Syneos Health Inc (SYNH) 2016 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the INC Research third-quarter 2016 earnings conference call.

(Operator Instructions)

I would like to hand the conference over to Ronnie Speight, Vice President of Investor Relations. Please go ahead, sir.

Good morning everyone. The purpose of this call is to review the financial results for INC Research's third-quarter 2016. With me on the call today are Alistair Macdonald, our Chief Executive Officer, and Greg Rush, our Chief Financial Officer.

In addition to the press release, a slide presentation corresponding to our prepared remarks is available on our website at investor.INCresearch.com within the events and presentations section. An archived version of this webcast will be available for replay on our website after 1 p.m. today and there will also be a telephone replay available for the next seven days.

Remarks that we make about future expectations, plans and prospects for the Company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors. These factors are discussed in the risk factors section of our Form 10-K for the year ended December 31, 2015 as well as our other SEC filings.

In addition, any forward-looking statements represent our views as of today and should not be relied upon as representing our views as of any subsequent date. While we might update forward-looking statements at some point in the future we specifically disclaim any obligation to do so.

During this call we will discuss certain non-GAAP financial measures which exclude the effect of events we consider to be outside of our core operations. These measures should be considered a supplement to and not a replacement for, measures prepared in accordance with GAAP.

We believe that providing investors these measures helps them gain a more complete understanding of our financial results and is consistent with how management views our financial results. For a reconciliation of the non-GAAP financial measures with the most directly comparable GAAP measures, please refer to slides 20 through 24 in our presentation.

As we will be limiting today's call to one hour we request that participants limit questions to one each with an opportunity to ask one follow-up question. I would now like to turn the call over to Alistair Macdonald. Alistair?

Thank you, Ronnie. Good morning and thank you for joining our third-quarter 2016 earnings call.

I'm excited to have officially assumed the role of CEO as of October 1, particularly given the strength of our business and the scrum backlog we have for the remainder of 2016 and beyond along with an excellent management team to guide the Company for the future. I am pleased report that INC continued to execute well across the business, delivering another strong quarter. We grew our net service revenue by approximately 11% compared to the third quarter of 2015 and by 14% on a year-to-date basis. Our net new business awards for the quarter were $330.1 million compared to $327.7 million during the third quarter of 2015 resulting in a net book to bill ratio of 1.3 for the third quarter and 1.2 on a trailing 12-month basis.

Our investments in operational, therapeutic and business development resources that support our customer proposal process continued to yield strong results. During the third quarter these results included adding 25 new customer relationships and strong demand from our existing customers, which represented 84% of the dollar value for our year-to-date new awards. Our top five customers comprised 33% of our revenue on a year-to-date basis, down from 34% for the same period in 2015. In addition, our presence remains strong in areas where clinical trials are particularly complex with these areas representing approximately 74% of our backlog as of September 30, 2016.

I'm also pleased to have recently announced some exciting changes in the structure for a management team which are designed to further strengthen both our focus on execution and the therapeutic alignment of our business model. As part of my transition into the CEO role I worked with our executive management team and the Board on an in-depth review of our organization and leadership in light of our strategic goals.

As a result, Dr. Michael Gibertini has been promoted to Chief Operating Officer from his prior role as President of Clinical Development. Michael will have global responsibility for all operational aspects of our business which now includes our therapeutic business units as well as the supporting services.

In addition, Tara Fitzgerald has been promoted to President of Clinical Development Services from her previous role as Executive Vice President of Biometrics and Safety. Tara will be responsible for the leadership of all clinical support services as well as the expansion of our key emerging value chains such as late phase consulting, medical devices and functional service provision.

Both of these individuals have a wealth of experience and have been critical to our success. I'm excited about their ability to drive our future growth while maintaining our unique culture and focus on quality.

At the end of the third quarter our total employee base has grown to over 6,700 staff and we expect to continue expanding our headcount through the remainder of the year. This includes our ongoing expansion in the Asia-Pacific region. We now have a total of 19 offices.

Demonstrating the success of our approach to customer engagement in the region I am proud that we were recently honored with a 2016 Frost & Sullivan Asia-Pacific Best Practices award. We received the Customer Value Leadership Award for contract research outsourcing services, representing high performance in areas of customer and business impacts including categories such as customer purchase experience, customer service experience and price-performance value.

Frost & Sullivan noted that INC Research has an established reputation among its customers for high productivity, rapid turnaround times and comprehensive customer support. This continued geographic expansion while remaining focused on customer engagement is key to achieving our strategic goals.

In closing, we have transitioned the leadership of the organization during the third quarter through a well planned and executed succession plan. During that time we have continued to seamlessly deliver against our targets as we strive to become the CRO of choice for all stakeholders, employees, customers, sites and investors around the globe.

Let me now turn it over to Greg Rush for more comments on our financials. Greg?

Thank you, Alistair, and good morning everyone. As a reminder, we are presenting our results on an adjusted or non-GAAP basis and have further normalized certain metrics to improve comparability. The normalized amounts presented on slides 3 and 4 and the adjusted amounts along with the detail of the normalizing adjustments are presented on slides 17 to 19.

We grew our net service revenue on a year-over-year basis by approximately 11% to $259.6 million during the third quarter, up from $234.5 million for the third quarter of 2015. This was net of foreign exchange headwind of $2.6 million, resulting in constant currency revenue growth of nearly 12%. On a year-to-date basis we grew our net service revenue by 14% from $673.4 million for 2015 to $767.4 million for 2016.

Excluding a foreign currency headwind of $8.6 million, our revenue grew by over 15% compared to the first nine months of 2015. Our direct cost increased 12.8% from $139.6 million for the third quarter of 2015 to $157.5 million for the third quarter of 2016 with gross margin declining from 40.5% to 39.3%. Foreign exchange had a positive impact of 85 basis points on our gross margin percentage during the third quarter of 2016.

For the first nine months of 2016 direct costs were $465.4 million compared to $403.7 million for 2015. This gross margin declined from 40.1% to 39.4%. Gross margin for the first nine months of 2016 included a positive foreign exchange impact of 65 basis points.

The decline in gross margin for both the third quarter and the year-to-date 2016 was primarily due to the increased use of contract labor associated with the accelerated work we highlighted in the previous quarters along with revenue mix. SG&A expenses increased from $39.5 million in the third quarter of 2015 to $40.1 million in the third quarter of 2016, declining from 16.8% to 15.4% of net service revenue. On a year-to-date basis our SG&A expenses have increased from $112.6 million to $122.8 million while declining from 16.7% to 16% of net service revenue.

I would like to point out that SG&A expenses were unusually low during the quarter due to lower-than-normal incentive compensation during the quarter, the continuing benefit from lower foreign exchange rates, particularly the British pound, and finally lower-than-expected headcount. Specifically, our SG&A headcount was lower-than-expected as investments to further support new business acquisitions through additional business development headcount and headcount within our general and administrative functions have been delayed until the fourth quarter of 2016 or early 2017. In addition, marketing spend was lower than in historical periods solely due to timing of the marketing spend which is expected in the fourth quarter of this year.

Our adjusted income from operations increased from $51 million to $56.7 million with the associated margin increasing slightly from 21.7% to 21.8%. Year-to-date adjusted income from operations increased from $143.5 million to $163.9 million over the same period and operating margin improving slightly from 21.3% to 21.4%. Adjusted EBIT grew by approximately 12% from $55.4 million to $62 million with the associated margin improving slightly from 23.6% to 23.9%.

For the first nine months of 2016 adjusted EBIT increased by approximately 14% to $179.2 million, up from $157.1 million for the first nine months of 2015 with the related margin remaining flat at 23.3%. Foreign exchange had a positive impact of $2.1 million on adjusted EBITDA for the third quarter of 2016, representing an impact of 100 basis points on EBITDA margin percentage. On a year-to-date basis foreign currency had a positive impact of $3.8 million on adjusted EBITDA or 75 basis points on EBITDA margin percentage.

Adjusted net income increased to $35.3 million for the third quarter of 2016 from $30.7 million for the third quarter of 2015 and increased to $102.1 million from $83.8 billion on a year-to-date basis. Adjusted EPS grew by 23.1% from $0.52 in the third quarter of 2015 to $0.64 in the third quarter of 2016 and by 32.6% during the nine months ended September 30, 2016 to $1.83 from $1.38 in 2015.

Diluted weighted average shares outstanding were 55.6 million for the three months ended September 30, 2016 and 55.8 million on the year-to-date basis which included the impact from an equity-based employee awards of 1.4 million and 1.7 million shares respectively. At September 30, 2016 the outstanding share count was 53.6 million.

Slide 7 provides key metrics related to our cash flow and leverage position. During the third quarter of 2016 our operations produced $50.7 million of cash as compared to $45.8 million for the third quarter of 2015. Cash flow from operations for the first nine months of 2016 was $95.1 million, a decrease of $46 million compared to the first nine months of 2015.

This decrease was primarily driven by the increase in our DSO during the first quarter of 2016 and other changes in working capital. We ended the third quarter of 2016 with $102.9 million in unrestricted cash and total debt outstanding of $500 million.

Slide 8 summarizes key metrics related to our backlog. We believe one of the most important leading indicators of future revenue growth is backlog coverage which is presented in the bar chart in the bottom left quadrant. We are maintaining favorable position with 98% coverage of the full-year 2016 revenue forecast at September 30, 2016.

To continue capitalizing on capital deployment opportunities as they arise, in August we repurchased 1.5 million shares of our common stock in conjunction with the final secondary offering by our sponsors. The share repurchase was executed under the $150 million share repurchase plan that we announced on our second-quarter earnings call leaving, leaving approximately $85.5 million in capacity remaining under the plan. We remain committed to creating shareholder value through the execution of our growth strategy and continuing to evaluate other capital deployment options. I would also like to highlight that as a result of the share repurchase and the associated secondary offering there is no longer any overhang on our stock related to possible future secondary offerings as both the Vista and Ontario Teachers' Pension plan no longer own any shares of INC in their respective funds.

On slide 9 we are providing our updated guidance for key financial metrics for the full-year 2016. This guidance takes into account a number of factors including our current sales pipeline, existing backlog and our expectations of net awards for the remainder of 2016. Further, our guidance is based on current foreign currency exchange rates, current interest rates and our expected tax rate.

We continue to expect our net service revenue for the full-year 2016 to range from $1.030 billion to $1.040 billion, representing a growth rate of 12.6% to 13.7%. This takes into account a foreign currency headwind estimated at approximately $10 million, a negative impact to our full-year growth rate of approximately 110 basis points. Accordingly, our constant currency growth rate is expected to be between 13.7% and 14.8%.

We expect interest expense for the full year to range between $13 million and $13.3 million and we expect our effective tax rate to be approximately 34%. We expect our adjusted diluted earnings per share to range from $2.48 to $2.52, representing growth of 29.2% to 31.3% compared to normalized adjusted EPS of $1.92 in 2015.

Lastly, we expect to earn $1.74 to $1.81 per share on a GAAP basis. Included in our GAAP earnings per share guidance is an estimated negligible impact of share-based compensation net of tax which is further detailed on slide 16 in the appendix.

While we are not providing detailed guidance for 2017 at this time I did want to provide a few comments on how 2017 is shaping up. First, we had a strong first nine months of the year with a book-to-bill of 1.2. This has led to backlog coverage for fiscal 2017 of approximately $820 million which puts us on track to achieve our long-term revenue growth target of 10% to 12%.

In addition, we currently expect to hold adjusted EBITDA margins relatively flat on a year-over-year basis while realizing the benefit in earnings of our recent debt amendments and a further decline in our tax rate to approximately 32% to 33%. These earnings enhancement opportunities coupled with our recent share repurchase in August provide a solid base to grow our adjusted EPS by the mid to high teens. Our revised guidance for 2016 and comments related to 2017 exclude the potential impact of any share repurchases that we may make in the future within the remaining capacity under our existing equity repurchase plan.

This completes our prepared remarks. And we'd be happy to answer any questions.

(Operator Instructions) John Kreger, William Blair.

Thanks very much. Greg, thanks for those comments about general 2017 outlook.

One other one that I don't think you mentioned, could you just talk about where you think the backlog conversion rate goes over the next few quarters if you expect any changes? Thanks.

Backlog conversion rate really depends on how our bookings come in for the fourth quarter. If they come in line with the 1.2 I think our backlog conversion will be right in the range it's in plus or minus a couple bps.

With regard to, obviously, if we have a really strong quarter like we did in Q3 that impacts near-term backlog conversion more than anything. As you know, you have a really strong booking quarter that creates a bigger backlog and then automatically has a negative impact on backlog conversion.

Okay, thanks. Then Alistair, can you just talk a little bit more broadly about what you are seeing in the market in terms of demand?

I'm curious if you are seeing any change in behavior from either your smaller or larger clients as we approach the election and given all the rhetoric around pricing? Thanks.

Thanks, John. I don't think we've seen much of a difference in that. I mean, the same really answer around Brexit, we haven't seen really any change in customer sentiment around either of those issues at the moment.

I think the pressure is there on the pricing and that seems to be a bigger concern to some larger pharmas at the moment. But we have a very balanced portfolio. We have customers across the US, Europe and Asia and they seem to be heads down driving forward on their development plans at the moment. So no real difference, no real difference in any of the sectors that we play in either that I could really tell you that we've noticed so far.

Okay, great. Thanks.

Dave Windley, Jefferies.

Hi, good morning. Thanks for taking the questions. I wanted to ask a couple around backlog composition and your trends in therapeutic areas.

I think we had talked in prior quarters about strength in oncology, how oncology was moving up to your top therapeutic area more similar to the rest of the space and that oncology studies were longer and that was stretching backlog duration a little bit. But I see in your release this morning you are emphasizing particular strength of CNS year to date. So if you could help me to understand how your therapeutic area mix is moving and how that is impacting the duration of your backlog please.

This is Greg. I think it's really more of a timing issue. I think if you remember in 2015 CNS was a little weaker in terms of bookings and the time I think backlog for them was dropping a little bit from what it was in 2014.

I think I even made the comment, I think it was Q4 of last year, that we saw 2016 as the year of CNS coming back a little bit. And we are just saying that what we thought was happening in that Q4 call is indeed happening. It's less about oncology having any issue or declining, it's just CNS had a really strong first nine months.

From a backlog conversion, I mean from a link to the backlog I think in 2014 we were in the mid-30 months to convert. I think that at the end of 2015 we talked about in the low 40s and then earlier this year we were in the mid to high 40s. We are in that same range.

I think we are in the mid- to high 40 months average duration of backlog. And that's still being driven primarily by mix of oncology, late phase and to a lesser extent just all therapeutic areas were a little longer just due to complexity finding patients.

Okay, thanks. Then as a follow-up, separate topic, on your add-backs, your GAAP to adjusted numbers, you've got some bigger restructuring numbers in the quarter and year to date I presume the quarter, in particular, was probably the CEO transition. If you could confirm that?

But then also stock-based comp is growing pretty significantly on a year-to-date basis. And I wondered if that is a philosophical change in the way you are compensating or is that just a one-year phenomenon? Thanks.

I don't think it's necessarily a change. I think, I know we've had some discussions, other people have asked the question maybe in the callbacks.

Basically if you remember before we went public as a private Company our share price and volatility was much more muted in determining the fair value of equity awards. And then so the amount of equity we've been giving to executives in terms of absolute dollar value has not necessarily declined in terms -- or not dollar value, but number. In fact, we've probably declined in the amount of shares we've been issuing to executives and Board members, but with a higher valuation, the higher Black-Scholes value that's increased it.

The other thing I'd like to point out just to make sure that everybody is aware we are actually getting on a GAAP basis a net positive impact from stock-based comp. So there's a slide, I think it's slide number 16, our total share-based compensation for the year and the year-to-date guidance is for $14.5 million. And then if you take out the tax benefit that we're getting from equity because of the value at the time of exercise this year to date has been much higher than the Black-Scholes value.

We've actually had a net positive impact in our guidance estimated at over $3 million. So we are actually by non-GAAPing it out we are actually hurting our non-GAAP earnings in aggregate by pulling it out versus helping it.

Okay, thank you.

Tim Evans, Wells Fargo Securities.

Hi, Alistair, I think you mentioned some conversations with your clients around pricing, their own pricing I assume is what you meant. And this is, I guess, something that we heard echoed last week in one of the big distributors talking about greater-than-expected issues that their customers are having with pricing. How do you think that this is going to end up impacting those customers' willingness to spend on R&D going forward?

Well, I think it's probably more of a long-term consideration for us is their willingness to invest in future development programs, of course. The methodologies of biotech and smaller organizations that look to out-license after Phase II or as they develop into Phase III, I don't know if that's going to change, the larger pharmas looking at their ROI on development programs whether that would adjust what they are willing to put through their development programs.

But we've seen that in the past where organizations come out who will take that development off-balance sheet and that development still ends up in the market for into our market for development. So as that pricing pressure changes, and we saw this at the end of 2008 and 2009 with the biotech funding, but as that pricing pressure changes does that make a difference as to who actually funds the development.

We saw that back in 2008, 2009. That was the case then. You got a wave of organizations coming out that take development off-balance sheet for organizations and as the ROI model changes because of the pricing pressures I think we will probably see that again.

I think there are a lot of people looking to get into development with capital that's sitting on the sidelines. So I don't think we can put a precise finger on it, but I should imagine that that will be one of the outcomes.

And maybe as pricing pressures change does that drive the level of outsourcing in big pharma even further? Do they look for more variablized expense that, obviously, the CRO model provides.

Tim, I want to add one thing on that. I think it also will better influence who they choose to help outsource if there is pressure from that. I don't think any CRO will be completely immune from that.

If you look at our therapeutic focus and one of the things that we add as a value proposition is we look at drugs as reflecting which ones to bid on aggressively or go after we want ones that aren't going to be canceled. And we think we have that added advantage with our focus. And from a cancellation rate it helps us on the one side.

And, secondly, customers are going to want to be able to make sure that if a drug has got is going to fail that it fails early. So that they keep their ROI up and I think that that's the value proposition that we bring to the table and are willing to help a customer do quickly.

Okay and Greg, just a quick separate topic, you called for relatively flat EBITDA margin next year which I think echoes the comments that you made earlier at the Analyst Day this year. There is a tendency I think among investors to want to give you credit for the strength that you've had in your margin since your IPO and really strong execution there and maybe assumed that you can end up beating that guidance. So given that this is the second time that you've really called for flat margins can you just remind us of the pushes and the pulls there that are going to keep that margin flat in 2017?

I think that everything else held constant margins actually have a little room to improve next year. The reason I am emphasizing that I think they will stay flattish and flat can be in my mind can be up or down to us or minus 50 bps when I use the term flattish.

What would cause it to be higher than that? We decide to delay investments in some of the things that we are trying to do for the long term and a focus solely on our margin improvement initiatives. What would cause it to be down the 50 bps at the other end of the spectrum?

We feel like we have a unique opportunity to invest organically in building our FSP business or our medical device or other areas that we feel like we need to invest in. And Japan is a great example that we did two years ago, we basically built up the Japanese office and presence at flat to slightly negative margins, but effectively we were able to generate enough revenue to roughly cover our cost.

In doing so we've got now over 100 people but it had a definite impact over the last two years on our margin point that otherwise would be. So with we do something similar to that with FSP medical device that will hurt the margin percentage but will set us up for long term. And so we are going through our three-year budget cycle now.

We are sitting down with our Board and we are as a management team we are making sure we evaluate all those investment opportunities. And also if we are successful with the top 20 in penetrating those, the more successful we are with that in getting initial awards that could have a slight impact on margin to the negative in the short run but in the long term will accelerate margin growth in absolute dollars.

Okay, thank you.

Erin Wilson, Credit Suisse.

Great, thanks for taking my questions. Going back to the fundamental demand trends, how do you view that environment across the small to midsize biotech market? And just biotech funding in general I noticed there was a small European biotech company out this morning commenting on a challenging funding environment and potentially opportunity to renegotiate with the CROs.

Is that something that you are seeing a lot of or more of lately? Any sort of greater number of contract renegotiations or anything like that that you could comment on would be great. Thanks.

Thanks, Erin. I don't think we've seen any contract renegotiations. I think the funding situation, obviously, is different for individual buyer tax.

I have not heard anything specific out of the EU market for that in terms of the difficulty of those guys finding funding. I think actually we saw little bit of an improvement in the biotech space over Q2, Q3 both in terms of the number of customers coming through in that space and I think we referenced in the release there that 25 new customers, obviously, some of those coming out of that biotech space, as well.

But we've made particular efforts to get more involved in that space to a certain degree as we expand, particularly in disease states of a high complexity. Obviously, a lot of those biotech companies are dealing with those types of trials, so it's a good space for us. I think the level of funding and the level of activity that we've seen has been pretty constant but, no, I don't see any difference in that space from Q2 to Q3.

Okay, great. And you mentioned during your Investor Day increased interest in the FSB or functional service business. How is that strategy progressing and is this still an area of increased focus for you and is that reflected in your 2017 preliminary targets?

Yes, I think we've seen continued progress in that, particularly in the areas of data management and the functional delivery of FSB. So data management statistics (multiple speakers) safety, some of the study startup for FSBs as well where we are delivering regulatory contracts, site contract management and TMF.

So we do see continued interest in that. I think as that portfolio grows and we do we penetrate larger and larger organizations who look for that style of outsourcing that's something that we need to continue to invest in.

Like you say is that taken into consideration in 2017? Yes, it is. We are planning to be more, delivering more of those style of services as we go forward.

But I think we are known for delivering full service, high-quality, very complex clinical trials. We want to maintain that ability to deliver that but also to follow our customers into FSB if that's what they want from us as we build platforms for them to launch projects off of or to deliver data management for.

So what we've seen a little bit is when we've been able to establish a large portfolio of full service work with an organization we are often asked the question could you do this and a full FSP for us across start-up across data management? So having that ability can feed off of full service work as well as feed into full service work. So it's an important thing for us to balance as we grow.

And one thing I want to make sure that's really clear, because there's a little bit of confusion out of our Investor Day on this topic, if you think about the top 20 customers, think about it from their perspective, they typically want to have a relationship with only two to three CROs that are their strategic partners. And most of the top 20 have a mixed model where on certain studies they want to go full service which is where our bailiwick is and where we feel like it is best for most CROs.

Most CROs can bring the best value to pharma by providing full service. But some of those, because they have a mixed model, want to be able to purchase from those three CROs an FSP model. If we want to be one of those three amongst the top 20 and we tell them we don't have an FSP offering, by definition they are down to two people to competitively bid amongst their studies.

And if we are only one of two they only have really one that they can do or they are going to have to bring in a third that they may not want to do. And so our main focus on FSP is not that we believe that that's the best model and we want to be a major provider of FSP services with 30% of revenue coming from that because it's lower margin, but more to make sure that when we go to bid with the top 20 that they view us as a very strong, capable firm that can provide those services and can make sure that we can be one of the competitive bid amongst the three that they've selected.

Okay great. Thanks so much.

Robert Jones, Goldman Sachs.

Thanks for the question. Greg, I wanted to go back to the EBITDA margin outlook, but ask more around gross margin specifically.

On the direct cost side, clearly the third-party contracts has been weighing on margins. How do you think about this as a key swing factor as you look at 2017 and your expectation for overall EBITDA margins to be flat?

Yes, I think gross margin is certainly the area that I would say has the most volatility for the reasons I mentioned. When we built Japan, out all of that new revenue and cost roughly equaling each other was an impact on gross margin. So as we look at FSP, we look at top 20, the impact that you are going to see on that will probably be more pressure on gross margin and I think there's more room to expand SG&A than there is necessarily gross margin.

Does that help answer the question?

No, it does. And just one quick follow-up, Alistair, around the really strong net bookings in the quarter. I'm curious if maybe you could comment at all about what you are seeing on the cancellation side reflected within your net bookings number? And then I guess more broadly as it relates to cancellations, did you say there is anything going on from an industry level as you service therapies and in more complex diseases that would heighten concern around cancellations?

I think our cancellation rate was pretty much in line with where it normally is. So we haven't seen any real increase in that, or by therapeutic area there is no spike in those cancellations by therapy or by class of drug or anything like that. So nothing unusual to report really there.

Yes, I think our cancellation rate was actually slightly down from Q3 of last year and probably in line on a year-to-date basis, if you remember, when we talked about the big cancellation in Q2. I do think that we, our cancellation rate, one thing to keep in mind that I think we do slightly different than many people in the industry is we will be very aggressive in terms of taking things out of backlog.

We do risk adjustments that are included in our cancellations. At least at this time that is how we do it, report it internally.

So as an example, if you have a study that we sign up and it looks like we are going to finish it early and there are some units that are going to be unused the project managers will take those units out. That's in our risk adjustment.

In addition, if a customer puts something on hold and we feel like that, even if it's only going to be on hold for two to three months in start time, we will look at that with our therapeutic expertise and say look, why are they putting it on hold, do we feel like that study has a reasonable possibility of ultimately being canceled? And if that's the conclusion we will go ahead and take the cancellation in advance of when the customer sends the cancellation notice.

So I think that always front loads our cancellations and will tend to make our cancellation rate maybe slightly higher than the industry. But if you strip that out we're probably lower than the industry.

Got it. That's helpful. Thanks, guys.

Sandy Draper, SunTrust.

Thanks very much. Just one question. Alistair, you had commented, I think you said there were 25 new relationships this quarter.

Just wanted to get a sense of any additional commentary around whether it's certain therapeutic areas, what people are coming to. I would assume these are typically probably smaller initial starts, but are any of these customers that over time you think had become very substantial or do you think these are more just you are adding smaller customers, nice to diversify but realistically they are not looking out to be a top 10, top 15 customers in three or four years? Thanks.

Yes, thanks, Sandy. Yes, they are mainly small to -- they're mainly biotech, small pharmas who are bringing out, who are entering the development phase. So a mix across Phase I and II mainly.

So they are not going to make huge impacts to backlog but obviously very important customers for us. It is an important factor for us, and I think INC's model of strong therapeutics, strong delivery is very appealing to that sector because we commit to them. We provide them with that expert leadership in clinical development and the actual operational delivery.

I think we have a strong reputation for delivering on time, on budget and having good cost controls that mean that when we tell customers a price for a study that's pretty much what they are going to pay. So I think that helps us attach to those organizations. Although we are one of the larger CROs now we are able to blend that with the ability to work intimately with small customers and I think the business unit structure helps with that.

If you work with our oncology team you are working with 1,000 people rather than 7,000 people in a CRO. So they get some of that intimacy that really helps them deliver what they are up against.

So, yes, smaller customers. And look, most of our relationships that I've been involved in for the last 15 years even the big ones started actually potentially at smaller biotechs with people who did a good job or who moved on in their career, moved to larger pharma and carried us with them or developed a great product that expanded their organization and we've been able to grow with them.

So I think the phrase is from tiny acorns major oaks grow. So we are happy to work with small, mid, large because they are all important for us in terms of development of relationships, generation of backlog and so on and so forth.

Great, that's very helpful. Thanks for the commentary, Alistair.

Greg Bolan, Avondale Partners.

Hey, thanks, guys for taking the question. So I apologize if this has already been asked, but if I think about the bookings for the quarter, and I know this is a very difficult question, but if you could maybe take a shot at that would be great, just want to -- I mean, it seems to us that there are at this point in the cycle for outsourced late stage drug development there are winners and there are losers, the tide doesn't seem to be as robust as it once was and as I think about a select few what I would qualify as marketshare gainers or takers I certainly would put you guys in that bucket.

And as I think about the nearly 1.3 book-to-bill for the quarter, does it feel like as you are talking to your business development folks that your win rate has maybe popped a little bit or increased somewhat as of late? And maybe if you could talk a little bit about where you guys are positioned versus maybe some of your peers from the standpoint of being a bit more agile, being able to move your folks around pretty quickly from a functional outsourcing perspectives and, obviously, how that bodes for your ability to take down new business, obviously, not having your FTEs locked into some type of huge marriage. And if you could maybe qualify competitive advantage, as of right now what's leading to possibly a better win rate and then how you guys view yourselves longer term from the standpoint of being, obviously, very focused on the FSP side of things?

I will take the first part and see if Alistair wants to comment. I think you had about 20 questions in there. Good way to phrase one question into 20 subparts.

I think the overall crux of your question is are we winning business from competitors? And I think over the last two to three years that's certainly been the case. We have been taking market share.

I think all the big CROs quite honestly are taking market share from the smaller guys. And then the question is who is then winning the bigger piece of that? In fact, is there anyone winning business amongst the bigger guys, and we certainly have been a net positive of that over the last two to three years.

More recently as to win rate, our goal actually is to maintain our win rate amongst our existing customer profiles but we also want to get more and more our fee in business. And so if we do that and we start to see a higher volume of our fee from customers we historically have not seen our win rate will decline, which is not necessarily bad thing because your strike rate or win rate amongst large opportunities that you never got to bid on in the past, if you are shooting from half court, so to speak, using a sports analogy, your win rate, your hit rate is going to go down but they also count three points. And so you only take them when you want to win the game.

And so our goal is as we laid out at Investor Day is to take as many half-court shots as we can on those big top 20 pharma. And even if we miss 10 of them but hit one we are going to be a net winner of from our competitors. And that's our strategy, that's why we are going after the top 20 and we hope to do that.

Just to add, we are -- I think your comment about agility, Greg, is right. It's having the ability to put a solution on the ground that's fit for purpose for a particular development program or individual trial or partnership. It's building things that are fit for purpose.

I think (inaudible) is very good at that. The team has always been very agile. I think the business unit structure that we have, the business unit structure really fosters that agility for us to be able to provide either full service delivery on a large scale or an a la carte piece of the business maybe as an FSP or as an individual trial.

So having that is very important. But I think also we are at the point where a lot of the investments that we've made over the years in structure and in the talent of individuals that we've had in the organization, the environment that we set them up to work in and also the technology that we've deployed, we've had long-standing partnerships with off-the-shelf service providers on the technology side.

A lot of our customers have also developed those technology relationships. So we are a strong fit for them technologically I think with our ability to deliver a trial and give great visibility into that delivery and give an end-to-end technical delivery as well as lining that with strong therapeutics and our ability to put teams on the ground quickly globally is an advantage for us.

And I think because we are at we are the smallest of the big CROs, if you like, that's quite attractive to smaller customers as well where they know they will get that intimacy from us. And back to Sandy's question, we are able to deliver all of that technology, all that great therapeutic coverage and delivery and do it in an intimate way with smaller customers. So I think that's a bit of a niche that we have fallen in and we are doing very well in that sector.

Thanks guys. I will get out of the way. Congrats.

Tycho Peterson, JPMorgan.

Hey guys, thanks for taking the question. Just one quick one here for Greg, and I think it may have come up earlier in some other context, as well.

Just wanted to get some color around where you think gross margins might level off over the next 12 to 18 months? And also what are the specific levers that you can pull in the SG&A line to offset some of that impact?

I did mention it earlier. I think gross margin plus or minus 50 bps is just like our EBITDA margin that's where most of the volatility over the next year or two will be.

And I'm not going to go 12 to 18 months at this stage given that we are in our three-year planning cycle. And the biggest impact I think on whether margins expand or decline over the next year is how much investment do we want to make and we feel is the right investment for our shareholders long term in building our FSP practice, building our medical device practice in those areas.

In addition, the other thing I wanted to highlight is I mentioned this in our discussions about BD, we didn't hire as many people in BD in SG&A as we would like in Q3. That certainly caused SG&A margins to be unusually low in Q3. And I think as those investments are made in the fourth quarter you will see SG&A come back in line with where it has been more historically.

But we also have resources that go into cost of goods sold that are supporting bid defenses, as an example, that are the guys and women who go out and do the actual work for our customers but they also have to go to bid defenses to say why they are the right team to provide that work. We will continue to make those investments as we've talked about over the last 18 months and we plan on doing that in 2017 and continuing to do that as we make these other investments gross margin will more likely be under a little bit of pressure and hopefully we can offset that with SG&A improvements.

Got it. Then one quick follow-up here on the DSO dynamic. Several of your peers last week mentioned that they were seeing DSOs trend up as customers look for just pushing out payment terms and later milestones.

Have you seen any of that come up in your conversations? I know I think Alistair mentioned something that contract renegotiations, you haven't really seen any of that. But are some of the smaller customers beginning to ask for better payment terms?

That's a hard question for us to answer. If you look at our customer base, we're not seeing a significant change in the small biotech and small pharma which is where a little less than half of our business comes from.

From the top 50 we certainly haven't seen customers renegotiating them necessarily but top 50 tend to be a little bit more aggressive on payment terms. And so as we start to talk with new customers their asks from the starting point are higher than what for a much more extended payment terms negatively impacting DSO we are certainly seeing that.

I can't tell you if that is because they've changed their protocol from the past or if it's just because we have a new relationship with them and trying to bid on that that's what we are seeing in the top 20. I think I made comments earlier, if you look at our DSO it's in the mid-teens and if you looked at where it was in 2015 we were actually negative because that was one of our most important terms. Over time we are going to probably trend back to where the industry is, so we will probably see a lengthening in our DSO over time, but at least in the next six to 12 months I think it will still be in the teens.

Got it. Thanks so much, guys.

(Operator Instructions) Michael Baker, Raymond James.

Thanks a lot. With the move in pharma towards outcomes value-based contracting more broadly speaking, was wondering what kind of investment initiative you have on that front?

I know you guys have always been focused in on access to data, etc. But just wanted to get a sense of where that stands. Obviously, you are very clear on the FSP investments, so I just want to get some color on that front.

Are you talking about from a technology perspective to get access to data sort of the QIMS story or the discussion that LabCorp has talked about in the investment in their technology to get better patients, is that where your question is coming from?

Well, the first part of it is obviously it creates a dynamic of change in the industry when you are seeing it from that level and one part of it or the part that gets talked about the most is the data side. So I wanted to just first off get your viewpoint on that change and the impacts you see to the business, and then secondarily from an investment perspective where that falls out. I know you've been very clear on the FSP side, so I just wanted to understand where that's coming through.

I think from an investment side we still believe that software companies such as metadata, SaaS, Oracle and [Gavolto], a lot of those guys are all better equipped to produce the technology that gets to the underlying data. So unless if you have a different business model like the QIMS story, because IMS had a more broad business model than QuantHouse did in terms of data, what everybody from a CRO perspective is really trying to get to is patients and the data is used as a means to an end which is to get the patient enrolled.

Our strategy, which is different than the other companies, is to get to that patient we are going to use best-in-breed technology, but our investment focus is on sites and how we believe sites is the best place to get that underlying data which is where the patients are. So I think at our Investor Day we talked about how just a few percentage points, single digits of all identified patients ultimately enroll in a study.

Our goal is how can we improve our hit rate, so to speak on identified patients, and we believe that investment is being made on sites. And that's where we continue to make that versus technology. That's not our core competency.

Does that answer your question, Michael, or are you also asking about outcomes trials?

So, yes, you could provide some color on that front. I think Greg's commentary was helpful, but there's also what types of data to access as well.

So the relationships that are not only on the technology side but access to the data, as well. Like (multiple speakers) and United or Optum.

Yes, so that's one thing we been growing organically alongside the therapeutic business units for a while now. So we either we've been working to combine evidence and access, real-world evidence data into later phase trials alongside work that's being done to deliver the Phase III or separate trials.

We have a strong history and reputation and registry and things like that. So it's always been a part of our overall service delivery.

We are seeing expansion in that. I think that's an important area for any of the larger CROs to be a strategic provider for their customers is the ability to not only get them to that first approval, the regulatory approval, but also to that commercial approval who's going to pay for the drug in the end, what's the value of it, what's its overall cost and what's the ROI for the patient.

So yes that's an area we're interested in. That's an area we are expanding into. We get more questions about that from customers. As we've grown and we've grown into larger relationships where we are delivering later phase trials I think it's a natural evolution for us to continue growing in that space.

Thanks for the update.

(Operator Instructions) It looks like we have no other questioners in the queue at this time. So I'd like to turn the call back over to management for closing remarks.

Okay, thank you. Well, thank you, ladies and gentlemen, for your attendance today, for your interest and investment in our Company. We look forward to reporting back to you on our next call with the progress made during the fourth quarter of 2016 and have a great day and thank you.

Ladies and gentlemen, thank you again for your participation in today's conference call. This now concludes the program and you may all disconnect at this time. Everyone have a great day.