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

Hi, everybody. I see the clock is already running. So we better get started. I'm Dave Windley with Jefferies Healthcare Equity Research based here in the States in, actually, Nashville, Tennessee. Welcome you all down to visit us for [ Bryan's ] bus tour later in the summer. But for now, we're here at our New York Global Healthcare Conference. Appreciate your attendance there and are here and also appreciate Charles River's participation. Birgit Girshick, the company's COO, is with me here to talk fireside. And so we'll get into questions. He's had busy day already and more to come. So I want to start Birgit, again thanks for being here.

I want to start just talking about the variety of drivers of growth and the biggest segment, Discovery and Safety Assessment, probably is the logical place to start. So the company has built a very substantial backlog, much longer than normal. I think that gives the company a higher-than-normal visibility. Management has also talked about how clients have kind of expressed not wanting to book as far out as maybe they were during the pandemic. So that long backlog is both high visibility, but also a little bit of a block to clients wanting to book nearer term. So how do you assess in light of kind of a broader life sciences string of news that biotech financial pressures are affecting life science tools companies? We've had a half a dozen companies here at the conference to say the same thing again at least. How do you discern slackening demand from just we don't want to book out further? What kind of signals do you get from clients on that front?

Yes. Thanks, Dave. Maybe let me take a tiny little step back maybe for the people here in the room that I'm not quite as familiar with our portfolio. So we are the leading early -- discovery, early research, preclinical drug development partner for biotech and pharmaceutical companies. The majority of our services and products we offer are required from a regulatory standpoint, which makes us our operating model very resilient in macroeconomic times because there's really no choice of doing the work or having the work maybe done a year or 2 years or 3 years later, which is possible, obviously, if you want to do some investments in the capital equipment. We have just reported a stellar quarter, which also should give you confidence into the strengths of the company as well as the overall competitiveness of the business. We had a 15.4% growth -- revenue growth and $2.78 EPS which is quite a bit better than we actually were hoping in the beginning of the year. To your question specifically, Dave, first of all, we, and as part of our operating model, always keep a certain amount of space for clients that need very short study starts or come and have changes because of that or results they've gotten in previous studies. So we always are trying to accommodate our clients in their needs to making sure that they can actually get their studies done when they need them to be done. From a macroeconomic standpoint, we are still having a backlog of 14 months, which gives us incredible visibility in the work that's coming up. This is shortening a little bit, but as you actually pointed out, from an operational perspective, actually not a bad thing because these long, long time lines are really difficult to manage as an organization and as far as our clients as well. We have really doubled down on talking to them about their programs, making sure that we know at any time if their plans are changing, what's the results they have gotten from previous studies? Are there compounds ready, which is generally the reason for a postponement of a study and cancellations? And with that, we are pretty certain and confident that the backlog that we are having is a very, very, very solid backlog. And really not too concerned about the macroeconomic times. We -- as I said, we see some normalization in that part probably going back to pre-COVID times where it was quite bullish during that time, enjoyable, but quite bullish from a booking out far and booking a lot of studies. And so what we're seeing at this point is continuing to support the growth that we're foreseeing and, as I said, probably providing us actually a better backlog, better quality of backlog and more visibility in collaboration with the client.

Interesting. Thank you for that. The better quality of backlog is an interesting point. Let me just ask a follow-up there. So if we -- if we think about the demand trends again because backlog has -- is so robust and stretches out into, I guess, next year. Your bookings -- your book-to-bill is running below 1, call it, between 0.7, 0.8 in the most recent quarter. That will bring the backlog down toward normal over time. Again, the -- and you commented on doubling down and talking to your clients, that kind of answer as part of this question. But if we're running at sub-1 book-to-bills and we get the normal backlog, kind of what gives you the confidence that book-to-bills will go back to north of 1 so that they would support growth?

Yes. I mean we have a lot of discussions with our clients, and we are seeing some elongation of making -- decision making, particularly, maybe with smaller clients. But we also have a lot of clients, pharma specifically. We actually talked about that in our earnings release who are quite -- they bring in a lot of work right now. And so overall, I think this evening itself out a little bit and as I said while having better study starts, being able to provide the work when our clients need it. I think our ability to win the proposals that are out there, to win the work that is out there is just going to get even better.

Got it. I appreciate the extra color there. Let's move on to Discovery, the D part of DSA. So Discovery services relatively smaller in that segment of the business, saw a little bit of weakness that management called out later last year, but I think actually firmed up and was more positive earlier this year. So maybe you could describe what you see in Discovery insomuch as it's maybe even closer to some of the tools, commentary and the moving parts in the end market?

Yes. So we're continuing to see some growth in our Discovery Services area, not as strong as during COVID times. So again, we're seeing a little bit of a normalization there. Discovery Services for us is shorter duration studies. They are also booked in a very quick manner. So backlog is much, much, shorter. Clients are making decisions generally relatively quickly. And with that, we can generally see changes quarter-over-quarter rather quickly and adjust our capacity and adjust our ability to start studies quite quickly there. So as I said, we see some normalization there. We still see growth. We have a unique portfolio that is supporting all the major therapeutic areas. We are geographically dispersed being able to work with clients around the globe. And so quite hopeful that we're continuing to see good growth there and good ability of winning work.

Got it. Helpful. So I'm going to try to limit my questions on NHPs because I know you're getting inundated, but is it a topic of high interest. I think that the company -- so the company had gone through a period of kind of limiting or even stopping importing of NHPs for a period of time. It seems like maybe that has reopened. Perhaps could you give us a perspective on the adequacy of your supply and where that's coming from and if you can, where it's going to? What parts of your business?

Right. So yes, happy to. And you all are living the nonhuman primate complexities as we are encountering them. So earlier this year, when we provided the first information, obviously shocked and in a little bit of a what do we do next? Where we're going from here? Since then, we had a few months of working on some mitigation strategies, having tons of discussions with our clients of how we can help them to get studies done. Overall, the situation remains fluid. However, we have done a tremendous amount of work and are successfully using our geographic locations and multiple supply sources to mitigate the supply chain challenges as much as possible. And I give highest compliments to our clients for really working with us closely on allowing to do that and being able to get that done.

So in terms of the mitigation strategies and the kind of broadening of supply chain, one of the things that has been challenging to figure out is, of course, the gestation period, the reproductive rates of these animals are quite slow, really low and so hard to build up breeding stock in a rapid manner. And we kind of -- are seeing the results of Cambodia backfilling China's ceasing of exporting has resulted in this legal investigation. How do you comfort yourselves that like supply from Vietnam or Mauritius or other places that might ramp in a short period of time is not risking the same problem?

Yes. I mean -- so first of all, none of the nonhuman primate farms can scale really, really quickly. So that -- as you said, the gestation doesn't allow that. The animals have to be a certain age. So what we are looking at is, in many cases, how many animals do we need on a study? What is the age range of an animal on a study? But would we -- and with that, we can maximize supply. What we're doing, we've always done is audits of our farms. So we work very closely with the farms on breeding practices by security health status. And COVID put a little bit of a stop to that because nobody was able to travel to the farms. But we are in full force back and we are at our facilities. We have veterinarian in the area of our -- of the farms and suppliers that we have there and we'll continue to do that.

Okay. Last question on this, I promise. So we're seeing some numbers in China where the prices of the animals in China, which obviously the inflation has moved those numbers around pretty dramatically. But the prices in China have actually started to drop. I'm wondering if you have a view as to -- it's been kind of a black box as to whether China would export or not export and things like that. Do you have a view as to whether China might reopen? And if they did at the prices where they were, how might that impact the business at $10,000, $20,000 an animal instead of $40,000 or $50,000 an animal?

Yes. I mean I hear the same rumors that you do, Dave. So it's hard for us to discern right now what's going to happen in China. Are they going to open their borders? And then to me, the more important question is not the exporting but the importing of animals. So as far as we now supply in China for NHPs is still being utilized by local industry. We have not been able to see that there is any access capacity and we know that there is a need for breed stock in that country. So if they're opening for import, but not for export, what is that going to do with rest of the world? So we actually could see more of a capacity crunch. And frankly, that's why we are urging the industry and the government here to take quick and efficient actions to resolve some of the supply chain concerns.

Yes, that's very interesting. So let's move on to margin and DSA more broadly. So I give the management team credit. I thought you were quite humble on the first quarter call about just how spectacular that margin was because it was the best ever by, I think, 150 basis points or more. What drove that?

So yes, certainly proud of the margin. We don't expect this to be the new standard quarter-over-quarter. So we will see some variations. That said, we are, as a company, always have focused on margin expansion. We are doing a ton of different initiatives to drive margin. A lot of digital work that we are implementing, some of that we actually just rolled out at SOT was a new platform for our clients, that gives them self-serve access. For this quarter specifically, it was really, really good utilization of our space, but then also a large component of mix. So I'm pretty comfortable saying that you will see -- continue to see margin improvements in DSA and as Charles River as a whole because that's just who we are. But certainly, that quarter was spectacular.

Yes. Okay. Great. So let's move on to RMS. RMS is kind of the foundational business of the company going back decades and has a slightly different customer mix overall than, say, DSA might because I think more of your academics are there. It has probably most of the China revenue flows through RMS. Perhaps you could talk about the customer mix in RMS and whether that provides a greater or lesser level of protection in a more volatile kind of end market?

Certainly, happy to. Yes. So for RMS segments, specifically, 40% of our revenue is in the academic government space. And then that's followed by pharma and then by biotech. So that does give us a little bit of more stability, I would say. We have a lot of long-term contracts in this space. And then, as I said, also, pharma is pretty strong right now for us as a company, so helping us with that as well. But for RMS specifically, what we're seeing here is a couple of different trends. So number one, our services in this division are extremely strong. One of them that I want to point out is our CRADL division. CRADL is a division that provides vivarium space to clients where they can come in and can rent a room or a rack or a cage basically and do their early research themselves in our facilities with some support. We have a -- we have an acquisition that we made last year and we now have a total of 9 more sites in -- for our CRADL customers to explore and to take space and lead space. This, together was our GEMS offering, which is genetically engineered models, which are high-end models that we breed and house for our clients, is driving quite a bit of the growth rate as well. So our services in this space are highly successful, highly relevant. And if you think about -- if a biotech company or a pharma company actually would like to spend less money, leasing some space temporarily or maybe for a longer time is actually a very good way of not using their capital and their cash to build the facility. So highly relevant in a macroeconomic time like this. The other trend is that we, over years, used to see some price growth in our research models business. We are currently seeing quite a bit of volume growth. And that I would say comes specifically from activities, initiatives we have done, we're really catering to our academic clients, allowing them to order much easier than before with some of the digital tools that we rolled out, but also providing them real data access like for engineered models and other models that they can explore and utilize in their daily work, which I do think made us a lot more competitive.

So that segues really nicely into my next which was going to be around small animals. You mentioned volume, are you still getting price in small animals or even more price than historical? What's the environment there?

Yes. So at this point, we actually have 2 quite distinct geographies. One is China, where we see high volume and price. And then the Western part, where we are now seeing more volume again, but price is definitely something we are seeing in that business as well as well as in all our businesses.

So you'd say still getting price similar to how you have in the past?

Yes.

Okay. So then moving to -- with a little bit of time left moving to manufacturing solutions. You've realigned the acquisitions, the CDMO acquisitions. Cognate and Vigene from a couple of years ago kind of upping the sales game, I think putting some leadership in place and creating centers of excellence in those sites. Maybe give us an update on where the regeneration of demand for that business stands?

Yes, happy to. So yes, the CDMO business is our newest business and a little bit of a learning curve for us, no doubt. One of the things that really has changed the trajectory of the business is creating centers of excellence. So we are now -- we have one facility in the U.K. who is focusing on high-end, high-quality plasmids, a facility in Maryland focusing on viral vector and then the cell therapy manufacturing in our Memphis, Tennessee site gives us 2 things -- 2 ways of selling. One, the plasmas in viral vector we sell as basically as a product sales to client both off the shell and customized, but then we also have the integrated way of working of using the plasmids for our vectors to do -- then gene-modified cell therapy. Some of the drivers is, one, the refocusing of the sites, higher quality, higher regulatory compliance but then also recent regulatory audits in our Memphis facility, where we now have a commercial product manufacturer really helped us to create the brand and create interest of client. So I just came from the Bio conference and quite a bit of activity. And I think that will just accelerate now the growth rate that we are expecting.

Interesting. So did I catch that -- I think the last time I heard you speak of it, the audit in Memphis was in preparation and facilitative of a commercial approval, but not a commercial approval yet. Are you saying that, that is now commercially approved?

It's a commercial approved product that we are manufacturing there, yes.

Excellent. And does that -- the variety of sizes of these end markets are pretty dramatic. Is that a product that the commercial activity could be a material contributor to manufacturing solutions?

So it's material to us because being a facility that is able to manufacture commercially is there's not a lot of competitors out there who can say that. There's very -- there's just a couple. So it creates a lot of interest and demand. The product itself for cell and gene therapy are generally rare disease, small-patient population. So it's not a major driver of capacity or of revenue per se, but it's also a start for where potentially the drug product is going and how many more we are going to see.

Excellent. So in terms of thinking about that segment and the first quarter performance, and you mentioned that there were some challenges. The margin impact that I think management described and you've talked about in meetings earlier today, had -- some of the competitors were affected by some kind of beneficial items in last year's quarter. And then I think there was an impairment charge taken in this year's quarter. The kind of the one item is this year's quarter is -- I guess what I'm getting at is what should we think about as being normalized margin for that business? And how quickly can it get back there?

Yes. I mean this quarter -- the first quarter of this year was a little bit off because of those onetime items, the impairment. We expect margins in the 30% range, and we still expect that going forward.

Okay. I think we landed the plane just on time. So we'll thank you for your attendance. And Birgit, thank you and look forward to hearing from everybody. Thanks.

Thank you.