Charles River Laboratories International, Inc. (CRL) Earnings Call Transcript & Summary

Fair enough. The -- you talked about this proposal to booking capture rate last quarter, win rate effectively. You said you've seen improvement, but you've also -- probably the same answer as the last question. You're not calling to the trend. Is it just too soon to call it a trend? And what would be the driver of that win rate? You said you've been aggressively going after some business most people think price.

Yes. Yes. So win rates -- we look at capture rates, actually bounces around quite a bit a quarter or month to month. So we want to see several quarters of capture rates being above what we used to see. We're seeing a quarter, we're seeing maybe 4.5, 2 quarters which is great to see, but with the mathematical bounce in these metrics, I want to see this for a longer time period. There was also a question about are you gaining share without external data to validate that, I always shy away to say, hey, we're gaining share. So give us a year, give us 1.5 years of capture rates and maybe then I'm comfortable talking about share gain here. In the meantime, what it tells us even on a shorter period is that strategies we have in place to win work seem to be working. Price would be the obvious, but we are not the company that leads in discounting. We might have dynamic pricing to win work or to not lose work. But what we're going after right now is winning proposals as aggressively as we can because of how we go to market, following up on proposals, making sure that our start times are at a shortest period parcel whenever our clients want it. We have optimized our portfolio. So we are fully focused back on our core, which is DSA. So that is not our -- not just our sales group, but it's my time. It's our leadership's time. I think this all helps and also how we differentiate ourselves to win the work in a time where our clients all are looking for getting more molecules into the clinic as fast as possible. A couple of years ago, discussions were about price, how cheap can you do it, is there another piece of discount. And often, clients went for it, often they didn't go for it. Right now, the discussions are, when can you start? When can I get my data? And how quickly can I get and how many molecules can I get into the clinic? Just about every one of our big clients have those lofty targets of how many more molecules they want a need in the clinic so they can hit their goals of commercial approvals. And I think that's what we're -- what I mean was being aggressive about winning the work.

Have you seen any evidence of AI-driven volume at this point?

I would say very little. They are obviously AI native companies out there that get great funding, and they are our clients, just like a conventional biotech because it doesn't matter if it's an AI design molecule, they still have to go through the validation. They still have to go through the regulatory process. So yes, we have clients. Yes, they are funding. Yes, they have a lot of programs. But in an overall aspect of Charles River and how many clients we have, it's not something where I'm like, this is driving my growth, not yet. I do think AI will be a tailwind for us. And I do think AI will be a tailwind for drug development in general. So more efficient drug development will create more programs, more reinvestment, which is more opportunity for us. And hopefully, we won't win that opportunity. Early indication, yes. Big volume, not yet, but I'm sure that will come.

Okay. Boy, I'll have a Pavlovian response even same Cambodian monkey crisis 5 years ago around this time. But we have to talk a little bit about HPs. And I know you, again, addressed some of this in recent commentary, and I'm sure we'll get a ton more next week. We have a fair amount of evidence now that China is in shortage. It's been a very heavy R&D growth market, monkey -- the animals can only do so much in terms of progeny and output. And there is a concern and some would say an opportunity if you're an investor that perhaps the Asia market reaches out into other parts of the world, tries to pick up demand that drives hyperinflation. In other parts of the world, it limits who can supply this market and we get back into a price heavily escalating price period as we saw for a period of time a few years ago. I know you've addressed that, but not everyone's heard what you've said before. So talk to us about where we are, talk to us about why that China hyperinflation and supply chain shortage, why that didn't impact your timing of shipments last quarter, which you simply said was normal and not a driver of year-over-year growth? Talk to us about these dynamics, please.

Yes, certainly happy to. So just as a little bit of a background information. So China is a market where the nonhuman primate is not native. So they have to bring in their breed stock from other countries. When they closed down their borders during the COVID time, they haven't had any import or exports of nonhuman primates since then. So they haven't refreshed their breed stock. That in itself can be managed, but they had really focused on just putting -- producing animals for studies. So you're right that the animal availability in China is a little challenged. I wouldn't say it's at a level where it's an emergency, but the farms are looking to refresh their breed stock to increase their productivity. So there -- I believe there have been some imports for breed stock, and that is now something that the Chinese government seemingly allows. So there's permits, but that will take a few years because you have to grow up the breed stock and then you have to produce the offspring. So it's not an immediate fix. We have seen pricing improve a little bit in China, frankly, to the level that we've seen a few years ago. So actually, pricing went down. Now it's just coming back up a little bit. So it's not -- I wouldn't call it hyperinflation. Our volumes -- so we actually have a farm in China that we had bought for export, but then we couldn't export anymore because of the restrictions. So our research models business is selling the animals to third-party clients. The volume isn't very high. And so the price increase is not really that material. And when we talked about timing of shipments, it was more of the overall revenue that comes from it and how it impacts our research models services business. So really just about not being that material what we're seeing right now. And we'll have to see where pricing goes, but it's a known fact that they need more animals and that they're looking to produce more. It's an isolated market. They're not importing right now for studies, and they're not exporting for studies. So at this stage, it does not have an impact on what's going on in the rest of the world. If they do, they could obviously allow that. The situation now is very, very, very different than what we have seen 3 or 4 years ago. And why is it different? Because Charles River has invested in nonhuman primates farms. So just about 80% of our future needs are covered with that. There is a stability in the market we are not relying on other third parties that may sell to the highest price. And by the way, in 3 years ago, there was a whole market that was not accessible and that's not the fact right now. So pricing could move a little bit, not a bad thing, but I wouldn't expect those spot prices, at least not overall market prices that you saw a few years ago. We don't model it. We don't put it in our target. So I wouldn't like expect that going forward.

Okay. When you talk about the benefits of the [Audio Gap] largely a fourth quarter benefit, maybe a little bit in the third, but largely fourth quarter. That is sustainable, right? That is a -- once it kicks in, once you can take those newly acquired animals get them shipped overseas, go through quarantine prepared for studies, live in studies. Once you get that recurring volume of animals coming in, that margin lift, which you quote is due to lower input costs, lower lower supply costs, you're taking out the middleman. That is a permanent benefit, correct? We're not going to hear about some abnormal comp or anomaly where fourth quarter is a onetimer in next year is not as good.

Correct. I think the important point to highlight. Though in Q4 is we have a bolus of shipments and NHP study starts in the quarter that are very high, whereas typically you see them spread out over multiple quarters. And so the actual lower sourcing costs are here to stay, that's a permanent reduction in our cost base. And we would expect year-over-year on a full year basis to see accretion and margin expansion as a result of that acquisition. So that will stay with us. But it's important to note that in Q4, we have a large amount of NHP revenue from Cambodia. And so you just can't necessarily take the fourth quarter margins and say that's the going off point if that's where you're going with the question.

Yes. Deep snow -- short snow kind of seasonality almost approach. But the underlying theme is the same.

Yes. And so the real reason why we did the acquisition was to gain control of the supply chain to have a supply chain resiliency. And obviously, with that, we also have the benefit of lower costs, better margins. That will continue as we go forward. But just be careful in taking a single quarter and extrapolating that into next year.

And then the the lower cost could actually -- though costs could go up and maybe has gone up a bit with tariffs and inflation and fuel shipping. I mean you do ship, right? So are you pricing or embedding the cost of the animal in the study at a market rate? I know it's not -- I would expect it's not a spot rate, but like a standard market rate are you a little bit a little bit discounted to win over customers because you have such a better buy point? What are the dynamics on pricing to customers? What are the customers seeing?

Yes. So what we're doing is we're pricing a study and the animal is part of that. And we're pricing our studies so that we can stay competitive. So again, we are not the discounting leader. We actually generally maybe the highest price or the same price than some of our better competitors. And so don't look at it as how do we price the animal. It's really how do we make sure that we stay competitive on our studies, and that has inputs of animals, inputs of labor, inputs of facilities and so on. So we will make sure we are staying dynamic and competitive overall in the marketplace.

I've got one from the audience, and I'm going to do a little bit of a preface because you did have some corporate transformation. You had some dispositions, including the cell and gene therapy, CDMO, but there's someone in the audience asking more broadly about what you are seeing overall in terms of demand around cell and gene therapy as we go into the end of the year, as there was a period where it was a bit softer, it wasn't quite meeting the base case that the company laid out with those original acquisitions, for example. And then if I could just perhaps tack on to that. One of the original thesis of doing the CDMO acquisitions was that it linked into other parts of Charles River, where you could get a bit of a virtuous cycle or cross-sell. How has unwinding that business actually impacted your broader selling gene therapy support capabilities or demand?

Yes. So let me address kind of both questions. So yes, we divested our CDMO business that was a selling gene therapy business, both reasons market wasn't quite where we wanted it to be. But it also happened to be a business that wasn't quite the right fit for us. So it's very different than our services business and the science still was quite immature and needed a lot of resource science technology investment much more than our current business. You see the benefits of our divestiture from a margin perspective. Looking at cell and gene therapy demand, in general, I would -- I want to broaden it to complex modalities. And we do see an uptick in complex mortalities, and we will actually talk about it next week, how complex modalities drive demand for our services in general because the more complex the work is the more science is needed, more endpoints, more analytical capabilities are needed. So that's actually a good thing. From a perspective of our manufacturing support business, there was some cross work. So we're doing testing for some of the CDMO clients. We are continuing to do that. So we have a close collaboration with the buyer on that. and the clients. So it's actually going really well, really smooth, and the clients continue to see the benefits of both organizations working together on that. So nothing to be concerned of really going really well.

I just highlight the financial benefit is pretty obvious based upon our most recent quarter results in the manufacturing segment. We put margins up that we're in the high 30s. We're indicating we're going to be approaching 40% as we exit the year. So a very fast-growing business with very high margins. We are in good position to continue to see that growth.

That's fantastic. We -- unfortunately, I can keep going, but we've gone past our time. So I'll let you get on to a busy one-on-one schedule for the rest of the day, and hopefully, you have a great week. Thanks again for joining us. Everyone, please join me in thanking Charles River.

Thank you.