Earnings Call Transcript - ICLR Q3 2024

Operator, Operator

Good day, and thank you for being here. Welcome to the ICON PLC Q3 Earnings Conference Call and Webcast. All participants are currently in a listen-only mode. After the presentation, there will be a question-and-answer session. Please note that today's conference is being recorded. I will now hand it over to Kate Haven. Please proceed.

Kate Haven, Head of Investor Relations

Good day, and thank you for joining us on this call covering the quarter ended September 30, 2024. Also on the call today, we have our CEO, Dr. Steve Cutler; our outgoing CFO, Brendan Brennan; our incoming CFO, Nigel Clerkin; and Senior Vice President of Corporate and Commercial Finance in Reliance. I would like to note that this call is webcast and that there are slides available to download on our website to accompany today's call. Certain statements in today's call will be forward-looking statements. These statements are based on management's current expectations and information currently available, including current economic and industry conditions. Actual results may differ materially from those stated or implied by forward-looking statements due to risks and uncertainties associated with the company's business and listeners are cautioned that forward-looking statements are not guarantees of future performance. Forward-looking statements are only as of the date they are made and we do not undertake any obligation to update publicly any forward-looking statements, either as a result of new information, future events or otherwise. More information about the risks and uncertainties relating to these forward-looking statements may be found in SEC reports filed by the company, including the Form 20-F filed on February 23, 2024. This presentation includes selected non-GAAP financial measures, which Steve and Brendan will be referencing in their prepared remarks. For a presentation of the most directly comparable GAAP financial measures, please refer to the Press Release section titled Condensed Consolidated Statements of Operations. While non-GAAP financial measures are not superior to or a substitute for the comparable GAAP measures, we believe certain non-GAAP information is more useful to investors for historical comparison purposes. Included in the press release and the earnings slides, you will note a reconciliation of non-GAAP measures. Adjusted EBITDA, adjusted net income and adjusted diluted earnings per share exclude stock compensation expense, restructuring costs, foreign currency gains and losses amortization and transaction-related and integration-related costs in their respective tax benefits. We will be limiting the call today to 1 hour and would therefore ask participants to keep their questions to one each in the interest of time. I would now like to hand the call over to our CEO, Dr. Steve Cutler.

Steve Cutler, CEO

Thank you, Kate. Before I begin my remarks on the quarter, I wanted to briefly welcome and introduce our incoming CFO, Nigel Clerkin, who is joining us on the call today. Nigel is an accomplished executive with excellent experience across both biopharma and pharma services organizations in a public and a private setting. We are thrilled to have him join our executive team at ICON. In addition, I want to extend my sincere thanks to Brendan, as this will be his last call with us, concluding a highly successful career at ICON. Thank you, Brendan, for your partnership and many contributions. Moving to the results for the quarter. Simply put, ICON's results for the third quarter were not in line with expectations we had previously anticipated. As in any period, we forecast, we have a number of risks and opportunities that are identified across our business that generally counterbalance as we progress through and close out the quarter. In this most recent quarter, the identified risks materialize to a greater extent than expected. And despite our efforts, the identified opportunities did not offset this impact resulting in a greater deviation from forecasted results than we would typically see. This was due to three main reasons. First, we are seeing a small number of top customers who are experiencing continued cost pressures and are implementing actions to manage their development spend more tightly. Second, within our Biotech business, slower decision-making and capital allocation led to award delays and slow trial starts. And finally, we had a large number of project delays and cancellations late in the quarter within our fast burn vaccine area that materially impacted revenue. To provide more detail on each of these challenges, the first was attributable to lower than anticipated revenue contribution from two of our largest customers that are undergoing development model transitions, which we have been supporting them with since the start of the year. As we have previously highlighted, we are seeing an increasing emergence of hybrid development models amongst our large pharma customer base, which has uniquely positioned ICON to win a disproportionate share of these large partnership opportunities. Heightened focus on portfolio prioritizations leading to tighter development spend emerged through the quarter delaying the expected ramp-up of new work that was forecast to begin in their new models. What this has resulted in is studies closing out in their previous model without the counterbalancing revenue from new studies as expected. While this creates pressure from a revenue perspective in the near-term, which we have reflected in our full year revenue guidance, we do believe this is an isolated impact that will be increasingly offset by growth outside of these two accounts as we move forward, and is underpinned by the revenue growth we've seen outside of these customers, which we expect to be in the mid-single digits on a year-over-year basis for the full 2024. The second issue was slower than expected activity in our Biotech segment. Both from a business development perspective, which impacted our total level of new awards as well as in operational prioritization decisions, which resulted in negative study modifications and delays in study startup that occurred in the quarter. While we continue to see a positive level of overall opportunity flow in this segment, customers continue to operate with caution in terms of the overall use of their capital. This is impacting the speed of decision-making on both award of new work and how quickly customers are starting new trial activity. We saw several decisions on large award opportunities delayed into quarter four, as customers required additional time to review final scope specifications before making award decisions, which are anticipated to take place this quarter. Lastly, we saw an outsized level of vaccine-related cancellations in quarter three, totaling approximately 20% of overall cancellations, which combined with slower COVID activity is also contributing to the lower than expected revenue in the second half of this year as these programs are fast burning in nature and were expected to start in the quarter. While we are dissatisfied with the performance this quarter and the reduction in guidance for the year, the factors contributing to the results are well understood by our team and we are taking decisive action to manage them appropriately. We will deliver on one of our strengths, which is expertly managing costs. This includes aligning our resources in the right locations globally to best support our customers and their critical projects as we continue to act as a strategic partner and deliver on our commitments for not just the short-term, but their long-term needs. We have already implemented plans to improve processes and reduce overall costs across the organization and we expect to see some benefits of these actions in quarter four and more fully as we move into 2025. This includes accelerating actions we already undertake as an organization with over 40,000 employees assessing spans and layers across our organization to determine optimal levels of oversight and utilization to drive efficiencies. Finally, we continue to increase our adoption of automation and the use of technology across our business to leverage our scale and center of excellence model. We remain confident in the underlying health of our business, the progress we are making in building critical partnerships, and our continued ability to deliver for our customers. In our large pharma business, we have been successful in renewing all strategic partnerships this year, and I'm very pleased to announce the award of another Top 10 strategic partnership, which was finalized in quarter three. ICON was selected for the breadth and depth of our capabilities including our therapeutic experience and expertise as well as our innovative approach in addressing challenges across the development continuum. The addition of this new competitive win brings our new strategic partnership count within the Top 30 pharma to three in the past 12 months, clearly showing our momentum in gaining market share in this important space. These relationships are already delivering increased opportunity flow to our pipeline and new awards to our business. We are seeing a notable increase in therapeutic areas such as cardio and metabolic diseases with new award growth increasing over 50% on a trailing 12-month basis, which is helping to offset the drop-off in vaccines. In quarter three, we had solid growth in our total backlog of 9.4% on a year-over-year basis with strength in new awards from laboratory and early phase services. However, there was an increase in total cancellations in the quarter driven by an outsized number of vaccine programs relative to our normal expectations. Relative to when we started this year, we saw more meaningful transitions in our business than anticipated with a significant level of COVID-related work moving out of this calendar year. Two of our large customers undergoing more significant development model shifts with resulting cost pressures and the biotech market that is taking longer to recover and remains cautious. Despite these circumstances, we have still managed the business to drive revenue growth of 5.6% excluding COVID-related revenue and adjusted earnings per share growth of 13.5%, both on a year-to-date basis. We remain encouraged that opportunities across the totality of our business continue to track positively given the contribution from new strategic partnerships as well as increased opportunity flow from biotech, which we believe is still supportive of holding at least a 1.2 times net book-to-bill ratio on a trailing 12-month basis. Fundamentally, our view has not changed in our mid- to long-term outlook for our industry and the opportunity for ICON. We continue to deliver for our customers across all segments of our business and will appropriately manage our business as we transition through what is a more challenging environment in the near term for specific customers and as a result for ICON. As we look forward to 2025, we are not yet issuing specific guidance for the full year, but plan to do so, as we normally do in January when we present at the JPMorgan conference. At a high level, provided the opportunity levels continue through the balance of the year, we would anticipate continuing to target a book-to-bill of 1.2x to 1.3x on a trailing 12-month basis. We would note that we are seeing an uptick in pass-throughs, as a more meaningful component of total trial costs, even in non-vaccine areas of the portfolio, which is expected to start to reflect in our overall revenue mix next year. While there are certain large pharma customers in our portfolio that remain challenged in their spending outlook for next year, our initial view on growth outside of these specific customers is positive and indicative of our overall development spend growth. While recovery in the biotech segment has been slower than we anticipated relative to the start of this year, large opportunities have been increasingly moving into the pipeline. And our performance this quarter from a business development perspective will be an important determining factor to growth in this segment for ICON next year. In totality, we will anticipate revenue growth in the low to mid-single-digit range for the full year, which takes into account the expected headwinds, which we expect will have a greater impact in the first half of the year. We continue to be extremely well positioned to take market share and grow in new and existing accounts, as evidenced by the recent strategic partnership wins we have accumulated since our union with PRA. The potential for these new partnerships to offset the aforementioned headwinds is very real, as we move into 2025, and this in addition to the growth of our strategic customers gives us confidence that ICON will emerge from this transition period even better positioned and diversified across our customer base. We remain committed to our capital deployment strategy which is focused on executing M&A in the areas of the portfolio we would like to strategically expand our capability and presence. Principally in our ancillary businesses such as laboratory services, site and patient solutions as well as select geographic areas such as Asia Pacific. We have opportunities in our pipeline that we are actively engaged on that could be executed in the short term. In addition, we have stated we would opportunistically evaluate deploying capital towards share repurchase which we did late in quarter three totaling $100 million worth of stock repurchased. We have recently secured authorization for a further $250 million for share repurchases which gives us a total of $650 million now available for further repurchases. We anticipate remaining active in opportunistic share repurchases through the balance of this year and beyond. Before I hand over to Brendan, I want to extend my thanks as always to our hard-working and dedicated employees across the globe that are committed to driving our mission and supporting our customers in accelerating their development programs.

Brendan Brennan, Outgoing CFO

Thanks, Steve. In the third quarter, ICON achieved gross business wins of $2.832 billion, a decrease of 7.3% compared to the previous year. We also recorded $504 million in cancellations, leading to net awards of $2.328 billion for the quarter and a net book-to-bill ratio of 1.15x. With the new awards in the third quarter, our backlog reached a record $24.3 billion, marking a 2.1% increase from the second quarter of 2024 and a 9.4% increase year-over-year. Our backlog burn was 8.5% in the quarter, down from the second quarter levels. Revenue in the third quarter was $2.03 billion, reflecting a year-over-year decrease of 1.2% or 1% on a constant currency basis. Customer concentration among our top 25 clients increased from the second quarter of 2024. Our top five customers accounted for 24.8% of revenue, our top 10 for 4.6%, and our top 25 for 62.9%. The gross margin for the quarter stood at 29.5%, down 40 basis points from the second quarter of 2024, and decreased 30 basis points from 29.8% in the third quarter of 2023. The total SG&A expense was $180.4 million in the third quarter, or 8.9% of revenue, an increase of 20 basis points from the previous quarter's 8.7% of revenue. In the same period last year, SG&A expense was $180.1 million or 8.1% of revenue. Adjusted EBITDA was $418.8 million for the quarter, translating to 20.6% of revenue. In the comparable period last year, adjusted EBITDA was $422.5 million or 21% of revenue, showing a year-over-year decline of 3.2% and a margin contraction of 40 basis points. Adjusted operating income for the third quarter was $383.8 million, with an 18.9% margin, a decline of 4.3% from the adjusted operating income of $401.1 million with a margin of 19.5% in the third quarter of 2023. Net interest expense was $49.4 million for the quarter. We still expect the total interest expense for the full year to be around $200 million to $210 million in 2024. The effective tax rate for the quarter was 16.5%, and we continue to forecast the full year's adjusted effective tax rate to remain around 16.5%. Adjusted net income for the quarter was $279.2 million, representing a margin of 13.8%, which corresponds to adjusted earnings per share of $3.35, an increase of 1.5% year-over-year. The company incurred $7.9 million in transaction and integration-related costs during the third quarter. US GAAP income from operations was $285.4 million, or 14.1% of revenue, in the third quarter. US GAAP net income stood at $197.1 million or $2.36 per diluted share compared to $1.97 per share during the same period last year, marking a 19.8% increase. Net accounts receivable was $1.172 billion as of September 30, 2024, down from $1.198 billion at the end of the second quarter of 2024. The days sales outstanding (DSO) was 52 days on September 30, 2024, an increase of three days from the third quarter of 2023 and one day from June 30, 2024. Cash from operating activities during the quarter was $402.7 million, and free cash flow was $359.4 million for the quarter, reflecting a 15% increase year-over-year. We experienced a notable improvement in cash collections in the third quarter despite ongoing challenges with customers, especially large pharma organizations that are extending their cash retention and seeking competitive credit terms. Nonetheless, we are on track to meet our original cash flow guidance of approximately $1.1 billion for the year. As of September 30, 2024, cash totaled $695.5 million, and debt stood at $3.4 billion, resulting in a net debt position of $2.7 billion. This is an improvement from a net debt of $2.9 billion as of June 30, 2024, and $3.7 billion as of September 30, 2023. Capital expenditures for the quarter were $43.3 million. We ended the quarter with a leverage ratio of 1.6 times net debt to adjusted EBITDA. Our key assumptions for the full year guidance remain largely unchanged: an effective tax rate of 16.5%, a free cash flow target of around $1.1 billion, capital expenditures of approximately $100 million, and interest expense between $200 million to $210 million, all for the full year 2024. With that said, we will now open the floor to questions.

Operator, Operator

Thank you. We will now proceed with our first question from Elizabeth Anderson from Evercore. Please go ahead with your question. Your line is open.

Elizabeth Anderson, Analyst

Hi, everyone. Thank you for the question. Welcome, Nigel. Could you provide us with more insight regarding your confidence in the Pharma 2025 budgets concerning your major clients? Do you feel that you have a clear understanding of their spending plans at this point? For those clients who are cutting back in certain areas, do you have a solid grasp of their decisions? I would like to gain a deeper understanding of this as we consider the fourth quarter and look ahead to 2025. Thank you.

Steve Cutler, CEO

Overall, we see the large pharmaceutical market growing at a reasonable rate in the low to mid-single digits. However, we are somewhat more impacted by a few large customers, which presents a different situation. As we move into 2025, we anticipate that we will reach the lowest point of the slowdown with these specific customers and begin to recover, likely towards the end of 2025. We do have some clarity regarding one of these customers, indicating that we may be nearing the bottom as we approach the end of this year. The situation with the other customer is less certain, but we believe we are getting closer to that turning point. By the middle of next year, we expect to start seeing improvement from the declines we've experienced with these customers. Overall, we perceive the large pharmaceutical market as positive, estimating growth between 3% and 4%, and we believe we can capitalize on this, especially thanks to the strategic partnerships we've secured over the past couple of years. Therefore, we view this as a medium to long-term positive outlook, though we do need to navigate a transition period in the next two to three quarters.

Operator, Operator

We are now going to proceed with our next question. The questions come from the line of Michael Cherny from Leerink Partners. Please ask your question.

Michael Cherny, Analyst

Good morning and thanks for taking the question. Maybe if I can follow on a similar trend to Elizabeth's question, but tied to biotech demand. You're not the only company that's signaling any type of concerns or worries about the state of decision-making in the biotech market. As you think through the various different constituencies that you work with across biotech is there anything that you can glean about various pockets of strength and weakness versus disease state versus status of where these companies sit from a venture funding perspective? Similar to the pharma question where does that comfort factor lie about the pacing of biotech recovery given that obviously market wide it's been a bit slower than we all would have anticipated?

Steve Cutler, CEO

Yes, Michael, we are probably a bit less certain regarding biotech. We have been projecting the end of the biotech challenges for several quarters, but as indicated this quarter, that hasn’t happened yet. We’re seeing the same funding data that you are; there was a strong start to the year, a slowdown in the middle, but September appeared more positive. Our customers are also expressing that they can raise capital, especially for promising science. However, they have been delaying decisions, awards, and scaling back projects, along with an increase in cancellations. Therefore, I don’t think we can confidently say we’ve overcome the challenges in the biotech segment just yet. However, we do believe that long-term, the outlook will be positive and we will return to a strong position. There's data supporting that view, but in the next two to three quarters, we still face some uncertainty. There are positive signs in the RFP numbers coming through; they are solid, and there are plenty of opportunities in our pipeline. The challenge lies in securing those opportunities and converting awards into projects that generate revenue at the expected rate and extent. We’re not quite at the endpoint of that challenge yet. I apologize for not being able to provide a definitive answer, but this remains one of the most challenging aspects of our business.

Operator, Operator

We are now going to proceed with our next question. The questions come from the line of Luke Sergott from Barclays. Please ask your question.

Luke Sergott, Analyst

All right. Great. Thanks, guys. I guess as you think about the recovery here and into 2025 and the market kind of being that low single-digit growth and you guys typically growing at the high end of that. Is that still a safe assumption here as we think about 2025? And then as you also think about the margin implications here the flexibility of your model and like that model one/hybrid business that you can provide allows a lot of flexibility to scale up and down resources pretty quickly. So, given this was late in the year understandable hits in 4Q. But how do you right-size those and how we think about that margin progression as the business starts to ramp back up?

Steve Cutler, CEO

Yes, Luke, we have clearly stated that we will not be providing any guidance for next year. We will be closely analyzing the business over the next three to four months and will give that guidance in January as usual. That said, we do believe we can achieve growth next year, likely in the low to mid-single-digits range at this time. That reflects our current expectation. We are not making any projections regarding margins right now. The mix of our business is evolving with the vaccine studies and some increase in functional work being balanced out by progress on full service, especially with new strategic partners joining us in that area. There are factors at play affecting margins in various directions. We do expect revenue growth, and that’s our focus, but for now we will not be too specific until we reach JPMorgan in January.

Operator, Operator

We are now going to proceed with our next question. The questions come from the line of Justin Bowers from Deutsche Bank. Please ask your question.

Justin Bowers, Analyst

Hi. Good afternoon. And just pivoting back to large pharma with a two-part question. On the development model changes in the replenishment cycle, how much visibility do you have into this dynamic persisting? Or is this a step change in that funnel? And then, is the messaging there that these two customers will sort of be a headwind into 2025 and then the rest of that customer cohort the Top 20 would then grow?

Steve Cutler, CEO

To answer your second question first, Justin, I think that's a reasonable way to characterize it. We certainly see growth outside of our Top 2, I think of the extent of around 6%. And we're happy to see that and that's fueled in many cases by more full-service work better margin work. And so, we think there's a nice offset on that front. In terms of the more functional, is that a permanent? These things are never permanent. These things tend to wax and wane depending on who's in charge of the company and what the operating model dejour is. We have some opportunity I think to work in both models, effectively in both models. We talked about our hybrid model and our ability because we are the largest functional provider to provide hybrid functional and full-service components of any sort of development program or portfolio. So, we do believe we're very well positioned no matter which way the market goes to be able to prosecute and to win that work. But as I say, at the moment, we're seeing that push towards a more functional approach persisting, at least in several of our top customers but it is being offset to some extent by some movement towards full service in other parts of the business. And of course, our biotech customers are all full service. So, as always, there's puts and calls, and there's an offset tailwinds and headwinds on this thing. I mean generally, we feel the market overall will progress nicely if we can prosecute and execute our projects as we believe we can; we believe we can get some modest margin uptick but that all remains to be seen. And as I said, we're not going to be specific about 2025 will be on just at this point.

Operator, Operator

We are now going to proceed with our next question. The questions come from the line of Ann Hynes from Mizuho. Please ask your question.

Ann Hynes, Analyst

Yes. Good morning. Thank you. Just the long-term goals you provided at the recent Investor Day to 2027, it seems like the environment has changed. Do you think it's still possible by 2027 what you see now to at least hit maybe the low end? And if you can't do it on the revenue side, would you commit capital to share repurchase to at least hit the EPS goals?

Steve Cutler, CEO

Yes, that's a question we're looking at very hard. We certainly will be looking at very hard over the next couple of months as we come towards the end of the year. But to give you a high-level answer on that, we do believe we're well positioned to be able to achieve those goals. Perhaps towards the lower end of the range and perhaps towards the end of 2027 might be the caveats I would give you. But we certainly haven't given up on those goals. We believe we're, as I said, well-positioned in the marketplace to gain market share. We do believe we're gaining market share particularly with these strategic customers. And as we move through this transition period as I said the next two to three quarters, we believe we're going to be in a good place to be able to accelerate our growth in the more medium term and move back towards achieving the goals we put out at our Investor Day in May. As I said perhaps more towards the lower end, and we're certainly prepared to utilize our balance sheet to prosecute the share buyback options and we also are very much in the market on the M&A side of things where we can bring in components of the business to supplement what we already have and to improve the performance of what we already have. That's certainly the push on the M&A side of things. So we do believe we've got the tools in the toolkit. We do believe we've got the balance sheet and we do believe we've got the people and the strategy to achieve the goals that we set out.

Operator, Operator

We are now going to proceed with our next question. The questions come from the line of Patrick Donnelly from Citi. Please ask your question.

Patrick Donnelly, Analyst

Hi guys. Thank you for taking the questions. I wanted to follow-up. I think with Luke's question on some of the margin stuff. I know you guys talked a little bit about some cost actions. Can you frame up what you guys are going to do on the cost side if the magnitude is possible that would certainly be helpful? Basically just trying to figure out when you look at the second half year implying EBITDA margin somewhere above 20%, is that a fair number to think about next year? And just the cost out piece would certainly help contextualize that. Thank you, guys.

Steve Cutler, CEO

Yeah, Patrick. In terms of cost, I think it has been noted, we've acted fairly quickly to realign our cost base with the work that we have in the backlog and the work that's proceeding in the backlog. Absolute priority for us is to make sure that our customers have the resources they need to get their critical projects done. That is priority absolute number one. And we're very focused on doing that. Having said that, we do recognize that an adjustment on the cost base is important and we're pulling a number of levers whether it be spans of control, whether it be looking at where we have an excess of people in certain areas but we are looking very hard at doing that and taking fairly decisive actions. So I'll leave it to that. I do believe it will have some impact on quarter four, not a huge impact but really that impact will be as we get into 2025. And I do believe we have some other areas we can look at as well and it's not just a one-off. We're going to continue to look at what we need to do on a cost base. And we do it well. It's something I think you would all know is one of our key strengths. We manage our costs very well. We don't wait around and then hope for the best. We actually take action and we're doing that right now. And I think that's an important component and something you should take some confidence in that we will address that. Brendan you want to address on that?

Brendan Brennan, Outgoing CFO

From my viewpoint, this is a significant services organization, and adjusting the cost base takes time. It's important to note Steve's comments regarding our commitment to delivering for our customers, which remains our top priority. This quarter feels somewhat unusual for me, as it has been quite effective overall. Over the past 19 years, I can confidently say that managing the cost base at ICON is a collective effort, not just the responsibility of one or two individuals. It's essential to remember that this organization will keep challenging and pushing itself, and as Steve mentioned earlier, we have the quality and strategy to do so. While I won't go into specific guidance for next year, I wanted to emphasize that point.

Operator, Operator

We are now going to proceed with our next question. And the questions come from the line of David Windley from Jefferies. Please ask your question.

David Windley, Analyst

Hi, good morning. Thanks for taking my question. I wanted to come back to big pharma with a little different angle. Steve, with the partnerships that you had at the time of the PRA acquisition or merger and the ones that you've won since as you highlighted this morning, you got a pretty broad footprint across Top 20 or Top 25. I guess my question is, twofold. One is that is, how much of the wallet do these partnerships avail you of and maybe that's mixed in different categories or whatever, but I'm just interested in what cases are you kind of paying the client and in what cases might you only be in one therapeutic area or only in one service or something like that. And then, with that footprint and that opportunity to interact with those clients at that higher level, and to the point that you made about development model changes, how much of this is kind of a major adjustment by big pharma to the outlook that they have loss of exclusivity cycle, a new pricing dynamic in the US and really reevaluating returns on invested R&D, and repositioning or pivoting pipeline. And the bottom line on this part of the question really is, is it just these two? Or are we only kind of midway through a lot of big pharma clients doing these types of things? Thanks.

Steve Cutler, CEO

That's a good question. Let me start by addressing the first part. The share of wallet for our strategic engagements varies significantly. In most cases, we are chosen as either the sole provider, one of two, or one of three on the floor, though it's often one of three. We typically gain access to their entire outsourcing portfolio, allowing us to bid against the other one or two competitors. If we've been performing well in Phase 2, we often have a strong advantage, almost creating a noncompetitiveness in those situations. It's crucial for us to execute well and build solid partnerships with those strategic clients to secure ongoing work under this noncompetitive arrangement. There are also instances where the focus is more therapeutic, which leads to less competition. In such cases, we may be assigned specific areas like cardiovascular, oncology, or metabolic segments. Here, unless our pricing is significantly out of line, we usually do not face competitive bids, as we've already negotiated the terms and conditions. Although this might be less competitive, we tend to work within a narrower aspect of their portfolio. Regarding the models we've been adopting recently, which reflect adjustments due to pricing pressures and patent expirations, that’s a complex question. These models appear to align with specific managers and leadership styles. When new individuals enter organizations, they often bring in the management or outsourcing processes they have previously experienced and prefer. As a result, it may hinge more on the leadership in charge of R&D spending than solely on pricing pressures or patent cliffs. We observe a range of approaches: some clients have shifted toward a more functional model while recent wins have moved to a full-service model. Thus, there’s no overwhelming trend that is steering the industry in one direction. We assess this in a nuanced manner. When clients face regulatory challenges, they tend to voice concerns and may transition to a functional model or a full-service model depending on their specific circumstances, such as a pressing need to develop drugs due to rapid growth. Ultimately, this is not closely related to any single regulatory or external factor; it's a mix of various issues unique to each client, and they choose their models accordingly.

Kate Haven, Head of Investor Relations

I think I'd just add quickly, Dave that it has presented us though with a lot of opportunity. I think it's fair to say over the last 18 months we've probably seen more activity, right? That's been caused by some of these concerns from a macro perspective, whether it be IRA or some of the other issues that have come up and caused large pharma to take a hard look at how their development organizations are structured and where they need to get to over time. Obviously, the outlooks are going to be different on a customer-by-customer basis. But that gives us an opportunity to go in and really fight for or continue to defend our position in existing partnerships and have an opportunity to win new ones. And obviously, we've been successful winning three new large partnerships in the last 12 months and that's critical in terms of our growth outlook for the future. So it's not necessarily a negative in terms of these customers looking at – looking harder around their development spend and opportunities.

Operator, Operator

We are now going to proceed with our next question. Questions come from the line of Max Smock from William Blair. Please ask your question.

Max Smock, Analyst

Hey, good morning. Thanks for taking our question. I just wanted to make sure I understand the drivers behind the miss on gross bookings versus the miss on revenue here because of all the factors you mentioned at the top of the call, the only one that really struck me as being more tied to new bookings and that burn rate was the award from small biotech. So – can you just walk through kind of what are the key drivers for that shortfall in net bookings, specifically? And if it really is just small biotech slowing down on the front end, is it fair to assume that that cohort has taken a meaningful step back over the last couple of months here, just given the size of that booking step down that we saw in the third quarter?

Steve Cutler, CEO

I believe one of the main reasons for the bookings shortfall is the delay in decision-making, especially from smaller biotech customers. Despite the uncertainty and volatility in capital markets, even those who have managed to raise funds are experiencing delays and are reassessing some of their current projects. This slowness in decision-making within the biotech sector is the primary reason we fell short of our target of 1.2 to 1.3. However, I mentioned earlier that there are still promising opportunities in the pipeline, and the request for proposals remains strong in both large pharma and biotech segments. I hope this is just a temporary issue. Nevertheless, the biotech segment is currently quite volatile, and I'm unsure if we have reached the end of that volatility or uncertainty, which could persist. Moving forward, I still believe that achieving a range of 1.2 to 1.3 on a trailing 12-month basis is a realistic objective for us.

Operator, Operator

We're now going to proceed with our next question. The questions come from the line of Michael Ryskin from Bank of America. Please ask your question.

Michael Ryskin, Analyst

Thank you for your question. This may relate to your earlier point about net bookings and the volatility in biotech. In your prepared remarks, you mentioned two key developments this quarter: the materialization of certain risks and the fact that some opportunities did not offset those risks. As we consider the revised guidance for 2024 and your statements about low single-digit to mid-single-digit expectations for 2025, I would like to know if you are more concerned about the prolonged nature of the risks, especially regarding the pharma reprioritization you mentioned, or if you have less confidence that some of the opportunities will provide sufficient offset. Which of these factors do you think will lead to more adjustments in the guidance?

Steve Cutler, CEO

That's a good question, Michael. In our business there are always risks and there are always opportunities. And as I said in my prepared remarks in this quarter for the first time in probably 55 or 60 quarters that I've been involved in the company, there really was a very substantial difference in what played out. The risks well outweighed the opportunities. I think going forward we'll reformulate and relook at what those risks and opportunities are and be able to be a little bit more accurate if that's the right word in terms of how we think the work is going to go and how it's going to come in. Quarter three as you all know is probably the most challenging quarter in the year given that August is very quiet. Our customers are away, sites are away. It's sometimes difficult to get the information you're looking for. And then everyone comes back in September and down to a number of key decisions as to whether you cure book-to-bill number or not. And so it is a challenging quarter. And when things don't hit and they don't go as we'd expect that, the very short-term impact plays out as it has for us in this quarter. I don't see going forward that we're going to have this sort of quarter. In fact, I would hope we're not going to see this sort of quarter on a regular basis. We've got a pretty good track record as I said over the last 50 quarters or 60 quarters. So we've been reporting at least that I and Brendan have been involved in reporting. And we feel our track record is pretty good. I don't think one quarter changes that. I recognize some disappointment. And certainly, the quarter as it is, it's not up to our expectations. But I don't think our process is fundamentally broken. I think we need to just look at ourselves a little bit more closely and make sure that we are projecting and forecasting in a way that is reflective of those risks, but I don't see the risks necessarily outweighing the opportunities more so going forward than they have in the past.

Kate Haven, Head of Investor Relations

I think it's important to note that we have incorporated the impact of the issues from Q3 into our forecast for Q4. We have anticipated this in our updated guidance, and we haven't changed our assumptions regarding opportunities in a way that differs from what we experienced this quarter.

Operator, Operator

We are now going to proceed with our next question. The questions come from the line of Dan Leonard from UBS. Please ask the question.

Dan Leonard, Analyst

Hi. Thanks. Another question on large pharma demand, which I think is similar to David's. As we're all trying to guess who is customer number two, we can come up with half a dozen names that fit the descriptor in your press release, which is what begs the question on whether this issue is really isolated or not. So are there some examples you can share where perhaps the headlines that we're reading aren't really mapping to your experience and your revenue growth with the customers? And if I can ask a second part, same question. Elsewhere in the R&D supplier landscape, looking at equipment suppliers, for example, they've been talking about large pharma weakness for a good 18 months now. So what comfort do you have that there is some pig through the python phenomenon going on here where you're just getting hit with a lag? And we could be talking about this for a good while longer?

Steve Cutler, CEO

Dan, I'm not quite sure I understood your first question. Do you want to run that for me again, please?

Dan Leonard, Analyst

Yes. Yes. The first question, so you mentioned two customers in large pharma, right? And one of them, I guess, we can presume as Pfizer, and we're all trying to guess who is customer number two. And we're looking at your descriptors around pipeline prioritization and development models and just trying to map those to headlines. There's half a dozen names that investors can readily come up with, which is what is begging the question whether or not the issues are isolated. And I wonder if one of the ways to address that is perhaps you could share examples where there have been some negative headlines, but you're still growing despite that because of all the reasons you talked about earlier, if that would help add some comfort.

Steve Cutler, CEO

Let me clarify that we don't discuss specific customers by name. However, we believe the challenges we are facing with these customers are unique to them. They are not the only ones adjusting their development models or adopting a more functional approach. The main concern for us is that these are significant customers, and they are both making similar changes at a comparable pace. As they modify their model, we expected a decrease in revenues from a certain aspect of their business related to full service work. We also anticipated a notable increase in their functional business, which has not materialized as much as we had hoped. The gap between what they would typically award us and what they are currently doing has widened more than we anticipated earlier this year. This is largely due to budget cuts that have reduced their pipeline. While other companies may be making similar adjustments, they are not impacting our portfolio or workload to the same extent. I hope this clarifies the situation. Regarding other customers or companies in related industries, I can't comment specifically on their businesses. We don’t foresee these issues extending beyond our two largest customers. We work with all major pharmaceutical companies, and overall, we are optimistic about where the business is headed and the opportunity to gain market share. We believe we are already doing this and will continue to see it reflected in our growth rates in the medium to long term rather than in the short term. We are currently navigating this transition period, and we expect to grow this segment in a more consistent and sustainable manner. Overall, we have a positive outlook for the medium to long term regarding the market and our growth potential within it. We are currently experiencing a transition period for two quarters, and as indicated by our guidance, we anticipate a challenging quarter in Q4, which we are prepared to manage. Moving into next year, we will provide additional insights based on what we have in January.

Operator, Operator

We are now going to proceed with our next question, and it comes from the line of Jailendra Singh from Truist Securities. Please ask your question.

Jailendra Singh, Analyst

Thank you, and thanks for taking my questions. Just a quick clarification, which could be just a nuance: that low-to-mid single-digit growth rate for 2025, is that just organic? Or are you including M&A there? And then my main question: on backlog burn rate, it declined up 60 basis points sequentially. Can you share some details around how much of this drop was driven by business mix versus, like, some of the non-vaccine-related opportunities not converting to revenues in the quarter? And how do you think about these non-vaccine opportunities coming back in the future? Just trying to understand, how should we think about burn rate beyond Q4? Clearly, Q4 looks like it will be similar to Q3 but just thinking about the long-term burn rate expectations.

Steve Cutler, CEO

As I consider our expectations for organic growth, I want to be clear that while we have a general outlook, this is not formal guidance. We'll provide specific guidance in January, so please keep that in mind. Regarding vaccines and our burn rate, we have deferred some important vaccine projects to next year, which presents both opportunities and challenges. The increase in pass-throughs with this work could put some pressure on our margins, particularly in the first half of the year as these projects proceed. However, the positive aspect is that this work tends to move at a much quicker pace than our usual project timelines, which should result in a slight improvement in our burn rate, provided everything goes as planned. Currently, although this work has experienced some delays and volatility, initial trials are starting, and we are beginning to recruit patients, even if the numbers are modest. This was always part of our strategy. Although the vaccine work can be unpredictable, it is beneficial for managing our burn and could support a reasonable growth rate into 2025. I hope that addresses your question.

Operator, Operator

We are now going to proceed with the next question. The questions come from the line of Eric Coldwell from Baird. Please ask your question.

Eric Coldwell, Analyst

Thank you. Why is unbilled revenue up 45% year-over-year? And have you sold receivables this period or year-to-date? And then my follow-up or other add-on here is what company did you buy at the end of 3Q? And what is the impact of that? Thank you.

Brendan Brennan, Outgoing CFO

Hey Eric, it's Brendan here. I'll address the first part of your question regarding the unbilled position. This situation is largely reflective of the current market dynamics. We've noticed significant shifts, particularly driven by large pharmaceutical clients and their new contracting practices over the last year. They've been postponing milestones and attempting to minimize the number of milestones in contracts, which has affected our unbilled levels significantly. However, if you look at our cash receipts for the quarter, we're still performing well and aiming to achieve our free cash flow goal for the year. It's definitely an area of focus for the organization moving forward. Additionally, we've experienced a decrease in upfront pass-through payments. Given our size, there aren't many who readily provide these. We manage our accounts receivable effectively over time, and I believe we have done a solid job in that regard. Some major clients have payment structures that necessitate engaging with customer programs, which can incur costs. That's just their current operating model, and we've observed this trend with a few of our large customers. We work with them within these frameworks, though it's not a widespread issue across our entire business. Now, regarding the second part...

Steve Cutler, CEO

Yes, I mean I'll take that. We did make a relatively modest-sized acquisition relating to an organization in Eastern Europe to supplement our Eastern European capabilities. They work in the biotech segment, they work in the functional segment. They made an immaterial contribution to Q3. And frankly, it's a relatively small contribution to Q4 as well. But that's the source of the majority of the increase in headcount. We also see an uptick in our functional services group, and we brought on some billable or revenue-generating people from our functional group in the quarter and that's also part of that increase in headcount. So, I hope that explains that to you Eric.

Operator, Operator

We are now going to proceed with the next question. The questions come from the line of Matt Sykes from Goldman Sachs. Please ask your question.

Matt Sykes, Analyst

Hi. Thanks for taking my question. Maybe just going back to the identified opportunities that didn't materialize in the quarter. Were there any specific themes to why those didn't materialize? Was it price? Was it reach? I mean anything that you can kind of call out that the reason, why those didn't materialize or there was really a case-by-case basis? Thank you.

Steve Cutler, CEO

Every case is different. If there was one common theme, it was related to the biotech sector and some uncertainty regarding their ability to secure funding for their projects, which is often a consideration for these companies. They are cautious with their resources and focused on ensuring that their development programs align with the right indications, leading to some delays. These delays are connected to funding issues. Overall, it seems to be more of a biotech issue linked to the availability of financing. We always communicate with our customers before accepting awards and starting projects to confirm they are adequately funded and have the capital for that. We take a careful approach to ensure their financial health, so we don't proceed without assurance of their ability to invest. This situation reflects the ongoing challenges in the biotech funding environment that have contributed to those delays.

Operator, Operator

We are not going to proceed with our next question. The questions come from the line of Jack Meehan from Nephron Research. Please ask your question.

Jack Meehan, Analyst

Thank you. Steve, I have a question for you. Considering the pressure from large pharmaceutical companies, do you believe that customers are reevaluating their workload with ICON? When I think back to your acquisition of PRA, it was exceptionally seamless. However, there are concerns that sponsors might be adjusting their budgets, potentially leading to ICON experiencing greater pressure due to increased concentration with PRA, despite being a few years post-acquisition. Has this issue arisen at all? And Brendan, could you elaborate on the comment about the expanding role of pass-throughs in 2025? How might that impact revenue growth? Thank you.

Steve Cutler, CEO

Yeah. Jack, in terms of the concentration of customers, I think it would be fair to say that one or two have looked at if PRA and ICON were significant providers in the previous mix and now we've come together. They've looked at that and they've been in one or two cases brought on another competitor. I think that's what we expected. And that's happen in most of the cases, it in the cases I can think of that that's happened. We've continued to outperform and we've continued to deliver on that. It probably has been the source of some challenge in terms of continued revenue growth within those customers. But we feel like we've continued to develop. But yeah, so as you do these unions and you get access to other customers through the scale that we've been developed and we've been pretty clear in upfront about the new strategic partners we brought on. There has in one or two cases, I think, been an extra competitor brought in. It's not that we've gone out as an extra competitor has brought in, which has made increased or at least made the competition to continue. Do you want to?

Brendan Brennan, Outgoing CFO

Yeah. I think, Jack, your question probably relates to my answer on the last one, which is we're not seeing the same quantum of both from payments on pass-throughs anymore, but that doesn't change the quantum of pass-throughs; that we're seeing as an organization. And as a consequence, there's no additional drag as a result of change in mix of pass-throughs. That remains relatively consistent. The only thing that pushes that up and down, of course, as we've talked about a little bit is vaccines and particularly cover studies, which obviously might have an impact depending on the timing of some.

Operator, Operator

We are now going to proceed with our next question. Questions come from the line of Casey Woodring from JPMorgan. Please ask your question.

Casey Woodring, Analyst

Great. Thank you for fitting me in. Just curious to hear what you guys are seeing in terms of the preclinical and discovery pipeline working its way through to clinical here in this current volatile environment. Wondering, if this is really just a two to three quarter dynamic or transition period as Steve, you kind of referred to it as working through several customers rightsizing budgets? Or if this is really the start of a longer slowdown in pipeline progression just based on what you're seeing on the preclinical side? Thank you.

Steve Cutler, CEO

Yes, we believe this situation is tied to our two larger customers, along with the uncertainties in biotech and vaccines. We're not observing a significant link between preclinical developments and our larger Phase 2 and Phase 3 business in the short to medium term. While there could be long-term implications, the attrition rate of compounds moving from preclinical to early clinical and Phase 2 is substantial, which means a major impact on preclinical would be necessary to affect clinical work. We consider this to be a relatively isolated and short-term issue that the customers are currently addressing, and we anticipate progress within the next two to three quarters.

Kate Haven, Head of Investor Relations

Yeah. And I'll just add quickly, actually in the early phase, more in the Phase 1 space, it's actually been quite good in terms of overall activity, particularly on the award front. We called that out, obviously, in addition to labs being a nice performer for us in the quarter. So actually, we're not seeing that even on the early and early stages of our business.

Steve Cutler, CEO

Good point.

Operator, Operator

We are now going to proceed with our next question. The questions come from the line of Charles Rhyee from TD Cowen. Please ask the question.

Charles Rhyee, Analyst

Thank you for including me. Steve, you mentioned earlier about capital deployment and that you're exploring several opportunities in the short term. Can you provide more insight on whether these would be more significant than the one you discussed in Eastern Europe? Additionally, is there any indication that you couldn't pursue both mergers and acquisitions as well as share buybacks given your current level of leverage?

Steve Cutler, CEO

I'll address your second question first, Charles. No, we believe we can do both. We think our balance sheet and cash flow have been strong this quarter, positioning us well to pursue either mergers and acquisitions or share buybacks, and we will definitely take advantage of opportunities in share buybacks. The M&A opportunities we're considering are not transformational but are similar in size to the previous one I mentioned. We aim to enhance and improve our current operations, whether in the lab space, patient or site access, or potentially in late-phase real-world applications. These are the areas where we believe sensible acquisitions can lead to overall performance improvements. It’s not only about the revenue and EBITDA we generate but also about the synergies we can achieve in terms of revenue and cost efficiencies. If we can better execute our projects for our customers, we can drive revenue and achieve all the positive effects that come with that. Therefore, we are focusing on areas where we can significantly enhance our clinical operations, particularly in Phase II and Phase III, to complete this work for our customers more effectively and efficiently. These are the types of areas we are exploring.

Operator, Operator

In the interest of time, we will end the question-and-answer session. And I would like to hand back to Steve Cutler for closing remarks. Thank you.

Steve Cutler, CEO

Okay. Thank you, operator, and thank you all for attending the call today. We're not where we anticipated to be at this point of the year. And when you look at the underlying business excluding the factors that we outlined, we are continuing to outperform the market and our market position does continue to get stronger as we expand the number of partnerships we have within the top 30 pharma group. And we are obviously very focused on continuing to help our customers, who are under pressure to structure their development organizations in a more efficient way for their pipelines of the future. So overall we remain very constructive on our midterm growth prospects and optimistic that we can progress our performance over the short term very effectively. Thanks all for attending.

Operator, Operator

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