Medpace Holdings Inc (MEDP) 2016 Q3 法說會逐字稿

Good morning and welcome to Medpace's third quarter 2016 earnings conference call. Before we begin, I will read Medpace's Safe Harbor regarding forward looking statements. During today's call, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This may include statements about Medpace and expectation regarding backlog conversion, plans and expectation regarding the treatment of stock base awards, plans and expectations regarding customer exposure, customer mix and customer profile and expectation regarding growth initiatives, plan and expectations regarding outstanding debt structure and another expectation regarding anticipated, financial and operational results.

These statements involve inherent assumptions, with known and unknown risks and other important factors that could cause the Company's future results to differ materially from management to current expectations. Including those discussed in the risk factor section in the reports filed with the SEC. Management disclaims any obligation to update forward-looking statements in the future, even if estimates change. Accordingly, you should not rely on any of today's forward-looking statements as representing management's views as of any date after today.

During this call, management will also be referring to certain non-GAAP financial measures in reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as attachments to the earnings press release and earnings call presentation slides. To the extent that management uses non-GAAP financial measures during this call that are not reconciled to GAAP measures in the earnings press release or earnings call slides, management will provide reconciliation properly on the investor relations section of the Company's website.

With that that said, I will now turn the call over to Dr. August Troendle, Medpace's president and Chief Executive Officer for opening remarks. Dr. Troendle, you may begin.

Thank you, operator. Good day, everyone and thank you for joining us on Medpace's third quarter 2016 earnings call. With me on the call is Jesse Geiger, our Chief Financial Officer and Chief Operating Officer of laboratory operations. I will begin with a brief overview of business activity for the quarter and then turn things over to Jesse for more detailed review of our financial performance and our 2016 guidance. We will then open the call to questions.

Please refer to slides three and four of our earnings call presentation. Net service revenue for the quarter grew 16.1% compared to the prior year period. Year-to-date net service revenue grew 17.4% over the prior year period. These changes represent entirely organic growth.

Net new business awards entering backlog for $109.1 million which represents a slight decrease sequentially over second quarter and a net book-to-bill ratio of 1.15 for the quarter. A ratio below are trailing 12 months average net book-to-bill. Although the target ratio was on -- I'm sorry, although the ratio was on target for our base expectations, it was a bit disappointing relative to our strong business environment that we've experienced.

It should be emphasized that business development activities remained quite strong. And we believed that we've had good RFP flow, both in terms of total dollar and quality of opportunities. While we do not break out gross awards or cancellations, I would like to note that our long-term average cancellation rate is between 4% and 5% of opening backlog each quarter. We have no reason to believe this cancellation -- that cancellations will exceed this range in Q4.

Total backlog at quarter end was $480.4 million, an increase of 14% compared to the prior year period. We project that approximately $280 million of that will convert to revenue in the next 12 months. Backlog conversion in Q3 was 24.4% of opening backlog for the quarter, which is above our longer term expectation of 19.5% to 20%.

It has been running a bit higher in 2016, and we expect that to normalize going forward. It should be pointed out that our revenue projections do not use an estimated net conversion rate. The projected net conversion rate is a product of our revenue projections, not the other way around. I think this is something that is often misunderstood.

Head count is up 28% as of September 30, 2016 compared to September 30, 2015. As we prepare for expected continued strong growth in the next year. However, our go-forward head count growth should be roughly in line with revenue growth. And with that, I'll turn the call over to Jesse to review our performance in more detail.

Thank you, August, and good morning to everyone listening in. Moving now to our key financial highlights and trends on slides five and six. I would note that foreign exchange did not have a material impact on our reported net service revenue, either in the quarter or for year-to-date period.

As August mentioned, we achieved net service revenue of $98.8 million in the third quarter, which represents growth of 16.1% from $81.6 million in the third quarter of 2015. Adjusted EBITDA of $29.5 million increased 13% compared to $26.1 million in the third quarter of 2015. Our calculation of adjusted EBITDA in the third quarter includes adjustments for one-time IPO-related costs and stock compensation expense, offset by the principal portion of our corporate campus lease payment.

Of note, the only portion of stock compensation expense being adjusted for in the third quarter is related to a mark-to-market adjustment associated with our liability-based awards. These awards were effectively modified upon completion of our IPO and will be accounted for as equity-based awards going forward. In connection with this modification, one final mark-to-market adjustment was necessary to reflect the value of these awards at our IPO value. As such, this period represents the final quarter of mark-to-market related adjustments included in the stock-based compensation expense.

Moving forward and consistent with our approach to date, we take a holistic approach to our ongoing stock-based compensation as we do not add this expense back in calculating our adjusted EBITDA. Adjusted EBITDA margin for the quarter declined 80 basis points to 31.1% versus 31.9% in the prior year period, primarily attributable to increased hiring in anticipation of future growth. GAAP net income for the quarter was $5 million compared to a GAAP net loss of $133,000 in the prior year third quarter.

Adjusted net income of $15.1 million grew 36% compared to $11.1 million in the third quarter of 2015. Adjusted net income growth was driven by strong top line performance and a reduction in our interest expense, partially offset by the decline in adjusted EBITDA margin. GAAP net income per diluted share for the quarter was $0.13 compared to $0.00 in the prior year period. Adjusted net income per diluted share of $0.40 grew 13.3% versus third quarter 2015 adjusted net income per diluted share of $0.35.

On slides seven and eight, we have provided a breakdown of our customer concentration by revenue across three key categories for both the third quarter and year-to-date periods. As well as the comparable prior year periods. It is typical, we see a higher heavily of variability for these metrics on a quarterly basis well to the year-to-date periods.

In terms of our customer composition, we have seen further diversification of our therapeutic mix. Oncology remains our single largest therapeutic area, while we have seen an encouraging uptick in our anti-viral, anti-infectious disease therapeutic area. With regard to our mix by customer size, we remain focused on serving our core market of small and mid-sized biopharma customers that represent a large portion of our total business and a segment of the market where we see a significant runway for growth still ahead.

Meanwhile, we continue to selectively capitalize on opportunities with large pharma customers on projects that fit well with our full service model and approach to clinical trial execution. A byproduct of our focus on small and mid-sized biopharma customers is a well-diversified customer mix. With our top five and top ten customers representing roughly 25% and 42% respectively of our total revenue in the quarter.

Slide nine provides a summary of our leverage and liquidity positions, as well as a schedule of our free cash flow conversion for both the third quarter and year-to-date compared to the corresponding prior year periods. Before touching on our capital structure, I would highlight the sequential rebound in cash flow over the second quarter as we generated cash flow from operations in the third quarter of $42.2 million. Furthermore, we saw a notable decrease in net day sales outstanding which we had anticipated would occur following the predominantly timing related fluctuations exhibited in the second quarter.

We have seen no notable deviations from recent trends in the credit risk profiles of our current customers and we continue to view customer balance sheets as well funded. During the their quarter, we utilized both the net proceeds from our initial public offering as well as $35 million of available cash to repay $210 million of our outstanding senior secured term loan facility. The resulting net debt position at quarter end of $150.4 million composed of gross debt of $165 million and cash of $14.6 million, represents a sizable reduction in our net leverage ratio which now stands at approximately 1.3 times.

Overall, we believe our post IPO capital structure, particularly in light of our strong free cash flow profile and low leverage level, provides us with sufficient flexibility to pursue continued growth initiatives. In addition, we plan to further evaluate our outstanding debt structure with the intention of optimizing our overall cost of capital. Moving now to our newly established guidance for 2016.

As shown on slide ten, we forecast net service revenue in the range of $368 million to $371 million for the full year 2016. Representing growth of 15% to 15.9% over 2015 net service revenue of $320.1 million. 2016 adjusted EBITDA is expected in the range of $112 million to $114 million. Representing an adjusted EBITDA margin of approximately 30.4% to 30.7%.

Additionally, we forecast 2016 adjusted net income in the range of $54.5 million to $56.5 million, representing growth of 34.9% to 39.9%. And $1.51 to $1.56 per diluted share. Lastly, we forecast 2016 GAAP net income in the range of $18.7 million to $20.2 million. And GAAP earnings per diluted share are expected in the range of $0.52 to $0.56.

And with that, I'll turn back over to the operator so we can take your questions

(Operator Instructions) Our first question comes from Dave Windley from Jefferies. Dave, your line is open. If your phone line is muted, could you please unmute the phone line? Again, Dave, your line is open. Could you please mute or pick up the handset?

Did you want me to go ahead and move onto the next person?

Sure, we can for now.

Okay. Our next question comes from Erin Wilson from Credit Suisse.

Great. Thanks for taking my questions. You're not giving 2017 guidance yet, but any comments on how that's kind of shaping up in terms of your -- or, I guess, versus your initial expectations in terms of the types, durations, stages of the projects and the backlog? And can you speak to the RFP volume trends that you are seeing? I think you briefly commented on it, but any sort of elaboration, that would be helpful. Thanks.

Sure. Thanks, Erin. From an RFP standpoint we're seeing a strong pipeline of opportunities. We're seeing good opportunities in the pipeline. As far as 2017 guidance, we'll be providing that on our next quarterly call when we release our fourth quarter results. What I can say in general is that we're still very confident in double-digit top line growth, maintenance of EBITDA margins in the 30% to 31% range going forward.

Okay. Great. And then you mentioned further diversification in the therapeutic mix. Can you talk a little bit about the infectious disease area that you're diversifying into?

I know it can vary widely across that therapeutic category but how would you characterize the infectious disease types of projects compared to, let say, an oncology project in terms of size, duration and magnitude? That would be helpful, thanks

Sure. So in general the oncology trials tend to be a little smaller and longer in duration versus anti-viral, anti-infectious diseases. We are seeing good traction in AV AI as a function of the opportunities that we're seeing in the market, given the market size in that category and also the capabilities and experiences that we've been building and capitalizing on here historically. As far as the type of projects within AV AI, it's a variety of infectious disease, areas and a little bit of vaccines, is where we're seeing the opportunities that we're winning.

Okay. Excellent. Thanks.

Thanks, Erin

Our next question comes from the Dave Windley of Jefferies?

Hi. Thanks for taking the question. Maybe to flesh out a little bit more on demand, could you talk about kind of maybe proposal flow, hit rate. I mean, it sounds like RFP, as your response to Erin, RFPs are so robust. I mean, kind of are you responding to a higher percentage of what you see? Is your hit rate the same or improving or declining? Just interested in fleshing that out a little bit more.

Hi, Dave, good to hear your voice.

Hi.

This is August. Yes, I think overall, yes, our number of RFPs are up. And I think particularly quality of RFPs. I think that's one thing that often looking at the metric of total number and hit rate and things like that isn't very useful because it varies so much in terms of existing clients, new clients, new areas where we have strength, where we don't have strength.

I think that our flow has been very good, both in quality, good match and volume. And as I said, in my comments, we actually thought hit rate might wind -- or I'm sorry, bookings might actually wind up a little bit ahead of the where they did. So, they were good bookings but not as strong as we kind of thought we were going to end up given the strength of the RFP flow.

Got you. And then also to kind of an angle on Erin's second question on your shifting therapeutic mix and duration of trial. As that relates, Jesse, to the way you're booking backlog and thinking about kind of average duration of your backlog, I think AV AI is short. It has moved up a little bit. I'm probably being overly specific there, but just -- are you seeing changes in the duration of your backlog is the spirit of the question.

No, not any significant change. I mean, the AV AI growth that we're speaking of is -- it's an increase of over where we had been just given some of the traction we're experiencing in that space. On the overall portfolio, it's not a massive shift in mix towards AV AI. We're just seeing some good traction there, so I don't want to overemphasize the AVAI.

Yes. Okay.

From the duration standpoint, given our backlog policy and the fact that we cut off that three years, only put the first three years of a project into backlog. For any trials that extend beyond that, we are somewhat safeguarded against trial duration, elongation, just given the policy that we have there.

Right. Certainly. I thought with -- I mean, again, like you say, it's a relatively a small part of the overall backlog so it doesn't move it very much. I thought you might even see some shortening instead of lengthening.

On the other part of that, your pie chart slide is very helpful, by the way. The movement in your customer care concentration is interesting. I think it's fairly consistent with what we saw in the first half of the year. But maybe remind us a little bit about the growing small biopharma part of the customer mix and dynamics that are driving that.

Sure. No, we're seeing heavier growth in the small biopharma space than we are in mid-sized and large. And that's predominantly a function of just the growth in that market that we're seeing versus the overall industry and we're taking share. You know, it's a customer segment that we focus very heavily on, and they're very attracted to our model and our approach and we're seeing good traction there.

Okay. I'll drop out. I'm sure other folks have questions as well.

Yes. Thanks, Dave.

Our next question comes from Jonathan Groberg with UBS.

Great. Thanks a million. Can you -- August, I just want to make sure I understood a little bit around what you were saying on cancellation. So, can you may be provide a little bit more color on cancellations in the quarter? And I think you said you expected those to move up a little bit in the fourth quarter. Is that tied to one particular project that maybe got canceled and the reason for that? Maybe just flesh that out a little bit more, thanks.

Yes, my comments were actually that cancellations generally in the 4% to 5% range and we do not expect them to be elevated in Q4. So I wanted to signal that we do not have any suggestion or early information on cancellations that would push our rate above our long-term average. It was a little bit on the low end in Q3 and it could very well be toward the lower end in Q4. So we don't really have any suggestion of a higher cancellation rate going into Q4.

All right, great. Sorry, I must have misheard that. Thanks. And then one more, just to follow up on that chart where you show year-to-date your mix of business. I understand you say that's where most of the growth is and where you're running share. On the flip side, are you seeing anything changing competitively in terms of your ability to win share with larger customers?

Yes. We continue to, with top 20 pharma, we continue to capitalize where there are opportunities and where they match our model. But it's not an area that we're actively targeting like we are in small and mid-size.

So, Jesse, if you think about the next -- obviously, it's hard to predict exactly, but is this kind of the mix that you would expect over the next couple of years? Or at what point do you think you get a little bit more aggressive on some of those larger accounts?

I think it's further out. You know, I think over the next couple years, we'll continue to focus heavily on small and mid-sized and we'll continue to see traction there. As far as -- if your question is if and when will large pharma grow as a percentage of our business, I think it's gradual over time. You know, sometimes there's opportunities that come into the portfolio but it's probably further out than the next year or two.

Okay. Thanks a lot and congratulations.

Thanks, Jon.

Our next question comes from Tim Evans with Wells Fargo.

Hi. August, I wanted to go back to something that you said early on. Your bookings were strong relative to what I think most of us were projecting, but it sounds like relative to what you were hoping for internally, maybe they were a little bit lighter. To what would you attribute that?

I mean, I hope it's somewhat timing. There were a few opportunities we thought we had a very good position in and didn't move forward. So, I think it's a mix. I just wanted to express that relative to our bookings, the RFP flow was very strong. Both quality and volume.

But it wasn't a particular issue that came up. It just wound up with a book-to-bill that was good but not great. And given the strength in the market, we were kind of thinking we might end up great. Anyway, that's where it ended up.

Yes, okay. And I also appreciate that you forecast revenue first and then the conversion rate ends up where it is. That said, can you may be help us think about the changing dynamics of your backlog conversion? It was, like you said, a little bit elevated the last few quarters and then sounds like it's going to be down in Q4 and possibly into 2017. Just for context, why was it elevated in 2015?

In 2015 or so far in 2016? I guess, it's been --

So far in 2015, I'm sorry.

The last several quarters it's been a little bit above where we generally project it to be. And I don't know exactly, and of course fourth quarter -- one thing I want to say the fourth quarter tends to be a little bit weaker. I think effort is a little bit less, more holidays, et cetera. So that obviously drags conversion down a little bit.

But I think it's all related to actual place of projects in their phase and not -- I don't expect an overall change year-to-year over the general burn rate and characteristics of our backlog. It does shift a little bit over time, but I don't think there's any trend towards lengthening. I think we're relatively protected from, I guess, the excuse of we're not meeting revenue expectations because complexity of trials is dragging things out longer.

And I don't think that is -- that should be a factor. And I don't think that in a long-term perspective, our conversion rate should be dropping over time. But it certainly will bounce around quarter-to-quarter.

Got you. And then last one for Jesse. You talked about -- I think, you used the word optimizing your capital structure. Can you help us understand what that means quantitatively? Where would you like your leverage ratio to go? What were you comfortable with it staying sort of a longer term view there?

Sure. So just to clarify my comments on optimization of capital structure are more about interest rate than leverage level opportunities that we're looking at here in the fourth quarter. Given the leverage that we have today versus where leverage was when we put our current credit facility in place, I think there's opportunities there. Where it can go on rate is dependent on the market, but I think there's opportunity.

From a leverage standpoint, target leverage, we don't have a target leverage level. I think, currently at 1.3 times we're a little bit sub optimized. And with our strong cash flow to pay down debt, it would left -- we'll continue to possibly pay debt down.

We will continue to reinvest in organic growth opportunities. And given the strong cash flow and leverage level that we do have, I think we are well positioned to help facilitate, I think, as we've mentioned before, an orderly exit for Cinven's equity position in the future when they're ready to do that. And that's the type of event that could take leverage back up to possibly 2.5, 3 times. Certainly comfortable in that range

Very helpful. Thank you.

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

Okay. Thanks very much. First off, August, you have great experience and expertise in cardio lipids and related areas. With the PCSK9s, I have to admit I was a little concerned about the market overall when I saw Pfizer canceling despite our trials. I know you were not the CRO involved here, but how much do you pay attention to one manufacturer's decision to perhaps slow down or exit a category for investment as it relate to similar work that you might be doing for other sponsors in that therapeutic area?

Yes, Eric, it's -- obviously we follow that very closely and are very interested. And sometimes as real impact going forward in terms of the risk of a program or opportunities on a program. In this case, I think that there were really some very -- it was not mechanism related. You know, there was no problem with the overall class. Or I think -- I don't think anyone is generalizing to a concern elsewhere.

The other antibody therapies available are fully humanized and much less prone to immunological response. And so -- and I don't think it impacts on other mechanisms or other modalities other than antibody-based therapies. So I think the entire class looks pretty good, but it is certainly any time there's a failure, it's a time to look at it and what the risks are for other projects.

Our overall concentration in the area specifically, looking at the PCSK9 kind of field has dropped a little bit. We do have work over three different companies and about $30 million in backlog in the overall area. But it looks pretty safe, all the projects that we're working on.

That's great. Thanks for the details on that. Jesse, just a second ago mentioned the continued growth investments and you've always said that you plan to keep those to be aggressive on investing but obviously to keep those in check as it relates to overall firm profitability.

I'm just curious where at the moment you're seeing the greatest desire to invest? Whether that be by geography, service area, technology and the like. If you could just give us some sense on where your biggest focus is at the moment.

Sure, Eric. There's no one area I would say that outweighs another. Growth is organic growth. It's across our footprint, not concentrated in any one area primarily, US, Europe, Asia Pacific, pretty consistently there. No notable technology investments needed that isn't already within our normal capital expenditures and operating expense trends.

So yes, there's no real focus area. It's continuing to hire people to support growth in a number of geographies, continuing to find good medical personnel to support each of our therapeutic areas. We have mentioned regulatory expertise as another growing area of organic growth in hiring people. That continues to be an area of focus. But none of those really outsizing any of the others

So very balanced, there's no one particular area we should be focused on at the moment?

Yes, very balanced and all within our margin expectations.

And then just finally, I know it's a very small piece of the Company but as we were doing our channel checks and diligence through the last year. So a lot of clients that have used your phase 1 facility have been very happy, but I got the sense that a lot of clients still have not tested Medpace in that area. I'm curious, what is the performance in that unit? And are you getting with more traction with clients perhaps coming in, looking at you a little earlier in the process?

Yes, it is growing. And you're right, it is a very small portion of the business. We've had good growth here this past year and continue to have strong performance in the unit. And that's largely a function of we've added a couple dedicated subject matter expert sales folks in that area.

And so in the past we had more of a general sales force that sold the entire suite. And we've added a couple individuals to be dedicated to being out with customers, talking about that area. And we're seeing some traction.

Okay. That's great. Thank you for the questions and congrats on a good start to public life.

Thanks, Eric.

Thank you.

Our next question comes from John Kreger with William Blair.

Hi, thanks very much. August, question. There's been certainly plenty of bad press and congressional scrutiny on your clients around drug pricing. Are you seeing that influence their behavior in any way? And if so, how?

I don't know of any influence on the clients we are a working with. But, the overall pricing environment and concern around it I'm sure influences decisions about program progression at some level. But no, none of the -- our work with clients is not really focused in that sphere.

Okay, great. Thanks. And then the other one, the two big mergers in the space I think have focused a lot of attention on the issue of patient enrollment. Can you just sort of talk about, is patient enrollment a bottleneck from your perspective? And if so, what's the Medpace strategy to improve it? Thanks.

Yes, patient enrollment is the rate limiting component of most clinical trials. It is a challenge and becoming a greater challenge as time has gone on. And that's really been the drive for the internationalization of clinical trials and there are really broad scale required to perform clinical trials is driven by difficulty of finding patients.

Obviously, a critical component of our business. We do think that proper protocol, feasibility, evaluation of where patients can be found and choosing the right investigators and using the right strategies for recruitment are critical. There are many -- we have a group dedicated to that. I think we do it very well. I think data is part of that.

But patients aren't generally found through a database and then we can effectively get them into a clinical trial. So it's still getting the right centers where investigators have experience and an ability to encourage and present to a patient an opportunity to participate in a clinical trial. So we do have a number of data feeds and relationships that allow us to look at patient records. They're more informed towards design and how to look for these patients rather than where exactly to look for the patients.

But I think it's a complicated area, and I think that we do it very well. And we have a dedicated group to it. And use many different means of finding patients.

That's helpful. Thank you.

Our next question is a follow-up question from Dave Windley with Jeffries.

Thanks for taking the follow-up. I thought I would just come back around on client base and credit worthiness and your checks on that. I believe, correct me if I'm wrong, but a believe as part of your backlog policy, kind of full funding of the trial is a criteria, is a check box that has to be checked in order to qualify as bookings and backlog for you.

I guess the thing that I've always been curious about is how do you ensure that, that funding remains in place, i. e., doesn't get spent on something else, over the full course of a trial that might last two or three years? Does that money go in escrow? Or what kind of agreement or relationship do you have with perhaps some of your smaller clients where they've raised private equity venture funds, whatever to fund the trial? And how do you ensure the access to those funds over the course of the entire project?

Sure, thanks, Dave. So, you're correct in the backlog criteria, we won't put a project into backlog until it's fully funded. How we ensure that those funds remain in place, they do not go into any sort of escrow. Depending on the client, and obviously we'll look at more information and be a little more actively engaged with smaller customers than we will with big from just a credit risk profile standpoint.

And so, we'll have an active dialogue, we'll have an account manager that's discussing financial matters with the client. And that includes often the level of their funding, the ongoing level of their funding in a diligent way, consistent with what we're doing up front. And so sometimes we're getting financial statements, sometimes we're getting representations from the client as we go forward. And it ends up becoming part of that accounts receivable discussion and funding discussion, not just in the beginning but ongoing with the client through the duration.

Got it. Okay. Thanks. Appreciate it.

Our next question is a follow-up from Erin Wilson with Credit Suisse.

Hi. Thanks. A quick follow-up here. What was the laboratory contribution in the quarter? And, I guess, if you don't quantify it, can you at least comment on how that's trending? Is this still an area of potential expansion for you? Thanks.

Thanks, Erin. Yes, we're not going to comment on specific laboratory numbers, but I will say that the lab contributed nicely to the quarter. Good growth from laboratory services, comparable to our overall portfolio of business and still about a consistent percentage of the total portfolio.

And is that an area, I guess, of expansion for you in terms of, like, the therapeutic areas of focus?

Yes, the lab is a continued area of growth and expansion. If we think about the lab from a therapeutic standpoint and how we're doing there, historically very strong in cardiovascular and metabolic. We are seeing more traction with other therapeutic areas and growing the oncology biomarkers. And laboratory being a component of infectious disease trials, et cetera.

Okay. Great. Thank you so much.

And I'm not showing any further questions at this time. I would like to turn the call back over to our host.

All right. Thank you, everyone for participating in Medpace third quarter 2016 earnings call. And look forward to speaking with you again in February next year for our first quarter -- full year 2016 earnings call and 2017 projections. Thank you.

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.