Earnings Call Transcript - FTRE Q4 2023

Hima Inguva, Head of Investor Relations and Corporate Development

Good morning, and thank you for joining Fortrea's fourth 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, Jill McConnell. The call is being webcasted, and the slides accompanying today's presentation have been posted to our Investor Relations page of our website, fortrea.com. During this call, we'll make certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to significant risks and uncertainties that could cause actual results to differ materially from our current expectations. We strongly encourage you to review the reports we filed with the SEC regarding these results and uncertainties. In particular, those that are described in the cautionary statements 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 11, 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 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?

Tom Pike, CEO

Thank you, Hima. Good morning, everyone. Thank you for joining today's fourth quarter earnings call. Let me begin with a few comments on our progress in 2023, as well as talk about a couple of current events. I feel great about the progress we're making toward making Fortrea attractive to all of its stakeholders. This time last year, we were a division of a division within a much larger parent and ended 2023 as a standalone company, demonstrating the ability to sell work at a level that we believe will achieve market growth rates, at the same time as delivering on our commitments and improving our operations. We completed the spin from our parent company just before midnight on July 1. This team completed the spin at an impressive speed, separating out a $3 billion enterprise while preparing it to go public in less than a year. As part of that process, we assembled a great leadership team, combining experienced leaders from the former parent and bringing in seasoned industry executives. At the same time, we recruited an outstanding board of directors. During the spin process, our team established a roadmap for independent operations in a way that protected our customers' data and assured ongoing projects. I'm proud to say that we did not lose any customers, and no customer projects were disrupted because of spin-related activities. We created and launched a new brand Fortrea and morphed our whole company from blue to green in a matter of just a few months. Since our debut as an independent company on July 1, the pace of our transformation has not slowed. This organization works hard and makes decisions at a fast pace. It's a testament to our team around the world that we continue to hit critical milestones. Our commercial transformation is off to a great start, already delivering tangible results. We're pleased with our book-to-bill ratio for the fourth quarter of 1.3 times, bringing us to a book-to-bill of more than 1.27 times for our first six months as an independent organization. Given the lag between bookings and revenue, we expect the company to return to growth later this year. Looking specifically at the bookings in the fourth quarter, the awards span biotech, large pharma, and across our therapeutic areas, and it's an attractive mix. We continue to be strong in oncology and have also seen wins in other growing areas such as GLP-1 and Phase 1. We've been successful selling solutions across all of our clinical businesses, Phase 1 through 4, both full service and FSP. Our ability to deliver critical projects globally, forge strategic partnerships, and add value has positioned us as a key player in the industry. The fourth quarter momentum is carried through to this quarter. We're looking at a solid pipeline for Q1 if we execute well. We've made strong progress in exiting the transition service agreements, which we call TSAs, with our former parent company. By the end of the year, we had exited about 40% of our TSAs with a few more added this quarter so far. To help us with the TSAs, we selected two leading global information technology and services providers as strategic partners. Cognizant will consolidate our infrastructure, hybrid cloud, and application support. We benefit from a deeply experienced partner who can help us solidify our position and move to a best-in-class technology, savvy global CRO. Accenture is both our managed security services partner and will help us transition to a new enterprise resource planning system. While we're exiting TSAs and building our infrastructure, we're also making selective investments in differentiation to drive our growth. We continue to make investments in our brand. We recently kicked off a new advertising campaign to raise awareness of our brand, as well as our impressive heritage of 30 years in drug development. We're raising our visibility at industry events. For instance, I'm going to be speaking at Bio in June. Another investment area is investigator site effectiveness. We established a site advisory board that currently represents over 440 sites across six countries and includes key pharma industry leaders. We're making progress on our technology and data strategies, which involve a complementary approach, partnering with industry leaders, and developing our own intellectual property where we add value. Recently announced Veeva and Advarra, an integrated patient and site-centric solution that streamlines the clinical trial experience. Fortrea has been selectively using artificial intelligence and machine learning for years to improve our operational efficiency, from trip report review for CRAs to bed scheduling in our early development clinical research units. We're pushing further now, hiring dedicated AI experts, who among other things are establishing an AI ML Innovation Studio to support our customers and accelerate our investments going forward. We'll soon be sharing more on this. In November, we announced a partnership with Medidata, where we're using Medidata AI to improve access to and participation of diverse population groups in clinical studies. While this partnership addresses diversity as a critical requirement of today's research, it's not the only advance that we've made in this area. Our consulting team, for instance, has developed a comprehensive epidemiological plan template that leverages our expertise to support improvement in the development and delivery of diversity and inclusion plans. This is becoming an area of expertise for Fortrea that's in demand from large and small sponsors. Across Fortrea, we're executing our strategic plan and investing in differentiation with the discipline and focus that you would expect from this seasoned leadership team that we've assembled. The changes we've made are already delivering results, most visibly in terms of new business. Earlier today, we announced another step forward in our journey. Last fall, we did a strategic review, which pointed to the importance of focusing our investments and innovation on Phase 1 to 4 clinical research services, including consulting, which deepens our real-world evidence capabilities and brings market access experience, which is helpful to drug development. Looking at our enabling services segment, while good businesses, they were less aligned with that needed focus. Following that, I'm happy to report that we just signed a definitive agreement to divest our endpoint clinical and Fortrea patient access businesses to Arsenal Capital Partners, a private equity firm with market-leading companies in healthcare. This will help Fortrea management to focus on important Phase 1 to 4 clinical services as we transform our company. It also helps improve our capital structure. As I commented in the press release from this morning with Arsenal, I'm confident that endpoint and Fortrea Patient Access will be able to strengthen their market position, nurture top-tier talent, and invest in new capabilities and resources while delivering solutions that improve patients' lives, which is a mission we all share. Before I pass to Jill for a review of our financial performance, I do want to describe a GAAP expense in the fourth quarter that was incurred in connection with our ongoing work with the customer, which has been the subject of prior disclosure. For background, in 2022 a third-party vendor, which is not associated with Fortrea, made a programming error that, when discovered, limited the usefulness of data from two arms of a forearm trial. As we noted in January, our independent expert reviewer determined this was not the fault of Fortrea or our processes. However, we incurred significant incremental expenses associated with this rare third-party error. As part of working with the customer, we wrote off certain receivables, discounted some work, and provided other considerations as part of a multiparty solution to facilitate ongoing trials. This amount will be reflected in GAAP earnings but not in adjusted EBITDA due to its unusual nature. Jill, I'll hand over to you now for more detail on the numbers.

Jill McConnell, CFO

Thank you, Tom, and thank you to everyone for joining us today. We are pleased that for fiscal year 2023, we achieved or slightly exceeded the milestones we shared with you at the time of our spin. Delivering the midpoint of our revenue guidance range, achieving two quarters in a row with a reported book-to-bill greater than 1.2 times revenue, and exiting roughly 40% of our TSAs with our former parent. These achievements were driven by deliberate changes we introduced, for example, incentivizing our sales organization more effectively, fostering a customer mentality across the entire enterprise, and tightly managing our infrastructure activity and cost space. Turning to our full-year 2023 results, our backlog grew 3.6% sequentially, ending the quarter at $7.4 billion under the revised backlog methodology that we announced with our second quarter results. The continued spin year headwinds of lower full-service clinical sales, elevated infrastructure costs, and the transition services agreement weighed on our fourth quarter results. We are working to mitigate these headwinds, and we expect to be on track with the previously shared margin improvement target of exiting 2024 and entering 2025 at a run rate around a 13% adjusted EBITDA margin. Revenues were $775.4 million in the fourth quarter, representing a 1.8% increase versus the same period last year. Clinical services revenues of $709.7 million grew 1.7% year-on-year driven by higher pass-through revenues, partially offset by lower service fee revenues. The lower service fee revenues were due to the reduced quantity of new business wins during the spin year that ran from July 2022 through June 2023, along with a mixed shift of some studies moving to longer duration. Enabling services revenues of $65.7 million increased 2.8%, driven by solid growth in our endpoint platform and higher pass-through revenue, partially offset by lower call center volume and patient access. Note that currency was not a material impact to our results in the fourth quarter. Let me provide more detail on our cost base. Direct costs in the quarter increased 9.3% year-over-year, primarily due to higher pass-through, TSA, and personnel costs, partially offset by the benefit from the restructuring program that commenced in the third quarter and the removal of former parent corporate allocations and carve out adjustments received prior to the spin. SG&A in the quarter was higher year-over-year by 56.2%, due primarily to stand-alone operational and TSA costs. Net interest expense for the quarter was $34.5 million. In addition, as Tom mentioned, we incurred expenses in 2023 relating to a rare programming error made by a third-party vendor, which is not associated with Fortrea, who was providing services to one of our customers that impacted the customer's trial. As part of working with this customer, we agreed to make concessions and provide discounts and other consideration to the customer as part of a multi-party solution. We recorded $5.5 million for these costs in 2023. These costs are excluded from adjusted EBITDA and adjusted net income due to their unusual nature. Turning to our tax rate, we had $1.1 million pre-tax book income on a full-year basis as a result of a large volume of one-time and spin-related expenses. Our full-year tax expense was $4.5 million and was driven by the non-deductibility of certain foreign tax expenses on low domestic earnings along with non-deductible executive compensation expense. This led to an effective tax rate for the full year ended December 31, 2023 of 406.3%. It is important to recognize that because of the spin, there are essentially two six-month periods that are distinctly different. For the six-month period ended December 31, 2023, the adjusted effective tax rate was 24.2%. This is improved versus our prior forecast, primarily due to favorable R&D tax credits. We continue to work with our advisors on detailed plans to improve our effective tax rate over time. Adjusted EBITDA for the quarter of $67.2 million decreased 38.8% year-over-year, compared to adjusted EBITDA of $109.8 million in the prior year period. Full-year 2023 adjusted EBITDA was $267.3 million, which decreased 34% year-over-year, compared to adjusted EBITDA of $405.1 million for full-year 2022. Adjusted EBITDA margin for the fourth quarter was 8.7%, compared to 14.4% in the prior year period. Adjusted EBITDA margin in the quarter was negatively impacted by the lower service fee revenues, portfolio mix, and longer duration studies, higher pass-through fee revenues, the higher inherited cost base, 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. Full-year 2023 adjusted EBITDA margin was 8.6%, compared to 13.1% for full-year 2022. In the fourth quarter of 2023, adjusted net income of $16.6 million decreased 79.7%, compared to adjusted net income of $81.6 million in the prior year period. Adjusted net income for both basic and diluted share for the quarter was $0.19, compared to $0.92 in the prior year period. Full-year 2023 adjusted net income of $124.5 million decreased 58.8%, compared to adjusted net income of $302.2 million in the prior year-to-date period. Full-year 2023 adjusted basic and diluted earnings per share were both $1.40, compared to $3.40 for both basic and diluted earnings per share in the prior year period. Turning to customer concentration, our top 10 customers represented nearly half of our 2023 revenues and one customer accounted for 10.7% of revenues. Regarding cash and liquidity, in 2023 we generated $167.4 million in cash flow from operating activities, compared to $87.5 million generated in the prior year. Free cash flow was $127.1 million, compared to $33.1 million in 2022. Cash flows from operations benefited from moderation in the growth of unbilled services and deferred revenue, along with lower cash use for accrued expenses, including lower incentive payouts earlier in the year, partially offset by a decrease in net income. Net accounts receivable in unbilled services were $1.05 billion as of December 31, 2023, compared to $1.02 billion as of December 31, 2022. Day sales outstanding was 92 days as of December 31, 2023, flat to the third quarter and one day higher than December 31, 2022. The increase versus the prior year end is primarily due to higher pass-through revenues, including the impact of working through the transition process for items that were previously in our company transactions. Over the last 18 months, we have commenced a number of initiatives to improve our DSO position. Because our contracts provide services over multiple years, there is a lag in seeing those changes reflected in our performance. We expect them to improve our DSO profile over time. We ended the quarter with a net leverage ratio of 5.7 times based on trailing 12-months adjusted EBITDA, and our target for net leverage ratio continues to be 2.5 times to 3 times over the medium term. 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. Taking these into account, our leverage for covenant compliance purposes was more than one full turn lower. Based on our current forecast and accounting for the additional add-backs, we expect to remain compliant with our covenants throughout 2024 and beyond. In general, our capital allocation priorities are infrastructure investments for timely exit of the transition services agreement; targeted investments to drive organic growth; and debt repayment. Before getting into guidance for 2024, I want to touch on the announcement we made earlier this morning regarding our agreement to divest our endpoint clinical and patient access businesses. As announced, the price was $345 million, and we anticipate using the majority of the proceeds to pay down our existing debt. We believe this divestiture will allow us to further sharpen our strategic focus as a pure play CRO and improve our financial flexibility. Closing this is targeted for the second quarter of 2024. Moving to our guidance for 2024, I will discuss this from both a full-year and a first-half, second-half perspective. We are targeting full-year 2024 total revenue in the range of $3.14 billion to $3.21 billion, compared to 2023 total revenue of $3.11 billion. We are targeting adjusted EBITDA in the range of $280 million to $320 million, compared to 2023 adjusted EBITDA of $267.3 million. Our guidance is pre-divestiture and assumes foreign exchange rates in effect as of December 31, 2023. For modeling purposes, you can use an estimated post-divestiture impact of $250 million in revenue and $30 million in adjusted EBITDA. We anticipate full-year 2024 interest expense to total approximately $130 million, based on the current view of market expectations for interest rate fluctuations. Now I will provide an update on the transformation efforts that I discussed on our third quarter call. 2024 marks a transformational year for Fortrea, a year where we plan to return to underlying growth and execute numerous operational improvements. We remain highly focused on our margin expansion efforts. These continue to be growth through the right mix and volume of new business awards, productivity enhancement, and SG&A cost reduction. We are improving our growth profile by increasing our efforts around contracts that deliver our targeted mix of business with proportional balance between full service, FSP, and clinical pharmacology awards. We expect to be able to absorb the growth in the near-term, translating directly into higher margins for Fortrea. Now let me cover our expected 2024 revenue and earnings. It will be a story of two halves; we expect a decline in service fee revenue in the first half of 2024. This is a result of the decline in net new awards along with the less favorable mix of business during the spin year that ran from July 2022 through June 2023. Assuming we continue to deliver net new business awards to meet quarterly book-to-bill ratios of at least 1.2 times, we anticipate revenue growth to improve throughout the second half of 2024 to bring second-half growth in line with market growth rates, which are currently seen at roughly 3% to 5% for this year. We are anticipating our margins to follow a similar path. Turning to adjusted EBITDA, if you consider the midpoint of our range, you should expect roughly one-third of the annual value to be delivered in the first half, weighted more to the second quarter, with the remaining two-thirds in the second half. In the first half, the reintroduction of variable pay, the ongoing TSA costs, and staff retention in anticipation of the growth we expect in the second half will weigh on the near-term margin. We are targeting the second half margin to improve from the revenue returning to market growth rates on improved productivity from our employee base along with the benefit of the anticipated cost reduction initiatives and TSA exits late in the year. In 2025, we expect to realize margin improvement from revenue growth in line with market growth rates and with our post-TSA exit, including a streamlined cost infrastructure, increased automation, and optimized resource utilization. We believe this transformation will enable us to reduce our SG&A expenses and empower us to deliver projects faster and more efficiently for our customers. Assuming our ability to continue to drive quarterly book-to-bill metrics of at least 1.2 times and exiting our TSAs per our current plans, we would target 2025 adjusted EBITDA margins consistent with 2022 on a full-year basis of approximately 13%. With the seasoned leadership team and innovative solutions that improve the efficiency of clinical development, we're relentlessly committed to maximizing value for our customers, employees, and shareholders. We are on a clear path to establishing Fortrea as the top choice CRO for pharmaceutical, biotech, and medical device companies, and our growth journey is just beginning. We are delivering against the growth and margin improvement plan we have laid out. We're streamlining our focus to our core CRO business, and we're executing our transformation plans at pace to capture the unprecedented margin expansion opportunity before us. Now I'll turn it back to Tom for the remainder of his remarks.

Tom Pike, CEO

Thank you, Jill. I'm beyond proud of this team and how far we've come in six short months as an independent company. We are now refocusing our company as a pure-play CRO. We're winning more business. We're running the business better. We're getting past the headwinds of the spin year. Growth, delivery, and profitability are the priorities. Fortrea has a great position as a CRO in the industry. We have solid medical, geographic, and operational root systems from Covance, our predecessor CRO that has been an industry leader for over 30 years. Our size and scale are a good fit for customers large and small. We serve a tremendous number of biotechs and want to serve more in the future. We understand that biotechs are looking for support with assets that have potential but might be overlooked by big pharma and thus need special care. Time frames and alignment with funding is critical. We have the expertise, high touch, and agility, but also manageable scale to meet their unique needs. Jill described a few financial elements of 2024 moving into 2025. We expect 2024 to be another year of hard but fulfilling work, continuing our commercial transformation, innovating with our customers, and largely exiting our former parent's infrastructure. Our business trajectory is up. Financially, it will be a tale of two halves. We believe this year we'll unleash opportunities that in 2025 will better serve customers and demonstrate we can run this company with better margins and continuing to improve them from there. We have an extraordinary team of people at Fortrea at all levels, who are powering us forward, driven by our patient and customer-inspired purpose and the growth opportunity ahead. We want to have the best culture in the industry. Guided by the engagement survey feedback from our employees around the world, we sometimes call for Fortreans, we're prioritizing what is most meaningful. Our people told us that a distinctive vision, strategy, and values are critical, and that's where we've been focusing. I'm pleased to report that our engagement index is above the industry benchmarks and our attrition is lower than pre-pandemic. It's been a heavy lift so far, but we're up for continuing to transform this business for the better; confidence and commitment create success, and our team is confident and committed. Fortrea is an exciting place to be. Now operator, let's open up for questions, please.

Operator, Operator

Thank you. Our first question comes from David Windley with Jefferies. Your line is open.

David Windley, Analyst

Hi. Good morning. Thank you for taking my question. I want to start with the divestitures. I'm looking to clarify the $250 million in revenue and $30 million in EBITDA for the divested businesses. I assume that's an annualized figure for 2024. If I understood that correctly, that indicates a higher margin for that business than I anticipated based on its previous performance. I want to understand the reasoning behind the decision to divest businesses that are higher performing and more profitable than the core.

Tom Pike, CEO

Yes, Dave, thanks for the question. I think I'd start by saying that when we looked at the business, we really believe being a pure-play CRO is the right focus for our management team. And so what we want to do is maximize the value for our customers and for our investors, frankly. And so we want to focus in that absolutely attractive segment. These businesses, while interesting businesses, and I like them, are not really core to that mission. And so we decided the best thing for Fortrea was to divest them. It does give us more flexibility in our capital structure, as well as more focus on the management team. In terms of your question, yes, for modeling purposes, we'd give you those numbers $250 million and $30 million. The thing that I would remember, Dave is that those numbers that we're giving you for modeling purposes do not necessarily correlate directly to the EBITDA contribution of those businesses because there are other factors associated with EBITDA. But for modeling purposes, we think that that's fair as we move forward.

David Windley, Analyst

In the fourth quarter, your book-to-bill ratio for RemainCo exceeded your target and likely surpassed market expectations as well. You mentioned the Acelyrin situation and the independent review, noting that it may have impacted your bookings toward the end of the year and into early 1Q. Could you provide more detail on two points? First, what concessions you are offering and the reasons behind those decisions following the independent review's outcome. Second, how would you evaluate the overall impact of this situation on your commercial efforts and bookings as you start 2024? Thank you.

Tom Pike, CEO

Yes. Let me start with your second question first there, Dave. With regard to the bookings, I think as we announced at JPMorgan, there was probably a little softness in December in the biotech pipeline, which may be associated with this. And then as we discussed, there were a couple of key opportunities that we lost attributed to that situation. As you described, we did bring in an expert who is independent and she determined that in terms of the two key issues that we, Fortrea really was not the cause of those. And so we're pleased with that result. In terms of the effect in this quarter, what we mentioned in my remarks is that we have a solid pipeline. And if we execute on it, we believe that we can continue to deliver those desired 1.2 book-to-bills. So it's been solid. We haven't seen specific incremental effects since we talked to in January. But we're cognizant. We were cognizant of the potential when you get those kinds of headlines. I will say we're pleased to resolve the matter. It wouldn't be appropriate for us to comment further. And I spent time with their CEO, and I'm excited about their company, and I wish them well.

David Windley, Analyst

Got it, thank you. Thanks for taking my questions.

Tom Pike, CEO

Thank you, Dave.

Operator, Operator

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

Elizabeth Anderson, Analyst

Hi, guys. Good morning. Thanks so much for the question. Tom, you described, obviously, the demand environment in terms of the book-to-bill and sort of the world demand environment. I think in your prior question, solid. Can you maybe talk to us a little bit about sort of what you're seeing in terms of the demand profile from sort of the biotech environment? Obviously, I heard your comments about December. Obviously, the funding environment since then has been quite a bit stronger. So how does that sort of translate as you move into the fourth quarter? And any sort of major differences between biotech and pharma would be very helpful. Thanks.

Tom Pike, CEO

Yes, thank you, Elizabeth. Since the second quarter of last year, we've observed a strong pipeline for our business, which has enabled us to achieve solid book-to-bills. Regarding biotech, we would describe the situation as solid. Funding looks promising for 2024, and we continue to see a steady flow from that sector. In terms of big pharma, we are also experiencing a healthy flow and a good mix of business, including full service and FSP. Overall, we are noticing a consistent flow, with the exception of some softness in biotech observed in December. Does that address your question, Elizabeth?

Elizabeth Anderson, Analyst

Yes, that's helpful. As a follow-up, this may be for Jill. How should we consider the margin improvement throughout the year? I understand your comments about the back half weighting, but how do we look at the balance between gross margins and the leverage improvements gained from growth and business mix versus the efficiencies and enhancements in SG&A?

Jill McConnell, CFO

Sure, Elizabeth. I think that when you think about the back half, you'll see it be weighted a little bit more to revenue growth because the TSA exits are happening later in the year. So there will be improvement in SG&A, but you'll see more of it coming from revenue because as I had commented, we're holding on to some resource in anticipation of that growth. So we wouldn't expect to have to add a lot of additional resources to support that growth, at least in the near-term. And then you will see some improvement in SG&A, but it's going to be much more weighted to the end of the year.

Elizabeth Anderson, Analyst

Got it. Thanks so much, guys.

Jill McConnell, CFO

Sure.

Tom Pike, CEO

Thank you.

Operator, Operator

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

Max Smock, Analyst

Hey, good morning. Thanks for taking our questions. Just wanted to follow up on the margin front a little bit here. So can you just help us understand the cadence, any more color there for 2024? I think you're expecting about 9.5% at the midpoint for the guide this year, but then exiting the year, I believe you said at about 13%. Can you just walk through the margin progression on a quarterly basis and then provide some more detail around the different drivers behind that really aggressive ramp into the end of the year here?

Jill McConnell, CFO

Yes. Sure, Max. So I'm not going to give you the exact amount by quarter. But I think in the commentary, when you think about the one-third in the first half and two-thirds in the second half and that one-third in the first half is going to come much more from the second quarter than the first quarter. The first quarter is going to be pretty much the nature of the impact of the soft book-to-bill that we had in that spin year because I know as we talked to some of you, we've talked about the fact that one year of soft net new business doesn't turn around in two quarters of good book-to-bill. But we will expect to see that start to improve a little bit in the second quarter and then predominantly more into the second half. I think when you get to the second half, it will obviously continue to improve on an ascending trajectory, but not in such a pronounced way. We would see Q3 and Q4 to be a little more balanced, although not exactly.

Max Smock, Analyst

Got it. That's helpful. And then maybe looking even further ahead here. If we think about you exiting the year at around 13%, and it sounds like Q3 and Q4, not entirely dissimilar kind of in that low-teens range. And the guide for this year in total calling for about 9.5%. I guess any sort of detail you can provide on what this implies for margins in 2025? I mean, is it fair to say we should get at least, I think, 300-plus basis points of margin expansion next year?

Jill McConnell, CFO

Yes. I think in my remarks, I was trying to say that if we're exiting the year at that trajectory of 13%, we would expect to hold that 13% and deliver that for the full-year of 2025. So you definitely would get at least the 300 basis points compared to where we were guiding for this year.

Max Smock, Analyst

Sorry, Jill, just to be clear, holding that, would that be kind of like worst-case scenario? I guess I'm just trying to understand, because I think you've laid out a path beyond that 13%. So is it a...

Jill McConnell, CFO

Yes, we would expect it, obviously, to improve slightly as we go through the course of the year, because the TSA exits allow us to start to make some of the more significant changes around SG&A, but those things will come at a little bit of a ramp. But I think just appreciating how much that is in terms of the total dollar value in that 300-plus basis points, I think at this point, we're not going to commit to anything greater than that. But we hope there will be upside. But obviously, we'll be able to share more with you on that, I would say, later this year once we confirm that we're fully on our TSA exit trajectory because that's really key to unlocking the SG&A improvement.

Tom Pike, CEO

Yes, Max, as you can imagine, naturally, we'll be working toward progression, but Jill wanted to give you something to model.

Max Smock, Analyst

Yes, certainly appreciate that, and thanks again for taking our questions.

Jill McConnell, CFO

Sure.

Tom Pike, CEO

Thanks.

Operator, Operator

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

Justin Bowers, Analyst

Hi, good morning everyone. Jill, can you help us understand what the ratios are in the midpoint of the guidance for direct costs and SG&A? I also understand that there are some investments and reallocations of costs. When do you expect that to normalize? From the previous question, it seems like this will continue into 2025. I'm trying to get a sense of what the baseline is and where things will end up.

Jill McConnell, CFO

Yes. In terms of investments, we've been making those throughout the second half of the year. They're not substantial in terms of dollar amounts, but we've been strategic about them. We need to ensure our competitiveness and meet customer demands, and that focus will persist. However, I don't anticipate any significant investments in the near term; we are likely to continue on a consistent path, which will enhance our cost of sales. As I mentioned earlier, as revenue increases, you will see improvements in cost of sales without needing to add many resources for the rest of this year, which should help reduce those costs. SG&A will also improve based on our current strategies, but the timing of the TSA assets presents a challenge. Since those largely occur in Q3 and Q4, we might not see significant improvement until late this year or into early 2025. I expect more enhancement in the cost of sales margin during the latter half of this year, with SG&A improvements accelerating in 2025.

Justin Bowers, Analyst

Okay. And then into 2025, will you be reporting the direct costs and SG&A in a way that aligns with peers and the industry?

Jill McConnell, CFO

Yes, that's a great question. Sorry, I could have added that. But yes, actually, you're going to see when we report our Q1 2024 results, we will be showing our cost of sales and our SG&A in a manner that we believe is consistent with our peers. And then hopefully, you'll be able to see that trajectory more clearly as those both improve over time.

Justin Bowers, Analyst

Okay. Great. I will save the rest for follow-ups. Thank you.

Jill McConnell, CFO

Thank you.

Operator, Operator

The next question comes from Patrick Donnelly with Citi. Your line is open.

Patrick Donnelly, Analyst

Thank you for taking the questions. Tom, can you discuss the competitive landscape a bit? You mentioned some uncertainty in December; can you elaborate on the pricing environment and what you're observing in terms of competition? The press release mentioned concessions related to the Acelyrin part, but insights on pricing and the competitive landscape would be valuable.

Tom Pike, CEO

Yes, thank you, Patrick. We continue to see promising opportunities, as I mentioned earlier, with a good mix of full service and FSP opportunities. Fortrea is gaining attention, and while we are concerned that some may recognize Covance but not Fortrea, many larger pharmaceutical companies and biotechs are aware of our size, scale, and capabilities. We are optimistic about that. We have an important customer coming to our office tomorrow, which is exciting. I believe we are competitive across the board now that we are engaged. Regarding pricing, there isn’t much change to report either way. Currently, we’re not experiencing significant pricing pressure from competitors in our deals, just the usual industry pressures. We manage our cost structures carefully and strive to price effectively, but nothing out of the ordinary at this moment, Patrick.

Patrick Donnelly, Analyst

Okay. That's helpful. And then maybe just one following up on some of the earlier bookings questions. You guys are probably in a little bit of a unique situation here where we're well into March here, and you're kind of talking about the 1Q environment. It sounds like, again, a little bit of that uncertainty that you talked about in January mostly passed. And again, I guess with three weeks or so left in the quarter, you sound pretty confident on kind of clearing for the 1Q, but I just want to make sure in terms of the booking environment to start the year, the trajectory is on track. And again, with 1Q coming close to the end here that you're confident on that bookings book-to-bill piece? Thanks so much.

Tom Pike, CEO

Yes. Thanks. Whenever you're in the third quarter and you're talking about your business, you have to be cautious because we have to execute, but the pipeline is sufficient for us to continue to drive this 1.2 or better book-to-bill. So I can tell you that at this point. And again, we feel good about the opportunity set that we're seeing. We feel good about the value we're delivering for the customers and their reaction to it. So I think we feel good about that. But as you say, like always with the CRO, that last month of the quarter, you've got to execute, and you've got to work hard. Otherwise, you don't make those numbers. And I think the industry is pretty good at that, and we are too.

Patrick Donnelly, Analyst

Great. Thanks, Tom.

Tom Pike, CEO

Thank you.

Operator, Operator

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

Tom Pike, CEO

Well, thanks, everybody, for joining today. We continue to work hard here at Fortrea for our customers and for our investors. And I think the team is doing a great job. So we appreciate your continued support in our journey. Thanks.

Operator, Operator

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