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

Well, thank you, everyone, for joining us again this morning. This is always one of my most fun presentations and fireside chats of the annual event. My name is Eric Coldwell, the Pharma Services analyst at Baird. Jim Foster, thank you for being here. Charles River, a big, big draw, a lot of interest also Todd in the audience. I couldn't twist his arm to have him come up on stage. But we're going to -- no formal comments. We're going to jump right into Q&A. I'm going to start it off with the [ Zinger ] Jim. You have a Virtual Investor Day next week. Why don't you just tell us what you're going to say then, so we can all go home...

Nice try.

All right. I have to ask a serious question or 2. Big picture without the details, fiscal -- or calendar '24 guidance? Is that on the table for next week? These are the things I'm getting asked from investors. So long-term plan. Is that on the table?

So what we'll do principally next week is give medium-length guidance, not too long, not too short. So reasonable guidance where we think we can get our arms around the time frame. Embedded in that, obviously, is '24 without being terribly explicit. But I think shareholder base will have a real good understanding of what '24 looks like and what's the trajectory ought to be. And then we'll do deep dives into all of our businesses with the folks run.

In the past, medium term, I think, typically meant 3 years?

That's probably the time frame.

Probably, okay.

Yes.

That was easy enough. So it didn't hurt too much. We're going to make it through this. I look forward to next week.

What did you have for breakfast today?

Not enough, obviously. Big picture. Look, we continue to hear of pockets of the R&D ecosystem being pressured. Other areas, we're seeing investment. We're hearing some companies that say things -- everything is great. Some of the clinical CROs sound really good. Not all of them, some of them. It's just such a mixed dynamic in the market right now. I'm curious if you have any latest and greatest thoughts. It's only been a handful of weeks since you reported but what do you think the overall market is going in terms of investment? I mean, what's the big shift occurring now this debate between tools and bioprocessing being weaker or maybe it's not so weak and we're back and forth every day. What's really going on in this ecosystem?

I mean our sort of our universe has a lot of different tools, folks for sure, right? So I mean, so much of what we do is required, both the discovery and development and to get drugs into the clinic. So I think it is a focus these days, get your IND filed. Everybody is in a rush to get the drugs into the clinic, so get your INDs filed, get your drug into the clinic. And obviously try to get it into the marketplace. So we're -- demand has been good for us.

Not in all categories.

It's not. Yes.

So I want to go through the individuals. So if you want to add that in.

So the research model business has been strong. The safety system business has been very strong. The Discovery business because of what I just started to say, has been softer. So I think there's a push to get through preclinical and into the clinic to the detriment of discovery that can't continue for too long, right? Because then you have nothing to get through preclinical. And we've seen this before. So that's slower for sure. We began to see it probably 12, maybe 18 months ago, sort of hesitancy to lockdown stays.. We also have some slowness in our Biologics business, but often the first quarter is slow and usually builds in the back half of the year. And that's probably a slight commentary on the fact that some biotech company. Look, we think that our client base is well financed. We only have 5% of our clients that have less than 2 years of cash. But even those folks, we think are well financed. Why do we say that? If you have a good drug for unmet medical need and you're tight on cash, big pharma probably rides and funds that. I just don't think those companies go under. You probably have a small number of companies that are unfolding, but we had 700 new clients last year. So we think that client base is well financed. The [indiscernible] people in this room probably have a better sense of this than I would. But I mean everybody has a different take on when the capital markets open up again. So if you've done an E round, when can you get public? And if you went public, either prematurely or not, when can you do a secondary. I mean everybody has a different take on that. So I think that phenomenon is causing some of our clients, particularly in Discovery and Biologics to pause. And I do think that changes pretty rapidly when things open up because there's lots of great new -- potential new drugs. There are a bunch of new modalities, particularly cell and gene. And I think some of these companies have had to prioritize their portfolios probably to the detriment of some of the drugs that they like to develop.

Discovery, Biologics testing, maybe some seasonality, certainly, some COVID comps there, but maybe a little bit softer right out of the gate this year. It sounded like 2Q was better there. Anything else in your total portfolio you would highlight? What I'm getting to is what percent of your total revenue base? And if I just take those 2 businesses, we're, give or take, 20% a little over, maybe, but in that ballpark?

Yes. I mean the rest of the portfolio seems more usual, stronger and I do think the Safety Assessment business is normalizing and we had this incredible growth in 2021, '22. Backlog was elongating to 18 to 24 months. It's really good news and bad news. The other good news is that's kind of nice. Bad news is that the clients were booking studies so far in advance that they're booking slots so far in advance that they often didn't have a study associated with that. So we're at about 13-month backlog now, probably normalizing to 9. Kind of 9 is probably a good place to be. Clients don't have to wait too long. We still have some leverage just in terms of getting them to prioritize. I think we have some pricing power as a result of that. And we have a really good sense of at least 2 quarters in the future and perhaps 3. But we don't know exactly where it's going to settle out. It could be higher. I doubt it will be lower.

So historically, let's just jump down to safety specifically within the DSA segment. You have $2.8 billion of backlog today. You're at 13 months, I think you averaged out at 17 months. Historically, you were 7.2%, 7.3% if I look at a 5-year average pre-COVID months of coverage. You historically set a 6- to 9-month range, and you're saying now maybe we should target 9 months. So if I'm at $2.8 billion of backlog, thinking about where revenue is, that means we need to pull out another big chunk from backlog over the next few years.

That's fine. So we always have slippage and cancellations in our business model and so do the drug companies internally, right? Drugs aren't ready on time. They have total formulating them. They're too toxic. They're not effective, whatever, right? And so -- and that -- and so slippage and cancellations are higher because it's really almost impossible to plan on what drug you're going to be working on 18 or 24 months from now. So we're going to see a reduction in slippage and cancellations in sort of -- in tandem with shorter backlog -- not a short backlog, just a shorter backlog I think that's fine.

Yes. Well, for what it's worth, I mean, I'm taking $800 million out of my model for the next year. Everybody's got their own modeling guess and we'll find out what reality is. But I don't think this is a surprise. It's just where -- how does the Street get comfortable because you have the reality that nobody is modeling your backlog actually translating to revenue right? If we had modeled that we would have had 40%, 50%, 60%, 70% growth rates built into our models a couple of years ago, that was never going to happen. So this isn't a surprise or new news. The question is what's so hard for investors to get over the hump on is, just optically, it's hard to buy a company when the book-to-bill is below 1. It takes time to get used to that. So what do you think on this cancellation phasing or process or magnitude? How long does that happen until we get to a juncture whereby that's all behind us and we're at stable awards, not awards each quarter may be moving a little higher eventually. When does that -- do you have a sense on when that can happen?

Yes. I mean a lot of that backlog was booked in '20 and '21. So we're working through that rapidly. And as clients prioritize their pipelines, which they all are, large and small, well-funded and poorly funded, you're going to see a meaningful reduction in cancellations. Slippage is always -- slippage is not a problem. That just means the drug wasn't ready, but any backlog will provide other work to be slided right into that gap. So I think we will be -- we're approaching that time and that should normalize. We always have some percentage of our revenue that slips or cancels and that's fine as long as the backlog is sufficient. I think we're getting to that point.

Well, I hope me taking $800 million out of my model and the next year is conservative, but we'll see. The good news is, historically, you would have done this revenue growth with $1.5 billion, $1.6 billion of revenue. So when things normalize, you don't need backlog. You wouldn't need $2.8 billion of backlog to get there. The other part of this for me and maybe you have another perspective on it, but I think about cancellations of backlog that at least we never model coming to fruition is one thing that's -- for me, that's more optics. What's the gross booking environment look like? Because I assume those awards -- if a client's given you a gross booking today, I assume they actually have work that they're ready to do. This is real backlog. Now they're not reserving space 2 years out because they're worried everybody is going to be getting the best sites and the best CRO. Today, if they're giving you bookings, they actually have work to do is my sense. So what does the gross booking look like? And how quickly is that -- what is the average duration of current gross awards, has to be a lot less than 13 or 17 months.

I think the closer they are to when the study can start, the stronger the work is, right? And everybody is in a rush to get to market. So they line up as quickly as possible. And as I said, I think the sort of 9-month situation. So what we said to all of our clients, particularly over the last couple of years was all of your drugs aren't uncreated equal, they're not all going to be blockbusters. So you get 10 drugs you're working on, picks the 1 or 2 that will have a smallest amount of competition or the greatest revenue opportunity or solving some horrendous unmet medical need and we'll prioritize those for you. I think we've done that really well. Clients are staying with us. We're gaining share and they can plan really well, except if it gets too long. So they have booked slots with no work further out it gets, assuming that they will have work and assuming the last thing they want to hear, the last thing they want to tell their bosses, we just couldn't get a slot at Charles River or anybody else. So this normalization, I think, will be a positive thing for all of us.

All right. Probably your least fun topic and that probably wasn't a ton of fun, but we have to hit on an NHPs.

We don't have to.

Yes. I'm waiting for tomatoes.

So go ahead.

Look, I'll just jump to the -- you know what the conclusion is, what the punchline is. You've done a great job navigating so far a heck of a lot better than I would have ever expected. A lot of heavy lifting, getting sites transferred where certain origins went to other countries, et cetera. But now the market concern is what if another foreign government makes the similar move as the U.S. with concerns over Cambodian imports? Or what about the [indiscernible] meeting in November. I'm just going to leave it open-ended and I just want to get your general thoughts and updates on where we are with the health of this market, the sustainability of it, actionable events are key dates that could be happening over the next few months and quarters.

So the whole subject and the way it broke is sort of bizarre, right? It came out of nowhere. We think with no merit and no pace. And by that, I mean the government is not engaging at all. We've had a couple of conversations, but it's not -- there's nothing progressing. So that's frustrating and annoying and was very concerning at the beginning of the year, for sure. And so the good news is that we've used our international footprint, which is quite large. We've got great facilities all over the world. We have people with lots of experience with very complex toxicology studies in large animals, and we have capacity. And we have friendly governments. And by that, I mean, working with us for permitting and tax breaks for building and hiring staff, and it's quite distinct from what's going on in the U.S., which is unfortunate, but we're really thrilled that we have all of this. So we were able to pivot really quickly. And I will tell you that the places that we're doing it they're inspecting every shipment that comes in, and it's really going well. We delayed no client work. I mean the very, very beginning it was very difficult to give clients an exact time when we can start a study. But as things play that, we're able to accommodate clients. So talk to our clients, they're really pleased with the quality we're getting an NHPs from multiple geographies around the world. So the irony is that there's actually a surplus, which is insane, right? So there's plenty of NHPs. The irony is that we're able to start studies relatively quickly for our clients, and we've demonstrated for them, if nothing else, that because we have some competitors that have one site, we have some competitors that have a couple of sites, we have a dozen in the Safety Assessment business. And so that's really beneficial for the clients. So I thought this thing would be resolved in 2 weeks because, as I said, is without merit and came out of nowhere and I thought this is a mistake. We produced this extraordinary white paper that talked about the necessity of using NHPs to do all of the development work on large molecules. And it was not a debatable proposition. So I figured people would read that and that somebody would call us up and say, "I'm really sorry, we made a mistake here." So we're almost a year into this whatever is going on. I don't even know how to describe it. So we are moving -- we've moved forward. I think if -- not if, I think when this is reversed, when the U.S. government is fine with Cambodian and NHPs coming into the country, by the way, Cambodia is furious at the U.S. So I think if it was allowed, I don't think they would ship them into the U.S. But assuming that, that this whole thing ameliorates, we're not going to pivot back to the U.S. We do a bunch of NHP work in the U.S. with some other sources of supply, it's fine, but the preponderance will be done elsewhere. So it's -- besides being aggravating and all sorts of innuendo that isn't true, I think I'm proud with the way we've managed it. Our clients are thrilled with that, and the work is getting done in a very high-quality fashion.

Where to go with that. Okay. How is the surplus? We talked about for so many years, the shortages, how long it took for animal farms, new breeding facilities to open up, get captive parents, have captive infants, have those raised, build a breeding stock, go through all of these processes. How did we suddenly wind up in surplus.

It's a function of having additional geographies providing the animals and...

So this would be Vietnam back to Mauritius, Philippines.

Yes, a bunch of places. And the animals are basically have the same genetic background and profile, even though they come from different countries.

Other species of macaques, not a transition yet?

No. I mean the whole industry pivoted 30 years ago to these. So all the research, all the papers and all the background data is developed on this species of animals.

I'm doubtful, but I have to ask the update on other large animal models, mini pigs, canines. Any clients moving in that direction?

So a perfect solution would be to produce micro pigs, so very small pigs that are 40 or 50 pounds.

I have a daughter that would probably buy one as a pet, but... .

40 or 50 pounds, use a small amount of drug. They have a cardiovascular system that's probably closest to humans. They're also a great model for a dermatological work and particularly things like skin cancer. There's like 2 small colonies in the world. So it's possible, take 5 years. So nothing could replace the current models immediately.

And even a 40- or 50-pound pig is 10 times, 5 times larger drug volume that would be needed I mean.

So that's -- the drug volume is a big issue.

Okay. What happens to pricing with excess -- with surplus supply?

Look, we price the studies well. By that, I mean the -- so much of our work has become way more complex than it used to be. So we do immunotox, so looking at the effects of the drug on your immune system; or genetic tox, effect on your genome; or ocular tox, effect in your eyes. And that's really complex stuff. Most of our competitors don't do it and even the big drug companies don't. So we price those, and we didn't always. You heard me say for years that I didn't think we've been paid well. But I'd say the last 5 or 6 years, the pricing has been appropriate. We're getting paid well for an NHP study. And then we're just passing along the increment -- crazy increments to our clients. So the way airlines pass along gas prices, right? So I think if and as and when prices come down, I'm not concerned at all about the margin of the studies themselves because there's more to the studies than the animal...

Would the dollars come down though?

Only with regard to the additional pass-through. So you could have a subtle effect on revenue and little or no effect on your operating margins.

Okay. Last one on Discovery. We spend a lot of time here. I do want to hit RMS in particular and also manufacturing. So Discovery, 10% to 15%-ish of your DSA segment. It's been weaker. That was to be expected. I think temporarily discretionary work. You're not going to invest in something that doesn't have a payoff for 10 or 15 years. It will come back in past cycles, and I know it's a different business today, a different client base. But in past cycles, how long did it take? How long was Discovery weakened and how long did it take to come back?

Yes, I still don't think the business is cyclical, but I get your point, the cycle being the factor to say...

Periods -- I call them periods of turbulence or disruption that usually been caused by multivariate equations and it's -- I'd sort of agree that it's not as cyclical. It's just a bunch of...

It's so different than historically. So what you have today that's different is you have thousands more biotech companies, you have less pharma companies at all, most of them outsourcing and you have a bunch of new modalities. So the harsh reality is that if an insufficient amount of money is spent in discovery for any of these companies at some point down the road, they have a problem. And so spending has been fabulous for the last, I don't know, 5, 6, 7 years, pretty evenly based. So as I said earlier, I would think that relatively soon after folks were confident that the capital markets were really open and they could get access to funding that would fund studies that maybe they had shelved or didn't think they would get back to that we'll see investment back in Discovery. We like our Discovery portfolio a lot. We got some good scale, some great science. It's definitely a feeder for the toxicology business and it provides a competitive advantage that most of the competition doesn't have. So we like it. We also like to start as early with the clients as possible.

If I step back in time, generations I think of and I think most people think of Charles River as a research models company, a catalog company, mostly product, a little bit of wraparound service. You've grown your service business portfolio tremendously over the last years. And more recently, the investments in CRADL have been, at least so far, have been very contributory and I think, exciting. Where do products and services stack today in terms of the revenue mix within RMS. It used to be all products...

In RMS?

Yes. I mean is it 50-50 or service...?

It's getting close. So the services are growing disproportionately fast. The margin profile for some of the services is accretive, not all of them. They're international and the sort of services that we're providing. So if you look at the CRADL thing, where we're providing facilities, we have mostly providing the animals and the animal facilities and some people taking care of them. That's hopefully going to evolve that we actually do -- run the studies for them. And this is R&D, which is early, right?

Give a 1 liner just for people who aren't as familiar, give a 1-liner on what you do in CRADL and how much it's grown, how many sites you have?

So we've got, I don't know, close to 40 sites now. We just did an acquisition last year. We thought it was just going to be for small biotech companies when we started this business and we've got big pharma in there as well. So they'll run out of space or they'll decide they don't want to build any more space. So we have long-term contracts with them. So there will be a bunch of animal runs. We'll do some of the work on the study. The goal, as I started to say, was to do the studies for them even better than that, that CRADL stuff eventually will move into Discovery and Safety. So on a see-through basis, it's a very important activity to engage with clients really, really early. So we're in there with PIs who are doing basic research, close to where the companies are, and most of them can't afford to build their own vivarium. So becoming a nice business, nice margins, pretty good growth rates, and we've got them. So far, we have facilities pretty much in all of the major biohubs.

So you saw where I was going with the question that services used to be a tiny piece and a very successful catalog business where pricing went up globally, maybe not every country, but globally, realized pricing went up every year for as long as I can remember in models. Over time, products come down, services go up, we naturally think margin erosion. We're not seeing it. And CRADL is growing so quickly. Is that still dilutive to overall RMS margin but getting better? Or is -- can you give us a sense?

Portion of CRADL is dilutive and a portion of its accretive. It's probably neutral to margins right now, I think has the potential to be accretive.

So when the facilities mature in full, it's accretive?

Yes. And the scale of the facilities or -- so we've got high growth there. We have high growth with making genetically engineered models. We've got a really good mix with really specialty models like diabetic animals and immunocompromised animals and we have always and will always get price in that business. So RMS feels really solid. I should just stop there.

So it feels really solid. Overall, the markets got a lot of moving pieces and a lot of uncertainty and debate out there about how big pharma is responding to the economy, to labor, to inflation, to an inflation reduction act and everything else under the sun, biotech funding on the other side of the equation. What does history tell you about the stability of models, the product piece of models in environments like this, not cycles, as you say, but challenging periods.

A fair number of those models are going to academic and government institutions. A fair number of them are going to CROs, ourselves and even competitors. And I think the basic models are essential building blocks for pure discovery and tox. So they'll always be a necessity, and they're getting increasingly sophisticated. So that's why I mean when I said solidity of that business.

Manufacturing in our last 2 minutes, speed round here, CDMO?

Yes. CDMO business is in a much better place than it was last year. That's an easy comp. We have one commercial client that we're actually producing a gene-modified cell therapy product for that client. We have several clients that are in the process, hopefully, moving from clinical to commercial. They finished Phase III. They're close to filing. We've had regulatory agencies into our facilities. We have some -- most of our clients that are making that transition and talking to us about take-or-pay contracts. So they're going to rent facilities, whether they're doing work in them or not. Client base is growing nicely, lots of small companies, but also some household names. And so it's a very -- it's a different business than so much of what we've done in CDMO business. So it's a nice niche, and it's very closely related to biologics. It's very closely related to safety. It's very closely related to Discovery. So on a portfolio basis, on a pull-through basis, it's a very impactful business. Of course, we got into it because we were doing all the testing for those drugs anyway. And the client said, "Well, you're doing the testing, can't you make the drug for us."

So you go from a sliver -- a focus on a sliver of the cell and gene therapy market on more of the research side, the pre-commercial support side. Now you have a commercial client. We had a large CDMO in the audience this morning a couple of hours ago. They have one gene therapy client that's running around 10% of the revenue and the Street's spending all of their time thinking about one commercial product they just launched. Does your revenue stream go from $150 million to $1 billion in 2 years with a bunch of commercial launches? I mean, what happens here on the commercial side? Because that is a potentially a big shift over time in terms of your revenue mix?

That would be a high class problem.

It would. And I'm being a bit I extreme.

I think it grows much more slowly -- it will grow nicely, but it'll grow much slower than that. What's the dosage, how much will clients pay for these products, what's their efficacy. I mean I think there are a lot of questions associated with selling gene which is why you only have 20 drugs approved, but it's a really important modality. So I think we'll be able to manage the growth in a measured fashion. Having said that, we figured this business would grow around 20%. So it should be accretive to manufacturing.

And it's working now.

It is.

Okay. Why don't we wrap up with that?

Great. Always a pleasure.

Thank you so much. Everyone, please join me in thanking Jim and I'm going to do quick round of intros. We have coming up in a few minutes. We have DexCom, AMN Healthcare, REGENXBIO and Solaris. Thank you very much. Thank you, everyone, for joining us again this morning.