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PPD Disappoints? Not Quite

Pharmaceutical Product Development (Nasdaq: PPDI  ) released its third-quarter earnings after market close yesterday, and with the stock down as much as 7.6% today in recent trading, investors are evidently less than pleased. The company, also known as PPD, did report flat earnings for the quarter, but a more in-depth analysis suggests that the pessimistic mood is greatly exaggerated.

PPD's net revenue rose 14.6% to $313 million, versus 2005's third quarter of $273 million -- hardly reason for panic. But income from operations came in at $52 million, an 8.3% drop versus last year, even after adjusting last year's results for new stock compensation expensing regulations. So what happened on the way to operating earnings?

The big difference between this quarter and 2005's third quarter is that Japan's Takeda Pharmaceuticals paid PPD $15 million last year for a discovery program, while this year, PPD received no such payment. As a result, the discovery sciences unit recorded a $1.7 million loss from operations, compared to last year's $13.1 million in income.

By contrast, PPD's core drug development operations continue to hum along. Income from operations in that division increased 23% to $53.6 million. Furthermore, backlog rose 25% versus last year's third quarter to $2.2 billion.

Of course, one shouldn't ignore the discovery sciences unit. The division, which in-licenses overlooked molecules, establishes their therapeutic potential, and out-licenses them to drug makers, is likely to be prone to fluctuations. PPD can't be expected to out-license new molecules every quarter.

Still, it must be conceded that PPD's discovery sciences work has yet to pay off, at least to any great extent. In 2005, the Food and Drug Administration denied approval for prospective premature-ejaculation treatment dapoxetine hydrochloride, which PPD licensed to Johnson & Johnson's (NYSE: JNJ  ) subsidiary ALZA. ALZA indicated at the time that it planned to continue development of the drug. Furthermore, the compounds PPD has licensed to Takeda are some time away from commercialization.

Ultimately, though, it seems prudent to remain patient on discovery sciences for now. If even one of the out-licensed compounds reaches the market, PPD will receive a nice ongoing revenue stream. And the incubator unit certainly doesn't appear to have taken away from the company's development operations.

For more on Pharmaceutical Product Development, check out these stories:

Johnson & Johnson is aMotley Fool Income Investorpick. Find more dynamic dividend payers when you try Income Investor free for 30 days.

Fool contributor Brian Gorman does not own shares in any of the companies mentioned. The Fool has a disclosure policy.

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