Syneos Health Inc (SYNH) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the INC Research/inVentiv Health Third Quarter 2017 Earnings Conference Call. (Operator Instructions)

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

Good morning, everyone. The purpose of this call is to review the third quarter 2017 financial results for INC Research/inVentiv Health.

With me on the call today are Alistair MacDonald, our Chief Executive Officer; and Greg Rush, our Chief Financial Officer. Also available for questions will be Chris Gaenzle, our Chief Administrative Officer and General Counsel, who is also leading our Integration Transition Management Office.

In addition to the press release, a slide presentation corresponding to our prepared remarks is available on our website at investor.incresearch.com. An archived version of this webcast will be available for replay on our website after 1:00 p.m. today and there will also be a telephone replay available for the next 7 days.

Remarks that we make about future expectations, plans and prospects for the company, including statements related to our backlog and pipeline, 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-Q for the quarter ended September 30, 2017, and 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 the 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 effects of events and transactions we consider to be outside of our core operations. In addition to presenting these results on an as-reported basis, which includes inVentiv Health as of August 1, we will also be presenting them on a combined basis as if the merger had been consummated as of the beginning of the earliest period. These non-GAAP measures should be considered a supplement to, and not a replacement for, measures prepared in accordance with GAAP. We believe that providing investors with these non-GAAP measures and the combined company presentation helps them gain a more complete understanding of our financial results because management uses such measures for operating, budgeting and financial planning, decision-making and reporting. Furthermore, we believe that also presenting the results on a combined basis provides investors with valuable information for comparing periods and assessing trends. For a reconciliation of the non-GAAP financial measures with the most directly comparable GAAP measures, please refer to the Appendix of our presentation.

(Operator Instructions). 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 2017 earnings call.

I'm really excited about our progress on integration and our go-to-market strategy. But first, I wanted to start by saying a huge thank you to all of our incredible colleagues who have continued to drive outstanding delivery to our customers. We have assembled a cross-functional team of professionals to lead our integration efforts. Their commitment to our shared vision has been truly remarkable. Our dedicated Transition Management Office is driving the integration process with an aggressive cadence, working with our teams to deploy best practices and execute on our communication strategies. For example, we announced our first 3 levels of global leadership by the time we closed the merger on August 1. In addition, all new full-service projects utilize the Trusted Process and, where appropriate, we are also applying this discipline to our larger relationships from the inVentiv customer base. We continue to receive great feedback on the benefits of the Trusted Process from both our customers and our new colleagues. I'm also really pleased with the integration from a customer service and employee retention perspective, with no customer delivery issues of note and our voluntary clinical employee attrition rate actually declining by 20% during the third quarter of 2017 compared to the same quarter of 2016.

I'm also happy to report that turnover amongst our top leadership and key personnel have been less than 2.5% since the announcement of our merger. This is a remarkable achievement, and I think it shows the power of the new combined organization and the excitement that our teams are experiencing as we take our new scale and model to the market. Further, we have executed our first Global Sales and Global Leadership meetings as a combined organization, helping to establish goals and expectations for everyone along with bringing alignment and focus within our business very quickly.

We also remain on plan to achieve the $100 million target that we laid out for annual cost savings by 2020, including the initial $25 million for 2018. We also expect to have our clinical business fully operating on the same systems and processes during the first half of 2018, and expect to consolidate the 5 ERP systems and numerous disparate processes within our Commercial business by late 2018 or early 2019. Although we have a lot of work to do in order to optimize the integration and realize the synergies, achieving these milestones on an aggressive time line represents a key step to unlocking value.

For our go-to-market strategy, we have already developed an integrated sales and marketing approach, including proposal responses, pricing and bid defense strategies. I'm also pleased that we have launched our Integrated Solutions Group in order to capitalize on our cross-selling opportunities for clinical and commercial services. The Integrated Solutions Group is a dedicated experienced team from clinical and commercial operations, consulting and real-world Late Phase. This team works directly in concert with our business development team, alliance management experts and corporate leaders to provide a comprehensive and innovative approach to meeting customer needs, utilizing the full spectrum of our services and delivery platforms. I am pleased to report that there is significant interest for our unique combination of service offerings and insights, particularly in the small- to mid-sized market segment. This includes interest in a comprehensive suite of multiphase clinical work and the ensuing real-world and commercialization services with the same compounds. We believe that if we can demonstrate our value proposition to customers at the time when their own clinical development is underway, we can ultimately enable all of our customer segments to achieve their commercial outcomes and goals.

In the clinical market, an important part of our strategy is to reinforce our focus on strong site relationships and improving the sustainability of their participation in clinical research. I'm pleased to report that INC Research/inVentiv Health was recently honored with the Eagle Award in the best CRO category by the Society for Clinical Research Sites. The Eagle Award recognizes the CRO that best exemplifies outstanding leadership, professionalism, integrity, passion and dedication to advancing the clinical research profession through strong site relationships. The Eagle Award comes on the heels of being ranked the Top CRO to Work With in the 2017 CenterWatch Global Investigative Site Relationship Survey for the third consecutive time. This is obviously strong evidence that the care and attention we provide to the sites we utilize gives us a true competitive edge by delivering industry-leading enrollment predictability through consistently identifying the right size to deliver the right patients for the right protocols.

Turning to the performance in our Clinical segment. We continued to extend our momentum from the first half of the year with another strong quarter of gross and net awards. On a combined basis, using historical reporting methods, third quarter net awards totaled $755 million, representing growth of 25% compared to $606.2 million during the third quarter of 2016. This resulted in a net book-to-bill ratio of 1.4x for the quarter, 1.3x year-to-date and 1.3x on a trailing 12-month basis. These awards were well-diversified with strong performance across top 20 pharma and small- to mid-sized biopharmaceutical companies, along with the diverse mix of therapeutic areas and delivery platforms. We believe this highlights one of the compelling strategic benefits of our merger, leveraging the complementary customer bases, delivery platforms and market approaches of both companies. These strong year-to-date awards continue to build a robust backlog, particularly for the full year 2018. It is important to note that we have made certain updates to our awards and backlog policies as part of our integration to align the legacy company's backlog policies and to move to industry-leading reporting. Greg will outline these changes in further detail later in the call.

In the Commercial segment, we continue to believe that this market has significant long-term growth opportunities for 2 reasons: firstly, the commercial market is only approximately 15% penetrated as of today; and secondly, we have the market leading differentiated offering. We also continue to strengthen our executive team within the Commercial division with recent hires in our communications business. We believe our highly differentiated offering is a compelling and an attractive platform for industry-leading talent, and we will continue to attract the best talent in the industry and deepen our leadership team.

As we have mentioned in the past, we believe there is an indirect correlation between the level of new drug approval activity by the FDA and the overall size of the outsourcing market for the Commercial segment. Year-to-date 2017, new drug approvals stand at 37 versus 22 approved in all of 2016. As we look to the future, based on our own and the industry experts' forecasts, we expect 40 to 45 new drug approvals per year through 2021. We believe this provides a strong foundation for sustainable growth.

Accordingly, we are beginning to see the signs of this market turning with the recent wins within our selling solutions and consulting offerings, our robust future sales pipeline and an increase in our proposal volume.

While in the short run, we certainly face a number of headwinds, which I will address in a moment, we continue to believe that a long-term growth rate in the mid-single digits for the segment is achievable. As a reminder, from 2013 to 2016, the legacy inVentiv Commercial division grew at a CAGR of 15%, and the growth challenges in 2017 and 2018 are significant. These challenges include: one, unprecedented levels of cancellations of drug programs by our customers in late 2016, and again during the third quarter of 2017; two, lower new drug approvals during 2016, which have negatively impacted 2017 revenue, in particular; and three, the loss of a run rate of approximately $30 million of annual revenue beginning in mid-third quarter 2017 from our largest advertising customer as a result of across-the-board reductions in their outsourcing spend.

Clearly, it's up to us to drive this business, and we believe we are up to that challenge. The ability to bring our customers' product development and commercialization goals to reality is a big differentiator for us in a highly competitive market. It is a message that is resonating with our customers, and we are enthused by the possibilities that lie ahead of us. Let me close by again expressing my gratitude to the thousands of our colleagues that continue to work tirelessly on their highest priority: serving our customers with the highest levels of professionalism and integrity. They are helping us create a truly unique organization that is unmatched in terms of capabilities and service excellence.

Now let me turn it over to Greg Rush for more comments on our financials. Greg?

Thank you, Alistair, and good morning, everyone.

To continue Alistair's theme on our integration efforts, I am pleased with the progress we are making in our integration efforts, including progress in consolidating our financial teams, accounting policies, processes and systems.

Before I begin, I wanted to take a moment to thank all of the finance staff who have spent countless hours compiling all of the conformed and combined financial data included in our earnings presentation. While I'll not go through all of the changes to our processes and policies on this call, I do want to highlight a few of those changes starting with those that we made to our awards and backlog policies.

Our new backlog policy can be found on Slide 12.

The significant changes to our backlog policy are as follows. Awards must have an expected start date within 6 months after the end of the quarter in which the award was received versus our previous policy requirement of 1 year. We will also no longer record the full value of an FSP award, opting to include only the first year of the award. We will book the incremental value on a rolling quarterly basis, such to maintain approximately 1 year in our backlog at any given time. We will also now disclose our backlog in 2 subcategories: first, we will disclose the portion of our backlog that's gone to contract, which we refer to as contracted backlog. We believe this portion of our backlog should be comparable to some in the industry that only report backlog on a contracted basis. Secondly, we will also disclose the portion of our backlog that has been awarded but has not gone to contract, which we refer to as awarded backlog. It is very important to note that awarded backlog goes through numerous steps on its way to contracted backlog. For example, a significant portion of our awarded backlog has moved from a written award to a small startup contract to allow us to contractually begin work on the study prior to completing the full contract. Also I want to remind you that we have historically had a higher cancellation rate than the industry due to our policy of removing previously awarded backlog when we determined that the awards are probable of being canceled, probable of not converting to revenue, or cease to meet the conditions for inclusion in backlog. We believe we are one of the few in the industry, if not the only one, that takes this proactive step to remove previously awarded backlog. We will continue this practice and have applied all of the above criteria to inVentiv backlog obtained in the merger.

Given our conservative stance on FSP awards and the risk adjustments that we make each quarter, we expect these changes to our backlog policy will result in a more conservative book-to-bill relative to the industry on a go-forward basis.

On Slide 13, we have provided a reconciliation of our backlog and net awards for the third quarter under our old and new policies, showing the impact of each of these changes. I want to point out that we do not expect the adjustments to backlog to have any impact on our expectations of revenue, as the adjustments for FSP and start date for studies were already appropriately phased in backlog coverage.

Further, the majority of our risk adjustments and contingent studies removed from inVentiv backlog were previously identified in due diligence, and were not considered in our expectations of their future revenue.

In addition, on Slide 14, we provide a historical view of the combined company's net awards and book-to-bill as originally reported compared to the book-to-bill under our new policy for the full year 2015 and each of the quarters in 2016 and 2017.

Now let me turn to our results for the third quarter. All of our results are on an adjusted or non-GAAP basis, as if the merger closed on January 1, 2015, as defined on Slide 3. In the Appendix to our slide deck, we have provided numerous reconciliations to help bridge previously reported inVentiv results to our accounting and disclosure policies. While I'll not discuss those in detail, I did want to point out that as a result of conforming inVentiv to our policies, we have eliminated certain add-backs and one-time benefits from inVentiv's previously reported adjusted EBITDA resulting in reductions of $10.2 million and $22.6 million for 2016 and year-to-date 2017, respectively. The majority of these adjustments related to one-time benefits, such as the R&D tax credit benefit that we highlighted on our second quarter call.

Slide 32 provides the detail of our adjustments and exclusions. Our total net service revenue for the third quarter of 2017 was $766.6 million, a decline of 6% compared to $815.2 million for the third quarter of 2016. This revenue decrease was driven by a 21% decline in our Commercial segment, which fell from $295.5 million in 2016 to $233.2 million, primarily due to the impact of cancellations at the end of 2016 and further cancellations in the third quarter 2017, coupled with a lower new drug approval activity during 2016. This deterioration was partially offset by a growth of 3% in our Clinical segment, which increased from $519.8 million in the third quarter of 2016 to $533.4 million in the third quarter of 2017. The growth in our Clinical segment was due to our strong bookings in 2017 partially offset by continued customer delays. These customer delays were particularly acute within our small- to mid-sized customers. Foreign exchange had a negligible impact on our revenue decline for the third quarter.

On a year-to-date basis, our net service revenues declined by 4% from $2.425 billion to $2.332 billion. This was comprised of a 15% decline in our Commercial revenue from $887.3 million to $752.9 million, which was partially offset by 3% growth in our Clinical segment from $1.538 billion to $1.579 billion for the reasons I previously highlighted. This decline in total revenue includes a foreign exchange headwind of $14.2 million.

Our gross profit decreased by 7% to $249.1 million in the third quarter of 2017 compared to $267.6 million in the third quarter of 2016, with a slight decrease in our gross profit margin from 32.8% to 32.5%, respectively. On a year-to-date basis, gross profit for 2017 decreased by 5% to $757.8 million from $793.4 million for 2016, with gross profit as a percentage of revenue decreasing slightly from 32.7% to 32.5%. Foreign exchange had a negligible impact on gross margin for the third quarter while having a positive impact of 60 basis points in the year-to-date period. The decrease in our gross profit was primarily driven by decrease in revenues and, to a lesser extent, an increase in underutilized personnel resulting from the excess staff that I discussed during our second quarter earnings call, along with the negative impact on staff utilization from customer delays. We expect to complete the reduction of these excess staff by the end of 2017 with many of those actions already having taken place in the third quarter and further reductions in early November.

SG&A expenses decreased from $114.4 million in the third quarter of 2016 to $110.3 million in the third quarter of 2017, increasing from 14% to 14.4% of net service revenue. While we had a modest decline in total SG&A costs, SG&A increase as a percentage of revenue due to our revenue declining at a faster pace within our Commercial segment than anticipated.

On a year-to-date basis, SG&A expenses decreased from $353.9 million in 2016 to $333.4 million in 2017, with the related margin decreasing slightly from 14.6% to 14.3%.

Adjusted EBITDA for the third quarter declined from $153.1 million in 2016 to $138.9 million in 2017, with the associated margin declining from 18.8% to 18.1%. On a year-to-date basis, adjusted EBITDA decreased from $439.4 million in 2016 to $424.5 million in 2017, with the associated margin improving slightly from 18.1% to 18.2%. The decrease in EBITDA was primarily due to the decline in revenue from our Commercial segment partially offset by lower incentive compensation expense. Specifically, both our direct costs and SG&A costs benefited from reduction and incentive compensation as their performance has not met our expectations.

Foreign exchange had a negligible impact on adjusted EBITDA margin during the quarter while having a positive impact of 70 basis points on a year-to-date basis. Adjusted net income increased to $56.5 million for the third quarter of 2017 from $49.2 million for the third quarter of 2016, and increased to $164.2 million for the year-to-date period in 2017 from $135.2 million in 2016. Adjusted net income increased in each of these periods despite a decline in adjusted EBITDA, primarily due to the significantly lower interest expense stemming from the refinancing of the combined company's debt at the time of the merger. Adjusted diluted EPS grew by 15% from $0.47 in the third quarter of 2016 to $0.54 in the third quarter of 2017, while also increasing from $1.28 to $1.56 on a year-to-date basis.

Slide 11 provides key metrics related to our cash flow and leverage position. During the 9 months ended September 30, our operations produced $109.7 million of cash on an as-reported basis. Our combined net DSO for the quarter was 38 days, consistent with our revised mix of customers. We expect our DSO will vary quarter-to-quarter based on seasonal trends in collections and billings and to range from the high 30s to mid-40s over time. We ended the third quarter with $304.3 million of unrestricted cash and total debt outstanding of $3.05 billion.

Slide 15 provides you with additional backlog metrics. This includes an updated view of our backlog conversion rates, which have been restated historically on a combined basis under our revised backlog policies. We expect to provide a complete view of our traditional backlog metrics beginning with our next earnings call once we complete our review and slotting of the backlog obtained from inVentiv in the merger.

On Slide 16, we are providing our guidance for the fourth quarter. Our guidance takes into account a number of factors, including our existing backlog, current sales pipeline, trends and cancellations and delays and our expectations for Commercial sales in the fourth quarter. Further, our guidance is based on current foreign exchange rate, current interest rate and our expected tax rate. We expect our net service revenue for the fourth quarter to range from $750 million to $780 million with a midpoint of $765 million. We expect our adjusted EBITDA to range from $137 million to $147 million. Lastly, we expect EPS on a GAAP basis to range from a loss of $0.25 to a loss of $0.14 per share, and we expect to earn $0.52 to $0.60 on a non-GAAP basis. We based our updated adjusted earnings per share guidance on, among other things, an expectation that interest expense will range between $29.5 million to $30.5 million, an effective tax rate of 35% and adjusted EBITDA margins of approximately 18% to 19%. We expect our fully diluted weighted average share count for the fourth quarter to be approximately 106.7 million shares.

Although we are not providing 2018 guidance until our fourth quarter call, I do want to give some color for 2018. As a reminder, these views are preliminary and are subject to continued strong new awards, normal levels of cancellations and a return to normal levels of steady delays versus the high rate we experienced in 2017. Based on existing accounting standards for revenue, we are cautiously optimistic that our consolidated net service revenue may grow in the mid-single digits, which takes into account the following expectations within each of our segments. For our Clinical segment, we continue to build our backlog for 2018 and, accordingly, we believe that we have line of sight to achieve mid-single-digits growth in 2018 for the segment with potential upside to the high single digits. For our Commercial business, while we don't have the same levels of visibility as our Clinical segment, we are cautiously optimistic that our revenue will be roughly flat with our 2017 revenue levels with a potential path to low single-digit growth. To achieve these expectations, we need to continue the high win rates within Selling Solutions, avoid any additional significant cancellations and limit the impact of an expected $30 million revenue decline from our higher-margin advertising offering.

As to our 2018 profitability metrics, I simply want to remind you of several comments we have made in the past that may impact your assumptions. First, the mix of revenue has a significant impact on our EBITDA margins. As I noted above, we will be facing a headwind in EBITDA margin expansion in 2018 as a result of our expectation of a decline in our higher-margin advertising revenue. Our ability to maintain or expand EBITDA margins will depend in part on our ability to offset this headwind. One source of potential offset to this headwind is the benefit from our expected $25 million of synergies in 2018. Second, we expect our non-GAAP tax rate to continue to be approximately 35%. Thirdly, on Slide 37 in the Appendix, in order to provide more visibility into our interest costs, we have provided the current components of our annualized interest expense, assuming current LIBOR rates and no additional debt payments. Finally, we expect our total diluted weighted average share count to be approximately 108.5 million shares during 2018.

This completes our prepared remarks, and we would be happy to answer any questions. Operator?

(Operator Instructions) Our first question comes from Robert Jones with Goldman Sachs.

I guess, Greg, a lot of comments there at the end around next year, but if I'm looking at the weaker Clinical baseline -- but you had the really strong book-to-bill year-to-date -- yes, to look at Clinical growth next year, if I heard you correctly, I believe you said mid-single digits for next year? Could you just maybe help us square that? I would think just given that some of this is delays, and obviously, the book-to-bill, either under the old or new methodology has been really strong, tough to kind of see how that only results in mid-single-digit growth. Could you maybe just help us square that?

Bob, it's Alistair. I'll start you off and then pass you over to Greg. So I think when we look at the backlog we have and, as you mentioned, that -- we've had 3 quarters of really strong net awards, Q3 was good as well from net awards as the first quarter as a combined organization. Our pipeline is strong. And I think those combined kind of do support that high single digit performance that we talked about before. But in 2017, we have a big piece of our work coming from the small to mids and they -- we've experienced delays in getting them through and into the revenue generating pieces of the projects. That's not study startup, in particular, but regulatory delays, protocol, waiting on protocol, drug supply, things like that, that are really outside of our control. And for some reason in 2017 that -- we've been hit by that 3 or 4 times on -- with smaller customers with bigger projects. They're still all in the backlog, they're still moving forward, they just keep slipping. So what we've done is for our kind of projections for 2018, we've -- we're starting to factor that in because they'll still be a big part in what we do. We're still focusing the organization to engage with those smaller organizations and that high-touch kind of small to mid sector. We like the work in there. It's always very exciting. It's always great science, sites are keen, patients are in need of this kind of -- this development. And I think some of those factors in -- contribute to the delays because they're harder to get ethics approval and they're harder to get protocols finalized, they're harder to get up and going. So we just want to be prudent with that. We just want to pull that back a little bit, so that we account for some of that as we go into 2018 as well.

So Bob, just 2 data points you should take from this: our backlog does support really strong growth next year, high single digits. We are trying to be prudent on the assumption of growth as -- if you -- in my prepared remarks I did say that mid-single digits with upside to the high single digits. We are trying to acknowledge that the pure math would say it would be high single digits but -- and we also want to be prudent. And come February, we hope to be able to tell you that the delays are back to normal and give you a different number. But right now, we wanted to be prudent.

No. I appreciate that. I guess just one other follow-up. I know there's a lot of moving pieces within the P&L with some of the changes. But if I just look at 4Q EPS at the midpoint, the guidance of $0.56, is that a fair run rate jumping off point to then build upon the synergies, the $25 million that you guys have stuck with and then some of the growth that you talked about? Or is there anything specific within 4Q that we should acknowledge that would make that midpoint of the 4Q guide not a good starting point?

There's 2 or 3 things you should keep in mind. We did go to a little bit more of a conservative policy on reporting than inVentiv had previously done. That will be in all of our numbers going forward. But from -- maybe what Wall Street expected, there's probably $0.01 or $0.02 impacting Q4 from what -- if you've just taken what inVentiv done previously. So keep that in mind in our guide that we are being negative impacted by $0.01 or $0.02. Going forward, I think we do have extra capacity in Q4 to deliver more revenue without adding costs. As Alistair mentioned, we had customer delays in Q3 and Q4. As a result, our staff were not as utilized and not as efficient. The revenue per head is probably lower than we would like to do. So I certainly believe we can expand. If the backlog starts burning, we will be able to expand revenue with very little incremental costs, particularly in SG&A, but also even at the cost of service line. So I do think that there's EBITDA margin expansion if we can stop -- if we can get through the delays. So if I'm talking to you on -- in February and telling you the delays are not there as much and I'm upping revenue guidance, you should see incremental EBITDA margin expansion too because a lot of that will drive straight to the bottom line as we're de-levering.

Our next question comes from Erin Wright with Crédit Suisse.

So can you parse out some of the moving parts in the Commercial side of the business? And how you can get to maybe some better visibility on that segment? What sort of tangible data points can you track internally to help us or help you sort of manage expectations around that segment? I guess you're getting to potentially the mid-single digit longer-term growth, but flat growth I guess implied in 2018. But I guess broadly speaking on a consolidated basis, do you think kind of a high single digit long-term growth rate for the consolidated business is still achievable?

Erin, it's Alistair. Thank you. I think we -- when we look at the metrics of -- on the Commercial side and as you know -- you guys know, we're still kind of still grappling with it all, because it is a very different business. We're looking at a couple of different sectors that feed our commercial business overall. Obviously, one of the metrics we talked about in the prepared comments was the number of drugs going through the approval cycle. 2016 was a low. We're looking at 2017 now, we're at 35-36, I think, in the overall number of drug approvals. And as we look forward to those drugs going into the pipe now through NDA/BLA submissions, we see that trend for 2018 as well and maybe even higher in 2019. So you're looking at like 40 to 45 new drug approvals or submissions at least through the next 2 years. We are seeing that starting to turn through in Greg's comments, I think, and in mine also, an uptick in -- and we track a bunch of different metrics into each of the business lines, number of meetings people are having, number of RFPs, values of those RFPs, we rank them in terms of how kind of a quality assessment scoring of how real they are and how we feel that we'll engage with them. And we're implementing all those things into the Commercial business as well now. So bringing in a much stronger sales approach across that business and making sure that we also take that approach to our small to mid sector. So we're working pretty hard right now across that group to also look at how do we take them from clinical through the whole continuum. So how do we convert them from a clinical customer into a clinical real-world evidence consulting and commercial customer. We have deployed a new group called the Integrated Solutions Team. And because the model we have is very complex, we need a specialist group effectively that understands the very broad view of the work that we do, can sit with customers, explain it very clearly and identify the needs that the customer has. What they have, what they're going to do themselves, how we plug into that, how we surround them with the services and build a bespoke solution for that customer. So we have a lot of those discussions ongoing. We -- they're in various stages of the kind of sales pipeline. Some of them are going very well, some of them are in early stages, and I think those 2 factors, being able to go out -- up against more drug approvals, being able to engage our small to mid customers and drive those through and having a more solution-orientated approach with the customer on a longer-term basis are all things that will help us turn our business up.

Okay. That's really helpful. And can you speak to maybe some of the elements of conservatism in your new backlog assumptions? And what does this imply in terms of a long-term normalized book-to-bill number thing?

This is Greg. A couple of things. The 2 main changes from "INC's policy" was first, anything less than 6 months in -- we are including trials that start within 6 months or less. Previously, it was 1 year. That doesn't impact our revenue expectations at all because, as you know, backlog coverage --- we phase trials in when they're supposed to start. So if it was supposed to start in 9 months, it wasn't -- it didn't give much impact to the backlog coverage at all because there's only 3 months quote in the next 12 included. So again, no impact on our revenue expectations, but it does lower our book-to-bill. There's some slides in there that reconciles that. The other thing on FSP basis -- basically, in the industry, I believe everybody books the full value of an FSP. So if you're awarded a 3-year FSP contract at $100 million a year, people put $300 million in their backlog. The one exception to that is PRA. They -- since they've gone public, only included 1 year's worth so they would include the $100 million, in my example, of the $300 million. Given that they have roughly $500 million of FSP, and we have roughly $500 million and everyone else is, I think, probably half that, we are the 2 market leaders, we wanted investors to have a comparable comparison of us versus them in that reporting. So we are only now including 1 year, that's probably the biggest adjustment to our backlog. If you look, we took about $1 billion out of backlog, about half of that came from pulling out all the FSP out. So as a result, I think other analysts have pointed this out, PRA's book-to-bill is always a little lower than most people in the industry because of that policy. Ours will be lower than people in the industry because of that. The other thing that we have always done is we risk adjust our backlog. I think we're the only one in the industry that does that. And typically, that results in about 0.1 or more haircut to our book-to-bill. So if you're trying to compare our book-to-bill to any other company, those 2 policies put together, the FSP and the cancellations, our book-to-bill relative to others will always be 0.1 or more lower than the others. No impact on revenue but again, our 1.2 is not the same as the industry's 1.2. It's about 0.1 or lower, relatively.

Our next question comes from Tycho Peterson with JPMorgan.

Alistair, I want to go back to the questions on Commercial. I understand there's not much you can do on drug cancellations or lower drug approvals, but anything you can do to improve visibility on the ad spending side? Or mitigate the $30 million impact from your largest customer? Can you also mention margin implications? I think the ad piece has higher margins? And how do we know this is a one-off versus a broader secular trend on the ad front?

Yes, yes. Good questions there, Tycho. So on the ad side of the Commercial business, we've already made some changes to this segment to give them a bit more focus in and around the advertising piece of it and also the PR piece. So it kind of roughly breaks -- that communications business breaks down into those 2 different sectors. So a lot of work we're doing in Clinical and converting those small to mid into clinical commercial customers. That starts with naming their drug to high probability when we get to that point and when we start working with them in naming their products that it converts to more spend across communications and then into selling solutions. So we've taken a much more integrated approach to that model, and I think, historically, inVentiv have not always capitalized on that. So one of the things we're trying to do is kind of change the way that we feed business into the Commercial side from the Clinical side. Big focus on collaboration, big focus on being more open and communicative, pivoting around real-world evidence and helping to drive all that through. We've made -- we've added, I should say, some significant talent to that commercial group. That was already in process as we went through the merger. We have 2 or 3 new leaders in that communication space who are out on the road, pressing the flesh, talking to customers, driving our business. So we did get the $30 million kind of haircut on a single customer. I think that is related more to that customer although I think we've seen pharma coming under more pressure in that commercial space. And that is actually one of the drivers of our merger because with that commercial, that spending pressure on commercial variabilizing that cost actually plays into our model a bit more, so I think there might be some headwind in some of the accounts, but I think the approach that we're taking now is more collaborative, more feed from the clinical side. If you think about -- we effectively doubled the Clinical pipeline that sits in front of Commercial. Of all the things that we touch, that enables us to pass more through, hopefully. So I think those factors will help us pull that business up. I think it will help us take some of our headwind out. Some of the customers have referenced before for, I think Erin's question, of around the small to mid customers, they have nothing internally to deliver that communication package themselves, so they are kind of a prime target for us as we help people transition from clinical into the commercial space.

Okay. And then the follow-up is on margins. Margins in Clinical look like they could be a bit constrained with the shift toward FSP. Obviously, on the commercial side, some of the revenue headwinds might crimp margins there. So as we think about EBITDA margins for '18, can you just maybe provide a little bit of color as to how you're thinking about it?

Yes. I don't know that I want to add anymore than what we said in the script. I do think that we -- as you look forward to our backlog billing, the biggest amount of growth in the future and where all the delays were that hurt our revenue this year, were in the full-service offering, which have higher margins than the FSP. So I do believe if we have the revenue growth that we're articulating on this call in Clinical that would be primarily in our higher-margin full-service business. Our biggest headwind for EBITDA margins for the total company is in the Commercial business. Even if revenue were to stay flat, to grow slightly, I think you'll see 2 things happen next year. One, the mix of our selling solutions business will be higher because it's where we're starting to see sort of the early turns in the growth rate is in that business. That's probably our lowest margin piece of our commercial offering. Advertising, we got that $30 million headwind, so everything else held constant, if we do the same revenue, you may even see a decline in EBITDA margins in the commercial next year because of that headwind in advertising. We're aware of that. And that's where all of our focus is, is if we can get that advertising dollar decline to be smaller than the $30 million and maybe even be flat, you'll have upside in the EBITDA margins.

Our next question comes from David Windley with Jefferies.

I wanted to follow up on a couple of things here. The bookings numbers, the change in policy, obviously, as I mentioned to you guys earlier, I'm kind of on the move and not able to look at the numbers real closely. But I wondered how much, given your change from 12 months to 6 months, how much of that caused bookings that you had previously recognized in the first and second quarter to fall now into the third quarter?

We have a reconciliation on Slide 13 of that. There's not much. The net impact was a -- of what we booked -- what we took out of Q3 that would have been under our old policy and put back in, the net was $27 million of a hurt.

Yes.

So we actually had a bigger hurt for having that policy in place net-net. So that's on Slide 13. And so -- and that includes the turnaround, so the net impact is actually a hurt now -- where we did get a pickup net-net, David, we only took out $35 million for the FSP. So we had very small amount of FSP awards in Q3 that where we took out the quote year 2 or beyond. But with that rollover impact from prior quarters, where you -- we booked it on a rolling quarter, we had a $75 million pickup on a combined company basis. So the net of the FSP change was actually a positive to our bookings of about $40 million. So that's where we did get a little bit of a positive. Then when we applied the risk adjustment policy that we have. And I think this is where I get the turn of about 0.1 or more. InVentiv did not previously -- they waited until they got a cancellation letter from the customer to take it out of backlog. We don't do that. In fact, most of our risk adjustments are not even related to anticipated cancellations, it's more of where we got our $40 million study, and now we think the value -- because of where we are in the study, or certain sites are not going to be initiated or whatever, we're going to finish early -- that the $40 million has turned into $38 million and there's $2 million of backlog that's no longer going to exist. We take that $2 million out. We booked a total of $85 million of a reduction in their bookings, not because of cancellations but just risk adjustments in the current quarter. So net-net, the policy was a hurt, mainly because of the risk adjustments.

Okay. On the delays related to your small, mid clients, are those -- I mean, I think you talked about just more complex and harder to get started, but are those funding-related? Clients that aren't moving forward because they don't have the funds in place? Or are they simply like molecule and regulatory and things like that?

Yes, it's not funding. I think that...

-- we don't have it in the backlog in the first place.

If we don't believe it's funded, it won't go into backlog. And I don't -- it's not funding issues, Dave. I think that sector is pretty well capitalized. But we -- it comes down to actually the production of the drug and getting their finalized protocol. I mean, some of this work that's been moving to the right through 2017 is really very groundbreaking treatment scenarios and kind of new classifications. So it takes longer to get those protocols developed, completed, the drug actually manufactured and distributed to sites. A lot of these drugs, compounds, treatments are very sensitive to different environmental practices, so it's a lot of different supply-chain issues. We're starting to stick in the backlog, which is good, which we'll see us start delivering that revenue in 2018. And I think just to recap, really, over the last 3 quarters, and particularly in Q3, I think we're particularly pleased with the way that our model has been received by not just small to mid and expanding that into the commercial side. But also the larger customers, those that came in through inVentiv, seem very happy with the service profile, the service capital outlook we can now put in front of them. The scale matters to them, and we're starting to see that come through certainly in the pipeline, but also I think we had a really nice strong bookings quarter in Q3, and we hope to capitalize on that.

So Dave, let me give you 2 real examples that -- of delays. One of them is -- one of our small to mids wanted to handle all of -- not all of it, a substantial portion of the pass-through costs themselves and negotiation. And they underestimated the cost of the comparator drug. They assumed they could get it at a discount from the other pharmaceutical company. Bad assumption. And so they held up the trial start date and -- because we can't start a trial without the comparator drug, and they continued that negotiation trying to get a better price. And that delayed the study by 2 to 3 months. Finally, they acquiesced and the trial started and they're paying the higher price. That's an example. A bigger pharma probably would have known that and you wouldn't have an issue with that. And those are things we try to help the small or mid. If they give us the -- their consulting work, we could have helped them to understand that. The other example, our biggest delay was a project we thought we would get $10 million of revenue in this year in the second half. And the study has started. We are working on it, but now our current forecast is $2 million and that is -- part of the issue is one of the -- the countries that we're going into, they had never been in, and they had a protocol issues and -- their own contractual issues with all the people and it started, but it cost us $8 million of revenue this year and very little to do with any of our operational issues.

Last question. Is there any ability -- I don't think I've heard you comment in too much specifics, but is there any ability to accelerate the synergies fourth quarter or into 2018 beyond the $25 million run rate? It seems like that would be a level that's more in your control that would...

Yes. Dave, we're going to introduce you to Chris Gaenzle, who's here. He's our Chief Administrative Officer, sort of leading the integration efforts.

So Dave, thanks for the question. I think given the August 1 close, we've got the benefit of having commenced our synergy play early in the year. So we get the full credit for not only part of '17 but all of '18. I think more broadly, we -- I'm very pleased with where the company is moving directionally with regard to each of the 3-year synergy targets culminating with $100 million 2020 synergy. We were very aggressive, as Alistair noted. Going back to that May 10 announcement, we had in place our Transition Management Office by early June. We announced our first 3 levels by August 1, which gave us great span of control, call it our Top 200. And we've now commenced on both the labor and non-labor synergy play starting in August. So I think we're -- we feel good about where we're at. I don't think we're prepared to give any additional guidance with regard to the in-year savings, but we're very confident that we will hit those numbers.

Our next question comes from John Kreger with William Blair.

Alistair, could you maybe just help us better understand the 21% decline on the Commercial side in the quarter? What -- was that sort of a -- broad across the board? Or was it in one of the -- I think you identified 3 or 4 buckets within Commercial. Just wanted to see how we should think about the breadth for that.

Yes. So I think it comes in 2 flavors. In 2016, there was a lower number of products come into the market. It was well-documented, I think it was 20 --- was it 22? Is the number 22? Yes, this year, we're back at 35, 36 right now, and then projected to be in excess of 40 products going through that kind of pipe. That lack of market for the selling solutions business in 2016 obviously impacts 2017. So that was a big part of the -- of that revenue decline year-on-year. But then the...

And does that impact all the different portions of Commercial that you've mentioned? The communications? The selling solutions?

It does to some degree, yes, because a lot of that communications work is obviously also incorporated in the launch of the new product, so you -- the communications piece also takes a hit with that. It effectively drives a piece of all of those groups across Commercial. But it's more acutely felt in the selling solutions sector because it's the...

It's 65% of our revenue.

Yes, 65% of the revenue falls out into that bucket. So and the second piece, just a big cancellation or a big reduction in the spend, I don't think really we'd look at it as a full cancellation, but a reduction in the spend from one of the major customers in kind of midstream Q3, which -- and it's not like a clinical trial, obviously, where you've got ethical and medical concerns when you switch a trial off. You still have to monitor the patients, close it all out. There's run on revenue. In Commercial, when they say stop, you stop immediately, so that revenue falls out immediately. And that -- we have to do a better job, I think, building a broader customer base around that, bringing in the small to mid, having more contracts that could soften an impact when that happens and drive upside when it's in a year when there's more drug approvals going through. So I think it comes in a couple of flavors. It's -- and the revenue switches off very quickly, but on the converse, obviously, if you win a contract today, we could be starting that revenue on Monday, which in the clinical trial, you don't get either.

John, one of the things that we're going to try to do, and I'm not going to make a commitment that we'll be able to do it is, obviously, one of the things that we're getting a handle on is what are the best leading indicators of revenue growth? Obviously, in the clinical space, we always lead with backlog coverage, book-to-bill is an indirect indicator of what future could be but nowhere near as good an indicator of backlog coverage. So you, as an analyst in this space, are used to -- on the CRO side, backlog coverage, you're used to book-to-bill, you're used to net awards growth. That's all indicators of what revenue growth could be. You're -- obviously, our investors and you're somewhat flying blind on the commercial. One of the things that I would tell you that we're -- we saw this year, even though new drug approvals are up and probably going to be in the low 40s, the mix of those drugs that are approved are smaller compounds and not producing some of the big sales teams that we saw even in '16. So I may have that wrong, so use this, what I'm about to say as directional. But I think last year, we had 4 -- there was 4 or 5 100-plus sales teams that went out to bid to the industry. So there's only 4 or 5 proposals last year whereas in the years before, it was much greater than that. Two were actually awarded to us last year, and we lost 3. So we had a 40% hit rate last year. I believe this year, there's only been 2 that have even gone out to bid to the sector and both of those were awarded to others based on price. We weren't willing to match the price and our competitors were willing to do that, and they had their own reasons for going to those prices. But -- so you only had 2 versus 5, and we're 0 for 2. And so that's one of the reasons why we also tempered our expectation for '18. We had expected commercial to have double-digit growth next year in our original proxy filing. But they -- that's not going to happen right now because we haven't won those big 100-plus selling teams this year that we would have expected to.

That's very helpful. And maybe just one quick follow-up on the same topic. So the -- I think you communicated that you think Commercial will be about flat in '18. Help us understand the buckets there. So it sounds like your advertising business will be down materially, is selling solutions flat and what about PR?

When I say communications, PR and advertising, we basically think of it as 4 pieces. Selling solutions, about 65% -- 60% to 65% of our revenue, typically. Communications, which is advertising and PR, that combined is usually, call it, 25% to 30%. And then our Adheris and consulting make up 10%, the balance and they're equally weighted. So our -- the communications piece is going to be down next year based on that 1 customer, probably down $20-$30 million. Selling solutions, we -- and we're starting to see good wins there, and we think that probably will be up absent cancellations, knock on wood, but that's -- that business is absolutely turning but it's lower margin. Consulting has been strong this year and that's an area we're investing in. That's an area where we can connect the commercial and the clinical and that's going to be an area of focus. And if we're able to do that successfully, that will pay in the long term, to wins in both units as we -- as Alistair mentioned, our Integrated Selling solutions Group. So hopefully, consulting will be a growth. Adheris is really more of a business that we tried to use as a tip of the spear to win selling solutions and advertising. It gives us a lot of incredible data insights, which I think out -- and I'll let Alistair address that.

Yes. Well, I think the Adheris business is interesting. I just want to touch on that communications business again for this year because I think we've got this headwind coming out from the 1 large customer there. But I think the -- we're seeing the pipeline for that work -- the work we need to win to replace that. So we'll be aggressively working on that through Q4 to get that work awarded and into backlogs for next year. The Adheris business for me, it's kind of the fuel that drives a lot of the work that we can deliver and not just in Commercial but also as we connect it through real-world and back into Clinical. We have competitors that make a huge play on data, and that's great. You need the data to drive where you look for patients and all the other solutions that you can bring to bear. We have a lot of that data, we have a lot of that information. We've invested in a group that looks at our data assets, how we use data, the use cases, how we deploy that through Clinical and Commercial, and we're able already to pull some of that data across and show Clinical customers what their landscape looks like, where they're at in the development space, but also where they're at in -- for their potential commercial spaces that bring that drug forward. So they know what their expectations are around that delivery. And I think that power that we have with that and also the connection that we have with the sites, when we can combine those 2 things together, finding the right protocols, knowing where to fish for the patients with the data and the relationships with the sites because it's one thing to have all that information, but if you can't convert it into a highly functioning, highly efficient clinical trial, it just ends up as data. So we're trying to make sure that we use all our assets to improve the clinical business, its connectivity to commercial through real-world and consulting and drive the whole model. And I think we're very excited about that.

Our next question comes from Tim Evans with Wells Fargo Securities.

I was hoping to take a big step back here and look at the forest instead of the trees. When you closed this deal or when you announced the deal, excuse me, you sounded like you had a very high amount of confidence in, say, the CAGR numbers that you gave for 2017 through 2020, the 9% top line, the 14% EBITDA. And from what you're telling us today, I think is going to kind of shake our faith in those numbers. What has -- what are the 2 or 3 things that have really changed since that point in time through today?

Yes. I'll take the first one and let Alistair address. I think clinical -- nothing has changed in terms of bookings. They've come in where we thought they were going to be our backlog is built -- building exactly where we thought it would be. And again, those numbers were in May, so you -- in fairness, 7 months have passed and all of our competitors have modified their numbers with new information. But Clinical, I would say not much, other than we've tried to be prudent in giving 2018 guide of delays. Long term, we still believe high single digits is where this company will be over the long term. That has not changed. And you -- when we gave that 9%, it wasn't by year. We didn't say every year it was going to be 9%. We articulated that Commercial in particular has a higher beta, and the variability in that will be -- will not be straight up and to the right. In fairness, 2018 is not going to be as strong as we would've thought initially, and that's all on the commercial side. I think that we had expected Commercial to be -- to finish this year, quite honestly, above $1 billion in revenue. Right now this guy would say, it's going to be below $1 billion, but we expected it to finish this year a little higher than it did. And next year, for it to be -- low double-digit growth. And the lack of the wins of the 100-plus sales teams and the $30 million hit that we're taking in advertising, that's 2 points on the growth rate right there or 2 to 3 points on Commercial and a solid 1 point on the total company growth. That 1 customer alone. So we still said mid -- in a mid-single digits. You can articulate that to be 4%, 5%, 6% is what we think the whole company, but the downturn from the 9% is almost solely within Commercial.

Yes. I used to work here at INC before it was INC inVentiv, for a CEO who would tell me all the time, conditions change. And we've seen that. We have the cancellation. We have the headwind from Commercial. I think when we look at where we're heading with Clinical, how we're connecting that with all the other parts of the business now, we have a very, very strong, very functional, high-performing Clinical business. We have had 3 great quarters of net awards that are starting to build out backlog nicely, and we will convert those, and I think that stream of work that comes out of clinical, obviously, some of it doesn't make it all the way through the commercial, that's the nature of our business, but those pieces that we're working on, that are moving through our model, that are moving towards Commercial, we have practice, we have a methodology to get with those customers at the right times, drive more pipeline into Commercial to bring that business up. And that connection from Clinical through Commercial, I think, makes it stickier with the customers because they see a longer-term future and a longer-term pathway with 1 organization where they can get more buying power because they're spending more with us and our relationships get deeper, longer and stronger. And I think that will help us drive to where we said we would. I think it's a great question, Tim. I think it's a great way to kind of think about the overall, but -- and it helps to tell you that we're very confident in the overall, not just now but in the future as well.

And I'm not showing any further questions at this time, I'd like to turn the call back over to Alistair.

Okay. Thank you. Well, thanks, everybody, for joining us today and for your continued interest and investment in our company. Have a great day. Thank you very much.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.