FTRE - NASDAQ

Good morning, and thank you for standing by. Welcome to the Fortrea Second Quarter 2023 Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Hima Inguva, Head of Investor Relations and Corporate Development. Please go ahead.

Good morning, and thank you for joining Fortrea's second quarter 2023 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 our CFO, Jim McConnell. The call is being webcasted, and the slides accompanying today's presentations 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 Securities Private Securities Litigation Reform Act of 1995 and 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 concerning forward-looking statements and risk factors in our Form 10 this morning, press release, and presentation that we posted on the website. Please note that any forward-looking statements represent our views as of today, August 14, 2023, 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 directly 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?

Thank you, Hima. Good morning, everyone. Let's get right down to business. In July of 2022, LabCorp announced at its spin-off its clinical services and Patient Access Services business unit from its global laboratory businesses. now named Fortrea, this business represented about half of the revenues of LabCorp's previous Drug Development segment and spans primarily clinical development Phase I to Phase IV. Fortrea's capabilities have an impressive heritage that goes back more than 30 years through the CRO pioneer Covance and acquisitions like Chiltern. This business grew at about 15% compound annual growth rate from 2010 through 2022. At the same time, the business was nested in a much larger organization. with the central lab and diagnostic labs and has not operated as a stand-alone unit before. Therefore, there was a tremendous effort required to prepare for a successful spin, which was completed quickly in under a year. This fast-paced approach to a spin is often referred to as a lift-and-shift approach, really no substantive business improvements. Over the past 12 months, the people here have been navigating what I've come to call this spin year. During this 12-month period, some customers took a wait-and-see approach with us before awarding new business. I think some wanted to see who was staying, who was going or if there would be some other disruption I'm not aware of the spin costing Petri any existing customers. The major issue in the spin year was a slowdown in new RFP opportunities properly compounded by a softer biotech environment and lack of larger new customers. We have been referring to the situation as our mix issue publicly. Headline book-to-bill numbers were okay and consistent with industry and prior company practices, but the mix of sales, including new business versus renewals, was not sufficient to meet even average industry growth rates for some quarters. Jill, our CFO, is going to walk you through the results of what I hope is the last quarter of the spin year. It's important to note that we are an independent company for only a minute literally so this is detailed reporting about a discontinued segment of the prior parent company, including corporate allocations, one-time and new recurring spin costs, and more. Jill, over to you.

Thank you, Tom, and good morning, everyone. Fortrea's second quarter results continued to include softness related to this spin year, but we are pleased to have completed the spin and become an independent organization. I want to give my personal thanks to everyone who is involved in making it happen. The speed and commitment that they demonstrated to ensure a smooth transition of our services gives me confidence as we head into this new chapter for Fortrea. It is great to see signs of improvement in both RFP flow and award volume as we move through the third quarter. This will be key to returning the company to industry growth or above and driving margin expansion over time. Now let's turn to results. Revenues were $793 million in the second quarter, essentially flat versus the same period last year. clinical services revenues of $726.1 million grew 0.4% year-on-year, driven by higher pass-through revenues, partially offset by lower service fee revenues. The lower service fee revenues were in part due to a previously disclosed prior year FSP contract loss and a one-time client adjustment as well as the mix and quantity of new business wins during this past spin year. Enabling Services revenues decreased 4.2% year-on-year as patient access revenues were impacted by lower call center activity, partially offset by growth in our Endpoint business. Revenues for the six months ended June 30, 2023, were $1.56 billion, a decrease of 0.9% year-on-year. Note that currency was not a material impact to our results in the second quarter. Before I move to our cost base, please remember that this quarter is unusual as these expenses are based on our results when we were a division of our former parent company and include a combination of both actual costs as well as former parent company allocations under the car accounting methodology. Direct costs increased 5.7% year-on-year primarily due to higher pass-through expenses, partially offset by lower temporary labor and bonus-related expenses along with other cost efficiencies. Was higher by 13.5% due to an increase in indirect labor, credit loss provisions, and an unanticipated adjustment to our year-to-date expenses of $5.4 million, partially offset by a decrease in bonus-related compensation expense. Net interest expense for the quarter was $0.7 million. We expect full-year interest expense to total approximately $70 million in 2023 and incorporating the change in market expectations for further rate increases in the second half of 2023. The effective tax rate was 26.9% for the quarter. We expect the full-year 2023 adjusted effective tax rate to be between 27% to 30%, which is higher than our full-year 2022 effective tax rate of 18.6%. The expected increase in the tax rate is due to anticipated reductions in domestic earnings, which in turn lead to increased domestic taxation of our foreign earnings as well as the loss of certain deductions we received as part of our former parent company. Now that we are a stand-alone company, we expect to revisit our tax structure to ensure it is optimized for the future. Adjusted EBITDA for the quarter of $72.5 million decreased 37.1% year-over-year compared to adjusted EBITDA of $115.3 million in the prior year period. Year-to-date adjusted EBITDA was $129.6 million, which decreased 31.8% year-over-year compared to adjusted EBITDA of $190.1 million in the prior year-to-date period. Adjusted EBITDA margin for the second quarter was 9.1% compared to 14.5% in the prior year period. Adjusted EBITDA margin in the quarter was negatively impacted by the lower service fee revenues as well as higher pass-through revenues. Year-to-date adjusted EBITDA margin was 8.3% compared to 12.1% in the prior year period. In the second quarter of 2023, adjusted net income of $46.3 million decreased 46.2% compared to adjusted net income of $86.1 million in the prior year period. Adjusted net income for both basic and diluted share for the quarter was $0.52 compared to $0.97 in the prior year period. In the first half of 2023, adjusted net income of $86.6 million decreased 38.3% compared to adjusted net income of $140.3 million in the prior year-to-date period. Adjusted net income for both basic and diluted share for the first half of 2023 was $0.98 compared to $1.58 in the prior year period. In terms of our margin efforts, we recognize that our current margins are not consistent with industry norms. It is important to remember that our priority over the last year was to successfully spin at pace and to ensure business continuity. Now that the spin is complete, we are actively assessing our cost base, both for direct costs as well as SG&A, and have begun to form our margin optimization plan. With one month of actual expenses available, we are continuing our SG&A benchmarking and exploring technology productivity initiatives. We are identifying improvements through sourcing and procurement and are finalizing our TSA exit strategies to replace them with more fit-for-purpose infrastructure. We are prioritizing margin improvement efforts and continue to expect to move towards peer margin levels over time. Turning to customer concentration. Our top 10 customers represented nearly half of our year-to-date revenue. Next, I'll provide an update on cash and liquidity. In the first half of the year, we generated $154.2 million in cash flow from operating activities. Net accounts receivable was $1.01 billion at June 30, 2023, and 0.7% lower than at December 31, 2022. During the quarter, we entered into an accounts receivable purchase program with the ability to sell up to $80 million of our receivables to accelerate cash collection. Prior to the spin, the company sold $17.5 million of accounts receivable, which drove the decrease in accounts receivable between December 31, 2022, and June 30, 2023. We Days sales outstanding was 86 days at June 30, 2023. We have initiated projects to improve our DSO profile. Due to the nature of our contracts, which provide services over extended periods of time, there is a lag to seeing changes reflected in our performance. In addition to these actions, we are focused on other opportunities to reduce this measure over time. For the six months ended June 30, 2023, free cash flow was $128.4 million. The improvement versus the prior year was primarily due to a lower incentive payout this year. Turning now to our debt. During the quarter, we issued $570 million of senior notes due in 2030, and we entered into a $450 million revolving credit facility a five-year $500 million term loan A facility, and a seven-year $570 million Term Loan B facility. Our blended interest rate for debt at June 30, 2023, was 8%. We ended the quarter with a net leverage ratio of 4 times. As noted previously, our near-term capital allocation priorities are: first, infrastructure investments for timely exit of the transition service agreements. Second, targeted therapeutic and technology investments to drive organic growth and then debt repayment. Longer term, as our net leverage improves, we will consider selective tuck-in acquisitions. Next, I will review our go-forward approach to backlog recognition. As part of becoming a stand-alone company, the company reviewed and modified its backlog composition and recognition policies to facilitate period-to-period reporting going forward. As a result of this review, we have decided to make modifications in the following areas: restating the backlog to remove projects where we no longer have current revenue as well as incorporating all known changes in scope from customers or other uncertainties. This was partially offset by adding in backlog where revenue is still being earned, but no backlog was represented. We have decided to remove for the enabling services backlog from our calculation, given the different operating profile of these businesses. Going forward, our backlog and book-to-bill reporting will be for our clinical services business only. And finally, we revised our FSP net new business awards recognition policy. For new awards, we will recognize the first two years of the award and for renewals, we will recognize only the first year of the award at the time of contract signature. This more appropriately reflects the nature of FSP awards, in particular, the phased revenue ramp that comes with the new award. It is important to note that outside of the first adjustment I referenced to remove uncertain positions the revenue opportunity of the enabling services backlog and our remaining FSP backlog fully exists. With these adjustments, we are effectively aligning the scope of our backlog to provide a view of our pipeline that is more tailored for our stand-alone business. Backlog at the end of the quarter under our new methodology was approximately $7 billion. The total reduction of $1.27 billion year-over-year was driven by the changes I described. Starting with this quarter, we will use this new methodology for reporting backlog. Because of these changes, we cannot actually restate the backlog history to incorporate all of the changes noted above, Therefore, we are not disclosing net new business awards or book-to-bill for this quarter. We will rebuild our trailing book-to-bill metrics from the third quarter onwards. In this final pre-spin quarter, we continue to see some softness in net new awards. So, with the spin behind us, we are pleased to see positive momentum in RFP flow and new awards in the third quarter. Moving now to our updated guidance for 2023. We expect full-year 2023 total revenue in the range of $3.03 billion to $3.1 billion compared to 2022 total revenue of $3.1 billion. We expect 2023 adjusted EBITDA in the range of $255 million to $285 million compared to adjusted EBITDA of $405.1 million in 2022. Our target for net leverage ratio continues to be 2.5 times to 3 times over the medium term. Our guidance assumes foreign exchange rates in effect as of June 30, 2023. This guidance assumes a full-year 2023 effective tax rate of 27% to 30% and weighted average shares outstanding for 2023 on both a basic and diluted basis at the current level of shares and does not reflect the potential impact of currency fluctuations. In terms of the second-half phasing, we expect fourth quarter performance to be slightly better than the third quarter as we begin to see the impact of some of our initial actions on aligning our cost structure to our revenue profile. We will share more details on our near-term and longer-term margin improvement initiatives with our third quarter earnings announcement in November. In closing, this was Fortrea's last quarter reporting as a division of its former parent company. We are navigating the impact from the spin-related uncertainty and are focused on winning new business to drive future top-line growth. We are excited about being an independent company. the strong momentum we are seeing in RFP flow and the margin expansion opportunities ahead of us give us confidence in our future. With a proven management team, innovative clinical development solutions, and an unwavering commitment to deliver value to our customers, we are well positioned to unleash our full potential and establish Fortrea as the top choice clinical resource organization for pharmaceutical, biotech, and medical device companies. And with that, I will turn it back to Tom for some additional remarks prior to moving to Q&A.

Thanks, Jill. I joined LabCorp in January of 2023 to become Portria's CEO and Chairman of the Board when it was spun out. For those of you who don't know me, earlier in my career, I was at McKinsey and then Accenture then more recently at Quintiles Transnational, where I served as the CEO and we took the company public through the merger with IMS Health in late 2016 to create IQVIA. Since then, I've been working with private equity and venture capital companies working with innovators, and from time to time, looking at other major CROs private equity. I know many CRO, investors, and analysts, and I feel like I have a personal commitment to both your success and Fortrea's. My job was to hire a management team and a Board for the spin with a target of having that team and board in place by May. We achieved that. carefully selecting people internally and externally. We have assembled a great management team and Board both with appropriate qualifications and experience to guide us. We appreciate the positive response to this team since our Investor Day. Our management team was revealed in early May and the new members started taking over business and functional areas in the last few weeks of the quarter, some actually at the end of the quarter. For instance, Jill's role became official at the end of Q2, and having spent the prior 10 months leading the internal spinout team of the parent and doing double duty during the road show. Now she's 100% focused on Fortrea. Two of our key operating executives have been running similar organizations to what they run today, which kept delivery of services for customers on track. The others -- many of the others are new. Let me be plain spoken here. I and the management team are not satisfied with the second quarter and first half results. I'm going to pause here. I don't believe the first half results represent the potential performance of this organization as an independent company. We are clear-eyed about both opportunities and issues. We have already started on changes in improvements. We will discuss some, but not all of those changes today. As leaders, we must place the spin year firmly in the rearview mirror. The new management team and I will transform Fortrea from an operating unit of a larger enterprise into a successful independent clinical services organization accountable for its own future. I've assessed our strengths and weaknesses and worked with the Fortrea leaders to craft a strategy that positions us to compete and win. This strong team, to have assessed their respective units and are putting new programs in place. We have begun transforming the business. Now here's my assessment. Fortria today is a capable CRO that has the scale and management to bring innovation and consistent global delivery to an R&D industry that needs and relies on both. Clinical research is complex, and this team is good at it. Fortrea is a Goldilocks size organization, not too big, not too small, where customers will find management knowledgeable and readily accessible. We have the scale and skills to grow attractively and importantly, organically from here. There are a lot of positives to this business. Let's remember, the roots of this business are in Covance, one of the longest-tenured successful CROs. We have global reach and 19,000 professionals there is medical and scientific breadth and depth on par with the best of our industry. We punch above our weight in oncology, the largest therapeutic area for trials. We have a great diversified customer base with long-term relationships, in some cases, more than a decade. We service both large and small biopharma effectively. There are years of experience, along with technology tools for working with the LabCorp data and we can bring that to the explosion of clinical data sources now available. We have many great executives and a talented workforce throughout the world. Our first order of business has been to reignite our new business engine. We now have weekly sales calls that involve me and our other business presidents to review and target opportunities. We have increased our executive involvement in the sales process, improving the process, targeting a mix, and making sure we apply the advantages of our size, experience, relationships, and our differentiated offerings. Another positive RFP flow is improving at a level for attractive growth, importantly, with the right mix. Our win rates are improving and our customers large to smaller engaging us in conversations as to how we can help them transform and streamline how they do clinical development. We are at the table. As a result, July 2023 has been the best first month of a quarter for new business wins since 2021. To shape our vision and strategy for the future, I've been meeting with research and development leaders throughout the spring and early summer, listening to what they need in exchanging ideas. We are wrapping our Fortrea strategies around what the industry needs. Customers are excited to work with a company that wants to innovate and improve things. And we have some nice wins as new management has taken over. Let me give you a few examples of the many successes we've seen. We're able to break in with a large, important Asia Pacific headquartered sponsor to support them in the global development of one of their key oncology assets. We had a nice Phase III win in psoriatic arthritis with one of our small biotech partners because we had completed enrollment ahead of schedule in their Phase II study. We also put together a new preferred partnership that resulted in a nice first award with a mid-tier company Metastatic Breast Cancer. We're also focusing more on CNS, an area where we've been underpenetrated. We won a very interesting and complex early Alzheimer's study with a large pharma company where deep scientific expertise is for requisite. Our new team is pushing harder on early engagement, too and it's bearing fruit. We've been awarded multiple clinical studies recently that started with initial regulatory strategies or consulting work. We're also seeing pull-through in later phases. We were awarded several contracts and post-approval patient access this year based on our clinical development work. These contracts spend several therapeutic areas, including oncology and anti-infectives. Our medical device and diagnostic business, which is a leader, as a pipeline of RFPs that continues to grow. In Q2, we saw our highest proposal volume in the last 12 months for this unit. And it grew about 40% compared to the first quarter of the year. We're also focused on leveraging technology. [indiscernible] data analytics, machine learning and AI and will bring that lens to us. Internally, we have pointed a new leader and created a dedicated data sciences team to update our data strategy and keep in tune with that explosion of EMR, genomic, and other focused clinical data providers. We have a great leader for our industry-leading site augmentation strategies, making rapid progress, and the team is delivering quantifiable acceleration in start-ups for new projects. We're pursuing investments in enabling services, we're also in the process of hiring more back that talent in therapeutic areas we're underpenetrated in. These anecdotes illustrate the progress we're making to deliver value for customers, which will strengthen our growth and financial performance. I'm proud of the progress we've made in a few short weeks since we've been an independent entity. It's a testament to our people around the world and their drive to create a better experience for customers. However, we know you would not think of us as good managers if I didn't address the financials specifically. We will get our financial house in order. I have seen other CROs and there's nothing in pricing or operations-wise, that's unusual or concerning here. This is a disciplined operations organization that can deliver programs with quality. However, we do need to invest more in supporting technology and the spin and the exit from the parent will allow us to completely revise our software suite. There is also an opportunity for greater productivity while reducing technology costs. We also see procurement facility savings and will align operations cost with revenues more effectively. Regarding SG&A, while our numbers as part of the parent have historically looked good on the surface, frankly, it all depends on how indirect costs are allocated, which is different for different companies. As Jill discussed, we see addressing SG&A as well as programmatically exiting the TSAs with the Parent on time as key activities that will improve our cost structure and aim to make our margins on par with industry leaders over coming years. I want to emphasize the most important thing right now is that this company does great work for customers, and it does, and it will continue to as the highest priority. We have the right team to do this. The new management team is now in charge. We're disciplined about both servicing customers and running a business. We are willing to change. We're hungry. This is a seven-day a week, 24-hour a day job. We will be transparent to keep you informed for our programs and progress. Expect further discussion in detail through the remainder of the year. We have the solutions to create value both for customers and shareholders. In closing, let me say that the R&D landscape is a tremendous place to be. customers large and small, are innovating, bringing forward advances that will transform millions of lives and save many more. Let me say to the people of Fortrea, I've been impressed by you, and I'm proud to be working with you. We're excited to play our part and driven by our mission of bringing life-changing treatments to patients faster. Thank you. And back to you for question and answer.

Thanks, Tom. With that, we'll now open the call for your questions. Michelle?

[Operator Instructions]. The first question comes from David Windley with Jefferies. Your line is open.

Hi, good morning. Tom, thanks for the transparency in your comments. I wanted to focus on cost structure with kind of a two-part question, and then I'll drop out. So first, just to better understand the costs that are weighing on the business now versus the comparable period, and maybe part of the answer might be, it's not totally comparable. But I would like to understand the cost that the business is bearing year-over-year that are depressing margin. And then in terms of addressing your forward costs, you've commented both at the Investor Day and also this morning, about bonus structure and kind of labor compensation. And I'd like to hear your thoughts on how you navigate that and maintain retention at levels that you need to maintain. Thank you.

Yes. I will say, I've learned a lot about carb accounting in the last few weeks, and the difference is here. And Jill, do you want to -- that's a huge question that Dave asked. Do you want to try to give a sense of some of that, and then we'll come back to the retention issue?

Yes, Dave, it's a great question. The first six months, well, obviously, looking back over the prior year period, that carb methodology is different from the actual allocation we have one month of actuals now. And as you can imagine, we're still trying to work through and understand what are the ongoing costs versus what are still some of the lingering things related to the spin. So, we wanted to be very thoughtful as we provided guidance until we've had the opportunity to fully understand and determine with benchmarking and some of the other things we're doing what the needs are. So, those spin periods under that card methodology are not going to be the same as the actuals, obviously, as they come through. But as we go forward with now our own quarters, we'll try to be very clear about calling out the differences between those periods.

I think what I'd add to that is we do understand now seeing July, what our cost structure is -- and to some degree until you see those costs, you don't understand them. Those of you who've been with us on this journey know that we've been where we wanted to wait and give you guidance until after we saw them. That turns out to have been the right move so that we understand the cost. We understand them now. And as Jill says, we're trying to give you our best sense of where this organization will land in this unusual year after the spin. That being said, as we go forward here, I think you asked the second question, Dave, about retention. And we are building into a management plan, the ability for employees to earn a bonus. So, now that the management plan is going to be aggressive, and we're going to strive hard to outperform, but we are building some of those things into the go-forward plan. So, right now, our attrition is at normal rates. People are excited to be here. I think we're going to make this a great place for them to work and we're going to compensate them appropriately.

Maybe for now afraid.

Oh, great next time tell on.

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

Hi, guys thank you for taking my question. I guess sort of just related to what David just asking. So, do you feel like you're fully staffed sort of 100% capacity, particularly in the customer-facing roles and even sort of the back-office roles would also be helpful? And then I guess I heard what you said and thank you for all the detail around sort of the IT investment and the procurement changes. Can you sort of talk to us about how you think of that margin journey? Is this kind of like a three-year margin journey? I assume it's not like a one-year margin. So, if you could just kind of lay out how you kind of broadly think about the time spent. Obviously, appreciating what you guys just said about having 1 month of financial and sort of still digging through all of that. Thank you so much.

Jill can I try -- let me go ahead and to Jill, like all CFOs, has 100 numbers in her head here, so she can help me out with this. But we generally are operationally staffed to deliver the business that we have. And we've talked in this call that we're going to make sure that we're aligning our cost structure with the revenues that we have. And there'll be more information on that in the coming quarter. In general, our goal is here 2024 is a year we would like to return to the kind of performance you saw in 2022 by the time we exit the year. And then on top of that, as we exit the TSAs, we'd like to start moving toward those industry benchmarks of our competitors. I think we publicly said there are a couple of competitors who have a business mix, it's a little bit more like ours, and we would go ahead and target those over time. We have a very intense effort coming up over the next six weeks to detail out the programs that we've already started associated with both how we're more successful in the marketplace, but also how we get the cost structure in line over the longer term. Does that help, Elizabeth?

Yeah, that's very helpful thank you so much.

The next question comes from Casey Woodring with JPMorgan. Your line is open.

Hi, thanks for taking my question. I'll give you a two-parter as well. So, I think going back to the Analyst Day, I think you noted that there are some customers that have been waiting until the spin closed until they would kind of book business with you. So, curious if that's something you're expecting and if that's an upside to the guide or not. And then also at the Analyst Day, you kind of spoke about how your smaller scale compared to the other larger CROs is actually a competitive advantage. You spoke to it again today on like the Goldilocks size. Just curious about what your value proposition is against some of those bigger players. You talked about less layers that a customer needs to go through. Can you just elaborate on that? Thank you.

Yes. Thank you very much. In all candor, it's not as if we have a queue of opportunities waiting. I think the way this industry works in general, we saw some opportunities during the course of the year and people deferred or went to others because they were a little concerned they didn't know who leadership was. They didn't know exactly what would happen. And in this industry, if there's uncertainty everybody sells against you. So, we don't have a queue. I think the interesting thing is that this quarter, over the last few months, the organization has worked hard to try to really make sure we're getting exposure to opportunities and really work on how we collaborate as a team and how we bring our differentiation forward in terms of winning business. And we're seeing some success out of that. So -- as I mentioned, July was the best first month of a quarter since 2021 and one of the better ones of the last several years for sure, even with COVID considered. So, we think that the pipeline is now shaping up with some work on it is shaping up for us to achieve attractive growth. With respect to our Goldilock size, yes, I mean the other guys have gotten -- some have gotten pretty big. So, our management is accessible I'd say, if customers are listening. When I -- Mark Marias, who's our COO of Clinical Services, when we get involved with the customer, they get our mobile phone numbers, we get involved in their product. So, we're happy to engage as a management team from top to bottom and make sure we own the product with them. I think we have a great proposition in data sciences. We've actually moved been this explosion of third-party providers. We're going to leverage our experience with the LabCorp data to really be able to do stacks of data providers to bring clinical information to clinical research. We're going to invest in some very strategic technology choices that overlay. We've already got one very interesting tool that's used by our customers to try to understand their projects and we're going to invest behind that further. We continue to look at process automation and other tools. We have some great talent here. We have over 700 medical doctors in this organization. And it's very much on par with the largest. And so, we're going to make sure that is fully leveraged in the coming months. We're changing how we interact and deal with medical docs. So, just without going into the whole sales pitch, I think it's pretty -- our customers are responding really well to the -- essentially the dusty jewels and new jewels that are here to bring to these opportunities.

Great thank you very much.

Thank you.

The next question will come from Max Smock with William Blair. Your line is open.

Hi, good morning thanks for taking my question. There's a two-parter here for me as well. Just at a higher level, one of the things you talked about at the Analyst Day was your expectation for the CRO market to grow by roughly 3% to 5% in 2024. Just wondering if there's been any change there over the last couple of months and what your thoughts are in terms of the timeline for that market growth stepping back up to 6% to 9%. And then more near term, I also just wanted to confirm the FSP contract loss was a headwind here in the first half of the year. Is there any lingering impact from that contract loss in the second half of 2023? Or is that out of the story here at this point? Thank you.

I'll give Jill little airtime in the FSP in a minute. We see the market the same way. We haven't had any data that contradicts or changes our view that it's basically very much as you described, Max, the CRO market is a little bit slower this year coming probably off the frothiness of COVID. And then we see out somewhere 2024, 2025, that we're expecting a return to normalcy of that higher single-digit growth rate by that combination of outsourcing and R&D growth. Again, we use third parties for this, though. So, the only thing that we do here really with it is we say, is that what it feels like. Luckily for us, because we are medium-sized, 19,000 people are medium-sized CROs. We market growth like that is -- it's a big opportunity for us because we don't have to put down the same absolute numbers as our competitors. So, we view that kind of market growth is an exceptional opportunity for us. Jill, do you want to talk a little bit about the FSP?

Yes. So, thanks, Max. As we had shared, yes, the predominance of the impact in the first half, and you can see that continuing in the second quarter. There was a little bit that lingers into the second half, but it's pretty minor immaterial at this point. The majority of it was in the first half of this year.

About that customers, they are now -- have come back to us to potentially propose on other stuff. So, it's funny how this world.

Understood. Maybe just a quick follow-up. In terms of what's embedded in the guidance for clinical services versus main services, one of the things that maybe stood out in 2022, I think in services was down 8%. It stepped down pretty meaningfully here in the first half of the year. Just wondering how we should think about the long-term growth rate for the segment and what you need to do in order to improve your performance there moving forward. Thank you.

Yes. I'm glad you asked about enabling services because we didn't treat it too much in the prepared remarks. It's interesting. There are two major things in there. One is patient access services and the other one is an IRT or randomization tool that we call endpoints actually branded as endpoints. And what we -- as we've been looking at it strategically, the patient access business is actually a very attractive business. It's a $3 billion to $4 billion business. The competitors are I would call them vulnerable in that business. Covance was a leader in this business if you went back a decade, and to be perfectly honest with you, it seems to us there's been a little bit of underinvestment associated with our offering there. So, we have a new leader who is taking a fresh look at that business. And we have won some pretty big projects there, but they're in an investment period. So, you've got a double effect going on the patient access side. One side is the call center-related work is a little bit lumpy and has had some falloff, as Jill said in her remarks, but another aspect of that business, other aspects of patient access services that we're building are actually growing and could be significant contributors to revenue next year. But they're in a fairly capital-intensive process right now. So, that one, we think it's got very good prospects. It's a little bit above. People don't understand the opportunity in that marketplace. To this degree, there is an opportunity. And so, we are looking at how we can invest in that area and return to Covance's leadership endpoints that actually one of the leaders in this randomization tool, and I'm really pleased that our leader of enabling services actually created the leader of the services, which is another CRO a few years ago, he turned it around and created it. And so, I have -- I'm very optimistic about the future for Endpoint too because we literally have the best guy in the industry running that. So, just a little bit on it. I think you'll see it be a bit of a drag through the rest of the year, to be honest with you. And then as we bring more customer products into patient access next year, we'll start seeing that revenue situation turn around.

Got it thank you again for taking my question.

Thank you.

The next question comes from Sandy Draper with Guggenheim. Your line is open.

Thank you so much. The question is probably directed at Jill for the -- just trying to understand the backlog. I think I understood you correctly, Jill when you said you're now booking work with a two-year. And I'm just curious what it was before. Is it -- I'm assuming the full contract or was it shorter? And then I wasn't clear on the other metrics, there were some changes you said about where you would include backlog if it was not recognized. I'm just trying to understand an example of maybe somehow a contract of work where it wouldn't be in backlog you be recognizing revenue or would be the contra I just got a little bit continued, so I apologize for maybe a really basic question. But just trying to understand the mechanics of the backlog change. Thank you so much.

Sure, Sandy. I'm happy to address that. So, in terms of FSP historically, we took largely the full award at the time of contract signature. And we've decided that going forward, we would take one year on renewal since they're already in the run rate essentially and then two years on a new award, and that reflects a bit of the revenue ramp that you would get out of the new awards. So, that is the change compared to the previous period. In terms of the resetting of the backlog, I think there's always -- there are literally hundreds and hundreds, maybe thousands of projects ongoing at any point in time. And so, when we went back as we were doing this opportunity to look, we realized that there were some places where we had projects that were giving us current revenue and have revenue to burn where there was no backlog in there. And then we had the opposite where some over six or so months, we hadn't seen any revenue. And so, we felt like it was appropriate to pull that out. We also took into account any changes in scope that we had from customers that were pending. So, it was really just an opportunity to ensure the robustness of everything that was in there. It wasn't a material adjustment, but it was part of the overall adjustment. The other two adjustments that I mentioned, pulling now enabling services and this adjustment to the FSP actually pulled out a much bigger percentage of that 1.27. And that all still remains a valid backlog for the future. It's just we felt like it was better to be more consistent going forward and it will also allow us as we go forward to kind of better improve backlog burn and have that be more reflective of the nature of the backlog.

Okay. Great. That's really helpful. So essentially, the changes were just a way to clean up the backlog now that you're going to be an independent public company to help people analyze the business whereas when you're part of a larger organization, it could be looked at a little bit differently. So, it's really just, hey, we have this opportunity to set the stage and make sure it's as clean as possible.

Exactly, yes.

And one quick follow-up. I don't know have you guys said your bookings policy, whether you book on written contract verbal award once the truck project starts, how your methodology on taking a bookings event for deferred clinical?

Yes. No, I'm happy to cover that. So, we do require a written contract for us to be able to take the award. And we only start to recognize it into a backlog if the revenue is going to start to burn within 12 months, otherwise, we'd hold it until we get within that 12-month window. So, that's essentially the approach for how we will recognize.

And that's a conservative policy we adopted from LabCorp. So...

The next question comes from Derik De Bruin with Bank of America. Your line is open.

Hi, good morning everyone thank you for taking my question. I have a couple. I think the first one is just -- I know, Jill, it's a little bit too early to maybe give full color on any full color on 2024. But given where the EBITDA numbers are this year and just any color at all you can talk about how you sort of see progression. And do it just as I think that your number for this year came in below a lot of expectations, obviously, given the cost of the era. But just any incremental color on.

Yes. I mean, Derik, we're not in a position yet to be able to provide that. We understand that it's challenging. And as Tom has said in his remarks, we are attempting to ensure that by the end of next year, we're on a run rate which is consistent with the -- where we -- kind of where we exited 22 on an overall basis. We won't get there for the full year, I don't think. But in terms of trying to come back and be consistent with those margins to get back to where we were really prior -- around the period of time the spin was announced before the impact of all these challenges in terms of the awards and everything have come through. So, we are working on that. To the extent that we have more ability with the margin plans to give you detail on that, in November, we will. We're just not able at this time to be able to give you that step-wise progression.

And Derik, you know our business pretty well. And you know that essentially, we when we book a sale and so we have new bookings -- and then that starts burning some time usually in six months, sometimes a little longer, some certainly shorter sometimes. And so, there's no question that second-half new business is important. And we said we feel good about the pipeline. The team has been working hard to fill it. They've been working on how we close, looking at other opportunities. But there's no question that our 2024 will be impacted by what we're able to show you. Now Rome isn't built in a day, but the -- but we're optimistic about the remainder of the year, and that will help 2024.

Got it. Just -- it's a good -- Tom, just a follow-up on that one. Have you just talked -- going back to the market, any pickup in cancellations that you've seen any changes in farmer behavior just given some of the pipeline reprioritizations and just going on with this? And just are you getting any sense that once we get a little bit more clarity on the IRA and some other things that that's going to their interest is going to pick up? Just wondering what you sort of think about the market progression. Thank you.

Yes. Let me start with the market and then Jill can talk specifically about cancellations. We feel like we're essentially past those -- any of the portfolio reprioritization that was taking place. Some of it seemed to be related to just normal activities, some of that might have been -- so we feel like based on what we're seeing, we're past that. It's not really much of a discussion item anymore. And Jill, what do you view on...

Yes. On cancellations, our first-half average is just really consistent with our historical norms. In fact, the second quarter was slightly lower than the first quarter. So, we're not seeing any major issues around cancellations at all. It's very in line with our normal low single digits for the quarter.

Thank you, Derik.

I show no further questions at this time. I would now like to turn the call back to Tom Pike for closing remarks.

Thank you. Well, I just want to thank everyone for joining us today. Let's put this spin year behind us, and you'll see what this management team can do. And you'll see it as we meet with you, and talk to you, but I'm really optimistic about the positioning of this company, the industry we're in and the talent base we have that will make a real contribution to our customers, to patients and that will produce great financial returns. Thank you.