PRA Health Sciences' (PRAH) CEO Colin Shannon on Q2 2016 Results - Earnings Call Transcript

| About: PRA Health (PRAH)

PRA Health Sciences (NASDAQ:PRAH)

Q2 2016 Earnings Conference Call

July 29, 2016 9:00 AM ET

Executives

Colin Shannon - President, Chief Executive Officer

Linda Baddour - Executive Vice President, Chief Financial Officer

Mike Bonello - Senior Vice President, Accounting, Corporate Controller

Analysts

Garen Sarafian - Citi Research

John Kreger - William Blair

John Kreger - William Blair

Donald Tucker - Keybanc

Eric Coldwell - Robert W Baird

Erin Wilson - Credit Suisse

Greg Bolan - Avondale Partners

Operator

Good day, ladies and gentlemen. And welcome to PRA Health Sciences' Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, today's teleconference is being recorded.

And now I'd like to introduce your host for today's conference Mr. Mike Bonello, Senior Vice President and Corporate Controller. Sir, please go ahead.

Mike Bonello

Thank you, Liz. Good morning, and thank you for joining us for the PRA Health Sciences' second quarter 2016 earnings teleconference. Today, Colin Shannon, Chief Executive Officer; and Linda Baddour, Chief Financial Officer will discuss our second quarter 2016 financial results.

Following our opening comments, we will be available to take your questions. In addition to our press release, a presentation with additional financial information is available on our website at www.prahs.com/investors.

Before we begin, I'd like to remind you that our remarks and responses to your questions during this teleconference may include forward-looking statements. Actual results could differ materially from those stated or implied by forward-looking statements, due to risks and uncertainties associated with our business, which are discussed in the risk factors section of our Annual Report on Form 10-K filed with the SEC on February 25, 2016. Such risk factors may be updated from time-to-time in our filings with the SEC. We assume no obligation to update any forward-looking statements. Certain other financial measures, we will discuss on this call are non-GAAP financial measures. We believe that providing these measures help investors gain a more helpful and complete understanding of our results and is consistent with how management views our financial results. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measure calculated and presented in accordance with GAAP are available in our earnings press release and investor presentation included in the Investor Relation portion of the website.

I would now like to turn the call over to our CEO, Colin Shannon.

Colin Shannon

Thank you, Mike. Good morning, everyone. I'd like to thank you all for joining the PRA Health Sciences conference call covering our second quarter 2016 financial results. I am pleased to report we continued our strong momentum in the second quarter with exceptional revenue and earnings growth and continued strength in net new business.

Service revenues for the quarter were $394 million, which represents an increase of 17% year-over-year at actual foreign exchange rate and also on a constant currency basis. Our adjusted net income for the second quarter was approximately $41 million, an increase of 36% over the same period last year. Adjusted net income per diluted share was correspondingly $0.63, a 34% increase versus the second quarter of 2015. Adjusted net income per share included $0.01 of improvement when compared to the foreign exchange rate used in preparing our financial guidance.

New business continues to be robust for the second quarter and increased 21% when compared to the second quarter of 2015. We record nearly $494 million of net new business awards representing a book-to-bill of 1.25x our service revenues. The concentration of our net new business awards also continues to be diversified with approximately 75% coming from the pharmaceutical sector and approximately 25% coming from the biotech sector.

Our backlog increased approximately 4% on a sequential basis to finish the quarter at approximately $2.6 billion. Our continued strength in net year business is a reflection of the quality of our broad and quite flexible service offerings, as well as our differentiation.

Our client base continues to be well diversified with our top five clients representing 43% of our total second quarter revenues and our single largest client constituting 11% of total revenue during the quarter.

The size of our customer from small development stage biotech to large biopharma remains diversified and clinical trial activity among our biotech customers was steady. With continued strength in net new business and our diversified client base, we believe we are in a strong position to drive, sustain future growth.

During the three months ended June 30, 2016 we derived 50% of our revenue from large pharmaceutical companies, 13% from mid sized pharmaceutical companies, 20% from large biotech companies and 17% from emerging biotech companies.

Looking forward to the rest of the year, we feel very confident on the guidance we previously provided you. We are working on some very exciting new client opportunities in Q3 that will likely maintain the intensity of our hiring and training programs for a lot longer than we had anticipated. These are really exciting opportunities that would take us few more weeks to quantify the second 2016 and so rather than raise our guidance we decided to be prudent and leave the guidance unchanged for now.

Finally, I would like to take this opportunity to thank our staffs for their continued commitment to PRA Health Sciences. We are very proud of the strong financial results we have achieved this quarter, as well as the industry awards and recognition the company continues to receive. I mentioned in the last that PRA has received the award the PharmaTimes Clinical Researcher of the Year for the Americas. For this quarter, I'd really like to thank our international team who were also awarded the PharmaTimes International Clinical Researcher of the Year for the third year in a row. These recognition awards are a direct result of dedication of our staff and a delivery of high quality service of client.

I'd now like to hand over the call to Linda Baddour, our Chief Financial Officer who will go through our quarterly financial results in more detail.

Linda Baddour

Thank you, Colin. Good morning, everyone. For the second quarter of 2016, our consolidated service revenues grew 17.2% at actual foreign exchange rates and 17.3% on a constant currency basis. We reported $394.2 million of service revenue for the quarter compared to $336.5 million for the same quarter last year.

On a sequential basis, revenue grew 5.9% at actual foreign exchange rates. Direct costs were $254.9 million in the second quarter of 2016 compared to $219.9 million in the same quarter last year. Direct costs were 64.7% of service revenue in the second quarter of 2016, compared to 65.3% in the same quarter last year.

On a constant-currency basis, direct costs increased by $39.4 million year-over-year as we continue to hire billable staff to support our current projects and additional staff in anticipation of future growth. This increase in our cost base was offset by a favorable foreign currency effect of $4.4 million when compared to last year's exchange rate.

On a constant currency basis, direct costs were 65.7% of service revenue in the second quarter of 2016, compared to 65.3% during the same quarter last year. SG&A expenses were $68.5 million or 17.4% of service revenues for the second quarter of 2016, compared to 17.5% of service revenue for the same quarter last year. The decrease in SG&A, as a percentage of service revenue is primarily related to our continued efforts to effectively manage our overhead functions as we grow.

During the second quarter of 2016, we incurred $2.9 million of transaction-related costs, which include all costs were associated with the closing of our secondary offering and primary relates to the professional fees and incremental stock based compensation costs associated with the release of transfer restriction on option held by employee. Second quarter adjusted income from operations grew 19.8% year-over-year to $67.4million, a margin of 17.1%, an increase 40 basis points year-over-year.

Adjusted net income, which include certain items, whose fluctuations from period-to-period does not necessarily correspond to changes in our operating results increased 36.3% year-over-year to $40.5 million in the second quarter of 2016.

Contributing to the adjusted net income growth were increased service revenues, improved operating margins and a lower effective tax rate, driven by the geographic dispersion of our pretax income. Adjusted net income per diluted share grew 34% to $0.63 per share in the second quarter of 2016, compared to $0.47 per share in the same quarter last year.

Cash provided by operations was $4.1 million for the quarter, compared to cash provided by operations of $26.6 million for the same period of 2015. The decrease in operating cash flow was driven by changes in our net working capital which is primarily driven by the timing of cash received and cash payment, which were in line with our forecast.

Capital expenditures were $9.4 million for the quarter, compared to $9.5 million during the same period of 2015. Our capital expenditures reflect our continued investment in information technology as well as cost incurred in moving into our new clinic in the Netherlands. Our cash balance was $95.9 million at the end of second quarter of which $25.6 million was held by our foreign sub.

Net debt outstanding defined as total debt less cash and cash equivalents, at June 30, 2016 was $804.5 million, compared to $862.9 million at June 30, 2015. The overall reduction in our net debt is attributable to repayments made during the second half of 2015 and an increase in the amount of cash-on-hand and the impact of our March 2016 tender offer.

Regarding the geographic concentration of our revenues, 61% of our service revenues were earned in North America for the quarter, however, approximately 83% of client contracts were denominated in US dollars, while 14% were in Euros. At June 30, 2016, approximately 61% of our total expenses were denominated in US dollars, 15% in Euros, and 6% in British Pounds. At June 30, 2015 approximately 83% of our client contracts were denominated in US dollar while 13% were in Euros, and approximately 60% of our total expenses were denominated in US dollars, 15% in Euros and 6% in British Pound. Our remaining expenses were incurred in Asia-Pac, Russia and Latin America.

That concludes our prepared remarks for this time. We'll be happy to take your questions. Please provide your name and affiliation when asking a question. Operator, you may now open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question comes from the line of Garen Sarafian with Citi Research. Your line is now open.

Garen Sarafian

Good morning. I guess the first question, Colin, I didn't hear you clearly. What was taking longer than expected that you were keeping guidance the same?

Colin Shannon

What was done is that I mentioned that actually during Q3 we have been very fortunate to be having really great client new opportunity but we have actually still taking our time working through, it's actually a really good opportunity that's involve all divisions in our company and but it is going to actually help -- we are going to have the continue the intensity of our recruiting and training program beyond what we have anticipated when we first modeled because as you know we said we are getting ahead of the curve on our recruiting which were done in the last two quarters. And we felt really good. We are actually sitting here with enough staff to cover all of our program and we were expecting to have the benefit of that over the next half of the year. But because of further developments which are actually very positive and very exciting, we know that, that's going to be many more moving parts. We can't assess them, I don't know -- all I know they will be positive and we are excited about the opportunity but at this point I don't want to change our guidance. I just wanted to reaffirm that I am very comfortable with what we said. But I felt it was too premature to increase at this point.

Garen Sarafian

Got it. Okay. That makes it. So basically costs are coming ahead of expected revenues and because of the recruitment and the training. But what gives you confidence that it is an extension of only one additional quarter versus your prior expectation and not longer?

Colin Shannon

I didn't say one quarter. We don't know when timing is going to be, what I am saying is we found staff and I didn't want to -- we still got half of the year left and we are feeling very good. I mean obviously it's really stacking up very nicely for 2017. And just how much of is going to fall into 2016 is the question so we are actually still working through a lot of the issues and unknowns with clients at the moment. So it will take some time. I just needed to highlight it because I am aware that with all the strong bookings and strong performance one would expect an increase in guidance. And so I just wanted to let you know what we've been through our minds and what was actually and why we wanted to address this.

Garen Sarafian

Got it. Okay. That makes sense. And then maybe a bigger pictures sort of a follow up. Just overall, there are quite a few new variables in the marketplace, both global macro trends as well as within the CROs with various mergers or potential chatter, larger privates, always eyeing dance at the markets. So could you just maybe characterize how your clients are reacting to all these, and might be interested in any overall impressions but if you could also include how that's impacting the sales process from the size and quantities of RFP flow, marketplace pricing, and can you trend in your win rates? That would be great.

Colin Shannon

Obviously every client has got different aspects depending on where and what geography they are in and how it has been affected by Brexit. Obviously, it's causing some of the client some concerns. And everyone is different, so I cannot generalize, I mean I think it is very specific to the company and I think you really need to look at what each individual company are saying. Overall for trends, we are seeing, we are still seeing a good flow of RFP volume and we are -- we are not seeing any slowdown since the beginning of the year. We are being consistent on forming of year and what we are seeing out there. And you know, we are feeling pretty good about where the market is. Obviously, that is uncertainty mainly arriving because of the vertical seen over in the US and with Brexit. So we are obviously cognizant of these factors and so far we're seeing -- I saw base of new opportunities.

Operator

Our next question comes from John Kreger with William Blair. Your line is now open.

John Kreger

Hi. Thanks. Colin, the mix of awards that you said I think it was 75% in pharma, I am guessing that's one large pharma but are your large pharma awards at this point still pretty much all strategic solutions or you starting to see that more towards your traditional full- service model?

Colin Shannon

It's actually very mix now John, in fact some of the large pharma have acquired some of the biotechs we were previously working on which is actually changed that mix substantially. I just really thought it would be worth pointing it because that's some people misunderstanding that we seemed to be concentrating in small biotech and I thought that maybe will be worthwhile to sharing what a mix is really looking like. So I thought I get this opportunity to give it to everyone.

John Kreger

Okay, great, thanks. And then your staff comments, looks like you had a just little bit more than 1,200 people at the end of the quarter. What sort of growth should we expect let say by year end given your comments about continuing the staff up?

Colin Shannon

We are still not in a position to forecasting that. That would be giving away the guidance that we are looking for. I am still working through that I mean really at this point in time very much a lot of work is to get to really understand all the moving parts that is so much things that we've really got and unknowns that we've really got to work through. So it's always a nice position to be in.

John Kreger

Okay, great, thanks. One last one. You've done a great job of driving margin improvement over the last year or so. Can you just give us your latest thinking on sort of longer term opportunities to move adjusted EBITDA margins higher?

Colin Shannon

Well, we've actually done a lot of investments this last six months and hiring people on training program so we will get the benefit of that, it might not be this year which we were hoping to start to see towards the end of the year. But certainly in 2017 we'll start to see that coming through. So we see there is potential for improvement over the next year.

Operator

Our next question comes from Donald Tucker with Keybanc. Your line is now open.

Donald Tucker

Hey, great. Thank you for taking my question. So I guess you guys have very consistent backlog burn rate relatively speaking. Is there a reason to think that given that composition of backlog that might change? You do have I guess PRA unusual that there is large functional piece. So always want to kind of get your view on backlog burn rate going forward over time. Is there any reason to think that might change up or down?

Colin Shannon

We don't anticipate any significant change. We do have a lot of project in start up but that's still flowing through and we are taking new business into backlog to starting so we are actually seeing -- we are starting work on it pretty quickly. So it should get pretty consistent over the period yes.

Donald Tucker

Okay. And then maybe on the going back in time the RPS acquisition, I guess now is about the time I would guess there would be some revenue synergies emerging between the two, legacy PRA and sort of RPS businesses, is this explaining some of the very strong bookings growth?

Linda Baddour

RPS has not contributed disproportionately to our new MDA growth. So we are seeing some synergies but it's not -- that's not what's going with our MDA this quarter.

Donald Tucker

Okay. And then my last question is I am also interested in your up-to-date views on predictive. I know this has been an area of focus for you investing wise in the company. When we think as investors over time, where would we see the benefits, financial benefits of your investments in predictive showing up on the P&L? Is it going to help kind of -- how do we think about that is in efficiencies, is it going to drive growth, can you walk through the different pieces with P&L were predictive impact?

Colin Shannon

Yes. What is actually going to do is help us with quality and reduce rework. So well and tight P&L because I like to reduce the rework which is actually something quite significant. And I was actually going to keep comment on predictive for later on in the year because it was one of the big factors in recent awards because our technology capability was one of the aspect so that allows to be chosen for a very nice strategic deal. So I'd like to just maybe keep some flesh on that maybe the next quarter or two. But certainly we see the improvements coming through on the P&L through just better steady management and doing the right things faster and more predictable.

Operator

Our next question comes from Eric Coldwell with Robert W Baird. Your line is now open.

Eric Coldwell

So good morning. On this large client opportunity can you give any sense on what percent of revenue that client at was over the last 12 months? I know you are not going to name the client but was it one of your biggest clients to begin with or smaller percent of total getting to a bigger percent? And then maybe give us a sense on what's changing in that client's outsourcing model that's driving this opportunity? Is it a shift from other CROs to PRA? Is it an increase in that client's pipeline and increase in what they are outsourcing? I'd love to have some sense on what's driving this new relationship or opportunity?

Colin Shannon

Eric, it is new relationship so I really can't comment further upon at this point. I mean it's now under client confidentiality but it would be a new client with -- and it is an interesting opportunity.

Eric Coldwell

Okay. That's great. Congrats on the new one. Also shifting over to maybe some follow on John's questions about headcount and growth. I know you are not going to give a projection there but could you talk at all about the number or percent of third party contracts that you are currently using and how does that stack up versus say history or optimal levels? Have you had to have a big increase in third party contractors in the short term?

Linda Baddour

Well, during the first half of the year we did. We had to ramp on contract CRAs in the North America and a bit in Europe. Also we had some contractors that we were still winding down in our biometrics division. But as we close out July we will see that those numbers decrease to very minimal amount. So we are very pleased about that. I just going to say during the first half of the year we also had a quite a bit of recruiting cost and we were hoping that as Colin mentioned about the second half of the year those recruiting costs start to diminish, but as we ramp up for this exciting award, exciting opportunity then we will be able to -- we have to increase our recruiting cost again.

Eric Coldwell

Got it. And then could you possibly give us a sense on what percent of your headcount or number of contractors? Is that --

Linda Baddour

Well, it is basically it is under 4% growth rate very well.

Eric Coldwell

Under 4%

Linda Baddour

Mike can get for you, yes.

Eric Coldwell

Okay. And then with this large client opportunity your book-to-bill has been fantastic and obviously stronger strengthening since the IPO but it doesn't feel like this opportunity is baked in there. I am just curious if there was.

Linda Baddour

Oh, absolutely not. No, there is no --

Colin Shannon

No. That's absolutely zero in there.

Linda Baddour

Yes.

Colin Shannon

Eric, it was just about 1% at the end of the quarter.

Eric Coldwell

Contractors 1%?

Colin Shannon

Yes.

Operator

[Operator Instructions]

Our next question comes from the line of Erin Wilson with Credit Suisse. Your line is now open.

Erin Wilson

Great. Thanks for taking my question. Do you have the full opportunity that is associated with this project in the bag already or is there a component that you are still deciding on? And is it definitely accretive on a net basis kind of tier 1 opportunity or/and also under disclosure front with that project? Is it like an inter quarter data point that you are willing to share? Do we just basically need to wait for quarterly report?

Colin Shannon

I think you can just wait. Thank you.

Operator

Our next question comes from the line of Greg Bolan with Avondale Partners. Your line is now open.

Greg Bolan

Thanks. I just want to make sure, Linda, you kind of corrected yourself from award to an opportunity. Can we define it as whether it is an actual award, or it's an opportunity that you -- the two of you, you, yourself, and the client are considering one another, or it sounds like you're more so considering it from your end just in terms of what will be required. If we could apply a definition to whether it's an award or an opportunity that would be great.

Colin Shannon

I think I'd say that would be something -- we are just not got definitive agreement contract yet so we are working to our definitive agreement.

Greg Bolan

Okay. That's great. And then just as I think about kind of along those lines as you think, Colin, just about your years obviously at one of the original large CROs that really kind of focused on trying to move clients, especially larger pharma to more of a strategic alliance model basically a very, I guess you will very, very monogamous marriage, if you will. As you think about functional outsourcing preferred provider-type strategy all the way down to the actual strategic alliance model where you're kind of the go to appendage if you will of the R&D infrastructure, what are you thinking these days? I mean where are we in the cycle? Obviously it is much larger than it was years ago. Is this an area where you guys are really starting to kind of punch above your weight for a strategic alliance, or is it more just kind of hey as a sponsor I'm going to choose the really, really big guy and then I'm also going to have also more of smaller mid tier to have some nice diversification between those two as a sponsor? If you could just maybe give us a lay of the land that would be great.

Colin Shannon

I think we are still seeing a bit of mix. I think that is -- lots of distant clients are looking for better ways of optimizing the clinical research dollars and we are been in a nice position with addition of this strategic solutions group to offer a much more flexible approach to actually meet and a different type of need and it's actually been attractive to a number of client. It takes a lot of bravery to move in a different direction and not every client is quite prepared to do that. But you certainly see some are wanting to lead the road and go forward with a new direction of more innovative. And that may shape the future and might be some of the trends moving to different types of models to achieve that optimization. So we are still seeing a lot of traditional project based work as well. So there is definitely a broad mix and so it is not like everybody is now joining and saying, oh strategic partners, strategic deals or whatever. We are definitely in a period where there are all types of variety.

Greg Bolan

That's great. And then, Linda, just, so in terms of profitability on these types of relationships, one type of relationship isn't necessarily more profitable than the others. I suppose as I think about functional maybe more shorter term it is more profitable than, say, a partnership between say two CRO partners for one sponsor, but then over time I suppose the partnership could be as profitable if not more profitable than the functional outsourcing. Is that the way to think about it?

Linda Baddour

I think that's a perfect way to think about it because basically I think there was misconception that as the larger the relationship was that they are less profitable but that's not necessarily true.

Operator

We have a follow up question from the line of Garen Sarafian with Citi Research. Your line is now open.

Garen Sarafian

Thanks for taking the question again. I just figured I'd ask since it didn't come up on the call. So, one of your competitors will be merging with a company that you may be doing business with to access data. So just wondering, could you share your overall perspective there and maybe elaborate a bit as to how you currently use this vendor, how easily you think you can find replacement vendors, timing, incremental costs?

Colin Shannon

Yes, sure. As you know we have been using big analysis for the last nine years. And we have formed a phenomenal data lake but it is got about 30 different assets in the lake. We have just IMS data in the past and we still contracted to get it. But we have organic resources as things change. It's only one of our sources and what we've been finding is the combination of all the different areas that has given us something quite unique. And is something that we have sanctioned over a period of nine years. And by trial and error over many different formats, we continue to add new asset to the lake to give us improved functionality. And but we have actually -- at best this is a management team a couple of years ago to make sure that we were not depended on any single source. So thanks for the question and I am glad we are able to clarify that.

Garen Sarafian

Got it, great. But with these replacement vendors for this one in particular, have you used these replacement vendors before? So just sort of wondering why you didn't use them before, if it was price or was it something else?

Colin Shannon

It was pricing. I mean we've used them in small areas just to make sure that we cannot say absorb the data and then it's actually all about looking for the cost. So that simply that.

Operator

We have a follow up question from the line of Erin Wilson with Credit Suisse. Your line is now open.

Erin Wilson

Hi. Thanks for taking my question again. Sorry about that. The FX impact, I think I might have missed this but what was the EPS impact in the quarter, and then also what should we anticipate for the remainder of the year just thinking about the base business?

Linda Baddour

During the quarter there was $0.01improvement when we are comparing to our foreign exchange rate that we used to preparing our financial guidance. And looking forward it would absolutely depend on what's rate do for the rest of the year. And Erin I am not going to be able to give an exact amount. So it all depends on that. So thank you.

Operator

I am showing no further questions in queue at this time. I'd like to turn the call back to Mr. Shannon for closing remarks.

Colin Shannon

Well, thank you everyone for participating on our call today. If you have any additional questions, please feel free to contact us. Have a great day everyone. Thank you.

Operator

Ladies and gentlemen, thank you for participation in today's conference. This concludes the program. And you may now disconnect. Everyone have a great weekend.

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