Syneos Health Inc

F:8IN

Earnings Call Transcript 2019-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Syneos Health Third Quarter 2019 Earnings Conference Call. [Operator Instructions] I would like to hand the conference over to Ronnie Speight, Senior Vice President of Investor Relations. Please go ahead, sir.

[Ronnie Speight, executive]

Good morning, everyone. With me on the call today are Alistair Macdonald, our Chief Executive Officer; Jason Meggs, our Chief Financial Officer; Michelle Keefe, our President of Commercial Solutions; and Paul Colvin, our President of Clinical Solutions.

In addition to the press release, a slide presentation corresponding to our prepared remarks is available on our website at investor.syneoshealth.com.

Remarks that we make about future expectations, plans, growth, anticipated financial results 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, and we disclaim any obligation to update them.

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 factor section of our Form 10-K for the year ended December 31, 2018, and our other SEC filings.

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. These non-GAAP measures should be considered a supplement to and not a replacement for measures prepared in accordance with GAAP. For a reconciliation of the non-GAAP financial measures with the most directly comparable GAAP measures, please refer to the appendix of our presentation.

I would now like to turn the call over to Alistair Macdonald. Alistair?

[Alistair Macdonald, executive]

Thanks, Ronnie. Good morning, everyone, and thank you for joining us today. During the third quarter, we continued to build market momentum for our integrated Clinical and Commercial Solutions. We experienced strong growth in our Clinical Solutions segment and in our overall profitability. We did, however, encounter some short-term headwinds for commercial revenue growth, which Jason will discuss in more detail.

We remain confident in our long-term growth trajectory and continue to be encouraged by very strong customer engagement across the model with healthy RFP flow and pipelines across segments. Importantly, market interest in our unique Syneos One product development offering continues to evolve and grow.

Let me start with a few key performance highlights. First, our total adjusted revenue growth was 5.4% or 6.3% in constant currency compared to the third quarter of 2018. This was driven by Clinical Solutions growth of 5.7% or 6.7% in constant currency and Commercial Solutions growth of 4.7% or 5.1% in constant currency.

Second, we maintained solid overall sales performance for the trailing 12-month period, with net awards of $5.2 billion and an aggregate book-to-bill ratio of 1.12x despite higher than normal cancellations this quarter, which I will address in more detail shortly. This was comprised of a clinical book-to-bill of 1.17x and a commercial book-to-bill of 1.0x.

Third, we are very enthusiastic about the positive feedback we have been receiving, particularly from large pharma companies regarding our product development model, fueled by comprehensive lab to life capabilities and deep product development insights. This differentiated model has been instrumental in expanding our access to large pharma customers.

As evidence of this impact, I am excited to announce a recent win of another preferred provider relationship with a large pharma company. This is in addition to the one we highlighted on our Q2 call. This win marks the first Syneos One-driven relationship with a large pharma company, utilizing our proprietary product development methodology to optimize the delivery of a series of assets. This relationship will leverage the power of our clinical and commercial capabilities and deep market insights to optimize our customers' delivery to the market, moving us from a transactional clinical trial partner to a long-term strategic portfolio partner. This preferred provider award grew out of an existing clinical relationship, validating how our commercial understanding and our unique Syneos One approach align with our customers' most important goals.

Now turning to our results by business. Clinical Solutions experienced strong gross awards in the third quarter. However, due to higher-than-normal cancellations, net awards were lower than expected. This resulted in total clinical net awards for the trailing 12-month period of $3.9 billion, producing a book-to-bill ratio of 1.17x. We believe these cancellations were isolated events due to efficacy and safety issues with the CNS compounds of 2 customers. To give you an idea of their magnitude, excluding these cancellations, our book-to-bill ratio would have been 1.22x for the trailing 12-month period, up from 1.2x last quarter.

Our year-over-year backlog growth also remained solid at 7.1%, and we continue to ramp up our new provider relationships, which we expect to fuel growth moving forward.

Our model delivers deep insights that enable us to build enduring relationships with communities, including sites and the patients they serve. Validating the emphasis we have placed on strong global site relationships through our catalyst program, I'm very proud to highlight that we were recently honored with our third consecutive Eagle Award from the Society for Clinical Research Sites.

The Eagle Award recognizes the CRO that best exemplifies a site-focused approach to clinical trial management demonstrating outstanding leadership, professionalism, integrity, passion and dedication to advance the clinical research profession through strong site partnerships. I want to thank all of our site partners and employees who collaborate every day to accelerate clinical research on behalf of patients to achieve our vision of shortening the distance from lab to life.

This award is also a reflection of our core belief that the key to successful clinical trial execution is not just finding the patients in databases, but engaging them in the real world and converting them into engaged trial participants. We believe that engaging them as a patient community through our catalyst site partners using our commercial communications and social listening capabilities allows us to leverage behavioral insights to design new ways to help people make better, more confident decisions about their health.

Our Commercial Solutions segment delivered net awards of $1.3 billion for the trailing 12-month period or a book-to-bill of 1x. Similar to 2018, we experienced typical seasonal pressure in awards during the third quarter, and net awards were also impacted by delays in certain customer decisions. However, we continue to have a strong pipeline of opportunities, which we expect to fuel continued growth in 2020.

As the market leader in the commercial space, we continue to engage in forward-looking conversations with our customers discussing value and access, evolve channels such as MSLs and nurse educators and omnichannel solutions. Our commercial capabilities reach a broad group of stakeholder communities on behalf of our customers beyond physicians, [ size ] and patients to payers and advocacy groups, building engagement that drives improved performance and better outcomes.

We also continued to see strong interest in our unique Syneos One product development offering, which provides customers of all sizes with novel outsourcing solutions to accelerate development and commercialization time lines. Learning from our early success with smaller biopharma companies, the Syneos One model is evolving into large pharma discussions. This is evidenced by the new preferred provider relationship I highlighted earlier.

We've also won Syneos One awards from other midsized pharma companies to implement turnkey development solutions, specifically for indications where customers may have limited internal expertise or bandwidth. In addition, the Syneos One pipeline of opportunities continues to grow and affords these customers a unique alternative to optimize portfolio management with a single-source, efficient outsourcing provider.

I'd like to close once again by expressing my appreciation to the 24,000-plus Syneos Health employees who continue to identify better, smarter, faster ways to advance clinical development and speed product performance. Our efforts every day help our customers across all sectors, improve the lives of patients worldwide.

Now let me turn it over to Jason for more comments on our financial performance. Jason?

[Jason Meggs, executive]

Thank you, Alistair, and good morning, everyone. As a reminder, all results are discussed on an adjusted or non-GAAP basis as defined on Slide 2. We will be discussing the current period adjusted results and period-to-period comparisons on an ASC 606 basis, which includes reimbursable expenses.

Let me begin by reviewing our financial results in detail. As shown on Slide 4, our adjusted revenue for the third quarter of 2019 was $1.18 billion, up 5.4% compared to the third quarter of 2018 and up 6.3% in constant currency when excluding a foreign exchange headwind of $9.6 million.

Our Clinical segment adjusted revenue grew 5.7% year-over-year to $869 million or 6.7% on a constant currency basis. Clinical revenue growth was driven by net awards over the last 12 months and a favorable revenue mix, partially offset by slower growth in reimbursable expenses and the impact of FX.

Our Commercial segment adjusted revenue was up 4.7% year-over-year to $309.6 million and up 5.1% in constant currency. Commercial growth was largely attributable to net awards over the preceding 12 months and higher growth in reimbursable expenses, partially offset by an unfavorable revenue mix and the impact of FX. Commercial revenue growth was slower than anticipated, primarily due to project delays in deployment solutions and consulting, coupled with the revenue decline in our medication adherence business, which was driven by a delay in a large customer program and other nonrenewals.

Importantly, excluding the isolated headwind in medication adherence, our commercial organic revenue growth would have been high single digits compared to the third quarter of 2018.

Adjusted EBITDA for the third quarter was $167.9 million, an increase of 5.9% year-over-year resulting in adjusted EBITDA margin of 14.2%. When adjusted EBITDA for the third quarter of 2018 is normalized for the $5 million of timing benefits we've previously highlighted, our adjusted EBITDA grew 9.4% and margin increased by 60 basis points. Adjusted EBITDA for the third quarter includes a foreign exchange benefit of $1.3 million, consistent with the impact contemplated in our guidance.

The growth in adjusted EBITDA was driven by overall revenue growth, favorable clinical revenue mix, the increase in net realized synergies and improved operating leverage. These benefits were partially offset by costs associated with the startup of large new customer relationships and the unfavorable commercial revenue performance previously discussed. Adjusted EBITDA includes the realization of approximately $29 million of synergies during the third quarter before the impact of our strategic reinvestments to drive growth.

Adjusted diluted EPS of $0.87 grew by 16% year-over-year, primarily driven by our growth in adjusted EBITDA and our lower non-GAAP tax rate. Specifically, the improved tax rate contributed $0.05 to our adjusted diluted EPS growth during the third quarter of 2019.

Now turning to cash flow and the balance sheet as summarized on Slide 7. During the third quarter, our operations provided $74.4 million in cash on an as-reported basis. Cash flow from operations declined compared to the third quarter of 2018, primarily due to lower utilization of our accounts receivable factoring arrangement.

DSO for the quarter was 46.1 days. We ended the quarter with $127.4 million of unrestricted cash and total debt outstanding of $2.75 billion.

Slide 7 also provides an update on our debt management and capital deployment activities. We remain focused on a balanced approach to capital deployment to drive shareholder value. This includes debt repayment, tuck-in acquisition, investments and share repurchases as determined by available cash flow as well as market opportunities and conditions while optimizing our capital structure.

During the third quarter, we increased the capacity and extended the maturity of our accounts receivable securitization facility, which represents our lowest cost of debt. We repaid an additional $114.8 million of our Term Loan B with $64.8 million being refinanced with our accounts receivable securitization facility and $50 million coming from free cash flow.

We also repurchased $7 million of our outstanding common stock, leaving $118.3 million of stock repurchase capacity available to be utilized through the end of the year.

In the beginning of October, we also executed the $400 million delayed draw feature on our Term loan A. The proceeds of which, along with free cash flow, were used to redeem our 7.5% senior notes and fund the redemption premium. Although this transaction was leverage neutral, we estimate it will result in $15 million of future annual interest expense saving.

Our non-GAAP effective tax rate for the third quarter was 23.2%, reflecting the adjustment of our full year rate to our revised expectation of 24%, a decrease of 50 basis points. As previously communicated, given the benefit of our NOL deductions, we expect our actual net cash outlay for taxes to be $15 million to $20 million for the full year 2019.

I'm also pleased to report that our teams remain focused on remediation of the previously disclosed material weaknesses in internal controls. We have largely completed our remediation process, although final testing and certification is ongoing as part of our annual internal control evaluation and audit process.

Lastly, as we announced in August, the SEC has concluded its investigation with no recommended enforcement action. I want to thank our internal team, our Board and our advisers for their thorough work to achieve a quick favorable resolution.

Turning now to our guidance on Slide 8. As a reminder, we increased our adjusted revenue guidance last quarter to reflect the strength in our clinical segment, largely due to reimbursable expenses. We're also slightly increasing clinical adjusted revenue guidance this quarter to reflect further strength and to incorporate the updated timing of revenue between the third and fourth quarter, but are reducing our commercial adjusted revenue guidance due to the headwinds I previously mentioned.

As Alistair noted, we believe these headwinds are short term in nature. Accordingly, we are reducing our expected range for full year 2019 adjusted revenue to $4.63 billion dollars to $4.69 billion, representing growth of 5.1% to 6.5%. This includes increasing our adjusted clinical revenue range to $3.38 billion to $3.42 billion or a growth of 4.8% to 6.1%. While reducing our adjusted commercial revenue range to $1.25 billion to $1.27 billion or a growth of 6% to 7.7%.

Our expectations for total adjusted EBITDA now range from $635 million to $655 million with the midpoint remaining unchanged, primarily due to higher expected synergies. We are increasing our expected range for adjusted EPS to $3.17 to $3.27.

This guidance is based on the following key assumptions: our existing backlog and sales pipeline, including trends and cancellations and delays; current foreign currency exchange rates; estimated merger synergies of approximately $115 million prior to reinvestments; expected interest rates, resulting in interest expense of $120 million to $124 million; our revised non-GAAP effective tax rate of approximately 24%; and our estimated diluted share count of 105.1 million shares, which excludes any share repurchases subsequent to the third quarter.

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

[Operator]

[Operator Instructions] Our first question or comment comes from the line of Sandy Draper from SunTrust.

[Alexander Draper, analyst]

I guess the first, I know you guys don't really talk...

[Alistair Macdonald, executive]

Sandy?

[Alexander Draper, analyst]

But can you give us a sense of if you look at it under net service revenue, would your book-to-bill have been higher or lower? I know it can flip around, I'm just trying to see how much the pass-through revenue may have impacted any move in the book-to-bill.

[Alistair Macdonald, executive]

Sandy, we lost you right at the start of that question. Can you just repeat that, please?

[Alexander Draper, analyst]

Sure. Sorry, can you hear me now?

[Alistair Macdonald, executive]

Yes. Yes.

[Alexander Draper, analyst]

Okay. Sorry. Can you just -- in terms of -- I know you don't talk about really and focus on 605 anymore, which I understand. But I know pass-through revenue can fluctuate quarter-to-quarter in terms of moving book-to-bill up or down. I just didn't know if you could say directionally whether pass-through revenue was having a positive impact or negative impact on book-to-bill right now in the quarter?

[Alistair Macdonald, executive]

Do you want to -- Jason will take that one.

[Jason Meggs, executive]

Sandy, I think we've talked historically about the fact that it -- the pass-throughs did give a little bit of bump overall. I think it was like 0.1 or something like that, to our book-to-bill. We haven't really seen anything that is materially different from that over time, particularly when you look at a TTM basis. And then as we talked about there in the prepared remarks, we did have the cancels of the 2 larger programs that didn't have any sort of underlying chain in that proportion really either.

[Alexander Draper, analyst]

Okay. That's helpful. And then maybe, Alistair, just a little bit more commentary on the -- congrats on the new preferred relationship. My guess is it's in partnership there. My understanding is there are 2 people who won that new deal. Are you guys -- when you think about Syneos One versus just basic execution, what do you think differentiated you Syneos, in this case, to really get that business?

[Alistair Macdonald, executive]

Okay. Thanks, Sandy. So we've -- just to clarify, the preferred for partnership -- preferred provider partnership we discussed this morning is in addition to the one we won in Q2. So I'll address both actually because they are subtly different, but similar in a couple of ways. The one win in Q2 is alongside another public CRO, the display -- we've collectively displaced a couple of others. And we won that -- the feedback is that we won that for a couple of reasons. Our ability to deliver commercial and clinical as stand-alone kind of sectors or stand-alone services was originally a large commercial customer -- great work from Michelle's team, enabled us to bridge that over to the clinical side. They like the fact that we have the ability to bring the commercial insights into the clinical development.

So what we're seeing here is, we always -- we came out of the merger with the rationale that clinical would feed commercial, and we are seeing that. Syneos One brings that. What we're also starting to see now, certainly in the larger pharma actually, is the commercial and the insights that we bring from commercial and the alignment that we have now around actually getting a product to market and getting it reimbursed, is really appealing to those larger customers.

So the new one that we've just announced this morning is really around -- it's really a product development relationship. It's effectively a supersized Syneos One relationship on an asset level, with this customer. So rather than having to go and fight and win the Phase I, the Phase II, the Phase III, we have -- this new relationship is based at the asset level. So we're working with them to develop the asset, to write the protocols, to bring it all the way through, wherever it gets to, whether it fails in clinical or it goes through Real World Evidence, et cetera, all the way through to commercialization. We'll be engaged with this customer all the way along with that asset. So a very different model.

They're a current clinical customer that we've had a long relationship with, but more in a transactional way. And I think the [ differentiation ], the Syneos One approach, the commercial insights, that capability, it's that alignment around what their ultimate goals actually are. It's getting a patient the drug, not just getting it approved, and that's the whole power, and that's kind of the whole design of the Syneos One model is to align with that customer and get them to a point where they're getting reimbursed.

So it's the horsepower that we now have in clinical, the scale gets us to the table. But I think the insights and the understanding on the commercial side and pulling that all in and how we use it to enroll patients and get them over the line at sites, et cetera, that's the differentiator that we're seeing on the model.

[Operator]

Our next question or comment comes from the line of Erin Wright from Crédit Suisse.

[Erin Wilson, analyst]

I wanted to check in on Syneos One and the progress on some of the metrics that you've recently provided. I guess in the last quarter, you said that it was $700 million in overall business wins from Syneos One. I guess it's representing about 9 end-to-end project wins, if I'm correct there. I guess where does that stand now?

And then you also had an additional benefit from Syneos One assisted clinical awards. And I think that was another $250 million. I guess where does that stand as well? And how should we think about those evolving into more end-to-end customers?

[Alistair Macdonald, executive]

Good morning, Erin, and thanks for the questions. So I'll answer the number of customers and opportunities we have. So we have 13 customers now in Syneos One. So that's up from the 9. And I think we're looking at 26 assets in that model, which is a substantial uptick as well from where we were at. We normally update the numbers around that twice a year. JPM, I think we do it. And I think Jefferies was the other one that we do it in the middle of the year. So we'll update the numbers at that point. But you can see from the number of kind of customers and assets that we're working on, you can expect to see a substantial lift in that.

[Erin Wilson, analyst]

Okay. All right. And then you now have 3 large partnerships I guess that you've announced. And how should we be thinking about the hiring patterns ahead of some potentially to building business here?

[Alistair Macdonald, executive]

Yes, that's a good question. It's -- the good news is they separate out on therapeutic indications to some degree, there's a little bit of overlap. And those therapeutic indication separations are important when you're thinking about resourcing. And obviously, with a big clinical group like we have, when projects come out -- when projects come down, when they're finished or we're able to step a team off, we can move them over on to the new work. So some of it will get built like that.

What we always try and do with large partnerships is to seed them with kind of 30%, 40% staff who are seasoned in the Syneos One model, right, or in the Syneos health model. So people who know the systems, processes, et cetera. And then we're looking at how do we add to that. The resourcing pattern is always pretty protocol-specific because you're looking at where does this project go? What sites are we going to take it to? And that then is the key-off of that where the resources need to be on the clinical side, CRAs, MSLs, et cetera, et cetera, because they're kind of geographically and therapeutically focused.

I think we'll see some margin headwind in 2020 because of the build in front of those projects -- in front of those programs. We're seeing one of those relationships is already starting to pull-through in Q3, Q4 bookings. So we're starting to see that the start of that awards curve from one of those 3, we expect to see that continue through, obviously 2020 and beyond. And then we just need to -- and once we get the protocols, work out how we staff ahead of that.

So it's going to be a lot of work in the recruitment side. Paul's smiling at me. But I think we're built now to be able to absorb that and make sure we do a good job of getting those stood up in good time.

[Operator]

Our next question or comment comes from the line of David Windley from Jefferies.

[David Windley, analyst]

Alistair, the -- I certainly understand, as you're talking about these partnerships, the qualitative discussion around that supports this description in your press release and prepared remarks about building momentum. That is frustratingly not translating into your bookings. You've highlighted that there's a fairly sizable cancellation or a couple of cancellations in the third quarter that certainly have an impact on that. In the third quarter specifically, if we look in Slide 11 in your deck, your trailing 12-month book-to-bills have ticked down kind of all year. And so if you would help us to understand where there may have been delays in onboarding or in production of bookings from some of these partnerships? Or where win rates or flow of RFPs in the spot market are affecting your book-to-bill progress?

[Alistair Macdonald, executive]

Yes. Thanks, Dave, good morning. So I will start by saying that we have the highest pipes in both business sectors at the moment that we've ever seen in company history, right? So I think the RFP pipeline that we see collectively is very strong. The partnerships that we have won over the last 18 months really, after getting out from the initial stages of the merger and getting these 3 partnerships up, one of them has been slow to start because it has had -- they've had some significant reprioritization focus since we were awarded that relationship. The second one from Q2, we expected those bookings to start in Q4, and I think we said that on the last call I think and we're starting to see that. And the new one is a customer that we've always had a relationship with. We expect that to amp up.

So yes, I mean I'm as frustrated as anybody that -- well, more than everybody, I would assume, that we're not seeing that pull-through to bookings right now. The cancellation in Q3 is I mean substantial, at very outsized and not a trend by any means, but 2 CNS compounds, 1 canceled for efficacy and 1 canceled on a interim analysis and report out from a DSMB. So safety monitoring board, on some safety signals that they didn't like the look of. So the customer's taken the program down.

Yes, we've been tracking both of those as kind of an elevated risk of cancellation, but [ the luck ] we have sometimes, they cancel right on top of each other within literally 3 weeks of each other towards the end of the quarter. So -- and we immediately take them out of backlog. We derisk them a little bit. We take them out of backlog. There's no kind of in and out for us. It's just they're out. And we're starting to finish off those projects, bring people down, titrate people off the treatment, back on to standard of care, that kind of thing.

So they were impactful. We wanted to make sure you guys saw the overall impact of that. I mean we are 1.17x trailing 12. We would have been at 1.22x, which would have been heading back in the right direction. We're very focused on the sales piece. We're winning assets rather than individual projects, and we can't take them into bookings because our policy is if it doesn't start within 6 months, we don't take in the bookings. So we're kind of -- as we go forward chronologically, we'll be able to take those into bookings as we enter into subsequent quarters.

So I think when we talk about momentum, we're very happy with where we're heading with bookings. We're just not translating them into a -- into that book-to-bill that you guys like to see. And we've talked many times before about what book-to-bill really means in clinical when a $50 million CNS project runs in 2 years and a $50 million oncology project takes 7 years, you get a very different profile.

So yes, we're very happy actually, where we're heading. I wish it was translating into a monster book-to-bill, but our bookings policies and the way we apply them doesn't allow that to pull through and the cancellations. Paul, any?

[Paul Colvin, executive]

Yes. I mean again, I think you've hit on the key point. I think this is a timing discussion. In both instances, with these partnerships we've got complete transparency on their pipeline and what's going on. I think what we've seen in the short term is as we've ramped these partnerships. There have been some decision points that had been delayed, but we know that the assets are moving forward and we see that coming. So I think we're really talking about a timing issue these ramp. And in my experience, at least these 2 partnerships that we're discussing, again, have given us really good visibility into what's coming. So I think that we do think that is coming in the future. It's a timing point on the partnerships as they ramp up.

[David Windley, analyst]

At the risk of making this longer, could you provide -- I mean, I think the same question applies to commercial. You said a 1.1x book-to-bill, and it's been kind of trending away -- down and away from that all year long.

[Alistair Macdonald, executive]

Yes. I think when we came out last year, we were at 1.16x I think. We -- commercial's seasonal. We hope to kind of see less of that seasonal effect this year with some of the changes we made, but we've seen it. So we're establishing that Q2, Q3 for us in commercial are going to be the down quarters, if you like, for bookings. And that trend will come down, and then we expect to see that go back up Q4, Q1. So the next couple of quarters for us in commercial will help us drive that number back up. And you're going to see -- it's not going to be a straight line, like you see on the CRO side of the businesses, I suppose, and across the industry, with commercial, I think we are going to see this seasonality. Obviously, we're going to work to try and smooth that out as much as we can by powering up the BD front end, et cetera. But that budget cycle in commercial is a lot more distinct than it is in clinical, seemingly.

I mean, Michelle, any?

[Michelle Keefe, executive]

David, nice to hear your voice. So here, I'll just provide a little more clarity. We did have -- we do have some timing issues. We've had some decisions delayed and pushed to Q4 and Q1, right? And I think you've heard me say before, we have customers that are buying integrated solutions, and they take -- they're longer on the decisions, right. They take longer to make those types of decisions versus more tactical things that maybe they traditionally bought in the past, right. So we have had some push in decisions. The good news is those are still on the table, right? So that's exciting for us that we have some good visibility into that.

Secondly, as Alistair shared, our pipeline remains extremely high. I mean it is almost at an all-time high. And it's exciting because they're really evolved types of opportunities, right. We've talked about the importance of omnichannel marketing. We've talked about the importance of the evolved integrated model with not just sales representatives, but MSLs and nurses and reimbursement specialists as well as integrating our communications and consulting's capabilities into these offerings. So the interest level remains very, very high.

I think the other exciting thing is that Syneos One has got some really nice clinical customers right now that as those assets mature and move through the product development life cycle, are huge opportunities for the commercial business. So obviously, we need to convert the business, David. That's my job, to make sure that we convert the business. But we're very bullish on being able to convert that business. And as I said before, 1.1x book-to-bill is our North Star. We're always working towards that. But based on what I see, the opportunity is there for commercial to continue to grow at mid-single-digits. So we're excited about that.

[Operator]

Our next question or comment comes from the line of Eric Coldwell from Baird.

[Eric Coldwell, analyst]

I actually have 3. First off, could you quantify the CNS cancels impact on revenue in 2020? I know they're shorter-term studies. So I just didn't know how much you had risk-weighted that in advance, if you could give us some signal of what we need to be thinking about there? Yes.

[Jason Meggs, executive]

Eric, it's Jason. So obviously, we're in planning season now and having to look at that. And given at least 1 of the larger of the 2 studies is midflight, as Alistair said, they're starting to transition that over. It's going to take some time. So when we look next year at the backlog that we had slotted, the impact is not as significant as one might think, given the impact on the book-to-bill and the awards. And then also, it's just a very long -- longer-term study relative to what you typically see on the CNS program.

[Alistair Macdonald, executive]

Yes. So I think that -- I think one of the things to add I think, Eric, is also the scale that we're at now. We can -- our backlog is kind of a bit resistant to that. Even that size of cancellation, which is probably one of the biggest ones we've ever seen. But I think we've had patients on that study and closing the sites out through probably Q2 next year. And then those people will be reallocated to awards that we're going to take in Q4, Q1, and they'll power through it. But titrating the patients off and making sure of the patients' safety, et cetera, it takes some time in clinical, which is -- softens kind of the cancellation always.

[Eric Coldwell, analyst]

And then my next one, when you talk about the margin headwind, building on the -- for building the new partnerships, the 3 deals. I know you're stating the obvious there. But are you also signaling maybe we need to be a little more cautious with our overall margin outlook for 2020 as you start to ramp these big engagements?

[Jason Meggs, executive]

Yes, Eric. It's Jason again. I mean as you say there, you have to build that out. What I would say is in 2019, we've been talking about this all year, we have been building out a partnership that has been a margin headwind to the performance of the business this year. Based on what we see in our discussions with the customer, that relationship is going to ramp on the revenue front and give us the margin tailwind. That then we can drop the others in the slot there and start to build those out. So that's how we're thinking about it. Plan's still coming together, as I mentioned, but that's the way that I would think about it.

[Eric Coldwell, analyst]

Okay. And then my last one, I know I'm asking a lot of forward-looking stuff here. But in the commercial update I mean clearly, numbers need to come down on revenue there. But would you be willing to give some directional thoughts on growth rates over the next year or 2 as you kind of rework through these air pockets and these delays?

[Alistair Macdonald, executive]

Yes. So let me start, and I'll pass you over to Jason, Eric. I think what we're seeing from commercial is the speed into clinical, which is a really -- starting to help us drive that clinical growth as well. Like Michelle said, record pipeline in commercial. This is the part of the year where we build backlog, Q4, Q1. So when the budgets get assigned and allocated in that sector. And we're very bullish on it. So we like what we see there. We can't make it a straight line like clinical. We've always known that. But what we're seeing from that, the advantage it brings to us is an overall kind of product development end-to-end, whatever you want to call it. And the differentiation it's giving us actually over on the clinical side with larger customers, which is something we wanted to see. And now we're seeing that pull through. I think that's great for us, and we're very bullish still on the growth pattern for commercial. Jason?

[Jason Meggs, executive]

Yes. I mean it's -- we tried to outline how temporary it is, Eric, given the timing and what we see in medication adherence and as Michelle added on, right, the pipe is at a near record. When we're looking at quarter 4 and quarter 1 on the seasonality piece that Alistair talked about, those are our best quarters to drive that backlog growth. And to drive us back up to the [ 1.1 ]. Based on what we see and what we're thinking about, and we're not giving 2020 guidance here. But we believe where Wall Street has it is a reasonable place.

[Operator]

Our next question or comment comes from the line of Tycho Peterson from JPMorgan.

[Tycho Peterson, analyst]

I want to follow up on the preferred provider deal. A couple of questions to ask. Just -- you talked about being tied to one asset on the new deal. That seems a little bit narrower than a typical strategic partnership. So can you talk about the opportunity to maybe add other assets in the therapeutic area or extend that partnership?

And then also the impact on EBITDA margins. You sort of touched on it to Eric's question, but just curious how we can develop the impact margin?

[Alistair Macdonald, executive]

Yes. Well, I'll probably take the first one and then pass you over to Jason for the second one, Tycho. Yes, it's multiple assets, the relationship. So the good news there, it's not on one asset. We're already working on a couple of the assets in the transactional manner. They're adding more -- an additional asset to that, and we're working across multiple assets from this get-go. And we believe from discussions with them, these -- the starts of an asset in a class that will expand. So it's not isolated to one product. It's across multiple assets, which we're very excited about, obviously. And as we look to bring them on over the next couple of quarters, you should -- we should hopefully get the benefit of that.

And as Michelle said, actually, this relationship is something that starts now in clinical and pulls all the way across through commercial, through consulting, through Real World Evidence, late phase, et cetera. So it's kind of the full Syneos One piece in a much more supersized fashion. So we're very excited about that.

[Jason Meggs, executive]

Yes. And, Tycho, I probably should have mentioned this earlier to Eric's question, but we've been talking about our margin projections, 2020 and 2021, being that, we're targeting that 30 to 50 basis point increase in growth and nothing has changed from that perspective, given these partnerships. And as I mentioned earlier, the first one that we won, starting to ramp after the delays, given their internal prioritization and what they had going on, is going to start to ramp and relieve some pressure from the others building behind it.

[Tycho Peterson, analyst]

Okay. And then on commercial, Alistair, can you provide a little more color on some of the headwinds you flagged here in the near term, the medication adherence? How do you think about that working its way through? And then you cited other project delays. Just curious what's behind that?

[Alistair Macdonald, executive]

Yes. Sure. Sure, Tycho. On the medication adherence side, kind of just the delay in a couple of contracts that we expect those to come on. Q4 is always a big -- well, really, Q4 is when medications durance gets all its assignments and renewals. So we'll see that as that comes through for 2020 and how that looks. And I think, overall, in commercial, we're seeing a lot more interest at a higher level within commercial organizations in the kind of integrated solution that we provide there. Not just as we talked about I guess a couple of years ago, where we start to move away from just selling a field team to selling a much more integrated, much stickier platform, we're seeing that backlog diversifying commercial continuously. We've seen great growth in the small to mid-customers picking up consulting projects, communications projects, branding projects, MSLs out in the field and that starts to mature through as we get into kind of the second half of 2020 and beyond. It's -- that's where some of that Syneos One work starts to convert from commercial -- sorry, from clinical over into commercial. So -- and we've got these big sales quarters ahead of us to bring that book-to-bill back up as well.

[Michelle Keefe, executive]

Sorry. The only thing I would add is that without the medication adherence headwinds, I think we said earlier that the organic growth would be in high single digits for commercial. So I think it shows the strength of the underlying offering.

[Jason Meggs, executive]

Yes, and we mentioned...

[Alistair Macdonald, executive]

Go ahead, Tycho.

[Tycho Peterson, analyst]

I was just going to ask on DSOs. You're now at 46, you were at 39 in the last year. Can you just touch on where you think those are headed?

[Jason Meggs, executive]

Yes, I mean, we -- I mentioned in the prepared remarks, we did use less of our factoring facility that we have with one of our customers. And that's probably something that we're going to continue to look at doing, just given coming into the leverage target that we're working through. And that's going to cause some pressure on it. And then these new partnerships on the large pharma side will cause some pressure, too. So we've been saying mid- to high 40s is where we think is a reasonable place, and that's sort of where we are. And we're flattish from quarter 2 to quarter 3. So that's what we're looking at.

[Operator]

Our next question to comment comes from the line of Robert Jones from Goldman Sachs.

[Robert Jones, analyst]

Great. I guess just to follow up on the commercial side. It sounds like you guys feel like some of these delays, whether it be on the deployment solutions, consulting, or the revenue declines in the medical adherence, it sounds like you think a lot of that should come back in 4Q. And, Alistair, as you pointed out, obviously, 4Q has been the kind of -- the big bookings quarter for commercial. Is there any sense you have in talking to the customers behind these shortfalls that there's anything broader going on? Any thought around delaying or pushing some of these things out for more around fears of the drug pricing environment or anything like that? Or do you think it really is just more tactical, something kind of price to play of being in a commercial business of what you saw this quarter?

[Alistair Macdonald, executive]

Bob, from my discussions with customers when I'm out with them, it seems to be more tactical. The drug pricing doesn't come up so much. The political environment, I mean U.S., U.K., who know what's happening, right, on a daily basis. But it doesn't seem to be anything kind of symptomatic underneath that. It seems to be -- these are 1 or 2 tactical headwinds short term. I think we absolutely believe it's short term, certainly we look at the level of interest we're getting and the level of RFP we're getting, the discussions that we're seeing a higher level in terms of partnerships, et cetera, and the inclusion of commercial into those, in the clinical delivery as well as commercial as a stand-alone are very encouraging. The penetration we're seeing with Syneos One is very encouraging.

I mean, Michelle, in your discussion, have you seen anything [ underneath that ]?

[Michelle Keefe, executive]

Yes. So I mean one of the things that I see, and I think I've said this in the past is many senior leaders in many pharma companies are really looking to outsourcing as a strategic imperative, right? They want to build more flexibility into their models. And so we're having conversations around how do you do that, right? How do you figure out how to build that into your model? So I'm not getting any sense that there is -- that there's a bigger strategic question they're asking. I think it is absolutely a timing issue and a tactical issue at the time.

[Robert Jones, analyst]

No, that's helpful. And then I guess just looking at the cancellation, I know you guys have covered this in a good amount of detail. But if I think over the last 3 years, Alistair, a couple of big cancellations. 2 out of the last 3 years have kind of caused a quarter of volatility or even some guidance to have to be changed, if I think back a few years -- I know the policy is not to put anything in it, if it's not going to produce revenue for 6 months. But is there anything you feel like maybe you guys are doing differently as far as assessing and risk adjusting projects as they go in? Or do you think this is, again, just the price to play of being a clinical CRO, and you're going to catch some cancellations from time to time just based off of partners and molecules and programs?

[Alistair Macdonald, executive]

So I think there's a clinical complexity to it. I don't think it's really our policy on risk adjustment or the way we take things in. I mean I think our backlog is very clean. We take things out when they cancel. We put things in when they're awarded and they hit our policy. And it's just black and white as that.

I think when we look at the history of the organizations that we brought together, INC had a history of really complex -- of winning really complicated higher risk work, if you like. I certainly remember the pain of the cancellation at the end of 2016, that was huge. I mean and this -- that's the binary effect, I think, that our customers -- it's the binary risk that our customers take, right? And when you win one of those big complex programs of first-in-class, therefore they're big and they can cancel. And we've been on the wrong end of a couple of those.

Like we talked about these 2 CNS products, we've been tracking them for a while, identified that they are -- that they had an elevated chance of cancellation because of the class that they were in, the drug class that we're actually in. So we've been tracking them for a while. But I don't think it's a policy we have. I just think it's the nature of the business that we won historically. I think as we're now getting into some of the larger pharma there's a bit of a less -- I think the risk is a little bit lower for cancellation from that sector because the products are, I don't know, baked a little bit harder, they're less risky, they're less of a optimistic shot on goal there. When they get to that stage of the big Phase III, it's more predictable in the large pharma. I mean, Paul, you -- your experience of that?

[Paul Colvin, executive]

No, I mean it is just part drug research. And if I look over a longer period of time, I don't think it's really changing fundamentally the cancellations across our entire organization. It's a timing issue related to quarter 3, but it's not at our size and scale, is something that makes -- not going to be a material issue over a longer period of time.

[Alistair Macdonald, executive]

Yes. I mean...

[Robert Jones, analyst]

No, I appreciate that, that all makes sense.

[Alistair Macdonald, executive]

Yes. I mean these -- we wish they weren't canceled, right, because not just from our perspective, but also some of these were new class of assets for disease states that don't really have any effective treatment. So these are bad cancellations all around, not just from us financially, but also in terms of patient treatment and advancing care. So yes, we wish they didn't cancel, Bob, that's all that I can say, but they did.

[Operator]

Our next question or comment comes from the line of John Kreger from William Blair.

[John Kreger, analyst]

Great. Can you hear me?

[Alistair Macdonald, executive]

Yes.

[John Kreger, analyst]

Great. Alistair, so you've laid out some impressive preferred partnership wins, but also some pretty big cancellations across the clinical side. So when you think about those puts and takes, does '20 feel like a better growth year in that business or maybe a little bit slower than what you're seeing currently?

[Alistair Macdonald, executive]

We've got to pull these pipes through yet and see what the start dates are, first patient, first visit, John. And then that's how we pull them into bookings, right? So 6 months before we starting work, within that window, you got to pull them in.

But when I look at where we're sitting in -- when you look at all the factors around that, the cancellation rate that we have, that -- the quarter's unusually high, right? So when we look at the regular cancellation rate, when we look at the RFP flow, when we look at these new partnerships coming in, I feel very bullish on clinical certainly, over 2020/2021. We've got this engine running. We've got the integration behind us. We've got new products coming online. We've got new therapeutic specialists coming online. We've got a lot of positives coming through just finishing out the integration. And I think the fact that we've won 3 very large partnerships, things that we would never have been competing for before the merger, we wouldn't have even got the invite to at least 2 of them. They're things that we should be very optimistic about. And as we see that work starting to flow through, I think we'll be in a great position though. Jason?

[Jason Meggs, executive]

Yes. I mean, John, we've said as we exit this year, getting to that sort of 5.5%, 6% growth when you look at the year or the quarter. And that as these relationships stand up and ramp that we would anticipate the growth continuing to move from there. Obviously, the cancellations do have some impact. But as we've mentioned, we don't see that being a material impact to us given our size and scale in these partnerships. So we're still looking at moving that up, as we've said in the past.

[John Kreger, analyst]

Very helpful. And then a follow up would be, as those 3 large relationships ramp, how do you think about how that would impact margins? Are you -- I assume you're going to get some scale benefits, but also there's probably some preferred pricing there too. So just curious about how you think that impacts your ability to drive margin improvements as those [ 3 climb ]?

[Jason Meggs, executive]

Yes. I mean we certainly have had the headwind in 2019 from the first partnership as we build out that partnership, the infrastructure and everything there, and we've mentioned that throughout the year. That is looking like it's going to start moving forward a little bit more rapidly into '20. That will give us some relief from these new partnerships standing up. But just like this year, with this partnership, there is some headwind in the early days when you start these new partnerships up, but I don't see it as anything that will prevent us from getting to that 30 to 50 basis point target of margin growth that we've articulated.

[Operator]

Our next question or comment comes from the line of Elizabeth Anderson from Evercore ISI.

[Elizabeth Anderson, analyst]

Just taking you a step back more broadly in the industry. Is there anything you can point to in terms of like changes in funding or just generalized RFP levels broadly?

[Alistair Macdonald, executive]

Elizabeth, I think that the funding levels are -- I think the biotech funding index has been -- has trended down a little bit. But I think a lot of the customers, certainly the ones that I've dealt with over the years, dip in and out that kind of market when the going is good. And a lot of our customers have 2.5, 3 years cash at hand. So there's a lot of buffer in that. I think RFP flows have been normal. I think we've seen an uplift because I think we're getting more RFP out of some of these larger customers. We see that with these partnerships coming on, you get kind of a longer insight into some of that. So you see that lift up. But when I look at the SMID market, I feel all right that RFP flow is still pretty strong. I mean, Paul, any thoughts on that?

[Paul Colvin, executive]

No, I mean in the SMID market, we're still seeing double-digit growth in the amount of RFP flow coming through. If I look at the RFP flow for clinical, speaking to clinical, it's at the highest level it's ever been.

[Alistair Macdonald, executive]

Yes.

[Paul Colvin, executive]

It's up significantly from prior years. And that's being starting to be driven by, not just the SMID growth, but seeing more growth from the partnerships we've mentioned. So we are going to see that flow into Q4 as well as into 2020. And that's where I feel strongly that we'll see some upside.

[Elizabeth Anderson, analyst]

Okay. Perfect. That's helpful. And this is more of a housekeeping question. But in terms of the kind of contribution of the quarter, I realize it's probably a partial quarter, but is there anything you can do to sort of elaborate on the contribution there?

[Paul Colvin, executive]

I mean the change year-over-year, given that was an August close last year, was immaterial relative to last year.

[Operator]

Our next question or comment comes from the line of Dan Brennan from UBS.

[Daniel Brennan, analyst]

Great. Maybe first, a quick one on the medication adherence [ lay ]. So is that contract, does that kind of imply that it's going to come in the fourth quarter with your new guidance? Or is that expected to come after the fourth quarter?

[Jason Meggs, executive]

Yes, Dan. So we mentioned last quarter that we had a customer that had a demand -- supply-demand challenge that we felt like was going to improve as we move through the back half of the year, and that has not happened. So that's still a challenge for us that we do not see coming through, and that is not contemplated in the guidance. And then we also had one of our supplier -- retailers have an issue that was not expected as we look at the second half, that's causing some of that headwind. And that also has not worked its way through yet, but we do anticipate that coming through at some point in the fourth quarter. And then some of the nonrenewals that we got is more of a sponsor thing, relative to their budget spend and just decisions they've made on those products. So those will not come through and aren't contemplated in the guidance.

What we do see, though, is the pipeline for 2020 starting to shape up so that when you look to next year, this decline that we've had in 2019, we see that flattening out, right? So that's where we're looking at that in terms of turning back around and being short term in nature.

[Daniel Brennan, analyst]

Great. And then maybe just on the burn rate, just wondering how we should think about that? Like as we look out fourth quarter and beyond, particularly in light of the new partnerships ramping?

[Jason Meggs, executive]

Yes, fourth quarter burn rate, the implied midpoint of our guidance is basically a little flat. Well, it is flat. And then if you look at the historical quarter 4, that's been a little bit of a stronger burn rate, given everyone pushes to get things pushed through. So that's what we're -- changing orders and contracts and things of that nature. So that's what we have right now.

Looking to next year, and we're talking about this and Paul can comment, but we are taking a look at it as we finish the plan as these partnerships stand up because it could be that, that lengthens a little bit. But -- Paul, I don't know if you want to comment on that.

[Paul Colvin, executive]

No, happy to. And I think you're spot on in that as some of these large partnerships come on, and we start adding value from the commercial team into the development of protocols into asset development in general, I think you're likely to see us have an earlier engagement, which could elongate just a little bit the ramping until you get to the actual start-up and enrollment period. But I view that as really a positive outcome in that we're being engaged much earlier in the development process, which will give us a full line of sight across that portfolio. So that would be my view on a long-term basis.

[Daniel Brennan, analyst]

And then I know, I think Alistair, you mentioned earlier on and maybe you guys have discussed this in the past, but given your bookings policy not -- in 6 months, and Paul mentioning the clinic -- just how strong the RFP flow is. Could you help us -- I mean is there any way to help us think about what that kind of pipeline looks like? Like what it looks like kind of year-over-year? Or any metrics you'd give that -- the bookings that you guys have line of sight on, but kind of aren't in the numbers yet?

[Alistair Macdonald, executive]

Well, I mean when we're looking at it, we can see growth, obviously in the top 20 as we penetrate more into those. So that sector for us is expanding. We're still expanding on the SMID side. We're still probably the market leader in the SMID execution-wise. As I said earlier on, I think on the clinical side, we have a record pipeline right now. And we have more capabilities. So we fancy our chances of closing a good chunk of that, like we always do.

So bar these cancellations that were particularly large for us and together in Q3, would be at 1.22x, which would be right in the middle of where we want to be. So we're underlying -- if you take off the cancellations, we're pretty happy with where the quarter came out, and we're very happy at the RFP pipe that we see right in front of us.

[Jason Meggs, executive]

Yes, I mean, Dan, just to add a little bit more color to that. I mean if you look at just -- and these are point in time estimates, right? But as of today compared to last year this time, right, our SMID pipe is up double digits. And where we're really seeing the strength is these partnerships starting to shape up in the pipe, where we're talking 2x or 3x what it was this time last year. So there's significant growth. We got to get it across the line, and we got to get it feeding through revenue, but that's just to give you a sense of how it looks.

[Operator]

Our next question or comment comes from the line of Stephen Baxter from Wolfe Research.

[Stephen Baxter, analyst]

Most of mine are asked. So I'll ask a quick one on numbers. I wanted to ask about the margins in the commercial business. It sounds like the decline this quarter was more temporary in nature with the revenue shortfall, so something you can adjust for with time. So you typically get a pretty big step-up in the Q4 margin in that business. So I just want to make sure we think about how that's impacted by kind of the guidance swing. I think previously, you were looking for growth in the fourth quarter and now it looks like it will be a little bit flatter or maybe a decline.

So just trying to think about whether we should expect a normal Q4 margin progression in that business? Or if there's something else we should be considering as we sort of fine-tune our models?

[Jason Meggs, executive]

Yes. Steve, it's Jason. So when you look at the quarter 3 guidance that we gave, inherent in that, we don't break out our guidance by segment, but we do show the actuals. When you normalize for that $5 million [ in time ] last year that was a pull forward into quarter 3 from quarter 4. 80% of that was in the commercial segment. So when you normalize for that, we actually were flat year-on-year. And when you look at our guidance and what we expected in the quarter, commercial actually was slightly up to our expectation from a margin percentage. So despite the revenue challenges, the business performed at the margin line from a percentage perspective. And we do see the business moving back up into a more normal margin range. When you normalize that back to 4Q last year, right, that 80% move into 4Q will be down a bit, but certainly up from where we finished quarter 3.

[Stephen Baxter, analyst]

Got it. I appreciate the color there. And then just one last kind of clarification. You guys talked about staffing up on the clinical side of business ahead of these preferred provider wins. Is there something similar to consider in commercial? Or do you have adequate capacity today to handle incremental growth there? Just trying to think about whether you guys are talking about the trend for margins next year maybe being down as being related just purely the clinical business? Or whether it's going to be both and therefore, potentially the overall company?

[Jason Meggs, executive]

Well, I'll start. So one thing I would like to clarify is that we -- while we are standing up relationships, we do not anticipate our margins being down in 2020. We still have a view of 30 to 50 basis points of margin growth next year across the company. We still are working through the segment level and things of that nature. But as we grow and get these relationships pulling through, we expect to get operating leverage and margin accretion out of the business.

On the commercial side, we do have some -- one large relationship standing up, and that's in Europe. And we've talked about that before. That has been a little bit of a margin headwind this year, that as we look to next year and continue to round that out, we hope that will turn into a tailwind. So we do have that phenomena on the commercial side as well. But it's just not as significant, given we have the 3 that we're looking at for clinical and the 1 in commercial.

[Operator]

I'm showing no additional questions in the queue at this time. I'd like to turn the conference back over to management for any closing remarks.

[Alistair Macdonald, executive]

Okay. Thank you, Howard. So we're very pleased with our continued growth in the third quarter, and we're well positioned to continue driving growth for the full year 2019 and beyond. Our pipeline of opportunities and RFP flow remains very robust, driven by our strategic investments and strong customer interest in our integrated operations and outsourcing solutions.

So thank you very much, ladies and gentlemen, for your attendance today and for your interest and investment in Syneos Health. Have a great day and be good.

[Operator]

Ladies and gentlemen, today's conference call has concluded. Thank you for your participation. You may now disconnect.