Fortrea Holdings - Earnings Call - Q4 2024

Executive Summary

• Q4 2024 revenue was $697.0M (down 1.8% YoY; up sequentially), GAAP diluted EPS from continuing operations was $(0.82), and adjusted EBITDA was $56.0M; book-to-bill was 1.35x and backlog ended at $7.699B.
• Management issued FY2025 guidance well below FY2024 actuals: revenue $2.45–$2.55B vs $2.696B in FY2024 and adjusted EBITDA $170–$200M vs $202.5M in FY2024, citing slower burn and lower margins on pre‑spin projects; SG&A net savings of $40–$50M are targeted in 2025.
• The quarter’s positives were strong CPS (Phase I) momentum, disciplined pricing, and improved customer satisfaction/NPS; however, late‑stage portfolio mix, slower onboarding of new wins, and TSA transition costs weighed on profitability.
• Investor sentiment was challenged around the print/guidance; an analyst noted the stock traded below $10 the morning of the call, with management highlighting cost actions and operational transformation as key levers going into 2026.

What Went Well and What Went Wrong

What Went Well

• Strong commercial momentum: book-to-bill 1.35x in Q4 and 1.29x in 2H; backlog grew to $7.7B; CPS posted its most successful quarter ever, with repeat awards and capacity investments.
• Pricing discipline and improved customer experience: “Our positive progress is also reflected in our improving quality metrics and increasing customer satisfaction scores” — CEO Tom Pike.
• TSA exit and systems go-live: migrated 17k devices, 8k phones, 500 applications, and built 1,600 servers; HR ERP went live Dec 16, finance ERP Jan 2, enabling process efficiencies post-spin.

What Went Wrong

• Pre‑spin project mix: older, late‑lifecycle full-service contracts are “burning more slowly” and at lower profitability; new wins are not ramping fast enough to offset in 2025.
• SG&A headwinds: incremental one‑time spin/TSA costs and securitization yield costs kept SG&A elevated; Q4 included a $21.3M restructuring charge to align resources.
• Margin pressure and guidance reset: FY2025 adjusted EBITDA margin guide implies further compression vs FY2024 (7.5% in FY2024), with margin recovery deferred into 2026 as mix improves.

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to Fortrea fourth quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would like now to turn the conference over to Hima Inguva, Head of Investor Relations and Corporate Development. Please go ahead.

Hima Inguva (Head of Investor Relations and Corporate Development)

Good morning, and thank you for joining Fortrea's fourth quarter 2024 earnings conference call. I am Hima Inguva, Head of Investor Relations and Corporate Development at Fortrea. On the call with me today are our CEO, Tom Pike, and CFO, Jill McConnell. The call is being webcast, and the slides accompanying today's presentation have been posted to the Investor Relations page of our website, fortrea.com. During this call, we'll make certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to significant risks and uncertainties that could cause actual results to differ materially from our current expectations.

We strongly encourage you to review the reports we file with the SEC regarding these risks and uncertainties, in particular those that are described in the cautionary statement regarding forward-looking statements and risk factors in our press release and presentation that we posted on the website. Please note that any forward-looking statements represent our views as of today, March 3rd, 2025, and that we assume no obligation to update the forward-looking statements even if estimates change. During this call, we'll also be referring to certain non-GAAP financial measures. These non-GAAP measures are not superior to or replacement for the comparable GAAP measures, but we believe these measures help investors gain a more complete understanding of results. A reconciliation of such non-GAAP financial measures to the most comparable GAAP measures is available in the earnings press release and earnings call presentation slides provided in connection with today's call.

With that, I'd like to turn it over to our CEO, Tom Pike. Tom.

Tom Pike (CEO)

Thanks, Hima. Good morning, everyone, and welcome to the call. Today, we're pleased to share Fortrea's fourth quarter results and look forward to what's ahead in 2025. I'll start with our commercial success. In the fourth quarter, we delivered a strong book-to-bill of 1.35, resulting in a 1.29 for the second half. Since our spin, our book-to-bill has averaged 1.2 times, which is what we had targeted. Our year-ending backlog has grown to $7.7 billion. We're pleased with the transformation of Fortrea's sales capabilities over this past 18 months. We delivered these sales with pricing discipline. Let me provide some color. We saw continued strong new business in our market-leading phase one Clinical Pharmacology Services business, which we call CPS. This included significant repeat awards from our largest CPS customer.

In fact, the fourth quarter was our most successful quarter ever in CPS sales, where we've made major investments in our network of clinics, strengthening our offering and increasing capacity. Beyond CPS, our awards for full-service clinical work from large pharma were also strong, including Global Oncology Studies and a Sole Source Award in Gastroenterology. We were also selected as the sole provider for drug safety services by a large pharma customer with an innovative solution that has an integrated AI tool for literature searches and medical writing to support post-market surveillance. Our success in supporting the biotech sector with full-service solutions also continued to pace in the fourth quarter. We were very strong in biotech oncology wins again this quarter based on our expertise and strong study delivery.

Beyond oncology, we want to cross a broad range of therapeutic areas, from a global phase II infectious disease study to a sole-source win in ophthalmology, an area in which we are building a strong reputation. I'd also like to call out a few other commercial highlights from the quarter. We had good sales in Asia-Pacific as customers in this region recognized our capabilities to support them with global programs. For instance, this quarter, wins included a nice global phase III oncology study and a significant medical device program. We were also pleased to have been selected for a global study led out of Asia-Pacific as part of a collaboration with a large pharma customer. Also, our consulting organization is implementing multiple real-world evidence studies in Asia-Pacific for a large U.S.-based large pharma firm looking to grow their business in the region.

We delivered a solid performance in functional service provision, which we call FSP, in the fourth quarter as well. In addition to some solid sales in this part of the business, we helped a large customer complete the launch of a safety platform through a very large FSP effort that we will now continue to operate. This implementation was the culmination of almost 24 months of work, integrating 11 complex systems and more than 80,000 product licenses, migrating about 3 million cases. Our safety and IT teams collaborated with the customer to deliver the platform ahead of schedule. It's a demonstration of Fortrea's capabilities applied to a complex situation for a customer. Our consulting group continues to grow, developing real productivity solutions for the industry and providing customers with science-based strategy from clinical development planning and regulatory strategy to real-world evidence solutions.

For example, our team delivered qualitative and quantitative research studies to support FDA acceptance of clinical outcomes assessment endpoint measures and incorporated the novel measures into two SMDA filings with one approval so far for a biotech customer. Our improving clinical pharmacology and later-stage full-service outsourcing delivery is contributing to our strong book-to-bill. It is not the only place we are seeing the improvements manifest. One of the first things we established after the spin was a comprehensive customer relationship feedback program, including a Net Promoter Score, or NPS, measurement system. I am pleased to share that our NPS scores have significantly improved over the year. We believe that we are creating a better customer experience of working with Fortrea, as well as understanding additional improvements that we can make.

Another highlight worth noting from the fourth quarter is the successful exit of most of the Transition Service Agreement, or TSA, with our former parent. That success has continued in Q1, and after this quarter, we expect payments to our former parent to be a fraction of what they were. Our team has delivered. It was no small feat. For example, to transition to the new Fortrea digital environment, we migrated 17,000 devices, 8,000 mobile phones, 500 applications, finished building 1,600 servers, as well as the launch of our HR ERP on December 16th and launched our Finance ERP platform on January 2nd. I want to commend both the Fortrea team and our effective teaming with technology partners to deliver these incredible results. Now, let me transition from customer successes. In both CROs I've run, I viewed the most important leading metric to be book-to-bill.

I'm certainly proud that our average book-to-bill is 1.2x since spin, and it bodes well for the future. However, let me discuss the big issue here. Our targeted revenue and Adjusted EBITDA trajectories for 2025 are not in line with our prior expectations. Let me remind you, this spin was lift and shift. We've been using the same management processes and systems that a division of a much larger company used, ideally waiting to update them until we convert them to our own environment. As we implemented our environment in connection with exiting the TSAs, we did a deeper analysis of full-service projects and other inputs to longer-term forecasts. Given this analysis, we have a better picture of the revenues, costs, margins, and timing on the full-service work for projects from the pre-spin period, and we understand that they represent a bigger slice of the pie in 2025.

This analysis, which also took significant time to confirm, indicated that the pre-spin projects, many late in their life cycle, have less revenue and less profitability than expected for 2025. The strong book-to-bills and spin are creating work that's sold and delivered at good margins. This post-spin work is not coming on fast enough to offset the pre-spin contract economics. This older versus newer mix issue will continue to negatively impact our financial performance during 2025 until revenue from our new business wins becomes a larger portion of the mix. We're implementing new management systems and processes that are sized with details and granularity appropriate for an independent company of our size. They will enable us to align our resources to the work we need to do to complete trials more efficiently and profitably.

Marcus Aurelius, the Stoic and Roman emperor, championed the idea of something called Amor Fati, which means embrace your difficulties as part of your journey. That is what we have to do here at Fortrea. We keep moving forward. Now, let me hand over to Jill.

Jill McConnell (CFO)

Thank you, Tom, and thank you to everyone for joining us today. As a reminder, all my remarks relate to continuing operations of Fortrea following the divestiture of our enabling services businesses last year, unless I note otherwise. I want to acknowledge that this period with limited communication to the external investment community has been challenging. As we got later into the fourth quarter, we realized that we needed to do significantly more analysis along a number of dimensions before continuing to communicate. It was important that we had the full picture of 2024 results, including ensuring that TSA services exits and strong book-to-bill were delivered and understanding where we might be falling short. We used this quiet period to interrogate our expectations for 2025 guidance and to ensure we had transformation programs underway so that we could provide the detail and transparency we are sharing today.

In my remarks, I will focus on the details of our 2024 results, our 2025 guidance, including the actions we have taken and will continue to take to reduce costs, and our outlook for the medium term. I will also discuss our transformation plans in detail so you understand how we plan to track our progress against them. As Tom shared, we had some very compelling successes in 2024. In addition to what he shared, recall that we sold two non-core businesses and paid down debt, reducing our annual interest expense. We also reduced our DSO by 60% versus last year. I'm incredibly proud of our teams for the on-time launch of our standalone HR system and our Finance ERP, and also for their efforts to enhance our internal control environment, which resulted in the successful remediation of the material weaknesses identified last spring. Now, I'll cover the financial results.

For the fourth quarter, revenues of $697 million declined 1.8% year-on-year. The lack of growth versus the prior year was driven by lower late-stage clinical service fee revenue, partially offset by higher service fee revenues from our phase I clinical pharmacology business. Our phase I clinical pharmacology unit has continued to perform well. Our later-stage clinical business is performing well for customers, as evidenced by their higher NPS ratings. However, service fee revenue declined based on a combination of factors, including lower new business awards in the pre-spin period, along with a mix of later in their life cycle and longer duration studies in our backlog, including slower-burning studies such as oncology, which have continued to be a significant part of our portfolio.

The fourth quarter was also negatively impacted by the effort associated with the system transitions to exit the TSA services, along with a more pronounced impact of the holiday period compared to historical experience. Pass-throughs as a percentage of total service fee revenue have remained generally consistent year-over-year. Full year 2024 revenue of $2,696.4 million, which was broadly in line with our guidance range, decreased 5.1% compared to revenue of $2,842.5 million for full year 2023. On a GAAP basis, direct costs in the quarter decreased 3.8% year-over-year, primarily due to lower personnel costs as a result of restructuring actions. These savings were partially offset by an increase in professional fees and stock-based compensation, as well as targeted hiring where necessary to support specific needs.

SG&A in the quarter was higher year-over-year by 16.9%, primarily due to an increase in professional fees and incremental one-time costs incurred for exiting the TSA services, along with the yield costs related to the receivable securitization program we initiated in the second quarter of last year. If you exclude the impact of one-time costs related to the spin, as well as the impact of the yield costs, underlying SG&A as a percent of revenue was broadly consistent with the previous two quarters. Net interest expense for the quarter was $21.9 million, a decrease of $12.6 million versus the prior year, primarily due to the $475 million in debt paydowns across our Term Loan A and Term Loan B that were made in June 2024. When combined with our securitization program, interest and securitization costs for the fourth quarter were down approximately 22% compared to the fourth quarter of 2023.

Turning to our tax rate, the effective tax rate for continuing operations for the quarter was a benefit of 1.2%. The rate was negatively impacted by withholding taxes on our 2024 non-U.S. earnings that we asserted are not permanently reinvested and an additional valuation allowance against our deferred tax assets. Our book-to-bill for the quarter was 1.35x, and for the trailing 12 months was 1.16x. Our backlog is at around $7.7 billion and has grown 4.2% over the past 12 months. Adjusted EBITDA for the quarter was $56 million compared to Adjusted EBITDA of $58.9 million in the prior year period. Adjusted EBITDA for full year 2024 was $202.5 million compared to Adjusted EBITDA of $245.8 million for full year 2023. Adjusted EBITDA margin for full year 2024 was 7.5% compared to 8.6% for full year 2023.

Adjusted EBITDA margin in the quarter and for the year was negatively impacted by the lower late-stage clinical service fee revenues, along with higher SG&A costs post-spin to support operations as a public company following the separation from our former parent. These were partially offset by the benefit from the restructuring program we initiated in the third quarter of 2023, which continued through 2024. Now, we'll move to net income and adjusted net income. In the fourth quarter of 2024, net loss was $73.9 million compared to net loss of $48.6 million in the prior year period. Full year 2024 net loss was $271.5 million compared to net loss of $31.7 million for full year 2023. In the fourth quarter of 2024, adjusted net income was $16.6 million compared to adjusted net income of $12.7 million in the prior year period.

Full year 2024 adjusted net income was $30.1 million compared to adjusted net income of $111.9 million for full year 2023. For the current quarter, adjusted basic earnings per share was $0.34, and adjusted diluted earnings per share was $0.33. Turning to customer concentration, our top 10 customers represented 53% of 2024 revenues. Our two largest customers accounted for 14.3% and 10.5% of revenues, respectively. As I comment on cash flow, note this relates to Fortrea in total, as we have not segregated cash flows from discontinued operations. For the 12 months ended December 31st, 2024, we reported $262.8 million in cash flow from operating activities compared to $168.4 million generated in the prior year.

Cash flow for the full year benefited from the initial sale of receivables under the securitization facility in the second quarter and an increase in unearned revenue, as well as strong cash collections, partially offset by the decrease in net income. Free cash flow was $237.3 million compared to $128.1 million in 2023. Net accounts receivable and unbilled services for continuing operations were $659.5 million as of December 31, 2024, compared to $988.5 million as of December 31st, 2023. Days sales outstanding from continuing operations was 40 days as of December 31, 2024, 10 days lower than September 30th, 2024, and considerably lower than the equivalent of roughly 100 days at 2023 year-end. The reduction versus the third quarter is due to our focus on billing and collection processes, along with our efforts to enhance our contracting terms.

We are compliant with the financial maintenance covenants of our credit agreement as of the end of the quarter. We ended the quarter with more than $500,000,000 of liquidity. Although we expect to remain compliant with our debt covenants going forward, in order to provide more flexibility, we renegotiated our net debt leverage ratio to provide more certainty through the fourth quarter of 2026. The maximum leverage ratio was increased from 5.3x to 6.0x for the four quarters beginning with Q3 2025, stepping down in both the third and fourth quarters of 2026, and reverting to 5.3x afterwards. With our TSA services exits largely behind us, we plan to focus our capital allocation priorities on targeted investments to drive organic growth and improve productivity, along with debt repayment. Now, turning to 2025 guidance.

Using exchange rates in effect on December 31st, 2024, we target our revenues to be in the range of $2.45 billion-$2.55 billion, and our Adjusted EBITDA to be in the range of $170 million-$200 million. Note that due to the nature of where revenue is contracted versus our global employee footprint, using December 31st, 2024 exchange rates provides a headwind to revenue and a tailwind to our cost base. The lower revenue targets year-on-year are driven by our project mix, which is burning more slowly due to the pre-spin awards moving through the later stages of their life cycle, and our therapeutic mix with a significant portion in oncology, which burns more slowly than other therapeutic areas. The post-spin portfolio is also impacted by slower startup and biotech projects and the soft first-half bookings in 2024.

The lower margin targets are driven by the inefficiencies in the pre-spin portfolio and the inherited SG&A costs that we are actively working to reduce. Many of the pre-spin projects are extended in duration and are well into their life cycle, as Tom described, both of which create headwinds to growth and margin expansion in 2025. Now, I'll discuss our robust transformation plans for 2025 and beyond. We believe the key to our transformation is restarting revenue growth, which is why we are laser-focused on continuing to build on the success of our commercial engine. To date, we've made good progress delivering strong book-to-bills in the second half of both 2023 and 2024 and have delivered a solid 1.2x average in the six quarters since the spin.

We continue to see an attractive pipeline of opportunities in all phases of clinical work, both full service and FSP, and we believe we are well-positioned to capitalize on this. We plan to increase our investment in biotech in 2025. Overall, we have about a 50/50 split between large pharma and biotech customers, and we believe it is a competitive strength. For 2025, we continue to target achieving a 1.2x average book-to-bill. Turning to our savings program, we've spoken previously about needing to bring our SG&A costs more in line with peers over time. Now that we are essentially exited from the TSA services with our former parent and are operating in our own enterprise systems, we have initiated transformation programs to reduce personnel costs, consolidate IT applications and licensing expenses, and to further optimize our facilities footprint and our third-party vendor spend.

We target year-on-year net savings of $40-$50 million in 2025 from these initiatives. This is included in our guidance, with the benefits increasing over the course of the year, and you should see a year-over-year reduction in total underlying SG&A spend. We expect these programs will extend into 2026 as we continue our efforts to bring our SG&A spend more in line with peers. Note that since the spin and separate from the divestitures, we have reduced more than 1,400 positions across our operations and SG&A teams in an effort to better align our cost base with our revenue profile. That journey is continuing, and we took a charge of $21.3 million to our P&L in the fourth quarter to recognize the additional restructuring programs we've already kicked off for 2025.

It is important to understand that since the spin, we have not had the impact of incentive compensation in our results due to our financial performance. We are restarting these programs for 2025, so we anticipate these programs to be a headwind compared to prior years. Regarding our operations optimization, we're looking at our projects as two categories: pre-spin awards and post-spin awards. With our pre-spin projects, we will continue to work on having an optimized level of resourcing and utilization and ensure we are compensated for the scope of work that we perform. Our goal is to see the pre-spin projects through to completion as efficiently as possible. At the present time, they are the vast majority of our later-stage full-service clinical revenue. We have included some operations restructuring in our 2025 guidance and will continue to seek opportunities for further optimization.

Our post-spin projects are performing well, and we will continue to look for opportunities to accelerate delivery. The post-spin projects only represent a small percentage of our full-service clinical revenue, less than we expected at this point. They will grow as a proportion of revenue over time, but we don't expect them to become the majority of our later-stage full-service clinical revenue until the second half of 2026. In order for you to follow our progress, we intend to discuss each quarter how these post-spin projects are becoming a larger percentage of our later-stage full-service clinical revenue over time. Because our 2025 guidance is not in line with what we expected a few months ago, I'll now share our current view of modeling for 2026. First, we prepared multiple years of project-by-project forecasts at a level more detailed than ever done previously.

We analyzed and adjusted other assumptions, including that the level of change orders and cancellation rates remain in line with our historic norms and current experience. For net new business assumptions, we used a more conservative 1.15x for our modeling. We applied a burn rate assumption similar to what we have experienced since the spin. We're planning for another 100 basis points of reduction in SG&A costs in 2026. With these parameters, our modeling anticipates a return to growth in the first half of 2026. Before I conclude, I want to take a moment to recognize the incredible hard work by Fortrea employees to deliver strong book-to-bills and results for customers and to exit our TSA services and streamline our infrastructure. We've shown this organization can accomplish difficult things.

There is still work to be done, but we have put in place the building blocks to create long-term value for all our stakeholders. With the solid foundation we have laid in the past year, attractive backlog of nearly $7.7 billion, and our talented global team, we are committed to delighting our customers and returning to growth and margin expansion. Now, I'll turn it back to Tom for the remainder of his remarks.

Tom Pike (CEO)

Thanks, Jill. Ultimately, our vision is to be the best choice CRO, a company that moves with the speed of science, listens intently to customers, and delivers with precision. While 2025 will continue to be a period of transition, the long-term trajectory is clear. We believe that we can master agility, scientific excellence, and customer-focused execution to define the next era of CROs.

By embracing this mindset, we are positioning ourselves not just to compete, but to lead. Now, regarding shareholder value creation, I'm not satisfied with where things stand, and we're reviewing additional opportunities for growth, cost reduction, and shareholder return. I'm still bullish on the CRO industry and Fortrea's role in it. The future of clinical research is being shaped through rapid advances in science and biology, evolving regulatory landscapes, and increasingly the transformative potential of AI. We believe the clinical research industry will grow, and CROs will be a key part of it. Here, as Jill said, our pipeline is solid, and we've demonstrated we can sell. We can also deliver sophisticated solutions for customers and are supporting leading-edge science that promises significant advances for patients.

For instance, we're proud to be working with several biotechs who are developing silencing RNAs to treat a variety of cardiovascular diseases, including hyperlipidemia and thromboembolic disease. New drugs can be administered as little as once every six months, significantly reducing patient burden and improving compliance. CAR-T therapies are the most common pipeline technology for genetically modified cell therapies, and Fortrea is one of the very few CROs that has ever successfully brought a CAR-T from first in human to market access. A new trend with CAR-Ts is treatment of autoimmune diseases, and Fortrea is there. The clinical research industry needs to evolve. Success will depend on our ability to be both agile and disciplined, more flexible in how we design and execute trials, upholding ethical and regulatory standards while running a good business. The intelligence revolution, or 4IR, is upon us.

Technology, particularly AI, will revolutionize clinical research over time, but we believe the greatest impact will come from combining these innovations with deep operational, therapeutic, and regulatory expertise. Our role is not simply to manage studies, but to bring intelligence, productivity, flexibility, and problem-solving capabilities to every trial we conduct. Fortrea is pushing ahead in a focused way on AI. We examined 185 use cases last year. We have specific initiatives coming from that, such as to further enable our Accelerate platform, as well as democratizing AI, which means cost-effectively rolling it out broadly to our people for productivity and more. We believe we can transform Fortrea for this future. In the past year and a half, we've demonstrated improvements in customer satisfaction and quality, all the while conducting an enormous transition as a spin-out. Over coming months, you will see this energy directed toward transforming for the future.

I'll close by recognizing the incredible efforts of our team at Fortrea. We have tremendous therapeutic, regulatory, and operational experts across the globe. Their dedication and hard work have been instrumental in driving our success and positioning us for a bright future. Driven by our purpose of delivering solutions that bring life-changing treatments to patients faster, our team is ready to accelerate. Stay tuned. Now, let's turn to our operator to begin Q&A.

Operator (participant)

Thank you. As a reminder to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. The first question will come from Patrick Donnelly with Citi. Your line is now open.

Patrick Donnelly (Analyst)

Hey, guys. Thanks for taking the question. Tom, maybe one for you, just on kind of the trajectory here, 25 into 26.

It sounds like you're citing kind of these pre-spin projects that were less rev, less profitability, this old versus new mix issue with a return to growth in 2026. I guess, can you just talk about the process to identify that, why it took so long to kind of identify what was going on, and again, that that was going to really weigh down 2025? Was this just getting contracts done before the spin, and the financials got a little bit loose? I guess on the back of that, just the confidence in the trajectory of the new mix, picking things up as we work our way into 2026?

Tom Pike (CEO)

Yeah, thanks, Patrick. Yeah, as I said, you try to use the existing processes. You can't change everything.

If you think about it, when you do a spin, you have some things you're trying to proactively change, like get out of the TSAs. You're trying to, in our case, we had to really redesign the commercial function and make it much more effective. You have these proactive things, and then you have reactive things along the way. What we determined here is that really the systems and processes associated with forecasting needed to get to a much more detailed level for us to have confidence in 2025. We had some signs of this, but as you can imagine, to deliver this kind of guidance, we really had to do a lot of confirmation. There was an initial pass at it, and then much more detailed analysis project by project, as Jill described in her remarks as well.

The result of that, which really took a couple of months to complete, is what you see here. Nobody wants to bring this kind of news. As a shareholder myself, I don't want to bring this kind of news, but we think we need to deal with the reality of this pre-spin portfolio and put it out there. I'd say the other thing, Patrick, that did surprise us in this analysis is that the newer work, the good work we've sold, which is being delivered at original deal economics, as we call it, is starting more slowly than I would have expected. We think some of that is our heavy mix of biotech that we have. Whereas you've heard from us and some of our peers, there is a longer process for startup in many cases. In addition, there is quite a bit of oncology.

As you heard my examples, we do a lot of excellent oncology work here, and it does burn a little slower. All of that took a few months, frankly, to identify, analyze, confirm, go through the forecast, every element, change orders, forecasts, etc., to sort out because we did not want to bring this kind of news lightly. We needed to make sure that we were confident in the underlying assumptions.

Patrick Donnelly (Analyst)

You mentioned there at the end, Tom, just the shareholder return opportunities. Stock broke below $10 this morning. I would love to just kind of pull the curtain back a little bit there. What do you see as a reasonable path forward here? What are the focus points, and what can you guys do to kind of unlock a little more value here?

Tom Pike (CEO)

Yeah, a few things.

These bookings, I believe, led our industry in the third and fourth quarter. The company is demonstrating that it does very good work for customers. I tried to give you guys a sense of that. I know that's a lot of detail for a call with our analysts and investors, but I would try to give you a sense that we do very good work, and our work is improving, and it's well received by customers. That's the number one thing. What Jill was describing in her remarks too is we continue to really have a couple of very focused programs. One is growing the stuff that we can grow, like clinical pharmacology business, continuing to grow that, really looking hard at growing FSP this year, and continuing to focus on full-service outsourcing.

At the same time, it is transforming our SG&A, and you heard that remark about the $40 million-$50 million improvement that we're looking for associated with it. Frankly, continuing to transform our operations in full service. With this more detailed information, we think we can align resourcing more effectively. We've given you a sense through these numbers of what we believe is clear, but we're going to continue to work on optimizing how we deliver to make sure we're delivering with quality and meeting customer expectations or exceeding them, but also doing it cost-efficiently. We're going to have those two programs very heavily. I should also mention that we also have one in the IT area.

It is very interesting because we know it's transformative in AI, but we also know that we have to deal with application rationalization and tech debt that we've got here from the prior decade. We have a very strong executive there who's driving improvements in that area too. Patrick, anything else? Okay. All right. Thank you, Patrick.

Operator (participant)

The next question comes from Justin Bowers with DB. Your line is open.

Justin Bowers (Analyst)

Hi, good morning, everyone. Just trying to help understand the cost structure a little better and then the top line assumptions as well in the guide. You talked about going into 2026 with a burn rate that's consistent with historical patterns, but it looks like with the revenue step down, that implies something around an 8% burn rate, which would be over 100 basis point contraction year-over-year.

Is that sort of the right ballpark for how we should be thinking about 2025? I just want to confirm that it sounded like earlier in late 2024, you talked about a lot of the opportunities being with large pharma. Tom, you also just mentioned some of the focus on FSP as well. I really just want to understand sort of the execution there and the opportunities that you're seeing in 2025 and how that plays into the burn rate. I'll come back with part two on the cost structure.

Tom Pike (CEO)

Why don't I start with that part, if you don't mind, Justin? In terms of the mix, we're still about 50/50, and we like that mix. We've been pretty successful with biotech.

You guys might recall that we talked about how in the third quarter and fourth quarter, we had the more balanced exposure in terms of the bookings to those two areas, the large and then the biotechs. We did deliver with that. As you look forward, we actually have a good pipeline now. I think we've learned in this business not to try to overcommit at this point in the process, but it continues to be this nice mixture of large pharma and biotech. You can hear from the examples that we're doing a lot of the most innovative work with biotechs. I will say before Jill comments on the burn rate that this is a very detailed analysis project by project, and many of these projects that we have are late in their life cycle.

What that means, if you think about it with percentage complete accounting, and I hate to get into a detail here, but with percentage complete accounting, even if you lower the cost of execution late in a trial, it's still very difficult to improve the margins of that trial when most of the hours have been expended. What it's got us in a situation of is working through almost an air pocket here of things that are in later stages, difficult to do much with, in many cases, do not have the kind of profitability that we would like to see. We replace them with new work, but that new work has to come on fully. That is what you're seeing in 2025. Jill, I do not know if you'd comment on the burn rate here.

Jill McConnell (CFO)

Yeah, I think we've seen the burn rate.

Our second half, you may recall from previous remarks, I said we did benefit some from the clinical pharmacology business, which burns faster just based on the nature of those studies. Obviously, FSP comes in more quickly. When we looked at this portfolio and really dug in, and we did try to be, as you heard me say, we modeled a 1.15, even though we've done better than that on average since the spin. We wanted to be slightly more conservative. We will be doing everything we can to try to see how we can improve those rates and be more efficient and optimized, as I mentioned, as Thomas talked about as well. For now, that's probably an appropriate way to model.

Justin Bowers (Analyst)

Okay. Maybe just I'll be quick here on this one, but can you provide us with just sort of ranges in terms of ratios for cost of services and SG&A in 2025?

Jill McConnell (CFO)

In 2025, we're looking to take out about 80 basis points as a percentage of revenue based on the guidance that we provided. As I said, we're looking to take out another 100 basis points in 2026 as we go forward.

Tom Pike (CEO)

For SG&A.

Jill McConnell (CFO)

For SG&A, yes.

Tom Pike (CEO)

For gross margin, it's clear to us, Justin, for gross margin, we need to continue to take action too. You're really seeing that as the overall EBITDA margin at this point, but it's clear to us that we need to continue to be more cost-effective in that area and match resources to work in a very detailed way.

Justin Bowers (Analyst)

Okay. Thank you, Jill and Tom, and I'll jump back in queue.

Tom Pike (CEO)

Thank you, Justin.

Operator (participant)

We do ask that everyone ask one question, and then please queue back up for a follow-up question to give everyone a chance to ask questions. The next question will come from David Windley with Jefferies. Your line is now open.

David Windley (Analyst)

Hi, good morning. Thanks for taking my questions. Appreciate the detail this morning. I wanted to kind of wrap a couple together that have already been asked, but around kind of thinking about burn rate, book-to-bill, and the level of backlog. As Justin said, it does calculate to a burn rate that seems to drop about 100 basis points or maybe a little more, maybe 125.

Hearing you describe that projects are kind of near the end of their life cycle and not going to be as revenue-generative in 2025 as maybe you previously expected, I guess what I would expect to see from that is kind of a clean out of backlog, maybe some dead backlog in there that's not going to be productive or trials that were reduced in size and need to be downscoped. I don't see that. I mean, it looks like to get the burn rate to stay in approximately the same level that it was in 2024 would be about a $900 million reduction in backlog. Absent that, Tom, on your percent of completion comment, I would expect if that backlog still stays in, you would have positive true-ups at the end of trials that would actually help margin.

The punchline here is it seems like a missing link is either you've got projects at risk that you're delivering on time, on schedule, that you could recognize favorably as they wrap up early, or you still have a big backlog cleanup that needs to happen. Which one is it, please? Thanks.

Tom Pike (CEO)

I'll start. Maybe I'll tell that Jill's a little under the weather today. I'm going to start, and then you can add to this, Jill. With respect to the dead backlog, we actually went through analysis this quarter to try to look at stuff in the backlog. The backlog is substantially fine the way it is. I do think it's possible that there are sometimes write-ups at the end of projects. Here, I think you actually get both kinds from what I've seen here, Dave.

You get some write-ups and some write-offs at the end, and they're tending to net here in general. It is a little different than in some places. It is a good detailed comment, but here they're tending to net. As they get long in life, they tend to operate at lower margins, and then at the very end, they have a bump in activity associated with closing them out. We have done the best of our ability to try to estimate that for 2025. This is what we see right now. In terms of backlog burn, as a public company, we can't arbitrarily go and chop some of the backlog out to make those burn rates work. I think we just need to do our best to burn those off. They're important projects for customers, and we need to finish them out.

What we need to work on is really trying to accelerate the new work and, frankly, trying to accelerate the existing work during the course of this year because that is good for everybody. At this point, the numbers are the numbers you can hear. We have worked on them for a long time. We have done more detail than ever before and have programs in place to be effective. This is our best judgment at this point. I do think there is upside as we get into 2026 and you start seeing the new work come into the portfolio. It should be a consideration. I am sure we will talk about it in later calls. It should be a consideration around Fortrea.

David Windley (Analyst)

I was pausing to see if Jill was going to add it.

Jill McConnell (CFO)

No, I mean, I think as Tom said, we spent a huge amount of time trying to go through. We did go back and revalidate the backlog. We looked at our cancellation rates because a number of our peers have talked about those increasing. We have not seen that. They have stayed in line with our historic norms. So we believe the backlog, as we have presented it, is appropriate.

Tom Pike (CEO)

Okay. Dave, I guess you could jump back in queue the way we are doing this, but thank you for the question.

Operator (participant)

Our next question comes from Elizabeth Anderson with Evercore. Your line is open.

Elizabeth Anderson (Analyst)

Hi guys. Thanks so much for the question. Can you talk about the current environment? I think there still remain some concerns about pricing in terms of demand. You have some of us in terms of also cancellations, some of your peers have obviously called that out. Could you help us level set on that? I hear what you're saying, obviously, about the change in forecast about sort of late-burning projects would be applicable too, but it would just be helpful to understand a little bit more in detail about what you're seeing in the current environment in the first quarter. Thanks.

Tom Pike (CEO)

Hey, Elizabeth. What I would say, it's substantially similar to what we've communicated in the last call, and that's that we do have a good amount of opportunities, both in large pharma and biotech. Our cancellation rates, based on who we're exposed to, are not elevated. I did see that in some of the others, but our cancellations are not elevated based on that.

The current environment, I think the honest thing is we're all a little nervous about the macros with everything going on, whether you're shopping at Walmart or you're thinking about your next clinical trial. The industry seems to be pressing ahead. Right now, I think there's a belief that biotech and entrepreneurs will be supported. There's a belief we'll continue to have opportunities there. Our large pharma partners, we chat about it as we were preparing for this call, and we're not seeing anything new associated with IRA. We're not seeing any particular portfolio restructuring. It seems like people are just pressing ahead. Our pipeline is solid. It still takes every quarter. In this business, as long as I've been doing it, it's never over till it's over, as Yogi would say.

Our pipeline is solid as we look out to the future here. Thank you.

Operator (participant)

Our next question will come from Luke Sergott with Barclays. Your line is open.

Luke Sergott (Analyst)

Hey, guys. Thanks for the question. Just kind of talk about the analysis on the background. What was the catalyst that tripped your controls that made you do the analysis and give us a sense of the timing on that? As you're thinking about the mix shift from legacy to newer work, talk about kind of the resource overlap that you guys have because there will be a concern if you're taking an extra 80 basis points of revenue out from SG&A this year and how that coincides with the new business that you've been winning that you might not have as much firepower to get those projects up and running as quickly as you could.

Tom Pike (CEO)

Thanks for the question. The catalyst was, as we were preparing for the 2025 budgets, we started to see some signs that made us want to go deeper in terms of the analysis. Those kinds of signs were potential revenue shortfalls coming through in certain areas. When you see that kind of thing, you can't take it at face value. What we knew about the company was that, like many CROs, but not all of them, projects were estimated out into the future, but not always in a detailed fashion. We have talked in prior calls that there really are not the project management systems and resource management systems here that you see in some other companies. We knew this as we were looking last year. Coming into this year, we really had to go deep.

To your point about the old versus new and new work versus old, one of my biggest concerns is that we do not want to turn around and actually slow down revenue because we do not have the resources. We are a business that builds on an hour basis and on a head basis based on the work that people do. One of the things the team did, it was really a dual effort to try to make sure we had what we felt was a pretty accurate forecast.

The operations team is working to really look out month by month, geography by geography, project by project, therapeutic area by therapeutic area because to some degree, you need to know the sites that people actually operate at and to try to optimize the resources so that if it's a longer span of time, we might do a reduction. If it's a shorter span of time, we may have to hold the resource because it's the better economic approach. I share that detail with you, Luke, because I just want to give you a sense that I have to credit our operations team. Under this adversity, they're trying to get incredibly detailed about demand coming in, very much like a manufacturing environment where you look at inbound demand.

How do they optimize that resource as there is flow up and down at the sites that we have and in the geographies that we have? I'm hopeful that we're going to optimize it, but it is going to be something that we're going to concentrate on every month. Actually, the teams will be doing every day, but we're going to look at every month to try to make sure we're optimized. If we can find more, we will. You might have heard my comment in there that I'm looking at further areas for revenue generation, cost reduction, and other shareholder value creation opportunities. It is not over yet in terms of this, but we wanted to give you a sense as of today where we are on it.

Luke Sergott (Analyst)

Okay. Great. Thanks.

Tom Pike (CEO)

Thank you, Luke.

Operator (participant)

The next question will come from Eric Coldwell with Baird. Your line is open.

Eric Coldwell (Analyst)

Thanks very much. Can you hear me?

Tom Pike (CEO)

Yes. Hey, Eric. How are you?

Eric Coldwell (Analyst)

Thank you. I'm sorry. Dialing in remotely today. I wanted to come back to the—yeah. Wanted to come back to the 2026 preliminary thoughts. Appreciate those details. Definitely picked up the 80 basis points on SG&A this year and another 100 basis points next year. I'm curious what you're thinking. Sounds like you're expecting to return to top-line growth in the first half and then maybe more in the second half with a better mix of projects in the second half of 2026. What are you thinking on gross margin next year and overall EBITDA? This year, you're targeting mid-sevens on EBITDA margin. 100 basis points would get me to the mid-eights if we held gross margin flat.

Are you anticipating a better lift in gross margin on the revenue growth and the better mix in the second half? We should not just be thinking mid-eights on EBITDA margin in 2026?

Jill McConnell (CFO)

Eric, I'll try to take that. I mean, we obviously have done a lot of that analysis, and I think we would be expecting more than the 100 basis points of margin improvement year-on-year. We felt like at this point, until we've been able to see how all these new processes we've put in place are playing out, we would be better off waiting a couple more months and see how these forecasts are tracking compared to what we've provided. We can probably provide a little more clarity on what that future looks like.

We did try to be relatively conservative in our modeling, but yes, you would expect also gross margin improvement in 2026 because we believe that even though you have to hold on to resource in certain areas because you have to have it, it's not all being fully utilized. They will be able to absorb that growth as we've been hoping would come, but we'll be able to absorb that growth without having to add a lot of significant additional resource in 2026.

Tom Pike (CEO)

Eric, the other thing I'd add is that if you just think about the math, roughly, as new work comes online, it's performing very close to the deal economics of this industry. When you—and I think you guys, you, Eric, you know this industry very well. You have a sense of what that is.

You can almost think of it as, as it becomes a bigger part of the mix, the percentage of that mix and that difference in margin will start accreting to the bottom line. The plan here is, as you see that new mix, you will see that at better margins, and that will lift it as it grows as a proportion. You are trying to get the model in your head, if you know what I mean, Eric, as you see that, that allows what Jill's saying to go forward. I think, frankly, you guys can model it slightly different ways as the 1.15 versus 1.2, but we've modeled it as 1.15 just to be a little conservative, and we feel like it's good progression. Okay. Operator, we might as well move.

Operator (participant)

Our next question comes from Max Smock with William Blair. Your line is open.

Max Smock (Analyst)

Hi, Tom and Jill. Thanks for taking our questions. Jill, hope you feel better soon here. Tom, I know you just discussed this in response to Dave's question a minute ago, but I'm sorry for a bit of a repeat question here, but frankly, still just kind of struggling on our end to understand your backlog in the quarter and the context of your commentary around determining that some of those pre-spend projects have less remaining revenue than you anticipated earlier or at the end of 2024. Just hoping, can you just walk through again why those findings wouldn't lead to some adjustment to backlog in Q4 in the form of cancellations? Again, I'm just trying to understand from a mechanics perspective why your findings are leading to a huge step down in burn rate instead of that big revision in backlog that Dave was discussing earlier. Thanks.

Tom Pike (CEO)

Yeah. Max, it's a good question because maybe I'll clarify. It's not so much less backlog. It's actually slower burn, and that's the difference in 2025. These projects, we did some interesting analysis that showed that a lot of these older projects extend out as much as 40%-50% longer than the projects we're selling today. As you can imagine, when they've extended out over time, they're burning more slowly. They have a lot of hours in them already, and every incremental hour is less as a percentage of the total. That causes them to burn more slowly. It's not so much that it's a reduction in backlog. It's just a lesser amount of it is going to show up in 2025 than we expect. It's a helpful clarification on your part. That work is out there.

It just is burning more slowly. And given it's a bigger percentage of the mix, it also has some built-in inefficiencies, perhaps concessions on margin, other things over time that we're still carrying with us through these older projects.

Max Smock (Analyst)

Got it. Super helpful, Tom. Thank you for clarifying. Sorry if I misunderstood based on the prepared remarks.

Tom Pike (CEO)

No, no. It's important stuff right now. This is obviously a super important call. Thank you, Max.

Max Smock (Analyst)

Of course. Maybe just as a—

Operator (participant)

Our next question comes from Matt Sykes with Goldman Sachs. Your line is open.

Will Ortmayer (Analyst)

Hey, guys. This is Will Ortmayer on for Matt Sykes. Thanks for squeezing me in here. The commentary around the 80 basis points of saving for the year is helpful, but just want to dig a little deeper on the expense side.

How should we think about the OpEx cadence and, I guess, gross margin as well throughout 2025? It's a lot of moving pieces with TSA rolloff, restructuring, shift to new business, and then some of the target investments. If you could just kind of parse out some of the puts and takes there and how we should think about phasing, that would be super helpful. Thank you.

Jill McConnell (CFO)

Sure, Will. I think in terms you will see margins improve over the course of the year. You're not going to see the same, for example, step from quarter one to quarter two that you saw last year. You'll see margin improve over the course of the year. However, we're going to provide more detail on that quarterly progression when we do our Q1 earnings. The reason I say that is because we've come out of the TSAs.

We have all the costs now. We're resetting. You're not going to see much benefit from the SG&A reduction in the first quarter because we're standing up the new systems and we're getting through year-end. We were remediating the material weaknesses I mentioned in my remarks. In IT, the work to consolidate applications takes a bit of time. It will improve over the course of the year and the margins will improve, but we'll provide more detail on that progression as we get our Q1 results.

Will Ortmayer (Analyst)

Got it. Thanks, Jill.

Jill McConnell (CFO)

We just need more time with the new system. As you can imagine, doing that with everything right now, we want to see a couple of months in the new system just to make sure everything is matching with the new processes we put in place.

Will Ortmayer (Analyst)

That makes sense. Thanks again.

Tom Pike (CEO)

All right. Operator, let me take—Operator, let's take two more calls. We are at 10:00 and we want to let people go, and we'll have some further calls with the analysts. Let's take two more. I apologize to folks. I know this is important, but we look forward to talking to you during the day.

Operator (participant)

All right.

Tom Pike (CEO)

Yep. Go ahead, Operator.

Operator (participant)

The next question comes from Charles Rhyee with TD Cowen. Your line is open.

Charles Rhyee (Analyst)

Yeah. Thanks for taking the question. Maybe just—and I apologize. I joined a little bit late, but can you talk a little bit about this idea of pre-spend versus post-spend projects? Were you looking at your backlog in this manner last year, or is this—when did you start to really focus on the difference between the pre-spend projects versus the post-spend?

Secondly, following up on an earlier question around sort of the SG&A leverage this year and then into next year, how much can you give us a sense on kind of what we're running at in terms of capacity utilization and sort of just a sense of how much excess capacity you're kind of carrying currently to allow you to sort of recapture that in terms of margin as we go forward? Thanks.

Tom Pike (CEO)

Yeah. Thank you, Charles. I'll comment on a couple of things, and then I'll give it to Jill. First, the pre versus post. We started to see trends. What has happened over the past year, and really in just the last few months now, is we were trying to look deeply into the portfolio to try to understand what we could do about the profitability of some of these older projects.

As we looked deeply in the portfolio, we started to see this pattern that we had relatively more percentage complete projects and certainly the new ones. We wanted to make sure the new stuff that we won was operating at good economics, and we confirmed that. We started to look at the older stuff, and we noticed that there were a couple of categories that were distinct: the much more mature ones that were more percent complete, and then ones where we still had an opportunity to have an impact. We started to look at that. This analysis at higher levels caused us to actually take it down all the way to project by project.

It's relatively recent to categorize it that way, but we certainly wanted to confirm that the new work that we won with our processes as an independent company was meeting its original economics because that's totally under our control. I will just say on the capacity utilization, that is closely managed, and we are trying to thread the needle of making sure that we have as limited capacity as we need to be able to deliver these projects with quality. That's clearly part of what we're trying to do. On the prior question, you can hear how we're going to try to thread that needle of delivering this more mature work that's lower profitability and then also adding the new work to it. The team is working at a much more detailed level. Jill, I don't know if you'd add something on that. Yeah.

I think the only thing I would say is the 80 basis points that I mentioned is going to be on a lower revenue base. Obviously, if revenue was flat, you'd be seeing a more substantial basis point reduction year-on-year. That is why we called out 80 basis points, but also kind of said $40 million-$50 million of net savings because of the revenue decline. Unfortunately, you do not see quite as much impact from just a basis point perspective.

Does that help, Charles? Okay. Let's take one last, Operator.

Operator (participant)

Okay. Our next question will come from Michael Ryskin with Bank of America. Your line is open.

Michael Ryskin (Analyst)

Great. Thanks for squeezing me in. I appreciate it.

Tom, I want to follow up on a point you've mentioned a couple of times in prepared remarks and Q&A, the sort of difference between pre-spin and post-spin in terms of the processes. I guess my question is, is it really that delineated? What I'm getting at is, yes, the management changed when you were spun out. If you're thinking about the employee base, that's stayed largely the same. The same people that were booking revenues and putting the bookings and putting the book together, that's been more or less consistent. Yes, you've implemented new processes and you've gone through the TSA exits, etc., but that all took time.

I guess what I'm getting at is, is it really that clear where it's the day before the spin, the day after the spin, or is there a risk that you look at some of your bookings from second half 2023 and they're also a little bit lower quality than maybe some of the most recent ones from the last couple of quarters?

Tom Pike (CEO)

I think it's a fair question, but the reality is we have changed quite a lot. This business is managed at a much more detailed level. For instance, every project, we now have regular calls where projects are reviewed at various levels of management, sometimes even up to me and Jill, associated with challenges that they face.

All the projects in terms of approval of any kind of change in terms of scope or any kind of change of additional hours without scope, all of that is now approved in some detail. If you look at the detailed processes that we've put in place, it actually has changed quite a bit. What we want to just make sure is that those more detailed processes of management, and frankly, not accepting variances as just something that has to happen, that those detailed processes, we just need to make sure that on the new projects, we're sustaining margin. On the older projects, if we can capture additional compensation for additional scope, we're doing it. If we can use more effectively costed resources, we're doing it. There has been quite a bit of change here.

I guess another example is we've taken work that used to have a higher cost resource. We started to put it into hubs. We have a very significant hubbing strategy. One of the things you'll know about Fortrea is before I came here, they actually made some excellent investments in India and those around other low-cost places in the world as well. Those elements are being used even more. I think we would say the focus and discipline we've had on this business has made a difference. It's just difficult with the mature projects to actually impact them. The newer ones, even if they're pre-spin, but they're earlier in their life, we can impact those. The newest ones that we've sold, we want to make sure they're delivered well. Michael, I appreciate the question. Operator, we probably have to wrap from here.

I just want to thank everybody for being with us. We've done a tremendous amount of work the last couple of months, and we think we have a firm foundation. We're being well accepted by customers with these leading book-to-bills. We're going to continue pressing ahead here at Fortrea, doing great things for our customers. Thank you.

Operator (participant)

This concludes today's conference call. Thank you for participating. You may now disconnect.