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Parexel International Corp. / (PRXL - NASDAQ) / $22.53All new material since last update is highlighted, otherwise there are no changes.
Overview
Industry conditions for Contract Research Organizations (CROs), including Parexel International Corp. (PRXL), continue to improve steadily following a host of disruptions including SARS-related travel moratoriums, and contract cancellations arising from the Pfizer/Pharmacia merger in early 2003. At the company level, PRXL overcame three volatile years characterized by a failed merger to Covance, loss of major client Novartis (due to pipeline reprioritization), and various restructurings since 1999, to achieve significant organic growth reporting sales growth of 14.6% in FY02. Nonetheless, PRXL’s operational performance remains mixed with margins substantially below industry averages and well under management’s stated target of 10% EBIT by end of FY05.
Strengths/Opportunities / Weaknesses/ThreatsExtensive international infrastructure / Lower than industry average operating margins
Intensifying cost and pipeline pressures in the pharmaceutical sector is increasing attraction of CROs / Significant industry wide risk factors such as lumpy business wins and volatile cancellation rates.
Relatively strong balance sheet with minimal debt. / Currency risk is significant given the company’s substantial international presence.
Massachusetts-based PRXL is a global pharmaceutical service provider. PRXL is the third largest pure-play CRO and a leading provider of late-stage biopharmaceutical testing services, including Phase I through Phase IV human clinical trial management, data management, biostatistical analysis, medical writing, and pharmacovigilance capabilities. Outside its core clinical trials management business, PRXL also provides drug development and regulatory consulting services, medical marketing and communications, training and various technology services, including web-based clinical trial management software. PRXL is differentiated from competitors by its global scale and scope (second only to Quintiles), consulting capabilities (heavy regulatory consulting, industry publishing, and training/CME footprint), clinical trial technology capabilities (Perceptive Informatics), and late-stage development and periapproval focus (PRXL does little non-clinical work). PRXL’s 4,935 employees provide bio/pharmaceutical research services in 36 countries, competing with firms such as Quintiles, Covance, PPD, ICON, Inveresk, Kendle, and SFBC.
CROs remain an attractive alternative to certain in-house drug development functions by providing an evolving array of services designed to enhance drug manufacturer productivity, increase efficient use of resources, spread risk, reduce costs, and improve R&D timeliness. However, industry consolidation is widely expected to add to the inherent volatility of contract work and dramatic shifts in market share at service provider level. While some analysts suggest that more mature CROs can better handle this inherent volatility, most remain cautious on the overall sector given the CRO industry-wide risks and the prevailing sentiment that further M&A activity is very likely in the pharmaceutical industry.
Sales
PRXL is a global provider of drug development outsourcing services to the pharmaceutical and biotechnology industry operating out of four divisions: Clinical Research Services, PAREXEL Consulting Group, product launch services in its Medical Marketing Services segment, and technology solutions from its Perceptive Informatics subsidiary.
PRXL’s Clinical Research Services (CRS) division is the third largest provider of global Phase II-IV clinical trial management & support services. The Clinical Research Services (CRS) segment constitutes the core development outsourcing offering. PRXL offers a full suite of clinical trial support services, including patient and investigator recruitment, data management, biostatics analysis, medical writing and regulatory affairs and periapproval services. PRXL’s data management group provides case report form design, tracking and audit trail documentation, data entry and verification, adverse event reporting, and medication coding. The company’s biostatisticians aid study design, conduct meta-analysis and data mining studies, and provide representation at FDA or other key regulatory meetings, among other services. It also provides medical services such as medical consultation, project team leadership, therapeutic area training, and SAE (serious adverse event) reporting as well as medical writing services. PRXL pharmacovigilance teams monitor the safety, quality and efficacy of marketed drugs and other late-stage services including patient, physician and disease registries, health economics research and expanded access programs. PRXL’s competitors in Phase II-IV services include Quintiles, PPD, Covance, ICON and Kendle, among many others.
PRXL’s Consulting Group (PCG) division includes Phase I clinical development, bioanalytical and consulting services. PRXL maintains Phase I facilities in Berlin, Germany; Poitiers, France; Bloemfontein, South Africa; Northwick Park, London, UK; and Baltimore, Maryland, USA. These facilities provide access to over 250 beds, as well as over 500 validated methods through associated bioanalytical groups. Phase I facilities house healthy study volunteers for intense, short-term testing of compounds previously untried in humans or to determine generic bioequivalence. These tests often focus on pharmacokinetics or ADME&T (absorption, distribution, metabolism, excretion, and toxicity) characteristics of novel compounds, including dosage variance, concomitant use, and bioequivalence and bioavailability studies. Bioanalytical labs provide biological fluid analysis, such as chromatographic support, analytical method development, validation and clinical study support. PRXL also provides a wide variety of consulting services, with a focus on training, drug development, regulatory affairs, validation and compliance. Services geared toward Biotech companies include project management, training, quality assurance, legal guidance, and contract personnel services, among others. PRXL’s Barnett International unit provides education, training and consulting services to pharmaceutical, biotechnology and medical device companies. Educational offerings include conferences, on-site training, seminars, and regulatory publications. Consulting services include clinical process optimization, SOP (standard operating procedure) development, outsourcing management, employee performance assessment and management, and clinical training. PRXL’s Worldwide Regulatory Affairs group focuses more on the drug approval process, with services such as GMP and GCP validation and compliance, regulatory strategy development, dossier and submissions, regulatory liaison, and labeling consulting services. PRXL’s Phase I competitors include SFBC International, MDS and Covance, while consulting competitors include Quintiles, ICON, Kendle and IMS Health, among others.
PRXL’s Medical Marketing Services (MMS) is one of the larger medical communications providers. Through MMS, the company provides medical marketing and communications for products in the pre- and post-launch phases of development. Medical capabilities include medical communications planning, meetings and events planning, medical publishing, and continuing medical education. PRXL also provides reimbursement services such as payer and provider market research, reimbursement plans, post-launch payment monitoring and advocacy, and policy issues monitoring services. PRXL also manages telecommunication centers to handle incoming calls, process data, and direct inquiries on large commercialization support programs. The MMS Telecommunications group provides patient reimbursement and payment program support, reimbursement hotlines, and patient access programs. Finally, PRXL provides managed care services, such as early planning to build payer needs into clinical development and formulary communications strategies and presentations to help manufacturers increase their chances of managed care formulary acceptance. PRXL’s competitors in these fields include Quintiles, Cardinal Health, Covance, PPD, and Kendle.
PRXL’s Perceptive Informatics Technology Services(PI) provides technology products and services internally as part of broader clinical trial services and externally to clients as a stand-alone offering. Its offerings include web-based solutions that speed up the clinical trial process, electronic data capture solutions that eliminate the need for data transcription, interactive voice response systems (IVRS) aiding patient enrollment, screening and diary information collection, and medical diagnostic imaging. We believe that PRXL is unique among CROs in having in-house imaging capabilities. PRXL’s competitors either rolled their "e-clinical trials" units back into their core CRO operations (Covance and Quintiles) or they never formally broke them out for reporting purposes (PPD, Kendle). PRXL has spent significant internal resources and partnered with companies such as PhaseForward and PHT to develop its Perceptive Informatics offerings. Perceptive’s main competitors include eResearch Technology, the in-house technology capabilities of other public CROs and Bio-Imaging Technologies.
Effective from the September 2004 reporting period, certain components of the Company’s strategic business units were reorganized to better align services offered to clients and to ensure a more integrated selling effort. Specifically, the Company’s clinical operations were consolidated by moving Clinical Pharmacology (Phase I) from the PAREXEL Consulting Group (PCG) to Clinical Research Services (CRS), and Phase IV clinical operations from Medical Marketing Services (MMS) to CRS. The remaining businesses of PCG and MMS were then combined to form the new PAREXEL Consulting and Marketing Services (PCMS) business segment. These changes resulted in various reclassifications to the historical financials, but had no impact on the Company’s total revenue, expenses, operating income, net income, or balance sheet. According to one analyst (RW Baird), the aforementioned segment classifications suggest that PRXL's combined Phase I and IV clinical businesses accounted for roughly $72M in FY04 revenue, up over 30% from roughly $55M in FY03 revenue. Reclassifications also suggest that PRXL's combined Phase I and IV clinical businesses, while faster growing, have operated at gross margins lower than that of the historical CRS businesses, and below other CROs in similar businesses. The analyst believes the combined Phase I and IV operations had a roughly 22% gross margin in FY03 and 24% gross margin in FY04. While PAREXEL does not disclose segment operating margins, management suggests that the operating expenses associated with these businesses are lower than that of core Phase II-III clinical operations leading to similar operating margins as Phase II-III clinical and the overall CRS business. However, the analyst believes the company should break out operating profit by segment, as gross margin analysis alone is of limited value to investors.
Margin
PAREXEL announced F2Q05 results on January 20, 2005, with consolidated service revenue reported at $137.9M, up 280 basis points y/y ($134.1M in F2Q04) and 490 basis points sequentially ($131.5M in F1Q05). On a constant dollar, same-store basis, however, revenue was actually down 3.9% y/y. Client concentration continues to come down. PRXL’s top client accounted for 9% of FQ2 revenue while its top-5 and top-20 clients contributed 28% and 54% respectively. An interesting thing to note is this quarter’s geographic revenue mix. The U.S. represented 38% (down from 48% last year), Europe represented 57% (up from 48% last year), and Asia represented 5% (up from 4% last year). The decrease in U.S. revenue is a combination of both the large project cancellation, as well as growing clinical trial activity outside the United States. However, the U.S. revenue is expected to bounce back as PRXL indicated that demand for U.S. services has recently picked up.
Clinical Research Services (CRS) revenue was $94.9M (68.8% of total revenues), up 0.1% y/y and 5.5% sequentially. On a same-store, constant dollar basis, CRS revenue was actually down 8.1% y/y (F/X contributed $7.9M during the quarter). Management attributed this primarily to the large contract cancellation earlier in the fiscal year. The segment accounted for 68.8% of total revenue compared to 68.4% last quarter. Gross margin of 37% was up 30 basis points over FQ1 and 150 basis points y/y. This was slightly better than management’s earlier expectation that CRS gross margin would remain at FQ1 levels or go down slightly in FQ2.
PAREXEL Consulting and Marketing Services (PCMS) reported revenue of $32.3M (23.4% of total revenues), up 5.7% y/y but down 0.1% sequentially. On a same store, constant dollar basis, segment revenue grew 2.9% y/y (acquisitions and F/X contributed $1.1M and $0.5M respectively for FQ2, while disposition of a business contributed $0.7M in the last year). All but one unit in this segment posted y/y revenue increases. GMP Consulting saw heightened activity. Overall demand for marketing services was also strong. Medical education programs at both pre- and post-product-approval stages form the core of PRXL’s marketing services. The 29.1% gross margin in the PCMS segment, down 4.5% sequentially, is one area which management intends to focus on, as they believe that this can at least match gross margin in the CRS segment. As a result, management projects an improvement in PCMS gross margin for FQ3.
Perceptive Informatics (PI) posted revenues of $10.7M (7.8% of total revenues) that was up 22.1% y/y and 16.1% sequentially. Robust demand for medical imaging services drove performance in this segment. The Clinical Trials Management Services (CTMS) unit in this segment performed slightly below the company’s internal forecast, but management cited a good hit rate in the CTMS unit as a consolation. Segment gross margin was 42.8%, up 20 basis points sequentially though not quite up to the 46.4% last year. Management views this segment as consisting of business units differentiated along product and service lines. The product units (CTMS) afford higher gross margin than the services units (Imaging) in this segment. Management stated that a shift in mix from products to services caused the y/y drop in margin for Perceptive.
Consolidated gross margin for the quarter at 35.6% was up 250 basis points y/y but was down 80 basis points sequentially. Management projects that consolidated gross margin will increase going forward. Operating margin of 7.0% was up 90 basis points y/y but was down 30 basis points sequentially. Management had earlier projected an EBIT margin range of 7.0%-7.5% for the quarter. In keeping with management’s expectations, SG&A as a percentage of revenue at 23.7% was down sequentially by 50 basis points. However, SG&A increased by 130 basis points y/y, driven by unfavorable currency movements and acquisition expenses. Furthermore, increased costs related to Sarbanes-Oxley requirements have impacted this line and are expected to do the same in the next several quarters (PRXL is expected to spend $2.1M to comply with the Act). Depreciation and amortization came in at 4.9% of consolidated revenue and management expects this percentage to decrease in FQ3. PRXL ended the quarter with a strong balance sheet position consisting of $108.7M in cash and equivalents, compared to $93.4M at the end of F1Q05.
For the next quarter, management targets an EBIT range of 7.5%-8.0% and continues to target a 10% EBIT margin by FY05 year-end. This implies a mammoth jump of about 200 to 250 basis points in F4Q – something that analysts believe is going to be a challenge for the company to achieve. One analyst (William Blair) is not fully convinced PRXL will reach this 10% target but believes the company can take large strides towards the goal. With its F2Q margin at 7.0% that was down by 30 points sequentially, a 300-point improvement is needed over the next two quarters to end FY05 with the desired target of 10%. Going by its EBIT trend, if one studies the table given below, it reflects PRXL has been twice able to generate margin improvements of 200 basis points or better from the second quarter to the fourth quarter, while the average change is a loss of 47 points. If the two years of extreme margin decline are excluded, the average change reflects an increase of a mere 100 basis points. While this falls short of the desired improvement by 200 points, one could nevertheless expect double-digit growth even if the 10% goal s not achieved by year-end.
FY / 1996 / 1997 / 1998 / 1999 / 2000 / 2001 / 2002 / 2003 / 2004EBIT margin change from F2Q to F4Q
(in basis points) / +100 / +50 / -20 / -540 / -580 / +200 / +360 / -110 / +120
Average 1996-2004 / -47 basis points
Average, excluding 1999-2000 / +100 basis points
Going forward, management gave new FY05 revenue guidance of $570M-$580M (vs. earlier guidance of $565M-$585M). For F3Q05, guidance is $145M-$150M for revenue and 7.5%-8.0% in operating margin. New CY05 guidance for revenue is $600M-$620M. The following table lists the average estimates for FY05 from our digest group.
FY2005E Data: / Direct costs / SG&A Exp / Operating Inc.Digest Average / $364.0M / $133.3M / $44.8M
Earnings per Share
For the three months ended December 31, 2004, Parexel reported net income of $6.1M and earnings of $0.23 per share that was one cent higher than consensus. EPS for the same period last year was reported at $0.19 (on net income of $5.0M), reflecting an increase of 22.2% y/y. Sequentially, EPS was up 7.2% ($0.21 per share on net income of $5.7M). However, one analyst (Advest) observes a lower than anticipated tax rate (34.4% vs. the previous guidance and investor expectation of 39.0%) contributed about a penny and a half. As such, the analyst chose to term the quarter EPS result as an in-line one. Management indicated it was able to reduce tax valuation reserves as certain operations in lower tax jurisdictions are growing faster than operations in higher tax jurisdictions.
Parexel believes its continued diligent focus on improving productivity enabled it to achieve year-over-year gross margin improvements in Clinical Research Services and PAREXEL Consulting and Marketing Services, despite a tough, competitive marketplace. This drove diluted earnings per share growth to over 20% in the period. Given the strength of its backlog and its new business momentum, management anticipates revenue growth will accelerate during the remaining six months of the fiscal year. This revenue growth, in combination with management’s expectations for operating margin expansion, gives it confidence that year-over-year EPS growth will continue to be solid throughout the remainder of Fiscal and Calendar 2005.
Management recently narrowed EPS guidance for FY05 from $0.99-$1.07 to $0.99-$1.05, with the third quarter EPS expected to be in the range of $0.25-$0.27. Our current digest analyst estimates for FY05 EPS range between $0.98 (Bear Stearns) and $1.04 (Advest) with the average estimate for the year pegged at $1.01. EPS estimate for FY06 averages at $1.21 and for FY07 at $1.37. The following table lists the digest estimates for FY05 and FY06:
FY-2005 / FY-2006Company Guidance / 0.99-$1.05 / -
Low Estimate / $0.98 / $1.15
High Estimate / $1.04 / $1.28
Digest Average / $1.01 / $1.21