ICON Public Limited Company
Q2 2013 Earnings Call Transcript

Published: 26 Jul 2013

[Operator:]

Good day, and welcome to the second quarter 2013 earnings conference call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Mr. Simon Holmes. Please go ahead.

[Simon Holmes:]

Thank you, Deidra. Good day, ladies and gentlemen. Thank you for joining us on this call, covering the quarter ended 30th of June, 2013. Also on the call today, we have our CEO, Mr. Ciaran Murray; our CFO, Mr. Brendan Brennan; and Dr. Steve Cutler, Group President of ICON Clinical Research Services. I would just like to note that this call is webcast, and there are slides available for download on our website to accompany today's call. I will now make the customary statement in relation to forward-looking statements. Certain statements in today's call are or may constitute forward-looking statements concerning the group's operations, performance, financial condition and prospects. Because such statements involve known and unknown risks and uncertainties and depend on circumstances and events that may or may not occur in the future, actual results may differ materially from those expressed or implied by such forward-looking statements. Given these uncertainties and as forward-looking statements are no guarantees of future performance, investors and prospective investors are cautioned not to place undue reliance on such forward-looking statements. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. This presentation includes selected non-GAAP financial measures. For a presentation of the most directly comparable GAAP financial measures, please refer to the press release statement headed, Consolidated Income Statements Unaudited U.S. GAAP. While non-GAAP financial measures are not superior to or a substitute for the comparable GAAP measures, we believe certain non-GAAP information is more useful to investors for historical comparison purposes. [Operator Instructions] I would now like to hand over the call to our CFO, Mr. Brendan Brennan.

[Brendan Brennan:]

Thank you very much, Simon. Net revenue in quarter 2 2013 was $334 million. This represents year-on-year growth of 21%. On a constant dollar organic basis, year-on-year growth was 17%. Year-to-date, our top client represented 23% of revenue compared to 18% for the full year of 2012. Our top 5 clients represented 53% of revenue, up from 48% for the full year 2012. Our top 10 clients represented 66% of revenue compared to 63% for the full year 2012. While our top 25 clients accounted for 80% of revenue compared to 76% for the full year of 2012. And our headcount for the quarter was approximately 10,200 staff, which was broadly flat quarter-on-quarter, the new staff members that we added during the quarter being offset by planned headcount reductions across certain areas of the business. These headcount reductions resulted in a restructuring charge of $4.6 million in the quarter. In quarter 2, group gross margin was 35.9%, which compares to 36.1% in quarter 1 of 2013 and 35% in the comparable quarter last year. We continue to make good progress in our Phase II to IV business. However, this was somewhat offset by weaker than planned performance in our Early Phase business. And Ciaran will comment more on that when he gets to his remarks. We continue to leverage SG&A, which was 23.2% of revenue in quarter 2, 2013, compared to 23.9% in quarter 1 and 25.1% in quarter 2, 2012. Operating income, excluding restructuring charges for the quarter, was $30.9 million, an operating margin of 9.3% compared to 8.7% in quarter 1 and 6% in the comparable quarter last year. The net interest charge for the quarter was $100,000, and the effective tax rate was 14%. This tax added $0.02 to the quarterly earnings compared to a normalized 18% effective tax rate. Net income, excluding restructuring charges in the quarter, was $26.5 million, equating to EPS of $0.43 compared to EPS of $0.36 in quarter 1, 2013. Excluding the tax benefit that I just mentioned of $0.02, EPS would have been $0.41 in the quarter. DSOs in the quarter were 33 days compared to 33 -- again, compared to 33 days in quarter 1, 2013 and 36 days in the comparable quarter last year. At the end of June 2013, net cash was $184 million compared to $201 million at the end of March 2013. During the quarter, we had a number of annual payments raised into prior acquisitions, which amounted to $26 million. And CapEx for the quarter was a $7.8 million. All that said, I'd like to hand over to Ciaran now to talk more about performance in the quarter and the outlook for the rest of 2013.

[Ciaran Murray:]

Okay. Thank you, Brendan, and good day, everyone. Our encouraging start to 2013 continued during to quarter 2. Gross bookings for the quarter increased to $496 million, which equals the highest level that we've ever recorded. However, as cancellations in the quarter were $132 million, our net book-to-bill was 1.1. Our backlog, however, remains healthy at $2.87 billion, and this gives a 77% forward coverage of the next 12 months revenue expectations. Overall, we are happy with our progress against plan for the year. In the first half of the year, revenues increased 23% on the same period last year. And our operating margin was 9% compared to only 5.4% in the first half of last year. Some of you have been commenting on the gross margin in the quarter. So before discussing the outlook for the second half of the year, I will make some specific comments on our performance in the quarter. Gross margin was flatter, possibly down about 20 bps quarter-on-quarter. But that was really as a result of one specific factor. Looking across the business, I have to say I'm very happy our Phase II to Phase IV business had another strong quarter. We continue to develop new client relationships and have positive discussions with sponsors, around the adoption of new outsourcing approaches. Our Phase II to Phase IV operating margin continues to improve, and we expect this business to perform well during the rest of the year. During the quarter, we also integrated the management of our Central Laboratory business into our Phase II to Phase IV clinical services group under the leadership of Dr. Steven Cutler. This change reflects that our customers are increasingly looking for more integrated clinical and lab service to better leverage laboratory data to support the filing and performance of clinical trials. And the lab continues to perform to plan. The integration of our DOCS staffing and FSP business with the ClinForce and Assent acquisitions that we made during Q1 continue to plan, and we're happy with the progress that we've made this quarter. The gross margin was -- suffered because of performance in our Early Phase business. The Early Phase market continues to evolve, and we're seeing an increasing trend for more targeted studies that go directly into patient populations rather than the traditional healthy volunteer studies. This means we need to adjust our service offering to meet client needs in the future. On our last call in May, remember, we talked about how we had closed our Omaha Phase I facility and consolidated all of our North American capacity into an expanded facility in San Antonio. In this quarter, we've also reacted to market conditions. And we've reduced activity in our Manchester Phase I CPU in preparation for the transition of that business into the new translational medical unit that we're developing on the site of Manchester Royal Infirmary that we announced last year and which we expect to open early in 2014. As a result of these changes and the transition to a new business model, revenues for our Early Phase business were below plan in the quarter and we posted our last, hence, the impact on gross margin. We expect Early Phase revenue to continue to be weak for the remainder of 2013 while we complete this transition, and we have reflected this in our forecast. I'd like to conclude with some comments on the outlook for the rest of 2013. In the first half of the year, our performance is stronger than expected. And this has been driven by strong revenue growth. As we move into the second half of 2013, some of our strategic accounts will move from ramp-up into steady state. So while we expect revenue to continue to grow in the second half of the year, it will not grow quite as quickly as we have seen during the first half. A result of this growth is that we expect to continue hiring in the second half of the year to have sufficient resources to service our backlog. So we expect margin to continue to expand in the second half of the year but at a lower rate than we've seen in the first half of the year. Consequently, we are raising our revenue guidance to the range of $1.3 billion to a $1.32 billion and our EPS guidance to the range $1.54 to $1.64 for the full year of 2013. Before we move on to questions, I'd like to thank all of the ICON team. This has been another encouraging quarter. So I'd like to thank everyone for their continuing commitment and dedication and for helping us achieve what we've achieved in the first half of 2013. So having said all of that, operator, we will take questions now, please.

[Operator:]

[Operator Instructions] Our first question comes from John Kreger of William Blair.

[John Kreger:]

Can you just talk about where you stand, Ciaran, with some of the key renewals that have been a frequent topic on the last couple of calls?

[Ciaran Murray:]

Yes, I can. Since the last call, one of those renewals has been renewed. As you know, I'm not going to call out names on these calls. And the second one is in a very advanced stage. And we've largely concluded agreement and it's going through the process of signing. So we would hope to move that forward during the quarter -- this quarter.

[John Kreger:]

Excellent. And then my -- I guess, my one quick follow-up, as these relationships have renewed, are you seeing a structure change at all or just pretty much a status quo?

[Ciaran Murray:]

We are seeing certain changes but nothing revolutionary. I think everybody learns through these relationships as you go forward -- what has worked and not -- what hasn't worked. I think when you look at some of the assumptions that were made originally around the structure of the deal and the pricing of the deal and where the economic benefit comes, we've all learned from that. So I think the nature of these partnerships is that there's been a lot of commitment from both parties. And it's in everyone's interest that we continue to help our customers take out time and cost from the trials and improve the quality in the trials by closer arrangements and deployment of technology. And it's in their area interest that they have healthy CRO partners who are able to invest in a relationship and be viable financially and have a good future and good resources. So we've actually found the process so far to be encouraging and that the scope has been altered and then the -- modestly, but the assumptions have all been reviewed and we've all learned from experience. So if anything, I think they are sounder deals for everyone than they would have been on the first time that everyone did this. So I think we're seeing the continuing maturing and learning from these deals that started in the first round. And I think we'll continue to see that for a number of years, yes, as everyone goes forward in these.

[Operator:]

Our next question comes from Todd Van Fleet of First Analysis.

[Todd Van Fleet:]

The -- I just wanted to talk about Phase I, so maybe kind of your holistic thinking, Ciaran, on the outlook for that in the context of ICON and how you guys view the business. I know your guidance includes, I guess, some improvement or not so much of an operating loss in that business, so maybe just a little bit more detail on how you guys are thinking about that business not just this year but beyond.

[Ciaran Murray:]

I suppose I'll just repeat what I said for clarity when I said the revenues were below what we expected in the quarter due to transition. And we expect revenue to continue to be weak for the rest of this year. So I wouldn't characterize our forecast as having showing improvement there. But I'm not concerned about that. I mean, the holistic thinking on Phase I is that it's a very important part of the whole development of the drug process and it's important to our clients. We're in that business, and we intend to continue in that business. And we're very committed to Phase I. I think what we're seeing, though, as medicine develops and trials change, we're just seeing the market change. We're seeing more targeted studies and more work in patient populations rather than in traditional healthy volunteers. So we're committed to being in that space. But it's our job to make sure that we have a high-quality, relevant service offering for our customers to best service those needs. So as a result of that, during the course of this year, we've been looking at what's the best service offering that we can have and what's the best way to position our clinics for quality and performance for us. And we've taken some actions in that, and we're reviewing it to see what else we could take. We have a good offering there in San Antonio in North America with a Phase I clinic. And I think that last year, we announced that we are moving to a translation or medical unit in Manchester. That plan goes ahead. It's going to happen next year. It's a sign of a -- sort of a closer move towards those patient populations that our customers are asking for. And what we're really seeing in the interim period is at some point, you have to start to transition from an old facility to a new one. So we started that transition now. And it's meant reduced activity in one facility sooner than we would have anticipated when we did the original plan. But it's just an important part of the change to our new model and to make sure that we have the service offering that's relevant to the market and puts us -- makes us well-positioned for the future. So that's really what we're thinking for the rest of the year. It's just pretty much a work in progress, and then we position that business for 2014.

[Todd Van Fleet:]

So Ciaran, just a follow-up on that then. It doesn't sound like you're contemplating any changes to your existing footprint just in terms of geographic footprint, but rather just maybe shoring up the assets there a little bit. And is there a belief that, that market is going to come back more in your favor after you've made these transitions in 2014? I'm just trying to -- it doesn't sound like...

[Ciaran Murray:]

Well, yes -- no, I would hope so given that we're making those transitions. No, we're not changing our footprint. We're just changing the nature of our offering in terms of what we're providing to customers. And it's still our intention that the new clinic in Manchester will cover the European footprint. What we do in our business, constantly look at -- as business globalizes, we constantly have the footprint under review. I suppose as I look to the future, increasingly, we have to consider what footprint we'll want to keep relevant service offering in Asia. And we look at options there in the future. But for now, the footprint remains unchanged in that we are in North America and Europe and -- albeit with a slightly improved and more relevant offering for the market. And when that gets up and running in 2014, we expect the market to be there for us. That's the feedback that we've got when we made this decision.

[Operator:]

Our next question comes from Tim Evans of Wells Fargo Securities.

[Timothy C. Evans:]

Now that you've worked through some of these contract negotiations -- renegotiations, I should say, how do you feel about your long-term margin guidance? Do you feel easier or harder to get to that 12% target?

[Ciaran Murray:]

No, I feel the same. Tim, we've renewed these contracts, and people have been asking about them for a long time. But they haven't come out any differently from we would have expected 6 or 12 months ago. I mean, you always have to consider the possibility of unforeseen events. But based on the experience we had over the years of working through those contracts, we expected them to go the way they did. So that would have been factored into our original thinking on our long-term guidance range. So I would say that there is no change to that as a result of these renegotiations.

[Timothy C. Evans:]

Okay. And I think I heard you mention some modest scope adjustments. Is that pertaining to Central Lab? Or could you just elaborate on that a little bit maybe?

[Ciaran Murray:]

No, it's just a bunch of detailed things that are the elements of clinical trials versus certain things getting through that weren't in before like maybe safety or a different kind of technology service. So do you want to comment on that?

[Brendan Brennan:]

No, I think we're able to some of the technology that we're developing that we talked about at the Investor Day last year. And we did have relay that to some of the partnerships to show the value of that. And I think we're able to do that and to show that value that's going to the benefit of both parties.

[Timothy C. Evans:]

Okay. Just to be clear, the net effect of the scope changes is positive and not negative?

[Ciaran Murray:]

Well, I mean, the net effect is that there's more in scope of the contract. But I mean, I've explained this a number of times. I'm not sure -- we sign these contracts and these agreements. And it's good to establish the framework that we work with customers. But of course, as the future goes on, the amount of work gets placed under the contract depends on the activity in the customer and the robustness at their own pipeline. So these are MSA agreements. They are not volume commitments or revenue commitments. So what we have are MSAs that provide an expanded range of services, which you could suggest that if more of the work is placed under the MSA, then it's an increase in scope. But there are no guarantees of that. I want to be clear of that. It depends how much work comes in under the MSA depending on the activity and the client and the exact nature of what they choose to do.

[Operator:]

Our next question comes from Tycho Peterson of JPMorgan.

[Tycho W. Peterson:]

Can you maybe just talk a little bit about some of your strategic initiatives on particularly the IT investment, how those are tracking relative to your expectations? Is ICONIK starting to drive larger winds? And maybe, can you also just touch on pricing in the market overall as well?

[Ciaran Murray:]

Yes. We think our technology investment have been successful in positioning what we can provide to our customers. I think this quarter, we booked $496 million of business wins. This is the joint highest quarter in the history of ICON. I think over the last 7 or 8 quarters, probably 5 of them have been a record for that time and gone to a new level of business. And it's our -- it's some of our differentiated services and investments amongst the other investments we've done in market access, consulting and Late Phase and Firecrest and site management and the whole portfolio offering. But those technology investments specifically have been a significant part of that. And I think the results pointed to the fact that we're happy with the payoff. And your second question then?

[Tycho W. Peterson:]

Just on pricing trends, I mean, tying into that, are you able to extract better pricing with some of the better analytics? And then can you just talk about whether you're getting more push back on pricing from some of your larger customers?

[Ciaran Murray:]

No, pricing is largely unchanged. I mean, if you look at the nature of what we do, pricing isn't the primary driver in our market of why people choose CROs. And if you look -- the overall value that that's delivered -- or that should be delivered from these partnerships and partnerships that are more strategic level than the transactional business in the past is that together, we improve the quality of clinical trials, we deploy data, which -- and technology tools which CROs have developed with the aim of taking out significant amounts of time and, therefore, costs from the trial and getting it done quicker to a higher level of quality, getting data that can be used for improved signals on safety or performance during the course of the trial that can permit risk-based monitoring and significant changes to past practice that allow trials to proceed more quickly and at a lower cost. So it's a complex formula, a complex cocktail. And when it comes to choosing partners for these trials, obviously, we have to be competitive. And there is competition in the market. But the price isn't the main driver of choice, in our opinion. It comes down to the relationship with the customer, trust, past working conditions and what you have to offer now. So I would say within the complexity of all that goes on that results in these decisions that the pricing equation isn't any different now from what it was 12 months ago.

[Operator:]

Our next question comes from Dave Windley of Jefferies.

[David H. Windley:]

I wanted to ask about, generally, client concentration and your comments, Ciaran, about seeing some of your strategic relationships ramp and soon level -- get to a more steady-state level. If you could just kind of talk more broadly about maybe how much are those signings are and more specifically about where they stand. And then when do you expect that client concentration will flatten? And can it then turn back around and go back down?

[Ciaran Murray:]

I suppose comments on client concentration, it's -- I think we flagged it quite some time ago with that over time we expected initially to increase. I think we're all happier. The last concentration we have, I won't pretend to be happy with client concentration. But what it reflects is there are big deals around. And as you are good enough to win them and then digest them, it's got to spike your concentration. So where it comes down is that as the market continues to expand and there are more significant strategic deals, the best way for us to reduce our planned concentration and the preferred way is to win more of those deals, drive the revenue. There is a sort of a natural limit to the size of any particular account that will track the pipeline and robustness of that pipeline. I mean, it might go up and down and fluctuate over time and over the medium term depending on the customer's activity. And what we've seen is that it takes a couple of years to get up to full speed and running on these deals. So as you're on board in work, you're driving significant growth. I mean, we have a 23% of growth in the first half of the year. As we move forward on some of those accounts on the more recent ones, we've ramped up to levels of work. So our forecast show that revenue, significant revenue, still comes from those in it grows. But it's just logical that it can't grow to the extent that it has been where you're starting from close to 0 and ramping up to a significant level of opportunity. So as the question for when exactly concentration will follow, David, I just wish I knew. So we just have to make sure that we keep booking new work. And we've been successful in that. If you look at our business wins over the last year, they're pretty broadly based and we have added a number of new significant new clients to our roster certainly since probably Q4 of last year, a number have come on. So they will come up to speed over time. And they're in that earlier stage of onboarding. But it will take a while. I don't expect to see our concentration fall significantly in the course of this year. And then depending on what we win and what we can achieve over the next number of quarters, it will give us a chance to have a look at what it might be next year.

[David H. Windley:]

So moving on then, on cancellations, could you comment a little bit on the nature of those? Were they a lot of small ones? Or was there a large one that caused the higher level in the quarter? And were those studies that were canceled or scope reduced? Were those ongoing to revenue-generating projects? Or were they more further out in the backlog such that they don't have immediate revenue impact?

[Ciaran Murray:]

Yes, I can. Firstly, I'm happy to say there's nothing systemic in there. That number is actually driven by one large study. And that accounts for nearly -- well, the vast majority of it. And there is one study that got canceled due to safety issues for the drugs that were actually identified in a different study. But it was the same drug. So it had not knock-on effect us. It was an ongoing study, this one. It had started and it was -- we were working through it. So there will be a wind-down period involved and as we follow up on it. And it does mean that revenue that would have been in our forecast for the second half of the year won't be in our forecast. However, our new guidance that we've issued today does reflect all of these factors. So I think -- we think that's the high level. It's that it was ongoing. We factored that into our numbers that will wind down. And that it was just one of those reasons that studies get canceled in drug development. And I think when I look back, we had 2 $100 million plus cancellation quarters back in Q1 and Q2. At the time, they were higher than we'd seen in some time. It was then followed by 3 really low quarters. And I think recently, on -- it is a conference or maybe it was on this last earnings call, someone said, "Given that the cancelations have been low for 3 quarters, does this mean we're living in a different world? Is this a paradigm shift in cancellations?" And, of course, once you're asked that question, it's like driving through a punching primate [ph]. And so at the time, when I answered this, I just kind of said, "I really don't see any shift in the nature of cancellations." Generally, they happen. Clients change minds. Projects get delayed. There are regulatory issues in designing them. Or sometimes, they start and there are safety or efficacy issues later on that they change the approach to the project. And all we're really seeing now is that we're a much bigger company than we were in the past. And we do a lot more of big trials. So unfortunately -- I mean, the good news with big trials is when you win them, they go into bookings as big trials. But when they go for the normal reasons that they've always gone for, it's big studies that are coming out of the backlog. And that's all we've seen this quarter.

[David H. Windley:]

So when somebody asks you that question, you need to not answer your phone after that?

[Ciaran Murray:]

We think so, yes. I'll say go to Brendan.

[David H. Windley:]

Right. If you could call it -- just one more thing, if you wouldn't mind calling out kind of the round numbers, lab revenue and margin in the quarter, that would be helpful.

[Ciaran Murray:]

Yes, we've integrated the lab into our -- more closely in our clinical business. So we don't have the same -- we've changed the way we count it. Sort of the rationale behind this is really twofold. We have seen our strategic account set [ph] develop and just generally as the big data agenda has developed in our business, and more and more of our lab business is tied to other clinical projects and accounts, so the dividing line between where wins and revenue fall is a bit more blurred than it was in the past. And then of course, the other benefit of integrating that into the kind of main or core clinical business is the benefit of certain shared costs and certain synergies. So as we go forward, we won't have the same kind of information on that than we had in the past. It wouldn't be as meaningful. So for this quarter, we're still roughly tracking some of them and the business wins were -- the gross wins were up pushing $20 million, which is a little bit lighter than we've seen in the past, but there's nothing there that we believe is indicative other than a quarter, where some things closed and some didn't. And the profitability is sort of -- we used measure the net profit. Now we look at the contribution margin because of the nature of shared costs. But if we were measuring it under the old way, it probably made about 5% in operating profit. I'm looking at Brendan to confirm that.

[Brendan Brennan:]

Yes, yes, yes.

[Ciaran Murray:]

Maybe mid-single digit. So there's no fundamental change there. What you're seeing again is our ongoing effort to make sure that we reflect the change in market and demands of customers as everybody moves forward to partner up and to make sure that the industry together is driving the service offering and to the change and improve the efficiency of clinical trials. So there's no significant change there numbers wise, but we're seeing it integrated for market purposes, and that integration process will continue.

[Operator:]

Our next question comes from Eric Coldwell of Robert W. Baird.

[Eric W. Coldwell:]

I think everybody's questions are in the same mindset. So I'll pick up some scraps here at the end. Headcount target at the end of the year?

[Ciaran Murray:]

I suppose it depends if revenue comes through. I'd say it will be somewhere around 10,500 to 10,600.

[Brendan Brennan:]

Yes, 600. We might go as opposed to we have a 500, but the 600 is for good.

[Ciaran Murray:]

Okay. Well, we'll finish somewhere around 10,600 is the consensus of the people at this table.

[Eric W. Coldwell:]

Okay, fair enough. Tax rate, a little bit of a benefit this quarter, obviously, still a nice beat at the operating level, but what happened with the tax rate and should we be looking for that to carry through for the rest of the year? Or will you have to play catch-up over the next 2 quarters to get us back to that 18% area?

[Brendan Brennan:]

Eric, Brendan here. Just to comment on tax rate in the current quarter, I suppose we look at our business on a quarterly basis and obviously, we're always striving to get the tax rate as slow as possible. This quarter, we were -- we took some benefits from some legislative changes in the U.K., from the new R&D structure that they're talking about. We'll see how that pans out over the rest of the year. 18% is still what we're guiding for the full year, but there may be some opportunities based on that, some ledger numbers on the back end of the year, but we'll only know as we get closer to it. So 18% is still what we're talking about for the full year.

[Eric W. Coldwell:]

Okay. And a couple of quick ones here, certainly no surprise on what your comments regarding the Early Phase unit. I think you and everyone else has pretty much had the same issues. That's a relatively small piece of your business, and obviously, given the recent growth in the other lines as compared to shrinkage in Early Phase, it has to be even smaller than I used to think about. So I'm just curious if you can put this in perspective for us in terms of percent of total revenue in the most recent quarter, kind of in the ballpark.

[Ciaran Murray:]

Oh gosh, you're right, it's really small, Eric. And I'm now staring at Brendan who is fumbling with a calculator. So do not take silence as anything other than fumbling here.

[Brendan Brennan:]

That said, we've -- I mean, just specifically, I mean Early Phase be less than 5 -- less than, actually, even 4%, in that ballpark, so a very small part of the overall organization.

[Ciaran Murray:]

That's the whole Early Phase offering of Phase I clinics and Bioanalytical labs and services and all of that. The pure Phase I itself is smaller than that again.

[Brendan Brennan:]

Small, maybe beyond -- maybe even less than half that number again.

[Ciaran Murray:]

Yes. And last one, very squishy numbers here. Just more of a qualitative commentary. When you look at these record gross wins, what percent of them came from what you would deem to be your larger strategic clients versus, say, more traditional tactical kind of activity in the marketplace? Just trying to get a sense on momentum with newer accounts perhaps smaller accounts?

[Ciaran Murray:]

Yes, I mean, if you look at our sort of traditional market segmentation and their performance over the last couple of years, about 70% to 80% of our business is usually in the large and midsize pharma, the rest is biotech. And when we stratify that further, our kind of smoothing out, the average quarterly, it's usually 60% to 70% if it comes large pharma. And that goes up and down in any given quarter. And it depends. Recall that we have about 5 strategic accounts. Our top 5 accounts for about 53% of revenue. I think if you look at the wins this quarter, it's pretty much in line with that. The top accounts were driving somewhere between 50% and 60% of the business, and the rest then is coming from traditional transactional accounts and large pharma, midsize pharma. And then we've made some interesting progress in some biotechs, and some of those numbers have been in there for the last couple of quarters, too.

[Operator:]

Our next question comes from Declan Morrissey of Davy.

[Declan Morrissey:]

Just one question maybe on I think you might have touched on this already, Ciaran, with the competitive landscape and I suppose your outturn in terms of how much of it is growing your market share versus how much is the market growing overall?

[Ciaran Murray:]

I think anybody that's been in this business a long time knows that the [indiscernible] on market share and size is a nebulus at best. I think when you look at it, every CRO -- when it comes to terms of market and market share, every CRO has to some extent got its own ecosystem. And the drivers of our volume will often not be specific to the market or the robustness and activity of the pipelines and the customers with whom we deal. So when we look at the market, we can see that it's increasing because there's more outsourcing. And that outsourcing is concentrating in the hands of the top global CROs, as large partners are looking to choose the people with a full range of services, full geographic footprint, resources to invest and leading-edge technology and to deliver on significant projects and volumes. So that's what's driving our market, are those general factors supported by our individual customer relationships. I don't know, Steve, if you -- anything on the market that you want to say?

[Steve Cutler:]

We see a positive outsourcing environment. I think we see mid- to high-single digits as the market grows to the level. I think we feel we're in a good position to be able to take market share and benefit from the increased penetration. I think that's the way we see the market. So we see our growth similar to the top echelon of organizations and we feel good that we're taking market share from those smaller mid-tier organizations.

[Operator:]

Our next question comes from Ross Muken of ISI Group.

[Ross Muken:]

In terms of maybe the tuck-in M&A environment, it seems like there's been a lot of activity around outcomes-based firms, some of the IT-oriented entities. You guys were sort of at the forefront of that. What's sort of the next area or what other areas do you feel like are a fairly good interest in terms of natural places, maybe just bigger picture not specific companies, where you think folks will look next? And maybe from a bigger picture perspective, how competitive are some of these processes getting? You had a number of your competitors change hands, either to back to the public market or to other private equity players. How much does that sort of influence folks' activity from a BD and M&A perspective?

[Ciaran Murray:]

Ross, there's 6 questions in there and you're going to -- if I don't answer any of them, just remind me. Okay, I'll take what I think you asked me first, about the M&A activity and the kind of bolt-on sector, because that's very different, the discussion around private equity buying some of our competitors or larger CROs. I think the rationale behind our acquisitions has always been, we want to have the right service offering for what we think the market and our customers need. And so it involves our sort of strategic planning process. Involves identifying the market requirements and then assessing our own organization. We identify the market through talking to our customers and looking at it. We assess our own organizational gaps then to see where it fits and where it doesn't. So our recent acquisitions has been driven by fairly simple, look, we have a gap in our service line. It is perhaps something that we traditionally weren't required to do as much by customers. Such as the outcomes and the IT. And if we can't grow it organically or don't have enough of it internally, we make acquisitions. So we'll always be looking for a certain infill to build our services. So some of it maybe traditional areas and stuff that we do but it's -- it beefs us up in a geographic area hence the rationale behind the BeijingWits acquisition some years ago. Other ones are about any things that traditionally we didn't do that our customer now wants. We bought Oxford, PriceSpective and Prevalier, and when we got into the Bioanalytical space more significantly, Firecrest. And then things like ICONIK, we've just developed organically ourselves. So it's hard to say where it will go in the future. I imagine we will continue to add bolt-ons and, of course, our most recent ClinForce and Assent acquisition was around building scale to that business to make it more globally balanced, as it was weighted too much towards Europe. So looking forward, it'll depend to some extent where the market goes and we'll still be interested in making sure that our service relevant -- range is relevant. And perhaps scaling up on specific areas of that. As for asset prices, competitiveness of the process, we're very disciplined on what we're prepared to pay. And in the bolt-on acquisition space, that discipline has stood us well and the market is no more or less competitive than it was. I think when you look at some of the larger transactions you referenced from private equity and what it does to asset prices, well traditionally, private equity are prepared to pay more than strategic purchasers, and that probably still endures and then, we haven't changed our view on that. And that's all I remember you asking me. So was it anything else there, Ross, that I didn't answer?

[Operator:]

Our next question comes from Greg Bolan of Sterne Agee.

[Gregory T. Bolan:]

I was a little late getting on the call, so I apologize if you already addressed this. But did the Cross Country clinical coming a little bit below plan, because if I recall, it contributed about $7 million for less than 1 month in the first quarter and it looks like it's around, what, I guess, $11 million for the second quarter?

[Brendan Brennan:]

Well, just to -- Greg, it's Brendan here. I think that was more or less more close to 2 months and you're probably looking at FX movement there as well. So I think FX movement offset Cross Country. So no, it didn't come in off plan at all. We kind of -- I think the market knew the numbers in terms of revenue for that business in the first as we came into and acquired the business. So we were happy with how it progressed during the quarter and actually thought it was a very good quarter from a first full quarter integration point of view. So any offset that you're seeing in the dip there is more FX that it is Cross Country.

[Gregory T. Bolan:]

Okay, got it. And then this is probably a nonstarter at this point given the weakness in first-in-man study activity. But can you talk about your experience so far with partnering with the preclinical 0 and if this might be an area you might move into given kind of current valuations?

[Ciaran Murray:]

We haven't really done much in the preclinical space at all, traditionally. We don't intend to.

[Gregory T. Bolan:]

Right. But just kind of a current, I guess, unofficial JV that you guys have out there, with a preclinical 0, is that helping at all on the Early Phase side of things just given the weakness in study -- the first-in-man study activity?

[Ciaran Murray:]

I don't think -- firstly, I'm not sure what you're asking me because maybe we have a sort of an insignificant partnership arrangement that's in the portfolio, some of the consulting group services that, that would work. More at a strategic consulting level, some of our consultants will engage in certain preclinical discussions, but we don't work on it in a significant way. And so I suppose the short answer is, no, it's not contributing anything to what we're doing. And preclinical isn't really a significant business at all, but to be honest, I'm not even sure what you're referring to. It's not something that's significant enough to percolate up through the structure onto my radar, anyway. Apologies.

[Operator:]

Our next question comes from Robert Jones, Goldman Sachs.

[Robert P. Jones:]

Most of my questions have been answered. I guess, Ciaran, just one question, more strategically. I was curious if you could weigh in on, you've given enough data on your current strategic relationships. I'm wondering if you could maybe comment on the RFP environment for other more broadened or more strategic deals that you see out there?

[Ciaran Murray:]

I suppose I can weigh in and probably say the same thing that I've been saying now for a long time so I don't know how helpful you'll find it. But it's healthy and there are a number of ongoing discussions, as a number of organizations both traditionally in large pharma and increasingly in midsize pharma, look at ways to get leverage and stabilize cost base and do what we're doing, and what I've talked about is the rationale for driving these strategic partners. But these discussions can take a long time. Some of them, it's a lot of work, these are huge change management projects transformational for our customers. And indeed, for ourselves, at times. So there's a healthy level of discussions, there's quite a few of them ongoing. But I wouldn't want you to think that because we're engaged in a healthy level of discussions, I can actually forecast when RFP, they might actually arise. I suppose it's fair to say the good news is they've been going on -- ongoing some time, so the longer they go on, there must be some of them reaching the endpoint or towards the endpoint. And certainly, it would be fair to say that we are talking to some people who are well down the track. But it's very, very healthy is how I would characterize it. Albeit, it's competitive and they're big projects. So our customers have to work through their process and we will work through them, our potential customers, I guess maybe. We really work through them with that and then we'll see where it all goes and I'm looking at Steve again who is closer to this than me.

[Steve Cutler:]

No, I think you said everything.

[Operator:]

Your next question comes from Sandy Draper of Raymond James.

[Alexander Y. Draper:]

Most of my questions have been answered, I'll maybe throw a couple to Brendan to give you a breather here, Ciaran. Brendan, can you specifically call out what the FX impact was in the quarter or was it not meaningful enough to specifically pull that out?

[Brendan Brennan:]

It was not meaningful. That's my stock answer, but it wasn't actually. I mean that dollar-euro rate has been hanging around 130 for a long time, so that's the main mover.

[Alexander Y. Draper:]

Okay, great. That's the first one. Then the second one, this maybe being slightly too nitpicky, but if I look at your guidance and sort of take the midpoint of your revenue range and split it, it would look like you would actually expect to see probably a decline in net revenue in the third quarter then maybe rebuilding up. That maybe due to, I'm not sure, maybe Central Lab, maybe due to cancellations. I'm just trying to get a sense of is there any reason why you would actually expect total revenue to be down sequentially? Or I'm just trying to or maybe I'm just parsing numbers too finely there.

[Brendan Brennan:]

Yes, I think -- yes, I mean, I would view it generally more flatter in the midpoint than dipping down and then coming back up and obviously, Ciaran made reference to the bit of a dip down in the Phase I revenue, not significant, though. So I would just say it's probably more of a flatter teen on the midpoint of the revenue guidance.

[Ciaran Murray:]

Yes, I think to share your thinking there, Sandy. Firstly, I'd agree with you wholeheartedly, you're parsing numbers. And you can parse away. I think what you've look at is we have a complex business here and we have a lot of big customers and a lot of big studies. And so in the old days, when it wasn't as concentrated and studies were smaller, you had a bigger population of things within the sample of what could go right or what could go faster or slower as you looked at in the future. That is some of the events is sort of binary, if something starts on time, it can contribute significantly to revenue in a quarter. And if it doesn't, there's something ongoing that's delayed, it can move the numbers a lot. So we look at the trends in the first half of the year and there are things that made us happy. Revenues, that's growing very strongly, our trailing book-to-bill is good, the tone on business is good and then we turn that into financial models and look towards the rest of the year. And we start saying, as I always say, we do a range for a reason. We start to stress test it and we say, well, what if. As I mentioned, we have one large cancellation so that will take some revenue out of the back end of the year, but it's too early to tell exactly how much it will take out, you have to work through a wind down process, that the Phase I clinic is -- business is in transition with the changes in North America and looking at our plans for the new future Manchester. So we're kind of assuming that, that revenue will still be weak there. So things like that we factor in and then we just generally sort of try and give a range to give a prudent view and cover the bottom end. So I think what we're trying to give is the sense of where we think things should turn out but we wouldn't parse it that clearly in terms of taking the specifics of what does it mean at the bottom and the midpoint and the top, vis-à-vis revenue and margin. It's a more holistic view of where we think things will go.

[Operator:]

Our final question comes from Douglas Tsao of Barclays.

[Douglas D. Tsao:]

The operating margin improvement has been impressive. When I look at it, as far as we come through leverage at the SG&A line, we've seen some consistency or certain stability at the gross margin level. 36% range in recent periods, although which is still several -- a few hundred basis points below the peak margins, that gross margins that we saw a few years ago. I was just curious in terms of perspectives on the opportunity to get the gross margins back to where they were in the 2008, 2009 time period?

[Ciaran Murray:]

Yes, I suppose I'll take that initially and then Steve and Brendan can weigh in their views, because I'm sure they do. I think the first thing to sort of say is that the improvements in the operating margin has been driven by SG&A control. But it's not accidental nor was it unforeseen. And if you go back to that 2008, 2009 period, the way I kind of seek to understand it in my own head and the way I would characterize it and how we approached our business model and our plan is that it was after sort of 2009 that we started to see a shift in the market, and we started to see more talk of strategic partnerships, with ranges of service and more volume. And so when we approached the change in the market and when we aligned our strategy to say we believe we should play in this market and we believe we should win at least, if not more than our fair share. Our pricing model sort of reflected the fact that we knew it's significant volume if we controlled our costs and managed them properly. We still took hard work in diminishing the fantastic contribution of our managers, and finance team who have done that. But we knew that was there, so we were able to model a situation, in which our pricing model reflected we were trading a little bit of gross margin for the fact that we would get more volume and get more leverage. That therefore made us competitive and helped us to win significant amounts of business and has driven our growth there over the last sort of couple of years. As I say, 23% in first half of the year. So I kind of say that you nearly have to look at the 2 together to get a balance of what we were trying to achieve. So when I look back at the 2008, 2009 gross margins, I mean, at one point, and I'm not sure it was then, I mean we were doing 44%, 45% gross margin. I think the changed nature of our business means that you can never say you'll never see those numbers again, but I wouldn't expect to see it in my lifetime or even in the distant future. But what we have seen over the last 2 years is, I think, our gross margin probably dropped what 32% or 33%...

[Brendan Brennan:]

About 33%.

[Ciaran Murray:]

In the back end of 2011, that will be quarter 3, and we've seen a steady improvement in that. But we've seen more improvement in the clinical services part of the business and it's still been dragged back by, for instance, the changes we're making in the Early Phase business. And again, that's not accidental, this is a good time if you want to change your business model, if you want to invest, we think it's an area we're very committed to. Phase I and Early Phase, we think, is an important part of our portfolio. So now is a good time for us to suck up any pain while the business is growing robustly, while we're growing at the top line and we're growing our bottom line significantly, this is the time to do these things rather than wait too late. So I see further gross margin recovery, and I just see it coming from slowly improving our operational efficiency, growing the business and getting more leverage. Also, as you invest in new accounts, there is a time lag. You're kind of loading the staff a little bit ahead of the curve. So every quarter that we book -- book-to-bill that's higher than our revenue, that's one point something means another quarter where we're going to be hiring staff and we're going to be doing that a little bit ahead of our revenue growth. And I think if I would look back, it would be safe to say the highest margins that we achieved were generally at times when our revenue growth wasn't as significant. So that's how I would think about it. Steve, anything you want?

[Steve Cutler:]

No, I think that's right. We certainly see different parts of our business having greater or lesser opportunity in terms of the gross margin business. And I think the clinical business is one that does have continued opportunity to improve our margin, so we're very focused on doing that. But there's a lot of hard work involved and we think we can make progress, but it will be over the longer term rather than the shorter term.

[Douglas D. Tsao:]

Just as a couple of follow-ups to that. And thank you for all the details, but just to clarify, so Ciaran, should we interpret that, that in the core clinical research business, that the gross margins have largely recovered to close to where they were and that some of the sort of the contraction versus where you were several years ago is in the Early Phase business? Or is it a reflection of just sort of the trade-off between the volume and that you got through some of the new relationships and pricing? Just to get some clarity.

[Ciaran Murray:]

I suppose -- and there I thought I was crystal clear, Doug. And wouldn't it, so your question. So I'll try again and this time, with more clarity. Look, it depends firstly where you think when you say margins where they were. I'm always nervous when nobody says exactly, what the number is. But I think what I'm trying to say is that now and over the next few years, I don't foresee gross margins at 45%, which I'm assuming is what you mean is where they were in 2008 or thereabouts. So what I'm saying is that the clinical business has been recovering, obviously, we've been driven off the trough by a recovery in the clinical business, and those margins are higher than our group margin, therefore, they are gradually moving back towards the level that we've seen in the past. But I don't necessarily expect them to get to mid-40s because of that trade-off between -- with new pricing models, where our deals tend to be at a lower gross margin than they were in the past, but we're seeing the benefit of that in the leverage of the cost base. So I still expect the operating margins, I mean, we've talked about our kind of short -- short/short-medium term 10% to 12% target. We set that target at a time when we made nothing in Q3 2011. And we've made pretty steady progress towards that with 9.3% in the last quarter. So the clinical business margins are recovering towards historic levels, but I don't think they'll necessarily go to that peak.

[Douglas D. Tsao:]

No, no, absolutely. And I mean, do you think, over the long-term, there are opportunities for you to optimize your staffing model to potentially recapture even additional ground, even given sort of the change in the pricing model?

[Ciaran Murray:]

Yes, I mean, it depends. You can recover some ground in terms of -- we continually drive efficiency with the way we run the business and adopt, say, more centralized monitoring practice, leveraging technology or more efficiency at the site with tools like FireCrest or a better project management information with the ICONIK of this world and we drive efficiency. However, in the business that we're in, we're very closely allied to a relatively small number of partners and potential partners. I mean, our top 25 customers are 80% of our business. So what we tend to find that the pattern of our business is that it's our job to be competitive and to help our customers take out cost and time. And that's the value of the ongoing long-term strategic relationship. So when we do find ways to increase margin and -- or improve productivity and performance, we tend often, after some time, to pass this benefit or some of this benefit on to our customers, and that becomes part of what makes us competitive, what makes us a valued partner, which makes us a valid long-term CRO that people have wanted to work with and continue to want to work with. So there is some potential there, Doug, but it is limited by the nature of our business.

[Operator:]

That will conclude today's question-and-answer session. I would now like to turn back the call to Mr. Ciaran Murray for any concluding remarks.

[Ciaran Murray:]

Okay. Well, thank you, everyone, for listening today. I'll just conclude and summarize by saying that we're very pleased with the progress we've made in the first half of 2013 and we expect to be working very hard during the remainder of the year to continue to position ICON as a global CRO partner of choice in the industry and delivering the best-in-class information and solutions and performance. So thank you, everyone, and good afternoon from Dublin.

[Operator:]

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.