Medpace Holdings, Inc. annual report, FY2017

Business context and reporting period

Medpace Holdings, Inc. filed this Form 10-K for the fiscal year ended December 31, 2017. It is a global, full-service clinical research organization serving pharmaceutical, biotechnology, and medical-device companies; it reports one operating segment. The filing also provides unaudited fourth-quarter results.

Financial performance and position

• Net service revenue increased 4.3%; total revenue increased 3.5%. Reimbursed out-of-pocket revenue was $49.7 million, down 2.5%, and is offset by equal reimbursed expenses.
• Operating margin on total revenue was approximately 14.9%, versus 12.4% in 2016; net margin was approximately 9.0%, versus 3.2%. Lower amortization and interest expense contributed materially to the year-over-year earnings improvement.
• Fourth-quarter 2017 net service revenue was $99.4 million, operating income $15.4 million, net income $11.3 million, and diluted EPS $0.30. Fourth-quarter 2016 net income was a loss of $0.02 million.
• Cash and cash equivalents were $26.5 million at year-end, versus $37.1 million. Working capital was negative $62.7 million. The company reported $80.0 million of undrawn revolving-credit capacity.
• Debt totaled approximately $222.6 million: $152.6 million under the term loan and $70.0 million under the revolver. The facilities mature in December 2021, bear variable rates, and the company reported compliance with covenants at year-end.
• Operating cash flow less property and equipment expenditures was approximately $85.7 million. Investing cash outflow was $12.2 million; financing cash outflow was $97.8 million, primarily reflecting $155.6 million of share repurchases, partly offset by revolver borrowings.
• Backlog rose 8.4% to $524.4 million. Net new business awards were $426.1 million, approximately unchanged from 2016. Management expected $285–$295 million of backlog to convert to net service revenue in 2018.

Material changes versus prior period

• Net income rose to $39.1 million from $13.4 million; pretax income increased to $56.9 million from $22.0 million. Interest expense fell to $7.6 million from $19.4 million, and amortization fell to $37.9 million from $50.7 million.
• Direct costs excluding depreciation and amortization increased 6.7%, faster than net service revenue growth of 4.3%; management attributed the increase chiefly to personnel and laboratory costs supporting project activity.
• Debt increased from $163.6 million at year-end 2016 to $222.6 million, while cash declined. The company used revolving borrowings and cash to fund repurchases.
• The company repurchased approximately 5.3 million shares during 2017, including 4.0 million from Cinven and approximately 1.34 million under a repurchase program. Year-end shares outstanding fell to 35.5 million from 40.7 million.

Outlook, commentary, risks, and unusual items

• No formal revenue or earnings guidance is provided. Management expects continued organic growth, investment in personnel and capabilities, and may pursue selective bolt-on acquisitions. The 2018 backlog conversion estimate is not a guarantee; contracts are generally terminable without cause on 30 days’ notice.
• Management cited strong activity in Oncology, Metabolic, and other therapeutic areas. Small and mid-sized biopharmaceutical companies generated 89% of 2017 net service revenue, making customer funding and study cancellations important exposures.
• The Tax Cuts and Jobs Act reduced the U.S. federal corporate tax rate. The 2017 effective tax rate was 31.3%, compared with 38.9% in 2016; the filing records provisional tax-reform effects and says assessment remained incomplete. Management expected the law to lower the effective rate relative to prior years.
• A May 2017 bankruptcy-related asset acquisition of NephroGenex generated tax attributes and a deferred credit; realization depends on using the related tax assets. Goodwill and intangible assets were $661.0 million and $98.7 million, together 79.9% of total assets; no 2017 impairment was identified.
• Key risks include customer cancellations or delayed projects, backlog conversion, fixed-fee cost overruns and change-order timing, recruitment and retention of staff and trial participants, regulatory and data-privacy compliance, cybersecurity, foreign exchange, and variable-rate debt. The company also disclosed significant related-party relationships, including leases and service arrangements.
• Management concluded internal control over financial reporting and disclosure controls were effective as of year-end. The auditor issued an unqualified opinion on the financial statements but did not attest to internal-control effectiveness.

Important facts for investors to verify

• Whether backlog converts on schedule and whether new awards, cancellations, and customer funding support the expected 2018 revenue.
• How much earnings growth reflects recurring operations versus lower amortization and interest expense, and whether direct-cost growth affects margins.
• Liquidity and debt-service capacity after substantial repurchases: year-end cash, remaining revolver availability, variable-rate exposure, and covenant headroom.
• Final tax-reform accounting, including NephroGenex tax-attribute utilization, deferred-credit recognition, and the impact of the new revenue-recognition standard adopted in 2018.
• Potential dilution from equity awards, the effect of controlling shareholders and their share pledges, and the terms and governance of related-party transactions.