Medpace Holdings, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K to provide an understanding of our results of operations, financial condition and cash flows. This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. For a comparison of our results of operations for the fiscal years ended December 31, 2019 and December 31, 2018, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 25, 2020. This item and the related discussion contain forward-looking statements reflecting current expectations that involve risks and uncertainties. Actual results and the timing of events may differ materially from those indicated in such forward-looking statements. Important factors that may cause such differences include, but are not limited to, those discussed under the “Forward-Looking Statements” above and “Item IA. Risk Factors” in Part I of this Annual Report on Form 10-K. Business Overview We are one of the world’s leading clinical contract research organizations, or CROs, by revenue, solely focused on providing scientifically-driven outsourced clinical development services to the biotechnology, pharmaceutical and medical device industries. Our mission is to accelerate the global development of safe and effective medical therapeutics. We differentiate ourselves from our competitors by our disciplined operating model centered on providing full-service Phase I-IV clinical development services and our therapeutic expertise. We believe this combination results in timely and cost-effective delivery of clinical development services for our customers. We believe that we are a partner of choice for small- and mid-sized biopharmaceutical companies based on our ability to consistently utilize our full-service, disciplined operating model to deliver timely and high-quality results for our customers. We focus on conducting clinical trials across all major therapeutic areas, with particular strength in Oncology, Metabolic Disease, Cardiology, Antiviral and Anti-infective, or AVAI, and Central Nervous System, or CNS. Our global platform includes approximately 3,600 employees across 39 countries, providing our customers with broad access to diverse markets and patient populations as well as local regulatory expertise and market knowledge. How We Generate Revenue We earn fees through the performance of services detailed in our customer contracts. Contract scope and pricing is typically based on either a fixed-fee or unit-of-service model, with consideration of activities performed by third parties, as well as ancillary costs necessary to deliver on the contract scope that are reimbursable by our customers. Our contracts can range in duration from a few months to several years. These contracts are individually priced and negotiated based on the anticipated project scope, including the complexity of the project and the performance risks inherent in the project. The majority of our contracts are structured with an upfront fee that is collected at the time of contract signing, and the balance of the fee is collected over the duration of the contract either through an arranged billing schedule or upon completion of certain performance targets or defined milestones. Revenue, which is distinct from billing and cash receipt, is recognized based on the satisfaction of the individual performance obligations identified in each contract. Substantially all of our customer contracts consist of a single performance obligation, as the promise to transfer the individual services defined in the contracts are not separately identifiable from other promises in the contract, and therefore not distinct. Our performance obligations are generally satisfied over time and recognized as services are performed. The progression of our contract performance obligations are measured primarily utilizing the input method of cost to cost. Cancellation provisions in our contracts allow our customers to terminate a contract either immediately or according to advance notice terms specified within the applicable contract, which is typically 30 days. Contract cancellation may occur for various reasons, including, but not limited to, adverse patient reactions, lack of efficacy, or inadequate patient enrollment. Upon cancellation, we are entitled to fees for services rendered and reimbursable costs incurred through the date of termination, including payment for subsequent services necessary to conclude the study or close out the contract. These fees are typically discussed and agreed upon with the customer and are realized as revenue when we believe the amount can be estimated reliably and its realization is probable. Changes in revenue from period to period are - 36 - driven primarily by new business volume and task order execution activity, project cancellations, changes in estimated costs to complete performance obligations, and the mix of active studies during a given period that can vary based on therapeutic area and or study life cycle stage. Costs and Expenses Our costs and expenses are comprised primarily of our total direct costs, selling, general and administrative costs, depreciation and amortization and income taxes. Total Direct Costs Total direct costs are primarily driven by labor and related employee benefits, but also include contracted third party service related expenses, fees paid to site investigators, reimbursed out of pocket expenses, laboratory supplies and other expenses contributing to service delivery. The other costs of service delivery can include office rent, utilities, supplies and software licenses which are allocated between Total direct costs and selling, general and administrative expenses based on the estimated contribution among service delivery and support function efforts on a percentage basis. Total direct costs are expensed as incurred and are not deferred in anticipation of contracts being awarded or finalization of changes in scope. Total direct costs, as a percentage of net revenue, can vary from period to period due to project labor efficiencies, changes in workforce, compensation/bonus programs and service mix. Selling, General and Administrative Selling, general and administrative expenses are primarily driven by compensation and related employee benefits, as well as rent, utilities, supplies, software licenses, professional fees (e.g., legal and accounting expenses), travel, marketing and other operating expenses. Depreciation Depreciation is provided on our property and equipment on the straight-line method at rates adequate to allocate the cost of the applicable assets over their estimated useful lives, which is three to five years for computer hardware, software, phone, and medical imaging equipment, five to seven years for furniture and fixtures and other equipment, and thirty to forty years for buildings. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful life of the improvement or the associated remaining lease term. Amortization Amortization relates to finite-lived intangible assets recognized as expense using the straight-line method or using an accelerated method over their estimated useful lives, which range in term from 5 to 15 years. Income Tax Provision Income tax provision consists of federal, state and local taxes on income in multiple jurisdictions. Our income tax is impacted by the pre-tax earnings in jurisdictions with varying tax rates and any related tax credits that may be available to us. Our current and future provision for income taxes will vary from statutory rates due to the impact of valuation allowances in certain countries, income tax incentives, certain non-deductible expenses, and other discrete items. Key Performance Metrics To evaluate the performance of our business, we utilize a variety of financial and performance metrics. These key measures include net new business awards and backlog. Net New Business Awards and Backlog New business awards represent the value of anticipated future net revenue that has been recognized in backlog during the period. This value is recognized upon the signing of a contract or receipt of a written pre-contract - 37 - confirmation from a customer that confirms an agreement in principle on budget and scope. New business awards also include contract amendments, or changes in scope, where the customer has provided written authorization for changes in budget and scope or has approved us to perform additional work as of the measurement date. Awards may not be recognized as backlog after consideration of a number of factors, including whether (i) the relevant net revenue is expected only after a pending regulatory hurdle, which might result in cancellation of the study, (ii) the customer funding needed for commencement of the study is not believed to have been secured or (iii) study timelines are uncertain or not well defined. In addition, st udy a mounts that extend beyond three years from measurement date are not included in backlog. The number and amount of new business awards can vary significantly from period to period, and an award’s contractual duration can range from several months to several years based on customer and project specifications. Cancellations arise in the normal course of business and are reflected when we receive written confirmation from the customer to cease work on a contractual agreement or when we believe the future revenue is unlikely to be realized. The majority of our customers can terminate our contracts without cause upon 30 days’ notice. Similar to new business awards, the number and amount of cancellations can vary significantly period over period due to timing of customer correspondence and study-specific circumstances. Net new business awards represent gross new business awards received in a period offset by total cancellations in that period. Net new business awards were $1,175.0 million, $1,094.4 million and $899.4 million for the years ended December 31, 2020, 2019 and 2018, respectively. Backlog represents anticipated future net revenue from net new business awards that have commenced, but have not been completed. Reported backlog will fluctuate based on new business awards, changes in scope to existing contracts, cancellations, net revenue recognition on existing contracts and foreign exchange adjustments from non-U.S. dollar denominated backlog. As of December 31, 2020, our backlog increased by $258.5 million, or 20.1%, to $1,541.7 million compared to $1,283.2 million as of December 31, 2019. Included within backlog as of December 31, 2020 was approximately $785 million to $805 million that we expect to convert to net revenue in 2021, with the remainder expected to convert to net revenue in years after 2021 . The effect of foreign currency adjustments on backlog was as follows: favorable foreign currency adjustments of $14.3 million for the year ended December 31, 2020, unfavorable foreign currency adjustments of $6.6 million for the year ended December 31, 2019 and unfavorable foreign currency adjustments of $2.3 million for the year ended December 31, 2018. Backlog and net new business award metrics may not be reliable indicators of our future period revenue as they are subject to a variety of factors that may cause material fluctuations from period to period. These factors include, but are not limited to, changes in the scope of projects, cancellations, and duration and timing of services provided. Coronavirus (COVID-19) On March 11, 2020, the World Health Organization declared the coronavirus COVID-19 outbreak to be a pandemic. This pandemic has resulted in increased travel restrictions and caused the shutdown of many businesses in countries in which we operate. While we continue to operate globally, the level of activity at each of our locations varies depending on the local governmental requirements and guidelines. Our office staff are effectively working in the office or remotely and our labs are fully operational with modifications made to ensure the safety of our employees. The diversion of resources to treat COVID-19 patients has significantly impacted the operations at most of the investigative sites where patients in our clinical trials are recruited and treated. This has resulted in reduced trial starts and slowed new business awards, each of which results in decreased revenues. Depending on the duration of the disruption, ongoing studies may be cancelled and some of our clients may lack the funding to complete trials which are extended due to slowed recruitment of patients. We work with many smaller clients with limited financial resources and market disruptions may make raising additional funds difficult for those clients. Travel restrictions and business closures have also impacted study participants and clinical sites which affects our ability to efficiently provide clinical trial services. As a result, we are working with our customers to develop solutions to limit disruption to clinical trials while following required regulatory guidelines and maintaining quality to ensure the health and well-being of study participants. These include alternative assessment methods such as virtual monitoring visits. The COVID-19 outbreak had a significant adverse effect on fiscal year 2020 and we believe that the outbreak may have - 38 - a continued adverse impact on our results of operations in the future. In connection with this adverse impact in 2020, we evaluated our headcount needs in a number of geographies and implemented some staff reductions where appropriate. As we cannot predict the duration or scope of the pandemic, the future financial impact on our results of operations and financial condition cannot be reasonably estimated. Exchange Rate Fluctuations The majority of our contracts and operational transactions are U.S. dollar denominated. The Euro represents the largest foreign currency denomination of our contractual and operational exposure. As a result, a portion of our revenue and expenses is subject to exchange rate fluctuations. We have translated the Euro into U.S. dollars using the following average exchange rates based on data obtained from www.xe.com : Year Ended December 31, 2020 2019 2018 U.S. Dollars per Euro: 1.14 1.12 1.18 Results of Operations Year Ended December 31, 2020 compared to Year Ended December 31, 2019 Year Ended December 31, (Amounts in thousands, except percentages) 2020 2019 Change % Change Revenue, net $ 925,925 $ 860,969 $ 64,956 7.5 % Direct service costs, excluding depreciation and amortization 354,426 321,006 33,420 10.4 % Reimbursed out-of-pocket expenses 292,773 294,266 (1,493 ) (0.5 )% Total direct costs 647,199 615,272 31,927 5.2 % Selling, general and administrative 92,156 95,245 (3,089 ) (3.2 )% Depreciation 11,652 8,360 3,292 39.4 % Amortization 7,876 14,829 (6,953 ) (46.9 )% Total operating expenses 758,883 733,706 25,177 3.4 % Income from operations 167,042 127,263 39,779 Miscellaneous income (expense), net 1,183 (863 ) 2,046 Interest income (expense), net 307 (1,568 ) 1,875 Income before income taxes 168,532 124,832 43,700 Income tax provision 23,148 24,389 (1,241 ) Net income $ 145,384 $ 100,443 $ 44,941 Total revenue Total revenue increased by $65.0 million to $925.9 million for the year ended December 31, 2020, from $861.0 million for the year ended December 31, 2019. The increase was primarily driven by strong activity within the Oncology , AVAI and other uncategorized therapeutic areas. Total direct costs Total direct costs increased by $31.9 million, to $647.2 million for the year ended December 31, 2020 from $615.3 million for the year ended December 31, 2019. The increase was primarily attributed to personnel costs to support the growth in service activities. The higher personnel costs portion, including severance, increased by $30.7 million in the year ended December 31, 2020, compared to the same period in the prior year. - 39 - Selling, general and administrative Selling, general and administrative expenses decreased by $3.1 million, to $92.2 million for the year ended December 31, 2020 from $95.2 million for the year ended December 31, 2019. The decrease was primarily driven by lower travel related costs of $2.5 million in the year ended December 31, 2020, compared to the same period in the prior year, due to travel restrictions related to COVID-19. Depreciation and Amortization Depreciation and amortization expense decreased by $3.7 million, to $19.5 million for the year ended December 31, 2020 from $23.2 million for the year ended December 31, 2019. The decrease in depreciation and amortization was primarily related to the amortization of our definite lived intangible assets, which are amortized on an accelerated basis. Miscellaneous income (expense), net Miscellaneous income (expense), net increased by $2.0 million to $1.2 million of income for the year ended December 31, 2020 from $0.9 million of expense for the year ended December 31, 2019. These changes were mainly attributable to foreign exchange gains or losses that arise in connection with the revaluation of short-term inter-company balances between our domestic and international subsidiaries, gains or losses from foreign currency transactions, such as those resulting from the settlement of third-party accounts receivables and payables denominated in a currency other than the local currency of the entity making the payment. Interest income (expense), net Interest income (expense), net increased by $1.9 million to $0.3 million of income for the year ended December 31, 2020 from $1.6 million of expense for the year ended December 31, 2019. The increase in interest income (expense), net was related to a lower average outstanding balance in the year ended December 31, 2020 under our credit facility. Income tax provision Income tax provision decreased by $1.2 million, to $23.1 million for the year ended December 31, 2020 from $24.4 million for the year ended December 31, 2019. The overall effective tax rates for the years ended December 31, 2020 and 2019 were 13.7% and 19.5%, respectively. The decrease in the income tax provision and overall effective rate was primarily attributable to an increase in excess tax benefits recognized from share-based compensation and an increase in tax benefits due to foreign tax credits and the benefit of uncertain tax positions. Year ended December 31, 2019 compared to Year ended December 31, 2018 See “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2019. Liquidity and Capital Resources We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Our principal sources of liquidity are operating cash flows and funds available for borrowing under our unsecured credit facility (the “Credit Facility”) . As of December 31, 2020, we had cash and cash equivalents of $277.8 million. Approximately $28.7 million of our cash and cash equivalents, none of which was restricted, was held by our foreign subsidiaries as of December 31, 2020. On September 30, 2019, the Company entered into the Credit Facility consisting of up to a $50.0 million revolving line of credit (the “Line of Credit”). The Credit Facility replaced a Senior Secured Term Loan Facility of $165.0 million (the “Prior Senior Secured Term Loan Facility”) and a Senior Secured Revolving Credit Facility of $150.0 million (the “Prior Senior Secured Revolving Credit Facility” and, together with the Prior Senior Secured Term Loan Facility, the “Prior Senior Secured Credit Facilities” ) which were set to expire in December 2021. In relation - 40 - to the termination of the Prior Senior Secured Cre dit Facilities, we repaid all outstanding obligations. As a result, no amounts remain outstanding under the Prior Senior Secured Credit Facilities. As of December 31, 2020, we had $49.8 million available for borrowing under the Credit Facility. Our expected primary cash needs on both a short and long-term basis are for investment in operational growth, capital expenditures, share repurchases, selective strategic bolt-on acquisitions, other investments, and other general corporate needs. We have historically funded our operations and growth with cash flow from operations and borrowings under our credit facilities. We expect to continue expanding our operations through organic growth and potentially highly selective bolt-on acquisitions and investments. We expect these activities will be funded from existing cash, cash flow from operations and, if necessary, borrowings under our existing or future credit facilities or other debt. We have deemed that foreign earnings will be indefinitely reinvested and therefore we have not provided taxes on these earnings. While we do not anticipate the need to repatriate these foreign earnings for liquidity purposes given our cash flows from operations and available borrowings under existing and future credit facilities, we would incur taxes on these earnings if the need for repatriation due to liquidity purposes arises. We believe that our sources of liquidity and capital will be sufficient to finance our cash needs for the next 12 months and on a longer-term basis. However, we cannot assure you that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us under our Credit Facility or otherwise, in an amount sufficient to fund our liquidity needs. Year Ended December 31, Cash Flows (Amounts in thousands) 2020 2019 2018 Net cash provided by operating activities $ 258,676 $ 201,867 $ 156,584 Net cash used in investing activities (31,214 ) (19,144 ) (16,973 ) Net cash used in financing activities (82,282 ) (73,918 ) (141,580 ) Effect of exchange rates on cash, cash equivalents, and restricted cash 666 (167 ) (1,241 ) Increase (decrease) in cash, cash equivalents, and restricted cash $ 145,846 $ 108,638 $ (3,210 ) Cash Flows from Operating Activities Cash flows from operations are driven mainly by net income, stock based compensation expense, amortization of intangibles and net movement in advanced billings, accrued expenses, prepaid and other current assets, and accounts receivable and unbilled, net. Accounts receivable and unbilled, net, and advanced billings fluctuate on a regular basis as we perform our services, bill our customers and ultimately collect on those receivables. We attempt to negotiate payment terms in order to provide for payments prior to or soon after the provision of services, but this timing of collection can vary significantly on a period by period comparative basis. Net cash flows provided by operating activities were $258.7 million for the year ended December 31, 2020 consisting of net income of $145.4 million. Adjustments to reconcile net income to net cash provided by operating activities were $47.0 million, primarily related to noncash lease expense of $13.9 million, stock based compensation expense of $13.8 million, depreciation of $11.7 million, amortization of intangibles of $7.9 million, and deferred income tax provision of $0.5 million. Changes in operating assets and liabilities provided $66.3 million in operating cash flows and were primarily driven by increased advanced billings of $63.4 million and increased accrued expenses of $24.2 million, offset by decreased lease liabilities of $11.5 million and increased accounts receivable and unbilled, net of $5.5 million. Net cash flows provided by operating activities were $201.9 million for the year ended December 31, 2019 consisting of net income of $100.4 million. Adjustments to reconcile net income to net cash provided by operating activities were $65.9 million, primarily related to stock based compensation expense of $20.7 million, amortization of intangibles of $14.8 million, deferred income tax provision of $10.1 million, noncash lease expense of $9.9 million, and depreciation of $8.4 million. Changes in operating assets and liabilities provided $35.6 million in operating cash flows and were primarily driven by increased advanced billings of $44.6 million and increased accrued expenses of $21.8 million, offset by increased accounts receivable and unbilled, net of $21.3 million . - 41 - Net cash flows provided by operating activities were $156.6 million for the year ended December 31, 2018 c onsisting of net income of $73.2 million. Adjustments to reconcile net income to net cash provided by operating activities were $43.8 million, primarily related to amortization of intangibles of $29.6 million, depreciation of $9.2 million, stock based compensation expense of $6.5 million, and deferred income tax provision of $3.9 million, offset by $7.7 million of amortization and adjustment of deferred credit. Changes in operating assets and liabilities provided $39.6 million in operating cash flows and were primarily driven by increased advanced billings of $35.6 million and increased accrued expenses of $29.0 million, offset by increased accounts receivable and unbilled, net of $27.0 million . Cash Flow from Investing Activities Net cash used in investing activities was $31.2 million for the year ended December 31, 2020 primarily consisting of property and equipment expenditures. Net cash used in investing activities was $19.1 million for the year ended December 31, 2019 primarily consisting of property and equipment expenditures. Net cash used in investing activities was $17.0 million for the year ended December 31, 2018 primarily consisting of property and equipment expenditures. Cash Flow from Financing Activities Net cash used in financing activities was $82.3 million in the year ended December 31, 2020, primarily related to $98.3 million in repurchases of common stock, offset by proceeds from stock options exercises of $16.0 million. Net cash used in financing activities was $73.9 million in the year ended December 31, 2019, primarily related to $80.4 million in principal payments on our Prior Senior Secured Term Loan Facility, offset by proceeds from stock options exercises of $6.5 million. Net cash used in financing activities was $141.6 million in the year ended December 31, 2018, primarily related to $72.2 million in principal payments on our Prior Senior Secured Term Loan Facility and $70.0 million in principal payments on our Prior Senior Secured Revolving Credit Facility . Share Repurchases In the first quarter of 2018, the Board of Directors approved a share repurchase program authorizing up to $50.0 million in share repurchases. In the first quarter of 2020, the Board of Directors approved an increase in the stock repurchase authorization by $50.0 million. In the fourth quarter of 2020, the Board approved the stock repurchase authorization up to $150.0 million. For the year ended December 31, 2020, the Company repurchased 1,183,095 shares for $98.3 million. As of December 31, 2020, we have remaining authorization of $102.6 million remaining under the repurchases program. Repurchases under the share repurchase program are executed in the open market or negotiated transactions under trading plans established pursuant to Rule 10b5-1. The Company constructively retired the repurchased shares associated with these approved share repurchase programs, with all amounts paid in excess of par value reflected within Retained earnings in the Company’s consolidated balance sheets. The repurchase program may be suspended or discontinued at any time without notice. - 42 - Indebtedness On September 30, 2019 (the “Closing Date”), Medpace Inc., as borrower (the “Borrower”), and Medpace IntermediateCo, Inc., a wholly-owned subsidiary of the Company, as guarantor (the “Guarantor”), entered into the new loan agreement (the “Loan Agreement”), which provides for an unsecured credit facility (the “Credit Facility”) in an aggregate principal amount up to $50.0 million . The Credit Facility provides that outstanding balances will bear interest at a rate of LIBOR plus 100 basis points (1.00%). The Loan Agreement also provides that the Credit Facility will expire in 364 days from the Closing Date. On March 30, 2020, the Company amended the credit facility to extend its expiration date to March 31, 2021 and add provisions for alternative interest rates when certain interbank market offered rates are not available. The Credit Facility is guaranteed by the Guarantor and its material, direct or indirect wholly owned domestic subsidiaries, with certain exceptions, including where providing such guarantees is not permitted by law, regulation or contract or would result in adverse tax consequences. All of the obligations under the Credit Facility are unsecured. The Credit Facility is subject to customary negative covenants. The Company was in compliance with all financial covenants as of December 31, 2020. The Credit Facility contains certain events of default, including, among others, non-payment of principal or interest, breach of the covenants, cross default and cross acceleration to certain other indebtedness, defaults on monetary judgment orders, certain ERISA events, certain bankruptcy and insolvency events, actual or asserted invalidity of any guarantee or security document and change in control. As of December 31, 2020, we had no indebtedness under the Credit Facility. As of December 31, 2020, we had $0.2 million in letters of credit outstanding related to certain operating lease obligations, which are secured by the Credit Facility. Contractual Obligations and Commercial Commitments We have various contractual obligations, which are recorded as liabilities in our consolidated financial statements. Other items are not recognized as liabilities in our consolidated financial statements but are required to be disclosed. The following table summarizes our future payments for all contractual obligations and commercial commitments for the years subsequent to the year ended December 31, 2020: Payments Due by Period Contractual Obligations (In thousands) Total Less than 1 year 1-3 years 3-5 years More than 5 years Operating lease obligations 196,471 22,415 35,509 26,884 111,663 Total $ 196,471 $ 22,415 $ 35,509 $ 26,884 $ 111,663 We have recorded a tax liability for unrecognized benefits for uncertain tax positions of $8.6 million, which has not been included in the above table due to the uncertainties in the timing of settlement of the income tax positions. We are a party to certain vendor contracts related to clinical services that if cancelled may require payments for services performed and potentially additional services required to protect the safety of subjects. The value of these potential wind-down provisions is generally borne by our customers and is not practical to estimate. - 43 - Off-Balance Sheet Arrangements Off-balance sheet arrangements refer to any transaction, agreement or other contractual arrangement to which an entity not consolidated under our entity structure exists, where we have an obligation arising under a guarantee contract, derivative instrument or variable interest or a retained or contingent interest in assets transferred to such an entity or similar arrangement that serves as credit, liquidity or market risk support for such assets. We have no off-balance sheet arrangements. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, or US GAAP, requires us to make a variety of decisions which affect reported amounts and related disclosures, including the selection of appropriate accounting principles and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgment based on our understanding and analysis of the relevant circumstances, including our historical experience and other assumptions. Actual results could differ from our estimates. We are committed to incorporating accounting principles, assumptions and estimates that promote the representational faithfulness, verifiability, neutrality and transparency of the accounting information included in the financial statements. Revenue Recognition We generally enter into contracts with customers to provide services ranging in duration from a few months to several years. The contract terms generally provide for payments based on a fixed-fee or unit-of-service arrangement. We account for revenue in accordance with ASC 606, Revenue from Contracts with Customers, which we adopted on January 1, 2018. Revenue on contracts is recognized, when or as we satisfy the contract performance obligations by transferring control of the services provided to the customer, at the amount that reflects the consideration to which we expect to be entitled in exchange for transferring those services. Our performance obligations are generally satisfied over time and recognized as work progresses. Contract Assumptions Accounting for contracts performed over a period of time involves the use of various assumptions to estimate total contract revenue and costs. We estimate expected costs to complete a contract and recognize contracted revenue over the life of the contract as those costs are incurred while performing our contracted obligations. Cost estimates are based on a detailed project budget and are developed based on many variables, including, but not limited to, the scope of the work, labor productivity, the complexity of the study, the participating geographic locations and the Company’s historical experience. To assist with the estimation of costs expected at completion over the life of a project, regular contract reviews are performed in which performance to date is compared to the most current estimate to complete assumptions. The reviews include an assessment of costs incurred to date compared to expectations based on budget assumptions and other circumstances specific to the project. The total estimated costs necessary to complete is updated and any revisions to the existing cost estimate results in cumulative adjustments to the amount of revenue recognized in the period in which the revisions are identified. Because of the uncertainties inherent in estimating the costs necessary to fulfill contractual obligations, it is possible that estimates may change in the near term, resulting in a material change in revenue reported. Contracts generally provide for pricing modifications upon scope of work changes. We recognize revenue, at an amount to which we expect to be entitled, related to work performed in connection with scope changes when the underlying services are performed and a binding contractual commitment has been established with the customer. If our customers do not agree to pricing changes upon changes in our scope of work, we could be exposed to cost overruns and reduced contract profitability. Costs are not deferred in anticipation of contracts being awarded or amendments being finalized, but are expensed as incurred. - 44 - Most contracts are terminable by the customer, either immediately or according to advance notice terms specified within the contracts. These contracts require payment of fees for services rendered through the date of termination and may require payment for subsequent services necessary to conclude the study or close out the contract. Final settlement amounts are agreed to with the customer based on remaining work to be performed. These amounts are included in revenue when we believe the amount can be estimated reliably an d its realization is probable. In evaluating the probability of recognition, we consider the contractual basis for the settlement amount and the objective evidence available to support the amount. Certain contracts contain volume rebate arrangements with our customers that provide for rebates if certain specified spending thresholds are met. These obligations are considered as a reduction in revenue when it appears probable that the arrangement thresholds will be met. We occasionally enter into incentive fee arrangements with customers that provide for additional compensation if certain defined contractual milestones or performance thresholds are met. These additional fees are included in the estimated transaction price when there is a basis to reasonably estimate the amount of the fee and when achievement of the incentive milestone is deemed probable. These estimates are based on anticipated performance, our best judgment at the time or ultimately, upon achievement of the threshold or milestone. We record revenue net of any tax assessments by governmental authorities that are imposed and concurrent with specific revenue generating transactions. Performance Obligations Substantially all of our contracts consist of a single performance obligation, as the promise to transfer the individual services described in the contracts are not separately identifiable from other promises in the contracts, and therefore not distinct. Revenue recognition is determined by assessing the progress of performance completed or delivered to date compared to total services to be delivered under the terms of the arrangement. The measures utilized to assess progress on the satisfaction of performance are specific to the performance obligation identified in the contract. For the majority of our contract performance obligations, we utilize the input method of cost to cost to measure progress. Under this method, the Company determines cost incurred to date for the services it provides compared to the total estimated costs at completion. For certain other contractual performance obligations, the Company has determined that an output method is the best measure of progress. These relate to certain unitized contracts, and the Company recognizes revenue in the period in which the unit is delivered compared to total contracted units. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in the forecasting of taxable income using historical and projected future operating results in determining our provision for income taxes and the related assets and liabilities. The provision for income taxes includes income taxes paid, currently payable and receivable, and deferred taxes. We record deferred tax assets and liabilities based on temporary differences between the financial statement bases and tax bases of assets and liabilities. Deferred tax assets are recorded for tax benefit carryforwards using tax rates anticipated to be in effect in the year in which temporary differences are expected to reverse. If it does not appear more likely than not that the full value of a deferred tax asset will be realized, the Company records a valuation allowance against the deferred tax asset, with an offsetting charge to the Company’s income tax provision or benefit. The recoverability of our deferred tax assets is estimated based on consideration of all available positive and negative evidence, including, but not limited to, our ability to generate a sufficient level of future taxable income, reversals of deferred tax liabilities (other than those with an indefinite reversal period), tax planning strategies and recent financial performance. The assessment of recoverability is performed on a jurisdiction by jurisdiction basis. Based on the analysis of the above factors, we determined that as of December 31, 2020 and 2019 a valuation - 45 - allowance in the amount of $ 0.6 million and $ 0.8 million, respectively, was required relating to certain foreign operating loss carryforwards, and other deferred tax assets that are currently not expected to be realized . Differences in actual results compared to our estimates and changes in our assumptions could result in an adjustment to the valuation allowance in the future and would generally impact earnings or other comprehensive income depending on the nature of the respective deferred asset for which the valuation allowance exists. We have recognized certain liabilities, including penalties and interest in the amount of $2.1 million as of December 31, 2020, within other long-term liabilities on the consolidated balance sheets. These relate to uncertain tax positions that are subject to various assumptions and judgment. Liabilities for these uncertain tax positions are assessed on a position by position basis. The calculation of these liabilities involves dealing with uncertainties in the application of complex tax regulations in both domestic and foreign jurisdictions. These positions may be subject to audit and review by tax authorities, and may result in future taxes, interest and penalties if we are unsuccessful in defending our positions. If the calculation of liability related to uncertain tax positions proves to be more or less than the ultimate assessment, a tax expense or benefit to expense, respectively would result. As of December 31, 2020 and 2019, as a result of an updated analysis of future cash needs in the United States and opportunities for investment outside the United States, we assert that all foreign earnings will be indefinitely reinvested and therefore we have not provided taxes on these earnings. These undistributed earnings of foreign subsidiaries will support future growth in foreign markets and maintain current operating needs of foreign locations. We will continue to monitor our assertion related to investment of foreign earnings. See Note 11 of the Notes to Consolidated Financial Statements for further information regarding this assertion. Stock Based Compensation We have stock based compensation plans in which we issue stock based awards to employees and directors in the form of vested common shares, stock options, stock appreciation rights (SARs), restricted stock awards (RSAs), restricted stock units (RSUs), or other cash based or stock dividend equivalent awards. All of our currently outstanding awards are subject to equity classification pursuant to the terms of the award grants and based on accounting guidance which governs such transactions. Accounting guidance applicable to equity classified awards require all stock based compensation, including vested shares, grants of employee stock options and restricted stock to be recognized in the consolidated statements of operations based on their grant date fair values. We estimate the fair value of our stock options utilizing the Black-Scholes-Merton option pricing model, which requires the input of highly subjective assumptions including: the expected stock price volatility, the calculation of the expected holding period of the award, the risk free interest rate and expected dividends on the underlying common stock. Due to the lack of Company specific historical and implied volatility data, we have based our estimate of expected volatility on the historical volatility of a group of peer companies that are most representative of our company. The historical volatility is calculated based on a period of time commensurate with the expected holding period assumption. The holding period represents the period that our option awards are expected to be outstanding. We use the simplified method as prescribed by accounting guidance governing such awards, to calculate the expected term for options granted to employees as we do not have sufficient historical evidence data to provide a reasonable basis upon which to estimate the expected holding period. This simplified method utilizes the mid-point between the vesting date and the date of the contractual term. The risk free rate is based on extrapolated rates of U.S. Treasury bonds whose terms are consistent with the expected holding period of the stock options. We have assumed a dividend yield of zero as we have not historically paid any dividends on our common stock. All our stock based option awards are subject to service based vesting conditions. Compensation expense related to stock option awards to employees is recognized on a straight line basis based on the grant date fair value over the associated service period of the award, which is equal to the vesting term. - 46 - The following table summarizes the key weighted average assumptions used in the Black-Scholes-Merton option pricing model to calculate the fair value of options during the periods: Year Ended December 31, 2020 2019 2018 Expected holding period - years 3.1 2.6 5.4 Expected volatility 31.0% 26.3% 27.0% Risk-free interest rate 1.0% 2.0% 2.8% Expected dividend yield 0.0% 0.0% 0.0% The assumptions used in the table above reflect both grant date inputs to arrive at the grant date fair values for stock options subject to equity-classified stock compensation accounting and reflect a fair value calculation for stock options outstanding in the period subject to liability-classified stock compensation accounting. As of December 31, 2020, all outstanding stock based awards were subject to equity classification. The weighted average grant date fair value of employee stock options granted was $15.19, $14.06 and $11.51 for the years ended December 31, 2020, 2019 and 2018. Effect of Recent Accounting Pronouncements Refer to Note 2 of the Notes to Consolidated Financial Statements for management’s discussion of the effect of recent accounting pronouncements.