FTRE - NASDAQ

Ladies and gentlemen, thank you for standing by. Welcome to Fortrea First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would like now to turn 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 First 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 webcasted, and the slides accompanying today's presentation have been posted to the Investor Relations 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 concerning 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 13, 2024 (sic) [ May 13, 2024 ], 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 help investors gain a more complete understanding of our 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?

Good morning. I appreciate everyone joining this morning. We have a good deal of ground to cover, so let's get into it. In summary, the environment for and reception of Fortrea's clinical services offerings remains strong and is good enough to meet our growth ambitions. Post-spin book-to-bills are adequate for growth so far and our pipeline is good. Revenues are returning more slowly than planned, and we're addressing it. The rest of our transformation is on track. The work we're doing transforming the business is building momentum for 2025, and we expect to be beyond the complexities of the spin and historical challenges. So let's dive deeper into the growth environment. The drug development landscape remains attractive. Biotech funding had a nice first quarter leading to optimism for the sector, which is good for CROs. The demand for Fortrea's services is good and improving. At Fortrea, we are building a distinctive CRO that's agile and innovative to help our customers with drug development. My leadership team and I have spent a lot of time with customers this quarter, and customers are responding well. We are spending time on and improving how we interact with customers of all sizes. We call this our commercial transformation. But the positive response is also due to the investments we're making. Our opportunity pipeline has grown versus the prior quarter, both in terms of quantity, up mid-single digits, and up solid double digits on a dollar value basis across the clinical business. We are seeing some potential for new or expanded relationships with larger firms. We've had some very attractive wins since we spun and interesting ones this quarter. Let me share a few examples of some wins. We won a large Phase II neuroscience study with a large pharma customer. This award was meaningful both for its size and patient impact, spanning North America, Europe and Asia Pacific. This award and others confirm that our continued investment and commitment to expanding our neuroscience therapeutic area is working. We're known for our experience in oncology, and we're earning repeat business. We were awarded a large oncology program by a midsized pharma company based on our delivery of its first oncology molecule. We have good access to and large -- to large and midsized pharma who understand the advantages of our ideal scale. In clinical pharmacology, we were awarded the largest study since Dr. Oren Cohen joined about 7 years ago to lead this business. The award was based on our medical and scientific expertise in a sophisticated, exciting therapeutic area. Dr. Cohen is leading from the front with customers. Two other things I should highlight before I move on from our demand situation. First, I want to share that we're at the table in some key partnering discussions. We need to show success this year on these kinds of opportunities to meet our goals. We're already being viewed differently than in the past, competitive with the larger CROs. Second, while the Fortrea brand is relatively young, our pipeline and mix of opportunities is attractive and growing. Our plans are to make the pipeline larger as the brand becomes more widely known. This quarter, we continued to advance our differentiation in the market. Our Site Advisory Board has grown in membership in globality, providing us with the insights that we're applying to improve site performance for customers. Our customers are responding well to our technology and data partnering and innovation. In addition to these investments in differentiation, we kicked off additional efforts to improve operational effectiveness and operating margins over time. We're excited about these improvements and believe they will also translate into a better experience for our customers. We remain committed to bringing the margins of Fortrea in line with peers. While we fell short of our targeted book-to-bill of 1.2 for Q1, I'm still pleased that we're averaging over 1.2 book-to-bill since we spun with a good mix. Note that I've said our commercial transformation will take a year. As we told you in January, we had a tough start to the quarter, and we hoped we could still deliver on our target on our last call. Unfortunately, a couple of transactions made the difference. Q1 behind us, given the size and quality of our pipeline, we see no reason we cannot achieve a book-to-bill of 1.2 or greater in coming quarters. As you've seen in our guidance, we believe now we will have slower revenue burn than initially forecast. Our analysis is that this is a timing issue. To address this, we put a program in place to track every one in detail and use the power of our team to accelerate from award to first patient enrolled to drive faster overall delivery. Our team is working hard to minimize the impact of less planned revenue in our organization and financials. While the top priorities are winning business, customer delivery and getting out of these burdensome TSAs, given our situation, we're pushing even harder on expense controls and cost improvements in operations and SG&A. We continue to analyze options to improve the capital structure we inherited. We made 2 planned changes this quarter which we noted in a filing on Thursday. Our lenders are very supportive of us. We continue to methodologically work through the books and accounts we inherited from the spin. Our accounting team, with consultants, went very deep this quarter. We're trying to put such spin-related issues behind us. We feel confident about the progress we're making transforming the organization and exiting TSAs. We continue to make strong progress and partner with our former parent effectively. Let me ask you to listen closely to Jill as we had a lot going on this quarter, listen knowing that our pipeline of opportunities is strong. We're on track with our operations and cost structure improvements. Our hardworking team expects to build momentum through the year and to be clear of the spin-related tactical issues in 2025. We not only expect better results in 2025, but greater clarity and predictability. Jill, over to you.

Thank you, Tom, and thank you to everyone for joining us today. The company is in the process of completing its unaudited interim condensed, consolidated and combined financial statements for the first quarter ended March 31, 2024. Accordingly, the financial information included herein may be subject to further adjustments, which we would expect to be immaterial. Before covering the detailed financial elements of the quarter, I want to take a moment to reinforce some of the things we're doing to position the company for success over the medium to longer term. We're taking action to improve our capital structure. We're also making progress on our transformation program to enable us to reduce our operating expenses and to deliver projects faster and more efficiently for our customers. All of these initiatives are intended to position us to deliver the financial performance we want as we move forward. I'll provide more detail on these later. There is a fair amount to cover in my remarks, so I will take you through things in this order. First, financial results for the continuing operations of Fortrea, including some changes to our financial reporting this quarter; second, a brief summary of the proposed divestiture and progress towards closure; third, recent actions we have taken to bolster our capital structure; fourth, our progress on transformation, margin expansion and expectations for 2025; and finally, our revised outlook for 2024. As you've seen in the press release and heard in Tom's remarks, our first quarter results primarily reflect the softness we have previously indicated relative to the mix and lower net new business awards won during the year prior to the spin late -- in late in June of last year. While our book-to-bill for the trailing 9 months since the spin is a solid 1.22x, this particular quarter, it fell slightly short of the 1.2x goal we have been targeting. We disclosed some risk to you earlier in the quarter, and outside of one project being rescheduled late in the quarter and one customer who decided to take a project in-house, we expect we would have achieved a 1.2x for the quarter. Now for this quarter's results. This quarter, as stated previously, was expected to be the nadir of our performance due to the lower sales during the spin year and it generally came in line with the expectations we had shared. Our backlog, which you will recall, we have calculated differently post spin to demonstrate a measure that will more appropriately signal future growth, has grown approximately 6% since the spin and 0.4% sequentially, ending the quarter at $7.4 billion. The continued spin year headwinds of lower full-service clinical sales, elevated infrastructure costs, and the resources associated with the transition services agreement, have continued to weigh on our results. We expected the elevated costs, and we are making progress on exiting the TSA and working to mitigate other headwinds. I will provide an update later on the key actions we are taking to achieve our target performance. In my remarks, and as you will see in our accompanying presentation, we are focusing on the results of continuing operations, which excludes the impact of the Endpoint and Patient Access businesses that are intended for divestiture later this quarter. Clinical Services revenues of $662.1 million declined 4.6% year-on-year. This was driven by higher pass-through revenues which were more than offset by lower service fee revenues. The lower service fee revenues were due to the reduced quantity of new business wins prior to the spin, along with the mix shift, including studies moving to longer duration. Let me provide more detail on our cost base. As shared previously, we have recast first quarter 2024 and first quarter 2023 direct costs and SG&A expenses to be more consistent with our peer set for comparison purposes. We believe this will allow you to see the significant opportunity we have to improve margins, post full TSA exit, by reducing our SG&A costs as a percent of revenue over time. On a GAAP basis, direct costs in the quarter increased 2.3% year-over-year, primarily due to higher pass-through costs and stock compensation awards. SG&A in the quarter was lower year-over-year by 1.7% due primarily to the removal of former parent corporate allocations, partially offset by the cost of stand-alone operations, TSA costs and onetime spin costs as well as additional stock compensation awards. The company reclassified $45.4 million from direct costs to SG&A expenses, primarily related to information technology costs and certain non-clinic facility charges. For the first quarter, you will see SG&A as a percent of revenue at around 18%. However, it contains $17 million of onetime costs. You can see that, even excluding the onetime costs, there is significant opportunity for margin expansion through reducing SG&A costs over time. Net interest expense for the quarter was $34.3 million. Turning to our tax rate. The effective tax rate for continuing operations for the quarter was negative 5.3%, primarily due to the combined effect of a forecasted pretax loss in 2024, given our large onetime costs, a change in the valuation allowance and earnings mix. During the first quarter, we have recognized tax expense of $4.1 million in continuing operations primarily due to a forecasted valuation allowance on our deferred tax asset related to disallowed interest expense. We have plans that we expect could reduce the impact of disallowed interest expense over time. As part of our work to make enhancements to our control framework and disentangle the Endpoint and Patient Access businesses for reporting as discontinued operations, we became aware of historical misstatements of certain financial line items, which we have identified. The overall impact of these adjustments is not considered material to any given year. The adjustments in the aggregate would be material if all years of adjustments were made in the first quarter of 2024. In light of this, these adjustments will be recorded in a footnote into our first quarter Form 10-Q which we plan to issue within the extended filing period. As a result of these findings, we are continuing to bolster our financial control environment. Continued operations adjusted EBITDA for the quarter of $29.5 million decreased 29.3% year-over-year compared to adjusted EBITDA of $41.7 million in the prior year period. Adjusted EBITDA margin for the first quarter was 4.5% compared to 6% in the prior year period. Adjusted EBITDA margin in the quarter was negatively impacted by lower service fee revenues from the lower awards during the pre-spin year, mix to longer-duration studies, higher pass-through revenues and higher SG&A costs post spin to support standalone operations. These were partially offset by the benefit from the restructuring program we initiated in the third quarter of 2023. In the first quarter of 2024, adjusted net loss of $3.5 million decreased 112% compared to adjusted net income of $29.1 million in the prior year period. Adjusted net loss for both basic and diluted share for the quarter was $0.04 compared to adjusted net income of $0.33 in the prior year period. Turning to customer concentration. In our continuing operations post divestiture, our top 10 customers represented slightly more than half of our first quarter 2024 revenues. One customer accounted for 14% of revenues and another customer accounted for 13% of revenues. In my comments on cash flows, note these relate to Fortrea in total as we have not segregated cash flows from discontinued operations. In the first quarter, we reported negative $25.6 million in cash flow from operating activities compared to negative $1.6 million generated in the prior year. The primary drivers of the negative cash flow from operating activities were annual tax resets, spend to support TSA exits, interest expense and other items, including a bonus earned as part of our former parent. Free cash flow was negative $34.9 million compared to negative $17.8 million in 2023. Cash flows used for operations decreased due to the reduction in net income offset by an improvement in unbilled services and deferred revenue and lower cash used for accrued expenses. Due to process and contracting changes we have been implementing, we are seeing initial improvements in unbilled and unearned balances. Net accounts receivable and unbilled services for continuing operations were $941 million as of March 31, 2024, compared to $988.5 million as of December 31, 2023. Days sales outstanding from continuing operations was 97 days as of March 31, 2024, 4 days lower than December 31, 2023. The reduction versus the prior year-end is primarily due to improvements in cash collections and an increase in advances. We continue to make these changes to our contracting and order to cash processes to enable further improvement in our DSO profile over time. Because our contracts provide services over multiple years, there is a lag in seeing those changes reflected in our performance while we work through the historic portfolio. Now I will briefly touch on progress towards the previously announced divestiture of our Endpoint and Patient Access businesses. These businesses' results are now being accounted for as discontinued operations, the details of which will be included in our Form 10-Q. We continue to make progress towards closing the transaction in the second quarter. Consistent with our internal planning, we recently made 2 adjustments to our capital structure. We worked with our lenders to amend our credit agreement and create temporary adjustments to our financial covenants. Our maximum total leverage ratio was increased from 5.3x to 6x, and our minimum interest coverage ratio was reduced from 2x to 1.7x. In both cases, the new ratios are effective in the second quarter of 2024 and step down over time until reverting to prior levels as of the third quarter of 2025. We intend to update the presentation posted on our website in connection with this call to include the trailing 12-month adjusted EBITDA measure used for leverage calculations for continuing operations after we file our Form 10-Q. Recall that under our credit agreement, we have additional add-backs beyond our adjusted EBITDA results, including public company costs, spin-related costs and the pro forma benefits from cost savings initiatives. We expect that we will remain fully compliant for the first quarter of 2024 and for the foreseeable future. We have also executed a receivables purchase agreement to sell a portion of our receivables on a recurring basis and we'll use the proceeds to pay down higher rate term loan debt to reduce our ongoing interest expense. We expect this arrangement would reduce our effective net annual interest expense by approximately $7 million. We intend to fully utilize this facility with the initial sale occurring before the end of the second quarter. Note that in connection with entering this facility, we terminated our existing factoring arrangement. Upon closure of the proposed divestiture, we will apply 100% of the net proceeds from the sale of the Endpoint and Patient Access businesses to pay down a portion of our term loan debt, which will also improve our covenant ratios and reduce the ongoing interest expense. Our capital allocation priorities are unchanged, focusing on infrastructure investments for the timely exit of the transition services agreement, targeted investments to drive organic growth and debt repayment. Our target for net leverage ratio continues to be 2.5x to 3x over the medium term. Now I will provide an update on our transformation program. It is a multifaceted program that requires thoughtful execution as we balance improving financial results with making changes to increase the longer-term health and performance of Fortrea. We've now exited roughly half of our TSAs with our former parent and we have robust plans in place to exit the majority of the remaining TSAs around the end of 2024. Let me remind you about other initiatives we have commenced to propel our transformation and deliver results that are more in line with peers. First, we have targeted programs to selectively reduce pockets of excess costs, areas of lower productivity and to flatten the organization. The first one began in the third quarter of 2023 and a second one is planned for 2024. These programs are intended to show benefits over time. Also, as previously discussed, we have benchmarked our SG&A against our peers and are building more efficient supporting organizations. In some key areas, we expect to begin to see benefits emerge later this year with others planned for next year as we fully exit the TSA. As you can see from our recasted SG&A expense line item, this is critical for us to be competitive with our peers. In addition, this quarter, we identified and started setting targets in some key areas to drive operating margin improvement. In addition to the cost structure improvements, we remain laser-focused on building our backlog with the right mix and volume of new business awards. We literally have everyone in sales in Fortrea and have granted more than 80 spot awards for individuals outside of our sales organization who have brought in qualified RFPs for us to pursue. Putting more revenue through the global footprint we require to be competitive will improve our operating leverage. Most of these changes will start to benefit us in 2025, where we expect to realize margin improvement arising from revenue growth and operational productivity as well as our post-TSA streamlined SG&A cost infrastructure. We believe this transformation will enable us to reduce our expenses and to deliver projects faster and more efficiently for our customers. Assuming our ability to continue to drive trailing book-to-bill metrics of at least 1.2x for the remainder of 2024 and exiting our remaining TSAs per our current plan, we continue to target full year 2025 adjusted EBITDA margins at least consistent with 2022 at approximately 13%. The improved revenues and margins will also enhance our debt-to-EBITDA ratios. Finally, I will cover our updated guidance for continuing operations. For full year 2024, we now target revenues to be in the range of $2.785 billion to $2.855 billion. This adjustment reflects slower study start-up due to the therapeutic mix and certain biotech programs, our lower-than-anticipated first quarter book-to-bill and lower recent pass-through trends. As a result of these headwinds, we now expect to have overall revenue growth broadly flat versus 2023, although the second half is targeted to be modestly positive at around 3%. Our updated adjusted EBITDA target is in the range of $240 million to $260 million. We have taken a number of actions to reduce the typical drop-through of revenue reductions, as I mentioned earlier. Note that our former recommendation on assuming approximately $250 million in revenue and $30 million in adjusted EBITDA for full year 2024 for the businesses to be divested still applies. Fortrea's leadership team brings a wealth of experience and is delivering innovative solutions to improve efficiency in clinical development. Our clinical services offerings are resonating with our customers where we are being invited to conversations that weren't available previously. As a pure-play CRO, we will be focused on implementing our transformation initiatives and are poised to become a leader in the industry to capture the substantial margin expansion opportunity that lies in front of us. Now I'll turn it back to Tom for the remainder of his remarks.

Thanks, Jill. We're roughly at the midpoint of an 18-month transition period after our spin. While there are challenges, the returns for going on this journey, whether as a customer, an employee or an investor, are very attractive. Fortrea can deliver innovations to customers while growing and improving margins in ways unmatched in our segment of the industry. We have a good pipeline that should deliver a solid book-to-bills in the future and will enable a return to growth. Customers are responding well to our offerings. We have a strong team making progress with our transformation. That includes more innovation, better customer delivery, exiting the TSAs with our former parent, reducing SG&A costs and ensuring we have strong financial internal controls. We are getting it done. We're taking a solid division of a larger company with historical roots in one of the leading CROs, Covance, and transforming it into a distinctive CRO that becomes the favorite choice for customers. I'm encouraged by the tenacity of the Fortrea team. We work very hard. We have great experience and skill. We're attracting great people. Just Friday, I met with one of our new executives who said both employees and customers can feel the energy and excitement in the organization. The entire Fortrea team is focused on our mission of delivering solutions that bring life-changing treatments to patients faster. As we do that, we're committed to, and will create value for, all of our stakeholders. We will build momentum and enter 2025 with growing strength. If I had one theme for you, it's this: We're making real progress on the important stuff. With that, operator, let's open it up for questions.

[Operator Instructions] Stand by for our first question, and it comes from David Windley with Jefferies.

I want to focus on demand, Tom. So you talked about pipeline of opportunities, book-to-bill a little below what you were hoping to get to this quarter, and it sounds like a couple of opportunities made the difference. If you could talk about win rate. And I guess I'm getting at win rate versus maybe opportunities that didn't go to decision in the first quarter. And then I've got a follow-up after that.

Yes. Actually, Dave, our win rate is strong. We had a strong win rate for that -- this quarter. It's the best one since we spun. I think the challenge really was that we had one fairly sizable opportunity rescheduled, which we've signed a start-up agreement now. And we expect it will not be a problem, but it got rescheduled. And then we also had a cancellation that was fairly large that came in right at the end. And as you know, you know this industry well. It only takes a couple of those this size and you lose that 0.1. I will say, though, Dave, I mean, the 2 things I really like about our demand situation. One is we are at the table with some large customers who are thinking about how they're going to proceed with providers and we're being viewed as a peer. And then the other one is just the pure number of opportunities. That solid -- really strong double-digit growth in dollar value of our pipeline is really a good thing for us. So I think we're just in a situation where we need to execute against the opportunities in front of us because we're getting the at-bats now.

That maybe segues nicely into my second question, which is, what is getting you those at-bats? So I hear you talking about more modern CRO differentiation. I guess I'm listening closely for what are the elements of that differentiation partnerships that you're striking, things like that? What maybe overarching themes would you put over the top of that? And maybe give some specific examples of what you're doing to create that differentiation?

Yes. A few things, Dave. One, the way we're thinking about sites, and I mentioned the Site Advisory Board, but there's really much more there is really resonating with customers. I think they know that, that last mile issue in our industry, that making sure the sites are productive, that we're -- we've kind of gone beyond simply trying to understand whether there are patients in the local geography or in the electronic medical records of the site. And now we're talking about how do you really execute on bringing people through enrollment in a study in innovative ways? And so we're pushing on that. They like the way we're thinking about data and technology. I think the notion that we have here of partnering with some of the leaders, like Veeva, Advarra and Medidata, leveraging what they're doing, partnering with some of the leaders in data, the TriNetX and Komodos and others, those kind of partnerships are the way to go. And then how do we use our tools to access even more value than those providers create? And then I have to, say some of the innovations we're doing, we had a session right in the room that we're sitting in today with a leading pharmaceutical firm where we talked about how we view artificial intelligence impacting clinical services. We have to -- this is an industry where we have to make sure that patients stay safe. The data has to be high quality. We can't make bad decisions. But we do see a number of areas where our operational intelligence that we've gained over the years can help us simplify processes and make better decisions in the process. And so really, Dave, they're responding to that. I think they feel the difference when they meet with us. They'll meet with Jill, me, other executives. I think they feel the difference in this organization in terms of how we have our hands really deeply into what makes this industry tick.

[Operator Instructions] The next question comes from Elizabeth Anderson with Evercore.

I was wondering if you could talk about the burn rate. I think you obviously talked about that a little bit in the prepared remarks. But if you could talk about -- a little bit about more detail about how that assumption tracks as we go through the year, and what the specific drivers are of that increase in burn rate.

Yes. Let me give a little overview, and then Jill can add some comments. I think I've been in this industry for a long time, and we use heuristics to think about how quickly new opportunities burn that are based on the experiences we all have. And there's this general view that new sold business burns in 6 to 9 months. I think what we found here, with the mix we have, with the amount of oncology that we do here. Plus, we do a lot of biotechs. We've talked about it before, Elizabeth, that we're 50% biotechs. And some of the biotechs are not quite as far along. There are more changes to the protocols, more elements of startup that need to be worked through in terms of responsibilities in detail. And so what we found is that some of the traditional metrics for those first few months of business after we spun that we sold aren't quite right and the burn is a little bit slower. The good news is that it looks like it's a timing issue. I would be worried if there were cancellations or other things that were causing that. But it looks like it's more timing and startup. And so what we're doing is we're working as a group to do what we do here. Now we have a call every other Friday looking at exactly what we've won and then how it's starting to progress. And we will try to do what we can to help teams, whether it's through leadership relationships, whether it's through tactical changes to help them speed things up. So Jill, I don't know if there's much to add to that.

I don't think there is, Tom. I think it's that you've described the environment well. And we do expect as we continue to build the net new business awards over time, it will start to pick up and the momentum will pick up. But it's probably going to take a little bit for us to get to that point. Later next year, more so into 2025.

Got it. That makes sense. And I appreciate your comments about the timing impact and sizable agreement that got rescheduled and is now signed. Would you say in terms of if we're thinking about like the second quarter in April and May, that, that -- those comments in terms of like the broadly increasing momentum and what you said about the RFP flow. How would you characterize that having flowed into the second quarter?

Yes. I mean, we'll probably say the same words. If we execute against the pipeline we have, we should be able to meet our targets. And it's a little earlier than last time we talked, Elizabeth, in the quarter. But we should be able to meet our targets if we execute against the pipeline we have. I will say the commercial team and our operations team are doing a very good job with these relationships. And it's an important quarter for us, obviously, to demonstrate that we can deliver what we'd like to deliver.

[Operator Instructions] Next question comes from Patrick Donnelly with Citi.

Jill, maybe one for you first. Just wondering on the margin side. You're still talking about the exit rate of 13% getting into year-end. Can you just -- can you talk about the path there, both on the gross margin side and the SG&A? And just the confidence level, given obviously this quarter came in a little light, but the margin still look pretty good. So can you please just talk about the path to that 13%.

Sure. Thanks for the question. We -- it's really about 1/4 that's going to come through on the cost actions, particularly around SG&A, some of the changes that we've made there and the programs that we've put in place to improve the productivity. And the other 3/4 is going to come from leverage on the modest revenue growth that we see in the second half because we don't believe that we need to add resource to support that growth in any great -- to any great extent, given that we've -- as we've said before, we've held on to the infrastructure that we have, you need that to be competitive on a global basis. So most of that revenue can drop through pretty strongly. So that's how we'll see us get from where we are this quarter to the end of the year.

Okay. That's helpful. And then, Tom, maybe just one more on the demand side. It sounds like, again, RFPs were very healthy. The win rate seems like it's a in a good place. And to your point, you've been in this industry a long time. Could it just come down to, again, that's kind of 1 contract, 2 contracts. You sounded pretty good in mid-March about hitting that 1 soon. So again, is it the fact of the book-to-bill, you're still a smaller company relative to some others, and it's just a little bit lumpier with 1 or 2 contracts? It sounds like -- you sound pretty good on the demand environment and the path to staying above 1.2 going forward. So I just want to talk to that a bit.

Yes, Patrick, I think you characterized it well. We are a little smaller. So when we have a couple of larger transactions, it can influence that number in the way it did by 0.1 points there. So I still -- I do feel good about the environment we're in. We still are in that commercial transformation. So we've talked with our Chief Commercial Officer about scheduling and estimating. And he and his team are really doing an excellent job. But obviously, we didn't quite get to where we hoped to get mid-March. And we're doing what we do here, so we're going to get better at it. So I do feel good. As we said, this solid double-digit growth of dollar value of pipeline is great. Some of the partnering discussions are really exciting. I spent a week in Europe a couple of weeks ago and met with many customers. And I'll tell you, we're having some great discussions. We're in the mix. So this is an important quarter and it's going to be an important summer as well. These next 2 quarters are going to be very important for us to show everybody what we can do here.

[Operator Instructions] The next question comes from Eric Coldwell with Baird.

I wanted to come back to the cancellation. I have a few just housekeeping question. So on the cancellations, you did mention the one fairly large cancel at the end of the quarter. Other than that, how were cancellations tracking in the period? Were they normal, below normal? Just trying to get a sense on the overall magnitude of cancellations.

Yes, Eric, they were normal in the quarter. They were normal in the quarter.

Great. And then on the mix of awards, could you talk a little bit about direct versus indirect revenue? And then also functional versus full service mix?

Talk about the pass-throughs versus other? Is that what you mean by direct versus indirect? Yes, let's...

Yes. Yes, let's go with it. So yes, so we have -- we are continuing to see -- if you look year-on-year for the quarter, the percent of -- pass-through as a percent of total revenue did increase year-on-year. Having said that, we are -- part of our call down in the revenue guide is because we have seen it come down a bit lower than it was in the fourth quarter of last year. And pass-throughs are incredibly hard to predict. We had a few studies last year that were big drivers that seem to be a bit more moderated. At the moment, we're not sure if that come back. So we took a little bit of caution in setting the revenue for the rest of the year. But we are seeing pass-throughs be a higher percentage year-on-year.

And was that the same comment on bookings this quarter, that the direct fee bookings continued to improve in pass-through or indirect...

Yes, I think we've actually seen fairly consistent between the 605 and the 606 on bookings in the quarter.

Yes. Nothing to note there. And our mix is good. I mean, it represents the business overall, Eric. It's not -- I will say it's very consistent with our clinical pharmacology, which had a strong performance. Kind of a normal rate of FSP and then a normal rate of what we call GCD here, or full-service outsourcing. Obviously, we would have liked to have done more, but the mix itself was solid.

And then if I could just do one last one. You made a number of comments about how the pipeline and opportunity set is out there. I am curious, halfway through 2Q to date, how do you stand on awards and cancels at the halfway point in terms of what you might have seen, say, just not very many quarters since the spin, but recent experience or expectations. Are you at, below, above where you feel like you need to be at the 1.2?

I think it's consistent with what we would expect to see at this point in the quarter. As Tom shared in his remarks, the pipeline is really strong, we've been pleased to see the growth in it, and we feel good about where we are at this point in the quarter. As you know, it always comes down to the last weeks of the last month. But at this point, we feel good about where we sit.

[Operator Instructions] The next question comes from Max Smock with William Blair.

Tom, over the last couple of quarters, it feels like you were maybe moving away from large pharma a bit, or at least being a little bit more selective about those opportunities and really talking about biotech. I didn't hear as much of that today. So wondering if there's been any change in terms of how you're thinking about prioritizing opportunities here near term. And then any incremental color you can give us around demand trends for biotech and how those compare to large pharma.

I may have miscommunicated, Max, if that's the case. I think of this as a very 50-50 business. So we do want to make progress with large pharma. And what I like about large pharma is we -- you get that consistency of being allocated projects, whether you have to compete for them or whether they just allocate it to you. And so we like that, and we know that we need to expand that. That being said, this organization historically has done a lot of biotech. And you all know the growth. I mean, there are statistics out there that as much as 65% of the innovative drug development is coming out of biotechs now, and that's growing over the next few years, not shrinking. And generally, in my conversations with industry executives, they all believe the same thing, and they're acting accordingly. So we're going to keep going after biotech. In fact, we're trying to enhance our biotech offering. I hope to have some something to announce on that. I'm going to be doing a panel at BIO and hope to have something to announce on that over the next few weeks. So it really is a very balanced look. I think the reason why I'm mentioning it this quarter is we do have some partnering opportunities that we are hopeful for. At a minimum, we're going to learn a ton from them. And at a maximum, it could be very good for Fortrea. So that's part of the reason why I'm emphasizing it today. Does that make sense, Max?

Yes, it does. And apologies, some of the misunderstanding was probably on my end as well. But in terms of the demand trends, the second part of that question. Have you seen an uptick from biotech? Is large pharma still strong? Like how do you think about demand trends for each of those buckets?

Yes. I'd tell you, it's very consistent with the reports coming out of -- whenever you do these calls, you take a look at what the third parties are producing, what Windley is producing, what others are producing on biotech. It's very consistent what I think, for instance Dave, is reporting, that it's a solid picture. It's not something where every box is being checked in terms of financing. But we certainly are seeing biotechs that we work with get funded, and we're seeing continuing opportunities. We're still screening them carefully. We talk about that quite a bit because there -- some of them will want to work with us contingent on funding, and so we're reluctant to do that. But we are seeing a solid funding picture and solid health and opportunity there. And so very innovative products, to be frank about it, too. So.

That's helpful. And maybe just sneaking a quick follow-up in there on pricing dynamics. Any commentary around how those have changed over the last couple of months? Are you seeing customers become even more price-sensitive? And do you have competitors out there that are starting to compete more aggressively on price here over the last couple of months?

It's funny. Customer has been price-competitive since I've been in this industry, so it makes me smile to hear that. So they're always price-competitive and very proud of it. But that being said -- and I'm talking big pharma in particular there. But that being said, there's nothing particularly new there. I do think the largest FSP is becoming very competitive. So I will say that. Sometimes, we participate in larger FSPs, sometimes we don't, but it's becoming very competitive. And certainly, we're all keeping an eye on the private CROs. What we're hoping is that everyone understands that disciplined pricing is good for the entire industry. But we're keeping a close eye on it, Max, because we've seen a couple of examples where it looks like work is being purchased or bought. So we're keeping a close eye on it. What Jill and I always say, though, is, in general, a lot of our customers will throw out the highest bid and the lowest bid if they're too far off because they feel like something may be wrong. And so there's this band that I think we all want to optimally price in where we can be successful financially and we can deliver them a good result without a lot of change orders. And so that's the band that we try to be in, the one where we -- both sides win and where we don't have to change our way out of some project.

[Operator Instructions] The next question comes from Michael Ryskin with Bank of America.

One quick one for you, Tom, to start, and then a follow up for Jill. On the big project delay in the quarter that you called out. Obviously, I think timing is probably hard to call here. But is that a couple of weeks, a couple of months delay? Or is that slipping into 2025? Do you have any clarity on when that might come through? Just because it seems relatively material on its own.

Well, the one is -- I think that we would expect that we would sign the one that slipped out of last quarter or this quarter completely. And as I said, we signed a start-up agreement with them. So I think that's progressing along. And again, one deal doesn't make or break this place. So it's not as if it's so large that it makes or breaks it. But it was enough that, between that and that fairly large cancellation, just the 2 numbers alone caused that miss. So those 2 transactions alone. So that's why we call it out. Because generally, the health of the pipeline is good and we're doing a lot of transactions. It's just that when you have a couple of larger ones that you thought were on track, and that's what happens.

Okay. Great. That's helpful. And Jill, a follow-up for you. I think just kind of going back to the point. Something that Patrick I think asked you about earlier. Just with all the moving pieces, with the fact that the divested assets are now out of the model and you talk about reclassifying some of the cost. So thinking about the difference between the gross margin, SG&A and EBITDA line as we go through the year. Obviously, you've got that steep ramp to sort of hit that exiting the year at roughly 13%. So should we be thinking that gross profit gets you part of the way there, but the majority is really should be coming from the SG&A line? And just any commentary on pacing through the year. It seems like it's a little bit more back-end loaded than what it had been before. Just to true up the dollar amounts. But any clarity there would be helpful.

Yes, of course. So actually, we do think that -- we think it will actually come more from gross margin improvements, which are kind of driven from the modest increase in revenue growth, so getting to about 3% in the back half compared to where we are in the first half with essentially the same size of operational footprint. Most of that increase then drops through and only about 1/4 of it will come from SG&A. Because you may remember from earlier calls, we are able to make some improvements and changes this year. But until we fully exit all of the TSAs, which won't be really until right at the end of the year. Maybe even just into 2025, but the majority by the end of this year, you really can't change some of the cost base you have in SG&A until you fully exit because you're kind of stuck with that cost base and supporting the existing processes and systems. So it actually comes more from top line than it does from just cost cuts to get to there in the back half. And in terms of confidence and ramp, you're right. We talked before of it being still a bit of a tale of 2 halves with the first half being slightly down from a revenue perspective. We had talked about, in totality for the business, when we had the different guidance, 1/3 and 2/3. And it's still roughly the same when we look at that even for continuing operations. And where we landed for the first quarter for continuing operations is in line -- is exactly in line with where we expected it to be.

[Operator Instructions] The next question comes from Rishi Parekh with JPMorgan.

Earlier, you noted that you're at the table with some of these large customers and viewed as a peer. As you're thinking about these contracts that you're competing for, what are some of the factors that may potentially allow you to win these contracts? Is it that these contracts are FSP? Are you taking on incremental risk? Any details would help.

The last one, no incremental risk. Just to be clear on that one. But Rishi, they're actually mixed. So there's some -- I think we talked in prior calls that we're seeing some evolution towards this notion of hybrid full-service and FSP, and we continue to see that. And so in general, a lot of the larger customers are asking for some full-service support but then also enhanced or evolved FSP support. So we're seeing both of those types of opportunities as we go forward. So I mean, there are just good opportunities, and we're working hard to try to satisfy those customers' interests. So we'll see how things go.

Okay. And then on the cap structure, was the amendment to your maintenance covenants mostly or entirely due to the asset sale? Or was there a meaningful percentage of the adjustment due to the Q1 contract issues and any other future or further operational headwinds? And then if you could just remind me -- sorry, if you could just remind me. Of the borrowings under the AR facility, is that included in your total leverage test?

Yes. So you're right in the reason and the rationale. The main rationale, out of abundance of caution, recognizing that the way the trailing 12-month measures are calculated post divestiture, we felt that it was prudent to go and it's a relatively low cost to secure those additional amendments to get us through that period while we work through those changes in the trailing measures. So that was one of the primary drivers for that. And then on the latter, that when you -- if you look at the presentation and you see the gross debt, that does include some borrowings from the revolver. We did have borrowings in the revolver at the end of the quarter, and that is included in the calculation.

And then free cash flow, you said it was negative in the quarter. What are your free cash flow expectations for the year, positive or negative? And if negative, do you expect to use the AR facility to fund that shortfall?

So we're expecting it probably to be slightly negative for the full year. It will improve as we go through the course of the year and should be positive by the time we get to the end of the year, But it's possible that for the full year, it will be slightly negative. And yes, we would just probably use the revolver or the AR facility to help support that. But we would expect it to come back to positive. So it's really -- it's a timing issue. It's just -- it's a function, quite frankly, of all the onetime costs that we're incurring related to the spin being so significant this year.

And you'll recall, Rishi, that our revolver is of a scale that's good for the situation.

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. I'll just close by saying we're making solid progress toward our goal of being the best choice among clinical research organizations for customers, large and small, trying to create a positive and distinctive experience for those customers as well as our employees. So we appreciate your support, and we'll talk to you soon. Thank you.