10-Q 1 b53454pie10vq.txt PAREXEL INTERNATIONAL CORPORATION 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 DECEMBER 31, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to ___________ Commission File Number: 000-21244 PAREXEL INTERNATIONAL CORPORATION (Exact name of registrant as specified in its Charter) MASSACHUSETTS 04-2776269 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) 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 February 4, 2005, there were 26,226,663 shares of common stock outstanding. PAREXEL INTERNATIONAL CORPORATION INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1 Financial Statements (Unaudited): Condensed Consolidated Balance Sheets - December 31, 2004 and June 30, 2004 3 Condensed Consolidated Statements of Operations - Three Months Ended December 31, 2004 and 2003, Six Months Ended December 31, 2004 and 2003 4 Condensed Consolidated Statements of Cash Flows - Six Months Ended December 31, 2004 and 2003 5 Notes to Condensed Consolidated Financial Statements 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3 Quantitative and Qualitative Disclosure About Market Risk 26 Item 4 Controls and Procedures 26 PART II. OTHER INFORMATION Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 27 Item 4 Submission of Matters to a Vote of Security Holders 27 Item 6 Exhibits 27 SIGNATURES 28
2 PART I. FINANCIAL INFORMATION PAREXEL INTERNATIONAL CORPORATION ITEM 1. FINANCIAL STATEMENTS CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
DECEMBER 31, 2004 JUNE 30, (UNAUDITED) 2004 ------------ --------- ASSETS Current assets: Cash and cash equivalents $ 66,792 $ 60,686 Marketable securities 41,873 34,921 Billed and unbilled accounts receivable, net 218,844 221,956 Prepaid expenses 10,373 11,681 Current deferred tax assets 29,865 29,710 Income tax receivable - 1,834 Other current assets 6,730 4,694 --------- --------- Total current assets 374,477 365,482 Property and equipment, net 74,102 68,983 Goodwill 46,824 41,002 Other intangible assets, net 11,017 10,636 Non-current deferred tax assets 10,204 10,160 Other assets 7,005 6,733 --------- --------- Total assets $ 523,629 $ 502,996 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and current portion of long-term debt $ 285 $ 768 Accounts payable 11,633 15,917 Deferred revenue 142,381 145,409 Accrued expenses 14,791 14,805 Accrued restructuring charges 3,961 5,481 Accrued employee benefits and withholdings 31,205 28,577 Current deferred tax liabilities 4,433 4,424 Income taxes payable 2,527 - Other current liabilities 4,868 4,693 --------- --------- Total current liabilities 216,084 220,074 Long-term debt, net of current portion 506 471 Non-current deferred tax liabilities 19,838 18,100 Long-term accrued restructuring charges 6,274 7,944 Other liabilities 5,230 5,886 --------- --------- Total liabilities 247,932 252,475 --------- --------- Minority interest in subsidiary 3,923 3,761 Stockholders' equity: Preferred stock--$.01 par value; shares authorized: 5,000,000; Series A junior participating preferred stock - 50,000 shares designated, none issued and outstanding Common stock--$.01 par value; shares authorized: 50,000,000; shares issued: 26,192,140 at December 31, 2004 and 26,522,178 at June 30, 2004; shares outstanding: 26,192,140 at December 31, 2004 and 26,077,078 at June 30, 2004 278 275 Additional paid-in capital 166,806 175,126 Treasury stock, shares at cost: 445,100 at June 30, 2004 - (8,056) Retained earnings 88,630 76,908 Accumulated other comprehensive income 16,060 2,507 --------- --------- Total stockholders' equity 271,774 246,760 --------- --------- Total liabilities and stockholders' equity $ 523,629 $ 502,996 ========= =========
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 SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------------------ 2004 2003 2004 2003 --------- ----------- --------- --------- Service revenue $ 137,913 $ 134,088 $ 269,424 $ 266,211 Reimbursement revenue 33,821 27,375 60,996 48,843 --------- --------- --------- --------- Total revenue 171,734 161,463 330,420 315,054 Costs and expenses: Direct costs 88,848 89,707 172,538 175,555 Reimbursable out-of-pocket expenses 33,821 27,375 60,996 48,843 Selling, general and administrative 32,619 30,144 64,460 62,612 Depreciation and amortization 6,781 6,013 13,191 12,000 --------- --------- --------- --------- Total costs 162,069 153,239 311,185 299,010 --------- --------- --------- --------- Income from operations 9,665 8,224 19,235 16,044 Other income (expense), net (365) (299) (801) (5) --------- --------- --------- --------- Income before provision for income taxes and minority interest 9,300 7,925 18,434 16,039 Provision for income taxes 3,199 2,811 6,734 5,935 Minority interest (benefit) expense 35 72 (22) 330 --------- --------- --------- --------- Net income $ 6,066 $ 5,042 $ 11,722 $ 9,774 ========= ========= ========= ========= Earnings per share: Basic $ 0.23 $ 0.19 $ 0.45 $ 0.38 Diluted $ 0.23 $ 0.19 $ 0.44 $ 0.37 Weighted average shares: Basic 26,059 26,027 26,034 25,802 Diluted 26,606 26,799 26,581 26,555
See notes to condensed consolidated financial statements. 4 PAREXEL INTERNATIONAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands)
FOR THE SIX MONTHS ENDED DECEMBER 31, ------------------------ 2004 2003 --------- --------- Cash flow from operating activities: Net income $ 11,722 $ 9,774 Adjustments to reconcile net income to net cash provided (used) by operating activities: Minority interest (benefit) expense in net income of consolidated subsidiary (22) 330 Depreciation and amortization 13,191 12,000 Changes in operating assets/liabilities (6,100) 4,112 -------- -------- Net cash provided by operating activities 18,791 26,216 -------- -------- Cash flow from investing activities: Purchases of marketable securities (22,936) (93,613) Proceeds from sale of marketable securities 15,984 85,467 Acquisition of business (1,460) - Purchase of additional investment in subsidiary - (1,004) Purchases of property and equipment (13,999) (10,900) Proceeds from sale of assets 293 96 -------- -------- Net cash used in investing activities (22,118) (19,954) -------- -------- Cash flow from financing activities: Proceeds from issuance of common stock 3,501 4,022 Proceeds from issuance of subsidiary common stock - 7 Payments to repurchase common stock (3,767) - Repayments under lines of credit and long-term debt (463) (117) -------- -------- Net cash (used) provided by financing activities (729) 3,912 -------- -------- Effect of exchange rate changes on cash and cash equivalents 10,162 3,642 -------- -------- Net increase in cash and cash equivalents 6,106 13,816 Cash and cash equivalents at beginning of period 60,686 69,734 -------- -------- Cash and cash equivalents at end of period $ 66,792 $ 83,550 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Net cash paid during the year for: Interest $ 2,038 $ 2,211 Income taxes $ 1,808 $ 2,300 Acquisitions, net of cash acquired: Fair value of assets acquired and goodwill $ 2,910 - Liabilities assumed (1,450) - -------- -------- Cash paid for acquisition $ 1,460 - ======== ========
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 six months ended December 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, 2004. Effective with the September 30, 2004 reporting period, certain components of the Company's strategic business units were reorganized to better align services offered to clients and to ensure a more integrated selling effort. Specifically, the Company's clinical operations were consolidated by moving Clinical Pharmacology (Phase I) and some small parts of the Regulatory business from the PAREXEL Consulting Group ("PCG") to Clinical Research Services ("CRS"), and Phase IV clinical operations from Medical Marketing Services ("MMS") to CRS. The remaining businesses of PCG and MMS were then combined to form the new PAREXEL Consulting and Marketing Services ("PCMS") business segment. These changes resulted in various reclassifications to the historical segment information presented in Note 6 to the condensed consolidated financial statements in this quarterly report, but had no impact on the Company's total revenue, expenses, operating income, net income, or balance sheet. 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 0.6 million and 0.9 million outstanding stock options were excluded from the calculation of diluted earnings per share for the three months ended December 31, 2004 and 2003, respectively, and approximately 0.6 million and 1.0 million outstanding stock options were excluded from the calculation of diluted earnings per share for the six months ended December 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 SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------------------ ($ IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003 ---------- ----------- ---------- --------- Net income attributable to common shares $ 6,066 $ 5,042 $11,722 $ 9,774 ======= ======= ======= ======= BASIC EARNINGS PER COMMON SHARE COMPUTATION: Weighted average common shares outstanding 26,059 26,027 26,034 25,802 ======= ======= ======= ======= Basic earnings per common share $ 0.23 $ 0.19 $ 0.45 $ 0.38 ======= ======= ======= ======= DILUTED EARNINGS PER COMMON SHARE COMPUTATION: Weighted average common shares outstanding: Shares attributable to common stock outstanding 26,059 26,027 26,034 25,802 Shares attributable to common stock options 547 772 547 753 ------- ------- ------- ------- 26,606 26,799 26,581 26,555 ======= ======= ======= ======= Diluted earnings per common share $ 0.23 $ 0.19 $ 0.44 $ 0.37 ======= ======= ======= =======
6 NOTE 3 - COMPREHENSIVE INCOME Comprehensive income 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 for the three months and six months ended December 31, 2004 and 2003 were as follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------------------ ($ IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003 -------- -------- ------- ------- Net income $ 6,066 $ 5,042 $11,722 $ 9,774 Add: foreign currency translation adjustments 11,688 4,550 12,906 6,566 unrealized gain/loss on investment 603 - 647 - ------- ------- ------- ------- Comprehensive income $18,357 $ 9,592 $25,275 $16,340 ======= ======= ======= =======
NOTE 4 - ACQUISITIONS Effective October 1, 2004, the Company acquired 100% of the outstanding stock of Integrated Marketing Concepts ("IMC"), a provider of specialty professional marketing and communication services in Whitehall, Pennsylvania for approximately $1.5 million in cash. Under the agreement, the Company agreed to make additional payments of $0.3 million and up to $2.9 million in contingent purchase price if IMC achieves certain established financial targets through September 30, 2007. Pro forma results of IMC have not been presented because the effect of this acquisition is not material to the Company's results. NOTE 5 - STOCK-BASED COMPENSATION The Company accounts for employee stock awards using the intrinsic value based method as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", as described by FASB Interpretation No. 44. Accordingly, no compensation expense was recognized because the exercise price of the Company's stock options was equal to the market price of the underlying stock on the date of grant. The Company has adopted the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for disclosure purposes only. If the compensation cost for the Company's stock options and the Company's employee stock purchase plan had been determined based on the fair value at the date of grant, as prescribed in SFAS No. 123, the Company's net income and net income per share would have been as follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------------------ ($ IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2004 2003 -------- --------- -------- --------- Net income as reported $ 6,066 $ 5,042 $ 11,722 $ 9,774 Deduct: effect of fair-valued based compensation, net of tax (996) (579) (1,975) (932) -------- -------- -------- -------- Pro forma net income $ 5,070 $ 4,463 $ 9,747 $ 8,842 ======== ======== ======== ======== Pro forma net income per share: Basic $ 0.19 $ 0.17 $ 0.37 $ 0.34 Diluted $ 0.19 $ 0.17 $ 0.37 $ 0.33
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. See Note 9 to the condensed consolidated financial statements included in this report for further detail regarding future Stock-Based Compensation accounting requirements. 7 NOTE 6 - SEGMENT INFORMATION Effective with the September 30, 2004 reporting period, certain components of the Company's strategic business units were reorganized to better align services offered to clients and to ensure a more integrated selling effort. See Note 1 to the condensed consolidated financial statements included in this report for further detail. The Company is managed through three business segments, namely, CRS, PCMS, and Perceptive Informatics, Inc. ("Perceptive"). CRS constitutes the Company's core business and includes clinical trials management and biostatistics, data management and clinical pharmacology, as well as related medical advisory and investigator site services. PCMS provides technical expertise in such disciplines as regulatory affairs, industry training, publishing, product development, management consulting, registration, commercialization issues, market development, targeted communications services in support of product launch, as well as health policy consulting and strategic reimbursement services. Perceptive provides information technology solutions designed to improve clients' product development processes. Perceptive offers a portfolio of products and services that includes medical imaging services, interactive voice response systems ("IVRS"), clinical trials management systems ("CTMS"), web-based portals, systems integration, and patient diary applications. 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, other income (expense), and income tax expense in segment profitability. 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. Furthermore, PAREXEL has a global infrastructure supporting its business segments, and therefore, assets are not identified by reportable segment.
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------------------ ($ IN THOUSANDS) 2004 2003 2004 2003 -------- -------- -------- -------- Service revenue: Clinical Research Services $ 94,885 94,756 $184,811 $188,686 PAREXEL Consulting and Marketing Services 32,311 30,557 64,667 60,607 Perceptive Informatics, Inc. 10,717 8,775 19,946 16,918 -------- -------- -------- -------- $137,913 $134,088 $269,424 $266,211 ======== ======== ======== ======== Gross profit on service revenue: Clinical Research Services $ 35,093 $ 33,654 $ 68,094 $ 69,644 PAREXEL Consulting and Marketing Services 9,387 6,652 20,273 13,237 Perceptive Informatics, Inc. 4,585 4,075 8,519 7,775 -------- -------- -------- -------- $ 49,065 $ 44,381 $ 96,886 $ 90,656 ======== ======== ======== ========
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 $1.3 million related to changes in assumptions for previously abandoned leased facilities under the Company's June 2001 restructuring plan. 8 Current activity charged against the restructuring accrual in the quarter ended December 31, 2004 (which is included in "Current Liabilities - Accrued Restructuring Charges" and "Long-term Accrued Restructuring Charges" in the Condensed Consolidated Balance Sheet) was as follows:
BALANCE AS OF 2ND QTR BALANCE AS OF SEPTEMBER 30, PAYMENTS/ DECEMBER 31, ($ IN THOUSANDS) 2004 ADJUSTMENTS 2004 ------------- ----------- ------------- Employee severance costs $ 1,080 $ (170) $ 910 Facilities-related charges 10,446 (1,121) 9,325 -------- -------- -------- $ 11,526 $ (1,291) $ 10,235 ======== ======== ========
NOTE 8 - STOCKHOLDERS' EQUITY As of July 1, 2004, all outstanding treasury stock was converted into authorized and unissued shares as mandated by a change in Massachusetts corporate law. On September 9, 2004, the Board of Directors approved a new stock repurchase program authorizing the purchase of up to an additional $20 million of the Company's common stock to be repurchased in the open market subject to market conditions. As of December 31, 2004, the Company had acquired 1,400 shares at a total cost of $25,000 under this program. During the period of January 1, 2005 to February 2, 2005, the Company acquired an additional 10,800 shares at a total cost of $250,000. NOTE 9 - RECENTLY ISSUED ACCOUNTING STANDARDS In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)"). SFAS 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Public entities (other than those filing as small business issuers) will be required to apply SFAS 123(R) as of the first interim or annual reporting period that begins after June 15, 2005. The Company is in the process of evaluating the impact SFAS 123(R) will have in reducing the Company's earnings. 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. Effective with the September 30, 2004 reporting period, certain components of the Company's strategic business units were reorganized to better align services offered to clients and to ensure a more integrated selling effort. See Note 1 to the condensed consolidated financial statements included in this report for further detail. 9 This quarterly report on Form 10-Q includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. For this purpose, any statements contained in this report regarding the Company's strategy, future operations, financial position, future revenue, projected costs, prospects, plans and objectives of management, other than statements of historical facts, are forward-looking statements. The words "anticipates", "believes", "estimates", "expects", "intends", "may", "plans", "projects", "will", "would", "targets", and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. The Company cannot guarantee that they actually will achieve the plans, intentions or expectations expressed or implied in its forward-looking statements. There are a number of important factors that could cause actual results, levels of activity, performance or events to differ materially from those expressed or implied in the forward-looking statements the Company makes. These important factors include the Company's "critical accounting estimates" and the risk factors set forth below. Although the Company may elect to update forward-looking statements in the future, it specifically disclaims any obligation to do so, even if its estimates change, and readers should not rely on those forward-looking statements as representing the Company's 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 to allow clients to better manage the bio/pharmaceutical product lifecycle with the goal of reducing the time, risk and cost associated with the development and commercialization of new therapies and medical products. Since its founding in 1983, PAREXEL has developed significant expertise in processes and technologies supporting these objectives. The Company's product and service offerings include: clinical trials management, data management, biostatistical analysis, medical marketing, clinical pharmacology, patient recruitment, regulatory and medical consulting, health policy and reimbursement, performance improvement, industry training and publishing, medical imaging services, IVRS, CTMS, web-based portals, systems integration, patient diary applications, and other drug development consulting services. The Company believes that its comprehensive services, depth of therapeutic area expertise, global footprint and related 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 three business segments, namely, CRS, PCMS, and Perceptive. CRS constitutes the Company's core business and includes clinical trials management and biostatistics, data management and clinical pharmacology, as well as related medical advisory and investigator site services. PCMS provides technical expertise in such disciplines as regulatory affairs, industry training, publishing, product development, management consulting, registration, commercialization issues, market development, targeted communications services in support of product launch, as well as health policy consulting and strategic reimbursement services. Perceptive provides information technology solutions designed to improve clients' product development processes. Perceptive offers a portfolio of products and services that includes medical imaging services, IVRS, CTMS, web-based portals, systems integration, and patient diary applications. Perceptive is a majority-owned subsidiary of the Company. As of December 31, 2004, the Company owned approximately 97.9% of the outstanding shares of common stock of Perceptive. On a fully diluted basis, the Company owned approximately 91.9% of Perceptive. The Company conducts a significant portion of its operations in foreign countries. Approximately 61.2% of the Company's service revenue for the six months ended December 31, 2004 and 53.4% of the Company's service revenue for the six months ended December 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 six months ended December 31, 2004, approximately 21.3% of total consolidated service revenue was denominated in British pounds and approximately 32.4% of total consolidated service revenue was denominated in Euros. For the six months ended December 31, 2003, approximately 19.2% of total consolidated service revenue was denominated in British pounds and approximately 27.2% of total consolidated service revenue was denominated in Euros. Approximately 85.0% 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. 10 Generally, the Company's clients can terminate their contracts with the Company upon 30 to 60 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 clinical drug manufacturing problems resulting in shortages of the product. 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. The Company regards an accounting estimate underlying its financial statements as a "critical accounting estimate" if the nature of the estimate or assumption is material due to level of subjectivity and judgment involved or the susceptibility of such matter to change and if the impact of the estimate or assumption on financial condition or operating performance is material. The Company believes that the following accounting policies are most critical to aid in fully understanding and evaluating its reported financial results: REVENUE RECOGNITION Service revenue on fixed-price contracts is recognized as services are performed. The Company measures progress for fixed-price contracts using the concept of proportional performance based upon a unit based output method. This method requires the Company to estimate total expected units, as well as the costs and revenue per unit. 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 actual costs incurred, which were not recovered from clients. In the event that future estimates are materially incorrect, they could materially impact the Company's consolidated results of operations and 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 historic collectability and specific identification of potential problem accounts. 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. 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 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 results of operations and financial position. 11 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. Under SFAS No. 142, "Goodwill and Other Intangible Assets", goodwill is subject to annual impairment testing or more frequent testing if an event occurs or circumstances change that would more likely than not reduce the carrying value of the reporting unit below its fair value. The Company has assessed the impairment of goodwill under SFAS No. 142 in fiscal years 2004 and 2003. The impairment testing involves determining the fair market value of each of the reporting units with which the goodwill was associated and comparing the value with the reporting unit's carrying value. Based on this assessment, there was no impairment identified at June 30, 2004 and 2003. 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 six months ended December 31, 2004 and 2003 were as follows:
FOR THE THREE MONTHS ENDED DECEMBER 31, FOR THE SIX MONTHS ENDED DECEMBER 31, ------------------------------------------- -------------------------------------------- INCREASE INCREASE ($ IN THOUSANDS) 2004 2003 (DECREASE) % 2004 2003 (DECREASE) % --------- --------- ---------- ----- --------- --------- ---------- ------ Service revenue: CRS $ 94,885 $ 94,756 $ 129 0.1% $ 184,811 $ 188,686 $ (3,875) -2.1% PCMS 32,311 30,557 1,754 5.7% 64,667 60,607 4,060 6.7% Perceptive 10,717 8,775 1,942 22.1% 19,946 16,918 3,028 17.9% --------- --------- --------- --------- --------- --------- $ 137,913 $ 134,088 $ 3,825 2.9% $ 269,424 $ 266,211 $ 3,213 1.2% ========= ========= ========= ========= ========= ========= Direct costs: CRS $ 59,792 $ 61,102 $ (1,310) -2.1% $ 116,717 $ 119,042 $ (2,325) -2.0% PCMS 22,924 23,905 (981) -4.1% 44,394 47,370 (2,976) -6.3% Perceptive 6,132 4,700 1,432 30.5% 11,427 9,143 2,284 25.0% --------- --------- --------- --------- --------- --------- $ 88,848 $ 89,707 $ (859) -1.0% $ 172,538 $ 175,555 $ (3,017) -1.7% ========= ========= ========= ========= ========= ========= Gross profit on service revenue: CRS $ 35,093 $ 33,654 $ 1,439 4.3% $ 68,094 $ 69,644 $ (1,550) -2.2% PCMS 9,387 6,652 2,735 41.1% 20,273 13,237 7,036 53.2% Perceptive 4,585 4,075 510 12.5% 8,519 7,775 744 9.6% --------- --------- --------- --------- --------- --------- $ 49,065 $ 44,381 $ 4,684 10.6% $ 96,886 $ 90,656 $ 6,230 6.9% ========= ========= ========= ========= ========= =========
THREE MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH THREE MONTHS ENDED DECEMBER 31, 2003: Service revenue increased $3.8 million, or 2.9%, to $137.9 million for the three months ended December 31, 2004 from $134.1 million for the same period one year ago. Service revenue was positively impacted by foreign exchange fluctuations of $6.7 million, or 5.0%. On a geographic basis, service revenue for the three months ended December 31, 2004 was distributed as follows: The United States - $52.6 million (38.1%), Europe - $78.7 million (57.1%), and Asia & Other - $6.6 million (4.8%). For the three months ended December 31, 2003, service revenue was distributed as follows: The United States - $62.5 million (46.6%), Europe - $66.4 million (49.5%), and Asia & Other - $5.2 million (3.9%). The year-over-year shift of revenue from the United States to Europe was primarily attributed to the softness in the U.S. clinical business and the growing level of clinical trial and consulting activity that is taking place outside of the U.S. 12 On a segment basis, CRS service revenue remained essentially flat at $94.9 million for the three months ended December 31, 2004, but was down 6.0%, net of the positive impact of foreign currency fluctuations of $5.7 million from the same three-month period in the last fiscal year. The 6.0% decrease was primarily as a result of the impact of a major Phase III project cancellation experienced early in the fiscal year as discussed in our August 2004 earnings release conference call, and relative softness in new business wins in the U.S. in previous quarters. PCMS service revenue increased by $1.8 million, or 5.7%, to $32.3 million in the three months ended December 31, 2004 from $30.5 million in the three months ended December 31, 2003. Approximately 1.6% of the total 5.7% increase was attributed to the positive impact of foreign currency fluctuations, with the remaining 4.1% increase primarily driven by increased demand for drug development consulting and strategic marketing services. Perceptive service revenue increased by $1.9 million, or 22.1%, to $10.7 million in the three months ended December 31, 2004 compared with $8.8 million in the same period one year ago. Of the total 22.1% increase, approximately 4.6% was attributed to the positive impact of foreign currency fluctuations, with the remaining 17.5% increase driven mainly by strength in the medical imaging business. 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 decreased by $0.9 million, or 1.0%, to $88.8 million for the three months ended December 31, 2004 from $89.7 million in the same period in the last fiscal year. Direct costs in the 2004 period increased as a result of foreign exchange fluctuations by approximately $4.8 million, or 5.3%. On a segment basis, CRS direct costs decreased by $1.3 million, or 2.1%, to $59.8 million for the three months ended December 31, 2004 from $61.1 million in the same three-month period in fiscal year 2004. The year-over-year decrease in CRS direct costs was primarily due to tighter cost controls and productivity improvements, partly offset by an increase of $3.7 million due to the impact of foreign currency fluctuations. As a percentage of service revenue, CRS direct costs decreased by 1.5 points to 63.0% for the three months ended December 31, 2004 from 64.5% for the three months ended December 31, 2003. PCMS direct costs decreased by $1.0 million, or 4.1%, to $22.9 million in the three months ended December 31, 2004 from $23.9 million in the same period one year ago. The year-over-year decrease in PCMS direct costs was a result of tighter cost controls, offset by a 3.9% increase due to the impact of foreign currency fluctuations. As a percentage of service revenue, PCMS direct costs decreased by 7.3 points to 70.9% for the three months ended December 31, 2004 from 78.2% for the three months ended December 31, 2003 as a result of efficiency improvements. Perceptive direct costs increased $1.4 million, or 30.5%, to $6.1 million in the three months ended December 31, 2004 from $4.7 million in the same period in the last fiscal year. Of the total 30.5% increase, approximately 5.0% was attributed to foreign currency fluctuations, with the remaining 25.5% due to higher labor costs associated with increased staffing needs to support business growth. As a percentage of service revenue, Perceptive's direct costs increased by 3.6 points to 57.2% in the three months ended December 31, 2004 from 53.6% in the same three-month period one year ago as a result of a less favorable revenue mix. Selling, general and administrative ("SG&A") expenses increased $2.5 million, or 8.2%, to $32.6 million in the three-month period ended December 31, 2004 from $30.1 million in the same period one year ago. Of the total 8.2% increase, approximately 5.3% was attributed to unfavorable foreign currency fluctuations, with the remaining 2.9% primarily due to incremental costs associated with acquisitions and increased spending on selling and promotions. As a percentage of service revenue, SG&A expenses increased by 1.2 points to 23.7% in the three months ended December 31, 2004 from 22.5% in the same period one year ago. Depreciation and amortization ("D&A") expense increased by $0.8 million, or 12.8%, to $6.8 million for the three months ended December 31, 2004 from $6.0 million for the same period in the last fiscal year primarily due to foreign currency fluctuations and an increased level of capital expenditures mainly in computer hardware and software over the past twelve months. As a percentage of service revenue, D&A expense was 4.9% for the three months ended December 31, 2004 and 4.5% for the three months ended December 31, 2003. Other expense was $0.4 million in the three months ended December 31, 2004 and $0.3 million in the same three-month period in the last fiscal year. The expenses in both periods were caused by foreign exchange losses, which were partly offset by interest income. The Company had an effective income tax rate of 34.4% for the three months ended December 31, 2004 and 35.5% for the three months ended December 31, 2003. The Company's tax rate is a function of profitability in the various taxing jurisdictions in which PAREXEL does business. Any future changes in the mix of taxable income in the different jurisdictions in which the Company operates could materially impact the Company's effective tax rate. 13 SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH SIX MONTHS ENDED DECEMBER 31, 2003: Service revenue increased $3.2 million, or 1.2%, to $269.4 million for the six months ended December 31, 2004 from $266.2 million for the same period one year ago. Service revenue was positively impacted by foreign exchange fluctuations of approximately $12.9 million, or 4.8%. On a geographic basis, service revenue for the six months ended December 31, 2004 was distributed as follows: The United States - $104.5 million (38.8%), Europe - $151.3 million (56.1%), and Asia & Other - $13.6 million (5.1%). For the six months ended December 31, 2003, service revenue was distributed as follows: The United States - $124.0 million (46.6%), Europe - $129.6 million (48.7%), and Asia & Other - $12.6 million (4.7%). The year-over-year shift of revenue from the United States to Europe was primarily attributed to the softness in the U.S. clinical business and the growing level of clinical trial and consulting activity that is taking place outside of the U.S. On a segment basis, CRS service revenue decreased by $3.9 million, or 2.1%, to $184.8 million for the six months ended December 31, 2004 from $188.7 million for the six months ended December 31, 2003, as a result of several factors including cancellations caused by drug safety issues, client driven project start-up-delays, and no current year counterpart to last year's favorable contract close-out in Japan, substantially offset by the favorable $11.2 million effect of foreign exchange fluctuations. PCMS service revenue increased by $4.1 million, or 6.7%, to $64.7 million in the six months ended December 31, 2004 from $60.6 million in the six months ended December 31, 2003. Approximately 1.6% of the total 6.7% increase was attributed to the positive impact of foreign currency fluctuations, with the remaining 5.1% increase primarily due to rebounding demand for most of this segment's services and incremental revenue from the IMC acquisition completed in October 2004. Perceptive service revenue increased by $3.0 million, or 17.9%, to $19.9 million in the six months ended December 31, 2004 compared with $16.9 million in the same period one year ago. Of the total 17.9% increase, approximately 4.3% was attributed to the positive impact of foreign currency fluctuations, with the remaining 13.6% increase driven mainly by strength in the medical imaging business. 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 decreased by $3.0 million, or 1.7%, to $172.5 million for the six months ended December 31, 2004 from $175.5 million in the same period last fiscal year. Direct costs increased as a result of foreign exchange fluctuations by approximately $9.4 million, or 5.4%. On a segment basis, CRS direct costs decreased by $2.3 million, or 2.0%, to $116.7 million for the six months ended December 31, 2004 from $119.0 million in the same six-month period in fiscal year 2004. The year-over-year decrease in CRS direct costs was primarily due to tighter cost controls, productivity and quality improvements, partly offset by an increase of $7.0 million due to the impact of foreign currency fluctuations. As a percentage of service revenue, CRS direct costs remained stable at 63.2% for the six months ended December 31, 2004 and 63.1% for the six months ended December 31, 2003. PCMS direct costs decreased by $3.0 million, or 6.3%, to $44.4 million in the six months ended December 31, 2004 from $47.4 million in the same period one year ago. The year-over-year decrease in PCMS direct costs was a result of tighter cost controls, no counterpart to a one-time catch-up adjustment in MMS in the prior year period, and lower hiring costs, partially offset by a 4.1% increase due to the impact of foreign currency fluctuations. As a percentage of service revenue, PCMS direct costs decreased by 9.5 points to 68.7% for the six months ended December 31, 2004 from 78.2% for the six months ended December 31, 2003 as a result of efficiency improvements and the other factors previously mentioned. Perceptive direct costs increased $2.3 million, or 25.0%, to $11.4 million in the six months ended December 31, 2004 from $9.1million in the same period in the last fiscal year. Of the total 25.0% increase, approximately 4.5% was attributed to foreign currency fluctuations, with the remaining 20.5% due to higher labor costs associated with increased staffing needs to support business growth. As a percentage of service revenue, Perceptive's direct costs increased by 3.3 points to 57.3% in the six months ended December 31, 2004 from 54.0% in the same six-month period one year ago as a result of a less favorable revenue mix. SG&A expenses increased $1.8 million, or 3.0%, to $64.4 million in the six-month period ended December 31, 2004 from $62.6 in the same period one year ago as the impact of unfavorable foreign currency fluctuations of approximately $3.1 million were offset by a decease of approximately $1.3 million as a result of tight cost controls and the favorable impact of past restructuring activities. As a percentage of service revenue, SG&A expenses increased by 0.4 points to 23.9% in the six months ended December 31, 2004 from 23.5% in the same period one year ago. 14 D&A expense increased by $1.2 million, or 9.9%, to $13.2 million for the six months ended December 31, 2004 from $12.0 million for the same period in the last fiscal year primarily due to foreign currency fluctuations and an increased level of capital expenditures mainly in computer hardware and software over the past twelve months. As a percentage of service revenue, D&A expense was 4.9% for the six months ended December 31, 2004 and 4.5% for the six months ended December 31, 2003. Other expense increased by $0.8 million in the six months ended December 31, 2004 from $5,000 in the same six-month period in the last fiscal year, primarily due to foreign currency transaction losses. The Company had an effective income tax rate of 36.5% for the six months ended December 31, 2004 and 37.0% for the six months ended December 31, 2003. The Company's tax rate is a function of profitability in the various taxing jurisdictions in which PAREXEL does business. Any future changes in the mix of taxable income in the different jurisdictions in which the Company operates could materially impact the Company's effective tax rate. 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. 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 was 38 days at December 31, 2004, 33 days at December 31, 2003, and 36 days at June 30, 2004. The two days increase in DSO at December 31, 2004 from June 30, 2004 was mainly due to a greater number of days in the period and lower gross revenue during the quarter ended December 31, 2004 as compared with the quarter ended June 30, 2004. Accounts receivable, net of the allowance for doubtful accounts was $218.8 million ($127.3 million in billed accounts receivable and $91.5 million in unbilled accounts receivable) at December 31, 2004 and $222.0 million ($127.5 million in billed accounts receivable and $94.5 million in unbilled accounts receivable) at June 30, 2004. Deferred revenue was $142.4 million at December 31, 2004 and $145.4 million at June 30, 2004. 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 six months ended December 31, 2004 totaled $18.8 million and was generated from $13.2 million related to non-cash charges for depreciation and amortization expense and $11.7 million of net income, offset by a $2.4 million decrease in current liabilities and an increase in current assets of $3.7 million. Net cash provided by operating activities for the six months ended December 31, 2003 totaled $26.2 million and was generated from a $21.3 million decrease in accounts receivable (net of the allowance for doubtful accounts and deferred revenue), $12.0 million related to non-cash charges for depreciation and amortization expense, $9.8 million of net income, and $1.2 million from other sources, partially offset by an $11.6 million decrease in liabilities (related in part to payment of annual management bonuses) and a $6.5 million decrease in accounts payable. Net cash used in investing activities for the six months ended December 31, 2004 totaled $22.1 million and consisted of $14.0 million used for capital expenditures (primarily computer hardware and software), $6.9 million used in the net purchase of marketable securities and $1.5 million used in the acquisition of a business, offset by $0.3 million of proceeds from sale of fixed assets. Net cash used in investing activities for the six months ended December 31, 2003 totaled $20.0 million and consisted of $10.9 million used for capital expenditures, $8.1 million used in the net purchase of marketable securities and $1.0 million used for the purchase of additional capital stock in a majority owned subsidiary. 15 Net cash used in financing activities for the six months ended December 31, 2004 totaled $0.7 million, and was generated from $3.8 million used to repurchase the Company's common stock pursuant to its stock repurchase program and $0.4 million for repayments under long-term debt, offset by $3.5 million in proceeds related to the issuance of common stock in conjunction with the Company's stock option and employee stock purchase plans. Net cash provided by financing activities for the six months ended December 31, 2003 totaled $3.9 million. These proceeds were generated mainly from the issuance of common stock in conjunction 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 line-of-credit may be revoked or canceled by the bank at any time at its discretion. The Company primarily entered into this line of credit to facilitate business transactions with the bank. At December 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 $1.8 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 December 31, 2004, the Company had approximately $1.8 million available 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 calculating interest. Each legal entity owned by the Company and party to this arrangement remains the owner of either a credit or debit balance. Therefore, interest income is earned in legal entities with credit balances, while interest expense is charged to legal entities with debit balances. Based on the pool's overall balance, the Bank then (1) recalculates the overall interest to be charged or earned, (2) compares this amount with the sum of previously charged/earned interest amounts per account and (3) additionally pays/charges the difference. Interest income and interest expense are included in "other income (expense), net" in 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 the next twelve months and on a longer term basis. 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. The Company expects capital expenditures to total approximately $27.0 million in fiscal year 2005. As of December 31, 2004, the Company had spent $14.0 million and expects to spend an additional $13.0 million mainly in computer hardware and software during the remainder of the fiscal year. CONTINGENT LIABILITIES AND GUARANTEES In connection with the FW Pharma acquisition as discussed in Note 3 to the consolidated financial statements included in Item 8 of the Company's June 30, 2004 Form 10-K, the Company is obligated to make a maximum additional payment of up to $2.4 million in contingent purchase price if FW Pharma achieves certain established financial targets through January 31, 2005. The Company is currently in the process of calculating the earn-out amount, if any. 16 In connection with the IMC acquisition as discussed in Note 4 to the condensed consolidated financial statements in this quarterly report, the Company is obligated to make additional payments of $0.3 million and up to $2.9 million in contingent purchase price if IMC achieves certain established financial targets through September 30, 2007. 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. FOREIGN CURRENCY EXCHANGE RATES The Company derived approximately 61.2% of its service revenue for the six-month period ended December 31, 2004 and 53.4% of its service revenue for the six months ended December 31, 2003 from operations outside of the U.S. The Company does not have significant operations in countries in which the economy is considered to be highly inflationary. The Company's financial statements are denominated in U.S. dollars. Accordingly, changes in exchange rates between foreign currencies and the U.S. dollar will affect the translation of financial results into U.S. dollars for purposes of reporting the Company's consolidated financial results. The Company may be subjected to foreign currency transaction risk when the Company's foreign subsidiaries enter into contracts denominated in a currency other than the foreign subsidiary's functional (local) currency. To the extent the Company is unable to shift the effects of currency fluctuations to its clients, foreign exchange fluctuations as a result of currency exchange losses could have a material effect on the Company's results of operations. The Company implemented a derivative hedging policy during the fourth quarter of fiscal year 2004 to hedge certain foreign denominated accounts receivable and intercompany payables. Derivatives are accounted for in accordance with FAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). The Company occasionally enters into other currency exchange contracts to offset the impact of currency fluctuations. These currency exchange contracts are entered into as economic hedges, but are not designated as hedges for accounting purposes as defined under FAS 133. The Company does not expect gains or losses on these contracts to have a material impact on its financial results. During the six-month periods ended December 31, 2004 and 2003, the Company recorded foreign-exchange losses of $1.9 million and $0.7 million, respectively. INFLATION The Company believes the effects of inflation generally do not have a material adverse impact on its operations or financial condition. RECENTLY ISSUED ACCOUNTING STANDARDS In December 2004, the FASB issued SFAS 123(R), "Share-Based Payment". SFAS 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Public entities (other than those filing as small business issuers) will be required to apply SFAS 123(R) as of the first interim or annual reporting period that begins after June 15, 2005. The Company is in the process of evaluating the impact SFAS 123(R) will have in reducing the Company's earnings. 17 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. These risk factors could cause actual results to differ from those indicated by 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 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 30 to 60 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, including a major Phase III cancellation during the first quarter of this fiscal year. 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 Food and Drug Administration ("FDA") may proceed with fewer clinical trials or conduct them without the assistance of bio/pharmaceutical 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 bio/pharmaceutical services companies such as the Company. THE COMPANY FACES INTENSE COMPETITION IN MANY AREAS OF ITS BUSINESS; IF THE COMPANY DOES NOT COMPETE EFFECTIVELY, ITS BUSINESS WILL BE HARMED The bio/pharmaceutical 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 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, PAREXEL's PCMS business also competes 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 CROs, 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. 18 THE FIXED PRICE NATURE OF THE COMPANY'S CONTRACTS COULD HURT ITS OPERATING RESULTS Approximately 85.0% 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 CHANGES, 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 regulated by the FDA or similar foreign regulatory authorities 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 approved common standards for clinical testing of new drugs throughout the E.U. 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. The FDA has had GCP in place as a regulatory standard and requirement for new drug approval for many years and Japan adopted GCP in 1998. The U.S., Europe and Japan have also collaborated in the 14-year-long 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 (the Common Technical Document) 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 PCMS business advises 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 PCMS business in this area. As a result of lower level of FDA enforcement activities over the last two years, PCMS experienced a decline in the group's GMP consulting business, which adversely affected the business unit. 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. 19 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. 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, 2004, the Company's five largest clients accounted for 30% of its consolidated service revenue, although no client accounted for 10% or more of consolidated service revenue. In the fiscal year ended June 30, 2003, the Company's five largest clients accounted for 32% of its consolidated service revenue, and one client, AstraZeneca, accounted for 11% of 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. 20 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. 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 were 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 bio/pharmaceutical 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. 21 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 CRS business primarily involves the testing of experimental drugs and medical devices on consenting human volunteers pursuant to a study protocol. Clinical research involves 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 drug or device 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 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 claims. In addition, liability coverage is expensive. In the future, the Company may not be able to maintain or obtain liability insurance on reasonable terms, at a reasonable cost or in sufficient amounts to protect it against losses due to claims. 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 on a worldwide basis. The Company's service revenue from non-U.S. operations represented approximately 61.2% of total consolidated service revenue for the six months ended December 31, 2004 and approximately 53.4% of total consolidated service revenue for the six months ended December 31, 2003. In addition, the Company's service revenue from operations in the United Kingdom represented approximately 21.3% of total consolidated service revenue for the six months ended December 31, 2004 and approximately 19.25% of total consolidated service revenue for the six months ended December 31, 2003. The Company's service revenue from operations in Germany represented approximately 18.1% of total consolidated service revenue for the six months ended December 31, 2004 and approximately 13.3% of total consolidated service revenue for the six months ended December 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. 22 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 from operations was $8.2 million for the quarter ended December 31, 2003, $(1.7) million for the quarter ended March 31, 2004, $10.3 million for the quarter ended June 30, 2004, $9.6 million for the quarter ended September 30, 2004 and $9.7 million for the quarter ended December 31, 2004. Factors that cause these variations include: - the level of new business authorizations in a particular quarter or year; - 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 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 65-70% of the Company's total operating costs in fiscal year 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. THE COMPANY'S REVENUE AND EARNINGS ARE EXPOSED TO EXCHANGE RATE FLUCTUATIONS Approximately 61.2% of the Company's total consolidated service revenue for the six months ended December 31, 2004 and approximately 53.4% of the Company's total consolidated service revenue for the six months ended December 31, 2003 were from non-U.S. operations. The Company's financial statements are denominated in U.S. dollars. As a result, changes in foreign currency exchange rate, 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 six months ended December 31, 2004, approximately 21.3% of total consolidated service revenue was denominated in British pounds and approximately 32.4% of total consolidated service revenue was denominated in Euros. For the six months ended December 31, 2003, approximately 19.2% of total consolidated service revenue was denominated in British pounds and approximately 27.2% of total consolidated 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. 23 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. 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. 24 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 8.06 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 February 4, 2005, the closing sale price of the Company's common stock on the NASDAQ National Market was $24.95 per share. During the period from January 2, 2003 to December 31, 2004, the price of the Company's common stock ranged from a high of $21.37 per share to a low of $10.17 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. 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. 25 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 rates 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 six months ended December 31, 2004, approximately 21.3% of total consolidated service revenue was denominated in British pounds and approximately 32.4% of total consolidated service revenue was denominated in Euros. The Company implemented a derivative policy during the fourth quarter of fiscal year 2004 to hedge certain foreign denominated accounts receivable and intercompany payables. Derivatives are accounted for in accordance with FAS 133. Occasionally, the Company enters into other foreign currency exchange contracts to offset the impact of currency fluctuations. These currency exchange contracts are entered into as economic hedges, but are not designated as hedges for accounting purposes as defined under FAS 133. The notional contract amount of these outstanding currency exchange contracts was approximately $10.4 million at December 31, 2004. The potential change in the fair value of these currency exchange contracts that would result from a hypothetical change of 10% in exchange rates would be approximately $1.0 million. The Company acknowledges its exposure to additional foreign exchange risk as it relates to assets and liabilities that are not part of the economic hedge program, but quantification of this risk is very difficult to assess at any given point in time. INTEREST RATE The Company's exposure to interest rate changes is minimal as the level of long-term debt the Company has is minimal. Long-term debt was approximately $0.5 million as of December 31, 2004 and June 30, 2004. 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 December 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 three months ended December 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. 26 PART II. OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS (c) The following table provides information about purchases of equity securities by the Company and its affiliated purchases of shares of the Company's common stock during the quarter ended December 31, 2004.
Maximum Number (or Total Number of Appropriate Dollar Shares (or Value) of Shares Total Number Average Price Units) Purchased (or Units) that May of Shares (or Paid per as Part of Publicly Yet Be Purchased Units) Share (or Announced Plans Under the Plans or Period Purchased Unit) or Programs Programs (1) 10/01/04 - 10/31/04 1,400 $18.04 1,400 $ 19,974,744 11/01/04 - 11/30/04 - - - $ 19,974,744 12/01/04 - 12/31/04 - - - $ 19,974,744 ----- ----- Total 1,400 1,400 ===== =====
(1) On September 9, 2004, the Board of Directors of the Company approved a stock repurchase program authorizing the purchase of up to $20.0 million of the Company's common stock to be repurchased in the open market subject to market conditions, which was announced on September 10, 2004. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) On December 16, 2004, the Company held its 2004 Annual Meeting of Stockholders. (b) Not applicable. (c) At the meeting, the stockholders of the Company voted: (1) to elect the following persons to serve as Class III directors, to serve for a three-year term (until the 2007 Annual Meeting). The votes cast were as follows:
For Withheld ---------- ------------ A. Dana Callow, Jr. 24,227,300 331,075 Josef H. von Rickenbach 24,148,778 409,597
(2) to ratify the selection of Ernst & Young LLP as independent auditors for the fiscal year ending June 30, 2005. The votes cast were as follows:
For Against Abstain ---------- ----------- ----------- 24,200,431 352,974 4,970
(d) Not applicable. ITEM 6. EXHIBITS 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. 27 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: February 8, 2005 By: /s/ Josef H. von Rickenbach -------------------------------------------- Josef H. von Rickenbach Chairman of the Board and Chief Executive Officer Date: February 8, 2005 By: /s/ James F. Winschel, Jr. -------------------------------------------- James F. Winschel, Jr. Senior Vice President and Chief Financial Officer 28 EXHIBIT INDEX
Exhibit Number Description ------------- -------------------------------------------------------------- 31.1 Principal executive officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Principal financial officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Principal executive officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Principal financial officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002