EUR 850.00 For Business Accounts Only

Morningstar | After Internal Audit, Syneos Reports Solid 4Q Results but Identifies Weakness in Internal Controls

Syneos reported fourth-quarter results largely within our expectations and managed to file its full-year results within the extension period. While the SEC investigation is still pending, the company completed an internal audit and concluded that there were material weaknesses in the internal controls related to the new revenue recognition standard. However, the company stated that this was the result of immaterial accounting errors and that no restatements or adjustments were necessary. While the identified weakness and SEC investigation does not materially alter our forecast for the company, we will be cautiously watching management's efforts to remedy the issues this year, in addition to undertaking continuing integration and strategic investment in the business. Despite these tasks at hand, we remain comfortable with our long-term forecast of mid-single-digit growth and margin improvements. We are maintaining our fair value estimate of $53 per share for narrow-moat Syneos.

Clinical solutions segment revenue of $3.2 billion missed our expectations by a fraction, while the commercial segment performed in line with our expectations with $1.2 billion in revenue. Operating costs came in slightly lower than we had expected, resulting in a full-year operating margin of 6.3%, about 80 basis points higher than our projections. Margin improvement was largely driven by synergies, slightly offset by unfavorable revenue mix in the commercial segment.

Clinical bookings were healthy, and the commercial segment's bookings were up about 150% from the third quarter, a promising sign for the no-moat segment that historically underperformed the clinical research side. Some larger cancelations in 2017 weighed on margins in the commercial segment, but as this begins to normalize, we believe that the resulting margin improvement in the commercial segment largely offsets any risk to the company of unfavorable mix shift as the commercial segment grows.

We were pleased to see that management is making the effort to manage its debt load. The company plans to refinance its existing term loans and revolving credit facilities in early 2019 in order to pay off about $400 million of 7.5% senior unsecured notes, decreasing the company's average interest rate. We expect the company to reduce its debt to adjusted EBITDA ratio to under 4 times in the next year, and continued debt paydown thereafter (we consider under 3.5 times to be reasonable for the industry).