe that outsourcing penetration is increasing and clients are more and more frequently seeking to develop strategic partnerships with established CROs with a robust global footprint like PAREXEL.

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

James Winschel

Thanks Joe and good morning everyone. First I would like to make some comments about our three reporting segments.

During the fourth quarter, CRS service revenue increased approximately 39% compared with the prior year quarter, driven by strength in the Phase II through IV portion of the business. Excluding the APEX acquisition which contributed approximately $7.9 million and the $13.5 million positive impact of foreign exchange movements, CRS same store constant currency service revenue growth was a very strong 25.3% in the quarter on a year over year basis.

For the full fiscal year, CRS revenue was up approximately 36% compared with fiscal year 2007 and was up approximately 22% excluding the $37.5 million impact from the acquisitions of APEX and CCT, and $45.4 million related to foreign exchange movements. CRS gross margin was 33.7% during the fourth quarter, down 2.1 points from 35.8% one year ago, and down nine-tenths of a point for the full fiscal year.

The year over year decline in Q4 occurred as a result of; one, continuing capacity utilization challenges in Phase I; two, increased hiring and training costs in light of the ongoing significant increases in backlog and service revenue we have achieved; and three, costs of our major productivity and efficiency initiative.

Quarterly service revenue in PCMS was basically flat year over year and grew by 7.6% for the full fiscal year. During the fourth quarter, growth in PAREXEL Consulting was offset by a decline in Medical Communications, related to the disposition of Barnett Educational Services and targeted withdrawals from certain unprofitable service lines.

On a same store constant currency basis, PCMS service revenue was up only 1.4% in the quarter due in part to signature delays in the consulting business. On a full year basis, the increase in service revenue resulted from strong growth in PAREXEL Consulting.

During the quarter, PCMS gross margin at 35.5% increased by 3.9 points compared with last year as a result of a very significant increase in Medical Communications. The increase in MedCom resulted from the disposition of Barnett Educational Services, the impact of prior period restructuring activities, and better productivity and efficiency. Year over year, gross margin improved 3.8 points, again driven mainly by MedCom.

Quarterly service revenue in Perceptive Informatics was up 39.8% year over year, and was up 22.6% for the full fiscal year driven by across the board improvements in both measurement periods.

As we noted last quarter, we had some signature slippage from Q3 into Q4, and that contributed in part to this quarter's strong results. Excluding the $1.4 million signature factor, service revenue would have been up a strong 32.5%.

As mentioned earlier, we expect to complete the ClinPhone acquisition some time this quarter. ClinPhone's results will be combined with Perceptive Informatics once the acquisition is completed.

Perceptive's gross margin in the quarter was 51.1%, up 6.6 points from the prior year quarter primarily on the strength of robust revenue growth and ongoing productivity and efficiency improvements. For the full fiscal year, gross margin was up six-tenths of a percentage point.

On an overall company basis, gross margin for the quarter was 35.7%, basically flat as compared with one year ago, as the improvements in PCMS and Perceptive essentially offset the decrease in CRS. For the full fiscal year, gross margin at 34.7% was again basically flat with last year.

During the first quarter of fiscal year 2009, we expect to see a decline in gross margin from Q4's level. In particular, I would surprised that Perceptive could sustain Q4's high gross margin level.

SG&A spending in the fourth quarter was 22.1% of revenue, down from 23.5% in the June quarter one year ago, but up from 21.5% in the March quarter. In dollar terms SG&A increased 24.4% in the quarter compared with service revenue growth of 32.6%. The higher year over year spending levels resulted from increased facilities and information systems cost, a $1.1 million impact from the APEX acquisition, $3.5 million from foreign exchange movements, and other costs incurred to support strong revenue growth.

The sequential increase in SG&A as a percent of revenue was caused by several factors including higher facilities, energy, and IT related costs, increased performance-related bonus accruals and commission expense, the impact of salary increases associated with a switch to a new employer review process, and increased professional fees.

For the full fiscal year, SG&A was 21.9% of service revenue as compared with 22.9% for fiscal year 2007. In dollar terms, SG&A spending was up 24.6% compared with fiscal year 2007 versus service revenue growth of 30% generating significant leverage.

During the first quarter, we expect SG&A as a percentage of revenue to be down slightly from Q4 levels.

For the quarter, depreciation expense equated to 3.3% of service revenue, down from 3.5% during the fourth quarter of last year. For the full year, depreciation was 3.4% of service revenue as compared with 3.6% in fiscal 2007.

Amortization expense was four-tenths of 1% of service revenue in the quarter versus seven-tenths of 1% one year ago. For the full year, amortization expense was five-tenths of 1% versus six-tenths of 1% one year ago. Obviously the ClinPhone acquisition will have a significant impact on amortization expense when we complete the transaction.

Operating margin in the fourth quarter was a record 9.9% of service revenue, up 170 basis points from 8.2% in the June quarter one year ago. For the full year, operating margin was 8.9% excluding the third quarter's favorable restructuring reserve adjustment as compared with 7.8% one year ago, up 110 basis points.

We were very pleased with our success in driving operating margin improvement while concurrently making substantial strategic long-term investments in the company. In line with our comments on other occasions, we expect to improve operating margin by 100 to 120 basis points going forward, which is to say that we would expect to achieve a full year operating margin in the range of 10% to 10.2% for fiscal year 2009. We expect operating margin to be in the 8.8% to 9% range during the first quarter.

Other income was a negative $726,000 in the quarter, driven by interest expense and foreign exchange losses. For the full year, other income was a negative $1.1 million, driven primarily by interest expense and foreign exchange losses partially offset by net gains from the dispositions of Barnett Educational Services and the Poitiers bioanalytical laboratory.

PAREXEL's fourth quarter as-reported tax rate was 3.3%. The low reflects an $11.1 million reversal of certain US valuation reserves, offset by a $2.4 million increase in cash reserves for one of our Dutch subsidiaries. After taking into account these adjustments, we had a normalized tax rate of 36.6% for the quarter.

We had a full year normalized tax rate of 38.3% which was slightly lower than the projected full year rate of 39% as estimated back in April 2008. The lower full-year rate can be attributed to a change in mix of profitability across the various jurisdictions in which the company does business.

At this time, we are projecting a tax rate of approximately 40% for the first quarter of fiscal year 2009 and 39.6% for the full fiscal year.

Adjusted net income of $6.3 million was up 56.5% compared with $10.4 million in the fourth quarter of fiscal year 2007. For the full fiscal year, net income increased by 37.8% as compared with 2007.

Moving onto the balance sheet, net receivables stood at $262.7 million at the end of June. Taking into account gross revenue of $380.1 million for the quarter, DSOs stood at 63 days, an increase of 14 days from the June quarter one year ago and an increase of four days from the March quarter.

Billing was somewhat back-end loaded in the quarter, contributing to the higher DSO number. The good news continues to be that our billed receivables are very much under control with very few collection problems.

During the quarter, cash flow utilized by operations totaled $1.2 million. Other cash outflows included $22 million for capital expenditures, mostly related to hardware and software purchases and leasehold improvements, and $2 million from foreign exchange movements.

Cash inflows included $20.8 million in borrowings under the company's line of credit and $2.7 million in proceeds from the issuance of common stock in conjunction with the company's employee stock option and stock purchase plans, and $300,000 from disposal of assets. Netting the inflows and outflows resulted in an overall decrease in cash of $1.4 million from the end of March, leaving us with the balance of $51.9 million.

Finally, with regard to the earnings guidance which is contained within our press release, we have increased the low and high ends of the revenue guidance, taking into account net new business wins, recent exchange rate movements, and the current strong outsourcing market environment. This revised guidance does not include the impact of the acquisition of ClinPhone. The company currently anticipates that the acquisition of ClinPhone will be completed during the first quarter of fiscal year 2009. When taking into account the impact of the anticipated acquisition, the company expects that there will be a diluted impact to earnings per share in fiscal year 2009 in the range of $0.04 to $0.06, including the amortization of intangibles and other costs.

Upon closing of the transaction, PAREXEL will also be taking a charge to write off costs associated with unamortized loan fees and costs related to unwinding its interest rate hedges. The company anticipates these costs will have a dilutive impact to earnings per share in fiscal year 2008 of $0.02.

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

Question-and-answer session

Operator

Thank you. (Operator instructions) Our first question is from the line of Todd Van Fleet with First Analysis. Please go ahead.

Todd Van Fleet – First Analysis

Hi, good morning guys. Great quarter. I know you don't want to talk numbers on the ClinPhone deal, but I'm wondering if maybe you can talk conceptually about integration strategy, what's your plan is in terms of how hands-off you are going to be on the company moving forward, and like it's just kind of how integrated that company will become over the course of the next 12 months from the efforts surrounding that? Thanks.

Josef von Rickenbach

Hi, Todd. We are obviously still somewhat limited as to what we can say. But I think we can point out today that we would expect to integrate the company pretty fully into our Perceptive business. So, going forward, that would be basically an enlarged Perceptive business segment.

Todd Van Fleet – First Analysis

Okay, and so, I don't know, Joe, if you can help us understand a little bit more about, the business that you do with ClinPhone currently perhaps you know is part of the package deal related to your CRS offering. Can you help us understand how that might change moving forward given that all of the assets will be under the same roof? Can you help us understand maybe what you see as some of the more significant advantages of having those assets under the same roof?

Josef von Rickenbach

Well, as I said Todd, I can't really get into any of those kinds of details. I just want to say that overall we have a clear vision for this business. This is for – if you want the new Perceptive combined with ClinPhone business. And we're really excited about this acquisition. I think the more we have learned about the company, the more we like it and I think the initial contact that we have had with the management were very encouraging. And you know when we – as soon as we are able to, we will obviously disclose and share as much information as you desire.

Todd Van Fleet – First Analysis

Let me as Jim one then. Jim, on the outlook for Q1 and maybe just the rest of 2009, are there any significant items that should be drawn out below the operating line that we should consider when putting together our models for next year.

James Winschel

Well, Todd, of course, once we have completed the ClinPhone transaction, there will be some activity there, interest expense for example. And once we have completed the transaction, obviously we will try to give people some more guidance on this type of information.

Todd Van Fleet – First Analysis

Right, but ignoring the transaction even, Jim, so just embedded in the 115 to 125, and then your outlook for Q1, is there anything significant below the line, ex removing the impact of the transaction?

James Winschel

Right. In my model, I have assumed about $2 million in losses for fiscal year 2009 and roughly equally spread out across the four quarters.

Todd Van Fleet – First Analysis

Is that related to ForEx then?

James Winschel

Foreign exchange mainly and some interest expense just from our ongoing operations.

Todd Van Fleet – First Analysis

Yeah. Okay, thank you.

Operator

And our next question is from the line of Dave Windley with Jefferies & Co. Please go ahead.

Dave Windley – Jefferies & Co.

Press release gives some rough guidance about what you expect the dilution from ClinPhone to be. Can you talk about the assumptions that are behind that guidance?

James Winschel

Yeah. Hi Dave. Sorry, we couldn't hear you at the beginning part of your question. Do you mind repeating it.

Dave Windley – Jefferies & Co.

Sure. Very sorry. On ClinPhone, in the press release there is some dilution guidance provided. Can you describe the assumptions that are made that arrive at that dilution calculation? Is that something they would discuss?

James Winschel

David, this is Jim Winschel.

Dave Windley – Jefferies & Co.

Yeah.

James Winschel

We in fact are specifically prohibited from sharing any additional information at this time, but once again once we have completed the transaction we would come out with some more detail.

Dave Windley – Jefferies & Co.

Okay. So that's one of the areas you can't go. Alright. On the, another kind of housekeeping question I suppose is, with the reversal of these tax valuation reserves, I know this has been, you know your ability to work down the tax rate has been something we've kind of talked on and off about for a long time, is this now more of a kind of a one-time benefit to the tax rate that then will not be seen as an ongoing lowering of the tax rate in future periods, or can you still see the tax rate move down from the high 30s?

James Winschel

Well, I think as we mentioned back in Investor Day, our plan with respect to the tax rate is to get the rate down to the mid to low 30s, and one of the ways that we are going to accomplish that is with some significant changes that we are making in our approach to transfer pricing. Those changes actually have been put into effect on July 1st. However, it's going to take some time I believe for all of the positive impacts to show up on the tax line, and I would like to get two, maybe even three quarters of experience with the new approach before I make any commitment exactly to the timing of when we might reach that mid to low 30 tax rate. But long term for sure, I believe we can get that.

Dave Windley – Jefferies & Co.

So the long term rough, I mean, as you said you need more experience, but the long term is certainly beyond fiscal 2009 and maybe a couple of years out or..

Josef von Rickenbach

I would say couple of years make sense.

Dave Windley – Jefferies & Co.

Okay. On gross margin, just real quickly and I'll jump out, is CRS on the last call you said pretty specifically that you thought that gross margin would improve sequentially and that did not. I think you also pointed specifically to ClinPharm and I think Joe called out that utilization there was a little tough or Jim you did. Perhaps you could provide some more color around that? And then also more broadly, and I know this is a question we've tried to answer a lot of times over the years, but when you look at gross margin for PAREXEL relative to some of your very similar peers, is it your perception that the differences are simply differences in accounting between direct and indirect costs or could there be some other contribution to that pricing or otherwise? Thanks.

Josef von Rickenbach

Hi David. As far as the overall gross margin is concerned, I would say there were a number of factors that contributed to the margin for moving higher, and I would say amongst those certainly is the fact that we have had good success in recruitment and acquiring talent, of course, commensurate with our growth. But also, ClinPharm has not performed to our expectations in the fourth quarter. And the complicated problem I would say and we're on top of that, but some of the factors that are sort of driving that, I would say is that the nature of the business is somewhat changing and those of you who have been at the Investor Day got a little bit of glimpse of that. I think first of all I would say actually the market opportunity continues to be very good. We expect – continue to expect growth in teens in the early stage Clinical Pharmacology arena, but at the same time the kind of business that we're getting is converting more slowly into revenue than has historically been the case. And as a result, while our backlog is going up and in some ways while we're meeting sales targets, we're not seeing the revenue certainly in the short term. We are addressing that right now and I believe that in the course of fiscal year '09, we should start to see a significant improvement, and therefore also lift in the overall CRS gross margin. And when it comes to the specifics of your question in respect to accounting, Jim will address that.

Dave Windley – Jefferies & Co.

Okay, thanks.

James Winschel

Well, David, it's always tough for me to know exactly what costs are included in direct costs and what costs are included in SG&A amongst our competitors. And so it's very difficult to answer that specific question. But of course, the great equalizer is operating margin and there we know we're still lower than many of our key competitors and are committed to continue the improvement, and I think we made a good down payment on that commitment in the fourth quarter of this year. We're going to, we believe, increase operating margins during fiscal year 2009 by another 100 to 120 basis points, which has I think significant implications for improved EPS, and I would hope that beyond fiscal year 2009, we would continue that kind of improvement.

Dave Windley – Jefferies & Co.

Okay. Thanks for those answers.

Operator

And our next question is from the line of John Kreger with William Blair. Please go ahead.

John Kreger – William Blair

Hi, thanks very much. Joe, question, as you – I'm guessing a lot of your larger clients are sort of working their way through their own restructuring efforts. As that happens, can you tell us if you are seeing anything interesting or unusual about how they are changing their outsourcing patterns, the models that they are pursing, the amounts that they are outsourcing, any picture that you can paint for us at that point?

Josef von Rickenbach

Yeah, John, I think you are right. Many of our larger clients are and in fact I would say almost all of them frankly are thinking about better ways and more efficient and effective ways to develop their product. I mean (inaudible) comes down too. And I have said many times that I believe we PAREXEL and maybe some of the other leading CROs are part of the solution to that. And so I would say many of our clients are currently thinking through how they can be more efficient in outsourcing, utilizing companies like ours, better which is to say more strategically. And I would have to say that some of the growth that we are experiencing is coming from an increased outsourcing rate from these larger companies. And specifically I would say this quarter for us a relatively larger component of our new business flow came from large pharmaceutical companies.

John Kreger – William Blair

Thanks. And then a follow up, one of your competitors announced that a kind of a larger strategic deal yesterday. From your perspective, do you view that as a trend where Pharma might be considering larger multi-year deals where they might carve out entire functions? Do you think we will see more of that and is that the kind of thing that PAREXEL would be interested in.

Josef von Rickenbach

Of course, we have all seeing this deal and it seems like a good deal, and it's a little more public if you want that more interesting because there was a lot of sort of asset activity involved. And as you know, in our (inaudible) we're not particularly involved with laboratories and pre-clinical facilities and so on. But having said that, yes, I would expect that these kinds of – and when I say these kinds of – generically speaking, these kinds of transactions probably will not be unique.

John Kreger – William Blair

Okay. Thanks very much.

Josef von Rickenbach

Sure.

Operator

And our next question is from the line of Randall Stanicky with Goldman Sachs. Please go ahead.

Randall Stanicky – Goldman Sachs

Great. Thanks for the question. Just a couple of specific ones. Joe, first follow up on John's question. Are you being invited specifically to some of those discussions around strategic opportunities with Pharma?

Josef von Rickenbach

Yes, we are.

Randall Stanicky – Goldman Sachs

And those are currently ongoing and do you think that's going to become a more broader trend with more announcements as we think about the back half of the year?

Josef von Rickenbach

Well, I don't know whether there will be more announcements. As I said, that's kind of the inverse of what I said before. You know in our way of working, you would not necessarily make such a big announcement simply because you would not transfer a lot of assets and there would not be this kind of big bang effect. But I believe that we are absolutely experiencing a shift in the way these discussions have been, and I think they are – I say this also because historically they also happen, and – but the fall through was easily somewhat tepid, and I think time they are more serious than they probably would stick. And so, I would really not be surprised at all of that. Within, let's say, three to five years, the way drugs are developed and especially the way large late-stage development programs are run, we will really change, and I believe that – and I say, I kind of emphasize that because we have heard many of these words many times in the past and basically went forward in a good way but not in an extraordinarily different way. And I think this time it is a little more serious, and I wouldn't expect to see huge announcements but sort of under the water line, there is a lot of discussion happening.

Randall Stanicky – Goldman Sachs

Well, I guess kind of on that point, the industry and certainly you guys as well have seen from a bookings, it still is like a new plateau over last three quarters, bookings have been noticeably big. I mean, have you seen a noticeable shift in size, and was there anything specific to this quarter that that may have helped that number.

Josef von Rickenbach

Actually interestingly not really. You know the median size of our average – let me say the median award – I have to kind of get my means and averages right – the mean award, meaning the mean size of our awards has not really changed that much, and that’s changed a little bit, let's say from last year, maybe it's up 25%, but it's till on average let's say in the mid-single digit million versus very large. And having said that, in a $2 billion backlog you have inevitably large, very large awards as well, and we are continuing to see those. But it's not as if the business awards that we have had this quarter were made up of a few very big awards, not at all the case. It's a very diverse, broad-based small company and large company, overseas and US based new business performance.

Randall Stanicky – Goldman Sachs

Is there I mean – is there a geographic swing that you are seeing, and then also maybe as you think about the cancellations in the quarter, is there something earliest trend ex US that continues to happen that that you guys are experiencing.

Josef von Rickenbach

Well, to the geography, I would say that the overseas market seems to be more active than it has been in the past. So we are pleased with that. So it's a little more balanced and I guess as a result our "net exports" of new business outside of US are shrinking basically. They are still there, meaning we still have more business in the US than we – and export that to other parts of the world than we import. But it's much more balanced that it used to be. And sorry, what was the second part of the question?

Randall Stanicky – Goldman Sachs

Well, I'm just thinking thematically, where some of the work is going, and maybe just related to that, the 370 people that you added in the quarter, you guys have continued to hire, feels like ahead of the industry curve if you will. Is there a rough breakdown that you could give us ex US versus US?

Josef von Rickenbach

Yeah, we are growing our headcount first of all substantially and predominantly outside of the US. I would say 80% of our headcount growth is happening outside of the US and that's true for fiscal year overall and also was true for the quarter.

Randall Stanicky – Goldman Sachs

And anticipated going forward?

Josef von Rickenbach

Yes. Although I'm happy to report that our US backlog is also growing, so we're growing here as well. And as you may remember, a big part of our recovering US operations basically is growth, scale, and that's happing for sure. But specifically when it comes to clinical research and especially late-stage clinical research, I would say the growth primarily happens outside of the US.

Randall Stanicky – Goldman Sachs

Well that's great. Thanks for the color. I'll jump out.

Josef von Rickenbach

Sure.

Operator

And our next question is from the line of Blake Goodner with Bridger Capital. Please go ahead.

Blake Goodner – Bridger Capital

Yeah, thanks. Just a couple of questions. When I'm looking at the margin improvements in the quarter and this quarter you noted a lot of it was driven by Perceptive, I'm just curious for '09, the 100 to 120 basis point, can you just give me a general sense for how much of that is expected to come from CRS versus MedCom versus Perceptive?

Josef von Rickenbach

Well, I guess the way I would put it is similar to what I said in the Investor Day, where I believe that the two-thirds of the margin improvement will come this next fiscal year from gross margin and about one-third of the improvement should come from SG&A leverage.

Blake Goodner – Bridger Capital

Right, but within the divisions, I mean again I'm just looking at CRS the gross margin was down about 200 bps year over year, as you noted in Perceptive is showing great improvement and MedCom showing improvement. I'm just trying to understand when I look at whether it's the two-thirds of that coming from gross margin or the one-third from SG&A, just by division I mean are you – in other words, are you expecting the CRS margins overall to be a driver of that 100 to 120 basis points or the CRS margin is going to be flat year over year in '09? I'm just trying to focus on that part of the business.

James Winschel

Alright. Well I think as Joe mentioned, there are four areas where we have we believe the greatest opportunity to improve our profitability. Within CRS, that is with the Phase I, our Clinical Pharmacology business. Within PCMS, we believe the biggest opportunity continues to be Medical Communications. And we also believe that Perceptive Informatics will be another key contributor to the improvement in year over year profitability.

Blake Goodner – Bridger Capital

Right. But I mean it sounds like ClinPharm was a little behind expectation in the quarter. So I mean – I guess just simple as this, I mean do you expect the CRS margin to improve in fiscal '09?

James Winschel

Well, I don't think that we want to get that specific within the business, but I would say within CRS for sure, the biggest opportunity to improve is within the Phase I business.

Blake Goodner – Bridger Capital

Okay, great, and then just two other quick questions. Do you have an operating cash flow? Could you just reiterate, what was operating cash flow in the quarter and what do you think it might be for fiscal '09?

James Winschel

Well, the operating cash flow for the quarter was relatively anemic, it was a usage of cash at an anemic level of $1.2 million.

Blake Goodner – Bridger Capital

So for '09..

James Winschel

In terms of fiscal year 2009, I believe free cash flow should be in the range of about $40 million. However, if we are able to get the DSO back down and that number could be substantially higher.

Blake Goodner – Bridger Capital

And the DSO target is still 45 to 50 days?

James Winschel

That's correct.

Blake Goodner – Bridger Capital

Okay. Thank you very much.

Operator

And we have a follow up from the line of Dave Windley with Jefferies & Co. Please go ahead.

Dave Windley – Jefferies & Co.

Hi. The question around John's question earlier about the competitive announcement and wanted to ask a little different twist on that. Does the specific announcement from yesterday have implications for PAREXEL?

Josef von Rickenbach

Dave, obviously we don't want to go into the details of specific client relationships. But having said that we don't expect this to have anything other than the positive impact. Frankly, what it signals is that these kind of a more strategic ways of working with a leading CRO, I think it will be seen and heard around the industry and I think this will eventually help everyone, including us.

Dave Windley – Jefferies & Co.

Okay. So it doesn't cut off a flow of business from a client – from an existing client for you?

Josef von Rickenbach

I don't expect that at all.

Dave Windley – Jefferies & Co.

Okay. Asking the gross margin question slightly different way. If you look at – I mean if we assume that you certainly have to add cost to service new business, and direct cost that is, and you look at your gross margin in the mid-30s what are the causes you describe, I mean generally speaking, investments being made to drive efficiency to support future growth. What are some of those indirect costs, indirect investment/cost that you are making that moderate that incremental margin and the acceleration in operating margin more immediately?

James Winschel

Hi David, this is Jim Winschel. Well, you may recall from Investor Day that we talked about this productivity and efficiency initiative called Leap that we have been working on in the CRS business. Now this particular project is going to actually cost us some money in the shorter run. But I would believe by fiscal year 2010, would we believe create a substantial opportunity for gross margin improvement within the CRS business. Mainly what we are doing is investing money in additional systems and enhancing existing systems. We are also, of course, having to do some things with facilities and we're trying to use some more efficient approaches there, and basically trying to eliminate a large number of manual processes that we still have in existence here at the company.

Dave Windley – Jefferies & Co.

Okay. And when you look at your geographic locales, do you anticipate that there will be a preferential growth in business in top line in areas where labor costs are lower and therefore could benefit your gross margin, or is that harder to control.

Josef von Rickenbach

Well, David, I think that will be the case. We are proactively exploring ways to actually take advantage of some of the lower costs locations that we have, and we are reconfiguring to some extent also the way we work, especially also in the SG&A areas. And I would say we have good opportunity to do that right now in the sense that the incremental growth essentially would go there and so that of course wouldn't mean necessarily that we would drive down costs or headcount in places like here or in Europe and so on. But incrementally we're starting investing in those areas.

Dave Windley – Jefferies & Co.

Okay. Great.

James Winschel

David – just to add to that, David, we are obviously investing in some additional infrastructure in these lower cost countries. But once again – and I think we mentioned it at the Investor Day in terms of maybe software development, new software developers could be added in those low cost countries which will then pay a nice divided to us going forward in terms of margins and profitability.

Dave Windley – Jefferies & Co.

Super. Thanks, that's helpful.

Operator

And we have a question from the line of Cregg Watner with Elm Ridge Capital Management. Please go ahead.

Cregg Watner – Elm Ridge Capital Management

Hi. Thanks for taking the call. I'm just wondering if you could provide some color with regard to the unbilled receivables. It looks like they have been growing faster than revenue for the first three quarters. Is there something specific going on in there?

James Winschel

It's a good question. I mean if you recall back in the third quarter, I had reported that this is another contributor to the increase in DSO, and that is still the case. What happens in our system, while we recognize revenue on more or less proportional performance what most people would call percentage of completion basis, under the terms of our contracts we're not able to bill clients until we hit certain milestone. And what's happen here in part is that we're just – the timing is off a bit and we're doing a lot of the work but not having hit some of the key milestones that would enable us to bill the clients. And of course, my billing and collections people can't collect receivables that we haven't billed yet. Some of the things that we could do to try to address that is to possibly make some changes to our contract terms as we go forward so that maybe milestones happen more frequently and will allow us to match up the work that we're doing better with the payments from clients.

Cregg Watner – Elm Ridge Capital Management

So, kind of over the near term, will there be a change in the trajectory there?

James Winschel

Well, I continue to focus a lot of attention on this issue and you would be amazed if you saw how much cash rolled in here for example during the first four days of July. And it's pretty obviously to me that our clients were – many of our clients were keeping the cash in-house for the end of their quarters and then sending it on to us very promptly at the beginning of July. And so that's part of a challenge I think that we will continue to have. But I'm still very committed to getting our DSO back down into that 45 to 50 days range.

Cregg Watner – Elm Ridge Capital Management

Thanks very much.

Josef von Rickenbach

Alright. So at this point, I would like to thank everybody for your interest in PAREXEL and we look forward to update you on our next call. Good bye.

Operator

Ladies and gentlemen, that just conclude our teleconference call for this morning. Thank you very much for your participation as well as for using the AT&T executive teleconference service. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: PAREXEL International Corp. F4Q08 (Qtr End 06/30/08) Earnings Call Transcript
This Transcript
All Transcripts