Medpace Holdings, Inc. Q2 FY2024 Earnings Call

Good day, ladies and gentlemen, and welcome to Medpace Second Quarter 2024 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 second quarter 2024 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 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 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 day everyone. Net new business awards entering backlog were down in Q2 compared to the same quarter of 2023. This was primarily the result of significantly elevated project cancellations, including backlog cancellations that were more than two times the quarterly average of calendar year 2023. Gross bookings were strong and, had the cancellation rate been equal to the average quarterly rate in 2023, our net book-to-bill would have been 1.24. Cancellations were disproportionately high in the month of June, with April and May cancellations in line with our expectations for a strong quarter. Reasons for cancellations included reprioritization, impaired sponsor liquidity and an acquisition of one sponsor by a large pharmaceutical company, with a subsequent decision to move the work to an existing preferred provider. As several of the cancellations involved awarded work not yet recognized in backlog, we also anticipate a depressed book-to-bill ratio in Q3. The business environment remains robust and we continue to be optimistic about our future growth, but it may take a few quarters to replenish the flow of opportunities converting into backlog at a more normalized rate. I should stress that despite the challenged backlog growth, we continue to anticipate industry-leading organic revenue growth and profitability. In fact, we are raising our 2024 EPS guidance as will be discussed by Kevin. With that, I will turn the call over to Jesse.

Thank you August, good morning everyone. Revenue for the second quarter of 2024 was $528.1 million, which represents a year-over-year increase of 14.6%. Net new business awards entering backlog in the second quarter, which were influenced by higher cancellations, decreased 4.1% from the prior year to $551 million. This resulted in a 1.04 net book-to-bill. Ending backlog as of June 30, 2024, was approximately $2.9 billion, an increase of 13.7% from the prior year. We project that approximately $1.585 billion of backlog will convert to revenue in the next twelve months and backlog conversion in the second quarter was 18.2% of beginning backlog. Now with that, I will turn the call over to Kevin to review our financial performance in more detail as well as our guidance expectations for the balance of 2024. Kevin?

Thank you Jesse and good morning to everyone listening in. As Jesse mentioned, revenue was $528.1 million in the second quarter of 2024. This represented a year-over-year increase of 14.6%. Revenue for the six months ended June 30, 2024 was $1.04 billion and increased 16.1%. EBITDA of $112.3 million increased 34.2% compared to $83.6 million in the second quarter of 2023. Year-to-date, EBITDA was $227.9 million and increased 29.1% from the comparable prior year period. EBITDA margin for the second quarter was 21.3% compared to 18.1% in the prior year period. Year-to-date, EBITDA margin was 21.9% compared to 19.7% in the prior year. EBITDA margin benefited from direct service activity, continued productivity and foreign exchange. In the second quarter of 2024, net income of $88.4 million increased 44.7% compared to net income of $61.1 million in the prior year period. Net income growth ahead of EBITDA growth was primarily driven by higher EBITDA and interest income, partially offset by a higher effective tax rate in the quarter. Net income per diluted share for the quarter was $2.75 compared to $1.93 in the prior year period. Regarding customer concentration, our top-five and top-ten customers represent roughly 22% and 29%, respectively, of our year-to-date revenue. In the second quarter, we generated $116.4 million in cash flow from operating activities and our net days sales outstanding was negative 58.1 days. We did not repurchase any shares during the second quarter. As of June 30, 2024, we had $510.9 million in cash and $308.8 million remaining under our share repurchase authorization program. Moving now to our updated guidance for full year 2024, total revenue is now expected in the range of $2.125 billion to $2.175 billion, representing growth of 12.7% to 15.3% over 2023 total revenue of $1.89 billion. Our 2024 EBITDA is now expected in the range of $430 million to $460 million, representing growth of 18.6% to 26.9% compared to EBITDA of $362.5 million in 2023. We forecast 2024 net income in the range of $361 million to $383 million. This guidance assumes a full year 2024 effective tax rate of 15% to 16%. Interest income of $24 million and 32.1 million diluted weighted average shares outstanding are incorporated into our guidance. There are no additional share repurchases in our guidance. Earnings per diluted share is now expected to be in the range of $11.24 to $11.93. Guidance is based on foreign exchange rates as of June 30, 2024. With that, I will turn the call back over to the operator, so we can take your questions.

Thank you, ladies and gentlemen. Our first question comes from Eric Coldwell with Baird. Your line is open.

Thank you. Good morning. I wanted to obviously dive into the cancellations. I was hopeful you could provide maybe some more details around perhaps the number of cancels or maybe relative sizing. Were there any that were particularly large here? And I'm curious if there's any way you could help us frame your expectations for the 3Q cancellations experience, or what you're expecting at this juncture for a reasonable net book-to-bill range, given that some of these cancels are for awards that had not previously been placed into backlog? Thank you.

Yes, sure, Eric. It's August. It's surprising. Usually when you have a big cancellation quarter, a couple of factors drive things, and I don't think this was driven by just one or two items. There were several that were large, but it wasn't just one or two very large cancellations. So it was pretty distributed in that way, although some of the bigger ones do drive a lot of it. They were across the board in terms of rationale for the cancellation. Primarily it was reprioritization, impaired sponsor liquidity or a decision not to focus on other projects. There were cancellations on programs that involved work that had been awarded but hadn't yet been recognized in backlog; we were getting very close and some of those items had been put into backlog but not all revenue had been recognized yet under our policy. So it causes a gap that will impact our Q3 bookings. Whether cancellations continue depends on future sponsor decisions. They were kind of focused in Q2; I don't see a reason they should remain elevated, but I also don't have a good rationale for why they were twice the run rate in Q2. Cancellations are always a variable that can happen at any point. We have reasonable visibility on awards coming along and awards looked good and we were getting close to backlog recognition. It was the cancellations that caught us by surprise. Yes, we already see a challenge to Q3, based on the cancellations that we had in Q2, that will impair recognition of backlog from projects that were canceled.

Now, I realize it's very difficult to forecast the remaining cancellation experience this quarter as well as your gross bookings experienced this quarter. But just to help level set, are you at least at this point initially thinking a book-to-bill that is similar to 2Q's experience, something maybe a little better, but not quite in that typical 1.2-plus ZIP code? Or are we talking a book-to-bill that could, at this juncture, reasonably look like something lower than 2Q's experience?

Well, look, in early June, I thought we were going to have a book-to-bill of at least 1.2. It's late in the quarter that you really kind of round things out and know where they are, so it's difficult to say. I would hope it's above the current quarter. I think 1.2 is probably not in the cards, so I would expect somewhere between where we booked this current quarter, 1.04, and closer to 1.2.

Thank you. Please stand by for our next question. Our next question comes from the line of Max Smock with William Blair. Your line is open.

Hi, good morning. Thanks for taking our questions. Maybe one here for me on win rate, you mentioned you had some cancellations that were associated with an acquisition where the sponsor ended up moving some work to a larger player. And you mentioned gross bookings seemed solid in the quarter, but any sort of update you can give us around how much of the booking shortfall, if any, was tied to maybe a step down in win rate? And did you see any sort of improvement in win rate after the bit of a step back that you took in the first quarter here?

No, the win rate was good, not outstanding, but it came back and snapped back from being down a bit in Q1. The business environment again looks very good. I really think we're in a position to rebuild the pipeline nicely. We got a little gap here, but I don't see a long-term issue. Our win rate is good and our opportunities are good. It's hard — CEOs are always optimistic — but things look a lot stronger than these unfortunate bookings reflect.

That's helpful. Maybe just putting some more color on that to frame out what you're seeing on the business environment side. Can you give us an update on how RFP flows in initial awards in 2Q trended and then any sort of initial look at how these metrics are trending so far here in the third quarter?

Yes, RFPs were strong. I think they were up about 16% both sequentially and year-over-year, so it was really strong. I don't like discussing RFPs strictly numerically because numbers alone don't capture quality — you can have many low-quality or rehashed RFPs. But the dollar value of RFPs we responded to was up 16%, and the quality was good as well. Our initial awards were strong in the quarter and all other metrics look good except cancellations. Cancellations are the main issue. They are always a downside risk, but I believe things will normalize and we will get back to backlog growth soon. We'll put up strong growth numbers on a GAAP basis in the meantime.

Yes, absolutely. And maybe just sneak in one final one here for me. You talked about third quarter bookings. Obviously going to be depressed, maybe a step up off that 1.04. But is there any other detail you can give us on the timeline for book-to-bill to move back above 1.2 and what that means for 2025? I'm assuming the step up in revenue you called for is obviously off the table next year. But can you frame out the range of outcomes for how we should be thinking about revenue next year, given your commentary about it taking some time to rebuild backlog?

I think it's too early to talk about 2025. We'll have a better view next quarter. We will see how things shake out and what seems likely to cross the line. Cancellations remain a wildcard, but you can line up what is likely to get across the line. I hope to be able to give more clarity at the end of Q3, but it's too early now to talk about the exact impact on 2025. I continue to anticipate better-than-industry growth and strong performance. I do not think this is a prolonged pullback. If awards and opportunities were drying up, that would be more concerning. We lost a group of projects, but I don't see that as predictive of the long term. Cancellations are often random, and I don't think this is a continuing pattern.

Thank you. Please stand by for our next question. Our next question comes from the line of Tucker Remmers with Jefferies. Your line is open.

Let me—might be Dave Windley with Jefferies. If you can hear me, can you hear me?

We can hear you, Dave. We can hear you.

Okay, great, thanks. So, wrong code number, sorry. A few questions. Thanks for taking my questions this morning. So, the impact to bookings and backlog, you've guided revenue. I guess I'm wondering how we should think about revenue conversion in light of the fact that it sounds like some of these cancellations were either revenue generating or about to be revenue generating. How does that impact your near-term revenue?

Kevin, you want to take that?

Yes, Dave, this is Kevin. Just in terms of 2024, we do feel pretty good about it. Certainly there's a bit of headwind associated with some of those cancels. We'll see how those programs tail off and finish up, but we still feel good about revenue. We did take the midpoint of the guidance and the range down a little bit. That was more indicative of the pass-through activity and the decline that we saw in the first quarter. It did bounce back a bit in the second quarter, but at the same time it wasn't something that we could fully overcome from the decline in the first quarter. But no, we feel good about revenue for the balance of the year, in particular. On the direct service side, there was some headwind associated with these cancels, but we still feel good about where we are.

Okay. On the pipeline, a couple things we've heard are that oncology as a therapeutic area is perhaps among the most volatile right now, with more jockeying among programs, and that there is quite a bit of price competitiveness. We also heard about some deep-discount deals by some of the bigger CROs earlier in the year. I'm wondering if you're seeing more of that. It sounds like win rate bounced back up, which is encouraging relative to that. But on those two fronts, is there any theme in oncology specifically, and is there a theme of large players being more price competitive?

In terms of our cancellations, they were not overly concentrated in oncology relative to our overall oncology exposure, though oncology is a big part of our work and was part of the cancellations. I'm not sure that oncology itself was the primary factor. Pricing overall is competitive. We have seen some cases of very aggressive offers given the environment a few quarters back. I think things are a lot better now. A few quarters ago, it was tighter and there may have been some aggressive pricing by some competitors, but I don't think pricing is a primary driver now.

Okay, last question for me. Your headcount growth in the first quarter was lower than expected and in this quarter it's basically flat. I know you've talked about some productivity initiatives, but I'm guessing those don't preclude any hiring at all or net hiring at all. How should we think about the margin increase you're showing in the guidance today? I'm sure it's positively influenced by the lack of hiring and the sustainability of that when growth resumes and you have to resume hiring. Help us with your hiring thoughts.

Yes, Dave, it's Jesse. We're still expecting hiring. Retention has continued to be good and productivity has been good, but we do anticipate mid- to low-single-digit net headcount growth for the year. So we are expecting to hire despite the cancellations and continuing productivity and efficiency.

Okay. And so that hiring you anticipate for the balance of the year, that's baked into the guidance so your margin can absorb that and still go up as you're guiding?

Yes, I believe it's reflected in the guidance.

Our next question comes from the line of Dan Leonard with UBS. Your line is open.

Thank you. I have a follow-up to that last question. Was the muted hiring in the quarter reflective of any countermeasures you took in response to the weaker bookings? Or was that consistent with your plan?

Dan, primarily consistent with plan. The cancellations came very late in the quarter and at an elevated level and we continued to hire according to plan through the quarter.

And then separately, that acquisition of a customer by large pharma — was that a trial that was already in flight? I know moving that type of work would be unusual. Could you clarify that and also clarify whether that was the biggest factor in the elevated cancellations or just one of many?

That was just one of many. The project was very early but near running and near significant revenue. It was late in the pipeline and was in backlog and had patients being recruited; it wasn't fully broadly operationalized yet. Losing a project that is in backlog and running in the field is highly unusual, which is why I noted it. But losing future work from an acquired client is more common as larger pharmas bring work in-house for future trials.

Final question: can you remind me what the normal cancellation rate is, so I can do my own math on doubling that?

Yes. Historically our cancellation rate has normally run below 4.5%.

Our next question comes from the line of Ann Hynes with Mizuho Securities. Your line is open.

Hi, good morning. I know you made a comment that cancellations got worse in June. Could you give us an update on what's happening in July since it's later in the month? My second question is around the RFP activity. I believe you said RFP activity is up 16% year-over-year. Is that just actual RFPs or does that represent revenue terms? If it doesn't, can you tell us from a revenue perspective whether total RFP activity is up year-over-year?

I don't have numbers on the actual dollar value to disclose, but the 16% increase I cited refers to dollar value. So RFPs responded to in the quarter were up 16% on a dollar basis. We don't disclose the absolute dollar value in that metric unless we specifically call it out. As for July, nothing unusual — not like June. There has been no unusual activity in July.

And then maybe we can just talk about EBITDA. Your EBITDA guide despite the book-to-bill weakness was very strong. Can you just talk about the drivers of that?

Yes. It's continued progress in our direct service activity. As we've mentioned previously, we've seen continued improved productivity from existing staff and somewhat slower hiring in the second quarter. We do still expect to end the year with mid- to low-single-digit net headcount growth, which might pick up in the balance of the year. We also had a modest foreign exchange benefit in the quarter from the strengthening of the dollar.

Our next question comes from the line of Charles Rhyee with TD Cowen.

I wanted to ask in terms of the guidance with the cancellations and the step down in backlog, first, how much of the backlog reduction is a function of pass-through revenue versus direct service revenue?

Both direct and pass-through were affected by cancellations. Cancellations tend to have a higher pass-through portion relative to direct service work, but we can provide more specific color.

I can tell you the percentage of the quarter cancellations that were pass-through was around 50% to 55%.

Okay. When we look at backlog reduction, is that a good proxy — the 50% to 55% pass-through — for modeling the reduction? Also, when you think about the burn rate and reaching the revenue guide for this year, should we expect a material uptick in the burn rate because pass-throughs are being removed, which would mean the EBITDA guide remaining up while revenue is reduced?

Yes. You will likely see somewhat of an increase in the burn rate in the balance of the year in light of the cancellations. The reduction in the revenue guidance is primarily related to pass-throughs — both the reduced pass-throughs we saw in the first quarter and the cancellations, which were a little heavier on pass-throughs than direct.

Okay. And when you think about funding, we had a very strong funding quarter in the first quarter for biotech and continued strength in the second quarter. When you look at the first half, it's very strong relative to the prior year. Is that funding yet to translate through to bookings and backlog? You mentioned without cancellations you'd be at a 1.24 book-to-bill. Are we seeing that funding flow through in gross bookings?

The business environment remains strong and we will replenish our pipeline of projects converting into backlog. Anything that reaches backlog tends to convert to revenue more quickly than pass-throughs. Cancellations tend to carry a higher percentage of pass-through, but overall the environment should allow us to replenish and normalize over time. I can't map funding directly to specific opportunities right now, but we believe the environment will keep up and we'll replenish the pipeline.

If I could sneak one more. The cancellation tied to the acquisition — can you help size that relative to overall cancellations? How much of the cancellation was related to that event?

It was not most of the cancellation or anything like that. It was a sizable cancellation, but not one of the largest and did not overwhelmingly drive the total.

Our next question comes from the line of Jack Wallace with Guggenheim Securities. Your line is open.

Hey, thanks for taking my questions. I wanted to ask broadly about cancellations related to M&A. Looking back, when your biotech clients are acquired by larger pharma, have you typically retained much of the business post-acquisition? Or have you lost most of it?

Losing future work from an acquired client is frequent because large pharma will often bring work in-house. But losing a project that is already in backlog and running in the field is highly unusual, which is why this particular cancel was notable. Usually if a client is acquired, the future pipeline work shifts, but ongoing studies typically continue with the same CRO.

Got it. And then just thinking about the competitive environment, have you seen any change in posture or activity from larger CROs coming more down-market? Which competitive actors have been most aggressive on price?

Anecdotally, the competitive environment remains much the same. Most of our competition is larger players. A few quarters back there was more aggressive pricing and some competitors making very aggressive moves, but I think the environment has relatively normalized and I'm not seeing a substantial change in dynamics now.

Operator: Our next question comes from Justin Bowers with Deutsche Bank. Your line is open. Justin Bowers: In the competitive environment, have you seen any change in posture or activity from larger CROs coming more down-market? Which competitors have been most aggressive on price? August Troendle, CEO: Anecdotally, the competitive environment remains much the same. Most of our competition consists of larger players. A few quarters ago there was more aggressive pricing and some competitors made very aggressive moves, but the environment has relatively normalized and I am not seeing a substantial change in dynamics now.

Good morning, everyone. Can you remind us of your backlog policy? The gist of the question is trying to understand your visibility on the 3Q bookings as you enter 2Q and your comments about what's coming out of backlog and how that would impact 3Q.

Yes, Justin. In terms of our backlog policy, there are a couple of gating items that have to be in place before something is included in backlog. There can't be any regulatory hurdles pending; the program has to be ready to start and actively recruiting patients; and there must be clear visibility to funding. We must have a clear line of sight to funding and where that funding is coming from before we put a program in backlog. Programs put into backlog typically start to generate revenue relatively shortly after inclusion, so a cancellation out of backlog has a nearer-term impact on revenue depending on how the program winds down. There were also cancellations that happened for programs that were awarded but not yet in backlog. There's a funnel of opportunities that will convert into backlog and we'll need to fill that funnel. As August mentioned, Q3 could be a bit light as we fill the pipeline.

On top of that, the other policy point is we only put the first three years of a project into backlog and then the balance beyond three years bleeds in over time as quarters progress. Some active backlog cancellations also had a portion that was straddling backlog and pre-backlog, which will impact future quarters like Q3 and beyond.

Okay, that's helpful and understood. So there were cancellations that were in backlog and some that were not in backlog in the current period, and that affects what goes into backlog for 3Q. And then in terms of hiring, with your productivity measures this year, is there a rule of thumb for thinking about hiring on the go-forward based on a level of revenue growth? For example, for every 10% revenue growth, is there a percent growth in FTEs we should consider?

Justin, it can be volatile and depends on where we are with utilization and near-term revenue. We estimate staffing needs on an ongoing basis, considering buffer capacity and utilization levels. Retention and low turnover have reduced the need for gross hiring recently, but how hiring progresses relative to revenue in 2025 will be dictated by how the pipeline shapes up and how awards and revenue growth evolve.

We have a follow-up question from the line of Eric Coldwell with Baird.

Last quarter you mentioned still expecting a 1.2 book-to-bill but you also discussed higher cancels in Q1. Some of these cancels impacted Q2. I'm curious if you can tell us the impact of year-to-date heightened cancellations on Q2's revenue. Was that more than, say, $1 million or $2 million at most? Is that fair?

While cancellations were somewhat elevated in Q1, Eric, it wasn't significant enough that it had a major impact on Q2. The Q2 cancellations were primarily in June, and the elevation we saw was concentrated there.

What I'm trying to understand is if the abnormal cancels in Q2—let's posit something like $100 million to $110 million of incremental abnormal cancels—you would have had $655 million of net awards at a 1.24 book-to-bill, but you did $551 million. So if $50 million of that is direct fee cancellations, given your three-year backlog, dividing by 12 gets you about $4 million per quarter of direct fee impact and maybe closer to $5 million on the indirect fee side, so about $9 million per quarter or about $17 million to $18 million for the year. You cut guidance by $25 million. I'm trying to see if that's directionally the rationale for the roughly 1% revenue reduction in guidance, or are these cancellations skewed more to the next 12 months and thus would have a larger near-term impact? In other words, did you build in extra cushion with the $25 million, or am I thinking about this wrong?

There are a lot of moving pieces. The lowering of the revenue range is driven by two things: the lower pass-through activity that we saw earlier in the year, particularly in Q1, and the headwinds from the cancellations. Quantifying precisely is challenging, but both items contributed to the narrowed guidance range.

Your math sounds reasonable. It's not exactly how we modeled it for guidance, which is based on what it looks like we lost and how programs tail off, but your calculations are directionally consistent with the idea that we would have had upside absent the cancellations. Remember cancellations don't always cause immediate revenue cessation; sometimes effects are seen over subsequent quarters. So yes, it is a sizable headwind to revenue overall.

We have a follow-up question from the line of Dave Windley with Jefferies.

Following up on Eric's line of questioning on pass-through. Kevin, in the first quarter pass-throughs were low, and you expected they would rebound and run around 38% similar to last year. It sounds like you're saying today that the pass-through percent is trending such that it finished at 38.4% in Q2. Do you have a view whether that will stabilize around that level or trend back toward long-term historical levels like 33% to 34%?

Dave, nothing has changed in our ability to predict where it will go, but modeling suggests it will be at or slightly above these Q2 levels for the balance of the year. We finished Q2 at approximately 38.4% of revenue. In the long term, it may trend back toward historical levels, but I'll provide more color on 2025 in the third quarter.

Okay. Last question for me: the balance sheet is at about $0.5 billion in cash. Can you talk about intent for use of that balance sheet?

More of the same: continue to invest in organic growth of the business, which is our first priority. We do have elevated capital expenditures planned as we expand the campus. Beyond that, we'll continue to look for opportunistic share repurchases and execute at levels where we see value. If we don't repurchase, we're comfortable building cash balances.

Ladies and gentlemen, I'm showing no further questions in the queue. I would now like to turn the call back to Lauren for 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 Third Quarter 2024 Earnings Call.

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