ICON PLC (ICLR) 2010 Q3 法說會逐字稿

Good day and welcome to the ICON PLC quarter three 2010 earnings conference call. For your information, this conference is being recorded.

At this time I would like to turn the conference over to Mr. Brendan Brennan. Please go ahead, sir.

Thank you, Saskia. Good day, ladies and gentlemen. Thank you for joining us on this call covering the quarter ended September 30, 2010. Also on the call today we have our CEO, Mr. Peter Gray, and our CFO, Mr. Ciaran Murray.

I would just like to note that this call is webcast and that there are slides available to download on our website to accompany today's call. I will now make the cautionary statement in relation to forward-looking statements.

Certain statements in today's call and/or may constitute forward-looking statements concerning the Group's operations, performance, financial conditions, 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 not 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, US 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.

Today's commentary refers to our third quarter ending September 30, 2010. Following on from many investors' feedback after the last earnings call, we will be limiting today's call to one hour and would therefore ask participants to keep their questions to one each, with an opportunity to ask one related follow-up question.

With all of that said I would like to hand over the call to Ciaran Murray.

Thank you, Brendan. In the third quarter, net revenue was $225 million compared with $220 million in the same period last year, which represents an increase of 2%. In constant currency terms, quarter three 2010 revenue increased by almost 7% over last year and by 1.2% over quarter two.

In the first three quarters of the year our top clients represented 9% of revenue compared with 6% last year. Our top five clients represented 33% of revenue, up from 23% last year. Our top 10 clients represented 51% of revenue, compared to 37% last year; while our top 25 accounted for 72% of revenue, compared to 56% in quarter three 2009.

We have noted in past earning calls that we expect client concentration to increase, given the shift towards more strategic relationships.

In quarter three, 44% of that revenue was generated in the United States compared to 45% last year; while in Europe, Middle East, and Africa the proportion of revenue decreased from 47% last year to 45%. And in Asia-Pac and Latin America, revenue grew from 8% last year to 11% this year.

Operating income for the quarter was $17.6 million compared with $30.4 million last year. Excluding the losses in the central lab, operating margins in the clinical business was 12%. Reported group operating margin was 7.8% of revenue in quarter three compared with 13.8% last year.

Net income for the quarter was $19.9 million compared to $24 million last year. Net margin for the quarter was 8.8% compared to 10.9% last year. Earnings per share was $0.33 compared with $0.40 last year.

During the quarter, a number of tax provisions reversed, resulting in a credit of $2 million, compared to our usual tax charge of around 18%. In quarter four, we anticipate further tax benefits; however, we maintain that our long-term tax rate will be in the region of 18% to 20%.

At the end of September our DSO was 36 days. This compares to 39 days at the end of September last year and 33 days at the end of December 2009.

Operating cash flow was $3.7 million in the quarter. We invested $6.9 million in capital expenditures during the quarter, and we now have $231 million of cash in our balance sheet.

I would like to hand over to Peter now to give you some overview on the quarter and to talk about the business environment and the outlook.

Thanks, Ciaran. We are pleased with the level of gross business awards, which were $317 million this quarter. However, we did have cancellations of $92 million, which included a $40 million-plus cancellation from a midtier biotech. This resulted in net business wins of $225 million, representing a book-to-bill of 1.

Cancellations in the quarter were at the higher end of our normal range. But on the slide that accompanies these comments, you can see that the 12-month trailing number of level of gross awards and our actual level of gross awards in the quarter are pointing to a good overall demand for our service and an improving picture.

By the end of September our backlog had risen to $1.9 billion. Of this we expect $679 million to be earned over the next four quarters, which is 73% of expected revenue in that period. This is the first time in almost a year that the value expected to be earned in the next four quarters has risen, which is a positive indicator for revenue growth in the future.

RFP flow year-to-date is up 15%. And taking the impact of strategic relationships into account, value of RFPs is about the same as last year. Overall, in our view, the market continues to solidify and improve.

We recognize that the performance of the central lab is disappointing. But as we shared in our press release, this business is doing very well in terms of building its backlog, partly from strategic relationships but also from its own business development efforts. Its trailing year-to-date book-to-bill is 1.8.

Over the last two years, we have been building out its global footprint, and we are reaping the benefit of this in the bookings that we are now achieving. But however, this has not yet translated into revenues, which actually declined further in quarter three, against our expectations.

We have been renewing the management team in the course of this year, and they are focused on bringing the lab back to breakeven as quickly as possible and continuing to drive growth to restore profitability. We're confident we can do this and expect to reach breakeven in the lab by the end of quarter two in 2011.

In Phase I, we improved in the quarter and expect further improvement in quarter four.

In Asia, we continue to invest and build alliances. The metrics Ciaran shared at the beginning of the call, which show that the percentage of our revenue being earned in Asia and Latin America has grown from 8% last year to 11% this year, I think illustrates the importance of our investments in the Asia region.

If we stand back and look overall, revenue grew as Ciaran said, by 7% on a constant currency basis. Our Phase II to Phase IV business performed well, as did DOCS and our Medical Imaging businesses, while the Development Solutions business, which includes Phase I, improved further.

For the year as a whole we continue to expect that both revenue and earnings per share will, as previously advised, come in at the low end of guidance. While there is some downside from the central lab performance, there is upside from tax; and we expect these two elements to offset each other.

We think the long-term outlook for the industry and for ICON is very positive, although the challenges our customers are encountering and the changes they are adopting in response to these are making the market a little choppy at present. But we continue to strongly believe outsourcing will continue to rise and that global CROs will benefit most from this. When you consider that our largest client last year contributed just $65 million in revenue, the scope for growth in the future is still very significant.

On a final note I want to update you that in the last couple of weeks we received a formal response from the FDA to our response to the warning letter they issued in 2009. While the matter is still open, we are encouraged by the nature and tone of their follow-up questions, which we will be responding to in the coming weeks.

That concludes the prepared remarks for the call, and I would like to hand over now to questions.

(Operator Instructions) Ross Muken, Deutsche Bank.

Good morning -- or I guess good afternoon for you guys. In terms of, Peter, your comments on the evolution of the business and obviously the fact that strategic relationships continue to be a more important part of the go-forward effort, how would you characterize how that is impacting the business; what you need to do to prepare for this change; and how you are thinking about it in the context of the revenue and profitability metrics going forward? From both a visibility perspective and I guess a magnitude of profitability.

I'm just trying to understand how this is clearly going to change both the business and the P&L going forward.

Okay. I suppose the short, quick answer, Ross, is we don't expect to change the profitability of the business in the future. The strategic relationships -- I think on the last call I highlighted the fact that in one of those relationships in particular, where a creative approach was being taken to the way in which we would work together with the client, there were costs we were incurring upfront that weren't being fully recovered and therefore were creating some drag on our margin in the near term.

I think I signaled that we thought we would be the other side of that by early in 2011. That continues to be the case.

As we price business in the strategic relationships, we have been very cognizant of retaining margins, but at the same time being very collaborative with our clients in sharing savings with them. So our objective is to protect margins and the clients' objective is to reduce cost. And in order to achieve that, both of us have to change the way in which we operate and streamline the way in which we do business.

So ultimately that means that we have to get smart in the way we run the business. We have to look at ways in which we can deliver the savings that we are promising to our clients.

And there's various ways in which we do that. One of the things we are currently working on -- it's a project that Ciaran is leading -- is to try to further consolidate the various service functions within the organization and ensure that we don't have duplication which obviously adds to cost.

Just one example of things that we are doing -- which I hesitate to call out, because they are things that one does in the normal course of business anyway as part of good management. But obviously as we respond to our clients' needs, we adjust our own business to ensure that we are operating as efficiently as possible. Hope that answers the question.

It does, but maybe just one quick follow-up. In terms of how these strategic relationships are evolving, we have heard a number of public announcements this year, whether it was from Lilly or Glaxo or sanofi, etc. What kind of network effect does that have in the business development effort in terms of your communication with other players who may not be quite where some of the larger players are?

And also, relative to some of the announced players who have pursued business, as we see some of these deals come to market I'm assuming this is the first step for some of those players, as opposed to it being them going all-in. Right?

So I am just trying to understand how some of this, this year, has affected the general business development effort.

I think to take a cliche or to add a cliche to what you have said, this is evolution, not revolution. So a lot of clients are changing, but it is through an evolutionary process rather than a big bang.

So there is change, and change will continue to take place in the way the clients interact -- in the way the clients structure themselves and organize themselves, the way they do outsourcing, and the way they interact with the CRO community.

In terms of the network effect, of course there seems to be a wave taking place in the industry. We began talking about this move towards more strategic relationships I think about two years ago. It has obviously gathered pace this year, but it still has many, many steps to go in its journey.

The networking effect is companies watch each other in what they are doing. And you won't be surprised to hear that consulting firms watch what is going on, and then begin to put a product together, and they go around and knock on every pharmaceutical company's door and tell them that they should do this or should do that, and that Company X is doing something that they should follow.

So naturally there is a network effect and a momentum effect that is behind this. And we are very cognizant of that and are responding to it in the way in which we interact with clients and people who are not clients.

Great. Thank you very much.

Sandy Draper, Raymond James.

Thanks very much and good afternoon. Maybe sort of a follow-up; I am not trying not to beat the dead horse here.

When you look at the strategic deals and what is going on, Peter, how would you --? On a quarterly basis, how much business is now influenced by stuff you have to go out and win for the quarter versus the strategic partnerships?

What I am getting at -- it seems to be not just momentum in terms of winning the strategic deals, but it seems like there is some persistence in momentum, or lack thereof, in bookings. When you get strategic partnerships or enough of them, it seems like if those partners are moving you benefit; and then if they are not, you're sort of stuck and waiting for them to come back. And you may not be able to win enough quarterly business to offset that.

Is that a fair assessment? If it is, is there a way to quantify it? Or maybe you can say that is just not an appropriate way to look at what is going on. Thanks.

Sandy, I think the way you have described it is very accurate. It's exactly the conundrum of these relationships that it is not a steady flow. It is not as if Company X is placing five studies per quarter and they are all the same size. How their pipeline is developing and decisions they make in relation to their pipeline is quite variable on a quarter-by-quarter basis.

So this month's top strategic partner might be next month's cold strategic partner in terms of business opportunities that arise. So the game has to be to develop a portfolio of those over the long term.

We are still doing 70%, I would say, maybe even more than 70% of our business on a tactical basis. So it's an influence, but it is not the dominant influence on what is happening in the bookings arena.

Great. That is very helpful, and I will drop out to keep the call short. Thanks.

John Kreger, William Blair.

Hi, thanks. Can you guys talk a bit more about the restructuring actions you are taking on the lab? How quickly will those savings start to kick in? And exactly what sort of changes are you making?

There is a long list of things, John. Obviously there are some headcount reductions. In fact, this week there are some headcount reductions in the lab.

And there are a variety of initiatives, including adopting outsourcing for some aspects of what they are doing; looking at their entire way in which they are managing their re-agent purchases, which is a huge cost in the lab.

In the write-off that we have in the quarter, we have got a write off of reagents, a significant amount of reagents, where the purchasing was undisciplined. Reagents have relatively short shelf lives, and because the forecasts of revenue were incorrect the reagents have gone out of date. And we have had to take a write-off in relation to those.

So there is a whole variety of things that we are looking at that can impact significantly on the cost base. Some of them will take longer to realize than others. For example, adopting outsourcing for some of their activities doesn't happen in a week or two weeks. It will happen over a period of time.

Hence my comments earlier that we expect the return -- at least the arrival at breakeven in the lab to not be achieved until the end of the second quarter of 2011. So we are talking about three quarters, including this one that we are now in, of work in order to get the cost base down to the appropriate level as revenues begin to move up to meet the cost base. Hope that answer the question.

It does. If you are willing -- the next time you report on the fourth-quarter call, what is the sort of loss in this business that you would find acceptable? I mean is it feasible (multiple speakers) half from here?

John, I suppose the answer to that is, I don't find any loss acceptable. But we would expect and we reported in the numbers that the operating loss in the quarter was $4.6 million. We would expect it to be below $4 million. And I won't make any more rash predictions than that at this stage.

We haven't got a proud record in terms of our forecasting on this business, and so I don't want to create more hope than is realistic at this stage. But we certainly expect some improvement in the level of losses in the fourth quarter and greater improvement, significantly greater improvement, in the first quarter of next year.

Very helpful. Thanks. Just one last one. I think a year ago, your non-lab operating margin was up closer to 14%. I believe you said on the call it was about 12% on this quarter.

Can you just walk us through what the drivers were for that reduction beyond the lab?

Beyond the lab, IDS is still dragging a little bit, John. We had expected it to come to breakeven in Q3; it posted a loss.

Also we are continuing to invest in Japan as part of our Asia-Pac strategy. So there has been a considerable increase in our capacity there since last year. We have talked about that I think at Q2, so that is driving the costs.

I think too, in general terms if you look over the past year we have added about 700 heads to our headcount on broadly similar revenue. This shows the sort of investment we are making in some of the headcount, in some of the strategic accounts in Asia-Pac, and in some of the places where we want to build that footprint. So I think they would be the principal drivers that I would point to.

Great. Thanks very much.

Tycho Peterson, ICON.

Okay, good morning, or good afternoon, I guess. Just wanted to follow up on the central lab issue. Just wondering if you can talk to the competitive dynamic for that business today?

I mean understanding there is a lot of market-related issues, but as you think about optimizing your cost structure there, you have obviously been a little bit under scale relative to some of your competitors in the space. Can you just talk to what you see as the competitive dynamics in central lab today?

Is there some risk as you are pulling costs out of that business that you may miss the upswing, if the market does really come back?

I don't think so, Tycho. By the way, you were introduced there as from ICON. Welcome to the Company. We are delighted to have you.

Thank you very much. Thank you.

The bookings that we are achieving in the lab, and 12 -- we have now had a year of very strong bookings. The trailing year-to-date, which is three quarters, is 1.8.

So the market dynamics as we see it for the lab business are actually good. Certainly the market dynamics for our lab business is good.

We have probably had a situation of being over optimistic in terms of how those bookings will convert. I think another factor in the mix here is that we have some specialization in the lab that means they get a reasonable proportion of oncology work. And oncology studies, as we all know, tend to be much slower to start up than other types of studies.

But if there is a flaw that we really need to own up to here, it is our forecasting of revenue in the lab business has been poor. It has misled us in terms of how we added cost in anticipation of revenues picking up. And that is where we need to make the adjustment.

In terms of our competitive positioning in the market, we think we are very well positioned. We are still one of the smaller players; we obviously recognize that.

But we are well positioned. We have the global footprint that we have been putting in place over the last two years. We just need to get our forecasting a little better and manage our costs appropriately.

I wish I could be -- I wish I had a better excuse than that, but that is the reality of what has happened here.

Do you anticipate more JV-type work like you have with Tigermed for that business?

Well, the JV, the alliance with Tigermed is actually in our Phase II to IV clinical business. We have a JV with Fountain Medical in China for the lab in China per se; and no, we don't anticipate further JV work in that region.

We think we have the global footprint we need in the lab now. We have labs -- our JV labs -- in the locations that are key to the development of the market.

One last place for us to look at is Japan. Some of our competitors have been making moves in terms of putting lab in place in Japan or forming alliances in Japan.

We don't -- we are not seeing the demand for that currently. It's one we keep under review. And obviously in circumstances where our lab business needs to get its house in order, that is probably not on the agenda in the foreseeable future.

Okay, thank you very much.

Robert Jones, Goldman Sachs.

Thanks for the questions. So just going back to this idea about revenue conversion, and I know you have touched this quite a bit already, but I was hoping we could maybe dig into the differences you are seeing on the backlog conversion.

I think I got an idea around the central labs. Could you maybe talk a little bit around the clinical side and just what you are seeing there as far as the backlog conversion?

I suppose what we are seeing there -- again, I alluded to in my opening comments, Robert -- for the first quarter in four, our next 12 months -- our forward 12 months' forecast of what will come out of the backlog has risen. It was, I think, $660 million (sic - see slide 13) last quarter and it is now $679 million in the current quarter.

So we are forecasting that out of our backlog of $1.9 billion, 600 and call it 70 million will come to revenues in the next four quarters. And that is, as I say, up from the forecast last quarter and the backlog has not changed that significantly.

So that begins to give us some indication that perhaps backlog conversion is at last beginning to emerge. I don't want to call the spring; this is one swallow we are seeing, so spring hasn't arrived yet. But the indicator is encouraging.

The kinds of projects that we are winning, that we won in the quarter, are -- there's no particularly long ones in them. So in terms of duration there is nothing there that we're going to come back and say to you, oh well, we won a couple of big ones that were really very long and therefore they burn slowly. No; we are back towards a more normalized level of duration for the projects that we won.

So I think all of that speaks to encouraging outlook for backlog conversion going forward. And I should say that the big cancellation, by the way, that I mentioned -- the mid-tier biotech company that has canceled a project of over $40 million. That had been sitting in the backlog for a couple of quarters. They were in discussions with the FDA.

We hadn't done any work on it or any significant work on it. So it isn't affecting our forward forecast, because it wasn't in our forward forecast over the last while because it was -- there was an uncertainty around it as the client discussed with the FDA.

We have taken it out because it doesn't look like the client is getting to any clarity with the FDA about proceeding in the foreseeable future.

That's helpful. That sounds a little bit encouraging. Just one follow-up then. I know you mentioned the response letter from the FDA.

I was just curious if you maybe could share next steps and timelines around that warning letter. Thanks.

No, is the short answer to that one. As I said in my comments, we will be responding.

They sent us some follow-up questions. We will be responding to that in the coming weeks.

When you think of the time frame that there was between our last response -- they sent us a warning letter towards the end of 2009; we responded in January; and we have just got a follow-up letter in the last couple of weeks. I don't think we should be overly bullish about a quick closeout of this.

We would obviously hope there is. We would obviously be -- as I said, we are encouraged by the nature of the response from the FDA and their follow-up questions. But I think this is a process that just takes time.

Thanks for the questions.

[Tim Evans], Wells Fargo.

Hey, guys, actually this is Greg Bolan in here. I am having some phone issues, but thanks for taking the questions. Now that we are nearly a year past the FDA warning letter, do you think ICON has experienced a meaningful impact on the win rate as it relates to larger clinical trials and/or partnerships and alliances?

I know that, I guess thinking back to the fourth quarter, I think Peter, you had kind of pontificated that maybe some smaller biopharma sponsors that were less in there with ICON might have kind of overlooked the Company and gone with someone else.

Can you talk about, now that we are nearly a year past when the actual letter was received?

Greg, I'll admit to being a Roman Catholic, but I won't admit to pontificating. I am not a pontiff yet.

But you are right. Last year, immediately after the warning letter we certainly had a couple of instances where clients told us they had not selected us because of the cloud or the issue that the warning letter created as they were making their decision. We have not had any repeats of that in the subsequent quarters.

When we look at our win rates, and we measure win rate versus RFP value, and we look at our win rates, they are running at the same sort of levels they were running last year before the warning letter came. So we don't think we are suffering any adverse effects of the warning letter at this point in time.

Now, you never know what you don't know. So is it possible that there are RFPs out there that we haven't got to see in the last year because of concerns over ICON getting an FDA warning letter? That's always possible.

But we have had no material indications that that is the case. And clients with whom we have had relationships for a long time have continued to give us RFPs, so we don't think that is a likely case.

But as I say, you never know what you don't know. But our win rate continues to run very well. It is in excess of 30% so far this year, so we are pretty pleased really with how that has been going.

That's great. Thanks for that. Just thinking about the backlog conversion for the central lab, this is more of a question about what is causing it.

Do you think that potentially it is maybe the growing competition for patient populations, especially in the hotter therapeutic areas like oncology, CNS, cardiology -- cardiovascular, excuse me? And that might be causing a slowdown in terms of the number of kits that are coming back to the central labs from the investigators' sites?

I don't know I suppose is the answer. But again, Ciaran, if you (multiple speakers).

Firstly, I don't think that is a follow-up question, Greg; I think that is a completely different question. But I will (multiple speakers) off this time.

No, I think it is hard to characterize it as that. You have a number of things going on. There is no one big thing.

I think it is the fact that the lab has had a great run of four quarters of business wins. We have seen larger wins in there than we have seen in the past. They're larger, therefore they are more complex and they have a longer duration.

They have also -- some of the bigger ones have resulted from strategic deals. The lab has been involved earlier in the process with the clinical group, therefore they are seeing the award earlier. And of course, as you say, the lab then is at the end of the chain for when things start to happen.

And there is probably in certain trials more complicated ones in oncology where there may be -- the complexity causes them to be slower; or if there is a trial where there is competition for patients, you would see a bottleneck.

But I don't think you could characterize any one of those things as being the primary driver. It is just the combination of those factors increasing the duration -- well, increasing the timeline at the startup and then the duration of the trial.

Understood, thanks. Thanks for the responses.

Todd Van Fleet, First Analysis.

Good afternoon, guys. I wanted to ask you about the cancellation that you experienced in the quarter; then I am hoping to squeeze in one about the central lab business mix as well.

But on the cancellation, you had indicated that it was a piece of business that you were kind of eyeing for a while, that hadn't really been going anywhere because of what was happening between the sponsor and the regulatory agencies. I guess I am just wondering is -- given the tumultuous healthcare situation that we have gone through here in the US over the past year or so, is there anything kind of big-picture or trends that you can point to that are occurring within the regulatory agencies that might lead you to expect that we could see maybe like what happened with your large cancellation this quarter? That maybe things could hang out there for a little bit longer than we are used to seeing?

I am just wondering, what is the risk to your backlog related to the type of event that we saw here in Q3 with respect to this one customer?

It's very hard to generalize, Todd. I think we all know that the regulatory environment is more cautious now, patient safety questions are larger. There is even a background where perhaps the agency is less inclined to allow a company move forward if there are other medications already available that are regarded as reasonable treatments and there is the slightest question about safety of the compound that is being brought forward and proposed to them.

So I think there is definitely -- the bar is higher for getting the agency to agree to clinical trials proceeding.

Typically when we have been involved in the tactical outsourcing environment, those issues have more often than not been resolved before the CRO is chosen, or they are well on the way to being resolved by the time CRO is chosen. In this particular case the client had done previous work on this compound and did not see any -- did not see the roadblocks that came their way and were surprised by the roadblocks that came their way. I don't think it is necessarily a readthrough to a pattern of behavior that we will see in the future.

And in the strategic deals, obviously one of the advantages of a strategic deal is we're involved earlier in the whole process of designing trials. Sometimes we are involved in the developing of a whole compound from cradle-to-grave, so to speak, certainly in a clinical sense. Obviously that can mean that as our backlog -- or as our relationship with the client on that particular compound develops, we can hit blocks.

However, in the nature of the way in which we are putting these strategic type of deals into our backlog, we do it as we go through each gate. And if you don't get through the gate, the next part of the program doesn't go into backlog. So don't think that the strategic deals are going to cause this to increase, because that is a question I got a number of times during the course of the last quarter.

In some ways it might mean that the strategic relationships will reduce the incidence of this happening, because we will be involved with the client and be aware of the discussions with agencies and so on from an early stage. So that is a long answer to your question.

I think the short answer is -- yes, the agencies are more conservative. Patient safety is even higher on the priority agenda than ever before. But we don't think it is going to necessarily change the pattern of cancellations that we have seen in the past.

Okay, thanks, Peter. That's helpful.

Then if I could, on the central lab business with the bookings activity that you guys are seeing, are you sensing any -- are you getting any shift in your customer base there as well?

I recall historically it was more small, midsized biopharma companies as opposed to the large clinical or large sponsors that you deal with on the clinical side. Is that shifting at all on these new bookings?

Yes, it is. That is one of the positive features of the growing backlog. And what they have been doing in the lab is more of their wins are coming from large pharma companies, and quite a number of them are being driven by companies where the clinical organization has a strong relationship and we are getting synergy from that relationship.

In some instances it's because there is a strategic deal in place. In some instances it's just relationship driven.

Good to know. Thanks.

Dave Windley, Jefferies & Company.

Hi, thanks for taking the question. Peter, you mentioned early in your comments that you have about 30% of revenue coming from strategic versus 70% on the tactical side still, and that -- to an earlier question -- the lumpiness of the bookings that could occur because of these strategic deals needing a portfolio, et cetera.

Can you give us a sense of how many relationships you have in what you would call strategic that contribute to that 30%? And then I guess again I am looking at the concentration building and wondering how that concentration is contributing to -- or not contributing to -- the coincidently rising cancellation rate through the year.

I am hesitant to answer the question about the number of strategic relationships, Dave, because it seems that in the industry there isn't commonality about what is defined as a strategic deal. If I give a number, it will either be regarded as very high relative to what other people are saying or very low relative to what other people are saying.

So one man's strategic deal is another man's preferred provider relationship is another man's tactical relationship. I don't think it is helpful for me to put a number out.

But I am quite comfortable that within our own minds we believe we would characterize about 30% of our bookings activity to be coming from relationships that we would consider to be strategic. I am not trying to be evasive; but at the same time I don't want to create a contest as to how many have you got, and how big is yours.

I was asked this question about three quarters ago, and I think I answered that we had 573.5 strategic relationships. I obviously had my tongue in my cheek when I was saying that.

But there is a lot of flux in the industry, and as I said in answer to an earlier question, it is evolving. What is -- what one company might consider strategic another company would regard as just a preferred provider relationship.

So it's a hard one to carry through. I would prefer not to put a number out. You had a second part of the question?

Understood.

Cancellations?

Right. (multiple speakers) So the second part of the question was --

I'll take that, Dave. Hi, how are you?

Okay.

Yes, I don't think it's strategic. Yes, you're right; our cancellation rate has been more elevated over the last number of quarters than we saw in the past.

I think it is driven more by the size of trials in the backlog and the fact that we are sort of converging towards the sector average of cancellation rates, where ICON tended to be below that some years ago.

I think it is just a reflection of, over the past few years as we have grown to our position, we have increasingly changed the mix of our backlog and we have more large trials as a component of that in the past. So the bigger the trials that you have in there -- obviously when one trial goes, it has a bigger number on it.

So if you were to look at the specifics of the cancellation this year, there is certainly no pattern that would suggest to me at this time that it is about concentration or strategic relationships.

I think that one of the big ones we had earlier in the year, a very specific set of circumstances around it; it wasn't from a strategic relationship. The big one this quarter, for instance, was just the circumstances of where that biotech was with its FDA negotiations.

So at this time I don't see that as being the driver. It is just the size of the trials that we have in there.

Okay, thank you.

Aiden O'Donnell, Davy Stockbrokers.

Hi, guys. I just wanted to ask you a quick question on -- what should we be thinking about for margins, operating margins, in Q4 and as we look into next year?

Also could you just maybe talk us through the guidance for tax similarly over the same period? Thanks.

I'm sorry, I didn't catch that question.

Sorry. Could you give us an indication of margins for the final, for Q4, and as we look into next year what we should expect? And similarly on tax?

Oh, tax? Okay. Yes, tax in Q4 we expect to continue to see some of the benefits that we have seen in Q2 and Q3. But they are not unexpected benefits and are very much of a one-off nature just related to how we structured our tax model and the process that you go through putting that in place with various audits and things like that. So next year we expect our tax to revert to its normalized 18% to 20% depending on where the revenue arises.

Okay.

As for the margin next year, we have not given guidance at this stage; and we will be giving our guidance as we did last year, on our Q4 earnings call.

For Q4, the only guidance outlook on margin that we have given is we have seen three quarters of actual numbers. We have said that we expect to come in at the lower end of our guidance. We haven't changed that comment since Q2, so that would characterize what our expectations are.

Okay, thank you.

Douglas Tsao, Barclays Capital.

Hi, good morning. Just a quick question, Peter. I was just hoping you could give an update in terms of some of the quality initiatives that you put into place or implemented at the beginning of last year, partly to address the FDA warning letter.

At the beginning of last year? At the beginning of this year, Doug? Yes.

This year, yes.

Well, the update on them is that we are doing them. And obviously the -- we have a variety of things which included some improvements to our processes. There were a number of training programs that we were doing. We have brought in some new people into QA.

We have put and developed new metrics coming out of our operational databases that give us better early warnings of any issues that might be arising in the monitoring or in the oversight of trials. It's a whole series of those.

And many of them, much of them are done at this stage. Although the big-ticket expense items -- which is bringing all of our staff worldwide into training sessions and refreshing their knowledge of procedures and GCP and all the things that are important when they are out there in the field, which is just something we decided we would do as part of a comprehensive response to the warning letter -- that is not completed yet.

To get 5,000 people into training sessions takes a lot of logistics and takes a fair amount of time. In our response to the FDA we said we would be continuing to do that into 2011, and that is the case.

So the major expenditures of the initiatives we started at the beginning of the year are well advanced. There are other initiatives that we're identifying as we go along.

We obviously have a very active quality process and a very active quality oversight within the Company. And there are other initiatives that we're identifying all the time and putting those in place. So it is hard to begin to call out special ones now, because there's a continuous process going on.

So, just from a dollar expenditure perspective, we should not expect additional cost? I mean in terms of the training it sounds like people have been coming into training; it is just going to continue on.

So would you think -- do you think that we reached a particular run rate that will continue into next year? Is that a fair characterization?

Yes, I wouldn't expect that there would be significant upticks, but I would expect that there would be a continuing level of increased expenditure through next year as we continue on putting in place the things we felt we should put in place.

Is there a point at which it comes back down to some lower level? Quality is not one that you can cut corners on, and it is clear that the regulatory environment is more vigilant today than it has ever been.

So I don't want to be rash and say, well, we will reduce our QA expenditure in the future. I don't think we will. I think we will continue to invest at maybe a slightly enhanced level of expenditure in QA than we were doing in previous years, even though in previous years we thought it was very adequate and very strong.

Okay, great. Thank you very much for taking the question.

Gareth Williams, Goodbody Stockbrokers.

Good afternoon, gentlemen. You may have alluded to this already just slightly, but just quickly -- are there any trends with regard to the type of business coming through the pipeline in terms of both stage of development and indication?

The short answer is no. No trends, no new trends coming through, Gareth.

Okay.

Nothing to report.

Nothing to report. Thanks very much.

John Kreger, William Blair.

Hi, thanks very much. I realize that you certainly don't want to talk about guidance before you give it formally in February. But as we think about the key variables behind that, Peter, it sounded like you are still saying that some of the uptick in coverage ratio ought to start to turn into better revenue growth in early next year. So I just wanted to see if we heard that right.

And when you think about the investments you have been making, such as ramping staffing, at what point do you expect to start to see more leverage from that? Should we view that as something that plays out all next year? Or are we coming to the end of that investment process?

I think the latter. I think we are coming to the end of that investment process for what we see in our book today, John. So the goal for us will be to get better leverage out of our infrastructure and our billable resources, our productive resources ahead.

In relation to does -- am I signaling that we will see revenue pick up in early 2011? As I said, one data point doesn't make a spring. But the better conversion or the slightly stronger conversion of the backlog looking into the next four quarters had an uptick in that compared to the previous three quarters -- is encouraging.

I think it is too early to say that means in Q1 of 2011 we will see stronger revenue growth. But I do think it signals that in 2011 we will see revenue growth.

Great. Thanks very much.

Steve Unger, Lazard Capital.

Hi. Peter, could you characterize perhaps the business or the RFP flow and the business flow for [you] from the small and midcap drug companies?

From the smaller midcap ones? I think I was saying at the beginning of the call, Steve -- I don't know if you heard that -- that volume was up 15% overall on a year-to-date basis.

When I look at it from the point of view of the breakdown -- got it here in front of me now. When I look at it from the point of view of breakdown this year compared to last year, actually small bio is up a little. Mid bio is up a reasonable amount. Large bio is about the same.

Small pharma -- and small pharma again would be companies really that don't have revenues; they are exploratory companies. Revenues down -- sorry, opportunities down significantly. Midsize pharma up a bit, and large pharma about the same.

Okay, and then just a follow-up on that. What is ICON doing I guess from a business development standpoint outside of the strategic relationships that is perhaps different to gain share amongst the small and mid areas?

What are we doing that's different? Different to whom or to what, Steve?

Relatively. Yes, relative to the competition.

I was going to probably give a politically incorrect, facetious answer, which I won't give to that one. I don't know what we do differently to the competition, because I don't have a good insight as to what the competition do.

I do know that what we do is segment our business development team into market segments. So we have people who specialize, for example, in small biotech, East Coast and West Coast. And we have others who specialize in midtier and so on.

We have therapeutic specialists who support them. And obviously the therapeutic specialty in oncology, for example, does a lot of work with biotech companies because there is a lot of oncology work being done at the biotech level.

Is that different to our clients? I don't know, but that is the approach that we take.

Got it. Okay. Thank you.

As we don't have any time for any further questions, I would like to hand the call back over to Mr. Peter Gray for any additional or closing remarks.

Thanks, everyone, for listening and for giving us the questions. We are pleased with ICON's performance in the nine months so far this year.

We are obviously disappointed with what has happened in the lab in the most recent quarter. It's been a challenging year with some disappointing performance; and we are encouraged, however, by the continued strength in our gross business wins and in the overall tone of the market.

We look forward with confidence to the quarters ahead. Thanks very much.

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