Fortrea Holdings Inc. (FTRE) Earnings Call Transcript & Summary

Welcome, everybody, to the JPMorgan Healthcare Conference. My name is Casey Woodring from the Life Science Tools & Diagnostics team. I'm pleased to introduce Fortrea here. We have CEO, Tom Pike, CFO, Jill McConnell. And they'll be doing a presentation here followed by Q&A. So with that, take it away, guys.

Great. Thank you, Casey. Good afternoon, everybody, Wednesday. So everybody is, I'm sure, starting to slow down a little bit. We'll see if we can go fast to keep you on your schedules. Forward-looking statements. We may make some forward-looking statements, you have all the usual stuff here. The thing about Fortrea, we do focus a lot on our mission. Our mission really is how do we bring life-changing patients to -- I'm life-changing medicines to patients faster but the thing that's important about this slide is we are about solutions. We're not just about medicines. We're not in that business of creating product. We want to bring solutions that actually help transform this industry over the next 5 years. With respect to the market that we have, this slide hasn't changed too much over the last number of years. You've seen consistent growth associated with R&D spend. You've seen a large market opportunity, you see in different organizations, you'll see a slightly different number, but all of us are going after a very large market that's made up of 2 things: R&D growth, and then some increase in the outsourcing that's taking place in the industry, very attractive. On the right side of this, I do have a few themes that are relevant that are to now. First, '24, '25, might be a little bit slower growth than we've historically seen. You've seen this in some of the analyst reports as well. I think we think it's going to be about a 4% to 5% growth year across the industry. Some of this is coming after in the post-COVID environment, perhaps post GLP-1 as we're coming to conclusion on some of those studies. And we're starting to go into a market that -- it's a solid market, but not the growth that we typically see, which is high single digits in the market. That being said, like many of the analysts say, we do believe that this market will continue to grow at those high single-digit rates as we go out in the out years because we continue to have a huge amount of innovation on the product side. And then at the same time, we are continuing to see outsourcing opportunities, and that will continue to drive growth of our CRO sector. In terms of RFPs and in terms of the marketplace, for us, in Fortrea, it's healthy. Remember, we're a $3 billion organization in revenues. We're not an enormous organization. So we're big enough to be able to do really large full-service outsourcing. We're big enough to be able to do FSP. We're large enough to work with the largest pharmaceutical firms. We're small and nimble enough to be able to work with the biotechs. So for us, at our size, the number of RFPs, the flow of RFPs as we say, looks healthy. With respect to the bottom issue here, we do think that some of the issues you hear about, whether it's Inflation Reduction Act, even some of the cuts associated with some of the pharmaceutical firms generally create opportunities. There's been a number of questions here today about whether we're getting near another patent cliff type moment and some discussion about the next few years. But in general, having been through one of those before, a leading CRO, in general, that creates opportunities for CROs because the pharmaceutical firms are trying to variabilize costs during those periods of time. So again, sometimes these short-term issues actually turn into positives for this industry. With respect to this company, it's an interesting company. It's a new company. So we spun out of Labcorp in very late in June, literally the last minute of June we spun out of Labcorp. However, this is a 30-plus-year-old company, one of the first CROs, one the largest CROs, if you meet one of our project teams, you might meet Dr. Michael George, who's been with us for 25 years or so, you might meet one of our executives, Terry, who's been with us over 20 years. So we have a deep root system here that is really rooted in science and high-quality practices. Over the years, Labcorp made quite a number of investments after the acquisition. You can see in addition to things like pharmacovigilance capabilities. We also made a major acquisition of an organization called Chiltern and Chiltern actually gave us global capabilities that were stronger than what we had in the core Covance, Labcorp root system of this company. And then there were continuing investments that brought this organization to a size of about 19,000 people. So we say, built through decades of experience because we have a tremendous medical team. We have a tremendous operational team, and we've been doing this a long time. We just haven't been doing it as Fortrea. With respect to our business platform, we are a large 19,000-person organization. We're very clinically focused. So about 95% of our business is really focused on Phase I through Phase IV in different ways. We are focused in all therapeutic areas. We actually cross about 20 therapeutic areas, but we are strongest in oncology in terms of percentage of our mix. That's a place you want to be in this industry because I think you all know that's the largest segment for clinical research, so it's a place you want to be and we do have great strength in all of them, but there are some areas that we're going to continue to try to build. We've just hired a terrific leader in CNS to try to expand our market share there. I think we've been a little underpenetrated in some areas like metabolism. We'll continue to focus there. So we have a wide breadth. We have some great specialties, but there's still more opportunity for us. In terms of the business segments, we are in clinical pharmacology. That's also known as Phase I. We have built-for-purpose centers. Those are very attractive. And so we're a leader in that area with a great client list. We do have Phase II, Phase III, Phase IV real-world evidence capabilities associated with traditional clinical development, if you will, the larger projects. We have a segment called enabling services, and this has a number of technology-related businesses and we may get into a case, we can talk about a little bit more, but as some technology businesses and historical business that Covance was a leader in called Patient Access. And then finally, who do we serve? We're about half big pharma, about half biotech, and we are a leader in medical device. With respect to our strategies, we've spent the spring talking to the pharmaceutical firms, larger pharmaceutical firms trying to understand what they want, trying to understand the capabilities they're not getting from our competitors. And we put together this list of strategies that are evidenced on this slide. I'm not going to talk about them all today for time, but let me hit on a couple of them. Complementary tech strategies. If you saw the press release that we just did yesterday, it's a good example of this. If you saw the one we did with Medidata a few weeks ago, it's a good example of this. The tech side of our business in clinical research has fundamentally changed over the last 5 or 6 years where we have larger players spending large amounts to really be leaders in technology in this large sector. So we've had Veeva come in. We've had Advarra come in. Advarra works more from the site side, Veeva works more across the clinical trials with all sizes of pharmaceutical firms. We're bringing them together in a unique way to make it simpler at a site to use technology. We can get into that a little bit more, but it's a good example of what we're trying to do is really facilitate practical creative solutions. We'll add our own intellectual property where it makes sense, but we're going to leverage the leaders in technology. Another one I'll mention here is another press release you may have seen a couple of weeks ago associated with sites. So over the last few years, in between Quintiles and then coming here to Fortrea, I've been doing a lot of work on innovations around use of AI at sites, around site management organizations, direct-to-patient activities and one of the things that came to believe is we have fundamental opportunities to improve how we interact with sites as CROs. And so we have an initiative now where we're trying to do what we can to simplify, to supplement, to help the sites to be more effective. The sites have been heavily impacted by things like the great resignation by COVID, by being closed. And we're really trying to help them be more efficient. We call it the last mile like the telecommunications industry. They talk about the last mile is to your curb -- from your curb to your home and it's the hardest part of telecommunications. In the same way in our business, the most challenging part for us to control is the site. So we're solving that problem. With respect to next-generation data strategies, we have a new strategy for this. I think times have changed. Proprietary data is not enough. We've had an explosion of investments around data over the last, again, 6 or 7 years, a lot of it private equity driven, some of it driven by large companies. And so now it's not about having your own data, it's really about stacking it together and getting insights out of it. So what we do is we leverage the LabCorp data, which we still have unique access to. We leverage our own data. But then we're using other data as well and putting it into. We have relationships with a number of providers in different areas. Some of them much more narrow and focused in a particular therapeutic area like a ConcertAI. Some of them are broader like a Comodo, but essentially, what we're doing is working together with a number of providers to really bring insights to different organizations associated with data. You can see on the right what we believe it's actually a broader data set, improved speed and agility, we're able to do things like we have a really unique piece of software that helps identify diverse populations and where we may be able to go to fill those diversity needs and then we do have our own direct-to-patient capabilities as well. Another thing I'll talk about and the last thing I'll talk about before handing over to Jill McConnell is the commercial evolution. As you can imagine, as part of a larger organization that had a big central lab, had a preclinical business, the sales organization was fundamentally different within LabCorp than it's going to be at Fortrea. And what we've done is we've hired a top executive who's done commercial activities before for both one of the largest CROs as well as other businesses where he's been an executive and he is in the process of working with us to really transform that commercial organization. What we're doing is a whole range of things from putting in world-class processes where every week we look at all of the larger deals, we look at how they're positioned. We look at who's making the decision. We look at our pricing, everything about a deal we look at as an executive team, make sure we're engaging properly but we're doing a lot more. We're also bringing the medical talent to bear on these opportunities. We're getting the medical talent out in the field to work in early engagement. We're changing the way we do strategies to make sure we're more commercially savvy. We're essentially doing everything we can to bring the best of Fortrea to these opportunities and it's fundamentally different. We like to say everyone is in sales here. Those of you who know me know I'm out with customers regularly. I expect all my executives to be. And so when you interact with Fortrea, you're interacting with an organization that is customer focused. I think we covered most of the stuff here. A couple of things I'd add, we are looking at large pharma, we have new approaches to penetrate additional large pharmaceutical firms, we are continuing to be a partner of choice and think about offerings that are effective for biotechs because we know it's a very different value proposition. Very importantly, we focused on the mix of business here. So historically, One of the things I'm sure Casey is going to talk to us about and Jill may talk about a little bit here is the margins of this business have not been comparable to the margin of our peers. And part of that is making sure we consistently have a good mix of attractive business running through here. So we've had a huge focus, change sales incentives and other things on getting the right mix of business here. Finally, agile processes and decision-making, we can make decisions fast. We can respond quickly. There aren't many layers here. The leadership team gets customers so this has been a tremendous part of our evolution and I think we're well into it. You probably saw that we just announced, we've had book-to-bills that exceed 1.2 in our first 2 quarters as an independent company. And we're going to continue to drive that transformation over the next year to try to add some consistency and effectiveness to the commercialization process. So I think with that, I'm going to hand to the CFO, Jill here.

Okay. Thanks, Tom. So I'm just going to touch on very quickly in my few slides about the progress that we've made post-spin because Tom commented on the margin and yes, I will address it, it will be remiss if I didn't in my role. But I think that the first point here around the leaders in the organization, we really made some significant changes. There were some good strong leaders within the organization. But Tom brought in a number of individuals. We talked about the commercial leader, for example, and we're really doing things very differently. We've had a very positive market response to the organization. Customers are really excited, actually customers that we haven't worked with historically are reaching out and asking for conversations. We'll see where that goes. But I think we've had really good reception. We clearly are getting a seat at the table when it comes to all the opportunities that are out there. Tom already talked about the 1.2. So we're seeing really good progress in that book-to-bill, which is really essential. I'll talk about that a bit more on the margin value. But the pipeline is solid, as Tom said, and that's really key for us to continue to fill that we can go forward. The next point, what I'll call out here is we also know that one of the best ways to get new business awards is do a great job of delivering on the ones you're working on. So we have the whole organization focused on that and operational excellence, which will tie into the margin stuff, I'll touch on a little bit more in a moment. Those TSAs in the press release that came out Monday morning, we talked about the fact that we exited about 40% to them in our first 6 months as a stand-alone company, slightly ahead of schedule. 2024 is the more complex year. There are -- this is where all the system technology ones that we really have to exit and those are the ones that are really key to unlocking a lot of that margin optimization. So those are a big focus for us this year, but we feel good about where we started. And we continue to make targeted organic investments, small ones, but Tom talked about some of the magnet talent. Some of the partnerships that we've been doing. So we feel really good about our progress in the first 6 months. I'm not going to drain this slide, but I think 2023 was really about laying the right foundation as we go forward. And '24 is really how do we make sure we exit those TSAs, start moving towards a more fit-for-purpose infrastructure. I think we were part of an organization that was predominantly lab-based and so a lot of the tools that came with us are more fit for that, rightly so. But now we need to build things that are more appropriate for our CRO. We did a study late Q3, early Q4 around our SG&A because we had a very strong belief that we were not aligned with our peers on a benchmarking basis. That study proved that to be true and there's significant opportunity there. So we have that opportunity in front of us for 2024. And we're just looking at our workforce productivity. Some of that will come through us better utilizing the resource we have, but some of that is just putting more revenue through the funnel. And that to the far right, we're thinking about how does 2024 really unlock the more significant margin expansion in 2025 and beyond. We want to be in that range where we're hitting that 1.2 every single quarter from a book-to-bill perspective, continuing to do some organic investments to further differentiate. And I think that last point is important, we do still have this medium-term commitment to getting to 2.5x, 3x leverage. Where we are right now is not where we want to be longer term and we'll be looking to manage that more as we go forward from a capital allocation perspective. So I think on revenue growth and margin expansion, the most important things to call out here, Tom mentioned, we are not where we need to be relative to our peers. When you think about that journey over time, we're thinking of it roughly half on SG&A and cost optimization and the other half around really revenue growth and better utilization of our revenue recognized or revenue-generating individuals. So I think the first couple of points here, we've talked a lot about the environment, the pipeline. We are really looking at performance differently within the organization. Every month we're getting together and not just talking about the financials, but really operational delivery, quality metrics and that's been really important in terms of everyone understanding what are the most important things that are in front of us in that next 4 weeks and what are we all doing and making sure we break down some of the silos that might have existed previously. We did late in Q3, early Q4, initiated some initial cost structure reductions. We're starting to see some of the benefits of those late in 2023. And as I mentioned, we did this benchmarking exercise, which is really helpful in terms of setting that roadmap for us to move our SG&A more in line with peers, some significant opportunity there. Just have a couple of quick slides here, we really wanted to call out our Quality Organization. We think it's important to understand Tom talked about our 30-year heritage, our Head of Quality is someone who also was Head of Quality, led quality at another large CRO previously. She's got a phenomenal team. It's really integrated into everything we do. And it's very important part of where we are. We're in hundreds of audits every year. We've got a lot of robust system around that. We use that technology and automation to make sure we're on top of it. So we're -- this is something that's really important to all of us, and we understand that this really critical for our customers to continue to work with us, and we take it very seriously at Fortrea. We've been pleased over the last few years. I'll just highlight a couple that were more relevant in terms of 2023. We had multiple of our employees be nominated for PharmaTimes and some winners in the -- PharmaTimes Researchers of the year and Americas multiple awards, really excited about that. Our CRO leadership award capabilities and actually Medidata down there, the next digital innovation, it was really around how we were starting to bring more use of real-world evidence to our clinical trials versus some of the more traditional ways of working them, and that's something that we're working with them on closely as we think about some of the things Tom talked about how to make things easier for sites and move the medicines through the funnel faster. And my very last slide is just around governance and ESG. We obviously were part of an organization where there was an ESG program that made a lot of sense for them. I think we're working on what does that look like. We're very different from the organization that we left. A couple of things that I just called out here. Obviously, things like privacy, data security, they're paramount to our license to operate. The environmental piece is really important, particularly with a lot of our customers. We hear that and our employees and so we're looking at something where we figure out how we do that in a way that's appropriately balanced for us as an organization, but meets the expectations of our stakeholders. And then under social, really that diversity and inclusion in clinical trials, that's a mandate now by many of the regulatory agencies, and we think we've got some really great insights how to do that better. So we're looking forward to building something here that's sustainable and fit for purpose for us going forward. And with that, I think we will move to questions.

Great. Thank you for that overview. Maybe just to start, and you guys talked about it a bit on the 4Q preannounced book-to-bill, the 1.2. Can you talk about how bookings shaped up exiting the year relative to expectations and then maybe split out that activity between different customer groups, like SMID versus large pharma orders trend?

Sure. I think overall, Casey, we're really pleased with how this organization has responded. If you looked historically, because we're part of a larger organization, there were ups and downs in the book-to-bill of this particular organization -- and with this concentrated effort we've had a commercial transformation involvement of the executive team, the first 2 quarters ended up with this consistent 1.2 book-to-bill. I suspect a number of people in here know that, that is a marker that we all try to hit as CROs because that means high single-digit growth at a minimum over the coming years. And so we're really pleased with that. The RFP flow has returned to the organization since we've spun. The RFPs, as we look at them right now for this quarter look like a solid foundation for us as long as we execute against them, which is always the challenge in these businesses. As long as we execute against them, we have a solid flow. So from our vantage point, it's a solid book of opportunities and they are diverse. They continue to be about what we are as an organization. We're about half biotech and about half larger pharma. And we continue to see a similar mix associated with our opportunities.

Got it. That's helpful. In the book-to-bill preannouncement, you did call out impact from a small biotech client. Should we think about this impact more related to 1Q or something the company will have to work through the first half of '24 and then stepping back, just do you see this as an overhang at all? And maybe walk through what you learned through that review process and some of the customer feedback since?

Yes. Thanks for bringing that up. I mean I think anybody who's been in business for a while knows that you sometimes encounter unexpected things. And unfortunately, there was a press release from a biotech -- a promising biotech firm that, that press release had a little run in the media. The media ran with some of the information in the press release. And it caused to me, it caused us to be placed in a bad light potentially on a couple of studies that we're doing with them. And what we ended up doing, and it was in that press release, we did an assessment of the situation. We tried to look at our own conduct. Were there any issues as the media was implying in its remarks. And we brought in an independent expert, Dr. McNair, who we never known before, I've never known her. And she's highly qualified ex Chief Medical Officer at WCG, teaches at a Boston University, masters in bioethics, she looked at all of our information and felt that the conduct that we had associated with those studies was strong. It was appropriate for the industry. And actually, Accelerants' oversight was appropriate as well. And so unfortunately, this issue that happened did spill into our contracts and opportunities and toward the very end of the year, we had a couple of contracts that we lost because of this matter and we are hoping, to your point about what is the impact of that. We're hoping with the combination of the expert report and really constructive discussions with that customer. I'm personally trying to really help because I think for the biotech industry and for CROs, the most constructive thing is if we hold hands and deal with the challenges of this industry together. I'm hoping that it was an event that is like an asterisk, doesn't affect our book-to-bill. We're hoping if it has any effect, it was only Q1. Right now, as I told you, we have enough in our pipeline that if we work hard and things go our way, we'll be able to deliver that 1.2. But we felt like we had to be candid about it. We're always going to be candid about this business. I mean one of the things about a spin that's interesting is you are going through some transitions that other people aren't going through. So we're committed to having real transparency, whether it's about a TSA, whether it's about something like this, we're committed to real transparency so you can understand our journey as investors. And so I'm hoping with the constructive discussions and with things going on that's all behind us and it's just an asterisk, and we kind of forget we ever talked about it.

Got it. That all makes sense. So yesterday, one of the larger CROs in the space talked about SMID biotech demand sort of attenuating a bit in 4Q after growing sequentially the past couple of quarters. Can you just talk about your exposure in the SMID space what you're hearing from customers there? And how would you assess the cautiousness in the space that some of the others are calling out in CROs? Like are you seeing the same thing? Maybe just kind of talk about your...

I think what we generally see is in biotech is pretty consistent with the reports out there that indicate that it's not a tremendous funding environment, but it's a solid funding environment and so in terms of what we see and at our size, and Casey and I were talking about this on the way in, it's very interesting when you're the size we are, you're an up and comer, you're interesting to pharmaceutical firms, we are seeing enough opportunity that we can continue to have that mix of 50-50 biotech and large pharma and continue to build relationships and win. I think if we were larger, it might look different but our bucket just isn't as big to fill. So from our vantage point, it looks like there's enough opportunity of organizations that are interested in Fortrea to be able to deliver the results that investors hope and so probably where I'd leave it on that.

What's your take on the current state of the large pharma customer demand? peers have talked about relative resilience there despite IRA impacts, pipeline reprioritizations, budget tightening. Is that something you would agree with? What gives you confidence in CRO spend from large pharma to kind of sustaining in 2024?

Yes, I would agree with that characterization. I think our larger pharmaceutical firms are continuing to try to drive innovation. They're doing it through some combination of their own in-house research plus really looking at biotechs. By the way, Casey, I think we think it's a nice potential tailwind when you start seeing acquisitions of biotechs by large pharma because that means more money will be pulled into the biotech sector. So we think that both of those things are healthy signs in terms of large pharma. There are some individual company issues. We haven't been affected by those. So in our particular case, we haven't been affected by those. But overall, I'm pleased to see, and I think if you listen to what's come out of this conference, I'm pleased to see pretty healthy R&D pipelines and activities from the larger pharmaceutical firms and spend as we go forward.

Got it. And then just on the TSAs, as you noted, 40% exited by the end of the year, how much of a margin lift should we expect from that to begin the year? And do you have a better idea in terms of the cadence of when the remaining 60% are going to roll off over the course of the year?

I'll introduce Jill here in a slightly different way. One of the benefits we have as an organization is she actually ran the spin program for LabCorp before we before we came up and spun out. And so she really has a great understanding of both the challenges and opportunities of these TSAs and coming out of them and what it can do for our business to be an independent company. So I've gave you that intro, you take that.

Thanks, Tom. So I think in terms of the TSAs, the 40% is a dollar amount, it's probably not necessarily reflective of the complexity of the whole suite of TSAs, Clearly, the ones that we have in 2024 because they relate to our systems, our technology, the infrastructure end user computing that those are going to take a bit more time. So we do -- we have detailed exit plans for everyone. They're really scheduled to roll off in tranches, starting with the second quarter in Q3, Q4, as you can imagine. But we are -- we've also announced recently, we're working with a couple of external partners, Cognizant, in particular, who are helping us with that because we know that we are going to need that additional support to be able to do timely manner. What that really -- so I would say the ones that we've come out aren't going to -- in and of themselves do a lot in terms of the margin. But these exits, it's really what we replace them with. And so every single one those exits, those owners have been tasked with coming back with a replacement system or technology or process that is more cost effective and so really, as we go through, we've talked a little bit about where we think we would exit 2024, getting through all those TSAs is really critical to unlocking that next step in margin expansion versus like individual TSAs in particular. I'll maybe just quickly give an example. If you think about an ERP system, we've been able to do some things. You have to have certain types of roles because we're so reliant on our former parent there, you can maybe move those roles to somewhere where there are lower cost, but you can't really not have those types of roles. And so hopefully, as you're building some of those new systems, you build in more automation so that the roles that you have are a lot more productive going forward, if that makes sense.