ICON Public Limited Company (ICLR) Earnings Call Transcript & Summary

Good afternoon. I'm Dave Windley with Jefferies health care equity research. Welcome to you all. Thank you for joining our 2023 London Healthcare Conference, appreciate your attendance and interest. I have covered ICON, I told the folks at breakfast this morning, since way back in the 1900s. So we go way back with ICON and have enjoyed that relationship very, very much. We're very pleased to have Brendan Brennan, the company's CFO, here to have a fireside chat with us this morning, or this afternoon, I guess, London time this afternoon. So appreciate you being here as well, Brendan.

Pleasure to be here.

So similarly to where I started this morning at breakfast but just want to start at the demand environment again this afternoon and talk about the RFP flow acceleration that both you and Steve Cutler have talked about kind of seemingly starting in 2Q and extending to now. So open with that, please.

Yes, it's been a solid environment over the last couple of quarters. We've seen definitely an uptick. We were talking a lot about the fact that in the period up to -- really from beginning of '22 up to kind of mid-'23 was a more subdued environment. And we obviously talked about the fact a lot of that was around biotech and biotech funding. I think what we saw really in around -- it was probably around June, July time, was a significant kind of uptick from our biotech customers. And that certainly has persisted into the good volumes that we saw and we talked about in the Q3 call and persists as we go into Q4 as well. So that's been a -- it's been a positive move in the right direction. We've seen kind of the funding levels overall, actually, they're okay you would describe them probably as year-over-year, not amazing but okay. But I think what you're seeing is there is funding for good drugs out there. There's no question about that. We've spent -- I've spent some meetings here over the last day or so talking to folks who are coming over from the U.S. looking for opportunities to invest in European biotech companies. So there's definitely dollars out there to fund and to develop good drug product lines. And I think that's what we've been lucky enough to see in the cohort of customers that are coming to us now. They've got their ducks in a row a little bit more. Their CEOs, CFOs have a clearer idea of when they're going to start their programs, the funding that's going to go into those programs and be able to work through that over time. So that's certainly what we saw in Q2. It started -- obviously, had an impact in bookings in Q3. And we're continuing to see that into Q4 at this stage.

Excellent. So if I drill down on the biotech environment. So we talked a little bit this morning about how there are probably too many in the market, a lot of funds flow to those companies. For those of you who are keeping track, 350 biotechs IPO-ed in the kind of pandemic era. The number of public companies, public cash-burning biotechs doubled in that period of time in the public domain. So if we're going now through this period where some of that is being winnowed out and it's kind of separating wheat from chaff, so you now have a shorter list. As you said, they have their ducks in a row. But presumably, you and your competitors are now more focused on these ones that do have cash and do have a project that is viable. What's that competitive environment like for the shorter list?

Yes. I think it is fair to say it's been a more competitive period. Dave, as you know, I suppose I've always thought the aberration in terms of our competitive levels were probably during that 2021 period, where there was more really kind of drugs being -- and obviously pharma companies being developed than there were actually people to service that revenue in the CRO industry. I think that's obviously turned back on its head now and back more to much more what we're familiar with, which is, yes, we have tough competitors in this marketplace. And we go in with sharp pencils into our commercial negotiations. And we make sure that we develop and deliver strategies that make a lot of sense for all of the pharma companies, whether it be those biotech or larger pharma companies that we work with. So I think that's certainly the case. I think that's exactly what we would expect as a CRO. It's exactly what we expect from our competitors. And so yes, there is definitely a keener eye to pricing. I think it's still a good environment. I think it still sustains the kind of margin profiles that we've seen and talked about in the past, particularly in the biotech segment. But I do think it's -- everybody is very careful with their dollars. And they want to make sure that your strategy is efficient and delivers for them at the same time. So that's definitely the focus that we have in the organization to make sure that we are being optimal with their dollars in their trial and that we're delivering for them at the same time in terms of efficiency and patient speed and all of those pieces.

Excellent. So transitioning then, the larger pharma end of the spectrum doesn't have the same inability to raise funds or the need to raise funds. But you've talked about them being a little bit more deliberate and careful and precise in their development pipelines. Maybe talk about that a little bit and how that environment feels.

I think from the start of the year -- and I know we've chatted about it,, Dave, over the course of this year, I was making the point to all concerned that it was very clear to me coming into this year that the C-suites of pharma companies are going to be very, very much more slap people on the wrists and say, "Okay, guys, this year, you really have to stick to your R&D budgets." I think that definitely has played out during the course of the year. And of course, what we've seen during the course of the year is folks considering about not only this year and next year, but thinking about what does the organization look like in '25, '26, when the real impact of the Inflation Reduction Act really has settled in on the organization and thinking more holistically about their total R&D expense and pipeline. I think that's given much more chance for us to have a deeper conversation, if you like, with our pharma partners. And it's also somewhat led the trend to this, and we've spoken to this a bit during our calls and over the course of the year, a bit slightly shifting away from -- a little bit away from the full service work and more towards that blended or FSP blended-type model. I think that's given us a real opportunity in the marketplace. And we have obviously a very, very -- we've got the world-leading FSP portfolio. And we've one of the world's leading full-service portfolios as well. So having those blend of options and the ability to move from that spectrum to -- from FSP all the way through full service and put together imaginative solutions for our pharma partners, I think it's given us a good position in the marketplace as folks are wrestling with this concept of how do I manage my R&D portfolio over the next number of years. So I think it's a real concern from there. They're really looking hard at it. I think they're making a lot of decisions. We certainly have had a lot of conversations with large pharmas over the course of the last year, and they're continuing. So I do feel that our solution in this marketplace is making a real impact, given those '26, '27 concerns they have.

Are those discussions with pharma that you're referencing, are those within cycle? Or are some of these pharma companies kind of coming to market, wanting to evaluate strategy out of their normal strategic partner renewal cycle?

There's a mix, there is a mix. I mean, a lot of those folks are doing it as part of their normal cycle. Some of them are thinking about -- and as we've -- and we've seen this in the past, some of them have taken the opportunity this year to have a look at how they outsource specifically around what their mix of FSP is, what their mix of full service is, what their mix of insourcing is, indeed, as part of that. So some of them are out of cycle, I would say, and taking another look at their model. I think that's definitely true. I think there is definitely -- this is in vogue, this FSP blended model is in vogue. And so I think everybody is having a look at it at the moment. But some of them are also in their normal pattern. So I think probably what I'm saying overall is that there's definitely more out-of-period pieces happening over the last 12 months maybe than we've seen over the last couple of years.

Got it. And just to ask this question from a slightly different perspective, we have -- I mean, most of the people in the room would be familiar that life science vendors, broadly speaking, have had a really tough year. A number of companies have guided down multiple times and to levels that are in decline territory for their particular book of business, their area of development. Why do you think clinical demand, clinical CRO-type demand is holding up somewhat better than what we might see in bioprocessing? Or I don't want to give too many examples because there are some call-outs on that. But why do you think late-stage clinical is holding up better?

I think it's not unusual. And we've seen this, I suppose, in the past. And anybody who's been in this industry for a long time will know that when belt tightening is happening, people will focus in the first instance on those drugs that are closest to approval. So they are looking at opportunities in the Phase II and III place, and obviously, Phase III being better because it's right there out the edge. I mean, that's where we play. I mean, that is still 60%-plus of all the business that we do in the industry. So I mean, when -- those elements of discretionary spend will be the first to be cut. So those things they can and will flex quicker. The other piece is, I suppose, is that the nature of Phase II and III work is that it doesn't ramp up or ramp down quickly. It takes time. You need to ramp into a cycle of Phase III trials. You need to ramp down from a cycle of Phase III trials. So it's not a switch as a cost control that you can quite easily flip from side-to-side. I think both of those things insulate the late-stage clinical research organizations. And again, we've seen that in the past, when there has been other [indiscernible] whatever even. During the '08/'09 financial crunch, there was definitely, again that focus on Phase II/III. And that then obviously is a catalyst at that point to these larger strategic relationships. I don't think we're seeing that kind of quantum shift again. But I think something not dissimilar is in the minds of some of these pharma companies as they think about consolidating their service offering, about getting more services from one CRO and about having fewer CROs in their books. So I think those two things are playing to our advantage.

In -- Over a period of a number of years, ICON, you've made your string of pearls acquisitions for a very long time and then stepped up to a much larger PRA merger. The company is so much -- it's always been full service or close to full service. But it's so much more full service today than it was, say, 5 or even 10 years ago, when, for example, you entered into some of the earlier strategic partnerships. You talked about selling some of these added -- we talked at breakfast this morning about sometimes you see inside pharma, some investment in cost structure that you wonder why in the world would they do that? Punch line of the question here is where are -- what types of bundling of services are customers pursuing now that they weren't before?

I suppose -- well, certainly, where we kind of want to lead them, if that's the right way of putting it, is obviously thinking about, okay, so in the past, I would have said, "My Phase II/III trials go to these 4 CROs." We're trying to, I suppose, lead them and say, "Listen, well, sure, we can do that for you. But we can also do your imaging. We can do your translation services. We can do your central laboratory services. We can do your early phase services. We have such a broad spectrum of what needs to be done from Phase I through IV. And we can do your post-approval trials as well, by the way, and your registration trials." So we do have a broad spectrum. Like we like to think that we touch pretty much everything that happens on that first-in-human right through to post-approvals certainly from a long-term study perspective. And I think that's the opportunity. Because there's still a lot of separate buyers within pharma companies that are very, very isolated. And we have that opportunity, I think, to kind of push this conversation with them a little bit this year, "You guys want to tighten your belts, that's fine. We'll help you in that." But we also want to have then access to the option, the optionality of that in a bigger range of services. And so that's the kind of ongoing dialogue that we're having with our customers, in some customers at the moment. And I have to say that, I think, that's finding more traction as the years go on. We talked, Dave, in the past about there was very little linkage between our lab and our Phase II/III business. That's now -- we've seen much, much more connection now between the customers, if not the trials, certainly that we work on between those 2 parts of our business.

My sense is that this particular go-to-market strategy or evolution has found some traction in some specific situations very recently, like maybe the last 6 months.

I think -- yes, I think that's it. I mean, as people have -- and as we know, I suppose there's a spectrum out there at the moment in terms of pharma companies. Some obviously are benefiting from some of the new class of drugs around weight loss that are coming in and have huge amounts of funding off the back of that and want to continue to do their development plans and have got big plans to expand R&D bases. Others have had structural issues, where they're coming down off revenue profiles and obviously are doing a lot of cost containment. So yes, I think it plays to both dynamics. You're saying to one cohort that you can help them obviously develop and use -- better use of their dollars to make sure that they get all the drugs that they want to the market. The other one, you're saying we can be more efficient in how you overall maximize what you do -- what dollars you do have to spend. And we can make sure that you're as efficient as you can be from that perspective. So I think it plays well in both cases.

Let's talk for a few minutes about the pendulum swing between full service and FSP. We have -- I think pendulum swing is the appropriate characterization; it goes one way and it comes back. Where are we in that pendulum swing right now? And what do you think is driving that?

Again, I think it probably comes back to some of the comments we made earlier about there certainly is belt tightening that's happening a little bit with our large pharma customers. And I think we certainly see that swing towards FSP at the moment. It's blended, it's not just pure FSP. There's -- and I think as a fairly sophisticated company running FSPs, we want to make sure that our customers understand that, yes, you can have that FSP model, where you're paying for the individual to do clinical monitoring, but let's also change the paradigm of that. What you actually want is an output or an outcome. So you want efficiency. And that might be days on sites for a clinical monitor. It might be pages for a data manager. So it should be around the efficiency. We gain from that by selling them the idea of efficiency means we can unitize the work and make better margin profiles. But also it then is actually answering the question that they're asking us about how efficient can we be as organizations in terms of how we spend. The last couple of years has been -- yes, it's been very heavy from a full-service perspective. And so to your point, we always get these pendulum swings. It's not the first time we've seen it. I think that pressure may be around their thought process, around what their R&D budgets look like for the next 3 or 4 years has definitely led them to thinking more about FSP, more about those type of blended models. And they want to enter into those partnerships with organizations who have a lot of experience in both types of modality. I think one of the important things for us as an organization is that we have big, embedded relationships with these large pharma companies. And whether that's led by FSP or full service, we kind of know as well that, at some stage, that pendulum will swing back. And if you're well embedded in the customer, whether it's through the FSP range or through the full service range, that's really where you need to be with these full -- or these very large pharma partners in order to make sure you've got a very sticky relationship.

Do you think that the growth in FSP is more reflective of currently internally -- fully internally managed work, so outsourcing that is going to FSP or shift from full service work to FSP or both?

I think it probably is a blend. Some folks are looking at it as optionality, so not necessarily, it could be FSP provider to FSP provider and consolidating their base in terms of how many FSP providers they have on their books. Certainly, some of it is that. I think some folks are thinking about, yes, is it more that I use more FSP and maybe that's in more of a blended hybrid solution than we would have done previously with full service? I think it's also fair to say, and we do see this with a couple of customers who are going absolutely the opposite direction, so going from having FSP contracts back to full service work. So the point, I suppose, that we're never all together exactly moving in the same direction, and that's the case. So we do see -- I mean, I think the weighting is probably more towards folks moving towards FSP, consolidation of that, moving slightly away from full service, which is fair. But again, we do see some folks having done that for the last number of years now swinging back the opposite direction. It's hard to tell who's in front and who's behind in terms of where the trend is.

Got it. Okay. And then maybe talk a little bit about the margin differential between those, to get a little financial here since you're the CFO, the kind of gross margin differential between FSP and full service.

So it's maybe not as meaningful as has been talked about in the last little while. And maybe that's -- part of that is our experience of running, as I said, the largest FSP business in the world. We obviously have a blended margin of -- in the 29% to 30% gross margin profile as an organization. It is fair to say that our pure full service work is a couple of percent higher than that in terms of its margin profile. It's also fair to say that our FSP work is a couple of percent below that. So one is in the kind of in the mid- to high 20s and the other one is in the kind of low 30s. On a blended basis, obviously, we make that work towards that 29%, 30% margin profile we see across the organization. And I think that's still what we expect as we go forward with this margin profile as we go into next year. Of course, if we see a little more FSP than we're currently anticipating, and that's been obviously the trend in the last little while, there could be that little bit of gross margin pressure. But I think it's probably in that -- 29% to 30% is still in the range of what our expectation is from our gross margin as we go through the course of next year. And that's even with some of that mix shift coming in. So I don't see it as being meaningfully detrimental. But I think the other piece that we've often talked about, Dave, is the fact that we always feel that we have good visibility through our SG&A base. And we feel that the leverage we can get out of that will, by far, outweigh any cost pressure we have from a business mix perspective as we go into '24.

Got it. So just want to understand the gross margin implications. So am I understanding you to say that you think gross margin will be fairly stable even though FSP is probably growing and that's a negative mix shift?

I think it's stable in that range of 29% to 30%.

Got you. Okay. So could move, but not to any great magnitude?

That would be it.

Okay. In terms of kind of your positioning in FSP, is being the biggest player with the most, I call it, flavors or variations within the different functions that you can treat in a functional service provider mode, how does that give ICON an advantage?

I think it just -- again, I mean, you're looking at -- FSP is an interesting animal. Because you've got a lot of procurement organizations, from a large pharma perspective, who would come in and think, oh, this clearly makes more sense because the rate per head might be lower that you'll get than you will on a full service work. But I think there's a lot of misnomers tied up in that. And so for example, one of the big things would be the experience of the staff. So of course, you can always reduce the cost of the FSP by having first- and second-year CRAs. But of course, then, the corollary of that will be your clinical development teams will be literally pulling their hair out because they're super concerned about the quality of the service that they're going to have project managing and working on their trials. So I think where we -- where our great experience comes in from is that actually, in some way, saving -- I wouldn't say saving the pharmas from themselves but certainly making sure that as we have these conversations with them, we're able to bring that experience to be able to say, "Actually, your indication, you really need more experience. You really need people who have 2, 3 years' experience from a clinical monitoring perspective. You need to combine that with a project management team, who have experience in this space." We may often sell both sets of folks. And then that's where the blending comes in. Because then you're saying, "Actually, we're not only going to give you monitors, we're going to give you project managers, and we're going to have a spine of a technology around that, that will help you use it and work it." So you still get the benefit from a rate perspective, but it's becoming something more like the -- getting a much better bang for the buck. And that's the utilization and all those pieces we spoke about in terms of optimizing margin and moving away from that it's a cost per head per day kind of model. So I think it's just -- to be honest, Dave, it's the weight of our experience, I think, that we're able to bring to the table that allows us to take the very bog-standard model and then actually blend it all the way up to something that looks like full service.

And on this, since this is a labor-driven business and we're talking about perhaps the most labor-driven part of it, what is the labor environment today? And how has that moderated from the peak of the pandemic?

Yes, it's much better, thankfully from where we were. We have now got turnover rates which are probably better than they have been in -- even prior to the pandemic. So we're in a very, very good place from that perspective. There's a lot of consistency in the workforce. And of course, as a pharma partner, that's what you want to see, right? You want to see that you've got to see CRAs, the same project management teams, the same project directors. And we have very little turnover above the manager level. So the vast majority of the turnover is at that lower level of the organization, which you'd expect when you've got folks who are coming out of university and they're in the kind of 25- to 35-year range. So there is more turnover in that cohort. But even in that cohort, it's down substantially. So it also allows us to manage the cost base better. We've got better consistency of project teams. So that's all been very positive over the last while. And I think gives us real ability to make sure we've got good retention of customers.

Coming back to the SG&A point discipline that you mentioned earlier but thinking about that specifically in the context of the PRA merger, are you to the point that you feel like you've extracted all the discrete synergies there and you're now just thinking combined company? Or are some of the levers you can pull in '24 still related to that?

I've never been a huge fan -- as you know, Dave, we chatted about this before, I've never been a huge fan of the phrase synergies because it gives the -- I've often wondered where does that go in the margins when you hear some companies talk about it. I've always been much more focused on what our margin profile can do. I think any of the easy, bring together organizational synergies certainly have been taken to this point. But I don't know if that deters me from, I suppose, our ability to continue to leverage our cost base and continue to think about how we are smarter at what we do, how we use more automation, how we pick and choose where we do, what services and our internal services in the organization as well. So I do think that's something that we kind of have often talked about. A couple of years ago, when myself and Kate and the other members of the management team were in Blue Bell talking to the market about what we expect from a margin perspective, obviously, we've put 21% out there as a target. We hit that in Q3 about a year and a bit in front of where we thought we would. But we also put out there that kind of idea of actually wanting to get to about an 8% SG&A line in the future. That's still very clearly on our horizon. That's where we want to go to. We're obviously 8.8% in Q3. But that's -- certainly, as I think you guys know of us, we don't tend to say numbers unless we can hit them. And that's where we're thinking about and talking about internally as an organization about where we can get to.

Excellent. And I would affirm what you just said. That is true. On the elements of the merger that kind of strategically required separation, have you been able to defend that? In essence, what is the temptation to put the ICON and PRA clinical operations businesses together to extract more, let's say, streamlining?

Yes. No, there is -- I said there is that -- that temptation is always there. I think we've been very careful about that, quite slow and deliberate in our processes around that. And we've made sure that we most fundamentally continue to serve the 2 customer bases, which was obviously the biotech-specific and then the mid and large customer base there. That's something that we still are in the process of. Some of the functions we have brought together, where it makes just more sense, but there fundamentally isn't a huge amount of differential between how you deliver for a biotech versus a large pharma company. But honestly, we think we've been more disciplined about that. And we've really maintained those workforces so that neither side feel like they're being diluted by the other at this point. We'll see how that continues as time goes by, but it's certainly been working for us to date.

Okay. The zeros are flashing at me, but I'm going to ask one more. The Accellacare site business, how important has that become in your ability to execute and deliver trials faster and, therefore, important from a capital allocation standpoint to continue to grow it?

I think it's -- and I mean, during -- there are obvious periods certainly for -- during the vaccine work that we were doing prior, was a clear, clear advantage. There was no question about that. Some of the best recruiting sites that were on the entire Pfizer trial for their antiviral were actually our Accellacare sites. So there was absolute definitive piece around that. And in some of those ambulatory settings, primary health care settings, vaccine-type settings, they're still extremely strong. The piece we've been trying and the nut we still have to crack is how do we then take that and put it into oncology? How do we take it and put into CNS? They're the pieces that I think we're still working on, Dave. That's the piece where I'd like to continue to fund and develop that group. How can we be more specific in our site networks? Can we have dedicated CNS elements? Can we have dedicated oncology elements to it? That's a piece that we will continue to work on and continue to invest in. And hopefully, that will help us move more substantially to helping speed up patient recruitment in those areas.

Excellent. I'll wrap it there, and help me to thank Brendan for his time here, and appreciate your time here. Thank you.