Fortrea Holdings Inc. (FTRE) FY 2024 MD&A

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in millions)

The following discussion and analysis is intended to provide a summary of significant factors relevant to the financial performance and condition of Fortrea Holdings Inc., which we refer to in this discussion and analysis as “Fortrea,” the “Company,” “our” and “we”. Prior to the spin-off (the “Spin” or “the Separation”), Fortrea existed and functioned as part of Labcorp Holdings Inc., which we refer to in this discussion and analysis as “Labcorp” or “Former Parent.” The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated and combined financial statements and corresponding notes and other financial information included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that are based upon current expectations and are subject to uncertainty and changes in circumstances. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A. “Risk Factors.” Actual results may differ materially from these expectations. See “Cautionary Statement Concerning Forward-Looking Statements.”

Company Overview

Fortrea, a Delaware corporation incorporated on January 31, 2023, is a leading global contract research organization (“CRO”) providing biopharmaceutical product and medical device development solutions to pharmaceutical, biotechnology and medical device customers. We offer customers highly flexible delivery models that include Full Service, Functional Service Provider (“FSP”), and Hybrid Service structures. We have a rich history of providing clinical development services for over 30 years across more than 20 therapeutic areas, first as Covance and later as Labcorp Drug Development. On June 30, 2023, we completed the Spin from Labcorp. We leverage our global scale, scientific and therapeutic expertise, clinical data insights, technology innovation, industry network and decades of experience as a standalone company and as a business unit prior to the Spin to deliver tailored solutions to our customers. With what we believe is a distinctive market offering, Fortrea meets growing global demand for clinical development services.

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Our team of approximately 15,500 employees conducts operations in approximately 100 countries and delivers comprehensive phase I – IV clinical trial management, clinical pharmacology, and consulting services for our customers. Our offering is scaled to deliver focused and agile solutions to customers globally, streamlining the biopharmaceutical product, and medical device development process.

Industry Outlook

For information about the industry outlook and markets that we operate in, refer to Part I, Item I. “Market Opportunity”.

Separation from Labcorp

On June 30, 2023, we completed the Spin from Labcorp through a pro-rata distribution of one share of Fortrea common stock for every share of Labcorp common stock held at the close of business on the record date of June 20, 2023. Fortrea began to trade as a separate public company (NASDAQ: FTRE) on July 3, 2023.

Subsequent Event

Credit Agreement Amendment

On February 28, 2025, the Company entered into an amendment (the “Second Credit Amendment”) to modify a financial covenant to provide the Company with additional flexibility under the Company’s credit agreement dated as of June 30, 2023 and as amended on May 3, 2024 (the “Existing Credit Agreement”), by and among the Company, certain subsidiaries of the Company and Goldman Sachs Bank USA (as administrative agent and collateral agent), governing the Company’s existing senior credit facility.

The Second Credit Amendment increased the Company’s maximum quarterly Total Leverage Ratio (as defined in the Existing Credit Agreement) from 5.30:1.00 to 6.00:1.00 for the fiscal quarters ending on September 30, 2025 through June 30, 2026, decreasing to 5.75:1.00 for the fiscal quarter ending on September 30, 2026, further decreasing to 5.50:1.00 for the fiscal quarter ending on December 31, 2026, and reverting to 5.30:1.00 thereafter.

In consideration of this adjustment, the Company paid a fee to consenting lenders and has agreed during the covenant adjustment period to certain additional limitations with respect to investments, restricted payments and liens.

Incremental Independent Public Company Expenses

The consolidated and combined statements of operations include costs for certain centralized functions and programs provided and administered by Labcorp that were allocated to us in the periods presented prior to the Spin. These centralized functions and programs include, but are not limited to, legal, tax, treasury, risk management, sales expenses, IT, human resources, finance, supply chain, executive leadership and stock-based compensation.

These expenses were allocated to us based on direct usage when identifiable or, when not directly identifiable, on the basis of proportional net revenues or headcount or another reasonable driver, as applicable. We consider the basis on which the expenses have been allocated to reasonably reflect the utilization of services provided to, or the benefit received by, us during the periods presented. However, the allocations may not reflect the expenses we would have incurred as an independent company for the periods presented and may not be representative of future expenses that may be incurred. Actual costs that may have been incurred if we had been a standalone company would depend on a number of factors, including the organizational structure, whether functions were outsourced or performed by employees, and strategic decisions made in areas such as IT and infrastructure. For a period following the Separation, however, some of these functions have been provided by Labcorp under the Transition Services Agreement.

The actual costs of services represented by these allocations may vary significantly from the amounts allocated to us in the accompanying financial statements.

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Sale of Assets Relating to the Enabling Services Segment

On March 9, 2024, the Company, together with its wholly-owned subsidiary, Fortrea Inc. (the “Seller”), entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Endeavor Buyer LLC, an affiliate of Arsenal Capital Partners, pursuant to which the Seller agreed to sell, and to cause its affiliates to sell, certain assets relating to its Enabling Services Segment (the “Transaction”), including the sale of equity interests of Fortrea Patient Access Inc. and its subsidiaries and Endpoint Clinical, Inc. and its subsidiaries. The final adjusted purchase price for the Transaction was $340.0, subject to customary purchase price adjustments, with $295.0 paid at closing and $45.0 to be paid upon achievement of certain transition-related milestones, which includes certain services provided through a Transition Services Agreement. The Transaction closed during the second quarter of 2024. Estimated proceeds of $285.2, resulted in a loss on disposal of $19.6, subject to further adjustment based on customary purchase price adjustments. The decision to sell such assets relating to the Enabling Services Segment represented a strategic shift that had a significant effect on the Company's results and operations and assets and liabilities for the periods presented. As a result, the Company has classified the assets related to the Enabling Services Segment as assets from discontinued operations and liabilities from discontinued operations on the consolidated balance sheet as of December 31, 2023. The operations of the Enabling Services Segment have been classified as income or loss from discontinued operations on the consolidated and combined statements of operations for all periods presented.

Backlog

Our backlog consists of anticipated future revenue from business awards that either have not started, or that are in process and have not been completed. Our backlog also reflects any cancellation or adjustment activity related to these awards. The average duration of our contracts will fluctuate from period to period based on the contracts comprising our backlog at any given time. The majority of our contracts contain early termination provisions that typically require notice periods ranging from 30 to 90 days. We adjust backlog for foreign currency fluctuations and exclude from backlog amounts that have been recognized as revenue in our statements of operations. Our backlog was $7.7 billion as of December 31, 2024.

We do not believe that, as a sole measure, our backlog is a consistent indicator of future revenue because it has been, and likely will continue to be, affected by a number of factors, including the variable size and duration of projects, many of which are performed over several years, and changes to the scope of work during the course of projects. Additionally, projects may be canceled or delayed by the customer or regulatory authorities. We generally do not have a contractual right to the full amount of the contract award reflected in our backlog. If a customer cancels a contract, we generally will be reimbursed for the costs we have incurred. For more information about risks related to our backlog see “Risk Factors—Risks Relating to Our Business—Our backlog might not be indicative of our future revenues, and we might not realize all of the anticipated future revenue reflected in our backlog.”

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help you understand our results of operations for the years ended December 31, 2024, 2023 and 2022.

Results of Continuing Operations for the years ended December 31, 2024, 2023 and 2022

The following tables present the financial measures that management considers to be the most significant indicators of the Company's performance.

Revenues

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The Company’s revenues for the year ended December 31, 2024, were $2,696.4, a decrease of 5.1% over revenues of $2,842.5 in the corresponding period in 2023. The change in revenues was due to a decrease in organic revenues of 5.2%, partially offset by favorable foreign currency translation of 0.1%. The Company defines organic growth as the change in revenues excluding the year over year impact of acquisitions, divestitures and currency. The 5.2% decrease in organic revenues was driven by decreased pass through costs and lower service revenues resulting from the lower quantity of new business wins prior to the Spin, along with the slower backlog burn rate and the mix of mature and longer duration studies in our portfolio. The decrease was partially offset by an increase in revenue from clinical pharmacology services.

The Company’s revenues for the year ended December 31, 2023, were $2,842.5, an increase of 0.2% over revenues of $2,837.0 in the corresponding period in 2022. The increase in revenues was due to organic growth of 0.1% and favorable foreign currency translation of 0.1%. The increase in organic revenues was primarily driven by an increase in pass through costs offset by the mix and quantity of new business wins prior to the Spin and by the impact of a prior year FSP cancellation.

Direct Costs, Exclusive of Depreciation and Amortization

Direct costs consist primarily of payroll and related benefits for project-related employees, reimbursable expenses (pass through costs), transition services agreement costs, information technology costs, and other direct costs.

Direct costs decreased 4.0% in 2024 as compared with 2023 and increased as a percentage of revenues to 80.2% in 2024 as compared to 79.2% in 2023. The decrease in direct costs was primarily due to lower pass through costs as well as cost efficiencies gained from restructuring actions, which has better aligned our resource levels and geographic footprint with project requirements. These declines were partially offset by an increase in stock compensation and professional fees.

Direct costs increased 6.6% in 2023 as compared with 2022 and increased as a percentage of revenues to 79.2% in 2023 as compared to 74.5% in 2022. The increase in direct costs was primarily due to higher pass through costs, transition services agreement costs and personnel costs partially offset by the removal of Former Parent corporate allocations and carve-out adjustments Fortrea received prior to the Spin.

Selling, General and Administrative Expenses, Exclusive of Depreciation and Amortization

Selling, general and administrative expenses consist primarily of administrative payroll and related benefit charges, transition services agreement costs, information technology costs, other facility charges, advertising and promotional expenses, and administrative travel.

Selling, general and administrative expenses increased 25.1% in 2024 compared to 2023. The increase was primarily due to an increase in professional fees and other costs to support the exit of the Transition Services Agreement with Labcorp and personnel and information technology costs as a stand-alone company.

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Selling, general and administrative expenses increased 7.7% in 2023 compared to 2022. The change in selling, general and administrative expenses was primarily due to an increase in personnel costs, credit loss provisions, transition service agreement costs and professional fees partially offset by elimination of prior year Former Parent corporate allocations and carve-out adjustments Fortrea received prior to the Spin.

Goodwill and Other Asset Impairments

During 2022, the Company recorded intangible asset impairment charges of $9.8. The Company concluded that the fair value was less than carrying value for one of its acquired technology related assets and recorded an asset impairment.

Depreciation Expense

The decrease in depreciation expense for 2024, as compared to 2023, was due to a decrease in depreciable property, plant and equipment, primarily IT assets. The increase in depreciation expense for 2023, as compared to 2022, was primarily due to the increase in of property, plant and equipment, primarily IT assets, as part of the Spin.

Amortization Expense

The increase in amortization of intangibles and other assets in 2024, as compared to 2023, was not significant.

The decrease in amortization of intangibles and other assets in 2023, as compared to 2022, is primarily the result of the impairment of technology assets that occurred in the fourth quarter of 2022.

Restructuring and Other Charges

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During the years ended December 31, 2024, 2023 and 2022, the Company recorded net restructuring charges of $50.1, $21.2, and $25.9, respectively, which are reflected within Restructuring and other charges in the consolidated and combined statements of operations. These charges are associated with Company actions to align resources and restructure certain operations which includes eliminating redundant positions and aligning resources and facilities for cost improvements and to meet customer requirements. In addition, in the fourth quarter of 2024, the Company approved a restructuring plan to streamline its operations and eliminate redundant positions. The Company recorded a restructuring charge of $21.3 related to this 2024 plan, which relate primarily to severance benefits and are accounted for under ASC 712, Compensation - Nonretirement Postemployment Benefits. Actions under these restructuring plans are expected to continue through 2025.

Interest Expense

The increase in interest expense for year ended December 31, 2024, as compared with the corresponding period in 2023, is primarily due to the higher overall debt balance, and the write-off of $12.2 of debt issuance costs associated with the pay down of debt in the quarter ended June 30, 2024, including the pay down of $70.2 on term loan A and $412.5 on term loan B.

The increase in interest expense for year ended December 31, 2023, as compared with the corresponding period in 2022, is primarily due to the incurrence of indebtedness in June 2023, consisting of borrowings under the senior secured term loan facilities and the senior secured notes.

Foreign Exchange Gain (Loss)

The change in foreign exchange gain (loss) for the year ended December 31, 2024, as compared to the year ended December 31, 2023, changed primarily due to the relative weakening of the U.S. Dollar against the British Pound and the Euro.

The change in foreign exchange gain (loss) for the year ended December 31, 2023, as compared to the year ended December 31, 2022, was primarily due to the relative strengthening of the U.S. Dollar against the British Pound and the Euro, and the allocation of hedging losses from the Former Parent hedging program for 2023.

1 Not meaningful

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Other, net

The increase in other, net for the year ended December 31, 2024, as compared to year ended December 31, 2023, is primarily related to the recognition of a contingent consideration payment on a sale of a facility to a third party and income related to services provided under Transition Services Agreements.

The increase in other, net for the year ended December 31, 2023, as compared to year ended December 31, 2022, is primarily related to a gain on sale of assets sold in 2023.

Income Tax Expense

For the year ended December 31, 2024, the Company’s effective tax rate was 1.3% compared to (3.8)% for the year ended December 31, 2023. The effective tax rate for the year ended December 31, 2024 was lower than the Company’s statutory tax rate primarily due to an increase in the valuation allowance, non-deductible employee benefits, foreign earnings taxed at rates higher than the U.S. statutory rate and U.S. tax on foreign income inclusions, partially offset by the U.S. R&D credit and certain state tax benefits. The effective tax rate for the year ended December 31, 2023 was lower than the Company’s statutory tax rate primarily due to foreign earnings taxed at rates higher than the U.S. statutory rate, U.S. tax on foreign income inclusions, the base erosion and anti-abuse tax (“BEAT”) and non-deductible employee benefits, partially offset by the U.S. R&D credit and certain state tax benefits.

For the year ended December 31, 2023, the Company's effective tax rate was (3.8)% compared to 22.0% for the year ended December 31, 2022. The effective tax rate for the year ended December 31, 2022 was higher than the Company’s statutory tax rate primarily due to foreign earnings taxed at rates higher than the U.S. statutory rate, U.S. taxes on foreign income inclusions and state taxes, partially offset by benefits for permanently non-deductible items, employee benefits, the U.S. R&D credit and certain state benefits.

The Organization for Economic Cooperation and Development has introduced new global minimum tax regulations, known as Pillar Two, that came into effect beginning on January 1, 2024. We will continue to monitor this development and its potential impact on our future tax rate. In 2024, we have calculated and accrued an additional top-up tax under the Pillar Two Framework in certain jurisdictions where the effective tax rate fell below the minimum threshold of 15%. This amount was not significant to the total 2024 income tax provision for the Company.

Liquidity, Capital Resources and Financial Position

The Company manages cash flow to fund and invest in operational growth, capital expenditures, and credit facility repayments. In connection with the Spin, we incurred indebtedness in an aggregate principal amount of $1,640.0, which consists of borrowings under senior secured term loan facilities and senior secured notes. We have also entered into a senior secured revolving credit facility, which consists of a five-year facility in the principal amount of up to $450.0 as further discussed in Note 11, “Debt” to our consolidated and combined financial statements. During the year ended December 31, 2024, we paid down $70.2 on term loan A, and $412.5 on term loan B, respectively.

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On May 6, 2024, we entered into a three-year $300.0 accounts receivable securitization program (the “Receivables Facility”). Under this program, Fortrea Inc. conveys receivable balances to a wholly-owned, bankruptcy-remote special purpose entity, which in turn, may sell receivables to a third-party financial institution in exchange for cash. We have sold $300.0 of receivables with net proceeds of $297.9 under the Receivables Facility.

We believe our existing cash and cash flows generated from operations, plus existing credit facilities, will be sufficient to cover the needs of our current and planned operations for at least the next 12 months. From time to time, we routinely evaluate strategic opportunities, including potential acquisitions, joint ventures or investments in complementary businesses. We may also access capital markets through the issuance of debt or equity, which we may use in connection with the acquisition of complementary businesses or other significant assets, or for other strategic opportunities, or general corporate purposes.

Cash Flows for the Year’s Ended December 31, 2024, 2023 and 2022

The cash flows related to discontinued operations have not been segregated and are included in the consolidated and combined statements of cash flows and the discussion of the cash flow activity. In summary the Company’s cash flows were as follows:

Cash and Cash Equivalents

Cash and cash equivalents at December 31, 2024, 2023 and 2022 totaled $118.5, $108.6 and $110.4, respectively. Cash and cash equivalents consist of highly liquid instruments, such as commercial paper, time deposits, and other money market instruments, which have maturities when purchased of three months or less.

Cash Flows from Operating Activities

During the year ended December 31, 2024, the Company's operations provided $262.8 of cash as compared to $168.4 in 2023, an increase of $94.4. This increase in cash flows from operating activities was primarily due to cash from accounts receivable, including the sale of receivables under the Receivables Facility, offset by the decrease in net income and higher use of cash for prepaid expenses.

During the year ended December 31, 2023, the Company's operations provided $168.4 of cash as compared to $82.7 in 2022, an increase of $85.7. Cash flows from operating activities benefited from moderation in growth of unbilled services and deferred revenue, along with lower cash used for accrued expenses, including lower incentive compensation payments, partially offset by a decrease in net income.

Cash Flows from Investing Activities

Net cash provided by investing activities for the year ended December 31, 2024 was $251.6 as compared to net cash used for investing activities of $(31.8) for the year ended December 31, 2023. The $283.4 increase in net cash provided by (used for) investing activities for the year ended December 31, 2024, was primarily due to $276.6 of net proceeds from the sale of the Enabling Services Segment and a year over year decrease in capital expenditures. Capital expenditures were $25.5 and $40.3 for the years ended December 31, 2024 and 2023, respectively. Capital expenditures in 2024 were 0.9% of revenues, primarily in connection with projects to support growth in the Company's core businesses. The Company intends to continue to pursue selective investments in key therapeutic areas, business areas and geographies to drive growth and to improve efficiency of the Company's operations. Such expenditures are expected to be funded by cash flow from operations.

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Net cash used for investing activities for the year ended December 31, 2023 was $(31.8) as compared to net cash used for investing activities of $(54.0) for the year ended December 31, 2022. The $22.2 decrease in net cash used for investing activities was primarily due to a year over year decrease in capital expenditures. Capital expenditures were $40.3 and $54.4 for the years ended December 31, 2023 and 2022, respectively. Capital expenditures in 2023 were 1.4% of revenues, primarily in connection with projects to support growth in the Company's core businesses.

Cash Flows from Financing Activities

Net cash used for financing activities for the year ended December 31, 2024 was $497.8 compared to cash used for financing activities of $140.8 for the year ended December 31, 2023. Cash used for financing activities for December 31, 2024 was primarily related to principal payments on the term loan A and term loan B.

Net cash used for financing activities for the year ended December 31, 2023 was $140.8 compared to cash used for financing activities of $6.3 for the year ended December 31, 2022. Financing activities for year ended December 31, 2023 included proceeds from term loans and senior note offerings which were more than offset by the net transfers to Former Parent in connection with the Spin. Information regarding the net transfer is provided in Note 2, “Summary of Significant Accounting Policies” and Note 19, “Transactions with Former Parent” to the audited consolidated and combined financial statements.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet financing other than short term operating leases and letters of credit.

Critical Accounting Policies and Estimates

We have chosen accounting policies that management believes are appropriate to accurately and fairly report our operating results and financial position in conformity with U.S. GAAP. We apply these accounting policies in a consistent manner. The Company’s critical accounting policies arise in conjunction with revenue recognition, business combinations, income taxes, and goodwill and indefinite-lived assets.

The application of these accounting policies requires that we make estimates and assumptions about future events and apply judgments that affect the reported amounts of assets, liabilities, revenues, expenses, contingent assets and liabilities, and related disclosures. These estimates, assumptions and judgments are based on historical experience, current trends and other factors believed to be reasonable under the circumstances. Management evaluates these estimates and assumptions on an ongoing basis. If actual results ultimately differ from previous estimates, the revisions are included in results of operations when the actual amounts become known.

Revenue Recognition

The Company provides comprehensive phase I through phase IV clinical development services to global pharmaceutical, biotechnology, and medical device companies worldwide. A majority of the Company’s revenues are earned under contracts that are long term in nature, ranging in duration from a few months to many years. The majority of the Company's contracts contain a single performance obligation, as the Company provides a significant service of integrating all obligations in the contract and the obligations are highly interdependent and interrelated with one another. For contracts that include multiple performance obligations, the Company allocates the contract value to the goods and services proportionately based on the determined stand-alone selling price. The Company uses an observable price, typically a price list. If a price list is not available, the Company will estimate the stand-alone price using either market prices or an “expected cost plus margin” approach. The total contract value is estimated at the beginning of the contract, and is equal to the amount expected to be billed to the customer. Other payments and billing adjustments may also factor into the calculation of total contract value, such as the reimbursement of out-of-pocket costs and volume-based rebates. These contracts generally take the form of fixed-price, fee-for-service or software-as-a-service arrangements subject to pricing adjustments based on changes in scope.

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Fixed-price contracts are typically recognized as revenue over time based on a proportional-performance basis, using either input or output methods that are specific to the service provided. In an output method, revenue is determined by dividing the actual units of output achieved by the total units of output required under the contract and multiplying that percentage by the total contract value. When using an input method, revenue is recognized by dividing the actual costs incurred by the total estimated cost expected to complete the contract, and multiplying that percentage by the total contract value. Contract costs principally include direct labor and reimbursable out-of-pocket costs. The estimate of total costs expected to complete the contract requires significant judgment and estimates are based on various assumptions of events that often span several years. These estimates are reviewed periodically and any adjustments are recognized on a cumulative catch-up basis in the period they become known. During the years ended December 31, 2024 and 2023, reductions of approximately $61 and $60, respectively, in revenue related to performance obligations partially satisfied in previous periods. During the year ended December 31, 2022, revenue of approximately $72 was recognized from performance obligations that were partially satisfied in a previous period. Substantially all of these adjustments were associated with changes in scope or price for full service clinical studies. The gross and net amounts of revenue recognized solely from changes in estimates were not material.

Fee-for-service contracts are typically priced based on transaction volume or time and materials. For volume based contracts the contract value is entirely variable and revenue is recognized as the specific product or service is completed. For services billed based on time and materials, revenue is recognized using the right to invoice practical expedient.

Software-as-a-service (“SaaS”) arrangements represent a single obligation to provide continuous access to a hosted software platform. As each day of providing access to the platform is substantially the same, and the customer simultaneously receives and consumes the benefits as access is provided, the Company recognizes revenue using an output method based on time elapsed, which is on a straight-line basis over the course of the contracted SaaS hosting period.

Contracts are often modified to account for changes in contract specifications and requirements. Generally, when contract modifications create new performance obligations, the modification is considered to be a separate contract and revenue is recognized prospectively. When contract modifications change existing performance obligations, the impact on the existing transaction price and measure of progress for the performance obligation to which it relates is generally recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

Most contracts are terminable with or without cause by the customer, either immediately or upon notice. These contracts often require payment to the Company of expenses to wind-down the study or project, fees earned to date and, in some cases, a termination fee or a payment to the Company of some portion of the fees or profits that could have been earned by the Company under the contract if it had not been terminated early. Termination fees are included in revenues when services are performed and realization is assured.

Allowance for Credit Losses

The Company maintains current receivable amounts with most of its customers. Fluctuations in accounts receivable, net are attributable to a variety of factors including, but not limited to, the timing of cash receipts from customers, the Company’s assessment of collectability and corresponding provision for bad debt expense and the inception, transition, modification or termination of customer relationships. The Company regularly monitors and assesses its risk of not collecting amounts owed by customers. This evaluation is based upon an analysis of current and past due amounts, along with relevant history and facts particular to the customer and the evaluation of the recoverability of amounts due. The Company records its allowance for credit losses based on the results of this analysis. The analysis requires the Company to make significant estimates and, as such, changes in facts and circumstances could result in material changes in the allowance for credit losses.

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Income Taxes

Prior to the Spin, the Company was included in the combined U.S. federal, state, and foreign income tax returns of Labcorp, where eligible. For the periods after Spin, the Company files income tax returns as a separate company. The income tax provisions, and related deferred tax assets and liabilities reflected in our financial statements represent the Company as separate from Labcorp. The Company accounts for income taxes utilizing the asset and liability method. Under this method, deferred income taxes represent the expected future tax consequences of temporary differences between the financial statements carrying amount and the respective tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. To the extent deferred taxes are recorded to accumulated other comprehensive income, we record the tax effect of any release of deferred taxes using either the specific identification approach or the portfolio approach based on the nature of the underlying item. We elected to not consider the estimated impact of potential future Corporate Alternative Minimum Tax liabilities for purposes of assessing valuation allowances on the Company’s deferred tax balances. The effect on deferred tax assets and liabilities of an enacted change in tax rates is recognized in income in the period that includes the enactment date.

The Company does not recognize a tax benefit for any uncertain tax positions, unless the Company concludes that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, the Company recognizes a tax benefit measured at the largest amount of the tax benefit that the Company believes is greater than 50% likely to be realized. The Company records interest and penalties in income tax expense.

We are subject to income taxes in the U.S. and various foreign jurisdictions. The Company is not currently under tax examination by the Internal Revenue Service (“IRS”) as a separate taxpayer. We are no longer subject to U.S. state income tax audits prior to 2018. There are ongoing foreign income tax audits in various jurisdictions ranging from 2018 - 2022. While we believe we have adequately accrued for all tax positions, amounts assessed by taxing authorities could be greater than what we have recorded in our financial statements. Accordingly, additional income tax provisions on federal, state and foreign income tax-related matters could be recorded in the future as revised estimates are made or the underlying matters are settled or otherwise resolved. Since the timing of resolution of income tax audits are uncertain, it is difficult to predict with certainty the range of reasonably possible significant increases or decreases in the liability related to uncertain tax positions that may occur within the next twelve months.

With limited exception, the Company has considered the earnings of its foreign subsidiaries prior to 2024 to be indefinitely invested outside the United States on the basis of limited foreign cash reserves and plans for the reinvestment of those subsidiary earnings. Our foreign undistributed earnings are computed under the U.S. federal tax earning and profits (“E&P”) principles. The determination of the amount of deferred tax liability that would be recorded for these earnings if they were not indefinitely reinvested is not practicable at this time. In 2024, management has recorded a deferred tax liability related to applicable foreign withholding taxes on approximately $95.3 of undistributed 2024 U.S. GAAP earnings of its foreign subsidiaries as these earnings will not be indefinitely reinvested outside the United States.

Goodwill

The Company has recorded $1,710.4 and $1,739.4 of goodwill as of December 31, 2024 and 2023, respectively. The Company assesses goodwill for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.

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The annual impairment test for goodwill includes an option to perform a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying value. Reporting units are businesses with discrete financial information that is available and reviewed by management. If the Company determines that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then the Company performs the quantitative goodwill impairment test. The Company may also choose to bypass the qualitative assessment for any reporting unit in its goodwill assessment and proceed directly to performing the quantitative assessment. The Company recognizes an impairment charge for the amount by which the reporting unit's carrying amount exceeds its fair value.

In the qualitative assessment, the Company considers relevant events and circumstances for each reporting unit, including (i) current year results, (ii) financial performance versus management’s annual and five-year strategic plans, (iii) changes in the reporting unit carrying value since prior year, (iv) industry and market conditions in which the reporting unit operates, (v) macroeconomic conditions, including discount rate changes, and (vi) changes in products or services offered by the reporting unit. If applicable, performance in recent years is compared to forecasts included in prior quantitative valuations. Based on the results of the qualitative assessment, if the Company concludes that it is not more likely than not that the fair value of the reporting unit is less than its carrying values of the reporting unit, then no quantitative assessment is performed.

The quantitative assessment includes the estimation of the fair value of each reporting unit as compared to the carrying value of the reporting unit. The Company estimates the fair value of a reporting unit using both income-based and market-based valuation methods. The income-based approach is based on the reporting unit's forecasted future cash flows that are discounted to the present value using the reporting unit's weighted average cost of capital. For the market-based approach, the Company utilizes a number of factors such as publicly available information regarding the market capitalization of the Company as well as operating results, business plans, market multiples, and present value techniques. Based upon the range of estimated values developed from the income and market-based methods, the Company determines the estimated fair value for the reporting unit. If the estimated fair value of the reporting unit exceeds the carrying value, the goodwill is not impaired and no further review is required.

The income-based fair value methodology requires management's assumptions and judgments regarding economic conditions in the markets in which the Company operates and conditions in the capital markets, many of which are outside of management's control. At the reporting unit level, fair value estimation requires management's assumptions and judgments regarding the effects of overall economic conditions on the specific reporting unit, along with assessment of the reporting unit's strategies and forecasts of future cash flows. Forecasts of individual reporting unit cash flows involve management's estimates and assumptions regarding:

•Annual cash flows, on a debt-free basis, arising from future revenues and profitability, changes in working capital, capital spending and income taxes for at least a five-year forecast period.

•A terminal growth rate for years beyond the forecast period. The terminal growth rate is selected based on consideration of growth rates used in the forecast period, historical performance of the reporting unit and economic conditions.

•A discount rate that reflects the risks inherent in realizing the forecasted cash flows. A discount rate considers the risk-free rate of return on long-term treasury securities, the risk premium associated with investing in equity securities of comparable companies, the beta obtained from the comparable companies and the cost of debt for investment grade issuers. In addition, the discount rate may consider any Company-specific risk in achieving the prospective financial information.

Under the market-based fair value methodology, judgment is required in evaluating market multiples and recent transactions. Management believes that the assumptions used for its impairment tests are representative of those that would be used by market participants performing similar valuations of the reporting units.

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Management performed its annual goodwill impairment testing as of October 1, 2024. The Company elected to perform a quantitative assessment on its two reporting units, Clinical Development and Clinical Pharmacology. Based upon the results of the quantitative assessment, the Company concluded that the fair values of each of its reporting units were greater than the carrying values. For the Clinical Development reporting unit, the fair value of the business exceeded the book value by approximately 10%. For the Clinical Pharmacology reporting unit, the fair value of the business substantially exceeded the book value.

Although the Company believes that the current assumptions and estimates used in its goodwill analysis are reasonable, supportable, and appropriate, continued efforts to maintain or improve the performance of these businesses could be impacted by unfavorable or unforeseen changes which could impact the existing assumptions used in the impairment analysis. Various factors could reasonably be expected to unfavorably impact existing assumptions: primarily delays or lower demand resulting in lower contract bookings and the related delay or reduction in revenue, increases in customer termination activity or increases in operating costs. Accordingly, there can be no assurance that the estimates and assumptions made for the purposes of the goodwill impairment and intangible asset analysis will prove to be accurate predictions of future performance.

The Company will continue to monitor the financial performance of and assumptions for its reporting units. A significant increase in the discount rate, decrease in the revenue and terminal growth rates, decreased operating margin or substantial reductions in end markets and volume assumptions could have a negative impact on the estimated fair value of the reporting units. A future impairment charge for goodwill or intangible assets could have a material effect on the Company’s consolidated financial position and results of operations.

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