Feel Better Now?

Ending one year, approaching the next

By Michael A. Martorelli

It’s always interesting to write a column about an event that is still in my future, but will have already happened by the time you read my words. This time, I’m referring to the third quarter earnings reports of the publicly-held providers of outsourcing services. Most firms I monitor posted terrible results in the first quarter of 2009 and only slightly better numbers in the second. In conference calls commenting on that quarter and discussing their future outlooks, some companies cautioned investors to expect lackluster results in the second half; others signaled a reasonably solid rebound in new business wins and revenue in July, and expressed some optimism that financial results would be much better in the third and fourth quarters.

Were you happy with their recent quarter’s results?

Several companies had already reported when I submitted this column.

Covance reported a year over year increase of 8% in revenue, but a decline of 17% in operating income. Weak performance in the Early Development segment was offset by good results from units in the Late Stage Development segment. New business wins rose modestly from the second quarter levels.

ICON reported year-over-year increases of 2% in revenue and 12% in operating income. Both metrics were very close to levels posted in the second quarter. New business wins were about 7% below the second quarter total; cancellations were again much higher than normal, leaving the company with a net book to bill ratio under 1.0.

PPD Inc. reported year over year declines of 12% in revenue and 25% in operating income in its Development segment. New business wins were about 8% below the second quarter level; cancellations were lower than in the previous two quarters, but still close to 5% of beginning backlog. Simultaneous with the earnings release, management announced the lowering of its revenue and earnings expectations for the year, the acquisition of the Chinese CRO Excel PharmaStudies, the investment of $100 million in Celtic Therapeutics and the planned spin-off of its compound partnering assets.

PAREXEL reported year-over-year declines of 1% in revenue and 16% in operating income. The comparisons were affected by an accounting adjustment made to the results in the 3Q08 quarter. New business wins were about flat with the 2Q09 levels; cancellations were again close to 5% of beginning backlog. In response to the continuing weakness in the global outsourcing business, management announced a restructuring of its operations, to include layoffs and facilities closings. They also lowered their revenue guidance for the fiscal year ending June 2010.

On conference calls to discuss the results, the managements of these CROs refused to follow a few analysts’ leads and project strong rebounds in their businesses in 2010.Instead, they suggested a continuing level of caution in predicting exactly when their bio/pharma clients would overcome their cautious approach to starting or continuing their clinical study programs and to outsourcing meaningful portions of that work. Left unspoken was the unknown impact in 2010 of the Pfizer/Wyeth and Merck/Schering-Plough mergers.

There were two other recent announcements that might also affect your comfort level about the CRO industry’s health over the next several quarters.

AstraZeneca offered all of its 5,500 sales reps in the U.S. the chance to take a buyout/early retirement offer. With important products soon losing patent protection, management acknowledges the need to reduce the size of the company’s sales force. As of this writing, they have not offered any more details on the extent of the reduction. This action might bode well for companies offering contract sales services, or it might presage a permanent reduction in all pharmaceutical sales and marketing activities.

IMS Health announced its intention to explore strategic alternatives, including the sale of the company to a private equity firm. In our most recent Outsourcing Industry Monitor, we commented on the many going-private transactions that have occurred during the past year. Companies knocking the cover off the ball and getting rewarded for outstanding performance by Wall Street do not usually decide to explore strategic alternatives. [After press time, IMS Health announced that it would be acquired by private equity firm TPG Capital and the investment board of the Canada Pension Plan for $5.2 billion, including assumption of debt. –ed.]

I’ll close by re-phrasing the question posed in this column’s title, without providing my own answer – yet. Do the third quarter financial results make you feel better about the near-term outlook for outsourcing? Or are you still nervous about business prospects in the coming quarters?

Michael A. Martorelli is a Director at the investment banking firm Fairmount Partners. For additional commentary on the topics covered in this column, please contact him at Tel: (610) 260-6232; Fax (610) 260-6285.