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PAREXEL INTERNATIONAL CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW We are a leading biopharmaceutical services company, providing a broad range of expertise in clinical research, medical communications services, consulting and informatics and advanced technology products and services to the worldwide pharmaceutical, biotechnology, and medical device industries. Our primary objective is to provide solutions for managing the biopharmaceutical product lifecycle with the goal of reducing the time, risk, and cost associated with the development and commercialization of new therapies. Since our incorporation in 1983, we have developed significant expertise in processes and technologies supporting this strategy. Our product and service offerings include: clinical trials management, data management, biostatistical analysis, medical communications, clinical pharmacology, patient recruitment, regulatory and product development consulting, health policy and reimbursement, performance improvement, medical imaging services, ClinPhone® RTSM, IMPACT® and TrialWorks® CTMS, DataLabs® EDC, web-based portals, systems integration, ePRO, and other drug development consulting services. We believe that our comprehensive services, depth of therapeutic area expertise, global footprint and related access to patients, and sophisticated information technology, along with our experience in global drug development and product launch services, represent key competitive strengths. We are managed through three business segments: Clinical Research Services ("CRS"), PAREXEL Consulting and MedCom Services ("PCMS") and Perceptive Informatics, Inc. ("Perceptive"). • CRS constitutes our core business and includes all phases of clinical research from Early Phase (encompassing the early stages of clinical testing that range from first-in-man through proof-of-concept studies) to Phase II-III and Phase IV, which we call Peri Approval Clinical Excellence ("PACE"). Our services include clinical trials management and biostatistics, data management and clinical pharmacology, as well as related medical advisory, patient recruitment, clinical supply and drug logistics, pharmacovigilance, and investigator site services. • PCMS provides technical expertise and advice in such areas as drug development, regulatory affairs, and biopharmaceutical process and management consulting. PCMS also provides a full spectrum of market development, product development, and targeted communications services in support of product launch. PCMS consultants identify alternatives and propose solutions to address clients' product development, registration, and commercialization issues. In addition, PCMS provides health policy consulting, as well as reimbursement and market access ("RMA") services. • Perceptive provides information technology solutions designed to help improve clients' product development processes. Perceptive offers a portfolio of products and services that includes medical imaging services, ClinPhone® RTSM, IMPACT ® and TrialWorks® CTMS, DataLabs® EDC, web-based portals, systems integration, and ePRO. We conduct a significant portion of our operations in foreign countries. Approximately 63.6% and 65.4% of our consolidated service revenue for the fiscal years ended June 30, 2011 and 2010, respectively, were from non-U.S. operations. Because our financial statements are denominated in U.S. dollars, changes in foreign currency exchange rates can have a significant effect on our operating results. For the Fiscal Year 2011, approximately 24.4% of total consolidated service revenue was denominated in Euros and approximately 13.9% of total consolidated service revenue was denominated in pounds sterling. For the Fiscal Year 2010, approximately 24.1% of total consolidated service revenue was denominated in Euros and approximately 14.6% of total consolidated service revenue was denominated in pounds sterling. Approximately 90% of our 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 recognized generally as work is performed. As a result, the timing of cash receipts do not necessarily correspond to costs incurred and revenue recognized on contracts. Generally, our clients can either terminate their contracts with us upon thirty to sixty days notice or delay execution of services. Clients may terminate or delay contracts for a variety of reasons, including: 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. 31 -------------------------------------------------------------------------------- Table of Contents ACQUISITIONS Acquisitions are an important component of our business strategy. We account for acquisitions in accordance with Accounting Standards Codification ("ASC") 805, "Business Combinations." Since June 30, 2008, we have completed the following acquisition: ClinPhone In August 2008, we completed the acquisition of ClinPhone, one of the world's leading clinical technology organizations, for approximately $190 million, comprised of $172 million for the stock of ClinPhone and $18 million as repayment of ClinPhone's existing debt. We believe that the acquisition of ClinPhone has advanced our position as a clinical technology leader. Biopharmaceutical companies have increasingly requested technology solutions and expertise to support the full range of clinical development activities while improving the speed and efficiency of clinical programs. We believe that the broad technological offering that we now provide gives clients a more comprehensive and robust suite of clinical information technologies. CRITICAL ACCOUNTING POLICIES AND ESTIMATES This discussion and analysis of our financial condition and results of operations are based on our 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 us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and other financial information. On an ongoing basis, we evaluate our estimates and judgments. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We regard an accounting estimate underlying our financial statements as a "critical accounting estimate" if the nature of the estimate or assumption is material due to the 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. We believe that the following accounting policies are most critical to aid in fully understanding and evaluating our reported financial results: REVENUE RECOGNITION We derive revenue from the delivery of service or software solutions to clients in the worldwide pharmaceutical, biotechnology, and medical device industries. In general, we recognize revenue when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the service offering has been delivered to the client; (3) the collection of fees is probable; and (4) the amount of fees to be paid by the client is fixed or determinable. Our client arrangements generally involve multiple service deliverables, where bundled service deliverables are accounted for in accordance with Accounting Standards Codification ("ASC") 605-25, "Multiple-Element Arrangements" and Accounting Standards Update ("ASU") 2009-13, "Multiple-Deliverable Revenue Arrangements." We determined that each of our service deliverables has standalone value and base the selling price upon third-party evidence (TPE). TPE is established for each of our arrangement deliverables based on the price we charge for equivalent services when sold to other similar customers as well as our knowledge of market-pricing from the competitive bidding process for customer contracts offering similar services to comparably situated customers. Within Perceptive's Clinphone® RTSM business, we offer selected software solutions through a hosted application delivered through a standard web-browser. We recognize revenue from application hosting services in accordance with ASC 985-605, "Revenue Recognition in the Software Industry" and ASC 605-25 as our customers do not have the right to take possession of the software. Revenue resulting from these hosting services consists of three stages: set-up (client specification and workflow), hosting and support services, and closeout reporting. 32 -------------------------------------------------------------------------------- Table of Contents Critical management estimates may be involved in the determination of "hosting period," and other revenue elements. Changes to these elements could affect the amount and timing of revenue recognition. BILLED AND UNBILLED ACCOUNTS RECEIVABLE 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. We maintain a provision for losses on receivables based on historical collectability and specific identification of potential problem accounts. Critical management estimates may be involved in the determination of "collectability" and the amounts required to be recorded as provisions for losses on receivables. INCOME TAXES Our global provision for corporate income taxes is determined in accordance with ASC 740, "Income Taxes," which requires that deferred tax assets and liabilities be recognized for the effect of temporary differences between the book and tax basis of recorded assets and liabilities. A valuation allowance is established if it is more likely than not that future tax benefits from the deferred tax assets will not be realized. Income tax expense is based on the distribution of profit before tax among the various taxing jurisdictions in which we operate, adjusted as required by the tax laws of each taxing jurisdiction. Changes in the distribution of profits and losses among taxing jurisdictions may have a significant impact on our effective tax rate. We account for uncertain tax positions in accordance with the provisions of ASC 740, which requires financial statement reporting of the expected future tax consequences of uncertain tax return reporting positions on the presumption that all relevant tax authorities possess full knowledge of those tax reporting positions, as well as all of the pertinent facts and circumstances. In addition, ASC 740 requires financial statement disclosure about uncertainty in income tax reporting positions. We are subject to ongoing audits by federal, state and foreign tax authorities that may result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is based on judgment. We believe we have adequately provided for any uncertain tax positions in accordance with ASC 740. However, future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period assessments are made or resolved or when statutes of limitation on potential assessments expire. 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 ASC 350, "Intangibles-Goodwill and Other," goodwill (and other indefinite-lived intangibles such as tradenames) 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 below its fair value. The impairment testing for goodwill involves determining the fair value of each of the reporting units with which the goodwill was associated and comparing that value with the reporting unit's carrying value. We conducted an impairment assessment in Fiscal Year 2011 using a market approach analysis and a discounted cash flow analysis at the reporting unit level to determine fair value. The discounted cash flow analysis included significant judgment regarding the assumptions used, such as our weighted average cost of capital, revenue growth rates, profit margins, capital expenditures, and other factors that were all based on current strategic forecasts and other financial metrics. As of June 30, 2011, there were no required adjustments to the carrying value of goodwill since the fair value of our net assets were substantially above the carrying value of our net assets at each of our reporting units. Variations over time in the measures and estimates used in the discounted cash flow analysis could result in future impairment of goodwill that could have a material impact to our financial position or our results of operations. 33-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Note 20 to our consolidated financial statements included in this Annual Report on Form 10-K provides a summary of our unaudited quarterly results of operations for the years ended June 30, 2011 and 2010. ANALYSIS BY SEGMENT We evaluate our segment performance and allocate resources based on service revenue and gross profit (service revenue less direct costs), while other operating costs are allocated and evaluated on a geographic basis. Accordingly, we do not include the impact of selling, general, and administrative expenses, depreciation and amortization expense, interest income (expense), other income (loss), and income tax expense (benefit) in segment profitability. We attribute 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, we have a global infrastructure supporting our business segments and therefore, assets are not identified by reportable segment. Service revenue, direct costs, and gross profit on service revenue for Fiscal Years 2011, 2010, and 2009 were as follows: (in thousands) Twelve Months Ended Increase June 30, 2011 June 30, 2010* (Decrease) % Service revenue CRS $ 922,827 $ 870,721 $ 52,106 6.0 % PCMS 129,728 121,652 8,076 6.6 % Perceptive 159,544 138,666 20,878 15.1 % Total service revenue $ 1,212,099 $ 1,131,039 $ 81,060 7.2 % Direct costs CRS $ 616,677 $ 562,784 $ 53,893 9.6 % PCMS 77,679 75,266 2,413 3.2 % Perceptive 91,478 80,794 10,684 13.2 % Total direct costs $ 785,834 $ 718,844 $ 66,990 9.3 % Gross profit CRS $ 306,150 $ 307,937 $ (1,787 ) (0.6 )% PCMS 52,049 46,386 5,663 12.2 % Perceptive 68,066 57,872 10,194 17.6 % Total gross profit $ 426,265 $ 412,195 $ 14,070 3.4 % (in thousands) Twelve Months Ended Increase June 30, 2010* June 30, 2009* (Decrease) % Service revenue CRS $ 870,721 $ 804,237 $ 66,484 8.3 % PCMS 121,652 121,785 (133 ) (0.1 )% Perceptive 138,666 124,733 13,933 11.2 % Total service revenue $ 1,131,039 $ 1,050,755 $ 80,284 7.6 % Direct costs CRS $ 562,784 $ 533,035 $ 29,749 5.6 % PCMS 75,266 78,116 (2,850 ) (3.6 )% Perceptive 80,794 79,814 980 1.2 % Total direct costs $ 718,844 $ 690,965 $ 27,879 4.0 % Gross profit CRS $ 307,937 $ 271,202 $ 36,735 13.5 % PCMS 46,386 43,669 2,717 6.2 % Perceptive 57,872 44,919 12,953 28.8 % Total gross profit $ 412,195 $ 359,790 $ 52,405 14.6 % * Effective July 1, 2010, certain selling, general and administrative expenses for Fiscal Years 2010 and 2009 were reclassified as direct costs to conform to the presentation for Fiscal Year 2011. These changes had no impact on total revenue, total expenses, operating income, net income, earnings per share or the balance sheet. 34 -------------------------------------------------------------------------------- Table of Contents FISCAL YEAR ENDED JUNE 30, 2011 COMPARED WITH THE FISCAL YEAR ENDED JUNE 30, 2010 Revenue Service revenue increased by $81.1 million, or 7.2%, to $1,212.1 million for Fiscal Year 2011 from $1,131.0 million for Fiscal Year 2010. On a geographic basis, service revenue was distributed as follows (in millions): Fiscal Year 2011 Fiscal Year 2010 Region Service Revenue % of Total Service Revenue % of Total The Americas $ 484.7 40.0 % $ 449.3 39.7 % Europe, Middle East & Africa $ 553.8 45.7 % $ 548.4 48.5 % Asia/Pacific $ 173.6 14.3 % $ 133.3 11.8 % For Fiscal Year 2011 compared with the same period in 2010, service revenue in The Americas increased by $35.3 million, or 7.9%; Europe, Middle East & Africa service revenue increased by $5.4 million, or 1.0%; and Asia/Pacific service revenue increased by $40.4 million, or 30.3%. The increases were due primarily to strong new business growth in CRS, especially in the Asia/Pacific region. Growth in The Americas was also due to a change in internal contractual arrangements that determine how much revenue from a client contract is attributed to respective PAREXEL legal entities. In the past, we recognized revenue in respective regions based upon the work performed therein. Furthermore, service revenue in Europe, Middle East & Africa was positively impacted by foreign currency fluctuations of approximately $3.0 million. The positive impact of foreign currency fluctuations in Asia/Pacific was approximately $0.8 million. On a segment basis, CRS service revenue increased by $52.1 million, or 6.0%, to $922.8 million for Fiscal Year 2011 from $870.7 million for Fiscal Year 2010. The increase was attributable to a $51.5 million improvement in our Phase II-III/PACE business and $2.7 million related to the positive impact of foreign currency fluctuations; partly offset by a $2.1 million decrease in Early Phase. The growth is a result of successful sales efforts over the past year and the continued positive impact of strategic partnerships. However, it has taken longer to recognize revenue from backlog related to strategic partnerships than from backlog related to traditional client contracts. PCMS service revenue increased by $8.1 million, or 6.6%, to $129.7 million for Fiscal Year 2011 from $121.7 million for the same period in 2010. The increase was due primarily to a $9.5 million increase in strategic compliance-related services due to increased regulatory activities that our clients have encountered. This increase was partially offset by a $1.5 million decrease in other parts of the business. Perceptive service revenue increased by $20.8 million, or 15.1%, to $159.5 million for Fiscal Year 2011 from $138.7 million for Fiscal Year 2010. The increase was due primarily to an $8.7 million increase in our RTSM business, a $7.6 million increase in Medical Imaging, and a $5.2 million increase in our other business lines. The growth in Perceptive can be attributed to increasing usage of technology in conjunction with clinical trials and successful implementation of our technology strategy. Reimbursement revenue consists of reimbursable out-of-pocket expenses incurred on behalf of and reimbursable by clients. Reimbursement revenue does not yield any gross profit to us, nor does it have an impact on net income. Direct Costs Direct costs increased by $67.0 million, or 9.3%, to $785.8 million for Fiscal Year 2011 from $718.8 million for Fiscal Year 2010. As a percentage of total service revenue, direct costs increased slightly to 64.8% from 63.6% for the respective periods. On a segment basis, CRS direct costs increased by $53.9 million, or 9.6%, to $616.7 million for Fiscal Year 2011 from $562.8 million for Fiscal Year 2010. This increase resulted from higher levels of project activity and increased labor costs and the $6.8 million negative impact of foreign exchange rate fluctuations. As a percentage of service revenue, CRS direct costs increased to 65.8% for Fiscal Year 2011 from 64.6% for Fiscal Year 2010 due primarily to increased headcount and a slower-than-expected realization of revenue from strategic partnership-related projects. PCMS direct costs increased by $2.4 million, or 3.2%, to $77.7 million for Fiscal Year 2011 from $75.3 million for Fiscal Year 2010. This increase was due primarily to a $5.5 million increase in strategic compliance-related service costs; partially offset by a $3.0 million decrease in other business lines (due to lower levels of business activity). As a percentage of service revenue, PCMS direct costs decreased to 59.9% from 61.9% for the respective periods as a result of improved productivity and efficiency. Perceptive direct costs increased by $10.7 million, or 13.2%, to $91.4 million for Fiscal Year 2011 from $80.8 million for Fiscal Year 2010. This increase was due primarily to higher RTSM business volume. As a percentage of service revenue, Perceptive direct costs decreased to 57.3% for Fiscal Year 2011 from 58.3% for Fiscal Year 2010. This decrease was due primarily to improved utilization rates and higher revenue growth. 35-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Selling, general and administrative ("SG&A") expense increased by $17.9 million, or 7.1%, to $271.0 million for Fiscal Year 2011 from $253.1 million for Fiscal Year 2010. This increase was primarily due to a $10.2 million increase in rent (due to increased rental space requirements) and other facilities costs (such as telecommunications and utilities, due to an 8.5% increase in overall headcount) and a $7.6 million increase in labor costs, and a $2.0 million negative impact of foreign currency fluctuations; partially offset by a $1.8 million decrease in other areas. As a percentage of service revenue, SG&A was flat at 22.4% for Fiscal Years 2011 and 2010. Depreciation and Amortization Depreciation and amortization ("D&A") expense increased by $5.2 million, or 8.6%, to $65.5 million for Fiscal Year 2011 from $60.3 million for Fiscal Year 2010, primarily due to additional depreciation expense from increased capital expenditures over the last several quarters, including the implementation of our new project accounting and billing system. As a percentage of service revenue, D&A was 5.4% for Fiscal Year 2011 versus 5.3% for the same period in 2010. Other (Benefit) Charge For Fiscal Year 2010, we released $1.1 million of reserves to reflect lower-than-anticipated close-out costs that were related to a biopharma client that filed for bankruptcy protection in Fiscal Year 2009. Restructuring Charge (Benefit) For Fiscal Year 2011, we recorded $8.1 million in restructuring charges in association with our restructuring plans, including approximately $3.7 million of facility-related costs, $1.8 million in employee separation benefits associated with the elimination of 54 managerial and staff positions, and $3.1 million in impairment charges related to exited facilities associated with the 2011 Restructuring Plan; offset by $0.5 million of net benefit due to adjustments in previous plans. For Fiscal Year 2010, we recorded $16.8 million in restructuring charges in association with the 2010 Restructuring Plan, including approximately $11.6 million in employee separation benefits associated with the elimination of 238 managerial and staff positions and $5.2 million in costs related to the abandonment of certain property leases. Income from Operations Income from operations decreased to $81.6 million for Fiscal Year 2011 from $83.1 million for the same period in 2010 due the factors described above. Income from operations as a percentage of service revenue, or operating margin, decreased to 6.7% from 7.3% for the respective periods. This decrease in operating margin was due primarily to increases in direct costs described above. Other Expense, Net We recorded net other expense of $23.0 million for Fiscal Year 2011 compared with $19.9 million for Fiscal Year 2010. The $3.1 million increase was due to a $1.6 million increase in interest expense, including $1.1 million of accelerated financing fees from the refinancing of our debt, and a $1.5 million increase in miscellaneous expense. Miscellaneous expense for Fiscal Year 2011 of $11.2 million was primarily attributable to $17.1 million of losses on certain foreign denominated assets and liabilities and the $1.2 million charge for the impairment of certain long-lived assets in France; partly offset by $6.7 million of unrealized gains related to derivatives contracts. The higher-than-anticipated net loss was caused, in part, by short-term disruptions associated with the implementation of our new project accounting and billing system which adversely impacted cash flow and delayed the settlement of certain intercompany transactions. Miscellaneous expense for Fiscal Year 2010 of $9.6 million included $7.0 million of losses related to derivatives contracts, a $6.1 million reserve for an impaired investment in a French laboratory that filed for bankruptcy protection, and a $0.4 million asset impairment charge; partly offset by $4.4 million in gains on the revaluation of foreign denominated assets/liabilities. Taxes For Fiscal Year 2011 and 2010, we had an effective income tax rate of 16.8% and 34.2%, respectively. The decrease in tax rate is primarily attributable to the favorable impact of a change in the geographic distribution of earnings, a reduction in non-deductible expenses outside of the United States, and a reduction in valuation reserves in the United Kingdom and United States. We do not expect that the low rate in Fiscal Year 2011 will carry into Fiscal Year 2012. 36 -------------------------------------------------------------------------------- Table of Contents FISCAL YEAR ENDED JUNE 30, 2010 COMPARED WITH THE FISCAL YEAR ENDED JUNE 30, 2009 Revenue Service revenue increased by $80.3 million, or 7.6%, to $1,131.0 million for Fiscal Year 2010 from $1,050.8 million for Fiscal Year 2009. On a geographic basis, service revenue was distributed as follows (in millions): Fiscal Year 2010 Fiscal Year 2009 Region Service Revenue % of Total Service Revenue % of Total The Americas $ 449.3 39.7 % $ 426.3 40.6 % Europe, Middle East & Africa $ 548.4 48.5 % $ 528.9 50.3 % Asia/Pacific $ 133.3 11.8 % $ 95.6 9.1 % Service revenue in The Americas increased by $23.0 million, or 5.4%; Europe, Middle East & Africa service revenue increased by $19.5 million, or 3.7%; and Asia/Pacific service revenue increased by $37.7 million, or 39.5%. Overall, service revenue was positively impacted by foreign currency exchange rate fluctuations including: $1.3 million in The Americas, $1.1 million in Europe, Middle East & Africa, and $7.9 million in Asia/Pacific. On a segment basis, CRS service revenue increased by $66.5 million, or 8.3%, to $870.7 million for Fiscal Year 2010 from $804.2 million for Fiscal Year 2009. The growth was attributable to a $47.1 million increase in Phase II-III/PACE, the positive $12.1 million impact of foreign currency exchange rate fluctuations, and a $7.3 million increase in Early Phase. Growth in the Phase II-III/PACE business was largely due to the impact of strategic partnerships and increased business activity in the Asia/Pacific region as a result of global studies and more work for local biopharmaceutical companies. Growth in Early Phase business was a result of increased demand due largely to improvements in the unit's sales team and approach. PCMS service revenue decreased nominally to $121.7 million for Fiscal Year 2010 from $121.8 million for the same period in Fiscal Year 2009. The decline was caused by a $2.4 million decrease in health policy and strategic reimbursement services, which was adversely affected by uncertainty in the regulatory markets due to changes in the U.S. healthcare law, and the $0.7 million negative impact of foreign currency exchange rate fluctuations; partly offset by a $3.0 million increase in the consulting business, including strong growth in strategic compliance consulting work. Perceptive service revenue increased by $14.0 million, or 11.2%, to $138.7 million for Fiscal Year 2010 from $124.7 million for Fiscal Year 2009. The increase was due to an $18.0 million increase in ClinPhone RTSM and support services, a $2.5 million increase in EDC services, and a $2.2 million increase in medical imaging; partly offset by a $7.6 million decrease in CTMS and installation support services, and the $1.1 million negative impact of foreign currency exchange rate fluctuations. The overall increases were due to the trend toward increasing integration of technology into clinical trials. As of Fiscal Year 2010, Perceptive handled more electronic case report forms than paper-based ones. The decrease in CTMS and integration support services was due, in part, to lower demand for perpetual licenses, replaced by increased demand for hosted solutions. Reimbursement revenue consists of reimbursable out-of-pocket expenses incurred on behalf of and reimbursable by clients. Reimbursement revenue does not yield any gross profit to us, nor does it have an impact on net income. Direct Costs Direct costs increased by $28.0 million, or 4.0%, to $718.8 million for the Fiscal Year 2010 from $691.0 million for the Fiscal Year 2009. As a percentage of total service revenue, direct costs decreased to 63.6% from 65.8% for the respective periods. On a segment basis, CRS direct costs increased by $29.8 million, or 5.7%, to $562.8 million for Fiscal Year 2010 from $533.0 million for Fiscal Year 2009. The increase was due to higher business activity levels and the $7.1 million negative impact of foreign exchange rate fluctuations. As a percentage of service revenue, CRS direct costs decreased to 64.6% for the Fiscal Year 2010 from 66.3% for the Fiscal Year 2009 due primarily to strong performance in Asia/Pacific, the continued effectiveness of cost controls, and improved productivity and efficiency; partly offset by an unfavorable swing in bonus expense. PCMS direct costs decreased $2.8 million, or 3.6%, to $75.3 million for Fiscal Year 2010 from $78.1 million for Fiscal Year 2009. This decrease was caused mainly by a lower level of activity in the medical communications business. As a percentage of service revenue, PCMS direct costs decreased to 61.9% from 64.1% for the respective periods. This reduction resulted from efforts by PCMS to implement substantial improvements in business processes, mainly related to the strategic marketing portion of the business and the shedding of certain unprofitable service lines. Perceptive direct costs increased slightly by $1.0 million, or 1.2%, to $80.8 million for Fiscal Year 2010 from $79.8 million for Fiscal Year 2009. The change was due to increases in ClinPhone RTSM and support services activities and higher 37 -------------------------------------------------------------------------------- Table of Contents spending in CTMS and integration support services; partly offset by a decrease in other areas. This latter decrease was due largely to the fact that we had no counterparts to a $1.4 million reserve for a customer dispute in medical imaging and $0.6 million associated with the termination of a (pre-acquisition) Perceptive IVR supplier contract, both recorded in Fiscal Year 2009. As a percentage of service revenue, Perceptive direct costs decreased to 58.3% for Fiscal Year 2010 from 64.0% for Fiscal Year 2009. Selling, General and Administrative Selling, general and administrative ("SG&A") expense increased by $36.8 million, or 17.0%, to $253.1 million for Fiscal Year 2010 from $216.3 million for Fiscal Year 2009. This increase was due primarily to a $19.3 million increase in personnel costs (driven in part by bonus expense in Fiscal Year 2010 for which there was no comparable bonus expense in Fiscal Year 2009), a $5.4 million increase in sales-related costs (including commissions), $4.3 million related to the legal settlement costs related to a small acquisition which was completed several years ago, $4.3 million in higher rent and other facilities expenses, and $1.6 million related to the negative impact for foreign currency exchange rate movements. As a percentage of service revenue, SG&A increased to 23.6% for Fiscal Year 2010 from 22.1% for Fiscal Year 2009. Depreciation and Amortization Depreciation and amortization ("D&A") expense increased by $7.4 million, or 14.0%, to $60.3 million for the Fiscal Year 2010 from $52.9 million for the Fiscal Year 2009 primarily due to increased capital expenditures over the prior twenty four months. As a percentage of service revenue, D&A expense increased to 5.3% for the Fiscal Year 2010 from 5.0% for the same period in 2009. Other Charge In the second quarter of Fiscal Year 2009, we recorded $15 million in reserves for bad debt expense related to impaired accounts receivable and anticipated wind-down costs and related expenses for service fees, pass-through costs, and investigator fees from a small biopharma client that filed for bankruptcy protection. In the second quarter of Fiscal Year 2010, we released $1.1 million of these reserves to reflect lower-than-anticipated close-out costs. See Note 18 to our consolidated financial statements included in this Annual Report on Form 10-K for more information. Restructuring Charge For Fiscal Year 2010, we recorded $16.8 million in restructuring charges in association with the 2010 Restructuring Plan, including approximately $11.6 million in employee separation benefits associated with the elimination of 238 managerial and staff positions and $5.2 million in costs related to the abandonment of certain property leases. Income from Operations Income from operations increased to $83.1 million for Fiscal Year 2010 from $75.6 million in Fiscal Year 2009. Income from operations as a percentage of service revenue, or operating margin, increased to 7.3% from 7.2% for the respective periods. Other Expense Other expense increased by $8.1 million to $19.9 million in Fiscal Year 2010 from $11.8 million in Fiscal Year 2009. The $8.1 million increase was attributable to $9.0 million in miscellaneous expense; partly offset by a $0.9 million increase in interest income, net of interest expense. Miscellaneous expense for Fiscal Year 2010 of $9.6 million included $7.0 million of losses related to derivatives contracts, a $6.1 million reserve for an impaired investment in a French laboratory that filed for bankruptcy protection, and a $0.4 million asset impairment charge; partly offset by $4.4 million in gains on the revaluation of foreign denominated assets/liabilities. Miscellaneous income for Fiscal Year 2009 of $0.6 million consisted of a $3.0 million legal settlement charge related to a contract dispute, $2.3 million for the write-off of certain impaired assets, $0.9 million of losses related to derivatives contracts, and $1.4 million in other losses; partly offset by $7.0 million of gains on the revaluation of foreign denominated assets/liabilities. Taxes For the Fiscal Year 2010 and 2009, we had an effective income tax rate of 34.2% and 38.4%, respectively. The reduction in the tax rate was primarily attributable to a decrease in the reserves required for uncertain tax positions as of June 30, 2010 and improved profitability in the United States. 38-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Since our inception, we have financed our operations and growth with cash flow from operations, proceeds from the sale of equity securities, and, more recently, credit facilities to fund business acquisitions and working capital. Investing activities primarily reflect the costs of acquisitions and capital expenditures for information systems enhancements and leasehold improvements. As of June 30, 2011, we had cash and cash equivalents of approximately $89.1 million. Our cash is held in deposit accounts and money market funds, which provide us with immediate and unlimited access to funds. Repatriation of funds to the U.S. from non-U.S. entities may be subject to taxation or certain legal restrictions. Nevertheless, most of our cash resides in countries with little or no such restrictions. DAYS SALES OUTSTANDING Our 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. We calculate DSO by adding the end-of-period balances for billed and unbilled account receivables, net of deferred revenue (short-term and long term) and the provision for losses on receivables, 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. The following table presents the DSO, account receivables balances, and deferred revenue as of June 30, 2011 and June 30, 2010. (in millions) June 30, 2011 June 30, 2010 Billed accounts receivable, net $ 341.3 $ 229.9 Unbilled accounts receivable, net 308.4 249.0 Total accounts receivable 649.7 478.9 Deferred revenue 332.7 261.1 Net receivables $ 317.0 $ 217.8 DSO ( in days) 69 49 The increase in DSO for the quarter ended June 30, 2011 compared to the quarter ended June 30, 2010, was due, in part, to short-term disruptions in the first half of Fiscal Year 2011 associated with the implementation of our new project accounting and billing system which caused some temporary delays in our ability to bill clients on a timely basis. However, DSO is favorably impacted by customer advances, which are included in deferred revenue balances. CASH FLOWS Net cash used in operating activities for Fiscal Year 2011 totaled $1.5 million and was generated by increases of $84.5 million in receivables (net of deferred revenues), a $37.4 million decrease in payables and other current liabilities, $14.5 million in deferred taxes, and a $10.0 million increase in other operating assets. These uses of cash were partially offset by $65.5 million of non-cash charges for depreciation and amortization, net income of $48.8 million, $16.2 million increase in net taxes payable, $10.2 million of non-cash charges for stock-based compensation, and $4.2 million of non-cash impairment charges. Net cash used in investing activities for Fiscal Year 2011 totaled $45.7 million, including $60.2 million of capital expenditures primarily for computer software and hardware, including a major upgrade to our ERP systems, and leasehold improvements; offset by $13.1 million for the redemption of marketable securities in foreign government treasury certificates. Net cash provided by financing activities for Fiscal Year 2011 totaled $36.6 million, including $30.5 million of net borrowings under lines of credit (including the refinancing of our outstanding debt in June 2011) and $7.7 million in proceeds related to the issuance of common stock in connection with our stock option and employee stock purchase plans. Net cash provided by operating activities for Fiscal Year 2010 totaled $157.7 million and was generated by net income of $41.5 million, a $61.9 million increase in accounts payable and other current liabilities, $60.3 million of non-cash charges for depreciation and amortization, $7.0 million of non-cash charges for stock-based compensation, $6.5 million of non-cash impairment charges, and $4.0 million related to increases in tax liabilities. These sources of cash were offset, in part, by increases of $9.7 million in accounts receivable (net of deferred revenues), and a $1.6 million increase in prepaid expenses and other current assets. Net cash used in investing activities for Fiscal Year 2010 totaled $92.3 million, including $79.0 million of capital expenditures primarily for computer software and hardware, including a major upgrade to our ERP systems, and leasehold improvements and $13.7 million for the purchase of marketable securities in foreign government treasury certificates. Net cash used in financing activities for Fiscal Year 2010 totaled $56.6 million, and consisted of $63.3 million of net repayments under lines of credit; offset, in part, by $6.8 million in proceeds related to the issuance of common stock in connection with our stock option and employee stock purchase plans. 39 -------------------------------------------------------------------------------- Table of Contents LINES OF CREDIT 2011 Credit Agreement On June 30, 2011, we, certain of our subsidiaries, Bank of America, N.A. ("Bank of America"), as Administrative Agent, Swingline Lender and L/C Issuer, Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPFS"), J.P. Morgan Securities LLC ("JPM Securities") and HSBC Bank USA, National Association ("HSBC") "), as Joint Lead Arrangers and Joint Book Managers, JPMorgan Chase Bank, N.A. ("JPMorgan") and HSBC, as Joint Syndication Agents, and the lenders party thereto (the "Lenders") entered into an agreement (the "2011 Credit Agreement") providing for a five-year term loan of $100 million and a revolving credit facility in the principal amount of up to $300 million. The borrowings all carry a variable interest rate based on LIBOR, prime, or a similar index, plus a margin (not to exceed a per annum rate of 1.750%). Loans outstanding under the 2011 Credit Agreement may be prepaid at any time in whole or in part without premium or penalty, other than customary breakage costs, if any. The 2011 Credit Agreement terminates and any outstanding loans under it mature on June 30, 2016. Repayment of the principal borrowed under the revolving credit facility (other than a swingline loan) is due on June 30, 2016. Repayment of principal borrowed under the term loan facility is due in equal quarterly installments for the annual periods as summarized below, with the final payment of all amounts outstanding, plus accrued interest, being due on June 30, 2016: • 5% of principal borrowed must be repaid by June 30, 2012; • 5% of principal borrowed must be repaid during the one-year period from July 1, 2012 to June 30, 2013; • 10% of principal borrowed must be repaid during the one-year period from July 1, 2013 to June 30, 2014; • 20% of principal borrowed must be repaid during the one-year period from July 1, 2014 to June 30, 2015; and • 60% of principal borrowed must be repaid during the period from July 1, 2015 to June 30, 2016. On June 30, 2011, we drew down $245.0 million under the 2011 Credit Agreement. The proceeds of the borrowing were used to repay indebtedness of PAREXEL owed under the 2010 Credit Facilities and the 2008 Credit Facility. We agreed to pay a commitment fee on the revolving loan commitment calculated as a percentage of the unused amount of the revolving loan commitments at a per annum rate of up to 0.400%. We also paid various customary fees to secure this arrangement, which are being amortized using the effective interest method over the life of the debt. The 2011 Credit Agreement contains negative covenants applicable to us and our subsidiaries, including financial covenants requiring us to comply with maximum leverage ratios and minimum interest coverage ratios, as well as restrictions on liens, investments, indebtedness, fundamental changes, acquisitions, dispositions of property, making specified restricted payments (including stock repurchases exceeding an agreed to percentage of consolidated net income), and transactions with affiliates. As of June 30, 2011, we were in compliance with all covenants under the 2011 Credit Agreement. Our obligations under the 2011 Credit Agreement may be accelerated upon the occurrence of an event of default under the 2011 Credit Agreement, which includes customary events of default, including payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, cross defaults to material indebtedness, defaults relating to such matters as ERISA and judgments, and a change of control default. As of June 30, 2011, we had $145.0 million of principal borrowed under the revolving credit facility and $100.0 million of principal under the term. We have borrowing availability of $155.0 million under the revolving credit facility. Principal in the amount of $150 million under the 2011 Credit Agreement has been hedged with an interest rate swap agreement and carries a fixed interest rate of 4.8%. This hedge will expire in September 2011 and we anticipate that it will be replaced by another instrument. As of June 30, 2011, our debt under the 2011 Credit Agreement, including the $150 million of principal hedged with an interest swap agreement, carried an average annualized interest rate of 3.5%. 2010 Credit Facility In September 2010, we entered into three short-term credit facilities of $25 million with each of JPMorgan, Bank of America, and KeyBank National Association ("KeyBank"), for an aggregate of $75 million (the "2010 Credit Facility"). In December 2010, we amended the credit facilities with JPMorgan and Bank of America to extend their respective expiration dates to June 30, 2011, and we replaced the credit facility with KeyBank with a short-term credit facility from HSBC in the amount of $25 million, which on December 31, 2010 was fully drawn and the proceeds of which were used to repay the borrowing under the credit facility with KeyBank that matured on December 31, 2010. These amounts were fully repaid with the proceeds from the 2011 Credit Agreement. 2008 Credit Facility On June 13, 2008, PAREXEL, certain subsidiaries of PAREXEL, JPMorgan, as Administrative Agent, J.P. Morgan Europe Limited, as London Agent, and the lenders party thereto (the "Lenders") entered into an agreement for a credit facility (as amended and restated as of August 14, 2008 and as further amended by the first amendment thereto dated as of December 19, 2008, the "2008 Credit Facility") in the principal amount of up to $315 million (collectively, the "Loan Amount"). The 2008 Credit Facility consisted of a $150 million unsecured term loan facility and an unsecured revolving credit facility up to $165 million. As of June 30, 2010, we had $212.5 million in principal amount of debt outstanding under the 2008 Credit Facility, consisting of $100.0 million of principal borrowed under the revolving credit facility and $112.5 million of principal under the term loan. Principal in the amount of $150 million under the 2008 Credit Facility was hedged with an interest rate swap agreement and carries a fixed interest rate of 4.8%. As of June 30, 2010, our debt under the 2008 Credit Facility, including the $150 million of principal hedged with an interest swap agreement, carried an average interest rate of 4.0%. As of June 30, 2011, all outstanding amounts under the 2008 Credit Facility were fully repaid with the proceeds from the 2011 Credit Agreement. In conjunction with this refinancing, we recognized $1.1 million of accelerated financing fees. Additional Lines of Credit We have an unsecured line of credit with JP Morgan UK in the amount of $4.5 million that bears interest at an annual rate ranging between 2% and 4%. We entered into this line of credit to facilitate business transactions. At June 30, 2011, we had $4.5 million available under this line of credit. We have a cash pooling arrangement with RBS Nederland, NV. Pooling occurs when debit balances are offset against credit balances and the overall net position is used as a basis by the bank for calculating the overall pool interest amount. Each legal entity owned by us and party to this arrangement remains the owner of either a credit (deposit) or a debit (overdraft) balance. Therefore, interest income is earned by legal entities with credit balances, while interest expense is charged to legal entities with debit balances. Based on the pool's aggregate 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. The gross overdraft balance related to this pooling arrangement was $50.2 million and $91.0 million at June 30, 2011 and June 30, 2010, respectively. However, on a net basis, we have surplus cash balances over all accounts for the respective periods. 40 -------------------------------------------------------------------------------- Table of Contents FINANCING NEEDS Our primary cash needs are for operating expenses, such as salaries and fringe benefits, hiring and recruiting, business development and facilities, business acquisitions, capital expenditures, and repayment of principal and interest on our borrowings. Our requirements for cash to pay principal and interest on our borrowings will increase significantly in future periods because we borrowed $245 million in Fiscal Year 2011 under the 2011 Credit Agreement to refinance our prior debt facilities and to provide working capital. Our primary committed external source of funds is under the 2011 Credit Agreement, described above. Our principal source of cash is from the performance of services under contracts with our clients. If we were unable to generate new contracts with existing and new clients or if the level of contract cancellations increased, our revenue and cash flow would be adversely affected (see "Part I, Item 1A-Risk Factors" for further detail). Absent a material adverse change in the level of our new business bookings or contract cancellations, we believe that our existing capital resources together with cash flow from operations and borrowing capacity under existing lines of credit will be sufficient to meet our foreseeable cash needs over the next twelve months and on a longer term basis. Depending upon our revenue and cash flow from operations, it is possible that we will require external funds to repay amounts outstanding under our 2011 Credit Agreement upon maturity in 2016. We expect to continue to acquire businesses to enhance our service and product offerings, expand our therapeutic expertise, and/or increase our global presence. Depending on their size, any future acquisitions may require additional external financing, and we may from time to time seek to obtain funds from public or private issuances of equity or debt securities. We may be unable to secure such financing at all or on terms acceptable to us, as a result of our outstanding borrowings under the 2011 Credit Agreement. In addition, under the terms of the 2011 Credit Agreement, interest rates are fixed based on market indices at the time of borrowing and, depending upon the interest mechanism selected by us, may float thereafter. As a result, the amount of interest payable by us on our borrowings may increase if market interest rates change. However, we expect to mitigate the risk of increasing market interest rates with our hedging programs described below. We made capital expenditures of approximately $60.2 million during the Fiscal Year 2011, primarily for computer software, hardware, and leasehold improvements. We expect capital expenditures to total approximately $65 to $75 million in Fiscal Year 2012, primarily for computer software and hardware and leasehold improvements. On September 9, 2004, our board of directors approved a stock repurchase program authorizing the purchase of up to $20.0 million of our common stock to be repurchased in the open market subject to market conditions. As of June 30, 2010, we had acquired 1,240,828 shares at a total cost of $14.0 million under this program. There were no repurchases made during the twelve months ended June 30, 2011. DEBT, CONTRACTUAL OBLIGATIONS, CONTINGENT LIABILITIES AND GUARANTEES The following table summarizes our contractual obligations at June 30, 2011: Less than More than (in thousands) 1 year 1-2 years 3-5 years 5 years Total Debt obligations (principal) $ 5,867 $ 15,000 $ 225,102 $ - $ 245,969 Operating leases 53,565 96,331 94,040 325,856 569,792 Purchase obligations* 20,971 12,759 3,429 16 37,175 Total $ 80,403 $ 124,090 $ 322,571 $ 325,872 $ 852,936 * includes commitments to purchase software, hardware, and services. The above table does not include approximately $62.2 million of potential tax liabilities from unrecognized tax benefits related to uncertain tax positions. See Note 14 to our consolidated financial statements included in this Annual Report on Form 10-K for more information. We have letter-of-credit agreements with banks, totaling approximately $7.9 million, guaranteeing performance under various operating leases and vendor agreements. We also have an unsecured facility consisting of a term loan facility for $100 million and a revolving credit facility for $300 million with a group of lenders (the 2011 Credit Agreement) that is guaranteed by certain of our U.S. subsidiaries. OFF-BALANCE SHEET ARRANGEMENTS We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors. 41-------------------------------------------------------------------------------- Table of Contents RESTRUCTURING PLANS In April 2011, we adopted a plan to restructure our operations to reduce expenses, better align costs with current and future geographic sources of revenue, and improve operating efficiencies (the "2011 Restructuring Plan"). For Fiscal Year 2011, we recorded $8.5 million in restructuring charges related to the 2011 Restructuring Plan, including approximately $1.8 million in employee separation benefits associated with the elimination of 54 managerial and staff positions, $3.6 million in costs related to the abandonment of certain property leases, and $3.1 million in impairment charges related to exited facilities. We expect to record additional charges of approximately $6.0 million in the first half of Fiscal Year 2012. In October 2009, we adopted a plan to restructure our operations to reduce expenses, better align costs with current and future geographic sources of revenue, and improve operating efficiencies. During Fiscal Year 2010, we recorded $16.8 million in restructuring charges related to this plan, including approximately $11.6 million in employee separation benefits associated with the elimination of 238 managerial and staff positions and $5.2 million in costs related to the abandonment of certain property leases. During Fiscal Year 2011, we recorded $1.4 million of provision adjustments, related primarily to employee severance costs. We believe that all costs associated with this restructuring plan have been recorded as of June 30, 2011. In Fiscal Year 2011, we recorded $1.0 million of restructuring charges related to older plans, primarily for changes in sub-leases of abandoned properties. INFLATION We believe the effects of inflation generally do not have a material adverse impact on our operations or financial condition. RECENTLY ISSUED ACCOUNTING STANDARDS In May 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-04, "Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs." ASU 2011-04 establishes a global standard for applying fair value measurement and is effective during interim and annual periods beginning after December 15, 2011. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In June 2011, the FASB issued ASU No. 2011-05, "Comprehensive Income (Topic 220): Presentation of Comprehensive Income." ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity and requires that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. 42-------------------------------------------------------------------------------- Table of Contents |