10-Q 1 b50345pie10vq.txt PAREXEL INTERNATIONAL CORP. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-27058 PAREXEL INTERNATIONAL CORPORATION (Exact name of registrant as specified in its Charter) MASSACHUSETTS 04-2776269 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)
195 WEST STREET WALTHAM, MASSACHUSETTS 02451 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (781) 487-9900 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes (X) No ( ) Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of May 6, 2004, there were 26,105,870 shares of PAREXEL International Corporation common stock outstanding, excluding 258,600 shares in treasury. PAREXEL INTERNATIONAL CORPORATION INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1 Financial Statements (Unaudited): Condensed Consolidated Balance Sheets - March 31, 2004 and June 30, 2003 3 Condensed Consolidated Statements of Operations - Three months ended 4 March 31, 2004 and 2003 (Restated); Nine months ended March 31, 2004 and 2003 (Restated) Condensed Consolidated Statements of Cash Flows - Nine months ended 5 March 31, 2004 and 2003 Notes to Condensed Consolidated Financial Statements 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results 10 of Operations Item 3 Quantitative and Qualitative Disclosure About Market Risk 19 Item 4 Controls and Procedures 27 PART II. OTHER INFORMATION Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity 27 Securities Item 5 Other Information 28 Item 6 Exhibits and Report on Form 8-K 28 SIGNATURES 29
2 PART I. FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS PAREXEL INTERNATIONAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
MARCH 31, JUNE 30, 2004 2003 --------- --------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 52,135 $ 69,734 Marketable securities 31,842 12,990 Billed and unbilled accounts receivable, net 222,827 222,726 Prepaid expenses 12,082 12,087 Current deferred tax assets 27,597 27,604 Other current assets 5,001 4,936 --------- --------- Total current assets 351,484 350,077 Property and equipment, net 65,726 61,924 Goodwill 41,403 29,803 Other intangible assets, net 11,233 5,763 Non-current deferred tax assets 10,432 10,043 Other assets 6,657 6,627 --------- --------- Total assets $ 486,935 $ 464,237 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and current portion of long-term debt $ 235 $ 118 Accounts payable 6,951 14,462 Deferred revenue 147,581 130,650 Accrued expenses 14,447 13,766 Accrued restructuring charges - short term 7,251 8,750 Accrued employee benefits and withholdings 27,272 37,849 Current deferred tax liabilities 2,881 2,557 Income taxes payable 3,775 1,801 Other current liabilities 4,977 5,778 --------- --------- Total current liabilities 215,370 215,731 Long-term debt 348 644 Non-current deferred tax liabilities 10,667 10,674 Other liabilities 15,114 6,092 --------- --------- Total liabilities 241,499 233,141 --------- --------- Minority interest in subsidiary 3,670 3,996 Stockholders' equity: Preferred stock--$.01 par value; shares authorized: 5,000,000 at March 31, 2004 and June 30, 2003; Series A Junior Participating Preferred Stock - 50,000 shares designated; none issued and outstanding Common stock--$.01 par value; shares authorized: 50,000,000 at March 31, 2004 and June 30, 2003; shares issued: 26,328,331 at March 31, 2004 and 26,683,055 at June 30, 2003; shares outstanding: 26,069,731 at March 31, 2004 and 25,822,055 at June 30, 2003 273 267 Additional paid-in capital 171,711 174,734 Treasury stock, at cost; 258,600 shares at March 31, 2004 and 861,000 shares at June 30, 2003 (4,445) (8,165) Retained earnings 70,407 63,117 Accumulated other comprehensive income/(loss) 3,820 (2,853) --------- --------- Total stockholders' equity 241,766 227,100 --------- --------- Total liabilities and stockholders' equity $ 486,935 $ 464,237 ========= =========
See notes to condensed consolidated financial statements. 3 PAREXEL INTERNATIONAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (in thousands, except per share data)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED MARCH 31, MARCH 31, -------------------------- ------------------------- 2004 2003 2004 2003 --------- --------- --------- --------- (RESTATED) (RESTATED) Service revenue $ 139,899 $ 135,005 $ 406,110 $ 381,364 Reimbursement revenue 28,350 24,157 77,193 73,393 --------- --------- --------- --------- 168,249 159,162 483,303 454,757 Total revenue Costs and expenses: Direct costs 90,762 88,260 266,317 253,353 Reimbursable out-of-pocket expenses 28,350 24,157 77,193 73,393 Selling, general and administrative expenses 33,234 33,157 95,846 89,953 Depreciation and amortization 6,791 5,307 18,791 15,155 Restructuring charge 10,796 - 10,796 5,886 --------- --------- --------- --------- Total costs 169,933 150,881 468,943 437,740 --------- --------- --------- --------- Income (loss) from operations (1,684) 8,281 14,360 17,017 Other expense (1,468) (740) (1,473) (3,122) --------- --------- --------- --------- Income (loss) before provision (benefit) for income taxes and minority interest (3,152) 7,541 12,887 13,895 Provision (benefit) for income taxes (636) 2,936 5,299 5,596 Minority interest expense (income) (32) 230 298 519 --------- --------- --------- --------- Net income (loss) $ (2,484) $ 4,375 $ 7,290 $ 7,780 ========= ========= ========= ========= Earnings (loss) per share: Basic $ (0.10) $ 0.17 $ 0.28 $ 0.31 Diluted $ (0.10) $ 0.17 $ 0.27 $ 0.30 Shares used in computing earnings per share: Basic 26,113 25,376 25,970 25,238 Diluted 26,113 25,825 26,720 25,511
See notes to condensed consolidated financial statements. 4 PAREXEL INTERNATIONAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands)
FOR THE NINE MONTHS ENDED MARCH 31, ------------------------- 2004 2003 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 7,290 $ 7,780 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 18,791 15,155 Minority interest in net income of consolidated subsidiary 298 519 Loss on disposal of fixed assets 55 151 Deferred income taxes (66) 450 Changes in operating assets/liabilities 1,887 12,401 ---------- ---------- Net cash provided by operating activities 28,255 36,456 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities (140,981) (175,348) Proceeds from sale of marketable securities 122,129 200,272 Acquisition of businesses (13,457) (11,201) Proceeds from sale of fixed assets 116 417 Purchase of property and equipment (17,655) (22,288) ---------- ---------- Net cash used in investing activities (49,848) (8,148) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 5,318 1,907 Proceeds from issuance of subsidiary common stock 8 - Payments to repurchase common stock (4,445) - Repayments under credit arrangements (179) (81) ---------- ---------- Net cash provided by financing activities 702 1,826 ---------- ---------- Effect of exchange rate changes on cash and cash equivalents 3,292 4,874 ---------- ---------- Net increase (decrease) in cash for the period (17,599) 35,008 Cash and cash equivalents at beginning of period 69,734 22,479 ---------- ---------- Cash and cash equivalents at end of period $ 52,135 $ 57,487 ========== ========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Income taxes $ 3,241 $ 12,802 Interest 3,401 2,217 Acquisitions, net of cash acquired: Fair value of assets acquired and goodwill $ 17,536 $ 20,633 Liabilities assumed (4,079) (6,925) ---------- ---------- Cash paid and common stock issued for acquisitions $ 13,457 $ 13,708 ========== ==========
See notes to condensed consolidated financial statements. 5 PAREXEL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of PAREXEL International Corporation ("PAREXEL" or "the Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (primarily consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months and nine months ended March 31, 2004, are not necessarily indicative of the results that may be expected for other quarters or the entire fiscal year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended June 30, 2003. Certain prior year balances have been reclassified in order to conform to current year presentation. Specifically, effective July 1, 2003, the Company decided to merge the Conferences and Publishing business of the PAREXEL Consulting Group ("PCG") with and into the Meetings and Events business of Medical Marketing Services ("MMS") in order to eliminate duplication and improve synergies. As a result, revenue and direct costs were moved from PCG to MMS. In addition, the Company combined certain Clinical Research Services ("CRS") and Corporate Information Technology groups into one organization led by the Company's Corporate Information Systems group in order to capitalize on various synergies in those areas. As a result, ongoing and historical expenses related to CRS activities were shifted from CRS direct costs to selling, general and administrative expenses. These financials reflect a restatement of the Company's financial results for the three and nine-month periods ended March 31, 2003 and the first two quarters of fiscal year 2004. The restatement relates to reclassifications of certain reimbursable expense of PCG from "Reimbursement Revenue" into "Service Revenue", and from "Reimbursable Out-of-Pocket Expenses" into "Direct Costs." The restatement had no impact to the Company's total revenue, expenses, operating income, net income, or balance sheet. THE EFFECT ON CONSOLIDATED RESULTS WAS AS FOLLOWS:
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED CONSOLIDATED MARCH 31, 2003 MARCH 31, 2003 -------------- -------------- Service revenue - as reported $132,263 $373,964 Effect of adjustments 2,742 7,400 -------- -------- Service revenue - restated $135,005 $381,364 ======== ======== Gross profit - as reported $ 46,745 $128,011 Effect of adjustments - - -------- -------- Gross profit - restated $ 46,745 $128,011 ======== ======== Gross margin as % of service revenue - as reported 35.3% 34.2% Gross margin as % of service revenue - restated 34.6% 33.6%
6 THE EFFECT ON SEGMENT INFORMATION WAS AS FOLLOWS:
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED THE PAREXEL CONSULTING GROUP MARCH 31, 2003 MARCH 31, 2003 -------------- -------------- Service revenue - as reported $23,439 $68,897 Effect of adjustments 2,742 7,400 ------- ------- Service Revenue - restated $26,181 $76,297 ======= ======= Gross profit - as reported $ 5,318 $17,528 Effect of adjustments - - ------- ------- Gross profit - restated $ 5,318 $17,528 ======= ======= Gross margin as % of service revenue - as reported 22.7% 25.4% Gross margin as % of service revenue - restated 20.3% 23.0%
Reimbursement Revenue totaling $3.5 million and $2.7 million was reclassified to Service Revenue for the three months ended March 31, 2004 and March 31, 2003 respectively. Adjustments of the same amounts were recorded to reclassify Reimbursable Out-of-Pocket Expenses to Direct Costs. NOTE 2 -- EARNINGS PER SHARE Basic earnings per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares plus the dilutive effect of outstanding stock options and shares issuable under the employee stock purchase plan. Approximately 0.9 million and 1.6 million outstanding stock options were excluded from the calculation of diluted earnings per share for the three months ended March 31, 2004 and 2003, respectively, and approximately 1.1 million and 2.2 million outstanding stock options were excluded from the calculation of diluted earnings per share for the nine months ended March 31, 2004 and 2003, respectively, because they were anti-dilutive. The following table outlines the basic and diluted earnings per common share computations:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED MARCH 31, MARCH 31, ---------------------------- --------------------------- ($ IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Net income (loss) attributable to common shares $ (2,484) $ 4,375 $ 7,290 $ 7,780 ============ ============ ============ ============ BASIC EARNINGS PER COMMON SHARE COMPUTATION: Weighted average common shares outstanding 26,113 25,376 25,970 25,238 ============ ============ ============ ============ Basic earnings (loss) per common share $ (0.10) $ 0.17 $ 0.28 $ 0.31 ============ ============ ============ ============ DILUTED EARNINGS PER COMMON SHARE COMPUTATION: Weighted average common shares outstanding: Shares attributable to common stock Outstanding 26,113 25,376 25,970 25,238 Shares attributable to common stock Options - 449 750 273 ------------ ------------ ------------ ------------ 26,113 25,825 26,720 25,511 ============ ============ ============ ============ Diluted earnings (loss) per common share $ (0.10) $ 0.17 $ 0.27 $ 0.30 ============ ============ ============ ============
7 NOTE 3 - COMPREHENSIVE INCOME Comprehensive income (loss) has been calculated by the Company in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." Comprehensive income (loss) for the three months and nine months ended March 31, 2004 and 2003 were as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED MARCH 31, MARCH 31, ---------------------------- --------------------------- ($ IN THOUSANDS) 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Net income (loss) $ (2,484) $ 4,375 $ 7,290 $ 7,780 Add: foreign currency translation adjustments 107 1,410 6,673 7,041 ------------ ------------ ------------ ------------ Comprehensive income (loss) $ (2,377) $ 5,785 $ 13,963 $ 14,821 ============ ============ ============ ============
NOTE 4 - ACQUISITIONS Effective March 1 2004, the Company acquired the remaining outstanding shares of 3 Clinical Research AG ("3C"), a clinical research organization with expertise in Phase I and Phase IIa Proof-Of-Concept studies in Berlin, Germany, for approximately $12.0 million in cash. Prior to March 1, 2004, PAREXEL was a minority shareholder of 3C. In association with this transaction, the Company recorded as goodwill approximately $8.1 million of excess cost over the fair value of the interest in the net assets acquired. Goodwill is subject to impairment testing under SFAS No. 142. NOTE 5 - STOCK-BASED COMPENSATION The Company accounts for employee stock awards using the intrinsic value based method as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", as described by FASB Interpretation No. 44. Accordingly, no compensation expense was recognized because the exercise price of the Company's stock options was equal to the market price of the underlying stock on the date of grant. The Company has adopted the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for disclosure purposes only. If the compensation cost for the Company's stock options and the Company's employee stock purchase plan had been determined based on the fair value at the date of grant, as prescribed in SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED MARCH 31, MARCH 31, ---------------------------- ---------------------------- ($ IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Net income (loss) as reported $ (2,484) $ 4,375 $ 7,290 $ 7,780 Deduct: total stock-based compensation, net of tax (1,132) (744) (2,064) (1,821) Pro forma net income (loss) $ (3,616) $ 3,631 $ 5,226 $ 5,959 ============ ============ ============ ============ Pro forma net income (loss) per share: Basic $ (0.14) $ 0.14 $ (0.20) $ 0.24 Diluted $ (0.14) $ 0.14 $ (0.20) $ 0.23
As stock options vest over several years and additional stock option grants are expected to be made each year, the above pro forma disclosures are not necessarily representative of pro forma effects on results of operations for future periods. 8 NOTE 6 - SEGMENT INFORMATION The Company is managed through four business segments: CRS, PCG, MMS, and Perceptive Informatics, Inc. ("Perceptive"). CRS constitutes the Company's core business and includes clinical trials management, biostatistics and data management, as well as related medical advisory and investigator site services. PCG provides technical expertise in such disciplines as clinical pharmacology, regulatory affairs, industry training, and management consulting. PCG consultants identify alternatives and propose solutions to address clients' product development, registration, and commercialization issues. MMS provides a full spectrum of market development, product development, and targeted communications services in support of product launch. Perceptive provides technology solutions to improve clients' product development and commercialization processes. Perceptive offers a portfolio of services that include design of web-based portals, interactive voice response systems ("IVRS"), clinical trial management systems ("CTMS"), electronic data capture solutions, and medical imaging services. Perceptive is a majority-owned subsidiary of the Company. As of March 31, 2004, the Company owned 98.2% of Perceptive, based on outstanding shares of common stock, and 93.4% on a fully diluted basis. The Company evaluates its segment performance and allocates resources based on service revenue and gross profit (service revenue less direct costs), while other operating costs are evaluated on a geographic basis. Accordingly, the Company does not include selling, general, and administrative expenses, depreciation and amortization expense, interest income (expense), other income (expense), and income tax expense in segment profitability. Furthermore, the Company attributes revenue to individual countries based upon the number of hours of services performed in the respective countries and inter-segment transactions are not included in service revenue.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED MARCH 31, MARCH 31, ---------------------------- --------------------------- ($ IN THOUSANDS) 2004 2003 2004 2003 ------------- ----------- ------------ ------------- (RESTATED) (RESTATED) Service revenue: Clinical Research Services $ 76,798 $ 81,496 $ 234,903 $ 228,542 PAREXEL Consulting Group 29,338 26,181 80,253 76,297 Medical Marketing Services 24,755 20,749 65,028 59,563 Perceptive Informatics, Inc. 9,008 6,579 25,926 16,962 ------------- ----------- ------------ ------------- $ 139,899 $ 135,005 $ 406,110 $ 381,364 ============= =========== ============ ============= Gross profit on service revenue: Clinical Research Services $ 30,552 $ 32,042 $ 92,759 $ 84,745 PAREXEL Consulting Group 7,529 5,318 19,017 17,528 Medical Marketing Services 6,651 6,701 15,837 19,764 Perceptive Informatics, Inc. 4,405 2,684 12,180 5,974 ------------- ----------- ------------ ------------- $ 49,137 $ 46,745 $ 139,793 $ 128,011 ============= =========== ============ =============
These financials reflect a restatement of the Company's financial results for the three and nine-month periods ended March 31, 2003 and the first two quarters of fiscal year 2004. The restatement relates to reclassifications of certain reimbursable expense of PCG from "Reimbursement Revenue" into "Service Revenue", and from "Reimbursable Out-of-Pocket Expenses" into "Direct Costs." The restatement had no impact to the Company's total revenue, expenses, operating income, net income, or balance sheet. See Note 1 for further discussion and analysis. NOTE 7 - RESTRUCTURING CHARGES During the quarter ended March 31, 2004, the Company recorded restructuring charges totaling $10.8 million. These charges included $3.9 million of employee severance and related costs for eliminating approximately 157 managerial and staff positions worldwide, $5.6 million related to newly abandoned leased facilities, and $1.3 million related to changes in assumptions for previously abandoned leased facilities under the Company's June 2001 restructuring plan. During the three months ended June 30, 2003 and December 31, 2002, the Company recorded facilities-related restructuring charges totaling $3.5 and $5.9 million, respectively, as a result of changes in prior assumptions regarding certain leased facilities which were previously abandoned as part of the Company's June 2001 restructuring charge. The changes in prior assumptions were caused by a further deterioration in challenging real estate market conditions, which made it difficult to sub-lease the abandoned facilities at previously estimated rental rates. 9 In June 2001, the Company made certain reasonable assumptions based upon market conditions, which indicated that sub-lease payments for these abandoned facilities were probable. The June 2001 restructuring charge involved fourteen properties. As of March 31, 2004, the Company has been successful in exiting or subleasing eleven of those properties. After expending significant effort attempting to sub-lease the remaining properties during a declining commercial real estate market, it became apparent to the Company during fiscal year 2003 that the original assumptions for the remaining three properties were no longer valid under current market conditions. Current quarter activity charged against the restructuring accrual (which is included in "Accrued Restructuring Charges - Short Term and Other Liabilities" in the Condensed Consolidated Balance Sheet) was as follows:
BALANCE AS OF BALANCE AS OF DECEMBER 31, 3RD QUARTER 3RD QUARTER MARCH 31, ($ IN THOUSANDS) 2003 PROVISION PAYMENTS 2004 ------------- ----------- ----------- ------------- Employee severance costs $ 221 $ 3,875 $ (938) $ 3,158 Facilities-related charges 6,756 6,921 (681) 12,996 ---------- ----------- ----------- ---------- $ 6,977 $ 10,796 $ (1,619) $ 16,154 ========== =========== =========== ==========
NOTE 8 - STOCKHOLDER'S EQUITY In September 1999, the Board of Directors approved a stock repurchase program authorizing the purchase of up to $20.0 million of the Company's common stock. Repurchases are made in the open market subject to market conditions. As of March 31, 2004, the Company has acquired 1,119,600 shares at a total cost of $12.6 million. During the period of April 1, 2004 to May 6, 2004, the Company acquired an additional 137,600 shares at a total cost of $2.6 million. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The financial information discussed below is derived from the Condensed Consolidated Financial Statements included herein. The financial information set forth and discussed below is unaudited but, in the opinion of management, reflects all adjustments (primarily consisting of normal recurring adjustments) considered necessary for a fair presentation of such information. The Company's results of operations for a particular quarter may not be indicative of results expected during subsequent fiscal quarters or for the entire year. Certain prior year balances have been reclassified in order to conform to current year presentation. Specifically, effective july 1, 2003, the Company decided to merge the conferences and Publishing business of PCG with and into the meetings and events business of MMS in order to eliminate duplication and improve synergies. As a result, revenue and direct costs were moved from PCG to MMS. In addition, the Company combined certain CRS and Corporate information technology groups into one organization led by the Company's Corporate Information systems group in order to capitalize on various synergies in those areas. As a result, ongoing and historical expenses related to CRS activities were shifted from CRS direct costs to selling, general and administrative expenses. During the third quarter of fiscal year 2004, the Company restated the three and nine-month periods ended March 31, 2003 and the first two quarters of fiscal year 2004, the effect of which had no impact to the Company's total revenue, expenses, operating income, net income, or balance sheet. The restatement related to reclassifications of certain reimbursable expense of PCG from "Reimbursement Revenue" into "Service Revenue", and from "Reimbursable Out-of-Pocket Expenses" into "Direct Costs". The reclassified amount was $8.9 million for the nine months ended March 31, 2004 and $7.4 million for the nine months ended March 31, 2003. The statements included in this quarterly report on form 10-Q, including the statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations", may contain "forward-looking statements", within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding the adequacy of the Company's existing capital resources and future cash flows from operations, and statements regarding expected financial results, future growth and customer demand. For this purpose, any statements that are not statements of historical fact may be deemed forward-looking statements. Without limiting the foregoing, the words "believes", "anticipates", "plans", "expects", "intends", "appears", "will" and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company's actual results, including the company's actual operating performance, actual expense savings and other operating improvements resulting from restructurings, and other corporate actions, to differ materially from the results indicated by the forward-looking statements. These important factors are discussed in greater detail under "RISK FACTORS" below and elsewhere in this quarterly report. 10 The forward-looking statements included in this quarterly report represent the Company's estimates as of the date of this quarterly report. The Company specifically disclaims any obligation to update these forward-looking statements in the future. These forward-looking statements should not be relied upon as representing the Company's estimates or views as of any date subsequent to the date of this quarterly report. OVERVIEW The Company is a leading biopharmaceutical services company, providing a broad range of expertise in clinical research, medical marketing, consulting and informatics and advanced technology products and services to the worldwide pharmaceutical, biotechnology, and medical device industries. The Company's primary objective is to provide solutions for managing the biopharmaceutical product lifecycle with the goal of reducing the time, risk and cost associated with the development and commercialization of new therapies. Since its founding in 1983, PAREXEL has developed significant expertise in processes and technologies supporting this strategy. The Company's product and service offerings include: clinical trials management, data management, biostatistical analysis, medical marketing, clinical pharmacology, regulatory and medical consulting, performance improvement, industry training and publishing, web-based portal solutions, interactive voice response systems ("IVRS"), clinical trial management systems ("CTMS"), electronic data capture solutions, medical imaging services, and other drug development consulting services. The Company believes that its integrated services, depth of therapeutic area expertise, access to patients, and sophisticated information technology, along with its experience in global drug development and product launch services, represent key competitive strengths. The Company is managed through four business segments, namely, CRS, PCG, MMS and Perceptive. CRS constitutes the Company's core business and includes clinical trials management and biostatistics and data management, as well as related medical advisory and investigator site services. PCG provides technical expertise in such disciplines as clinical pharmacology, regulatory affairs, industry training, and management consulting. PCG consultants identify alternatives and propose solutions to address clients' product development, registration, and commercialization issues. MMS provides a full spectrum of market development, product development, and targeted communications services in support of product launch. Perceptive provides technology solutions to improve clients' product development and commercialization processes. Perceptive offers a portfolio of services that include the design of web-based portals, IVRS, CTMS, electronic data capture solutions, and medical imaging services. Perceptive is a majority-owned subsidiary of the Company. As of March 31, 2004, the Company owned 98.2% of Perceptive, based on outstanding shares of common stock, and 93.4% on a fully diluted basis. The Company conducts a significant portion of its operations in foreign countries. Approximately 53.7% of the Company's service revenue for the nine months ended March 31, 2004 and 48.2% of the Company's service revenue for the nine months ended March 31, 2003, were from non-U.S. operations. Because the Company's financial statements are denominated in United States ("U.S.") dollars, changes in foreign currency exchange rates can have a significant effect on its operating results. For the nine months ended March 31, 2004, approximately 18.3% of total service revenue was denominated in British pounds and approximately 28.2% of total service revenue was denominated in Euros. For the nine months ended March 31, 2003, approximately 18.4% of total service revenue was denominated in British pounds and approximately 23.7% of total service revenue was denominated in Euros. Approximately 90% of the Company's contracts are fixed price, with some variable components, and range in duration from a few months to several years. Cash flows from these contracts typically consist of a down payment required to be paid at the time of contract execution with the balance due in installments over the contract's duration, usually on a milestone achievement basis. Revenue from these contracts is generally recognized as work is performed. As a result, cash receipts do not necessarily correspond to costs incurred and revenue recognized on contracts. Generally, the Company's clients can terminate their contracts with the Company upon thirty to sixty days' notice or can delay execution of services. Clients may terminate or delay contracts for a variety of reasons, including, among others: merger or potential merger related activities involving the client, the failure of products being tested to satisfy safety requirements or efficacy criteria, unexpected or undesired clinical results of the product, client cost reductions as a result of budgetary limits or changing priorities, the client's decision to forego a particular study, insufficient patient enrollment or investigator recruitment, or production problems resulting in shortages of the product. In the fiscal year ended June 30, 2003, the Company's five largest clients accounted for 33% of its consolidated service revenue and one client, AstraZeneca accounted for 11% of consolidated service revenue. In the fiscal year ended June 30, 2002, the Company's five largest clients accounted for 34% of its consolidated service revenue, and one client, AstraZeneca, accounted for 11% of its consolidated service revenue. 11 CRITICAL ACCOUNTING POLICIES The discussion and analysis of the Company's financial condition and results of operations are based on the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expenses, and other financial information. On an ongoing basis, the Company evaluates its estimates and judgments, including those related to revenue recognition. The Company bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While the Company's significant accounting policies are more fully described in Note 2 to the consolidated financial statements included in Item 8 of Form 10-K for the year ended June 30, 2003, the Company believes that the following accounting policies are most critical to aid in fully understanding and evaluating its reported financial results. REVENUE Service revenue on fixed price contracts is recognized as services are performed. The Company measures progress on fixed price contracts using the concept of proportional performance based upon a direct labor cost-to-cost methodology or by the unit based output method. These methods require the Company to estimate total expected revenue and total expected costs. Generally, the assigned financial manager or financial analyst reviews contract estimates on a monthly basis. Adjustments to contract estimates are made in the periods in which the facts that require the revisions become known. Historically, there have not been any significant variations between contract estimates and the actual costs incurred, which were not recovered from clients. In the event that future estimates are incorrect, they could materially impact the Company's consolidated results of operations or financial position. BILLED ACCOUNTS RECEIVABLE, UNBILLED ACCOUNTS RECEIVABLE AND DEFERRED REVENUE Billed accounts receivable represent amounts for which invoices have been sent to clients. Unbilled accounts receivable represent amounts recognized as revenue for which invoices have not yet been sent to clients. Deferred revenue represents amounts billed or payments received for which revenue has not yet been earned. The Company maintains an allowance for doubtful accounts based on historical collectability and specific identification of potential problems. In the event the Company is unable to collect portions of its outstanding billed or unbilled receivables, there may be a material impact to the Company's consolidated results of operations and financial position. INCOME TAXES The Company's global provision for corporate income taxes is calculated using the tax accounting rules established by SFAS No. 109 "Accounting for Income Taxes". Income tax expense is based on the distribution of profit before tax amongst the various taxing jurisdictions in which the Company operates, adjusted as required by the tax laws of each taxing jurisdiction. Changes in the amount or distribution of profits and losses between taxing jurisdictions may have a significant impact on the Company's effective tax rate. The provision is a combination of current-year tax liability and future tax liability/benefit that results from differences between book and taxable income that will reverse in future periods. Deferred tax assets and liabilities for these future tax effects are established on the Company's balance sheet. A valuation allowance is established if it is more likely than not that future tax benefits will not be realized. Monthly interim tax provision calculations are prepared during the year. Differences between these interim estimates and the final results for the year could materially impact the Company's effective tax rate and its consolidated financial results and financial position. 12 EMPLOYEE STOCK COMPENSATION The Company elected to follow Accounting Principal Board Opinion No. 25, "Accounting for Stock Options Issued to Employees" ("APB 25"), and related interpretations in accounting for the Company's employee stock options because the alternative fair value accounting provided for under SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), requires the use of option valuation models that were not developed for valuing employee stock options. Under APB 25, no compensation expense is recognized if the exercise price equals the market price of the underlying stock on the date of the grant. If PAREXEL accounted for stock options under SFAS 123, the Company would have recorded additional compensation expense for stock option grants to employees. If PAREXEL were unable to account for stock options under APB 25, the Company's financial results would be materially affected to the extent the additional compensation expense would have to be recognized. The additional compensation expense could vary significantly from period to period based on several factors including the number of stock options granted and stock price fluctuations. FOREIGN CURRENCIES The Company derives a large portion of its service revenue from operations in foreign countries. The Company's financial statements are denominated in U.S. dollars. As a result, factors associated with international operations, including changes in foreign currency exchange rates, could significantly affect the Company's results of operations. Gains and losses on transactions denominated in currencies other than an entity's functional currency are reported in other income (expense). Adjustments from the translation of the subsidiary entities' foreign functional currencies to U.S. dollars are reported in accumulated other comprehensive income/(loss) within stockholder's equity. GOODWILL Goodwill represents the excess of the cost of an acquired business over the fair value of the related net assets at the date of acquisition. Prior to the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142"), goodwill was amortized using the straight-line method over its expected useful life. Subsequent to the adoption of SFAS No. 142, goodwill is subject to annual impairment testing. The Company has assessed the impairment of goodwill under SFAS No. 142 in fiscal year 2003. Based on this assessment, there was no impairment identified. The Company tests for impairment at least annually (generally in the fourth quarter) and more often if events or circumstances warrant. Any future impairment of goodwill could have a material impact to the Company's financial position or its results of operations. RESULTS OF OPERATIONS ANALYSIS BY SEGMENT The Company evaluates its segment performance and allocates resources based on service revenue and gross profit (service revenue less direct costs), while other operating costs are evaluated on a geographic basis. Accordingly, the Company does not include the impact of selling, general, and administrative expenses, depreciation and amortization expense, other income (expense), and income taxes in segment profitability. Service revenue, direct costs and gross profit on service revenue for the three months and nine months ended March 31, 2004 and 2003 were as follows: 13
FOR THE THREE MONTHS ENDED MARCH 31, FOR THE NINE MONTHS ENDED MARCH 31, ------------------------------------------- ----------------------------------------- ($ IN THOUSANDS) INCREASE INCREASE 2004 2003 (DECREASE) % 2004 2003 (DECREASE) % -------- -------- -------- -------- -------- -------- -------- --------- (RESTATED) (RESTATED) Service revenue: CRS $ 76,798 $ 81,496 $ (4,698) -5.8% $234,903 $228,542 $ 6,361 2.8% PCG 29,338 26,181 3,157 12.1% 80,253 76,297 3,956 5.2% MMS 24,755 20,749 4,006 19.3% 65,028 59,563 5,465 9.2% Perceptive 9,008 6,579 2,429 36.9% 25,926 16,962 8,964 52.8% -------- -------- -------- -------- -------- -------- $139,899 $135,005 $ 4,894 3.6% $406,110 $381,364 $ 24,746 6.5% ======== ======== ======== ======== ======== ======== Direct costs: CRS $ 46,246 $ 49,454 $ (3,208) -6.5% $142,144 $143,797 $ (1,653) -1.1% PCG 21,809 20,863 946 4.5% 61,236 58,769 2,467 4.2% MMS 18,104 14,048 4,056 28.9% 49,191 39,799 9,392 23.6% Perceptive 4,603 3,895 708 18.2% 13,746 10,988 2,758 25.1% -------- -------- -------- -------- -------- -------- $ 90,762 $ 88,260 $ 2,502 2.8% $266,317 $253,353 $ 12,964 5.1% ======== ======== ======== ======== ======== ======== Gross profit on service revenue: CRS $ 30,552 $ 32,042 $ (1,490) -4.7% $ 92,759 $ 84,745 $ 8,014 9.5% PCG 7,529 5,318 2,211 41.6% 19,017 17,528 1,489 8.5% MMS 6,651 6,701 (50) -0.7% 15,837 19,764 (3,927) -19.9% Perceptive 4,405 2,684 1,721 64.1% 12,180 5,974 6,206 103.9% -------- -------- -------- -------- -------- -------- $ 49,137 $ 46,745 $ 2,392 5.1% $139,793 $128,011 $ 11,782 9.2% ======== ======== ======== ======== ======== ========
These financials reflect a restatement of the Company's financial results for the three and nine-month periods ended March 31, 2003 and the first two quarters of fiscal year 2004. The restatement relates to reclassifications of certain reimbursable expense of PAREXEL Consulting Group from "Reimbursement Revenue" into "Service Revenue", and from "Reimbursable Out-of-Pocket Expenses" into "Direct Costs." The restatement had no impact to the Company's total revenue, expenses, operating income, net income, or balance sheet. See Note 1 to the Condensed Consolidated Financial Statements for further discussion and analysis. THREE MONTHS ENDED MARCH 31, 2004 COMPARED WITH THREE MONTHS ENDED MARCH 31, 2003: Service revenue increased by $4.9 million, or 3.6%, to $139.9 million for the three months ended March 31, 2004 from $135.0 million for the same period one year ago. On a geographic basis, service revenue for the three months ended March 31, 2004 was distributed as follows: The Americas - $64.7 million (46.3%), Europe - $70.7 million (50.5%), and Asia/Pacific - $4.5 million (3.2%). For the three months ended March 31, 2003, service revenue was distributed as follows: The Americas - $70.0 million (51.9%), Europe - $60.5 million (44.8%), and Asia/Pacific - $4.5 million (3.3%). On a segment basis, CRS service revenue decreased $4.7 million, or 5.8%, to $76.8 million for the three months ended March 31, 2004 from $81.5 million in the same period in fiscal year 2003. Of the 5.8% total decrease, 15.9% was attributable primarily to fewer favorable changes-in-scope and the lingering impact of a relatively low level of new business wins in calendar year 2003, offset by positive impacts of 7.4% from foreign currency fluctuations and 2.7% from the final reconciliation of closed-out contracts. PCG service revenue increased by $3.1 million, or 12.1%, to $29.3 million in the three months ended March 31, 2004 from $26.2 million in the three months ended March 31, 2003. Of the total 12.1% increase, approximately 10.7% was attributed to a positive impact from foreign currency fluctuations and 3.5% to an increase in incremental service revenue associated with the 3C acquisition completed during the third quarter of fiscal year 2004, offset by a 2.1% decrease in service revenue primarily due to a reduction in FDA enforcement activity. MMS service revenue increased by $4.0 million, or 19.3%, to $24.7 million in the three-month period ended March 31, 2004 from $20.7 million in the same period one year ago. The 19.3% increase was primarily due to the impact of signature timing and a strong rebound in demand for the group's services as customers kicked off their new budget years. Perceptive service revenue increased by $2.4 million, or 36.9%, to $9.0 million in the three months ended March 31, 2004 as compared with $6.6 million in the same period one year ago. Of the total 36.9% increase, 5.2% was attributed to a positive impact from foreign currency fluctuations and 8.8% to an increase in revenue associated 14 with FW Pharma, which was acquired by the Company in January 2003. The remaining 22.9% increase resulted primarily from continued increased demand for the group's medical diagnostic imaging services. Reimbursement revenue consists of reimbursable out-of-pocket expenses incurred on behalf of, and reimbursable by, clients. It does not yield any gross profit to the Company, nor does it have an impact on net income. Direct costs increased by $2.5 million, or 2.8%, to $90.8 million for the three months ended March 31, 2004 from $88.3 million in the same period last fiscal year. On a segment basis, CRS direct costs decreased by $3.2 million, or 6.5%, to $46.2 million for the three months ended March 31, 2004 from $49.4 million in the same three-month period in fiscal year 2003. Of the total 6.5% decrease, 13.9% resulted from lower labor costs associated with restructuring activity, tighter cost controls and continued improvements in quality and productivity, partly offset by a 7.4% increase from foreign currency fluctuations. As a percentage of service revenue, CRS direct costs improved by 0.5 points to 60.2% for the three months ended March 31, 2004 from 60.7% for the three months ended March 31, 2003. PCG direct costs increased $0.9 million, or 4.5%, to $21.8 million in the three months ended March 31, 2004 from $20.9 million in the same period one year ago. Of the total 4.5% increase, foreign currency fluctuations contributed approximately 9.9%, partially offset by a 5.4% decrease as a result of tighter cost controls. As a percentage of service revenue, PCG direct costs decreased by 5.4 points to 74.3% for the three months ended March 31, 2004 from 79.7% for the three months ended March 31, 2003 as a result of increased strength in three of the group's four operating units. MMS direct costs increased approximately $4.1 million, or 28.9%, to $18.1 million in the three months ended March 31, 2004 from $14.0 million for the three months ended March 31, 2003. Of the total 28.9% increase, approximately 6.1% was attributed to foreign currency fluctuations and the remaining 22.8% was caused by incremental labor costs related to recent staff additions. As a percentage of service revenue, MMS direct costs increased by 5.4 points to 73.1% in the three-month period ended March 31, 2004 from 67.7% in the same period in the last fiscal year primarily due to the impact of additional hiring in anticipation of increased business and a change in business mix. Perceptive direct costs increased $0.7 million, or 18.2%, to $4.6 million in the three months ended March 31, 2004 from $3.9 million in the same period in the last fiscal year. Of the total 18.2% increase, approximately 4.5% was attributed to foreign currency fluctuations, 2.7% was attributed to incremental costs associated with the FW Pharma acquisition completed during the third quarter of fiscal year 2003 and the remaining 11.0% increase primarily due to higher labor costs associated with increased staffing needs to support business growth. As a percentage of service revenue, Perceptive's direct costs improved by 8.1 points to 51.1% in the three months ended March 31, 2004 from 59.2% in the same three-month period one year ago as a result of sharply higher revenue and continued productivity improvements. Selling, general and administrative ("SG&A") expenses remained flat at $33.2 million in both the three-month periods ended March 31, 2004 and 2003. As a percentage of service revenue, SG&A improved by 0.8 points to 23.8% in the three months ended March 31, 2004 from 24.6% in the same period one year ago. The improvement was primarily due to tighter cost controls and reduced discretionary spending. Depreciation and amortization ("D&A") expense increased by $1.5 million, or 28.0%, to $6.8 million for the three months ended March 31, 2004 from $5.3 million for the same period in the last fiscal year. Of the total 28.0% increase, 13.9% was attributed to impairment charges associated with abandoned leased facilities and other fixed assets, and the remaining 14.1% was primarily due to foreign currency fluctuations and an increased level of capital expenditures in the fourth quarter of fiscal year 2003. As a percentage of service revenue, D&A was 4.9% for the three months ended March 31, 2004 and 3.9% for the three months ended March 31, 2003. During the quarter ended March 31, 2004, the Company recorded restructuring charges totaling $10.8 million. These charges included $3.9 million of employee severance and related costs for eliminating approximately 157 managerial and staff positions worldwide, $5.6 million related to newly abandoned leased facilities, and $1.3 million related to changes in assumptions for previously abandoned leased facilities. There were no restructuring charges recorded during the three months ended March 31, 2003. Income from operations decreased by $10.0 million to a loss of $1.7 million for the three months ended March 31, 2004 from income of $8.3 million in the same period one year ago primarily due to the reasons noted in the preceding paragraphs. Total other expense increased by $0.7 million, to $1.4 million in the three months ended March 31, 2004 from $0.7 million in the same three-month period in the last fiscal year primarily due to higher foreign currency transaction exchange losses and a one-time charge associated with a vendor dispute. 15 The Company had an effective income tax rate of negative 20.2% for the three months ended March 31, 2004 and 38.9% for the three months ended March 31, 2003. The decline was primarily due to this quarter's restructuring charge as noted above and a re-assessment of tax reserves based on current tax exposure. NINE MONTHS ENDED MARCH 31, 2004 COMPARED WITH NINE MONTHS ENDED MARCH 31, 2003: Service revenue increased by $24.7 million, or 6.5%, to $406.1 million for the nine months ended March 31, 2004 from $381.4 million in the same period one year ago. On a geographic basis, service revenue for the nine months ended March 31, 2004 was distributed as follows: The Americas - $190.6 million (46.9%), Europe - $200.3 million (49.3%), and Asia/Pacific - $15.2 million (3.8%). For the nine months ended March 31, 2003, service revenue was distributed as follows: The Americas - $199.8 million (52.4%), Europe - $167.6 million (43.9%), and Asia/Pacific - $14.0 million (3.7%). On a segment basis, CRS service revenue increased by $6.4 million, or 2.8%, to $234.9 million for the nine months ended March 31, 2004 from $228.5 million in the same period in fiscal year 2003. Of the total 2.8% increase, approximately 7.1% was attributed to the positive impact of foreign currency fluctuations, partially offset by a 4.3% decrease in revenue caused by signing of fewer favorable changes-in-scope, and the lingering impact of a relatively low level of new business wins in calendar year 2003. PCG service revenue for the nine months ended March 31, 2004 increased by $4.0 million, or 5.2%, to $80.3 million for the nine months ended March 31, 2004 from $76.3 million in the same period one year ago. Of the total 5.2% increase, approximately 10.9% was attributed to the positive impact of foreign currency fluctuations, partly offset by a 5.7% decrease in revenue primarily due to a reduction in FDA enforcement activity and reduced levels of discretionary spending by biopharmaceutical companies, which impacted the regulatory and consulting segments of the PCG business as compared with the same nine-month period in the last fiscal year. MMS service revenue increased by $5.5 million, or 9.2%, to $65.0 million in the nine-month period ended March 31, 2004 from $59.5 million in the same period one year ago. Of the total 9.2% increase, 1.3% was attributed to incremental revenue from the Pracon and HealthIQ business, which was acquired by the Company in November 2002, and the remaining 7.9% was primarily due to a strong rebound in demand for the group's services as customers kicked off their new budget years during the third quarter of this fiscal year. Perceptive service revenue increased by $9.0 million, or 52.8%, to $25.9 million in the nine months ended March 31, 2004 as compared with $16.9 million in the same period one year ago. Of the total 52.8% increase, 31.7% was attributed to incremental revenue associated with the FW Pharma business, which was acquired by the Company in January 2003, approximately 4.9% was attributed to the positive impact of foreign currency fluctuations, and the remaining 16.2% primarily resulted from a continued increased demand for the group's medical diagnostic imaging services. Reimbursement revenue consists of reimbursable out-of-pocket expenses incurred on behalf of, and reimbursable by, clients. It does not yield any gross profit to the Company, nor does it have an impact on net income. Direct costs increased by $13.0 million, or 5.1%, to $266.3 million for the nine months ended March 31, 2004 from $253.3 million in the same period last fiscal year. On a segment basis, CRS direct costs decreased $1.7 million, or 1.1%, to $142.1 million for the nine months ended March 31, 2004 from $143.8 million in the same nine-month period in fiscal year 2003. Of the total 1.1% decrease, 10.1% resulted from tighter cost controls, continued improvements in quality and productivity, and reduced loss reserve requirements related to the Company's success in resolving aged receivable issues, partially offset by a 9.0% increase caused by foreign currency fluctuations. As a percentage of service revenue, CRS direct costs for the nine months ended March 31, 2004 improved by 2.4 points to 60.5% in the nine months ended March 31, 2004 from 62.9% in the same period in the last fiscal year primarily due to tighter cost controls and continued improvements in quality and productivity. PCG direct costs increased $2.4 million, or 4.2%, to $61.2 million in the nine months ended March 31, 2004 from $58.8 million in the same period one year ago. Of the total 4.2% increase, foreign currency fluctuations contributed approximately 10.8%, partially offset by a 6.6% decrease in direct costs from the same nine-month period in fiscal year 2003, as a result of tighter cost controls. As a percentage of service revenue, PCG direct costs for the nine months ended March 31, 2004 decreased by 0.7 points to 76.3% in the nine-month period ended March 31, 2004 from 77.0% in the same period one year ago. MMS direct costs increased $9.4 million, or 23.6%, to $49.2 million in the nine months ended March 31, 2004 from $39.8 million for the nine months ended March 31, 2003. Of the total 23.6% increase, approximately 4.1% was attributed to foreign currency fluctuations, with the remaining 19.5% primarily due to additional hiring in anticipation of increased business. As a percentage of service revenue, MMS direct costs increased by 8.8 points to 75.6% in the nine months ended March 31, 2004 from 66.8% in the same period one year ago primarily reflecting the increased costs described above, coupled with a less favorable revenue mix. Perceptive direct costs increased by $2.8 million, or 25.1%, to $13.7 million in the nine months ended March 31, 2004 from $11.0 million in the same period in the last fiscal year. Of the total 25.1% increase, approximately 4.1% was attributed to foreign currency fluctuations and 9.1% was attributed to incremental costs associated with the FW Pharma acquisition completed in January 2003, with the remaining 11.9% increase primarily due to increased labor costs associated with increased staffing needs to support business growth. As a percentage of service revenue, Perceptive's direct costs for the nine 16 months ended March 31, 2004 decreased by 11.8 points to 53.0% in the nine-month period ended March 31, 2004 from 64.8% in the same period one year ago primarily due to sharply higher revenue and continued productivity improvements. SG&A expenses increased by $5.9 million, or 6.6%, to $95.8 million for the nine months ended March 31, 2004 from $89.9 million in the same period in the last fiscal year primarily due to foreign currency fluctuations. As a percentage of service revenue, SG&A was flat at 23.6% in both of the nine-month periods ended March 31, 2004 and 2003. D&A expense increased by $3.6 million, or 24.0%, to $18.8 million for the nine months ended March 31, 2004 from $15.2 million for the same period in the last fiscal year. Of the total 24.0% increase, 4.9% was attributed to impairment charges associated with abandoned leased facilities and other fixed assets, and the remaining 19.1% was primarily due to foreign currency fluctuations and a higher level of depreciation expense as a result of an increase in capital spending during the second half of fiscal year 2003. As a percentage of service revenue, D&A was 4.6% for the nine months ended March 31, 2004 and 4.0% for the same period one year ago. During the nine months ended March 31, 2004, the Company recorded restructuring charges totaling $10.8 million. These charges were all recorded in the quarter ended March 31, 2004, and included $3.9 million of employee severance and related costs for eliminating approximately 157 managerial and staff positions worldwide, $5.6 million related to newly abandoned leased facilities, and $1.3 million related to changes in assumptions for previously abandoned leased facilities. During the nine months ended March 31, 2003, the Company recorded a facilities-related restructuring charge totaling $5.9 million, as a result of changes in prior assumptions regarding certain leased facilities which were previously abandoned as part of the Company's June 2001 restructuring charge. The changes in prior assumptions were caused by challenging real estate market conditions, which made it difficult to sub-lease the abandoned facilities, especially at previously estimated rental rates. Income from operations decreased by $2.6 million, or 15.6%, to $14.4 million for the nine months ended March 31, 2004 from $17.0 million in the same period one year ago primarily due to an increased level of restructuring charges and the other reasons noted in the preceding paragraphs. Income from operations decreased as a percentage of service revenue to 3.5% for the nine months ended March 31, 2004 from 4.5% for the same period in the last fiscal year. Total other income (expense) improved by $1.6 million to $(1.5) million in the nine months ended March 31, 2004 as compared with $(3.1) million in the same nine-month period ended March 31, 2003, primarily due to lower foreign currency transaction exchange losses. The Company had an effective income tax rate of 41.1% for the nine months ended March 31, 2004 and 40.3% for the nine months ended March 31, 2003. Tax rates are a function of profitability in the various taxing jurisdictions in which the Company does business. A valuation allowance that had been previously established for certain future foreign income tax benefits related to income tax loss carryforwards and temporary tax adjustments was released during the second quarter of this fiscal year based on an assessment that it is more likely than not that these benefits will be realized. LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company has financed its operations and growth, including acquisitions, with cash flow from operations and proceeds from the sale of equity securities. Investing activities primarily reflect acquisition costs and capital expenditures for information systems enhancements and leasehold improvements. Approximately 90% of the Company's contracts are fixed price, with some variable components, and range in duration from a few months to several years. Cash flow from these contracts typically consists of a down payment required to be paid at the time of contract execution with the balance due in installments over the contract's duration, usually on a milestone achievement basis. Revenue from these contracts is generally recognized as work is performed. As a result, cash receipts do not necessarily correspond to costs incurred and revenue recognized on contracts. 17 DAYS SALES OUTSTANDING The Company's operating cash flow is heavily influenced by changes in the levels of billed and unbilled receivables and deferred revenue. These account balances as well as days sales outstanding ("DSO") in accounts receivable, net of deferred revenue, can vary based on contractual milestones and the timing and size of cash receipts. DSO in accounts receivable, net of deferred revenue, was 37 days at March 31, 2004 compared with 45 days at June 30, 2003. The decrease in DSO at March 31, 2004 as compared with June 30, 2003 primarily resulted from continued improvement in billing practices and increased collection activities, including resolution and collection of aged accounts receivable. Accounts receivable, net of the allowance for doubtful accounts was $222.8 million ($124.5 million in billed accounts receivable and $98.3 million in unbilled accounts receivable) at March 31, 2004 and $222.7 million ($144.0 million in billed accounts receivable and $78.7 million in unbilled accounts receivable) at June 30, 2003. Deferred revenue was $147.6 million at March 31, 2004 and $130.7 million at June 30, 2003. DSO is calculated by adding the end-of-period balances for billed and unbilled account receivables, net of deferred revenue and the allowance for doubtful accounts, then dividing the resulting amount by the sum of total revenue plus investigator fees billed for the most recent quarter, and multiplying the resulting fraction by the number of days in the quarter. CASH FLOWS Net cash provided by operating activities for the nine months ended March 31, 2004 totaled $28.3 million and was generated from $18.8 million related to non-cash charges for depreciation and amortization expense, a $17.1 million decrease in accounts receivable (net of the allowance for doubtful accounts and deferred revenue), $7.3 million of net income, and $1.2 million from other sources, partially offset by a $7.7 million decrease in accounts payable, a $4.3 million increase in other assets, and a $4.1 million decrease in liabilities. For the nine months ended March 31, 2003, net cash provided by operating activities was $36.5 million and was generated from a $20.5 million decrease in accounts receivable (net of the allowance for doubtful accounts and deferred revenue), $15.2 million related to non-cash charges for depreciation and amortization expense, and $7.8 million of net income, offset by a $3.7 million decrease in accounts payable and a $3.3 million increase in other assets. Net cash used in investing activities for the nine months ended March 31, 2004 totaled $49.8 million and consisted of $18.8 million used in the purchase of marketable securities, $17.6 million used for capital expenditures (primarily computer hardware and software), and $13.4 million used for the acquisition of 3C and for the purchase of additional capital stock of FARMOVS, a majority owned subsidiary of the Company. Net cash used in investing activities for the nine months ended March 31, 2003 totaled $8.1 million and consisted of $22.3 million used for capital expenditures (primarily computer software/hardware and leasehold improvements and $11.2 million used for the acquisitions of Pracon & HealthIQ and FW Pharma, offset by $25.0 million of net proceeds from the sale of marketable securities and $0.4 million in proceeds from the sale of fixed assets. Net cash provided by financing activities for the nine months ended March 31, 2004 totaled $0.7 million, and was generated from $5.3 million in proceeds related to the issuance of common stock in conjunction with the Company's stock option and employee stock purchase plans, offset by $4.4 million used to repurchase the Company's common stock pursuant to its stock repurchase program, and $0.2 million of other items. For the nine months ended March 31, 2003, net cash provided by financing activities totaled $1.8 million, and was primarily generated from proceeds related to the issuance of common stock associated with the Company's stock option and employee stock purchase plans. LINES OF CREDIT The Company has a line of credit with ABN AMRO Bank, NV in the amount of Euro 12.0 million. This line of credit is not collateralized, is payable on demand, and bears interest at a rate ranging between 3% and 5%. The Company entered into this line of credit primarily to facilitate business transactions with the bank. At March 31, 2004 the Company had approximately Euro 12.0 million available under this line of credit. The Company has other foreign lines of credit with banks totaling approximately $1.7 million. These lines are used as overdraft protection and bear interest at rates ranging from 4% to 6%. The lines of credit are payable on demand and are supported by PAREXEL International Corporation. At March 31, 2004, the Company had approximately $1.7 million available credit under these arrangements. The Company has a cash pooling arrangement with ABN AMRO Bank. Pooling occurs when debit balances are offset against credit balances and the net position is used as a basis by the bank for interest calculations. Each legal entity owned by the Company and party to this arrangement remains the owner of either a credit or debit balance. 18 Therefore, interest income is earned in legal entities with credit balances, while interest expense is charged in legal entities with debit balances. Based on the pool's overall balance, the bank than recalculates the overall interest to be charged or earned, compares this amount with the sum of interest amounts already charged/earned per account and pays/charges the difference to the entities. Interest income and interest expense are included in "other income (loss), net" of the Company's condensed consolidated statements of operations. FINANCING NEEDS The Company's primary cash needs are for the payment of salaries and fringe benefits, hiring and recruiting expenses, business development costs, acquisition-related costs, capital expenditures, and facility-related expenses. The Company's principal source of cash is from contracts with clients. If the Company were unable to generate new contracts with existing and new clients or the level of contract cancellations increased, the Company's revenue and cash flow would be adversely affected (see "Risk Factors" for further detail). Absent a material adverse change in the level of the Company's new business bookings or contract cancellations, PAREXEL believes that its existing capital resources together with cash flow from operations and borrowing capacity under existing lines of credit will be sufficient to meet its foreseeable cash needs over both the next twelve months and the next five years. In the future, the Company expects to consider acquiring businesses to enhance its service offerings, expand its therapeutic expertise, and/or increase its global presence. Any such acquisitions may require additional external financing, and the Company may from time to time seek to obtain funds from public or private issuances of equity or debt securities. The Company may be unable to secure such financing on terms acceptable to the Company. GUARANTEES The Company has letter-of-credit agreements with banks totaling approximately $1.0 million guaranteeing performance under various operating leases and vendor agreements. OFF-BALANCE SHEET ARRANGEMENTS The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to the Company. RELATED PARTY TRANSACTIONS During the third quarter of fiscal year 2004, the Company disposed of a small business by closing an asset sale arrangement with a former employee. In association with the transaction, the buyer issued a four-year promissory note to the Company. Payments on the promissory note are due on a quarterly basis, commencing on June 30, 2004. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK MARKET RISK Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency rates, interest rates, and other relevant market rate or price changes. In the ordinary course of business, the Company is exposed to market risk resulting from changes in foreign currency exchange rates, and the Company regularly evaluates its exposure to such changes. The Company's overall risk management strategy seeks to balance the magnitude of the exposure and the costs and availability of appropriate financial instruments. FOREIGN CURRENCY EXCHANGE RATES The Company may be subjected to foreign currency transaction risk when the Company's foreign subsidiaries enter into contracts or incur liabilities denominated in a currency other than the foreign subsidiary's functional currency. For the nine months ended March 31, 2004, approximately 18.3% of total service revenue was denominated in British pounds and approximately 28.2% of total service revenue was denominated in Euros. The Company enters into foreign currency exchange contracts to offset the impact of currency fluctuations. Such contracts are not treated as hedges for accounting purposes. The notional contract amount of outstanding currency exchange contracts was approximately $11.2 million as of March 31, 2004. The potential loss in the fair value of these currency exchange contracts that would result from a hypothetical change of 10% in exchange rates would be approximately $1.2 million. 19 INFLATION The Company believes the effects of inflation generally do not have a material adverse impact on its operations or financial condition. RISK FACTORS In addition to other information in this report, the following risk factors should be considered carefully in evaluating the Company and its business, including forward-looking statements made in the section of this report entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other forward-looking statements that the Company may make from time to time. If any of the following risks actually occur, the Company's business, financial condition, or results of operations would likely suffer. LOSS, MODIFICATION, OR DELAY OF LARGE OR MULTIPLE CONTRACTS MAY NEGATIVELY IMPACT THE COMPANY'S FINANCIAL PERFORMANCE The Company's clients generally can terminate their contracts with the Company upon thirty to sixty days notice or can delay execution of services. The loss or delay of a large contract or the loss or delay of multiple contracts could adversely affect its operating results, possibly materially. The Company has in the past experienced contract cancellations, which have adversely affected its operating results. In both the fiscal years 2003 and 2002, AstraZeneca accounted for 11% of the Company's consolidated service revenue. If the Company's largest client terminated all of its contracts with the Company, it would adversely affect the Company's operating results, possibly materially. Clients terminate or delay their contracts for a variety of reasons, including, but not limited to: - merger or potential merger related activities; - failure of products being tested to satisfy safety requirements; - failure of products being tested to prove effective; - products having unexpected or undesired clinical results; - client decisions to forego a particular study, perhaps for economic reasons; - insufficient patient enrollment in a study; - insufficient investigator recruitment; - production problems which cause shortages of the product; - product withdrawal following market launch; and - manufacturing facility shut down. In addition, the Company believes that companies regulated by the FDA may proceed with fewer clinical trials or conduct them without the assistance of biopharmaceutical services companies if they are trying to reduce costs as a result of budgetary limits or changing priorities. These factors may cause such companies to cancel contracts with biopharmaceutical services companies. THE COMPANY FACES INTENSE COMPETITION IN MANY AREAS OF ITS BUSINESS; IF THE COMPANY DOES NOT COMPETE EFFECTIVELY, ITS BUSINESS WILL BE HARMED The biopharmaceutical services industry is highly competitive, and the Company faces numerous competitors in many areas of its business. If the Company fails to compete effectively, the Company may lose clients, which would cause its business to suffer. The Company primarily competes against in-house departments of pharmaceutical companies, other full service biopharmaceutical services companies, Contract Research Organizations ("CROs"), small specialty CROs, and to a lesser extent, universities, teaching hospitals, and other site organizations. Some of the larger CROs against which the Company competes include Quintiles Transnational Corporation, Covance, Inc. and Pharmaceutical Product Development Inc. In addition, the Company's PCG and MMS businesses also compete with a large and fragmented group of specialty service providers, including advertising/promotional companies, major consulting firms with pharmaceutical industry groups and smaller companies with pharmaceutical industry focus. Perceptive, a majority owned subsidiary of the Company, competes primarily with biopharmaceutical services companies, information technology companies and other software companies. Some of these competitors, including the in-house departments of pharmaceutical companies, have greater capital, technical and other resources than the Company. In addition, those of the Company's competitors that are smaller specialized companies may compete effectively against the Company because of their concentrated size and focus. 20 THE FIXED PRICE NATURE OF THE COMPANY'S CONTRACTS COULD HURT ITS OPERATING RESULTS Approximately 90% of the Company's contracts are at fixed prices. As a result, the Company bears the risk of cost overruns. If the Company fails to adequately price its contracts or if the Company experiences significant cost overruns, its gross margins on the contract would be reduced and the Company could lose money on contracts. In the past, the Company has had to commit unanticipated resources to complete projects, resulting in lower gross margins on those projects. The Company might experience similar situations in the future. IF GOVERNMENTAL REGULATION OF THE DRUG, MEDICAL DEVICE AND BIOTECHNOLOGY INDUSTRY WERE STREAMLINED OR RELAXED, THE NEED FOR THE COMPANY'S SERVICES COULD DECREASE Governmental regulation of the drug, medical device and biotechnology product development process is complicated, extensive, and demanding. A large part of the Company's business involves assisting pharmaceutical and biotechnology companies through the regulatory approval process. Changes in regulations, that, for example, streamline procedures or relax approval standards, could eliminate or reduce the need for the Company's services. If companies needed fewer of PAREXEL's services, the Company would have fewer business opportunities and its revenues would decrease, possibly materially. In the U.S., the FDA and the Congress have attempted to streamline the regulatory process by providing for industry user fees that fund additional reviewer hires and better management of the regulatory review process. In Europe, governmental authorities have moved towards common standards for clinical testing of new drugs throughout the European Union by adopting standards for Good Clinical Practice ("GCP") and by making the clinical trial application and approval process more uniform across member states starting in May 2004. In the past several years, Japan also has adopted GCP. The FDA has had GCP in place as a regulatory standard and requirement for new drug approval for many years. The U.S., Europe and Japan have also collaborated in the 11-year-long International Conference on Harmonization ("ICH"), the purpose of which is to eliminate duplicative or conflicting regulations in the three regions. The ICH partners have agreed upon a common format for marketing applications that eliminates the need to tailor the format to each region. Such efforts and similar efforts in the future that streamline the regulatory process may reduce the demand for the Company's services. For example, parts of PAREXEL's PCG business advise clients on how to satisfy regulatory standards for manufacturing processes and on other matters related to the enforcement of government regulations by the FDA and other regulatory bodies. Any reduction in levels of review of manufacturing processes or levels of regulatory enforcement, generally, would result in fewer business opportunities for the PCG business in this area. IF THE COMPANY FAILS TO COMPLY WITH EXISTING REGULATIONS, ITS REPUTATION AND OPERATING RESULTS WOULD BE HARMED The Company's business is subject to numerous governmental regulations, primarily relating to pharmaceutical product development and the conduct of clinical trials. If the Company fails to comply with these governmental regulations, it could result in the termination of the Company's ongoing research, development or sales and marketing projects, or the disqualification of data for submission to regulatory authorities. The Company also could be barred from providing clinical trial services in the future or be subjected to fines. Any of these consequences would harm the Company's reputation, its prospects for future work and its operating results. In addition, the Company may have to repeat research or redo trials. The Company may be contractually required to take such action at no further cost to the customer, but at substantial cost to the Company. THE COMPANY MAY LOSE BUSINESS OPPORTUNITIES AS A RESULT OF HEALTH CARE REFORM AND THE EXPANSION OF MANAGED CARE ORGANIZATIONS Numerous governments, including the U.S. government and governments outside of the U.S., have undertaken efforts to control growing health care costs through legislation, regulation and voluntary agreements with medical care providers and drug companies. If these efforts are successful, pharmaceutical, medical device and biotechnology companies may react by spending less on research and development. If this were to occur, the Company would have fewer business opportunities and its revenues could decrease, possibly materially. For instance, in the past, the U.S. Congress has entertained several comprehensive health care reform proposals. The proposals were generally intended to expand health care coverage for the uninsured and reduce the growth of total health care expenditures. While the U.S. Congress has not yet adopted any comprehensive reform proposals, members of Congress may raise similar proposals in the future. The Company is unable to predict the likelihood that health care reform proposals will be enacted into law. 21 In addition to health care reform proposals, the expansion of managed care organizations in the healthcare market may result in reduced spending on research and development. Managed care organizations' efforts to cut costs by limiting expenditures on pharmaceuticals and medical devices could result in pharmaceutical, biotechnology and medical device companies spending less on research and development. If this were to occur, the Company would have fewer business opportunities and its revenues could decrease, possibly materially. NEW AND PROPOSED LAWS AND REGULATIONS REGARDING CONFIDENTIALITY OF PATIENT INFORMATION COULD RESULT IN INCREASED RISKS OF LIABILITY OR INCREASED COSTS TO THE COMPANY, OR COULD LIMIT THE COMPANY'S SERVICE OFFERINGS The confidentiality and release of patient-specific information are subject to government regulation. Under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, the U.S. Department of Health and Human Services has issued regulations mandating heightened privacy and confidentiality protections. The federal government and state governments have proposed or adopted additional legislation governing the possession, use and dissemination of medical record information and other personal health information. Proposals being considered by state governments may contain privacy and security provisions that are more burdensome than the federal regulations. In order to comply with these regulations, the Company may need to implement new security measures, which may require the Company to make substantial expenditures or cause the Company to limit the products and services it offers. In addition, if the Company violates applicable laws, regulations or duties relating to the use, privacy or security of health information, it could be subject to civil or criminal liability. IF THE COMPANY DOES NOT KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES, ITS PRODUCTS AND SERVICES MAY BECOME LESS COMPETITIVE OR OBSOLETE, ESPECIALLY IN THE COMPANY'S PERCEPTIVE INFORMATICS BUSINESS The biotechnology, pharmaceutical and medical device industries generally, and clinical research specifically, are subject to increasingly rapid technological changes. The Company's competitors or others might develop technologies, products or services that are more effective or commercially attractive than the Company's current or future technologies, products or services, or render its technologies, products or services less competitive or obsolete. If competitors introduce superior technologies, products or services and the Company cannot make enhancements to its technologies, products and services necessary to remain competitive, its competitive position will be harmed. If the Company is unable to compete successfully, it may lose customers or be unable to attract new customers, which could lead to a decrease in revenue. BECAUSE THE COMPANY DEPENDS ON A SMALL NUMBER OF INDUSTRIES AND CLIENTS FOR ALL OF ITS BUSINESS, THE LOSS OF BUSINESS FROM A SIGNIFICANT CLIENT COULD HARM ITS BUSINESS, REVENUE, AND FINANCIAL CONDITION The loss of, or a material reduction in the business of, a significant client could cause a substantial decrease in the Company's revenue and adversely affect its business and financial condition, possibly materially. In the fiscal year ended June 30, 2003, the Company's five largest clients accounted for 33% of its consolidated service revenue, and one client, AstraZeneca, accounted for 11% of consolidated service revenue. In the fiscal year ended June 30, 2002, the Company's five largest clients accounted for 34% of its consolidated service revenue, and one client, AstraZeneca, accounted for 11% of its consolidated service revenue. The Company expects that a small number of clients will continue to represent a significant part of its revenue. The Company's contracts with these clients generally can be terminated on short notice. The Company has in the past experienced contract cancellations with significant clients. IF THE COMPANY'S PERCEPTIVE INFORMATICS BUSINESS IS UNABLE TO MAINTAIN CONTINUOUS, EFFECTIVE, RELIABLE AND SECURE OPERATION OF ITS COMPUTER HARDWARE, SOFTWARE AND INTERNET APPLICATIONS AND RELATED TOOLS AND FUNCTIONS, ITS BUSINESS WILL BE HARMED The Company's Perceptive Informatics business involves collecting, managing, manipulating and analyzing large amounts of data, and communicating data via the Internet. Perceptive depends on the continuous, effective, reliable and secure operation of its computer hardware, software, networks, telecommunication networks, Internet servers and related infrastructure. If Perceptive's hardware or software malfunctions or access to Perceptive's data by internal research personnel or customers through the Internet is interrupted, its business could suffer. In addition, any sustained disruption in Internet access provided by third parties could adversely impact Perceptive's business. 22 Although Perceptive's computer and communications hardware is protected through physical and software safeguards, it is still vulnerable to fire, storm, flood, power loss, earthquakes, telecommunications failures, physical or software break-ins, and similar events. In addition, Perceptive's software products are complex and sophisticated, and could contain data, design or software errors that could be difficult to detect and correct. If Perceptive fails to maintain and further develop the necessary computer capacity and data to support its customers' needs, it could result in loss of or delay in revenue and market acceptance. IF THE COMPANY IS UNABLE TO ATTRACT SUITABLE WILLING VOLUNTEERS FOR THE CLINICAL TRIALS OF ITS CLIENTS, ITS CLINICAL RESEARCH SERVICES BUSINESS MAY SUFFER One of the factors on which the Company's CRS business competes is the ability to recruit patients for the clinical studies the Company is managing. These clinical trials rely upon the ready accessibility and willing participation of volunteer subjects. These subjects generally include volunteers from the communities in which the studies are conducted. Although to date these communities have provided a substantial pool of potential subjects for research studies, there may not be enough patients available with the traits necessary to conduct the studies. For example, if the Company manages a study for a treatment of a particular type of cancer, its ability to conduct the study may be limited by the number of patients that it can recruit that have that form of cancer. If multiple organizations are conducting similar studies and competing for patients, it could also make the Company's recruitment efforts more difficult. If the Company is unable to attract suitable and willing volunteers on a consistent basis, it would have an adverse effect on the trials being managed by its CRS business, which could have a material adverse effect on its CRS business. IF THE COMPANY'S HIGHLY QUALIFIED MANAGEMENT AND TECHNICAL PERSONNEL LEFT, ITS BUSINESS WOULD BE HARMED The Company relies on the expertise of its Chairman and Chief Executive Officer, Josef H. von Rickenbach. If Mr. von Rickenbach left, it would be difficult and expensive to find a qualified replacement with the level of specialized knowledge of the Company's products and services and the biopharmaceutical services industry. The Company is a party to an employment agreement with Mr. von Rickenbach, which may be terminated by the Company or Mr. von Rickenbach upon notice to the other party. In addition, in order to compete effectively, the Company must attract and maintain qualified sales, professional, scientific and technical operating personnel. Competition for these skilled personnel, particularly those with a medical degree, a Ph.D. or equivalent degrees, is intense. The Company may not be successful in attracting or retaining key personnel. THE COMPANY MAY HAVE SUBSTANTIAL EXPOSURE TO PAYMENT OF PERSONAL INJURY CLAIMS AND MAY NOT HAVE ADEQUATE INSURANCE TO COVER SUCH CLAIMS The Company's Clinical Research Services business primarily involves the testing of experimental drugs or other regulated FDA products on consenting human volunteers pursuant to a study protocol. These services involve a risk of liability for personal injury or death to patients who participate in the study or who use a product approved by regulatory authorities after the clinical research has concluded, due to, among other reasons, possible unforeseen adverse side effects or improper administration of the new product by physicians. In some cases, these patients are already seriously ill and are at risk of further illness or death. In order to mitigate the risk of liability, the Company seeks to include indemnity provisions in its Clinical Research Services contracts with clients. However, the Company is not able to include indemnity provisions in all of its contracts. The indemnity provisions the Company includes in these contracts would not cover its exposure if: - the Company had to pay damages or incur defense costs in connection with a claim that is outside the scope of an indemnity; or - a client failed to indemnify the Company in accordance with the terms of an indemnity agreement because it did not have the financial ability to fulfill its indemnification obligation or for any other reason. The Company also carries product liability insurance to cover its risk of liability. However, the Company's insurance is subject to deductibles and coverage limits and may not be adequate to cover product liability claims. In addition, product liability coverage is expensive. In the future, the Company may not be able to maintain or obtain product liability insurance on reasonable terms, at a reasonable cost or in sufficient amounts to protect it against losses due to product liability claims. 23 THE COMPANY'S BUSINESS IS SUBJECT TO INTERNATIONAL ECONOMIC, POLITICAL AND OTHER RISKS THAT COULD NEGATIVELY AFFECT ITS RESULTS OF OPERATIONS OR FINANCIAL POSITION The Company provides most of its services worldwide. The Company's service revenue from non-U.S. operations represented approximately 53.7% of total service revenue for the nine months ended March 31, 2004 and approximately 48.2% of total service revenue for the nine-month period a year ago. In addition, the Company's service revenue from operations in the United Kingdom represented approximately 18.3% of total service revenue for the nine months ended March 31, 2004 and approximately 18.4% of total service revenue for the nine months ended March 31, 2003. The Company anticipates that service revenue from international operations may grow in the future. Accordingly, the Company's business is subject to risks associated with doing business internationally, including: - changes in a specific country's or region's political or economic conditions, including Western Europe, in particular; - potential negative consequences from changes in tax laws affecting its ability to repatriate profits; - difficulty in staffing and managing widespread operations; - unfavorable labor regulations applicable to its European operations; - changes in foreign currency exchange rates; and - longer payment cycles of foreign customers and difficulty of collecting receivables in foreign jurisdictions. THE COMPANY'S OPERATING RESULTS HAVE FLUCTUATED BETWEEN QUARTERS AND YEARS AND MAY CONTINUE TO FLUCTUATE IN THE FUTURE, WHICH COULD AFFECT THE PRICE OF ITS COMMON STOCK The Company's quarterly and annual operating results have varied and will continue to vary in the future as a result of a variety of factors. For example, the Company's income (loss) from operations was $3.6 million for the quarter ended June 30, 2003, $7.8 million for the quarter ended September 30, 2003, $8.2 million for the quarter ended December 31, 2003 and $(1.7) million for the quarter ended March 31, 2004. Factors that cause these variations include: - the timing of the initiation, progress, or cancellation of significant project; - exchange rate fluctuations between quarters or years; - restructuring charges; - the mix of services offered in a particular quarter or year; - the timing of the opening of new offices; - costs and the related financial impact of acquisitions; - the level of new business authorizations in a particular quarter or year; - the timing of internal expansion; - the timing and amount of costs associated with integrating acquisitions; and - the timing and amount of startup costs incurred in connection with the introduction of new products, services or subsidiaries. Many of these factors, such as the timing of cancellations of significant projects and exchange rate fluctuations between quarters or years, are beyond the Company's control. Approximately 80-85% of the Company's operating costs are fixed in the short term. In particular, a significant portion of the Company's operating costs relate to personnel, which are estimated to have accounted for 80-85% of the Company's total operating costs in the nine months ended March 31, 2004. As a result, the effect on the Company's revenues of the timing of the completion, delay or loss of contracts, or the progress of client projects, could cause its operating results to vary substantially between reporting periods. If the Company's operating results do not match the expectations of securities analysts and investors as a result of these factors, the trading price of its common stock will likely decrease. 24 THE COMPANY'S REVENUE AND EARNINGS ARE EXPOSED TO EXCHANGE RATE FLUCTUATIONS Approximately 53.7% of the Company's service revenue for the nine months ended March 31, 2004 and 48.2% of the Company's service revenue for the nine months ended March 31, 2003 were from non-U.S. operations. The Company's financial statements are denominated in U.S. dollars; thus, factors associated with international operations, including changes in foreign currency exchange rates, could have a significant effect on its operating results. Exchange rate fluctuations between local currencies and the U.S. dollar create risk in several ways, including: - Foreign Currency Translation Risk. The revenue and expenses of the Company's foreign operations are generally denominated in local currencies, primarily the British pound and the Euro, and then are translated into U.S. dollars for financial reporting purposes. For the nine months ended March 31, 2004, approximately 18.3% of total service revenue was denominated in British pounds and approximately 28.2% of total service revenue was denominated in Euros. For the nine months ended March 31, 2003, approximately 18.4% of total service revenue was denominated in British pounds and approximately 23.7% of total service revenue was denominated in Euros. - Foreign Currency Transaction Risk. The Company's service contracts may be denominated in a currency other than the functional currency in which it performs the service related to such contracts. Although the Company tries to limit these risks through exchange rate fluctuation provisions stated in its service contracts, or by hedging transaction risk with foreign currency exchange contracts, it may still experience fluctuations in financial results from its operations outside of the U.S., and may not be able to favorably reduce the currency transaction risk associated with its service contracts. THE COMPANY'S BUSINESS HAS EXPERIENCED SUBSTANTIAL EXPANSION IN THE PAST AND SUCH EXPANSION AND ANY FUTURE EXPANSION COULD STRAIN ITS RESOURCES IF NOT PROPERLY MANAGED The Company has expanded its business substantially in the past. Future rapid expansion could strain the Company's operational, human and financial resources. In order to manage expansion, the Company must: - continue to improve operating, administrative and information systems; - accurately predict future personnel and resource needs to meet client contract commitments; - track the progress of ongoing client projects; and - attract and retain qualified management, sales, professional, scientific and technical operating personnel. If the Company does not take these actions and is not able to manage the expanded business, the expanded business may be less successful than anticipated, and the Company may be required to allocate additional resources to the expanded business, which it would have otherwise allocated to another part of its business. The Company may face additional risks in expanding its foreign operations. Specifically, the Company may find it difficult to: - assimilate differences in foreign business practices, exchange rates and regulatory requirements; - operate amid political and economic instability; - hire and retain qualified personnel; and - overcome language, tariff and other barriers. THE COMPANY MAY MAKE ACQUISITIONS IN THE FUTURE, WHICH MAY LEAD TO DISRUPTIONS TO ITS ONGOING BUSINESS The Company has made a number of acquisitions and will continue to review new acquisition opportunities. If the Company is unable to successfully integrate an acquired company, the acquisition could lead to disruptions to the business. The success of an acquisition will depend upon, among other things, the Company's ability to: - assimilate the operations and services or products of the acquired company; - integrate acquired personnel; - retain and motivate key employees; - retain customers; and - minimize the diversion of management's attention from other business concerns. 25 Acquisitions of foreign companies may also involve additional risks, including assimilating differences in foreign business practices and overcoming language and cultural barriers. In the event that the operations of an acquired business do not meet the Company's performance expectations, the Company may have to restructure the acquired business or write-off the value of some or all of the assets of the acquired business. THE COMPANY'S CORPORATE GOVERNANCE STRUCTURE, INCLUDING PROVISIONS OF ITS ARTICLES OF ORGANIZATION AND BY-LAWS AND ITS SHAREHOLDER RIGHTS PLAN, AND MASSACHUSETTS LAW MAY DELAY OR PREVENT A CHANGE IN CONTROL OR MANAGEMENT THAT STOCKHOLDERS MAY CONSIDER DESIRABLE Provisions of the Company's articles of organization, by-laws and its shareholder rights plan, as well as provisions of Massachusetts law, may enable the Company's management to resist acquisition of the Company by a third party, or may discourage a third party from acquiring the Company. These provisions include the following: - the Company has divided its Board of Directors into three classes that serve staggered three-year terms; - the Company is subject to Section 50A of the Massachusetts Business Corporation Law which provides that directors may only be removed by stockholders for cause, vacancies in the Company's Board of Directors may only be filled by a vote of the Company's Board of Directors and the number of directors may be fixed only by the Company's Board of Directors; - the Company is subject to Chapter 110F of the Massachusetts General Laws which limits its ability to engage in business combinations with certain interested stockholders; - the Company's stockholders are limited in their ability to call or introduce proposals at stockholder meetings; and - the Company's shareholder rights plan would cause a proposed acquirer of 20% or more of the Company's outstanding shares of common stock to suffer significant dilution. These provisions could have the effect of delaying, deferring, or preventing a change in control of the Company or a change in the Company's management that stockholders may consider favorable or beneficial. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions. These provisions could also limit the price that investors might be willing to pay in the future for shares of the Company's stock. In addition, the Company's Board of Directors may issue preferred stock in the future without stockholder approval. If the Company's Board of Directors issues preferred stock, the holders of common stock would be subordinate to the rights of the holders of preferred stock. The Company's Board of Directors' ability to issue the preferred stock could make it more difficult for a third party to acquire, or discourage a third party from acquiring, a majority of the Company's stock. THE COMPANY'S STOCK PRICE HAS BEEN AND MAY IN THE FUTURE BE VOLATILE, WHICH COULD LEAD TO LOSSES BY INVESTORS The market price of the Company's common stock has fluctuated widely in the past and may continue to do so in the future. On April 30, 2004, the closing sale price of the Company's common stock on the NASDAQ National Market was $19.54 per share. During the period from January 1, 2002 to March 31, 2004, the closing sale price of the Company's common stock ranged from a high of $18.49 per share to a low of $8.05 per share. Investors in the Company's common stock must be willing to bear the risk of such fluctuations in stock price and the risk that the value of an investment in the Company's stock could decline. The Company's stock price can be affected by quarter-to-quarter variations in: - operating results; - earnings estimates by analysts; - market conditions in the industry; - prospects of health care reform; - changes in government regulations; and - general economic conditions. 26 In addition, the stock market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may adversely affect the market price of the Company's common stock. Since the Company's common stock has traded in the past at a relatively high price-earnings multiple, due in part to analysts' expectations of earnings growth, the price of the stock could quickly and substantially decline as a result of even a relatively small shortfall in earnings from, or a change in, analysts' expectations. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company's management, with the participation of the Company's chief executive officer and chief financial officer, evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the Company's chief executive officer and chief financial officer concluded that, as of March 31, 2004, the Company's disclosure controls and procedures were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company's chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. No change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the nine months ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. CHANGES IN INTERNAL CONTROLS There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation. PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES (e) THE FOLLOWING TABLE PROVIDES INFORMATION ABOUT PURCHASES OF EQUITY SECURITIES BY THE COMPANY AND ITS AFFILIATED PURCHASERS DURING THE QUARTER ENDED MARCH 31, 2004.
(c) Total Number of (d) Maximum Number (or Shares (or Units) Appropriate Dollar (a) Total Number Purchased as Part Value) of Shares (or of Shares (or (b) Average of Publicly Units) that May Yet Be Units) Purchased Price Paid per Announced Plans or Purchased Under the Period (1) Share (or Unit) Programs (2) Plans or Programs ------------------- ---------------- --------------- ------------------- ----------------------- 01/01/04 - 01/31/04 56,000 $ 17.17 56,000 $10.8 million 02/01/04 - 02/29/04 193,200 $ 17.19 193,200 $ 7.5 million 03/01/04 - 03/31/04 9,400 $ 17.32 9,400 $ 7.4 million ---------------- --------------- ------------------- Total 258,600 $ 17.19 258,600 ================ =============== ===================
(1) The Company purchased an aggregate of 258,600 shares of its common stock pursuant to the repurchase plan that was publicly announced on September 27, 1999 (the "Plan"). (2) The Company's Board of Directors approved the repurchase by the Company of shares of its common stock having a value of up to $20.0 million in the aggregate pursuant to the Plan. Unless terminated earlier by resolution of the Company's Board of Directors, the Plan will expire when all shares authorized for repurchase thereunder have been repurchased by the Company. 27 ITEM 5. OTHER INFORMATION The Board of Directors of the Company (the "Board") formed a Nominating and Corporate Governance Committee (the "Committee") in December 2002 and adopted a charter for the Committee in February 2004. The Charter provides that the Committee shall consist of two or more members of the Board, all of whom shall be independent unless otherwise permitted by the applicable rules of NASDAQ. The Committee has the authority and responsibility, among other things, to identify individuals qualified to serve as members of the Board and nominate persons for election as a director by the stockholders, and nominate persons for election by the directors to fill vacancies on the Board. In making such nominations, the Committee shall consider candidates proposed by stockholders of the Company. The Committee will apply the same criteria to, and follow substantially the same process in considering, candidates proposed by stockholders as it does with other candidates. The Committee may from time to time adopt such procedures regarding shareholder candidates for director as it deems appropriate. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) See the Exhibit Index on the page immediately preceding the exhibits for a list of exhibits filed as part of this quarterly report, which Exhibit Index is incorporated by this reference. (b) The Company furnished a Current Report on Form 8-K on January 22, 2004 under Item 12, which included the Company's press release dated January 22, 2004 containing financial results for the quarter ended December 31, 2003. 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PAREXEL International Corporation Date: May 13, 2004 By: /s/ Josef H. von Rickenbach -------------------------------------- Josef H. von Rickenbach Chairman of the Board and Chief Executive Officer Date: May 13, 2004 By: /s/ James F. Winschel, Jr. -------------------------------------- James F. Winschel, Jr. Senior Vice President and Chief Financial Officer 29 EXHIBIT INDEX
Exhibit Number Description -------------- ------------------------------------------------ 31.1 CEO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 CFO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 CEO certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 CFO certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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