Good day, ladies and gentlemen, and welcome to the Medpace Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference call, Lauren Morris, Medpace’s Director of Investor Relations. You may begin.

Good morning. And thank you for joining Medpace's third quarter 2022 earnings conference call. Also on the call today is our CEO, August Troendle; our President, Jesse Geiger; and our CFO, Kevin Brady. Before we begin, I would like to remind you that our 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 uncertainties, as well as other important factors that could cause actual results to differ materially from our current expectations. These factors, including the ongoing impact of COVID-19 on our business, are discussed in our Form 10-K and other filings with the SEC. Please note that we assume no obligation to update forward-looking statements, even if estimates change. Accordingly, you should not rely on any of today's forward-looking statements as representing our views as of any date after today. During this call, we will also be referring to certain non-GAAP financial measures. These non-GAAP measures are not superior to or a replacement for the comparable GAAP measures, but we believe these measures help investors gain a more complete understanding of results. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available in the earnings press release and earnings call presentation slides provided in connection with today's call. The slides are available in the Investor Relations section of our website at investor.medpace.com. With that, I would now like to turn the call over to August Troendle.

Good morning. RFP metrics were reasonably strong, though down slightly on a sequential basis in Q3. Initial award notifications, which I described in our second quarter call, were weak but recovered strongly and were at a healthy level in the third quarter. This was a surprising outcome given the continued financial challenges faced by a large fraction of our clients. Headwinds to revenue from delayed funding, reprioritization and even bankruptcy were higher in the quarter, but not yet broad-based. The business environment is challenging and we remain concerned that a prolonged period of depressed funding flows will eventually lead to a rapid escalation in project delays. Our initial 2023 guidance reflects this caution, and we anticipate slowing growth next year. Jesse and Kevin will now review our financial results for Q3.

Thank you, August, and good morning, everyone. Revenue for the third quarter of 2022 was $383.7 million, which represents a year-over-year increase of 29.8%. Net new business awards entering backlog in the third quarter increased 15.4% from the prior year to $470.9 million, resulting in a 1.23 net book-to-bill ratio. Ending backlog as of September 30th was approximately $2.2 billion, an increase of 20.9% from the prior year. We project that approximately $1.17 billion of backlog will convert to revenue in the next 12 months. Backlog conversion in the third quarter was 17.7% of the beginning backlog. And we continue to make progress in hiring, adding 11% to head count from the end of 2021 and 13.7% from the prior year. And with that, I'll turn the call over to Kevin to review our financial performance in more detail, as well as our guidance expectations for the balance of 2022 and initial guidance for 2023.

Thank you, Jesse, and good morning to everyone listening in. As Jesse mentioned, revenue was $383.7 million in the third quarter of 2022. This represented a year-over-year increase of 29.8% on a reported basis and 31.9% on a constant currency basis. Revenue for the nine months ended September 30, 2022, was $1.066 billion, and increased 27.8% on a reported basis and 29.3% on a constant currency basis from the comparable prior year period. EBITDA of $89.3 million increased 48.5% compared to $60.1 million in the third quarter of 2021. On a constant currency basis, third quarter EBITDA increased 41.5% compared to the prior year. Year-to-date EBITDA was $227.7 million and increased 40.9% on a reported basis and 35.7% on a constant currency basis from the comparable prior year period. EBITDA margin for the third quarter was 23.3% compared to 20.3% in the prior year period. Year-to-date EBITDA margin was 21.4% compared to 19.4% in the prior year period. The increased EBITDA margin was driven by revenue growth, net foreign exchange benefits from the strong US dollar, and slower headcount growth compared to 2021. In the third quarter of 2022, net income of $66 million increased 35.9% compared to net income of $48.6 million in the prior year period. Net income growth over the prior year was primarily driven by higher EBITDA, offset by interest expense and the higher effective tax rate. Net income per diluted share for the quarter was $2.05 compared to $1.29 in the prior year period. Regarding customer concentration, our top five and top 10 customers represent roughly 17% and 25%, respectively, of our year-to-date revenue. In the third quarter, we generated $108.5 million in cash flow from operating activities and our net day sales outstanding was negative 40.5 days. We did not repurchase any shares during the third quarter. In October, our Board of Directors authorized the company to repurchase up to $500 million of the company's common stock. During the quarter, we paid $110 million against the credit facility, and our net debt position at the end of the quarter was $108.7 million, which was composed of debt of $139.7 million and cash of $31 million. Our net leverage ratio is approximately 0.4 times last 12 months EBITDA. Moving now to our updated guidance for 2022. Full year 2022 total revenue is now expected in the range of $1.44 billion to $1.46 billion, representing growth of 26.1% to 27.8% over 2021 total revenue of $1.142 billion. Our 2022 EBITDA is now expected in the range of $302 million to $310 million, representing growth of 35.4% to 39% compared to EBITDA of $223.1 million in 2021. Guidance is based on foreign exchange rates as of September 30th. This guidance assumes a full year 2022 effective tax rate of 16% to 17% and 33.7 million diluted weighted average shares outstanding for 2022. There are no additional share repurchases in our guidance. We forecast 2022 net income in the range of $232 million to $236 million, which includes $3.3 million of interest expense on our outstanding debt. Earnings per diluted share is now expected to be in the range of $6.88 to $7. As Jesse mentioned, we are providing initial 2023 guidance for revenue and EBITDA. For the full year 2023, we expect revenue in the range of $1.68 billion to $1.74 billion and EBITDA to be in the range of $325 million to $350 million. We plan to provide additional detailed full year 2023 guidance on our fourth quarter earnings call in February. With that, I will turn the call back over to the operator so we can take your questions.

Our first question or comment comes from Dave Windley from Jefferies. Your line is open.

August, you mentioned in your remarks some of the financial headwinds and even, I think, you mentioned even some bankruptcies, but that those weren't that broad. I guess, that mention seems, I guess, new or maybe somewhat intensified. So it would seem sequentially like a little bit of a headwind. I'm looking at some of the metrics like your revenue burn rate actually accelerating by quite a bit. And those things seem to be at odd. So maybe you could help us to understand like what helped the backlog burn rate to accelerate in the quarter and how the margin jumped so much sequentially. Was there any pull forward of revenue in the third quarter?

No, I don't think there's any pull forward, but projects did progress. I think, you got two things going on. We're a little bit concerned about new project starts, but we haven't really seen broad-based delays there. But ongoing projects are going very well, and that's what's driving conversion is the ongoing projects. And I think that we made good progress on them. The pass-throughs were even higher than service fees growth, but projects are progressing very nicely and to a better extent than we expected. And the amount of what we estimated for delays and slowdowns and cancellations were less than what we expected, so I think we had a very good conversion.

Dave, the other thing to consider on margin in addition to revenue is just the FX impact that we saw in the quarter. The dollar significantly strengthened again in the third quarter. And for us, it was about a $6.5 million impact when you also factor in the FX gain from the revaluation of our balance sheet.

And that last part that you mentioned is the other income in the component?

Yes, that's right.

That addresses the margin question. August, you've mentioned that contracts are sometimes solidified over a shorter period in your case compared to others before the study begins. After that, you have several years of operating under those contracts, with certain price escalators that may not be renegotiable. One might expect these factors to negatively impact your margin. Currency exchange rates could be influencing that as well. Have you managed to negotiate any adjustments for labor inflation to mitigate that impact?

We haven't really addressed labor inflation on existing contracts to any extent. Obviously, we do annually and sometimes even small tweaks in between in terms of pricing on new projects, but they're not reflected in our current work. Things that we're bidding in the last nine months or not are not really burning. So pretty much this reflects awards that were in place a few years back. And there's no real way to address inflation other than the contractual terms, which generally have a set fixed amount of increase each year.

Our next question comes from the line of Sandy Draper from Guggenheim Partners Draper.

I’d like to follow up on Dave's question regarding your 2023 guidance, which I found quite robust. In August, you mentioned there seemed to be a degree of conservatism in that guidance. While I understand you're not going to provide all the details, I'm considering the factors that will influence revenue growth, including your bookings, the implied book-to-bill ratio, and backlog burn. Some of this is related to trials and service revenue mix. Can you share your thoughts on whether you anticipate booking levels or the book-to-bill ratio maintaining these implied levels, or if you expect a slowdown? Additionally, for 2023, do you foresee the backlog burn stabilizing at its current rate, considering it seems to have increased? I'm trying to understand what's factored into your guidance because I was somewhat surprised by your conservative positioning, given that the guidance appears quite strong.

Yes, we expect book-to-bill ratios to remain in the same range as they have been this year. They might be stronger if we weren't anticipating a slowdown. There are many factors involved, so it’s hard to say for certain. However, we have reviewed our entire pipeline, including past decisions and initial awards, and assessed how they will flow through. We are still keeping an eye out for a financial downturn, as mentioned by Jamie Diamond. We expect a general slowdown in starts and a notable increase in cancellations, given the current funding environment and client feedback. So far, we have managed these challenges. However, we anticipate that this slowdown will impact us eventually. If it doesn't, we could have an upside on our guidance. If it does, we hope to remain within the guidance we've provided. There is little we can do about significant cancellations across the board, but we do not foresee that happening. We believe we have been conservative enough in our guidance to accommodate the slowdown we expect, which should allow us to stay within our projected range.

My next question is for Kevin or maybe Jesse. Looking at the EBITDA guidance for next year, it seems to be growing slower than revenue. I'm trying to understand the margin - is this mainly due to gross margin changes, possibly related to the mix of service revenue to pass-throughs and potentially higher pass-throughs, or is it more about inflation? I'm interested in figuring out what is affecting expenses more, whether it's driven by inflation or the service revenue mix, or if it's primarily in the SG&A area.

Just to answer your questions, a couple of things that are going on. One is the FX gain that you see in miscellaneous income, that's just driven by the revaluation of the balance sheet. And so to the extent that rates stay consistent, we don't expect to see a positive or negative influence from that in 2023, and there's $7.8 million year-to-date in foreign currency gains right now. The other component is just on in terms of building in some level of continued installation or retention efforts in hiring is to make sure that we can support the anticipated growth in '23.

Our next question or comment comes from the line of Mr. Max Smock from William Blair.

I just wanted to ask a quick one here on revenue by Customer Care. Based on their deck, it seems like midsize and large pharma were both really strong in the quarter. I think each increased by 1% based on year-to-date revenue and small biopharma, it seems like obviously very impressive, but as a percent of revenue, year-to-date dropped off a couple of percent. So just wanted to see if you had any detail you could provide around whether or not there any notable wins in the mid to large pharma space that we should be aware of, and then any cause for concern on the drop off in small biopharma as a percent of revenue beyond what you've already talked about in terms of some of the near term headwinds from the slowdown in funding that we've seen over the last couple of quarters here?

Max, nothing really good to point out there. Other than when we do have activity in the mid and large, it tends to be a little bit lumpier than how revenue spread across the population of small biotech customers. But nothing really that I'd point out there in terms of any therapeutic concentration or specific customer concentration that really drove activity in the quarter.

And then I wanted to go back to the 2023 guide again and appreciate the conservatism that you've built in there. But in terms of funding and whether or not we see it pick back up here near term, if we do actually see it pick back up here near term. Do you think there could actually be some upside to 2023 guide? Or given the lag between bookings and revenue, would this actually be more of an impact for 2024? And then assuming funding, that's going to pick back up in the next couple of quarters. Is it fair to think about revenue growth reaccelerating back into that 20% range in 2024 and beyond? And then sorry for lumping a few in here. But relatedly on the other hand, if we don't see funding pick back up, do you think about 2024 maybe dropping off further from the projected year-over-year growth that you're guiding to in 2023?

The longer the slowdown in biotech funding, I think, the greater the headwind for us. So I do think it is cumulative. So 2024 would be impacted by a very prolonged depression of revenues. If things snap back, yes, there's upside to the 2023. We've kind of baked in some disruption, both in terms of starting of programs, delays, as well as some kind of cancellation expectations, to get to where we are in the guidance. Again, not a disastrous kind of scenario that could be below. But we have tried to be more conservative than usual in terms of anticipating that slow down. But there certainly is upside if funding rebounded or we don't have the slow down that we expected. And we would look at the last few years and yet 20% plus revenue growth should be quite possible if things don't deteriorate or funding snaps back. Does that answer your question?

Yes, that's very helpful. Thank you. And I'll leave it there. Thanks.

Our next question or comment comes from the line of John Sourbeer from UBS.

Congrats on the quarter and the impressive guidance. Just I was wondering, is there any additional color you can provide on that recovery on the initial award notifications that you saw in 3Q versus 2Q, and do you think that recovery is sustainable as we head into 2023?

Yes, I believe it's sustainable. We were uncertain why it declined initially, thinking it indicated a widespread slowdown, but that has not materialized. It rebounded, and the figures are consistent with previous quarters, showing a significant increase from Q2. We haven't observed any more declines. Initially, we thought it was a sign of a broad-based slowdown, but that appears to have been a false alarm, at least up to now. While we do expect some slowing, we haven't witnessed a substantial amount so far. There are some anecdotal instances, and we've experienced additional project delays and even a bankruptcy, which is unusual for significant ongoing projects. However, these issues haven't broadly impacted our growth. Overall, things are looking promising.

And then just on the cash burn and the increase Q-over-Q and year-over-year in 3Q. Just any additional color there and then just thoughts given some of the hiring over the last year on just what that trajectory looks like in 2023?

You said the cash burn?

Yes.

In the context of… Yes, the cash conversion, it is pretty volatile for us. We had another good quarter of free cash flow generation, really just driven by earnings and positive working capital. We had a little bit of a blip in the first quarter, if you recall, but things have recovered nicely since then.

John, I was just going to comment on the hiring and the headcount growth. We did pause a little bit or slowed things down a little bit in the third quarter, just given the uncertainty in the environment. We are ramping that back up and do expect healthy hiring expectations in 2023. since in 2023. It does continue to be a challenging environment. So we're really focused on hiring, we're focused on retention because the labor market still is a tough one.

And then just one more regarding existing contracts and pricing for new contracts. Are you experiencing any pressure or repricing due to the increase in wages?

We evaluate our rates every year, and this year we've seen a slightly larger increase compared to the last few years. However, we haven't encountered much pushback. Given the competitive environment, our clients, facing reduced funding, are looking for savings. We discuss how the inflationary environment affects our rates, but as long as we remain competitive, we haven't experienced any significant pushback.

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

There was a question earlier about the business mix in the quarter, and building on that, do you plan to focus more on larger clients in this environment? Are you considering being more aggressive with larger biotech companies or more open to working with big pharmaceutical firms to create additional opportunities for growth and bookings, especially if you're concerned about the trajectory with smaller clients?

No, that's just not really our focus and not where the model aligns well. It's not a bad situation that prompts us to explore a new segment. It is largely a different market. We do pay more attention to the funding of the client, so we might slightly increase our focus on larger biotech clients. However, I don't think we are shifting our focus towards mid-size or large pharmaceutical companies. Those opportunities may occasionally come our way, but we don't actively seek them out.

Bankruptcies, I'm curious, could you share how many total active clients you have this year and how many bankruptcies across that, whatever that number that cohort is? How many bankruptcies in total did you experience in 3Q or year to date?

No, I don't really have a number on that. What's important is the amount of work being done. We had one client with significant ongoing work who went ahead, which resulted in a few million dollars lost due to a bankruptcy related to a sizable project. This isn't something that happens frequently. Usually, by the time it gets to that point, there's either minimal revenue left, or it happens early on, leading to little impact. The dollar value of this instance was greater than usual, but I don't have a solid metric on the total number of clients that have declared bankruptcy over time. Additionally, you would need to consider the impact, including the backlog with those clients, when the bankruptcy occurred, the amount of unpaid revenue, and other factors, but I just don't have that information.

I understand that you typically don't provide specific cancellation rates, but could you clarify whether you mentioned the cancellation rate or indicated if it was at, above, or below normal for this period?

I did not provide a specific cancellation rate, but I can say that it was actually within a very favorable range. We've discussed cancellation rates before, although we don't disclose a formal figure. Generally, we refer to it being around 3% to 5% for our ongoing backlog. There are times when we mention total cancellations, which includes projects awarded to us that haven't started yet. In periods of slowdown, clients may delay starting due to funding issues, leading to cancellations. However, overall, we haven't experienced a significant increase in cancellations. Our formal cancellation rate for backlog projects remained within the 3% to 5% range, indicating that things look quite positive for the quarter, even better than last quarter. So, it’s difficult to predict future trends based on these metrics.

When you mention the metrics, it seems like a general comment. When you say the metrics look better, does that also apply to win rate and pipeline? I'm interested to know if you can provide a specific number.

The win rate has increased slightly. Although RFPs were down a bit, the win rate rebounded. We noted last quarter that there was a minor decline, but it wasn't significant. Award notifications were strong. Overall, the environment appears robust, yet many clients are experiencing financial difficulties, and we've seen more impairments than usual in recent quarters. We're still waiting for any real impacts to manifest, and so far, I haven't noticed them. However, the longer our clients face funding deficiencies, the greater the risk becomes. During the last slowdown, it happened quickly, leading to a significant drop in project starts and a rise in cancellations. We made efforts to invest in business development and broaden our understanding of clients to adapt quickly to potential slowdowns among a segment of our clients. I believe we’ve managed that exceptionally well so far. That said, there are limits to how much we can do, and eventually, we will feel the effects. The situation is contingent on how long the downturn lasts. The decline in funding has been significant, and we've observed its impact on our clients. So far, we've managed to avoid it affecting our bookings and the overall progress of projects, although some clients are facing challenges and their projects have been delayed. We've been able to adjust to other clients, but I’m uncertain how long that adaptability can last.

Our next question or comment is a follow-up from Mr. Dave Windley from Jefferies.

August, you introduced the initial project awards metric last quarter, and we're all trying to understand how it relates to your sales pipeline progression from RFPs to initial project awards to bookings. I suspect that the transition from initial project awards to bookings isn't a straightforward timeline. If we look at a full quarter's worth of initial project awards, which were down 45% year-over-year from what you mentioned last quarter, and apply that decline to the bookings from the third quarter of last year, the fourth quarter of last year, and the first quarter of this year, it implies a book-to-bill ratio well below 1.0. Everything you're indicating suggests that you will avoid a significant challenge with that low book-to-bill ratio. Am I misunderstanding this? I would appreciate any clarification on how the flow of initial project awards transitions to bookings and backlog, and how you're managing to smooth this out despite a potentially difficult book-to-bill ratio that could make an 18% growth rate next year look quite tough.

I understand your concerns regarding the issues in the pipeline and how they manifest later on. It's important to recognize that there are many variables at play; it's not just a straightforward flow of liquid through a pipe. Various elements can disrupt that flow. The timeframe before projects move to backlog is impacted by environmental factors, and our win rate plays a significant role in adjusting that duration. Even if the flow slows down, an improved win rate can offset any shortcomings in the process. It’s also crucial to consider that while we had fewer initial award notifications, we have experienced several quarters of strong initial awards. This past quarter was unexpectedly low, and it's difficult to pinpoint the reasons for that. Additionally, there are changes in win rates and project durations that influence outcomes. Just because we receive award notifications doesn't guarantee they will transition to backlog; this involves a broader context, including cancellations that are not reflected in our cancellation metrics. If we have fewer projects and initial awards but maintain lower attrition toward requests for proposals, we might still see a similar number make it to that stage, especially with fluctuating win rates. There are several strategies to manage low initial awards in a quarter, but these effects are often not visible until a couple of quarters later on average. As I mentioned last quarter, averages can be misleading, and external factors can significantly alter those trends.

The other driver of revenue is your burn rate. It's a combination of your burn rate and not just the book-to-bill ratio, and that's something to consider as well.

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

Thank you for joining us on today's call and for your interest in Medpace. We look forward to speaking with you again on our fourth quarter 2022 earnings call.

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