Medpace Holdings Inc

NASDAQ:MEDP

Earnings Call Transcript 2017-Q4

[Operator]

Good morning and welcome to the Medpace Fourth Quarter and Full Year 2017 Earnings conference call. Before we begin, I will read Medpace’s Safe Harbor regarding forward-looking statements.

During today’s call, management’s remarks and responses to your questions during this teleconference may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve inherent assumptions with known and unknown risks and other important factors that could cause the company’s future results to differ materially from management’s current expectations, including those discussed in the Risk Factors section of our Form 10-K for the year ended December 31, 2016 filed with the SEC. Management disclaims any obligations to update forward-looking statements in the future even if estimates change. Accordingly, you should not rely on any of today’s forward-looking statements as representing management’s views as of any date after today.

During this call, management will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to the earnings press release and earnings call presentation slides provided in connection with today’s call. The slides are available on the company’s Investor Relations section of its website at investor.medpace.com.

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

[August Troendle, President, Chief Executive Officer]

Thank you, Operator. Good day everyone and welcome to Medpace’s fourth quarter and full-year 2017 earnings call. With me on the call is Jesse Geiger, our Chief Financial Officer and Chief Operating Officer of Labs.

Medpace ended 2017 with a strong finish to a challenging year. Net new business awards entering backlog were up sequentially in the fourth quarter at $114.7 million, resulting in a net book to bill ratio of 1.15. Our Q4 service revenue was up 4.3% compared to the same quarter of 2016, and service revenue for all of 2017 was also up 4.3% compared to full year 2016. Slide 4 of our earnings presentation shows improving new business awards through 2017 in sequential dollar terms and on a net book to bill ratio basis, with a reasonably stable backlog conversion rate. We anticipate accelerating revenue growth in 2018 as a result of our improved bookings.

Jesse will review our guidance for 2018 in a few minutes, but I would like to make a few comments in advance. At the midpoint of our 2018 guidance range, we anticipate ASC 605 service revenue growth of 8.7% for full year 2018. If achieved, I believe this will represent another year of above industry growth rate on an organic basis and represent organic share gain by Medpace in the clinical CRO space. I believe we outgrew the industry on an organic basis in each of the past two years and I anticipate higher than industry organic growth over the next few years.

We also anticipate strong adjusted net income growth in 2018 driven primarily by taxes; however, I know many observers will focus on our flat to down adjusted EBITDA in 2017 and 2018 and question the factors leading to a decrease in our adjusted EBITDA margin, which we anticipate to be approximately 25% in 2018 compared to 28% in calendar year 2017.

The following are four of the largest factors reducing our margin for 2018 relative to 2017. One, foreign exchange rates - the FX impact on 2018 margin relative to 2017 is an unfavorable 130 basis points. Two, bonus - our 2018 bonus accrual will be substantially higher than 2017 resulting from a reduction made to 2017 bonus due to our lower than planned financial performance that year. This had the effect of lowering costs in 2017 relative to a more representative plan year such as that reflected in our 2018 budget and results in about 125 basis points of unfavorable impact to 2018 when compared to 2017. This should be viewed more properly as an overstatement of 2017 margin rate by 125 basis points. Three, investments in infrastructure and business development - we have or will be expanding and enhancing our physical infrastructure in several locations globally and are expecting increased rent and related costs which will put increasing pressure on margin in 2018, 2019 and 2020. We are also expanding our business development activities and bandwidth to accelerate growth. Four, salary costs - we have seen an uptick in market-driven labor costs beyond the usual, particularly in the U.S., and have responded with some upward adjustments to pay levels.

A follow-up question many will have is how sustainable and persistent these drivers of margin depression will be in future years. Without giving specific guidance on margin for future years, I have every reason to believe that bonus, salary, infrastructure, and BD costs will continue at, or in the case of facilities and business development costs above the 2018 level in proportion to service fees and thus represent a relatively permanent or increasing margin headwind in the next few years. Future changes in exchange rates are a wildcard that cannot be predicted, but what I can say is that exchange rates in 2017 relative to the average contracted rates for the period were a moderate tailwind to margin, and the rates anticipated in our 2018 budget are expected to be essentially neutral; therefore, going forward, I have no reason to believe excess will be more likely a tailwind than a headwind to core margin.

Jesse will now review in more detail our financial performance for 2017 and our guidance for 2018.

[Jesse Geiger, Chief Financial Officer]

Thank you, August, and good morning to everyone listening in. Moving now to our key financial highlights and trends on Slides 5 and 6, net service revenue was $99.4 million in the fourth quarter, which represents growth of 4.3% from $95.4 million in the fourth quarter of 2016. Full-year 2017 net service revenue increased 4.3% to $386.5 million from 2016.

Adjusted EBITDA was $27 million compared to $27.5 million in the fourth quarter of 2016. Our calculation of adjusted EBITDA in the fourth quarter of 2017 includes adjustments for our corporate campus lease payments and transaction related costs associated with the closing of our secondary offering. Full-year adjusted EBITDA was $108 million compared to $113.4 million in 2016.

Adjusted EBITDA margin for the quarter declined 160 basis points to 27.2% versus 28.8% in the prior year period. This decline was primarily attributable to higher employee related costs. Adjusted EBITDA margin for the full year was 28%.

In the fourth quarter of 2017, we had GAAP net income of $11.3 million compared to GAAP net loss of $21,000 in the prior year period. For the full year 2017, GAAP net income was $39.1 million compared to GAAP net income of $13.4 million in 2016. Adjusted net income of $14.8 million in the fourth quarter increased 3.2% compared to $14.3 million in the fourth quarter of 2016. Full-year 2017 adjusted net income of $60.5 million increased 8.5% compared to $55.7 million in 2016. Adjusted net income growth was primarily driven by revenue growth partially offset by higher employee related costs.

Our GAAP net income per diluted share for the quarter was $0.30 compared to a GAAP net loss of $0.00 in the prior year period. For the full year 2017, GAAP net income per diluted share was $0.98 compared to GAAP net income per diluted share of $0.37 in 2016. Fourth quarter 2017 adjusted net income per diluted share of $0.39 grew 11.4% versus fourth quarter 2016 adjusted net income per diluted share of $0.35. For the full year 2017, adjusted net income per diluted share was $1.52 compared to $1.53 per diluted share in 2016.

The U.S. Tax Cuts and Jobs Act impacted our 2017 fourth quarter and full year GAAP financial results. We recorded a one-time tax benefit of $2.8 million related to the revaluation of the deferred credit, deferred tax assets and liabilities, and other miscellaneous tax attributes, and the provisional transition tax on un-repatriated foreign earnings. Our full year 2017 effective tax rate was 31.3%. Excluding the impact of tax reform, our 2017 effective tax rate was 36.2%.

On Slide 7, we have provided a breakdown of our customer concentration by revenue across three key categories for both 2016 and 2017. Full year revenue growth was primarily driven by growth within oncology, which remains our largest therapeutic area. With regard to our mix by customer size, we remain focused on serving our core market of small and midsized bio-pharma customers that represent a large portion of our total business and a segment of the market where we see further opportunities for continued growth. Regarding customer concentration, we’ve maintained a well diversified mix with our top five and top 10 customers representing roughly 20% and 32% respectively of our total revenue for the year.

Slide 8 provides a summary of our leverage and liquidity positions as well as a schedule of our free cash flow conversion for both the fourth quarter and full year 2017 compared to the prior year periods. In the fourth quarter, we generated $28.7 million in cash flow from operating activities and our net day sales outstanding increased compared to the third quarter from 5.3 days to 7.6 days as we experienced an increase in trade accounts receivable. Our net debt position at year-end was $196.1 million composed of gross debt of $222.6 million and cash of $26.5 million. Our net leverage ratio is approximately 1.8 times 2017 adjusted EBITDA.

During the fourth quarter, we repurchased 2 million shares from Cinven for $60.3 million. These share repurchases contributed approximately $0.01 per share to earnings per share in the quarter. The share repurchase program that we initiated in 2017 terminated in the fourth quarter, and our board of directors has recently authorized up to $50 million in new share repurchases.

The 2018 guidance we are presenting today is based on ASC 605, consistent with our 2017 reporting. Before we discuss 2018 guidance, I will address the new revenue standard, ASC 606.

As of January 1, 2018, we will be required to recognize revenue on a percentage of completion basis as a single performance obligation, inclusive of service revenue, reimbursed out-of-pocket revenue, and revenue from fees paid to investigators and other arrangements where the company acts as an agent on behalf of the customer. Under this new standard, all revenue will be reported within a single revenue line item and related expenses will be presented within direct costs. We do plan to provide a breakout of direct costs to separate the costs associated with reimbursed out-of-pocket expenses and fees paid to investigators, although there could be a timing difference between when these costs are incurred and when the associated revenue is recognized.

We have adopted ASC 606 using the modified retrospective approach and will begin reporting revenue under this new standard beginning with the reporting of our 2018 first quarter results. We will not be restating 2017 financial statements under ASC 606, but throughout 2018 we will also be providing 2018 disclosures as if we were still reporting under ASC 605 so that comparisons can be made on a consistent basis.

Moving now to our newly established guidance for 2018, as shown on Slide 9, we are forecasting net service revenue on an ASC 605 basis in the range of $412 million to $428 million for the full year 2018, representing organic growth of 6.6% to 10.7% over 2017 net service revenue of $386.5 million. Despite this anticipated revenue growth, we are expecting continued adjusted EBITDA pressure. Our 2018 adjusted EBITDA is expected in the range of $102 million to $108 million. Compared to full year 2017, this range is flat to down 5.6%.

As August mentioned, there are a number of items having an impact on this suggested EBITDA range. We are making investments in our people and facilities to position the company for continued growth and our 2018 guidance assumes full-year exchange rates at the end of January. This currency assumption translates into a revenue tailwind and an adjusted EBITDA headwind compared to 2017 average exchange rates. Considering these assumptions, our 2018 guidance on a constant currency basis is revenue growth in the range of 5.9% to 10.1%, and adjusted EBITDA growth in the range of down 1.2% to growth of 4.4%.

From a quarterly cadence perspective, we expect revenue to be slightly weighted towards the second half of 2018 and cost that is fairly well balanced throughout the year, resulting in adjusted EBITDA phasing that is more back-end weighted than revenue. We expect the recent U.S. tax reform to have a positive impact on the company and we anticipate our 2018 effective tax rate to be in the range of 22% to 25%.

We forecast 2018 GAAP net income in the range of $43.9 million to $48.1 million and GAAP earnings per diluted share is expected in the range of $1.21 to $1.33. On an adjusted basis, we forecast 2018 adjusted net income in the range of $66 million to $70 million, representing growth of 9.2% to 15.8% and $1.82 to $1.93 per diluted share, representing growth of 19.7% to 26.9%.

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

[Operator]

[Operator instructions]

The first question is from Dave Windley of Jefferies. Your line is open.

[Dave Windley, Jefferies]

Hi, good morning. Thanks for taking my questions. The first one, I wanted to come back to the margin questions and the headwinds that you identified, and come at it a slightly different way. August, you talked about 2017 insomuch as there wasn’t, I guess, bonus accrual, that 2017 outperformed on that basis. If I think about that and a year-over-year comparison to 2016, perhaps you could talk about the pressures that you’re seeing that have brought EBITDA margin down in ’17, and if not for the bonus accrual would have been down more.

[August Troendle, President, Chief Executive Officer]

In ’17, why it was down relative to ’16 by such a large amount?

[Dave Windley, Jefferies]

Right, exactly. So I’m looking at, like, 30.6% in ’16 and then 28, but as you said, it would have been 26 and change if you had accrued full bonus.

[August Troendle, President, Chief Executive Officer]

Sure. Some of the factors are the same - partially there was FX change between ’16 and ’17. I think the amount of tailwind from FX is maybe under-appreciated. It was rather substantial - Jesse, do you have the number on--?

[Jesse Geiger, Chief Financial Officer]

Yes, so EBITDA headwind for 2017 full year, a little over a million dollars.

[August Troendle, President, Chief Executive Officer]

Okay, so that’s not that very large, but--. I guess it’s--then I guess as we’ve stated before, reduced revenue relative to budget with relatively fixed employee base led to a substantial headwind. I guess that was probably the largest of all. If we’d had--you know, we basically had the staff we’d have had if we’d had our original budgeted revenue for the year, and of course that came down and we decided not to make any action on any employees to rein in that cost. I guess the question is how we unwind perhaps a larger capacity going forward, and we stated before that we wanted to maintain at least a larger portion of that employee overhang for accelerating growth, which we’ve not anticipated to date but we do anticipate picking up, and we’ve--I guess still a little bid discouraged with the rate at which our revenue has come back, and so one of the initiatives for 2018 is really to expand substantially our efforts in generating business. In a different and changing biotech environment, we’ve taken some different approaches to expanding our business development activities and growing our revenue more rapidly.

[Dave Windley, Jefferies]

Okay, so two follow-ups to that, if I could. One, the point about labor capacity versus revenue, it sounds like, Jesse, based on your cadence comments for 2018 that that’s still a little bit true in the first half of 2018, that your revenue will ramp, you’re maintaining an employment base that you’ll leverage over the course of the year - confirm that for me?

Then second question, in relation, August, to your comment about still wanting to see better revenue traction and investing in new business in that regard, is your win rate changing, is it that you need to see more RFPs, or are you seeing enough RFPs and your win rate is dropping? Thanks.

[August Troendle, President, Chief Executive Officer]

Our win rate has been pretty stable to up in the past year, so that has not really been a problem. It’s really a matter of finding and selecting appropriate opportunities, so we’ve decided to expand our catchment of incoming opportunities and the infrastructure around managing that.

[Jesse Geiger, Chief Financial Officer]

Dave, back to your comment on salary costs, we do plan to be hiring as we go through 2018, so cost will build as we build heads; but I do want to point out, and this maybe gets back a little bit to your question about ’17 relative to ’16, is we do enter 2018 with a substantially higher employee cost base at the outset, so we had salary cost that was increasing more than revenue as a percentage in ’17 relative to ’16, even though we had slightly down headcount during 2017. That’s a function of those pressures that August spoke of from a market standpoint as well as some mix that we experienced during 2017 and continuing into 2018.

[Dave Windley, Jefferies]

Okay, thank you.

[Operator]

Thank you. The next question is from John Kreger of William Blair. Your line is open.

[Jon Kaufman, William Blair]

Good morning, this is Jon Kaufman on for John Kreger. August, a second ago you mentioned finding and selecting more opportunities. Is this a matter of clients becoming less willing to work with Medpace in the full service model and shift towards perhaps an FSP model, and as a result maybe you guys are seeing just fewer RFPs? Can you just describe that a little more in detail?

[August Troendle, President, Chief Executive Officer]

Sure. We haven’t really seen any movement toward FSP. That may be a factor in larger companies - I don’t know, but our client base is smaller companies and they’re exclusively or nearly exclusively full service, and generally do not use FSP to any material extent. Maybe on the margin, some of the larger customers might use some FSP, so that’s not really it. It’s a matter of finding an increasing number of opportunities and being able to manage that and select the right ones.

[Jon Kaufman, William Blair]

Okay, great, and then just one follow-up. In terms of the biotech funding environment, from our perspective the macro level of data appears to be pretty robust. Are you guys seeing any issues with your clients obtaining funding or being able to pay you right now?

[Jesse Geiger, Chief Financial Officer]

Yes, from a funding standpoint, the environment has returned to more of a steady state, certainly not much improved from what it was this time last year. From a payment standpoint, we had little to no bad debt expense - actually, we had a bad debt credit in the fourth quarter. There’s always a couple in the portfolio that we’re keeping an eye on, but the credit quality of the existing portfolio has also much improved over the year.

[Jon Kaufman, William Blair]

Okay, great. Thank you.

[Operator]

Thank you. The next question is from Eric Coldwell of Baird. Your line is open.

[Eric Coldwell, Robert W. Baird]

Hey, thanks. Jesse, is the mismatch in revenue and expense and euro and pound your two biggest exposures on the currency side, and maybe you could quantify those for us?

[Jesse Geiger, Chief Financial Officer]

Yes, it is the biggest driver, Eric. About 10% of our revenue roughly is in ex-U.S. currencies, and most of that is in the euro. On a cost standpoint, about 30% of our cost is ex-U.S., and on the cost side about 14% of total cost is euro and 5% is pound, and 10% is other currencies, none of which represent more than 1%.

[Eric Coldwell, Robert W. Baird]

Okay, thanks. I think we were off a little on one of those, but that would help explain it. Shifting gears, the combination of FX and bonus, 255 of the 300 BP of margin headwind, to some people that might imply that investments in labor are the remaining 45 BPs. My gut is those are actually greater headwinds and being offset perhaps through the years you see some improvements in other areas like workforce productivity or revenue leverage, so I’m just hoping you could quantify for us what you think the actual basis point impact of the investments in the labor is, in terms of the total impact on EBITDA this year. Thanks very much.

[August Troendle, President, Chief Executive Officer]

I don’t think we have that with us here to provide, but you’re right - there is some of that going on. There is a little bit of unwinding of--you know, better utilization of staff, and that eats up a little bit of the additional negative. But I don’t have a magnitude on that.

[Jesse Geiger, Chief Financial Officer]

But you’re right, Eric - those three are more than the total, and there are some positives that offset it.

[Eric Coldwell, Robert W. Baird]

Okay, thank you.

[Operator]

Thank you. As a reminder, if you do have a question, please press star then one on your touchtone telephone. The next question is from Donald Hooker of Keybanc. Your line is open.

[Donald Hooker, Keybanc]

Great, good morning. You had mentioned earlier in the call that oncology was increasing as a portion of your business mix. Has that impacted the length of the average clinical trial and projects that you’re working on, and then when I think about how you recognize backlog, I know you guys are really conservative there, and remind me but I think you cap anything at three years, so I’m wondering how much business you’ve won that extends beyond what you recognized in backlog, given the big pick-up in oncology.

[Jesse Geiger, Chief Financial Officer]

You’re right, Don - we do cap it at three years. The amount that we’ve held back beyond that three-year time is not a big portion of the total as a percentage of active backlog. You’re right - growth in oncology does have an effect of elongating the timelines in trials, which has increased a little bit but on average is still within in general the three-year duration.

[Donald Hooker, Keybanc]

Okay. That’s helpful. Just checking on that given the mix changes. Then when I think about your outlook for EBITDA for 2018, for those of us who kind of focus on different parts of that, if I think about gross margin, how do I think about that changing in 2018, and are there ways that you guys can proactively use some of your technology investments to manage labor and staffing and things like that around gross margin as you look into next year?

[Jesse Geiger, Chief Financial Officer]

Sure, so as we think about this bridging margin from year to year, we do expect SG&A percentage to be in the 16% to 17% range and the balance would be in direct cost and gross margin. There are a number of areas really throughout the business that we’re continuing to evolve our system and our platforms for efficiency, but nothing individually that I would point out that would be a large driver of margin efficiency in 2018.

[Donald Hooker, Keybanc]

Okay, and then last question from me, when I think about your EPS guidance, you do have good cash flow and you’ve been buying back stock. Do you assume share repurchases in your 2018 EPS guidance?

[Jesse Geiger, Chief Financial Officer]

We do not. We’re assuming 36.3 million fully diluted shares, and our guidance does not include any assumed share buybacks. Really, if and when we would act upon the authorization depends on a number of factors, including market conditions.

[Donald Hooker, Keybanc]

Thank you very much.

[Jesse Geiger, Chief Financial Officer]

Thanks Don.

[Operator]

Thank you. There are no further questions in queue. I’d like to turn the call back over for closing remarks.

[August Troendle, President, Chief Executive Officer]

All right, well thank you everyone for joining us on our earnings call and your interest in Medpace. We look forward to speaking to you again on our first quarter call. Thanks.

[Operator]

Thank you. Ladies and gentlemen, this concludes today’s conference. You may now disconnect. Good day, everyone.