PAREXEL International (NASDAQ:PRXL) is having no trouble winning contracts. But the contract research organization's profitability has faltered even as backlog grows. While it tries to put its house in order, fierce competition continues to pound the small company.
PAREXEL's fiscal first-quarter service revenue increased 6.1% to $138.4 million, while its net income under generally accepted accounting principles was $3.3 million, down 42% from $5.7 million last year. The company's net earnings were negatively affected by a temporarily high tax rate and some special charges, but even after taking these factors into account, income from operations on a pro forma basis was still down 30%.
Business flow, however, remains solid. Backlog as of Sept. 30 increased 6.7% sequentially and 20.6% year over year to $782 million. The real challenge seems to be with the profitability of contracts. Gross margins were down in all three of the company's operating units. Consulting and marketing services, the company's second-largest unit, saw the steepest decline, with gross margin dropping 3.9 points year-over-year. PAREXEL's other units, clinical research services and perceptive informatics, did not perform much better, though -- they recorded gross margin drops of 3.3 and 3.6 points, respectively.
PAREXEL acknowledged that profitability in its North American business is weak. Part of the problem may be size. Aggregate research and development spending from large pharmaceutical companies such as Pfizer (NYSE:PFE) and Eli Lilly (NYSE:LLY) has been growing somewhat more slowly in recent quarters. As a smaller company, PAREXEL may be forced to accept low-hanging fruit as larger competitors capture the more lucrative contracts.
There may be light at the end of the tunnel. The company has redirected its energies outside the U.S. to the point that North America contributed just 36.5% of sales this quarter. Further, PAREXEL indicated that non-North American backlog is more profitable and is growing nicely. But it will take some more time before PAREXEL finds the right mix. For now, this may be one stock to avoid.
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Fool contributor Brian Gorman is a freelance writer in Chicago. He does not own shares of any companies mentioned in this article.
