Medpace Holdings, Inc. - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2018

or

For the transition period from             to             .

Commission file number: 001-37856

Medpace Holdings, Inc.

(Exact name of registrant as specified in its charter)

5375 Medpace Way, Cincinnati, OH 45227

(Address of principal executive offices) (Zip Code)

(513) 579-9911

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes  ☒  No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.            ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ☐  No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.

MEDPACE HOLDINGS, INC. AND SUBSIDIARIES

FORM 10-Q

FOR QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018

TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION 

Item 1. Financial Statements

MEDPACE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

See notes to condensed consolidated financial statements.

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MEDPACE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

See notes to condensed consolidated financial statements.

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MEDPACE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

See notes to condensed consolidated financial statements.

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MEDPACE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

See notes to condensed consolidated financial statements.

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MEDPACE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2018

(1) Basis of Presentation

Description of Business

Medpace Holdings, Inc. together with its subsidiaries, (“Medpace” or the “Company”), a Delaware corporation, is a global provider of clinical research-based drug and medical device development services. The Company partners with pharmaceutical, biotechnology, and medical device companies in the development and execution of clinical trials. The Company’s drug development services focus on full service Phase I-IV clinical development services and include development plan design, coordinated central laboratory, project management, regulatory affairs, clinical monitoring, data management and analysis, pharmacovigilance new drug application submissions, and post-marketing clinical support. The Company also provides bio-analytical laboratory services, clinical human pharmacology, imaging services, and electrocardiography reading support for clinical trials.

The Company’s operations are principally based in North America, Europe, and Asia.

Unaudited Interim Financial Information

The interim condensed consolidated financial statements include the accounts of the Company, are prepared in conformity with U.S. generally accepted accounting principles (“GAAP”), and are unaudited. In the opinion of the Company’s management, all adjustments of a normal recurring nature necessary for a fair presentation have been reflected. Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been omitted. The preparation of the interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the interim condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results and outcomes could differ from management’s estimates and assumptions. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Secondary Offerings

During the three and nine months ended September 30, 2018, Cinven Capital Management (V) General Partner Limited (“Cinven”), sold a total of 10,399,997 and 16,399,997 shares, respectively, of the Company’s common stock as part of multiple secondary offerings (the “Offerings”). The Company incurred professional fees in connection with the Offerings of approximately $0.3 million and $0.7 million, respectively, during the three and nine months ended September 30, 2018. The fees are included within operating expenses in the accompanying consolidated statement of operations. As of August 27, 2018, Cinven does not beneficially own any shares of the Company’s outstanding common stock. The Company did not sell any shares in or receive any proceeds from the Offerings.

(2) Summary of Significant Accounting Policies

Our significant accounting policies are detailed in Note 3 “Summary of Significant Accounting Policies” of our Annual Report on Form 10-K for the year ended December 31, 2017. Significant changes to our accounting policies as a result of adopting Accounting Standards Codification Topic 606 (“ASC 606”) are discussed below:

Revenue Recognition

We generally enter into contracts with customers to provide services ranging in duration from a few months to several years. The contract terms generally provide for payments based on a fixed-fee or unit-of-service arrangement. We account for revenue in accordance with ASC 606, Revenue from Contracts with Customers, which we adopted on January 1, 2018. Revenue on contracts is recognized when or as we satisfy the contract performance obligations, at the amount that reflects our cumulative progress toward delivery of the performance obligation. This progress assessment is applied to the amount of consideration to which we expect to be paid for delivery of the performance obligation. Our performance obligations are generally satisfied over time and related revenue is recognized as services are provided to meet these obligations.

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Contract Assumptions

An arrangement is accounted for as a contract within the scope of ASC 606 when the Company and its customers approve the contract, are committed to perform their respective obligations, each party can identify its rights regarding the goods or services to be transferred, commercial substance is present, and it is probable that the Company will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.  

For our services to meet this criteria, contracts generally need to be written, pending regulatory hurdles required to commence work must be cleared, the study protocol must be completed, the customer must have adequate funding or reasonable path to funding to execute the contracted portion of the study, and the study must be actively moving forward. Once these criteria have been met, it is deemed that the Company and its customers are committed to perform their respective obligations. Depending on the timing of when these criteria are met, revenue recognition may vary significantly on a period over period basis.      

Accounting for contracts performed over a period of time involves the use of various assumptions to estimate total contract revenue and costs. We estimate expected costs to complete a contract and recognize contracted revenue over the life of the contract as those costs are incurred.

Cost estimates are based on a detailed project budget and are developed based on many variables, including, but not limited to, the scope of the work, the complexity of the study, the participating geographic locations and the Company’s historical experience. To assist with the estimation of costs expected at completion over the life of a project, regular contract reviews are performed in which performance to date is compared to the most current estimate to complete assumptions. The reviews include an assessment of costs incurred to date compared to expectations based on budget assumptions and other circumstances specific to the project. The total estimated costs necessary to complete is updated and any revisions to the existing cost estimate results in cumulative adjustments to the amount of revenue recognized in the period in which the revisions are identified. In the case of cost estimates related to activities legally contracted as reimbursable in nature, including but not limited to investigator fee activity, these estimates also influence our assumed contract value and assumed remaining performance obligations. Because of the uncertainties inherent in estimating the costs necessary to fulfill contractual obligations, it is possible that estimates may change in the near term, resulting in a material change in revenue reported.

Contracts generally provide for pricing modifications upon scope of work changes. We recognize revenue, at an amount to which we expect to be entitled, related to work performed in connection with scope changes when the underlying services are performed and a binding contractual commitment has been established with the customer. If our customers do not agree to contract changes upon changes in our scope of work, we could be exposed to cost overruns and reduced contract profitability. Costs are not deferred in anticipation of contracts being awarded or amendments being finalized, but are expensed as incurred.

Most contracts are terminable by the customer, either immediately or according to advance notice terms specified within the contracts. These contracts require payment of fees for services rendered through the date of termination and may require payment for subsequent services necessary to conclude the study or close out the contract. Final settlement amounts are agreed to with the customer based on remaining work to be performed. These amounts are included in revenue when we believe the amount can be estimated reliably and its realization is probable.  In evaluating the probability of recognition, we consider the contractual basis for the settlement amount and the objective evidence available to support the amount.

Certain contracts contain volume rebate arrangements with our customers that provide for rebates if certain specified spending thresholds are met. These obligations are considered as a reduction in revenue when it appears probable that the arrangement thresholds will be met, which can be at contract inception.

We occasionally enter into incentive fee arrangements with customers that provide for additional compensation if certain defined contractual milestones or performance thresholds are met. These additional fees are included in the estimated transaction price when there is a basis to reasonably estimate the amount of the fee and when achievement of the incentive milestone is deemed probable.  These estimates are based on anticipated performance, our best judgement at the time or ultimately, upon achievement of the threshold or milestone.

We record revenue net of any tax assessments by governmental authorities that are imposed and concurrent with specific revenue generating transactions.

Performance Obligations

Substantially all of our contracts consist of a single performance obligation, as the promise to transfer the individual services described in the contracts are not separately identifiable from other promises in the contracts, and therefore not distinct. Revenue recognition is determined by assessing the progress of performance completed or delivered to date compared to total services to be delivered under the terms of the arrangement. The measures utilized to assess progress on the satisfaction of performance are specific to the performance obligation identified in the contract.  

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For the majority of our contract performance obligations, we utilize the input method of cost to cost to measure progress, as the Company has determined that it is the most consistent measure of progress among contract tasks and represents the most faithful depiction of the transfer of services over the contract life. Under this method, the Company determines cost incurred to date for the services it provides compared to the total estimated costs at completion.  

For certain other contractual performance obligations, the Company has determined that an output method is the best measure of progress. These relate to certain unitized contracts, and the Company recognizes revenue in the period in which the unit is delivered compared to total contracted units.

On September 30, 2018, we had approximately $1,047.1 million of performance obligations remaining to be performed for active projects.  

Costs and Expenses

Total direct costs

The Company incurs costs associated with service delivery including direct labor and related employee benefits, laboratory supplies, and other expenses. These costs are recorded in Direct service costs, excluding depreciation and amortization as a component of Total direct costs in the accompanying condensed consolidated statements of operations.

In addition, the Company incurs expenses on behalf of its customers for various project expenditures including, but not limited to, investigator site payments, travel, meetings, printing, and shipping and handling fees that are reimbursed by our customers at cost.  These costs are included in Reimburseable out-of-pocket expenses as a component of Total direct costs in the accompanying condensed consolidated statements of operations.

Total direct costs are expensed as incurred and are not deferred in anticipation of contracts being awarded or finalization of changes in scope.

Recently Adopted Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09 ‘‘Revenue from Contracts with Customers,’’ (“ASC 606”) to clarify the principles of recognizing revenue and create common revenue recognition guidance between US GAAP and International Financial Reporting Standards. The new standard became effective for the Company in the first quarter 2018.

Under ASC 606, the majority of the Company’s contracts will have a single performance obligation that is satisfied over time, with revenue recognized based on overall project progress measured as of the financial statement date. This represents a change in the Company’s previous revenue accounting methodology, Accounting Standards Codification Topic 605, Revenue Recognition (“ASC 605”), as a majority of contracts were accounted for under the multiple element arrangement guidance.  Under the previous revenue recognition accounting methodology, certain revenue related to reimbursable expenses was presented either as a separate line item within Reimbursable out-of-pocket revenue or net of related expenses within Service revenue, net in the condensed consolidated statements of operations.  As a result of having a single performance obligation, the Company accounts for all revenue related to reimbursable expenses on a gross basis within a single revenue line item.  Measurement of progress on contracts with customers will generally be based on the input measurement of cost incurred relative to the total expected costs to satisfy the performance obligation.  

The Company elected to utilize the modified retrospective implementation method for its transition to ASC 606 as of January 1, 2018 (the “Implementation Date”).  Under this implementation method, the Company recognized the cumulative effect of initially applying the ASC 606 revenue recognition guidance to contracts that were not completed at the Implementation Date.  At the Implementation Date, the Company elected to reflect the aggregate effect of all contract modifications that occurred before January 1, 2018 in determining the satisfied and unsatisfied performance obligations and determination of the transaction price.

The cumulative effect adjustment was recorded as a reduction to the opening balance of Accumulated deficit in the condensed consolidated balance sheets in the amount of $2.7 million, with offsetting amounts of $12.9 million to Accounts receivable and unbilled, net, $(0.7) million to Deferred income taxes, $35.4 million to Accrued expenses, $(57.4) million to Pre-funded study costs and $31.5 million to Advanced billings, respectively. The amounts recorded to Accounts receivable and unbilled, net, Deferred income taxes, Accrued expenses, Pre-funded study costs, and Advanced billings reflect differences between revenue recognized and billings to customers by project as well as costs incurred but not settled as of the Implementation Date. The above disclosed cumulative effect adjustments have been revised from the amounts previously disclosed in our interim financial statements filed on Form 10-Q for the quarterly period ended March 31, 2018 to correct certain immaterial misstatements. The effects of these misstatements were immaterial to our results of operations.

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In connection with the implementation of ASC 606 on the modified retrospective method, we are presenting additional information to assist with the comparability of select line items of the current and prior period year to date reporting in our condensed consolidated balance sheets and condensed consolidated statements of operations.  Below we have presented the amount by which each financial statement line item is affected in the current reporting period by the application of ASC 606 as compared with the guidance that was in effect before the change (ASC 605).

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Recently Issued Accounting Standards

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASC 842”). The guidance in ASC 842 supersedes the lease recognition requirements in ASC Topic 840, Leases (FAS 13) (“ASC 840”). ASC 842 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. ASC 842 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted.

ASC 842 allows by policy election, an entity to choose its transition approach.  Entities must adopt ASC 842 on a either a modified retrospective basis to each prior reporting period presented or through an optional alternative method referred to as the “Comparatives Under ASC 840 Approach” which allows entities to apply the new requirements to only those leases that exist as of January 1, 2019.  The Company has elected to adopt ASC 842 utilizing the Comparatives Under ASC 840 Approach.  As such, ASC 842 will be applied on a prospective basis as of January 1, 2019 and any cumulative catch up adjustment for differences between ASC 842 and ASC 840 will be recorded upon adoption.

ASC 842 also allows for the election of certain practical expedients that are meant to ease the burden of transitioning to ASC 842 while still achieving compliance.  The Company will elect the “package of three” practical expedient allowing the Company to carry forward decisions made and documented under current US GAAP, rather than reassessing all of the Company’s contracts to determine whether they are or contain leases and how they would be classified under ASC 842.  The Company has decided not to elect the hindsight practical expedient, which if elected would require the Company to reassess the lease term and assessment of impairment for all of the Company’s leases using the facts and circumstances known up to the adoption date of the standard.  

In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. ASU 2018-02 allows for an entity to elect to reclassify the income tax effects on items within accumulated other comprehensive income resulting from U.S. tax reform to retained earnings. The guidance may be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized and is effective for fiscal years beginning after December 15, 2018 with early adoption permitted, including interim periods within those years. The Company is currently evaluating the effect this standard will have on its condensed consolidated financial statements.

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(3) Net Income Per Share

Basic and diluted earnings or loss per share (“EPS”) are computed using the two-class method, which is an earnings allocation that determines EPS for each class of common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Restricted Stock Awards (“RSAs”) are considered participating securities because they are legally issued at the date of grant and holders are entitled to receive non-forfeitable dividends during the vesting term.

The computation of diluted EPS includes additional common shares, such as unvested stock options with exercise prices less than the average market price of the Company’s common stock during the period (“in-the-money options”), which would be considered outstanding under the treasury stock method. The treasury stock method assumes that additional shares would have to be issued in cases where the exercise price of stock options is less than the value of the common stock being acquired because the cash proceeds received from the stock option holder would not be sufficient to acquire that same number of shares. The Company does not compute diluted EPS in cases where the inclusion of such additional shares would be anti-dilutive in effect.

The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2018 and 2017 (in thousands, except for earnings per share): 

During the three and nine months ended September 30, 2018, the Company had 13,420 stock options, respectively, that were excluded due to the exercise price exceeding the average fair value of the Company’s common stock during the period. During the three and nine months ended September 30, 2017, the Company had 27,500 stock options, respectively, that were excluded due to the exercise price exceeding the average fair value of the Company’s common stock during the period.

(4) Fair Value Measurements

The Company follows accounting guidance related to fair value measurements that defines fair value, establishes a framework for measuring fair value, and establishes a hierarchy for inputs used in measuring fair value. This hierarchy maximizes the use of “observable” inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy specifies three levels based on the inputs, as follows:

Level 1: Valuations based on quoted prices in active markets for identical assets or liabilities.

Level 2: Valuations based on directly observable inputs or unobservable inputs corroborated by market data.

Level 3: Valuations based on unobservable inputs supported by little or no market activity representing management’s determination of assumptions of how market participants would price the assets or liabilities. 

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The fair value of financial instruments such as cash and cash equivalents, accounts receivable and unbilled, net, accounts payable, accrued expenses and advanced billings approximate their carrying amounts due to their short term maturities.

The Company does not have any recurring fair value measurements as of September 30, 2018. There were no transfers between Level 1, Level 2 or Level 3 during the three and nine months ended September 30, 2018 or 2017.

(5) Contract Assets and Contract Liabilities

Contract assets and liabilities are reflected in the Company’s condensed consolidated balance sheets within the accounts reflected below.  

Contract Assets

Accounts receivable represent amounts due from the Company’s customers who are concentrated primarily in the pharmaceutical, biotechnology, and medical device industries. Unbilled represents revenue recognized to date that has not been billed or is not yet contractually billable to the customer. In general, amounts become billable upon the achievement of negotiated contractual events, in accordance with predetermined payment schedules or when a reimbursable expense has been incurred. Amounts classified to unbilled are those billable to customers within one year from the respective balance sheet date.

Accounts receivable and unbilled, net consisted of the following (in thousands):

Unbilled receivables increased from $41.0 million at January 1, 2018, which includes adjustments of $12.9 million related to the adoption of ASC 606, to $49.1 million at September 30, 2018. The increase is primarily driven by revenue recognized on certain contracts in advance of customer invoicing.

Contract Liabilities

Advanced billings represents cash received from customers, or billed amounts per an agreed upon payment schedule, in advance of services being performed or revenue being recognized.

Advanced billings consisted of the following (in thousands):

Advanced billings increased from $105.3 million at January 1, 2018, which includes adjustments of $31.5 million related to the adoption of ASC 606, to $133.4 million at September 30, 2018. The increase is primarily driven by billing and/or collection activity in the nine months ended September 30, 2018 in advance of revenue being earned for delivery of service obligations.

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(6) Intangible Assets, Net

Intangible assets, net consisted of the following (in thousands):

As of September 30, 2018, estimated amortization expense of the Company’s intangible assets for each of the next five years and thereafter is as follows (in thousands):

(7) Accrued Expenses

Accrued expenses consisted of the following (in thousands):

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(8) Debt

Debt consisted of the following (in thousands):

Principal payments on debt are due as follows (in thousands):

The estimated fair value of the Company’s debt based on Level 2 inputs using the market approach, which is primarily based on rates at which the debt is traded among financial institutions, approximates the carrying value as of September 30, 2018 and December 31, 2017.

(9) Shareholder’s Equity and Stock-Based Compensation

The Company granted 722,200 awards to employees under the 2016 Incentive Award Plan, during the nine months ended September 30, 2018, consisting of 443,000 stock option awards and 279,200 restricted stock units (“RSU”), all vesting after four years. The Company granted an additional 33,801 stock option awards to non-employee directors under the 2016 Incentive Award Plan, during the nine months ended September 30, 2018. These awards will vest on the earlier of (a) the day immediately preceding the date of the first annual meeting following the date of grant and (b) the first anniversary of the date of grant, subject to the non-employee director continuing in service through the applicable vesting date. The Company granted 933,550 awards to employees under the 2016 Incentive Award Plan, during the nine months ended September 30, 2017, consisting of 777,550 stock option awards, 118,000 restricted stock awards (“RSA”) and 38,000 restricted stock units (“RSU”), all vesting after four years. The Company granted an additional 41,346 stock option awards, vesting after one year, to non-employee directors under the 2016 Incentive Award Plan during the nine months ended September 30, 2017.    

Award Activity

The following table sets forth the Company’s stock option activity:

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The following table sets forth the Company’s RSA/RSU activity:

Stock-based compensation expense recognized in the condensed consolidated statements of operations related to all outstanding stock based compensation awards is summarized below (in thousands):

(10) Income Taxes

The Company’s effective income tax rate was 24.2% and 35.1% for the three months ended September 30, 2018 and 2017, respectively. The Company’s effective income tax rate was 22.0% and 35.7% for the nine months ended September 30, 2018 and 2017, respectively. The Company’s effective income tax rate for the three and nine months ended September 30, 2018 varied from the U.S. statutory rate of 21% primarily due to the impact of state taxes and the benefit of uncertain tax positions coupled with a favorable tax impact associated with previously acquired tax attributes.

The Company recognized the income tax effects of the “Tax Cuts and Jobs Act” (TCJA) in its audited consolidated financial statements on our 2017 Annual Report on Form 10-K in accordance with Staff Accounting Bulletin No. 118, which provides Securities and Exchange Commission staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the TCJA was signed into law. The guidance also provides for a measurement period of up to one year from the enactment date for the Company to complete the accounting for the U.S. tax law changes. As such, the Company’s 2017 financial results reflected the provisional estimate of the income tax effects of the TCJA. For the three months ended September 30, 2018, the Company revised the following provisional estimates for the amounts recorded as of December 31, 2017:

Absent the adjustments noted above, no subsequent adjustments have been made to the other provisional amounts recorded as of December 31, 2017, which continue to represent a provisional estimate of the impact of TCJA. The estimate of the impact of TCJA is based on certain assumptions and the Company's current interpretation, and may change, as the Company receives additional clarification and implementation guidance and as the interpretation of the TCJA evolves over time.

TCJA made broad and complex changes to the U.S. tax code, including a new tax law that may subject the Company to a tax on global intangible low-taxed income (“GILTI”) beginning in 2018. GILTI is a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. Companies subject to GILTI have the option to account for the GILTI tax as a period cost if and when incurred, or to recognize deferred taxes for temporary differences including outside basis differences expected to reverse as GILTI.

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We have not yet determined our policy election with respect to whether to record deferred taxes for basis differences expected to reverse as a result of the GILTI provisions in future periods or use the period cost method. We have, however, included an estimate of the current GILTI impact in our tax provision for 2018.

(11) Commitments and Contingencies

Legal Proceedings

The Company is involved in legal proceedings from time to time in the ordinary course of its business, including employment claims and claims related to other business transactions. The Company cannot predict with certainty the outcome of such proceedings, but it believes that adequate reserves have been recorded and losses already recognized with respect to such proceedings, which were immaterial as of September 30, 2018 and December 31, 2017.  There is a reasonable possibility that a loss exceeding amounts already recognized may be incurred related to these actions; however, the Company believes that such potential losses were immaterial as of September 30, 2018.

(12) Related Party Transactions

Employee Loans

The Company periodically extends short term loans or advances to employees, typically upon commencement of employment.  Total receivables as a result of these employee advances of $0.2 million existed at September 30, 2018 and December 31, 2017, respectively, and are included in the Prepaid expenses and other current assets and Other assets line items of the condensed consolidated balance sheets, respectively, depending on the contractual repayment date.

Management Fees

During the third quarter of 2018, Cinven sold its remaining shares of the Company’s common stock and all three members of the Company’s Board of Directors (the “Board”) affiliated with Cinven subsequently resigned. Cinven is no longer considered to be a related party subsequent to these events. Prior to these events, the Company paid fees for director services provided by Cinven employees that were members of the Company’s Board and any related committees. The director fees were paid directly to Cinven in accordance with the Company’s non-employee director compensation policy. During the three and nine months ended September 30, 2018, the Company incurred board of director fees and related travel fees to Cinven of less than $0.1 million and $0.1 million, respectively, in the Company’s condensed consolidated statement of operations. During the three and nine months ended September 30, 2017, the Company incurred board of director fees and related travel fees to Cinven of less than $0.1 million and $0.1 million, respectively, in the Company’s condensed consolidated statement of operations.

Service Agreements

Coherus BioSciences, Inc. (“Coherus”)

The chief executive officer of the Company was a member of Coherus’s board of directors until his resignation in the first quarter of 2018. Coherus is no longer considered a related party as of the first quarter of 2018. During the three months ended September 30, 2017, the Company recognized service revenue from Coherus of $1.4 million and during the nine months ended September 30, 2017, the Company recognized service revenue from Coherus of $6.5 million in the Company’s condensed consolidated statements of operations.  In addition, the Company recognized Reimbursed out-of-pocket revenue with Coherus in the condensed consolidated statements of operations of $0.1 million during the three months ended September 30, 2017 and $1.1 million during the nine months ended September 30, 2017. As of December 31, 2017, the Company had Accounts receivable and unbilled, net from Coherus of $0.3 million recorded in the condensed consolidated balance sheets. As of December 31, 2017, the Company had, from Coherus, $1.5 million of Advanced billings and $1.0 million of Pre-funded study costs, in the condensed consolidated balance sheets.

Xenon Pharmaceuticals, Inc. (“Xenon”)

Certain executives and employees of the Company, including the chief executive officer, have held equity investments in Xenon, a clinical-stage biopharmaceutical company. During the second quarter of 2017, the chief executive officer sold his entire equity position held in Xenon. Xenon is no longer considered to be a related party subsequent to this sale. The Company recognized service revenue from Xenon of $0.6 million during the six months ended June 30, 2017 in the Company’s condensed consolidated statements of operations.

Cymabay Therapeutics, Inc. (“Cymabay”)

Cymabay is a clinical-stage biopharmaceutical company developing therapies to treat metabolic diseases with high unmet medical need, including serious rare and orphan disorders. During the first quarter of 2016, it was announced that a Medpace employee would join Cymabay’s board of directors. The Company and Cymabay entered into a MSA dated October 21, 2016. Subsequently, the Company and Cymabay have entered into several task orders for the Company to perform clinical trial related services. During the

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three and nine months ended September 30, 2018, the Company recognized total revenue from Cymabay of $4.1 million and $6.2 million, respectively, and for the three and nine months ended September 30, 2017, the Company recognized service revenue from Cymabay of $0.2 million and $0.4 million, respectively, in the Company’s condensed consolidated statements of operations. As of September 30, 2018 and December 31, 2017, respectively, the Company had Accounts receivable and unbilled, net from Cymabay of $1.9 million and $0.1 million recorded in the condensed consolidated balance sheets.

LIB Therapeutics LLC (“LIB”)

Certain executives and employees of the Company, including the chief executive officer, are members of LIB’s board of managers. The Company entered into a MSA dated November 24, 2015 with LIB, a company that engages in research, development, marketing and commercialization of pharmaceutical drugs. Subsequently, the Company and LIB have entered into several task orders for the Company to perform clinical trial related services. During the three and nine months ended September 30, 2018, the Company recognized total revenue from LIB of $1.0 million and $2.8 million, respectively, and for the three and nine months ended September 30, 2017, the Company recognized service revenue from LIB of $0.5 million and $1.1 million, respectively, in the Company’s condensed consolidated statements of operations. As of September 30, 2018 and December 31, 2017, respectively, the Company had Accounts receivable and unbilled, net from LIB of $0.4 million and $0.5 million recorded in the condensed consolidated balance sheets. In addition, as of December 31, 2017 the Company had Advanced billings from LIB of $0.2 million recorded in the condensed consolidated balance sheets.

CinRx Pharma and subsidiaries (“CinRx”)

Certain executives and employees of the Company, including the chief executive officer, are members of CinRx’s board of managers and/or have equity investments in CinRx, a biotech company. The Company and CinRx have entered into several task orders for the Company to perform clinical trial related services. During the three and nine months ended September 30, 2018, the Company recognized total revenue from CinRx of less than $0.1 million and $0.2 million, respectively, and for the three and nine months ended September 30, 2017, the Company recognized service revenue from CinRx of $0.1 million and $0.3 million, respectively, in the Company’s condensed consolidated statements of operations. In addition, as of September 30, 2018 the Company had Advanced billings from CinRx of $0.1 million recorded in the condensed consolidated balance sheets.

Purchase of Real Estate Properties

In December 2016, the Company entered into a purchase agreement for four parcels of real estate property that are closely situated to the Medpace campus in Cincinnati, Ohio, from AT Redevelopment Company, LLC, which is wholly-owned by the Company’s chief executive officer. The purchase price of the real estate property was $0.4 million as determined by an independent third party broker's opinion of value. The transaction closed on January 11, 2017.

Leased Real Estate

Headquarters Lease

The Company entered into an operating lease for its corporate headquarters with an entity that is wholly owned by the chief executive officer of the Company. The Company has evaluated its relationship with the related party and concluded that the related party is not a variable interest entity because the Company has no direct ownership interest or relationship other than the lease. The lease for headquarters is for an initial term of twelve years through November 2022 with a renewal option for one 10-year term at prevailing market rates. The Company pays rent, taxes, insurance, and maintenance expenses that arise from the use of the property. Annual base rent for the corporate headquarters allows for adjustments to the rental rate annually for increases in the consumer price index. Lease expense recognized for each of the three months ended September 30, 2018 and 2017 was $0.5 million, respectively, and lease expense recognized for each of the nine months ended September 30, 2018 and 2017 was $1.6 million, respectively. The lease expense was allocated between Total direct costs and Selling, general and administrative in the condensed consolidated statements of operations.

Deemed Assets and Deemed Landlord Liabilities

The Company entered into two multi-year lease agreements governing the occupancy of space of two buildings in Cincinnati, Ohio with an entity that is wholly owned by the Company’s chief executive officer and certain members of his immediate family. In accordance with the accounting guidance related to leases, the Company was deemed in substance to be the owner of the property during the construction phase and at completion. Accordingly, the Company reflected the buildings and related liabilities as deemed assets from landlord building construction in Property and equipment, net, Other current liabilities, and Deemed landlord liability, less current portion, respectively, on the condensed consolidated balance sheets. The Company assumed occupancy in 2012 and the leases expire in 2027 with the Company having one 10-year option to extend the lease term. The deemed assets are being fully depreciated, on a straight line basis, over the 15-year term of the lease. Deemed landlord liabilities are recorded at their net present value when the Company enters into qualifying leases and are reduced as the Company makes periodic lease payments on the properties. Accretion

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expense is being recorded over the term of the lease as a component of Interest expense, net in the Company’s condensed consolidated statements of operations. The Company paid $1.0 million and $0.9 million during the three months ended September 30, 2018 and 2017, respectively, and $2.9 million and $2.8 million during the nine months ended September 30, 2018 and 2017, respectively. The current and long-term portions of the Deemed landlord liability at September 30, 2018 were $2.0 million and $25.0 million, respectively. The current and long-term portions of the Deemed landlord liability at December 31, 2017 were $1.9 million and $26.6 million, respectively. The Company has recognized deemed assets, net of $15.1 million and $16.3 million at September 30, 2018 and December 31, 2017, respectively, in the condensed consolidated balance sheets.

Travel Services

The Company incurs expenses for travel services for company executives provided by a private aviation charter company that is owned by the chief executive officer and the executive vice president of operations of the Company (“private aviation charter”). The Company may contract directly with the private aviation charter for the use of its aircraft or indirectly through a third party aircraft management and jet charter company (the “Aircraft Management Company”). The travel services provided are primarily for business purposes, with certain personal travel paid for as part of the executives’ compensation arrangements. The Aircraft Management Company also makes the private aviation charter aircraft available to third parties. The Company incurred travel expenses of $0.4 million and $0.3 million during the three months ended September 30, 2018 and 2017, respectively, and $1.0 million and $0.9 million during the nine months ended September 30, 2018 and 2017, respectively, related to these travel services. These travel expenses are recorded in Selling, general and administrative in the Company’s condensed consolidated statements of operations.

(13) Entity Wide Disclosures

Revenue by Category

The following table disaggregates our revenue by major source (in thousands):

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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, 2017 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, 2017. 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, 2017.

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, including statements regarding our future results of operations and financial position, business strategy, product approvals and plans and our objectives for future operations, are forward-looking statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “see,” “will,” “would,” “target,” 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 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 Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

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 Cardiology, Metabolic Disease, Oncology, Endocrinology, Central Nervous System (“CNS”), Antiviral and Anti-infective (“AVAI”), as well as therapeutic expertise in Medical Devices. Our global platform includes approximately 2,800 employees across 36 countries, providing our customers with broad access to diverse markets and patient populations as well as local regulatory expertise and market knowledge.

Change in Controlled Company Status

Prior to August 10, 2018, the Company met the definition of a “controlled company” as defined by Nasdaq rules. A “controlled company” is defined in Nasdaq Rule 5615(c) as a company of which more than 50 percent of the voting power for the election of directors is held by an individual, group or another company. Certain Nasdaq requirements do not apply to a “controlled company”, including requirements that: (i) a majority of its board of directors must be comprised of “independent” directors as defined in Nasdaq’s rules, and (ii) the compensation of officers and the nomination of directors be determined in accordance with specific rules, generally requiring determinations by committees comprised solely of independent directors or in meetings at which only the independent directors are present. On August 10, 2018, the Company’s previously largest shareholder, Cinven Capital Management (V) General Partner Limited (“Cinven”), sold a portion of its shares in a public offering, which resulted in the Company no longer meeting the definition of a “controlled company”.  

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How We Generate Revenue

We earn fees through the performance of services detailed in our customer contracts. Contract scope and pricing is typically based on either a fixed-fee or unit-of-service model, with consideration of activities performed by third parties, as well as ancillary costs necessary to deliver on the contract scope that are reimbursable by our customers. Our contracts can range in duration from a few months to several years. These contracts are individually priced and negotiated based on the anticipated project scope, including the complexity of the project and the performance risks inherent in the project. The majority of our contracts are structured with an upfront fee that is collected at the time of contract signing, and the balance of the fee is collected over the duration of the contract either through an arranged billing schedule or upon completion of certain performance targets or defined milestones.

Revenue, which is distinct from billing and cash receipt, is recognized based on the satisfaction of the individual performance obligations identified in each contract. Substantially all of our customer contracts consist of a single performance obligation, as the promise to transfer the individual services defined in the contracts are not separately identifiable from other promises in the contract, and therefore not distinct.  Our performance obligations are generally satisfied over time and recognized as services are performed.  The progression of our contract performance obligations are measured primarily utilizing the input method of cost to cost.  Cancellation provisions in our contracts allow our customers to terminate a contract either immediately or according to advance notice terms specified within the applicable contract, which is typically 30 days. Contract cancellation may occur for various reasons, including, but not limited to, adverse patient reactions, lack of efficacy, or inadequate patient enrollment. Upon cancellation, we are entitled to fees for services rendered and reimbursable costs incurred through the date of termination, including payment for subsequent services necessary to conclude the study or close out the contract. These fees are typically discussed and agreed upon with the customer and are realized as revenue when we believe the amount can be estimated reliably and its realization is probable.  Changes in revenue from period to period are driven primarily by new business volume and task order execution activity, project cancellations, changes in estimated costs to complete performance obligations, and the mix of active studies during a given period that can vary based on therapeutic area and or study life cycle stage.

Costs and Expenses

Our costs and expenses are comprised primarily of our total direct costs, selling, general and administrative costs, depreciation and amortization and income taxes.

Total Direct Costs

Total direct costs are primarily driven by labor and related employee benefits, but also include contracted third party service related expenses, fees paid to site investigators, reimbursed out of pocket expenses, laboratory supplies and other expenses contributing to service delivery. The other costs of service delivery can include office rent, utilities, supplies and software licenses which are allocated between Total direct costs and selling, general and administrative expenses based on the estimated contribution among service delivery and support function efforts on a percentage basis. Total direct costs are expensed as incurred and are not deferred in anticipation of contracts being awarded or finalization of changes in scope. Total direct costs, as a percentage of net service 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 and deemed assets from landlord building construction are amortized on a straight-line basis over the shorter of the estimated useful life of the improvement or the associated remaining lease term.

Amortization

Amortization relates to finite-lived intangible assets recognized as expense using the straight-line method or using an accelerated method over their estimated useful lives, which range in term from 17 months to 15 years. 

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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 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 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. Total cancellations in a period are offset against gross new business awards received in a period to determine net new business awards in our backlog calculation. On an Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606”) basis, net new business awards were $227.6 million and $668.3 million for the three and nine months ended September 30, 2018, respectively. On an Accounting Standards Codification Topic 605, Revenue Recognition (“ASC 605”) basis, net new business awards were $150.1 million and $112.1 million for the three months ended September 30, 2018 and 2017, respectively. On an ASC 605 basis, net new business awards were $434.2 million and $311.3 million for the nine months ended September 30, 2018 and 2017, 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. On an ASC 606 basis, as of September 30, 2018, our backlog was $1,024.5 million. On an ASC 605 basis, as of September 30, 2018, our backlog increased by $98.7 million, or 19.4%, to $608.7 million compared to $510.0 million as of September 30, 2017. Included within backlog on an ASC 605 basis as of September 30, 2018 was approximately $360 million to $370 million that we expect to convert to net service revenue over the next twelve months, with the remainder expected to convert to net service revenue thereafter.

On an ASC 605 basis, the effect of foreign currency adjustments on backlog was as follows: unfavorable foreign currency adjustments of $0.6 million for the three months ended September 30, 2018; favorable foreign currency adjustments of $0.3 million for the nine months ended September 30, 2018; favorable foreign currency adjustments of $1.5 million for the three months ended September 30, 2017; and favorable foreign currency adjustments of $2.6 million for the nine months ended September 30, 2017.

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.

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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:

Results of Operations

Three Months Ended September 30, 2018 compared to Three Months Ended September 30, 2017