Parexel reported their Q3 2017 results on May 3, 2017 and in the process reinforced the importance of understanding backlog. Parexel communicated that they were changing their backlog reporting policy to be more in line with their peer group (other publicly traded clinical research organizations). Here is their change in methodology:
Old Policy: Backlog with a signed contract, letter of intent or written indication of an award (from client)
New Policy: Backlog with a signed contract or letter of intent and revenue must be expected to begin in 6 months
The impact of this reporting change was a downward adjustment of approximately $2B or 33 % of Parexel's total backlog. To understand the significance, $2B represents almost 9 months worth of net awards for Parexel. Let's take a look at the impact and have fun with some pro forma analysis.
Below is a 11 quarter backlog trend going back to Q1 2015 - you can see the dramatic decrease in Q3 2017 which is a result of their change in backlog policy.
Below, check out Parexel's quarterly revenue burn rate. As a reminder, revenue burn rate is calculated by dividing the current quarter's revenue by the current quarter's beginning backlog. So higher revenue and lower backlog equals a higher burn rate. Industry burn rates tend to be in the 13-15% range - there are always outliers, such as Medpace in the 20% range and Parexel at less than 10%. Not only has Parexel's burn rate been below industry norms is has also been trending down to below less than 9%. I always wondered why it was so low, now we may have an answer.
Pro Forma Analysis
I reduced Parexel's previous 10 quarters by 33% to be consistent with the recently announced Q3 2017 adjustment. I wanted to see if any unique trend would pop out. Nothing unique other than slow steady backlog growth. Keep in mind that this is a high level manipulation of the numbers, Parexel has not stated that all previous quarters would have been adjusted by 33%. I have also not taken backlog acquired through acquisition into consideration.
Here is where things get a little interesting. With the adjustment, Parexel's burn rate is still in decline but it jumps up to between 13%-15%, which is right in line with industry averages. More than likely Parexel's backlog to revenue conversion has been within industry norms, it was their backlog reporting that was perhaps a little too aggressive.
Is this adjustment good, bad or does it even matter? Backlog is not a profitability metric nor is it necessarily a harbinger of future performance, although it is true that revenue growth is expected to follow backlog growth. The real value of backlog is in the details and how a company uses their backlog details to plan operational capacity. I've discussed the importance of understanding backlog when doing an acquisition, but not having a solid backlog to revenue conversion process can cause a good deal of heartburn. If Parexel was keeping studies not expected to start in the next 6-12 months out of their near term revenue and resourcing forecast then they shouldn't have large amounts of extra capacity. Unfortunately, Parexel has announced restructuring charges of $49M-$63M are expected resulting in actions that will save $75M-$85M in 2018. As an outsider I'll never know, but I wonder if Parexel had implemented a more conservative backlog reporting policy would a global restructuring even be necessary.
Jason Monteleone is President at Pivotal Financial Consulting, LLC. Pivotal provides Divestiture Assistance, Acquisition Advisory Services and Strategic Planning to the Pharmaceutical Outsourcing Industry. Jason can be reached at firstname.lastname@example.org. Follow me on Twitter @JMPivotal. Sign up for Jason's latest blogs and updates at my www.pivotalfinancialconsulting.com.