Fortrea Holdings Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (in millions) The following discussion and analysis is intended to provide a summary of significant factors relevant to the financial performance and condition of Fortrea Holdings Inc., which we refer to in this discussion and analysis as “Fortrea,” the “Company,” “our” and “we”. Prior to the spin-off (the “Spin” or “the Separation”), Fortrea existed and functioned as part of Laboratory Corporation of America Holdings, which we refer to in this discussion and analysis as “Labcorp” or “Former Parent.” The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited combined financial statements and corresponding notes included in our Annual Report on Form 10-K (the “Form 10-K”) and our unaudited condensed consolidated and combined financial statements and corresponding notes in Item 1. “Financial Statements.” Unless otherwise noted, the following information and discussion relates to our continuing operations. Cautionary Statement Concerning Forward-Looking Statements This Form 10-Q and other materials we have filed or will file with the Securities and Exchange Commission (the “SEC”) include or will include forward-looking statements. Some of the forward-looking statements can be identified by the use of terms such as “believes,” “expects,” “may,” “will,” “should,” “could,” “seeks,” “approximately,” “intends,” “plans,” “estimates,” “anticipates,” or other comparable terms. These forward-looking statements include all matters that are not related to present facts or current conditions or that are not historical facts. They appear in a number of places throughout this Form 10-Q and include statements regarding our intentions, 46 Table of Contents beliefs, or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects and growth strategies, and the industries in which we operate and include, without limitation, statements relating to our future performance. Forward-looking statements are subject to known and unknown risks and uncertainties, many of which are beyond our control. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and industry development may differ materially from those made in or suggested by the forward-looking statements contained in this Form 10-Q. In addition, even if our results of operations, financial condition and liquidity, and industry development are consistent with the forward-looking statements contained in this Form 10-Q, those results or developments may not be indicative of results or developments in subsequent periods. A number of important factors could cause actual results to differ materially from those contained in or implied by the forward-looking statements, including the risks and uncertainties discussed in the “Risk Factors” Section of our Form 10-K, as filed with the SEC. Factors that could cause actual results to differ from those reflected in forward-looking statements relating to our operations and business include, among other things: the risk that we may not realize some or all of the benefits expected to result from the Spin, or that such benefits are delayed; risks and consequences that are a result of the Spin; the impacts of becoming an independent public company; our reliance on Labcorp to provide financial reporting and other financial and accounting information for periods prior to the Spin through the end of the relevant transition agreements, as well as IT, accounting, finance, legal, human resources, and other services critical to our businesses; our dependence on third parties generally to provide services critical to our businesses throughout the transition period and beyond; the risk that establishment of our accounting, enterprise resource planning, and other management systems post the transition period could cost more or take longer than anticipated; our identification of existing material weaknesses in our internal control over financial reporting; the impact of the rebranding of the Company; our ability to successfully implement our business strategies and execute our long-term value creation strategy; risks and expenses associated with our international operations and currency fluctuations; our customer or therapeutic area concentrations; any further deterioration in the macroeconomic environment, which could lead to defaults or cancellations by our customers; the risk that our backlog and net new business may not grow to the extent we anticipate or the time period we anticipate, that such measures may not be indicative of our future revenues and that we might not realize all of the anticipated future revenue reflected in our backlog; our ability to generate sufficient net new business awards, or the risk that net new business awards are delayed, terminated, reduced in scope, or fail to go to contract; the risk that we may underprice our contracts, overrun our cost estimates, or fail to receive approval for, or experience delays in documentation of change orders; our ability to complete the divestiture of the Endpoint and Patient Access businesses on time or at all and our ability to realize the full purchase price and benefits of the transaction; and other factors described in the Form 10-K and from time to time in documents that we file with the SEC. All forward-looking statements are made only as of the date of this Form 10-Q and we do not undertake any obligation, other than as may be required by law, to update or revise any forward-looking statements to reflect future events or developments. Comparisons of results for current and any prior periods are not intended to express any future trends, or indications of future performance, unless expressed as such, and should only be viewed as historical data. For a further discussion of the risks relating to our business, see the “Risk Factors” section of our Annual Report on Form 10-K. Company Overview Fortrea, a Delaware corporation incorporated on January 31, 2023, is a leading global contract research organization (“CRO”) providing biopharmaceutical product and medical device development services to pharmaceutical, biotechnology and medical device customers. We offer customers highly flexible delivery models that include Full Service, Functional Service Provider (“FSP”), and Hybrid Service structures. We have a rich history of providing clinical development services for over 30 years across more than 20 therapeutic areas, first as Covance and later as Labcorp Drug Development. On June 30, 2023, we completed the Spin from Labcorp. We leverage our global scale, scientific expertise, clinical data insights, technology innovation, industry network and decades of experience as a standalone company and as a business unit prior to the Spin to deliver tailored solutions to our customers. With what we believe is a distinctive market offering, Fortrea meets growing global demand for clinical development services. 47 Table of Contents Our team of approximately 16,000 employees from continuing operations conducts operations in approximately 90 countries and delivers comprehensive phase I – IV clinical trial management, clinical pharmacology and consulting services for our customers. Our offering is scaled to deliver focused and agile solutions to customers globally, streamlining the biopharmaceutical product and medical device development process. Separation from Labcorp On June 30, 2023, we completed the Spin from Labcorp through a pro-rata distribution of one share of Fortrea common stock for every share of Labcorp common stock held at the close of business on the record date of June 20, 2023. Fortrea began to trade as a separate public company (NASDAQ: FTRE) on July 3, 2023. Incremental Independent Public Company Expenses The condensed consolidated and combined statements of operations include costs for certain centralized functions and programs provided and administered by Labcorp that were allocated to us in the periods presented prior to the Spin. These centralized functions and programs include, but are not limited to, legal, tax, treasury, risk management, sales expenses, IT, human resources, finance, supply chain, executive leadership and stock-based compensation. These expenses were allocated to us based on direct usage when identifiable or, when not directly identifiable, on the basis of proportional net revenues or headcount or other reasonable driver, as applicable. We consider the basis on which the expenses have been allocated to reasonably reflect the utilization of services provided to, or the benefit received by, us during the periods presented. However, the allocations may not reflect the expenses we would have incurred as an independent company for the periods presented. Actual costs that may have been incurred if we had been a standalone company would depend on a number of factors, including the organizational structure, whether functions were outsourced or performed by employees, and strategic decisions made in areas such as IT and infrastructure. For a period following the Separation, however, some of these functions will be provided by Labcorp under the Transition Services Agreements. The actual costs of services represented by these allocations may vary significantly from the amounts allocated to us in the accompanying financial statements. Sale of Assets Relating to the Enabling Services Segment On March 9, 2024, the Company, together with its wholly-owned subsidiary, Fortrea Inc. (the “Seller”), entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Endeavor Buyer LLC, an affiliate of Arsenal Capital Partners, pursuant to which the Seller has agreed to sell, and to cause its affiliates to sell, certain assets relating to its Enabling Services Segment (the “Transaction”), including the sale of equity interests of Fortrea Patient Access Inc. and its subsidiaries and Endpoint Clinical, Inc. and its subsidiaries. The purchase price for the Transaction is $345.0, subject to customary purchase price adjustments, with $295.0 to be paid at closing and $50.0 to be paid upon achievement of certain transition-related milestones. The Transaction is targeted to close in the second quarter of 2024, subject to customary closing conditions and government approvals, as well as the parties entering into certain services and operating agreements. The decision to sell such assets relating to the Enabling Services segment represented a strategic shift that had a significant effect on the Company's results and operations and assets and liabilities for the periods presented. As a result, the Company has classified the assets related to the Enabling Services segment as assets from discontinued operations and liabilities from discontinued operations on the condensed consolidated and combined balance sheets as of March 31, 2024 and December 31, 2023. The operations of the Enabling Services segment have been classified as income from discontinued operations on the condensed consolidated and combined statements of operations for all periods presented. Backlog and Net New Business Our backlog consists of anticipated future revenue from business awards that either have not started, or that are in process and have not been completed. Our backlog also reflects any cancellation or adjustment activity related to these awards. The average duration of our contracts will fluctuate from period to period based on the contracts comprising our backlog at any given time. The majority of our contracts contain early termination provisions that 48 Table of Contents typically require notice periods ranging from 30 to 90 days. We adjust backlog for foreign currency fluctuations and exclude from backlog revenue that has been recognized as revenue in our statements of operations. Our backlog was $7.4 billion as of March 31, 2024. We do not believe that, as a sole measure, our backlog is a consistent indicator of future revenue because it has been, and likely will continue to be, affected by a number of factors, including the variable size and duration of projects, many of which are performed over several years, and changes to the scope of work during the course of projects. Additionally, projects may be canceled or delayed by the customer or regulatory authorities. We generally do not have a contractual right to the full amount of the contract award reflected in our backlog. If a customer cancels a contract, we generally will be reimbursed for the costs we have incurred. For a further discussion of the risks relating to our business, see the “Risk Factors” section of our Annual Report on Form 10-K. RESULTS OF CONTINUING OPERATIONS Three Months Ended March 31, 2024 compared with Three Months Ended March 31, 2023 The following tables present the financial measures that management considers to be the most significant indicators of the Company's performance. Revenues Three Months Ended March 31, 2024 2023 Change Revenues $ 662.1 $ 693.9 (4.6) % The Company’s revenues for the three months ended March 31, 2024 were $662.1, a decrease of 4.6% from revenues of $693.9 in the corresponding period in 2023. The change in revenues was due to a decrease in organic revenues of 4.7% offset by a favorable foreign currency translation of 0.1%. The Company defines organic growth as the change in revenues excluding the year over year impact of acquisitions, divestitures and currency. The 4.7% decrease in organic revenues was primarily driven by lower service revenues resulting from the quantity and burn rate of new business wins pre-Spin, and the challenges of mix, partially offset by increased pass through revenues. Direct Costs, Exclusive of Depreciation and Amortization Three Months Ended March 31, 2024 2023 Change Direct costs $ 554.2 $ 541.5 2.3 % Direct costs as a % of revenues 83.7 % 78.0 % Direct costs increased 2.3% during the three months ended March 31, 2024 as compared with the corresponding period in 2023. Direct costs increased as a percentage of revenues to 83.7% during the three months ended March 31, 2024 as compared to 78.0% in the corresponding period in 2023. The increase in direct costs was primarily due to higher pass through costs. Pass through costs are paid by the customer resulting in revenue fully offset by these direct costs. Selling, General and Administrative Expenses, Exclusive of Depreciation and Amortization Three Months Ended March 31, 2024 2023 Change Selling, general and administrative expenses $ 120.1 $ 116.8 2.8 % Selling, general and administrative expenses consist primarily of administrative payroll and related benefit charges, information technology costs, other facility charges, advertising and promotional expenses, administrative travel and credit loss provisions. Selling, general and administrative expenses increased by 2.8% during the three months ended March 31, 2024 as compared with the corresponding period in 2023. The increase was primarily due 49 Table of Contents to an increase in personnel costs as a stand-alone company, transition service agreement costs, and professional fees, partially offset by the removal of Former Parent corporate allocations and decreased credit loss provisions. Depreciation Expense Three Months Ended March 31, 2024 2023 Change Depreciation expense $ 6.6 $ 5.9 11.9 % The increase in depreciation expense for the three months ended March 31, 2024, as compared to the corresponding periods in 2023, was due to the increase of property, plant and equipment, primarily IT assets, as part of the Spin. Amortization Expense Three Months Ended March 31, 2024 2023 Change Amortization of intangibles and other assets $ 15.3 $ 15.0 2.0 % T he increase in amortization of intangibles and other assets during the three months ended March 31, 2024, as compared to the corresponding period in 2023 , was not significant. Restructuring and Other Charges Three Months Ended March 31, 2024 2023 Change Restructuring and other charges $ 3.3 $ 0.6 450.0 % During the three months ended March 31, 2024, the Company recorded net restructuring charges of $3.3, which are reflected within restructuring and other charges in the condensed consolidated and combined statements of operations. These charges are associated with Company actions to reduce overcapacity, align resources, and restructure certain operations and include eliminating redundant positions and aligning resources for cost improvement and to meet customer requirements. During the three months ended March 31, 2023, the Company recorded net restructuring charges of $0.6. These costs were associated with general cost improvement and headcount reduction initiatives at various locations around the world. Interest Expense Three Months Ended March 31, 2024 2023 Change Interest expense $ 34.3 $ (0.1) 34,400 % The increase in interest expense for the three months ended March 31, 2024, as compared with the corresponding period in 2023, is primarily due to the incurrence of indebtedness, consisting of borrowings under senior secured term loan facilities and senior secured notes. Foreign Exchange Gain (Loss) Three Months Ended March 31, 2024 2023 Change Foreign exchange gain (loss) $ (5.3) $ (5.2) 1.9 % 50 Table of Contents The foreign exchange loss for the three months ended March 31, 2024 and 2023 was primarily due to the relative weakening of the U.S. Dollar against the British Pound and the Euro. Income Tax Expense Three Months Ended March 31, 2024 2023 Income tax expense $ 4.1 $ 1.5 Income tax expense as a % of income before tax 5.4 % 15.8 % For the three months ended March 31, 2024, the Company's effective tax rate was 5.4% compared to the 2023 tax rate of 15.8%. The fluctuations in the quarter-to-date period were primarily due to a change in valuation allowance, the geographic mix of earnings and non-deductible compensation expenses. The Organization for Economic Cooperation and Development (“OECD”) has introduced new global minimum tax regulations, known as Pillar Two, that began to come into effect on January 1, 2024. We are monitoring this development and evaluating its potential impact on our tax rate and eligibility to qualify for the safe harbor provisions. For 2024, we currently anticipate meeting the transitional safe harbors in all jurisdictions and do not expect a material impact to our financial statements. Liquidity, Capital Resources and Financial Position The Company manages cash flow to fund and invest in operational growth, capital expenditures, and credit facility repayments. In connection with the Spin, we have incurred indebtedness in an aggregate principal amount of $1,640.0, which consists of borrowings under senior secured term loan facilities and senior secured notes. We have also entered into a senior secured revolving credit facility, which consists of a five-year facility in the principal amount of up to $450.0 as further discussed in Note 7 - Debt to our condensed consolidated and combined financial statements above. We previously entered into an accounts receivable purchase program (“ARPP”), which established a receivables factoring facility that permits the Company to sell up to $80.0 in customer receivables to a financial institution based on the availability of certain eligible receivables and the satisfaction of certain conditions. As of March 31, 2024, the Company had no outstanding factored customer receivables, and the ARPP was terminated in May 2024. We believe our existing cash and cash flows generated from operations, plus existing credit facilities, will be sufficient to cover the needs of our current and planned operations for at least the next 12 months. From time to time, we routinely evaluate strategic opportunities, including potential acquisitions, joint ventures or investments in complementary businesses. We may also access capital markets through the issuance of debt or equity, which we may use in connection with the acquisition of complementary businesses or other significant assets, or for other strategic opportunities, or general corporate purposes. Cash Flows for the three months ended March 31, 2024 and 2023 The cash flows related to discontinued operations have not been segregated and are included in the condensed consolidated and combined statements of cash flows and the discussion of the cash flow activity. In summary, the Company's cash flows were as follows: Three Months Ended March 31, 2024 2023 Net cash used for operating activities $ (25.6) $ (2.0) Net cash used for investing activities (9.2) (16.2) Net cash provided by financing activities 21.3 24.5 Effect of exchange rate changes on cash and cash equivalents (2.3) 1.5 Net change in cash and cash equivalents $ (15.8) $ 7.8 51 Table of Contents Cash and Cash Equivalents Cash and cash equivalents at March 31, 2024 and 2023 totaled $92.8 and $118.2, respectively. Cash and cash equivalents consist of highly liquid instruments, such as commercial paper, time deposits and other money market instruments, which have maturities when purchased of three months or less. Cash Flows from Operating Activities During the three months ended March 31, 2024, the Company's operations used $25.6 of cash as compared to $2.0 of cash used for operations during the three months ended March 31, 2023. The decrease of $23.6 for the three months ended March 31, 2024 was due to a decrease in net income offset by an improvement in unbilled services and deferred revenue and lower cash used for accrued expenses. Cash Flows from Investing Activities Net cash used for investing activities for the three months ended March 31, 2024 was $9.2 as compared to net cash used for investing activities of $16.2 for the three months ended March 31, 2023. The $7.0 decrease in net cash used for investing activities for the three months ended March 31, 2024, was primarily due to a year over year decrease in capital expenditures. Capital expenditures were $9.3 and $16.2 for the three months ended March 31, 2024 and 2023, respectively. Capital expenditures in 2024 were 1.4% of revenues, primarily in connection with projects to support growth in the Company's core businesses. The Company intends to continue to pursue selective investments in key therapeutic areas and geographies to drive growth and to improve efficiency of the Company's operations. Such expenditures are expected to be funded primarily by cash flow from operations. Cash Flows from Financing Activities Net cash provided by financing activities for the three months ended March 31, 2024 was $21.3 compared to cash provided by financing activities of $24.5 for the three months ended March 31, 2023. Cash provided by financing activities was related to net proceeds from the revolving credit facility offset by principal payments on the term loan A and term loan B. Off-Balance Sheet Arrangements The Company does not have transactions or relationships with “special purpose” entities, and the Company does not have any off-balance sheet financing other than normal operating leases and letters of credit. Critical Accounting Policies and Estimates We have chosen accounting policies that management believes are appropriate to accurately and fairly report our operating results and financial position in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). We apply these accounting policies in a consistent manner. Significant accounting policies are summarized in Note 2 to the combined financial statements included in the Annual Report on Form 10-K. The application of these accounting policies require that we make estimates and assumptions about future events and apply judgments that affect the reported amounts of assets, liabilities, revenues, expenses, contingent assets and liabilities, and related disclosures. These estimates, assumptions and judgments are based on historical experience, current trends and other factors believed to be reasonable under the circumstances. Management evaluates these estimates and assumptions on an ongoing basis. If actual results ultimately differ from previous estimates, the revisions are included in results of operations when the actual amounts become known. The accounting policies that involve the most significant estimates, assumptions and management judgments used in preparation of the condensed consolidated and combined financial statements, or are the most sensitive to change due to outside factors, are discussed in Management's Discussion and Analysis in the Form 10-K. Except as disclosed in Note 1 - Basis of Financial Statement Presentation to our condensed consolidated and combined financial statements in this Form 10-Q, pertaining to the adoption of new accounting pronouncements, there have been no material changes in these policies. 52 Table of Contents