Medpace Holdings Inc (MEDP) 2017 Q2 法說會逐字稿

Good morning, and welcome to Medpace's Second Quarter 2017 Earnings Conference Call.

Before we begin, I will read Medpace's safe harbor regarding forward-looking statements. During today's call, management remarks and responses to your questions during this teleconference may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve inherent assumptions with known and unknown risks and other important factors that could cause the company's results to differ materially from management's current expectations, including those discussed in the Risk Factors section of our Form 10-K for the year ended December 31, 2016, 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 today's call, management will be referring to certain non-GAAP financial measures. A 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 provided in connection with today's call. The slides are available on the company's Investor Relations section of its website at investor.medpace.com.

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

Thank you, operator. Good day, everyone, and welcome to Medpace's Second Quarter 2017 Earnings Call. With me on the call is Jesse Geiger, Chief Financial Officer and Chief Operating Officer, Labs.

In Q2 2017, we saw a steady improvement in client funding, and overall, we experienced less bad debt realization than we had anticipated at the time of our Q1 call. Many of the programs we characterized on prior earnings calls as stalled have begun to move forward. Program decision delays have largely unwound, and we are on plan to building the backlog and new business pipeline we need for strong organic growth next year.

I would like to point out that our backlog policy provides a close tie to revenue growth, with award recognition delayed in relation to other backlog policies in the industry. We anticipate realizing an increasing number of awards in the second half of the year.

For completeness, I will mention that new RFP flow was lower in Q2 compared to Q1, and our competitive hit rate, which was above the trailing 4-quarter average in Q1, was below that average in Q2. I do not believe this represents a trend but only mention the change because I discussed these metrics on the last call.

Medpace remains focused on the most attractive segment of the biopharmaceutical and medical device market, small and midsized companies, where we have a differentiated service offering, utilizing a full-service approach and with strong therapeutic expertise. We continue to have great success in recruiting and developing outstanding individuals, and we have continued to invest heavily in our human resources ahead of anticipated growth.

With that short introduction, I will turn the call over to Jesse to review financial performance.

Thank you, August, and good morning to everyone listening in.

Moving now to our key financial highlights and trends on Slides 5 and 6 of the presentation. Net service revenue was $94.6 million in the second quarter, which represents growth of 2.1% [compared to] $92.6 million in the second quarter of 2016. On last quarter's earnings call, we mentioned we had several existing programs which may subject us to higher bad debt expense. But in the second quarter, these have generally stabilized, and current balance sheet exposure at the end of the second quarter has been minimized.

Adjusted EBITDA was $26.8 million compared to $30.7 million in the second quarter of 2016. Our calculation of adjusted EBITDA in the second quarter of 2017 includes an adjustment to subtract our corporate campus lease payments.

Adjusted EBITDA margin for the quarter declined 480 basis points to 28.3% versus 33.1% in the prior year period. This decline was primarily attributable to our increased hiring during 2016 and a shift in personnel mix to higher-cost employees, partially offset by revenue growth.

In the second quarter of 2017, we had GAAP net income of $9.6 million compared to GAAP net income of $5 million in the prior year period. Adjusted net income of $15.5 million in the second quarter increased 5% compared to $14.7 million in the second quarter of 2016. Adjusted net income growth was primarily driven by revenue growth and reduced interest and taxes, partially offset by higher employee-related costs.

GAAP net income per diluted share for the quarter was $0.23 compared to GAAP net income of $0.15 per diluted share in the prior year period. Second quarter adjusted net income per diluted share of $0.38 declined 15.6% versus second quarter 2016 adjusted net income per diluted share of $0.45.

On Slide 7, we have provided a breakdown of our customer concentration by revenue across 3 key categories for both 2016 and 2017 year-to-date periods. Year-to-date revenue growth was primarily driven by growth within Oncology, which remains our largest therapeutic area. With regard to our mix by customer size, we remain focused on serving our core market of small and midsized biopharma customers that represent a large portion of our total business and the segment of the market where we see further opportunities for continued growth.

Regarding customer concentration, we maintain a well-diversified mix, with our top 5 and top 10 customers representing roughly 20% and 33%, respectively, of our total revenue year-to-date.

Slide 8 provides a summary of our leverage and liquidity positions as well as a schedule of our free cash flow conversion for both the second quarter and year-to-date 2017 compared to the prior year periods. In the second quarter, we generated $30.4 million in cash flow from operating activities. This was driven primarily by a decrease in our net days sales outstanding, which decreased compared to the first quarter from 18.4 days to 9.5 days as we experienced a decrease in trade accounts receivable and an increase in advanced billings as a result of strong collection activities in the second quarter.

Our net debt position at quarter-end was $129.7 million, composed of gross debt of $158.8 million and cash of $29.1 million. Our net leverage ratio is approximately 1.2x. We are confident in the company's long-term cash flow generation ability and believe our free cash flow profile, our low leverage level and current capital structure provide us with flexibility to pursue continued growth initiatives and deliver shareholder returns.

During the second quarter, we repurchased approximately 1.04 million shares for a total of $26.4 million under the $50 million repurchase program, which contributed less than $0.01 per share to earnings per share in the second quarter.

Also during the quarter, we acquired NephroGenex out of bankruptcy by exchanging our unsecured claim for 100% of the common stock. The assets acquired from this pharmaceutical company consisted of in-process research and development, inventory, tax attributes and other intangible assets.

Moving now to our updated guidance for 2017 on Slide 9. Our net service revenue guidance remains unchanged in the range of $373 million to $385 million for the full year 2017, representing organic growth of 0.6% to 3.9% over 2016 net service revenue of $370.6 million. Our 2017 adjusted EBITDA guidance is also unchanged in the range of $104 million to $108 million. This reflects our continued investment in people and a reduction in our previous assumptions about bad debt expense, with our guidance range now reflecting an estimate of $1 million in potential bad debt expense in the second half of 2017 as some of the credit-challenged programs we'd mentioned have stabilized as of the second quarter but have not been completely resolved. In addition, although we have reduced balance sheet risk and total exposure, we continue to have several projects where revenue recognition may be impaired.

We have updated our guidance to reflect a new estimated effective tax rate of approximately 36% to 38% compared to previous guidance of 38.5% to 39.5% to reflect the anticipated result of some tax planning initiatives and the NephroGenex transaction.

We have also updated our guidance to reflect the share repurchased in the second quarter, which has an impact of approximately $0.02 per diluted share for the full year 2017. This guidance does not reflect the potential impact of any share repurchases pursuant to the share repurchase program in the second half of the year.

Our 2017 GAAP net income range is now $33.2 million to $36.6 million, and GAAP earnings per diluted share is expected in the range of $0.80 to $0.89. On an adjusted basis, we are now forecasting 2017 adjusted net income in the range of $56 million to $60 million and $1.36 to $1.46 per diluted share.

With that, I will turn the call back over to the operator so we can take your questions.

(Operator Instructions) Our first question is from Tim Evans of Wells Fargo.

August, there's been a number of other CROs that have more or less explicitly stated that they are interested in being more aggressive in the types of clients that would traditionally have been more in Medpace's wheelhouse. Are you perceiving that, that space is becoming more competitive? And if so, is that perhaps what's impacting your RFP commentary this quarter?

I don't know. Obviously, in most competitive situations, we have maybe 2 or 3 other parties involved. We still see 2 or 3 other parties involved. The mix of them, as we know, has not changed. So I don't know. Our RFP volume was slightly off this quarter compared to last quarter, but I can't make a trend out of that. Is our -- are we getting less opportunities because of competition? That's something I think we have to determine over time. We do see a strong market. We do see a really good business -- new business pipeline. And we do think we're really on track for building the backlog, as I said in my opening comments, toward meaningful growth in 2018.

Okay. And to that point, I know you're not willing to give 2018 guidance probably at this point. But can you just help us characterize how you would want us to think about the long-term trend line at this point in time, maybe relative to what you laid out at the time of your IPO?

Trend line in terms of revenue growth?

Yes. Revenue growth, yes.

Yes. So I think we anticipate and are working towards revenue growth that gets us back to double digits.

Our next question is from John Kreger of William Blair.

August, with 2 or 3 quarters that were kind of below trend in terms of awards and a delayed decision cycle that you talked about in the past, is there any sort of pent-up demand that you're seeing that might have helped either in the latter part of the second quarter or might still kind of be out as an opportunity in the second half?

Yes. As I did mention, things are pretty baseline in terms of timing on decisions. So they -- we had seen a significant pent-up number, and there was a number of programs that were held up because of funding. To -- that funding environment has improved considerably and continues to improve. There's still a number of cases where further improvement is necessary or further time is necessary. But I think if you look at the overall numbers, it looks like we're relatively close to a baseline situation, and I don't see a large pent-up number of overhanging things. We do have a very nice pipeline of new opportunities, though. And so I think we are building towards increasing numbers in the second half, but I don't think there's sort of an overhang that's waiting there.

That's helpful. And Jesse, for you, from a longer-term perspective, do you think there are opportunities to move the tax rate down into the lower 30s or maybe even higher 20s as your peers have done? And did you have to adjust the second half guidance at all for the dollar's recent weakness?

Sure. So on tax rate, the -- right now, we're assuming that the movement to this range is sustainable for the next couple of years. What we haven't done in any of our tax planning to date is any federal or international -- global tax planning, really subject to kind of where some of the legislation goes there. So I'll kind of reserve further movement for -- we're kind of in a wait-and-see mode on where the U.S. tax rates go. And from there, we'll be able to decide which approach we take that could potentially further reduce tax rate. But right now, for the time being, we're kind of set on this range here. As it relates to currency, yes, so there is a little bit of a headwind reflected in our guidance for the second half of the year, kind of moving from exchange rates as of the first quarter, bumping up to June exchange rates.

Our next question is from Dave Windley of Jefferies.

August, I want to follow up on the comments you're making about kind of intermediate term, building back up to double-digit intermediate-term growth. I'm wondering, as I look at your backlog and particularly the amount that you guys call out as burning in the next 12 months, what coverage ratio -- if you think about it this way, what coverage ratio do you think you need to have to be comfortable with the revenue forecast in general? I'm looking at a trend that at IPO was about 74 and has dropped down into the high 60s, and wondering if that needs to be built back up to low to mid-70s.

Yes. It's Jesse. I'll take this one. So I mean, we disclosed our next 12 months roll-off. It's $270 million here at the end of the second quarter. It's up slightly from the first quarter, kind of back to levels that it was in the fourth quarter. From a coverage perspective we don't disclose or talk about our quarterly coverage ratio. But I will say we're comfortable with the coverage level that we have currently in relation to the revenue guidance range that we're confirming today.

Okay, all right. So in thinking then about environment and bookings opportunities, the -- I presume you're talking about your kind of core client base and not really an overhang, but you are seeing an increase in RFP flows, I think, in new opportunities. Did I understand that correctly?

That's correct. And as I pointed out, our backlog policy does tend to delay recognition of awards, probably a bit from some of the peers. So I guess what we're signaling is that we have a pipeline both of new opportunities and ongoing opportunities that we believe should -- given a favorable environment in the next quarter, which we're seeing so far, should convert into higher bookings going forward and build towards the revenue growth we expect next year.

Got you. So just to get a little more specific on that, you have -- I think for 2Q, we would have said you have some pent-up demand or have some opportunities hung behind funding issues. Those have cleared themselves as of now. Bookings did step up. We're probably a little better than anybody expected for 2Q, but perhaps some of that pent-up demand contributed to that. And then I hear you reminding me that your backlog -- your recognition policy on bookings is, say, a little later than peers. Is there -- should I interpret from this that 2Q got a little help from pent-up demand and 3Q will not? And because of these awards just coming over the transom that these could be 4Q opportunities rather than 3Q, and we need to think about 3Q maybe being flat or stepping down a little bit?

No, I don't think so. And I guess in terms of pent-up demand, unfortunately, many of the programs were decided. A number didn't go forward. A number of them we didn't get. For instance, one program had funding challenges. We were awarded the program. It was actually a nice-sized program, and they eventually got funded, and the way they got funded was by getting acquired. The program went forward but to...

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the preferred provider of the acquiring company. So I -- then I think that's why our competitive hit rate dropped a bit. Again, I don't see that as an overall trend, but there were a few situations, some of them partially related to the funding environment, that led us to miss an opportunity. So I don't think there's a large pent-up assistance that was provided. I do think we have a pretty broad portfolio of opportunities going forward. And some of those, though, as you mentioned, are pushed from second quarter into third quarter. And we think our -- the programs are moving forward, and we think we will get to a recognition in the future.

Okay. Last question. I believe, Jesse, you called the acquisition, is it NephroGenex? Was that the name? And what are the plan -- what are you going to do with that?

Yes. Thanks, Dave. So this is more of I would call it opportunistic than strategic. We had mentioned on a prior call, we had a customer file bankruptcy, and we were working on an agreed plan with that customer through the bankruptcy process because we believed that we may be able to better recover by taking control of the underlying assets post-bankruptcy than we otherwise would have achieved through the liquidation process. So this is that customer. We exchanged our unsecured claim for the assets, the underlying assets of the company and the stock of the company. We have engaged a partner who has previously been involved with the assets to pursue a development strategy, and that will require minimal additional capital from Medpace. It's really our partner pursuing the development here. And so our plans are effectively to try to recover something more than we would have gotten in the liquidation, but it's not a significant drag on resources, and it's not a strategic focus of ours.

Our next question is from Erin Wright of Crédit Suisse.

This is Adam Krasner on for Erin Wright. Wanted to ask on where the cancellation rate was relative to the typical range. I think last quarter, cancellations had a higher-than-normal impact on revenue given the timing. Just wondering what the impact of that was this quarter.

Yes. Our cancellation rate, I think long term, we say it's in the kind of 4% to 5% range, and we were right in that line for the quarter.

Okay, great. And maybe shifting to new business wins, thinking about therapeutic mix and customer mix, were there any disproportionately large factors or contracts that influenced new business in the quarter?

No, not really.

No, none that stand out. I did -- Oncology was a big driver of the revenue year-to-date, but from an award perspective, pretty balanced.

(Operator Instructions) Next question is from Eric Coldwell of Baird.

First question on the bookings in the quarter. You actually showed, I believe, an $11 million, $12 million sequential increase in bookings, yet at the same time, you said a few times today that your RFP flow was lower and your hit rate was lower. So the devil's advocate in me says, how do you have bookings go up quarter-to-quarter when total opportunities and hit rate are down? My assumption is maybe some of the items you signed or saw in the first quarter just didn't get recognized in the backlog until the second quarter because of your 30-day policy. Is that what's happening? Or am I missing a component here?

Okay. There's usually a meaningful delay between receipt of an RFP, which is kind of our RFP flow, and a decision. So most of the decisions in the second quarter were from RFPs that we received in prior quarters. And so we talked about that overhang. And unfortunately, we didn't get as much kick from that overhang as we'd hoped because a number of the programs we lost. So our hit rate did go down a little bit. But RFP flow this quarter is really decisions that will occur in the next couple of quarters. So I mean, obviously, some come in, in a quarter and are also decided in the same quarter, but usually, there's some delay there between quarters.

Okay, got it. And then just a quick technical one for Jesse on NephroGenex. Was there anything in numbers, balance sheet, cash flow statement related to that deal that we should footnote for future reference?

Yes, absolutely. There's -- you probably noticed a large new line item on the balance sheet. So we...

I did.

Yes. What is that deferred credit? We recorded about $22 million in deferred tax assets related to the acquired intangibles and NOLs. Related to that, the accounting dictates that you record an offsetting deferred credit liability on the balance sheet. And that gets amortized into tax expense in proportion to the deferred tax asset recognition over time.

Okay. Anything else, even if insignificant?

That's pretty much it. I mean, I guess the only other item I would note is in relation to bad debt expense, we mentioned that in the quarter, many of the risky items that we thought might materialize in the quarter would -- have stabilized, and we do have some additional amount recorded in our guidance assumptions for bad debt. But in the second quarter, we did record about a $600,000 credit to bad debt expense. And most of that was related to some of the accounting around the NephroGenex transaction related to previously recorded receivables and work in process.

So really, at the end of the day, the big delta in 2Q SG&A compared to Street models was the absence of the $2 million to $3 million of bad debt plus the benefit of $0.5 million of credit on bad debt.

That's right, that's right.

August, last question. Last quarter, in relation to some of the volatility you were seeing with client delayed decision-making, funding, et cetera, I think you had perhaps theorized that if this continued, you might look at ways to perhaps alter what kind of clients you go after, maybe be a little more rigorous on client financial credit before pursuing opportunities. I'm just -- it does seem like the correlation to biotech financing is a lot closer and higher to P&L performance than I think a lot of us might have expected prior to the IPO. So I'm just curious if you have, in fact, changed any of your thought process in terms of what kind of credit scores you look to financing hurdle rates, for example, things like that, if any of that stuff has changed over the last few quarters.

Well, look, we continue to look at that, and we do modify things on an ongoing basis. I don't think we're going to overreact to it. I think if I had a crystal ball and could predict future funding levels, I might take a different approach at different times. But I think there are real opportunities when there are funding, when funding is available. I think giving up that opportunity is not wise. So I think it is a mix. I think we have to have the right mix. And I think you're right, there may be a little bit more correlation with us than with some others. But I think that adds to our overall volatility score, I guess. But I think that's just the nature of the business.

We do have a follow-up from Erin Wright of Crédit Suisse.

Erin this time. Could you give us an update on the central lab performance? And if you already gave this, we can follow up off-line. And I think previously, you mentioned some incremental investments there. Can you give us an update on that front as well?

Sure, Erin. Yes, so the lab performance is in line with total company performance. We are continuing to make some investments in the laboratory, more in the capital expenditure area. So CapEx in the second quarter was about 1.7% of revenue. We do expect that to tick up here in the second half as we're continuing to invest in some equipment to expand our testing platform as well as expanding our logistics area to handle kits and supplies here. So we do expect CapEx to be roughly in the 6% to 7% of second half revenue, primarily related to the lab.

And on that lab expansion, is that in terms of also like therapeutics focus as well?

It is. So our -- we've talked in the past about the testing that we offer for the laboratory historically being very focused on cardiovascular and metabolic. And we're continuing to expand the test menu really with an eye towards pairing with some of the other therapeutic areas.

There are no further questions at this time. I'd like to turn the call over to Dr. Troendle for any closing remarks.

All right. Thank you for joining us on today's call and your interest in Medpace. We look forward to speaking with you again on our third quarter 2017 earnings call. Thanks. Bye, everybody.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.