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

All right. It looks like the clock is ticking. So good morning. I'm Dave Windley with Jefferies Healthcare Equity Research, and I do talk loud, so I probably don't need much mic. Welcome to day 3 of our conference. Appreciate your interest and attendance day 3 of 3. So we are not quite winding things down, but excited to have another day of presentations today. So our next presenting company is Fortrea. Here with us are the company's recently named CEO, Peter Neupert; and the company's CFO, Jill McConnell. I joked over that one. Sorry, Jill.

So really pleased to have you here. You've had a lot going on. I thought I'd just start off with the high-level question on the most recent developments and Peter ask you to talk about review process and CEO search and status on those things.

Okay. Great. Thanks. Welcome. I'm not surprised to get the question. The good news is, I think, as I said earlier, we're quite close on a CEO. We hope to have somebody in the seat before the summer is over. Nothing more than that to respond. I'm very excited about our slate. There are several good candidates with deep experience in the business that will come and energize the company. So looking forward to having something to talk about in the future.

Got it. And I guess not to understand you've got an ongoing process. You don't want to reveal too much. But in terms of you mentioned experience. It does seem like to me, when I've followed this industry for a while, my perhaps view is somewhat myopic to this industry, you've had broader view than that. But it seems like from a competitive standpoint, from an industry demand challenges, it's not a particularly easy industry to be navigating right now that experience, relationships, perhaps ability to reach out to clients and say, Hey, give us a shot is pretty important. Maybe you could perhaps without talking specifically about candidates, but talk about the key criteria that you see as important in this candidate or in this new CEO.

Yes. No, that's fair. So my experience is I'm a software guy back at Microsoft since 1987, got to see the restructuring of many industries as the world evolved to where software eats the world. I think you're right. This is a very complicated business, one that I do think software will make a big difference in over the next 10 years. But it -- and it's a very fragmented business in the context that running a clinical trial is really running 10 different components with 10 different business models associated with it. So when you deconstruct it, I think it is really important because the evolution in those models is going to be at varying rates. And so having somebody that really deeply understands both the business, the customer, which is different along different segments of that business, has the relationships, but also has a growth mindset that understands what the framing of the problem was over the last 10 years is probably not the framing of the problem over the next 10 years. So somebody that can help bridge what was successful historically to what will be successful in the future and is willing to take some risk along that is an important criteria for us. But all the dimensions that you mentioned, relationships because that's super important, a talent pool perhaps that is super important and the ability to synthesize information really quickly to make some choices as we evolve our portfolio.

Got it. Helpful. So then in the meantime, I guess, I'll ask so again, the industry doesn't stop while you search for CEO, a new CEO. So what are the top priorities that you're focused on to kind of keep moving forward while also searching for this new leader?

Yes. Well, certainly, the most important thing is to satisfy our customers. So very focused on keeping the team and have had 2 all-hands meetings already, met with all the executives in the team, keep the leadership team in place. We have a great leadership team, help them align against some priorities and so delight customers, keep the team motivated. We have a clear set of objectives that we've been clear about with investors about what our goals are for the year to make sure we hit those goals because that's probably the most important thing to regain trust with investors and run the business while we try to find new leadership.

Got it. In thinking maybe Jill, these may get into your power alley, but thinking about some of the terminology you've used about. And you may have on the call even tried to move away from this, but pre-spin, post-spin type business and the differences in how those trials are running, what their profiles are, perhaps you could get into a little bit of detail on what are kind of the key differences between pre-spin and post-spin work, and then I'll follow up.

Sure. I think it all comes down to how the trials are being executed. We don't think that pricing has been the issue as we look across the course of both types of work, both the ones that were entered into before we spun in after. It's all about the execution of the trial and probably the way that we approached change orders around those trials. So historically, going after the change orders was not a strength for the business. We've really tried to reinstate that where it's appropriate, of course. But historically, when customers ask for changes, we weren't always asking for the commensurate compensation for them, and we've changed that approach. And now we're also very focused on how we resource the projects. And that was historically more of the challenge is that those inefficiencies weren't really being monitored. Some of it was system related. Some of it was just around execution. And we have -- I think with the older ones, we have been able to get them at a point now where they're plateaued. But for the new projects, we're trying to keep those -- that operational efficiency in line with kind of industry averages. And so far, we've been successful with that. So that's going to be the big driver in terms of the improvement.

Okay. So if I think back to some of the dialogue around the backlog, I suppose, that spin or soon thereafter, some of the characterization was maybe that work, things like the sales force pre-spin wasn't really incented to distinguish between central lab work versus clinical work versus maybe even preclinical work, it wasn't incented to look at direct revenue versus pass-through revenue. And so from a profile standpoint, it was my understanding that some of the pre-spin work was heavy pass-through, maybe not -- I don't know, maybe duration wasn't particularly attractive and maybe pricing wasn't as good. I hear you saying that pricing is really not the difference. Maybe we could get into a little bit more granular detail around that.

Yes. I mean...

Can I take a step back in terms of framing the challenge? I think realistically, if you zoom out just a little bit, and Fortrea is a spinout from Labcorp, as many of you know. And as a part of Labcorp, its focus was very different than it is as a stand-alone business, which is one of the reasons we spun it out. We recognized it was underleveraged, if you will, not leveraged in the financial sense, but leveraged in the opportunity sense because we never gave it the focus that it deserves as a stand-alone business. And that unfortunately, during the spin, so much of it was focused on getting the spin done. We announced it in 9 months, we spun it out, which is about 9 months faster than most people do it. And so during the first 18 months of Fortrea's existence, it was about how do we get out of what we were doing. I would say that the portfolio, you can't characterize as being dramatically different pre and post spin because the relationships take a long time to evolve. The mix might have changed at the margin, but not to the way you were saying it, Dave, in my opinion. One of the choices that was made as we spun was to keep capacity. That works if you grow. It doesn't work so well if you don't grow. And we didn't grow into the expectations that were part of the original plan. That's the foundational driver on the margin issue, in my opinion. Plus you've got to recognize in this business or at least now being on the operator side as opposed to the governance side, the tension between customer delight and investor delight is real. When you're part of, a small part of Labcorp, it's very easy to focus on customer delight because you don't have to worry about investor delight. We now have to focus on both. We understand that, and we are making the changes. We have very detailed plans about those changes, but to get the capacity rightsized to the portfolio mix is going to take a period of time.

Okay. So when -- I guess, respecting, Peter, that you're trying to keep it bigger picture.

No, I just want to say...

Yes, understood. So I guess when you look at this element, I mean, investor delight would be getting profitability up, et cetera. There's an element of -- there's been discussion about differences in cost structure between you and your peers and benchmarking against gross margin, SG&A, IT costs, et cetera. I'm sure at the Board level, you're looking at these differences. The differences are dramatic. Yes. They are very, very wide. And so to your point on -- I mean, the thing that does resonate with me is your point about you staffed to grow and then the growth hasn't come in part -- in large part because the industry hasn't been -- or the demand environment hasn't been cooperative. So how easy is it now? And you've done some waves of this, but how easy is it to go in and resize the labor force to get the cost to a level that reflect the nongrowth environment?

Well, it's never easy, but it's doable, right? We have clear plans. Jill can be much more eloquent about the plans, the specifics of the plans than I can. But I think that really comes in 2 waves. The first wave is there's the known set of things that we are going to do to hit our goals for this year. And if it's important, Jill can describe those. The second thing is, I think as we bring in new leadership, we are positioned in a difficult challenge of we're a little bit of all things to all people. And that probably in a lower growth environment is more difficult to execute on than originally anticipated. So there will be some portfolio decisions, I suspect, as new leadership comes in as to how to rightsize the various components of that mix, whether it's therapeutic or type or other global, those things to get the fit just right so that we can get those out of whack expense variables into the right alignment.

Got it. So to give -- and maybe the answer will be neither, but to give an either/or, you're essentially over hired, overstaffed for the level of work that you have. And you mentioned Jill resourcing and certainly the TSA transition tech, et cetera, is going to help that a lot. Are you like -- I'm going to be overly kind of hyperbolic about this, but do you have people sitting around doing nothing and then you have people that are on trial at kind of an appropriate resourcing level, but you have to absorb these people that aren't fully utilized? Or are you over resourcing projects? And so you have to take people off projects to resize your labor force. It seems like there's a difference in customer delight in those 2 scenarios.

Yes. I think it's the former, not the latter.

Okay. Okay. And so presumably getting back to this pre-spin, post-spin dynamic, the -- those changes could be done regardless of trial, right? Timing of trial, where they are in their life, kind of reset either resizing your labor force can kind of be done across the portfolio. So maybe transitioning to the TSAs and perhaps a little bit, I'd love to shine a light on what kind of divorcing yourself from the old systems and the reliance on the former parent, what has that year-to-date enabled you to do?

So we've talked about the savings opportunities for this year. And I'll just remind, there's $150 million that we've committed to externally on a gross basis, and its $90 million to $100 million net. And that's split roughly half and half between what would hit direct costs or gross margin and the other half would be improving SG&A. On the SG&A front, it is very much around we are making very deliberate decisions, and I talked a little bit about this with our Q1 results on rationalizing applications, reducing duplication and subscriptions, we are looking at opportunities for labor reductions and arbitrage, but also thinking about how we can use automation now that we are operating in a different infrastructure ecosystem to do things differently. I've talked about this before, but one of our decisions, for example, with our system choice, ERP and HCM was to one system that does both, right? So things like that to reduce duplicative licensing costs. Those are the nature of the things we're doing, and we are very firmly on that path. I talked about -- we've had about $19 million of that we captured on a gross basis and around 1/3 in the first quarter. We weren't expecting much, and we are making good progress towards those targets, and we believe that we're on track to achieve those for this year.

So those are rationalization of IT costs. The...

Let me jump in. I think it's an important thing. And again, I focus on infrastructure. More importantly, from a savings point of view is we now have a bespoke infrastructure that will allow us to run the business more effectively. We get to set it up -- we got to set it up the way we wanted to set it up. We're still not done. There's a lot more work to get done. As Jill knows, I'll like to ask 50 questions about various analytics that we're not quite able to do that we'd like to be able to do. But we will be able to get there because it's now our business and not 10% of somebody else's business that has a very different business rhythm.

Yes. So you read my mind. I was going to say, so there's the IT savings. First of all, a little bit on what's the time line? Are you at a point where you can jettison these duplicative IT systems? Or are there still transitions and things to be done before you can let them go?

The big systems are done. There are still the application stack from -- remember, Fortrea is the agglomeration of 4 other businesses. So the app stack is pretty diverse. And Alejandro, who runs IT has a long project ahead of still rationalizing the apps. We now have the infrastructure that allows us to monitor it so that we can rationalize it effectively. But that is one of our goals in reducing the total IT cost. While at the same time, we want to invest in building new tools, not too many building, but leveraging existing tools and adding capabilities on them to make the workforce more productive.

And so from a time frame standpoint?

I think it's a journey of 2 years. I think we will see important improvements this year. That will be mostly in the rationalization as opposed to the investment in new. I think the investment in new rollout will take a couple of years with some very interesting things already on the horizon, which was actually the topic of one of the all hands I was able to do, which was well received.

Yes. And so then you went to the other areas. So you get the IT systems in place that allow you to have visibility down into the business and see efficiency of resourcing or not and chase of change orders or not and things like that. And so what -- is there a kind of soon, medium term, long term in terms of the actions that you can now take with that visibility?

Increasingly, yes. Certainly, any IT road map has things are going to launch next month, next quarter, next year. How that impacts the business we can't predict yet.

Okay. So let's maybe transition to environmental questions. So maybe just in general, describe what you are seeing from clients in terms of demand and intention around product -- their candidate portfolios, and if you would distinguish between kind of large, medium and small?

Sure. Yes. So with our large pharma partnerships, we're continuing to see strong pipeline of things coming in opportunities, winning new work. Everyone is mindful of the external environment, but good molecules are still moving forward and things that are being developed are still being developed. With biotech, we're continuing to see opportunities come in, but there are still some delays in the decision-making given the kind of macro environment and the uncertainty. And when that will abide, I think nobody knows. It's probably similar to what a lot of our peers are seeing, but we are still continuing to -- we're not having challenges with -- we're not seeing any change in terms of funding where people are having issues so much with funding or getting paid. That is not the issue for us. I think it's just the slowness in decision making while people wait to see how some of these external factors play out.

Yes. On the large pharma front. So most of you -- I don't know if you've said this publicly, but most of the peers have talked about the last couple of years being a pretty intense period of procurement and reprocurement both on cycle, off cycle, it kind of felt like customers were bringing you to the table, whether you wanted to or not. Is there still some of that left? Do you have partnerships that are up for renewal in the, say, the next 12 months?

There is still -- I think that will always be the case. That's just the nature of how business evolves because the world is changing so rapidly. But having said that, we are -- our partnerships are continuing. They're all very long in duration. We're in meaningful projects with these customers that are, in some cases, very early in their life cycle. So we wouldn't expect that to change midstream. But we don't take anything for granted. And so we're always looking at ways to engage our customers on how we can bring them more value and try to help them achieve their goals faster. It's about understanding what's really important to them and trying to bring solutions that are going to help them get answers more quickly because speed is still obviously important. So there's nothing major imminently in front of us in terms of those renewals. But that we don't really consider that an issue anymore because, to your point, they can bring you to the table at any point. So you have to constantly be thinking about, am I showing up in the best way that I can for this customer.

While we're on the large pharma side, FSP is mostly a large pharma phenomenon or dynamic. I thought that on the 1Q, maybe the tone or the attitude or willingness toward FSP had changed a little bit in a positive direction. Did I detect that correctly? And could you elaborate on that, please?

Yes, it has. I think that initially, when we were looking at all the things that we were trying to achieve as an organization, to Peter's point, in those 18 months, a fair amount of focus on the separation and getting ourselves stabilized. And so going after large FSP partnerships, given that they have a lower margin profile, we were more focused on full service and our Phase I unit. But as we've gotten into a more steady state and we see the value of those partnerships because oftentimes they can morph. We are more interested in FSP. It was not that we weren't interested. I think we talked about the largest customers where the margins were very, very tight, not being of good sense for us. But there's obviously a lot of FSP space out there that still has solid margin that can contribute accretively, and that's what we're focused on.

And so is there a profile of -- I think the way to think about these is in like a number of heads that are they're allocated to a client in an FSP arrangement. Is there a sweet spot that you think Fortrea can both be competitive in because your scale in that business is not nearly as big as, say, IQVIA and ICON, but it's a size that you could compete for and then yet still make a decent margin.

We don't focus on any size in particular. I think it's more around where do we have skill sets that we believe are really important, where we have also enabling technologies that help to make those resources be more effective and then good partnerships. I think where we are already working with companies in their FSP, they seem to like working with us and tell us that they like working with us, and we are constantly trying to find ways to help them manage their costs and the productivity of those resources, where it's helpful for us to go after is ones where we're not working with the customer. So if there's an opportunity to engage with the customer that we are working with in large part now and go into that FSP relationship with them, that seems like an opportunity for us, I think, more than trying to cannibalize where we already work with somebody on full service. Those are the types of things that we'd be looking at. And the global footprint [indiscernible].

I was going to comeback there. FSP helps in the sense of it takes some of the indirect costs and absorbs them. And so the global footprint and the therapeutic footprint are really important in evaluating the overall contribution margin.

Okay. Okay. So when you talk about areas where you have skills to apply, and I'm asking you to correct me here, I think about it as monitoring, data management, biostats, in some cases, maybe even a study start-up FSP or things like that. Are there flavors of FSP that Fortrea either has or is working on that would be a little differentiated?

I mean I don't think that we're trying to say we want to be focused on FSP in just this 1 or 2 areas. Many times when the -- sometimes we have one, partnerships that are focused on specific areas for FSP. But many times, they're coming and saying, I'm going to need you in these certain geographies, I'm going to need you for these certain skill sets, and it often can be a mix of those issues. And so it's about trying to make sure that, again, you bring something to them that helps them understand you're responsive, you can fill the roles quickly with good talent. And in some cases, you're trying to think about your own portfolio and how you redeploy some of the existing resources you have into those roles so that you can get them staffed quickly. Because speed is often an issue with those as well. So it's not -- we're not focused on anything in particular. But in terms of saying we want to just be here or here.

Right. Okay. So I was flipping to biotechs, you talked about certainly the environment funding. We published funding this week, and it's unfortunately not very strong. What -- I mean, really a book-to-bill question is pan the business, not just biotech, but in so much as biotech is a little softer now. And with the funding environment the way it is, I mean could soften further. What are your expectations or what is underpinning your guidance for this year and your ability to hit your goals in terms of contribution from biotech?

So given that we're almost halfway through 2025, the things that we're winning now are not really going to have an impact on 2025. So we reaffirmed our guidance when we came out with our Q1 results in May and still feel that we're in that position. So it's more about the future state. I think when it comes to biotech, where we obviously stay very close. We have really good relationships. I think that's one of the reasons why we win is because we do build relationships at every level of the organization with those organizations, and we try to stay and keep abreast of what's happening with them. We are much more robust internally in terms of navigating those. If we see any signs of challenge or distress with a customer, we get in front of it really early on compared to what we did historically. So for us, payments and the issues around them haven't -- it's not gotten -- it hasn't changed, right? It's consistent. We're continuing to focus. We've talked about the fact we're looking to be mid- to low 40s on DSO. And given that we're about a 50-50 organization, it's important that we keep on top. So I don't think we're seeing challenges. We will have to watch this backdrop, that uncertainty and the slowness certainly has been impacting company's book-to-bills. And I think while that uncertainty continues, that will -- it's still going to play a factor.

How would -- in general, how would you describe the temperature of the water today versus what you saw early in the year? Is it same, better, worse?

I think it's the same, except that the fact that it's gone on a bit longer is probably giving people a little bit more pause. But my sense is that we're still seeing opportunities come in. We're still seeing good volumes of RFP, good dollar values of RFP. It's just people are taking longer to make decisions while they wait to see how some of these trends play out.

Got it. And I'll sneak one last question here while we're on biotech. So one of the things with biotech that had been discussed maybe some quarters ago, but was biotech is kind of getting to the start date and not being ready or being slow to start, it's kind of all part of this lack of commitment in decision-making and things like that. Has that improved relative to, I think it first came up maybe 2 or 3 quarters ago. Has that changed or improved?

I mean this getting to the start date or post the start date? I just want to clarify.

Both. Let's say both.

I think that getting to the start date is also -- it hasn't gotten worse. I'd say it's still a bit slower. It's definitely slower than what we see with large pharma in terms of getting to the start date. Post the start date, we do see that once they get going, they burn a little bit faster and maybe some of that slower upfront helps them to be more prepared. And then they're -- once they get the money and they're ready to go, and the decision, they want to go. So I don't think we're seeing that change afterwards, but it is slow getting to that starting point.

Okay. All right. I appreciate the distinction there. Thank you for being with us today. I really appreciate it, and thanks to our audience for listening in. I hope you have a great rest of the day. Feel free to reach out to the team. Thanks a lot. Good to see you.

Thanks. Good to see you too.