eResearch Technology Inc. Q4 2008 Earnings Call Transcript

| About: eResearch Technology (ERT)

eResearch Technology Inc. (ERES) Q4 2008 Earnings Call February 26, 2009 5:00 PM ET


Dr. Michael McKelvey – President and Chief Executive Officer

Keith Schneck – Executive Vice President and Chief Financial Officer


Gene Mannheimer – Auriga


Good day, ladies and gentlemen. Welcome to the fourth quarter 2008 eResearch Technology earnings conference call. At this time, all participants are in listenonly mode. We will conduct a questionandanswer session toward the end of this conference. (Operator Instructions) This conference is being recorded for replay purposes. I would now like to turn the call over to Dr. Michael McKelvey, Chief Executive Officer of ERT. Please proceed.

Michael McKelvey

Good afternoon. Thank you for joining us for ERT's fourth quarter 2008 earnings results conference call. A press release announcing the fourth quarter and yearend 2008 results was released this afternoon and is available on the ERT and most financial websites. Joining me today is Keith Schneck, Executive Vice President and Chief Financial Officer.

Prior to beginning the call, I would like to read the forwardlooking event statement. When used in this conference call, words such as anticipate, could, estimate, expect, intend, may, will, would, believe, or other similar expressions are intended to identify forwardlooking statements. These statements are subject to risk and uncertainties that could cause actual results to differ materially from those expressed or implied in the forwardlooking statements.

Factors that might cause such a difference include unfavorable economic conditions; our ability to obtain new contracts and accurately estimate net revenues due to uncertain regulatory guidance; variability in size, scope, and duration of projects and internal issues at the sponsoring client; integration of acquisitions; competitive factors; technological development; and market demand. There is no guarantee that the amounts in our backlog will ever convert to revenue. Should the current economic conditions continue or deteriorate further, the cancellation rates that we have historically experienced could increase.

Further information on potential factors that could affect the company's financial results can be found in the company's reports on Form 10K and Form 10Q filed with the Securities and Exchange Commission. Guidance is based on management's good faith expectations given current market conditions, but continued or further deterioration of general economic conditions in addition to other factors cited elsewhere could result in the company not achieving the revenue and earnings per diluted share guidance provided.

Our forwardlooking statements speak only as of the date made. We do not undertake and expressly disclaim any obligations to update forwardlooking statements to reflect events or circumstances after the dates of the statements except as required by law. You are cautioned not to place undue reliance on our forwardlooking statements.

I will first give highlights for the quarter and details on new bookings and our business lines. Keith will then discuss the detail financials for the quarter and full year 2008 and provide guidance for the first quarter and full year 2009. I will then give some general reflections on our business and then open the call up to questions.

The fourth quarter of 2008 showed sign of the delayed decision-making and push outs and trial starts as a reflection of the general economic and final uncertainty that we discussed on the third quarter call. Thorough QT revenues saw the largest drop, although there were small declines in Routine, which are Phase I through IV trials, and site support revenue.

As a reminder, Thorough QT trials are relatively large and have quick revenue burnoff periods. They can be run anywhere after Phase I in the drug development spectrum. Although the timing of when Thorough QT trials are performed is within the discretion of the sponsor, regulatory guidance ultimately requires that they be performed prior to the submission of an NDA.

What we have seen over the last few months is that some pharmaceutical and biotechnology companies, especially the smaller ones, are postponing the signing of Thorough QT contracts and the start dates of some of these trials in order to preserve cash. We anticipate that most of these Thorough QT trials will be run sometime later in 2009 or in 2010. However, the exact timing of when they will start is difficult to predict. We saw a similar pattern in the 2005, 2006 period when Thorough QT trials were delayed due to uncertainty about the ICH E14 guidance and were eventually performed over the next couple of years.

Revenue for the fourth quarter of 2008 was $30.1 million, up 4.0% from the fourth quarter of 2007. A strong increase in revenue from routine trials was offset by a decline in revenue from Thorough QT trials. Sequentially, revenue declined by $3.9 million. This was largely caused by a drop in Thorough QT revenues although routine revenue and site support revenue also showed slight declines.

Despite the sequential decline in revenue, we were pleased with our margin expansion during the quarter. Our gross margin was 57.3% in the fourth quarter, up from 52.6% in the fourth quarter of 2007 as well as up from 56.3% in the third quarter of 2008. This reflects our expense management efforts as well as the first full quarter after the completion of the Covance Cardiac Safety Services, or CCSS, integration. This demonstrates the inherent strength of our leverage business model.

Operating income margin was 28.6% in the quarter. This was negatively impacted by approximately $800,000 attributable to the net effect of onetime and other unusual expense items such as reserves for tax issues, third party consultants, [inaudible] of bonuses, and the cost of double rent for the fourth quarter in our Philadelphia facilities and our move costs.

Net income per diluted share was $0.11, up from $0.10 in the fourth quarter of 2007, but down from the $0.13 recorded in the third quarter of 2008.

Turning to the year as a whole, 2008 was a very good year for ERT. As Keith will discuss in a moment, the year saw record revenues, record bookings, record transactions and significantly increased profitability. We were particularly pleased that we could grow operating income by 72.6% in 2008 on top of 86.0% growth in 2007. In 2008, revenue increased by 34.9%, bookings increased by 35.0%, and operating margins increased by 629 basis points.

We accomplished many nonfinancial objectives in 2008. We completed the integration of CCSS in August 2008, four months ahead of schedule. We commenced our exclusive marketing agreement with Covance. We expanded a number of other relationships with large contract research organizations and Phase I units. We completed a rebranding of our company and moved our corporate headquarters and U.S. core lab operations to a new location in Philadelphia. Our EXPERT 2 platform continued to show its ability to process record volumes and accommodate the unique configurations of over 1,000 studies since the platform's launch in early 2007.

Turning to new bookings, we had another strong new bookings quarter. New bookings were $45.1 million for the fourth quarter, an increase of 15.1% from the $39.2 million recorded in the fourth quarter of 2007 and the third highest level of new bookings ERT has ever recorded. The three highest new bookings quarters for ERT were all recorded in 2008.

The fourth quarter of the year as a whole saw a marked shift toward a higher percentage of new bookings in Phase III and Phase II and a lower percentage of new bookings for Thorough QT and Phase I studies. We have also seen in recent months a significant increase in the proportion of new bookings with top 30 pharmaceutical companies.

In the fourth quarter of 2008, 55.7% of new bookings were in Phase III compared to 43.8% in the fourth quarter of 2007. In the fourth quarter of 2008, 17.2% of new bookings were in Phase II compared to 11.5% in the fourth quarter of 2007. This is consistent with trends that we have seen reported in the CRO industry in general.

Offsetting these increases were declines in Thorough QT and Phase I new bookings. Thorough QT new bookings declined to 14.2% of total new bookings in the fourth quarter, compared to 26.3% in the fourth quarter of 2007. Phase I new bookings declined 8.5% of total new bookings in the fourth quarter compared to 13.8% in the fourth quarter of 2007. Percent of bookings by top 30 pharma increased to 63% in the fourth quarter of 2008 from 49.2% in the third quarter of 2008.

We continue to see no demand from sponsors for using an automated methodology in our bookings numbers. We continue to see stable pricing environment with the average price for new bookings flat in the fourth quarter compared to the fourth quarter a year ago. We continue to be pleased with the results of the CCS acquisition and our ability to leverage the exclusive marketing agreement with Covance into incremental revenue opportunities. We added 30 new clients last year from this relationship.

The gross book to bill ratio in the fourth quarter was 1.5 up from 1.3 in the third quarter of 2008 and from 1.4 in the fourth quarter of 2007. The cancellation rate in the fourth quarter was an annualized 19.3% as compared to 19.6% in the third quarter of 2008. This was up from the cancellation rate of 15.3% in the fourth quarter of 2007. The cancellation rate we report is a fully factored cancellation rate that consists of the actual value of study cancellations plus the value of studies that are completed at amounts under the original contracted value, all divided by the beginning period backlog. Our backlog increased to a record $166.5 million.

In terms of the new business environment, we have seen differential trends between large pharmaceutical companies, smaller to midsize pharmaceutical, and biotech companies. Large pharmaceutical companies are still spending, albeit at a slightly slower pace while engaging their suppliers in more strategic outsourcing discussions. Smaller pharma companies are sometimes experiencing funding issues that make them more cautious in committing scarce cash to certain compounds, especially those with less bright future prospects.

We find that our reputation for quality and our strong financial position are especially important in these uncertain times. Companies are focused on outsourcing their key development programs to companies that will be around for the next few years and that have substantial accumulated experience in helping get drugs approved through the regulatory agencies. ERT's leadership position in the market, and quality scientific and medical leadership, project execution, and the use of advanced technology, gives our clients a strong reason to continue to utilize our services.

We announced recently a partnership with Integrium to bring ambulatory blood pressure monitoring services to our clients. We believe that cross selling our services with those of Integrium and other providers such as nSpire, another company we partner with that provides respiratory services, will allow us to reach additional clients in therapeutic areas.

The pipeline of new opportunities for our eClinical offerings is growing, especially in the ePRO area, although its contribution to our overall revenue remains small.

We have seen interest in our suicidality monitoring system, which we introduced last year as well as in our EDC Now! offering. Our eClinical business saw an increase in revenue in the fourth quarter in contrast to the declines in revenue that we have seen in the recent past. eClinical revenue as defined by the sum of professional services, client services, and license revenues increased 21.8% from the fourth quarter of 2007 primarily due to ePRO activity.

I will now turn the call over to Keith for some more details on our financials for the fourth quarter and full year 2008 and guidance for the first quarter and full year of 2009.

Keith Schneck

Thanks, Mike. Highlights of the quarter were a fourth quarter revenue of $30.1 million, a 4% increase from the $28.9 million in the fourth quarter of 2007, but an 11.4% sequential drop from the $33.9 million in the third quarter of 2008. The majority of the sequential revenue decline from the third quarter was due to lower transaction volume on Thorough QT projects.

For the fourth quarter, our cardiac safety service revenue was $20.0 million compared to $20.1 million a year ago, but down $3.3 million from the third quarter of 2008, again, due to lower Thorough activity. Site support revenue was $7.5 million, up $1 million from a year ago but down $.6 million from the third quarter; and our eClinical business totaled $2.6 million, up $440,000 from a year ago and up slightly from the recent third quarter.

Covance cardiac safety services, or CCSS, revenues, all of which relate to our acquired backlog, was $1.9 million in the fourth quarter of 2008 compared to $1.5 million in the prior year quarter and $1.9 million in the third quarter.

Gross margins for the fourth quarter were 57.3% compared to 52.6% a year ago and 56.3 in the third quarter of 2008. Gross margin is up this quarter yearoveryear due primarily to the lower costs associated with processing the CCS backlog as this was done in our ERT lab, lower depreciation due to some of our ECG equipment becoming fully depreciated, and the overall leverage on increased revenue.

CCS costs included in cost of sales were $1.2 million in the fourth quarter of 2008 and $1.4 million in the fourth quarter of 2007. Operating expenses for the fourth quarter were $8.6 million or 28.7% of revenue, compared to $7.7 million or 26.5% of revenue in the fourth quarter of 2007.

Operating expenses in this fourth quarter were impacted by several onetime or other unusual expense items mostly impacting G&A and included additions to nonincome related tax accruals of about $400,000; moverelated costs related to our new facility of about $200,000; higher legal fees related to several matters, totaling about $100,000; higher consulting fees on several projects, including IT costs related to the move; and marketing rebranding that totaled about $400,000; and additions to our AR reserve of about $130,000. CCSS costs included in OpEx were $92,000 in 2008 fourth quarter compared to $560,000 in 2007 fourth quarter.

Let me now cover the fiscal year. Revenue was $133.1 million up $34.4 million, a 34.9% increase from the $98.7 million a year ago. Cardiac safety service revenue was $92.9 million, up $29.4 million from 2007. [Flight support revenue was $30.7 million, up $4.2 million from 2007. E clinical business totaled $9.6 million, up $861,000 from 2007.

CCSS revenue, all of which again was from acquired backlog, was $10.1 million in 2008, compared to $1.5 million in 2007. Major contributors of the $34.4 million revenue growth yearoveryear were $24.8 million due to increased volume of both the routine and Thorough transactions, the $8.6 million incremental from the CCSS acquired backlog, and the $1.0 million incremental from our eClinical business.

Gross profit margin was 55.8% compared to 50.7% a year ago. Gross profit margin and cardiac safety was 60.2% compared to 56% a year ago, site support was 39.9% compared to 32.7% a year ago, and eClinical was 63.8% compared to 66.9% a year ago.

Gross profit margin is up yearoveryear due primarily to the leverage in the operations as we were able to process higher revenue without significantly impacting costs and, to a lesser extent, lower depreciation on some of the ECG equipment that became fully depreciated but still in service. Offsetting this is the cost from operating and transitioning CCSS. The CCSS costs included in cost of sales were $8.4 million in 2008 and $1.4 million in 2007.

Operating expenses were $35.8 million in 2008 or 26.9% of revenue compared to $27.8 million in 2007 or 28.2% of revenue. CCSS costs included in OpEx were $3.2 million in 2008 and $560,000 in the fourth quarter of 2007.

Sales and marketing was up $2.1 million in 2008 due primarily to higher commissions on higher revenue, increased staff and marketing costs related to our recent rebranding activities.

G&A increased $5.9 million in 2008 due to a number of large items, including a $2.6 million incremental related to the CCSS costs for integration and transition and $3.3 million due to higher costs including additional staff, bonus and salary increases, higher stock option expense, and the unusual items for 2008 which included nonincome tax tax accruals, the facility, legal fees, consulting fees, offset by a slight reduction of $700,000 related to employees terminated in early 2007.

Let me now move to the balance sheet. ERT ended the year with $66.4 million in cash, an increase of $19.5 million from last year and up $4.1 million from September 2008. For 2008, net cash provided by operating activities was $39.9 million. During 2008, we paid $6 million in additional purchase price for CCSS related to contractual earnouts and transactions costs. We also paid $11.1 million related to capital equipment purchases.

In December 2008, we purchased 439,749 shares of ERT stock at an average price of $5.80 for a total of $2.6 million under our buyback program. At this time, we have authorization to purchase up to an additional 7.9 million shares.

Accounts receivable were $29.2 million down from $32.8 million at September 30, 2008. The DSOs were 87 days, which is the same as they were in the third quarter of 2008 but up from 83 days in the fourth quarter of 2007. We continue to focus additional resources on improving collections and billing processes with the goal of bringing down DSOs.

Given the economic environment, we also performed a more detailed review of credit risks and evaluation of the collectibility of individual amounts. We consider our receivable balances to be of good quality and do not have undue concern at this time with collectibility from our customers. We did increase the reserve this quarter on several smaller customers but nothing of significance.

Now, for guidance for the first quarter of 2009 and the year ended December 31, 2009. As we indicated in the press release, we are seeing several factors that have negatively impacted our quarter and that will likely continue into 2009 including cautious and delayed decision making, a decline in Thorough QT bookings, and delay in starts of Thorough QT trials, and the shift to larger percentage of Phase III bookings which will take a longer period to turn into revenue.

In the press release, we issued guidance for the first quarter and full year reflecting the delays in the starts with new Thorough QT studies and the cautious spending decisions of many of our clients. We anticipate net revenues between $21.0 million and $24.0 million for the first quarter and net income per diluted share of $0.01 to $0.04 for the first quarter ended March 31, 2009.

For the full year ending December 31, 2009, we anticipate net revenues of between $110 million and $125 million. We anticipate net income per share between $0.25 and $0.43 for the full year ended December 31, 2009.

In developing the guidance, we considered the following. We anticipate that the economy will be weak in the first half of 2009 and show some gradual improvements in the second half. This is the same assumption we are making about the improvement of the capital markets impacting some of our smaller to midsize clients. If this does not materialize, it could have impacts for our forecast.

The main area impacting the range of our guidance is in the Thorough QTs. The lower end of the guidance assumes a sharp falloff in Thorough QTs with some slight uptick in the second half of the year. The upper end of the range assumes a quicker pickup in the second half of the year.

We anticipate our routine business should show growth yearoveryear given the backlog and new customer relationships established in the latter half of 2008. We are targeting gross profit margins of 52% at the low end and 58% at the high end of the revenue range and operating expense as a percentage of revenue of 32% at the low end and 29% at the high end.

Our effective tax rate is expected to be about 40% in 2009, an increase of about 2 percentage points from 2008. The 2008 rate was impacted by the favorable tax adjustments that reduced 2008 effective tax rate by about 2 percentage points which are not expected to occur in 2009.

A reconciliation from our 2008 earnings per share of $0.48 per share to the top end of our 2009 guidance of $0.43 per share can be derived by adding $0.11 due to the completed integration of CCSS and, if you recall, the total CCSS expenses were $11.6 million in 2008. We expect them to be only $1.6 million in 2009, all related to depreciation and amortization. Also subtracting $0.09 as a result of the $125 million of revenue at the upper end compared to $133 million for 2008, subtracting $0.04 per share for new investments that we are making in sales and marketing and internal IT systems which we are planning, subtracting $0.02 per share due to a higher assumed tax rate in 2009, and subtracting $0.01 per share from lower interest income.

We do plan to run the rest of our business at basically the same level as in 2008 with some higher costs being offset by reduction in other areas.

I am going to turn the call now back to Mike.

Michael McKelvey

I think, Keith, in terms of the guidance we meant to say the guidance range was revenue of $105 million to $125 million.

Keith Schneck


Michael McKelvey

Thank you, Keith. As we mentioned at the beginning of the call, we are currently operating in an economic and financial environment that is as difficult as we have ever seen. This manifests itself in our business in many ways, but three in particular stand out.

First, many of our clients are exhibiting caution in making new spending and cash outlay decisions on projects whose timing to both book and to start are somewhat discretionary, such Thorough QT studies.

Second, clients have been much more focused on funding Phase III trials as evidenced by the significant increase in the percentage of Phase III new bookings mentioned above. Since these trials can take up to four to five years to complete, they take longer to turn into revenue than other types of trials. This trend has been exacerbated by our increased amount of work that we do through CROs which generally are in later phase work.

Third, the general economic environment makes clients cautious on spending in general. We believe that most of these factors are timing factors. The confluence of these three factors leads us to the anticipated decline in revenues in 2009 relative to 2008.

Despite these challenges, we are continuing to position ERT for the future. To support future growth and enhance our competitive position, we plan to significantly invest in our sales and marketing organization as well as in our internal IT infrastructure. The main focus of the investment in sales and marketing will be to increase the market penetration of centralized ECGs.

We will be expanding our public relations, industry trade show presence, direct sales, other marketing activities, and improving our message we take to the market. We feel that 2009 could be a good opportunity to increase our market share and increase our market penetration of ECGs centrally collected in clinical trials. We feel that in difficult economic and financial times, innovative market leaders can prosper and position themselves for increased growth in the future.

Looking at the bigger picture, the four growth drivers that we have discussed in the past, growth in pharma and biotech R&D spending, increased centralization of ECGs, increased focus on cardiac safety, and increase in market share are as valid as ever. While two of these growth drivers, growth in pharma and R&D or biotechnical spending and the increased focus on cardiac safety are out of our direct control, they will continue to be important for our future growth. We anticipate the growth in pharma and biotech R&D spending to pick up in 2010 and beyond.

In terms of the increased focus on cardiac safety, a good example of this is the December 2008 guidance issued by the FDA that requires sponsors to evaluate cardiac safety risk of all antidiabetic therapies for type II diabetes. This will result in more intensive ECG testing on drugs in clinical trials related to type II diabetes.

Turning to the drivers that we can directly control, We believe that the current environment gives us an opportunity to accelerate the growth in the other two factors, increased centralization of ECGs and increase in market share. Over the past few months, we have been increasingly engaged by a large number of top 30 pharmaceutical companies in strategic outsourcing decisions.

These discussions have centered on establishing longterm exclusive or nearexclusive enterprisewide relationships with only one or two preferred suppliers and driving increased volume to these suppliers. I am pleased to report that we have been successful in every one of these engagements that has been decided so far, including some with clients with which we did little business in the past. We continue to work on several other longterm enterprise relationships with client. We believe that this will position us well for the future.

We also are working on a number of innovative ways that will make the business case for the cost effectiveness of centralization all that more compelling. We look forward to providing you updates of these in the future.

In closing, we believe that we are well positioned to work through the current economic and financial environment and come out a stronger company. We have a strong debtfree balance sheet, we are the market leader in the industry, we have an enhanced reputation for project management quality, and we continue as the thought leaders in the industry. These position us well to take advantage of the current regulatory and development climate that seeks to enhance the safety determination of new drugs.

While we may see some other delays in the future due to potential funding issues, we believe that the longterm fundamentals of our industry and ERT's position in the industry are strong. We find in today's uncertain economic climate that our clients are more determined than ever to work with established partners who have proven track records of implementing tried and true solutions with proven substantial experience submitting data to the regulatory authorities. With that, we will now take any questions. Operator.

QuestionandAnswer Session


(Operator Instructions) Our first question comes from Gene Mannheimer of Auriga.

Gene Mannheimer - Auriga

Good afternoon. As I review the results looking at bookings up 35% yearoveryear, backlog at record levels, yet the guidance reflects or the midpoint of your guidance reflects about 15% decline in revenue. I understand that's due to delays in trial starts. Is that really the essence of the guidance that the delays are taking so long that you don't expect to see this revenue until the outyears? Is that essentially what you are saying?

Michael McKelvey

It's both the delays in the revenue and then the smaller amount of bookings in Thoroughs. What we're seeing is some pharmaceutical or especially smaller companies decide to go wait until they get funding for their entire program, Phase II or Phase III with a Thorough and waiting until they get that funding to then actually perform the Thorough. That's pushing the Thoroughs out, and also it's just less new bookings from Thoroughs as we reported in terms of 14% of bookings being from Thoroughs.

The third fact that we also mentioned was that more of the bookings are in Phase III that take longer to turn into revenue.

Gene Mannheimer - Auriga

Can you quantify for us the number of Thoroughs booked in Q4 and at what average price?

Michael McKelvey

We've decided not to give out that information because it's become fairly competitive information. I can say it was roughly the same number, one less than our average. The average price was down about $50,000 per Thorough.

Gene Mannheimer - Auriga

You don't think that's a trend? just sort of a onetime anomaly?

Michael McKelvey

It's a onetime. One thing we talked about before is Thoroughs have a wide range. They can go from $500,000 to $2 million. It just really depends how they fall in a particular quarter. But we don't see that as a particular trend, no.

Gene Mannheimer - Auriga

And the reduction in the number of Thoroughs going forward, the number of thorough bookings, is that a function at all of the increasing competition?

Michael McKelvey

We don't think so. It's something that I've asked our salespeople many times. They don't see that as a factor at all. I think it really is related to the reluctance of some smaller pharmaceutical companies to spend in this current environment.

Gene Mannheimer - Auriga

Then, last question, I will drop out. You mentioned pharma and biotech R&D spending trends. Did you say that you expect it to be down in 2009 and then pick up in 2010? Did I hear that right?

Michael McKelvey

We don't explicitly model that, but we're looking at a roughly 0% or flat in 2009 and then picking up in 2010 probably in the midsingle digits.

Gene Mannheimer - Auriga

This sounds like the first time in a long, long while that pharma biotech R&D spending is not growing.

Michael McKelvey

That's what we've looked at in terms of the industry and what we've heard at some of the conferences we have gone to. I think that large pharma is probably increasing slightly and small to medium sized pharma may be declining slightly or something.


At this time, we have no additional questions in the queue. I will turn the call back over to Dr. Michael McKelvey.

Michael McKelvey

Thank you all for your interest in ERT and for joining us today. We wish you all a great evening and a good weekend. Thank you very much.


Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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