Medpace Holdings, Inc. 10-Q

Item 2. 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 condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q, with our audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 and with the information under the heading “Management Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. 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” below and “Risk Factors” in “Item 1A Risk Factors” of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical facts contained herein, are forward looking statements. Forward looking statements include, without limitation, statements regarding our results of operations; financial position and performance; liquidity and our ability to fund our business operations and initiatives; capital expenditure and debt service obligations; business strategies, plans and goals, including those related to marketing, acquisitions and expansion of our business; product approvals and plans; industry trends; general economic conditions, including inflation and other pricing pressures that could decrease our operating margins; expectations regarding consumer behaviors and trends; our culture and operating philosophy; human resource management; arrangements with and delivery of our services to the customers; conversion of backlog; dividend policy; legal proceedings; and our objectives for future operations. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “see,” “will,” “would,” “target,” “likely,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are based largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to inherent uncertainties, risks, changes in circumstances and other important factors that are difficult to predict. Moreover, we operate in a very competitive and rapidly changing environment in which new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all important factors on our business or the extent to which any factor, or combination of such factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed may not occur and our financial condition and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We caution you therefore against relying on these forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise. For a further discussion of the risks relating to our business, see “Item 1A Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 and “Part II – Other Information, Item 1A Risk Factors” herein. 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, Central Nervous System, or CNS, and Antiviral and Anti-infective, or AVAI. Our global platform includes approximately 5,600 employees across 41 countries as of June 30, 2023, providing our customers with broad access to diverse markets and patient populations as well as local regulatory expertise and market knowledge. -18- Table of Contents 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 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 driven primarily by new business volume and task order execution activity, project cancellations, 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), bad debt expense, 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 of 15 years. -19- Table of Contents 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 new business awards, cancellations and backlog. New Business Awards, Cancellations and Backlog New business awards represent the value of anticipated future net revenue that has been awarded during the period that is recognized in backlog. This value is recognized upon the signing of a contract or receipt of a written pre-contract 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, study amounts that extend beyond a three-year timeline 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. 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 $574.8 million and $1,130.6 million for the three and six months ended June 30, 2023, respectively. Net new business awards were $450.6 million and $873.6 million for the three and six months ended June 30, 2022, respectively. Backlog represents anticipated future net revenue from net new business awards that have not commenced or are currently in process but not complete. Reported backlog will fluctuate based on new business awards, changes in the scope of existing contracts, cancellations, revenue recognition on existing contracts and foreign exchange adjustments from non-U.S. dollar denominated backlog. As of June 30, 2023, our backlog increased by $403.6 million, or 18.6%, to $2,571.9 million compared to $2,168.3 million as of June 30, 2022. Included within backlog as of June 30, 2023 was approximately $1,410.0 million to $1,430.0 million that we expect to convert to net revenue over the next twelve months, with the remainder expected to convert to net revenue thereafter. The effect of foreign currency adjustments on backlog was as follows: favorable foreign currency adjustments of $0.9 million for the three months ended June 30, 2023; favorable foreign currency adjustments of $3.9 million for the six months ended June 30, 2023; unfavorable foreign currency adjustments of $17.0 million for the three months ended June 30, 2022; and unfavorable foreign currency adjustments of $15.8 million for the six months ended June 30, 2022. 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. -20- Table of Contents 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 are 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: Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 U.S. Dollars per Euro: 1.09 1.07 1.08 1.09 Results of Operations Three Months Ended June 30, 2023 compared to Three Months Ended June 30, 2022 Three Months Ended June 30, (Amounts in thousands, except percentages) 2023 2022 Change % Change Revenue, net $ 460,868 $ 351,207 $ 109,661 31.2 % Direct service costs, excluding depreciation and amortization 158,526 132,118 26,408 20.0 % Reimbursed out-of-pocket expenses 178,025 120,093 57,932 48.2 % Total direct costs 336,551 252,211 84,340 33.4 % Selling, general and administrative 39,404 33,215 6,189 18.6 % Depreciation 5,970 4,707 1,263 26.8 % Amortization 550 838 (288) (34.4) % Total operating expenses 382,475 290,971 91,504 31.4 % Income from operations 78,393 60,236 18,157 Miscellaneous (expense) income, net (1,283) 2,311 (3,594) Interest expense, net (1,366) (548) (818) Income before income taxes 75,744 61,999 13,745 Income tax provision 14,676 12,639 2,037 Net income $ 61,068 $ 49,360 $ 11,708 -21- Table of Contents Six Months Ended June 30, 2023 compared to Six Months Ended June 30, 2022 Six Months Ended June 30, (Amounts in thousands, except percentages) 2023 2022 Change % Change Revenue, net $ 894,942 $ 682,154 $ 212,788 31.2 % Direct service costs, excluding depreciation and amortization 309,594 257,552 52,042 20.2 % Reimbursed out-of-pocket expenses 330,842 226,929 103,913 45.8 % Total direct costs 640,436 484,481 155,955 32.2 % Selling, general and administrative 77,431 62,581 14,850 23.7 % Depreciation 11,378 8,977 2,401 26.7 % Amortization 1,100 1,676 (576) (34.4) % Total operating expenses 730,345 557,715 172,630 31.0 % Income from operations 164,597 124,439 40,158 Miscellaneous (expense) income, net (596) 3,378 (3,974) Interest expense, net (2,227) (494) (1,733) Income before income taxes 161,774 127,323 34,451 Income tax provision 27,812 16,652 11,160 Net income $ 133,962 $ 110,671 $ 23,291 Total revenue Total revenue increased by $109.7 million to $460.9 million for the three months ended June 30, 2023, from $351.2 million for the three months ended June 30, 2022. Total revenue increased by $212.8 million to $894.9 million for the six months ended June 30, 2023, from $682.2 million for the six months ended June 30, 2022. The increase for the three months ended June 30, 2023 was primarily driven by growth within the Oncology, Metabolic, AVAI, Cardiology and other therapeutic areas, compared to the same period in the prior year. The increase for the six months ended June 30, 2023 was primarily driven by growth within the Oncology, Metabolic, Cardiology and other therapeutic areas, compared to the same period in the prior year. Total direct costs Total direct costs increased by $84.3 million, to $336.6 million for the three months ended June 30, 2023 from $252.2 million for the three months ended June 30, 2022. Total direct costs increased by $156.0 million, to $640.4 million for the six months ended June 30, 2023 from $484.5 million for the six months ended June 30, 2022. The increase was primarily attributed to higher reimbursed out-of-pocket expenses and higher personnel costs to support the growth in service activities. Reimbursed out-of-pocket expenses, which can fluctuate significantly from period to period based on the timing of program initiation and closeout, increased $57.9 million and $103.9 million for the three and six months ended June 30, 2023, compared to the same period in the prior year. The higher personnel costs portion increased by $21.4 million and $40.9 million for the three and six months ended June 30, 2023, compared to the same periods in the prior year. Selling, general and administrative Selling, general and administrative expenses increased by $6.2 million, to $39.4 million for the three months ended June 30, 2023 from $33.2 million for the three months ended June 30, 2022. Selling, general and administrative expenses increased by $14.9 million, to $77.4 million for the six months ended June 30, 2023 from $62.6 million for the six months ended June 30, 2022. The increase was primarily attributed to higher personnel costs to support the growth in service activities. The higher personnel costs portion increased by $4.6 million and $9.5 million for the three and six months ended June 30, 2023, compared to the same periods in the prior year. Depreciation and Amortization Depreciation and amortization expense of $6.5 million and $12.5 million for the three and six months ended June 30, 2023 remained relatively consistent with $5.5 million and $10.7 million for the three and six months ended June 30, 2022. -22- Table of Contents Miscellaneous (expense) income, net Miscellaneous (expense) income, net decreased by $3.6 million to $1.3 million of expense for the three months ended June 30, 2023 from $2.3 million of income for the three months ended June 30, 2022. Miscellaneous (expense) income, net decreased by $4.0 million to $0.6 million of expense for the six months ended June 30, 2023 from $3.4 million of income for the six months ended June 30, 2022. These changes were mainly attributable to foreign exchange gains and losses that arise in connection with the revaluation of short-term intercompany balances between our domestic and international subsidiaries and 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 and third-party investment losses. Income tax provision Income tax provision increased by $2.0 million, to $14.7 million for the three months ended June 30, 2023 from $12.6 million for the three months ended June 30, 2022. Income tax provision increased by $11.2 million, to $27.8 million for the six months ended June 30, 2023 from $16.7 million for the six months ended June 30, 2022. The overall effective tax rate for the three months ended June 30, 2023 was 19.4%, compared to an overall effective tax rate of 20.4% for the three months ended June 30, 2022. The overall effective tax rate for the six months ended June 30, 2023 was 17.2% compared to an overall effective tax rate of 13.1% for the six months ended June 30, 2022. The increase in the income tax provision for the three months ended June 30, 2023 was primarily attributable to the increase in pre-tax book income which was partially offset by an increase in excess tax benefits recognized from share-based compensation and tax benefits related to Foreign Derived Intangible Income (“FDII”) compared to the same periods in the prior year. The decrease in the overall effective tax rate for the three months ended June 30, 2023 was primarily attributable to an increase in excess tax benefits recognized from share-based compensation and tax benefits related to FDII compared to the same periods in the prior year. The increase in the income tax provision and overall effective tax rate for the six months ended June 30, 2023 was primarily attributable to the increase in pre-tax book income and a decrease in excess tax benefits recognized from share based compensation and benefits from uncertain tax positions compared to the same periods in the prior year. 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 from borrowings under our unsecured credit facility consisting of up to a $150.0 million revolving line of credit which we entered into on September 30, 2019 (the “Credit Facility”), and has subsequently been amended. As of June 30, 2023, we had cash and cash equivalents of $39.1 million which increased from $28.3 million as of December 31, 2022. Approximately $14.5 million of cash and cash equivalents, none of which was restricted, was held by our foreign subsidiaries as of June 30, 2023. As of June 30, 2023, we had $94.8 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, credit facility repayments, 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. As of June 30, 2023, cash commitments to support operating business needs include lease liabilities discussed in Note 8 of the Condensed Consolidated Financial Statements, short-term debt discussed in Note 7 of the Condensed Consolidated Financial Statements, purchase commitments discussed in Note 11 of the Condensed Consolidated Financial Statements and capital expenditures primarily related to infrastructure investments in our facilities, equipment and technology. Capital spending as a percentage of revenue decreased by 99 basis points to 2.01% in the six months ended June 30, 2023, compared to the same period in the prior year. 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 borrowings under existing and future credit facilities, we would incur taxes on these earnings if the need for repatriation due to liquidity purposes arises. -23- Table of Contents Six Months Ended June 30, Cash Flows (Amounts in thousands) 2023 2022 Net cash provided by operating activities $ 162,594 $ 142,875 Net cash used in investing activities (17,970) (22,335) Net cash used in financing activities (134,893) (535,546) Effect of exchange rates on cash, cash equivalents and restricted cash 1,142 (3,747) Increase (decrease) in cash, cash equivalents and restricted cash $ 10,873 $ (418,753) Cash Flow from Operating Activities Cash flows from operations are driven mainly by net income, noncash lease expense, depreciation, stock based compensation expense, and net movement in advanced billings, accrued expenses, prepaid expenses 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 was $162.6 million for the six months ended June 30, 2023 beginning with net income of $134.0 million. Adjustments to reconcile net income to net cash provided by operating activities were $27.9 million, primarily related to depreciation of $11.4 million, stock based compensation expense of $10.3 million and noncash lease expense of $9.7 million. Changes in operating assets and liabilities provided $0.7 million in operating cash flows and was primarily driven by increased advanced billings of $27.8 million and increased accrued expenses of $21.3 million, offset by increased accounts receivable and unbilled, net of $21.7 million and increased prepaid expenses and other current assets of $11.8 million. Net cash flows provided by operating activities was $142.9 million for the six months ended June 30, 2022 beginning with net income of $110.7 million. Adjustments to reconcile net income to net cash provided by operating activities were $27.6 million, primarily related to stock based compensation expense of $10.0 million, depreciation of $9.0 million and noncash lease expense of $9.0 million. Changes in operating assets and liabilities provided $4.6 million in operating cash flows and was primarily driven by increased advanced billings of $56.7 million and increased accrued expenses of $15.6, offset by increased accounts receivable and unbilled, net of $39.1 million and increased prepaid expenses and other current assets of $18.8 million. Cash Flow from Investing Activities Net cash used in investing activities was $18.0 million for the six months ended June 30, 2023 primarily consisting of property and equipment expenditures. Net cash used in investing activities was $22.3 million for the six months ended June 30, 2022 primarily consisting of $20.5 million in property and equipment expenditures. Cash Flow from Financing Activities Net cash used in financing activities was $134.9 million for the six months ended June 30, 2023 primarily related to $144.0 million in repurchases of common stock and $100.0 million in repayments of the Credit Facility, partially offset by $105.0 million in proceeds related to the Credit Facility and $4.1 million in proceeds from stock option exercises. Net cash used in financing activities was $535.5 million for the six months ended June 30, 2022 primarily related to $800.7 million in repurchases of common stock and $49.5 million in repayments of the Credit Facility, partially offset by $299.2 million in proceeds related to the Credit Facility and $15.4 million in proceeds from stock option exercises. Share Repurchases In 2018, the Board of Directors approved a stock repurchase program which has been amended several times to increase the aggregate amount of the stock repurchase authorization. During the three and six months ended June 30, 2022, the Company repurchased 2,717,379 shares and 5,463,244 shares for $374.6 million and $800.5 million, respectively. -24- Table of Contents In the fourth quarter of 2022, the Board approved a new stock repurchase program of up to $500.0 million. During the three and six months ended June 30, 2023, the Company repurchased 126,281 shares and 781,068 shares for $23.9 million and $144.0 million, respectively. As of June 30, 2023, we have remaining authorization of $308.8 million under the new repurchase program. Repurchases under the share repurchase program are executed in the open market or negotiated transactions under trading plans put in place pursuant to Rule 10b5-1. The Company constructively retired the repurchased shares associated with these approved share repurchases, except for a small portion which were retained as Treasury Shares on the condensed consolidated statements of shareholders' equity. Retired share repurchase amounts paid in excess of par value are reflected within Accumulated deficit/Retained earnings in the Company’s condensed consolidated balance sheets. Indebtedness As of June 30, 2023, we had total indebtedness of $55.0 million and $0.2 million in letters of credit outstanding related to certain operating lease obligations, which are secured by the Credit Facility. Refer to Note 7 of the Notes to Condensed Consolidated Financial Statements for details regarding our Credit Facility. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with generally accepted accounting principles in the United States of America, or U.S. 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. There have been no significant changes in the critical accounting policies and estimates as previously described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes to our quantitative and qualitative disclosures about market risk as compared to the quantitative and qualitative disclosures about market risk described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.