Lauren Migliore: Hi, my name is Lauren Migliore. I'm a health-care analyst here at Morningstar.
Contract research organization Parexel is a leading provider of outsourced research and development services to pharmaceutical and biotechnology companies.
With us today is the firm's CFO, Jim Winschel, to speak with us about the competitive landscape in the drug development industry.
Thanks for joining us, Jim.
James F. Winschel: Thanks, Lauren.
Migliore: Well, let's start off with an overview of the industry. Can you outline the benefits that CROs offer over traditional in-house drug development?
Winschel: Sure. One of the things that has happened in the past is there have been some independent studies done, which indicate that if you do the work in-house, it's going to take you anywhere from three to six months longer to actually complete the study that you might be doing. So, what we offer to these clients is faster development time, generally lower cost, productivity and efficiency savings, and really flexibility, if you think about it. If a pharmaceutical company has locations all around the world in order to do drug development, and a drug gets canceled for whatever reason, or they stop development on it, then suddenly the pharma company's got a group of employees who have some kind of lag time in order to be re-engaged under the next study coming through for their particular company.
But in the case of a CRO, when we have those kinds of cancelations, we can immediately redeploy those individuals to the next study that's coming in the door, and the global presence that we have means that the pharma company doesn't have to keep this very heavy and expensive infrastructure in place.
Migliore: Got it. So, the CRO industry is still very fragmented, though we have several hundred providers offering a range of drug development services. So what advantages does a global CRO like Parexel have over their smaller competitors?
Winschel: Well, one of the things that happens with a small CRO or a mid-sized CRO when they win a big global study is that they have to do work with partners, and they might have a partner in Europe, with a partner in Asia, and maybe even a partner in South America. The pharmaceutical companies tend to be frustrated in those circumstances, because if something then goes wrong in the trial, people start to point fingers in other directions and things, and not necessarily take responsibility for the work that is done; whereas, the global, big CRO has got responsibility for the whole thing, and there's no finger pointing to be done in that particular respect.
What I like to think of it is, sort of one-stop shopping. T-hat can get all of this work done from us, from the beginning of actually designing and developing the protocol, in conjunction with them, all the way through to helping them get that particular drug to peak sales at the earliest possible opportunity.
Migliore: Speaking of one-stop shops, top-tier CROs are increasingly being pursued by big pharma firms as long-term strategic partners in drug development. How has this trend affected industry dynamics, and how is Parexel stacking up against its peers in the race to sign on the world's largest drugmakers?
Winschel: Well, Parexel has been one of the leaders in these strategic partnerships, and I think there are three primary reasons for that. We have the largest global presence of any of the public CROs and pretty much the equal of one of the big private CROs. We have a strong base of expertise in the company, former FDA employees who help with drug development, and also if your drug manufacturing plant has been shut down by the FDA, you call our guys, they come in, assess the problem, lay out their recommendations, and help you to implement those recommendations.
Lastly, we are the only CRO that has a technology component, and for a long, long time, the pharma companies were reluctant to implement new technologies, and a lot of the work that we do was done on a manual basis. But that has shifted during the last decade, and we have been ideally positioned to take advantage of that. And all of this, of course, helps to improve productivity and efficiency, and to drive down the cost of clinical trials, which is one of the primary objectives.
Migliore: Another key trend in the industry is the offshoring of R&D services, and we've seen the leading CROs rush into Asia-Pacific, whether it be through acquisitions, partnerships with local providers, or internal expansion. What benefits does Asia Pacific offer for drug development and how is Parexel has positioned itself in this region?
Winschel: I think our strategy proved to be very visionary in what was going to be happening with respect to drug development, and the access to patients that you can get in that region of the world. So, for example, if you want to do an oncology study and you plan to do it in the United States, it's going to take you longer to get those patients enrolled, and it's going to be more expensive; whereas, if you go into the Asia Pacific region, there are just a huge volume of patients available to participate in these studies.
But I think what the pharma company strategy is, is that they want to get also access to those markets. So, if they run portions of their study in that region of the world, when they do eventually get the drug approval, they will have run studies in those countries that can help them to get approval there and therefore to get access to those markets.
The final thing I would say about that region of the world is that it is lower cost and also faster process, and therefore saves the pharmaceutical company money in the development process, but also enables them to get to peak sales at a quicker pace.
Migliore: Parexel continues to report very strong bookings and double-digit backlog growth, but earnings still remain off year-ago levels. When can we expect the firm's financial performance to turn the corner?
Winschel: Well, you're right. Of course, in terms of new business, our last eight quarters, last two years, really have been extremely strong, with an average book-to-bill ratio that's been close to 1.6, and clearly indicating that we're taking a strong market share. But a lot of this business is coming from the big pharma companies and a lot of the new business has come from the many strategic relationships that we've entered into. I think we've been probably more successful than any of our competitors in engaging in these strategic partnerships. A number of those partnerships have been announced, but a number of other ones have not been announced, at least up to this point.
The other thing that we noticed about the strategic partnerships, though, was we're being brought in earlier in the process, we're actually working on protocol, design and development, and trial design, and being therefore exposed to some of the regulatory delays that might occur. There have been other types of delays, including what I describe as economic delays on the part of the pharma company. So, we believe, for example, that the work that we're going to do is going to start within three months, and two months later the pharma company comes back to us and says, "Hey, we need to delay the start of this trial for two months," either for regulatory reasons or maybe there has been some problem with the drug manufacturing of the study drug, or these economic delays where the pharma companies, particularly in 2010, did not do as well from a revenue standpoint as they expected, in part maybe because of some of the problems that have occurred in Europe.
So, we had a large number of studies that were sort of in the startup phase where we were qualifying investigator sites and qualifying or initiating activity at sites, where it was very easy for the pharma company, if they needed to cut costs in the short term, to say, "Okay, we're going to delay those particular studies."
On the other hand, if we had already been to the point of dosing patients and things, you can't do those kinds of short-term delays. So, that hurt us quite a bit. Then, all of a sudden, in the June quarter of 2011, we saw all of these delays being lifted, and suddenly there was a huge demand for additional employees to execute that work.
So, we hit a low point from a gross margin and an operating margin standpoint in that quarter, at least from an operating margin standpoint. We saw some sequential improvement now in the September quarter, and we would expect to see actually significant improvement in both revenue growth and margin improvement and expansion over the next three quarters, and beyond.
Migliore: Well, thank you so much for providing your thoughts.
Winschel: Okay. Thanks, Lauren. Appreciate it.
Migliore: I'm Lauren Migliore for Morningstar. Thanks for joining us.