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

Good morning, everybody. My name is Luke Sergott. I cover Life Science Tools and Diagnostics here at Barclays. With me, I have Birgit Girshick, COO of Charles River. Thank you for making it down.

Thank you, Luke.

I think it is our first time in Miami, not the last, I hope. So let's talk about the topic do jour on the biotech funding side. It feels like a lot of the funding raises that have been going on, they're likely going to go more towards the trial work or the late stage for Phase II or III. So give us a sense of your conversations with the customer base. How that's progressing and just the general change in tone, if there is any?

Sure. Happy to. So first of all, we are certainly really, really pleased to see the uptick in biotech funding and IPOs that we've seen over the last couple of months, something long awaited in the last 2 years. And -- so we actually just been with the team of our employees at SoT, which is our primary toxicology conference. And so it's really fresh. It's really from this week. And what we are seeing there is there is a positive vibe. There's literally a little bit of a buzz going on of clients coming in, being excited about their future programs, talking about programs they have in the pipeline and things that they may start working on in the future. Now that said, we all know that this is early. We only have 2 months. We're cautiously optimistic, and we know that it will take a little time for the demand to trickle down, probably through the clinic into preclinical into toxicology work. And then from -- in my perspective, from my assumption lead to discovery later on. Clients need to get the funding, they need to reach the budgets, they need to send us proposals, we pick their programs. So I'm optimistic that we will see the demand coming up, but I'm also cautious giving you a time line as this generally takes a little time. That said, we're not going to wait for that. We actually have a lot of activities going on, including at SoT right now, where we are pushing market share. We have reorganized our go-to-market organization. We have new tools and platforms in place that will help us -- and we have done a lot of work from an operational perspective to be more efficient, more responsive, faster proposals. So that will help us in the meantime. But it's actually a good time to come to a conference with some positive news here.

Yes. So it feels like good vibes right now. That's about it. And then we'll wait to see how that plays out. So you're kind of thinking about the timing there from the businesses that -- the various businesses you guys have, like walk us through, which is -- how you see the recovery playing out for them sequentially or however that should be?

Yes. So in our earnings call earlier in February, we have talked about our guidance being 0% to 3% organic revenue growth. I believe this is still a good number with top end expecting some demand acceleration in the bottom line and I think it is looking for some stabilization. We are looking at the different business lines. So if you look at our RMS business, we have several of our services ramping up in the second half of the year, CRADL being one of them that we will open a few more cradle locations. For the people who don't know CRADL, CRADL is our vivarium offering. So we're offering space and services for clients that don't have their own vivariums or need extra space. Looking at our manufacturing division, we're really seeing some activity there. So our CDMO business has actually a pretty strong 2023. We continue to see growth in 2024. We have quite a bit of interactions about new programs, and we believe that will translate into double-digit growth going forward. Our biological testing business as part of manufacturing. Here, we're seeing quite a bit of proposal uptick in the early 2024. Obviously, [ they need to be won ] and then the work started, but that is a great indicator of demand coming back. And what biologics testing is doing is early analytical work as well as commercial and clinical lot release. So it tells me 2 things. Early work is coming back, but then also clinical work is ticking up. So that's a good indicator. Our microbial business, again, another business in the manufacturing division. Here, we had a little bit of an impact -- negative impact over the last year or 2 from clients having a lot of inventory. So throughout COVID, you know that every company trying to build inventory of necessary reagents and tools so that if there is a shortage, they're protected. Our clients did that too. And then after COVID, their organization said, so now let's get inventories back down, we saw quite a few clients who didn't order [ from us ] nothing last year. So we just [indiscernible] exercise is actually seemingly over. So we see quite a few clients coming back, reordering reagents. And so with that, we will see an uptick. Our DSA division here is where we need to see what's going to happen now with increased demand. Positive indicators, but we want to see a little bit more of an uptick on demand. SoT conference was good to get some feedback. We had a lot of discussions about future work. So as I said, a positive buzz is there and that should hopefully translate into some work, timing to be determined.

On the DSA side, so you talked -- you guys have had elevated cancellations, kind of what's going on and how much of this is due to large pharma versus the biotech environment. Just give us a lay of the land there, and we'll continue to dig on that.

Yes, happy to. So if you -- cancellations is a normal part of running a drug development, particularly in toxicology business because our clients are booking out ahead, booking out slots for programs that they believe they will run. Then in between, they will get some data, they need to maybe run a study in between. They need to push something, they need to shift something or they get data and they're like, yes, no, that's not going to work. We're going to deprioritize or cancel a program. So we are dealing with cancellations every month, every quarter of every given year. What we have seen in 2023 -- start of 2022, 2023, in particular, was an elevated level of cancellations. And the primary reason, in my opinion, was that backlogs throughout COVID had elongated to 18 months. And if you think about 18 months as an eternity in getting data, knowing what programs to start. So clients just book the slot, maybe booked 3 slots, knew they run 2, maybe 3 programs. And the quality of the backlog was probably not as high as we would normally see. Our backlog has come down. We're now an average of 12 months. With that, I believe that the quality of the backlog is much, much better what we have seen in prior periods. So -- and with that cancellation automatically will be quite reduced. We certainly saw some cancellations and clients told us that it's program reprioritizations because of tight budgets. So we have seen that as well. And hopefully, that at least psychological effect of more biotech funding will help for that too. We -- and then certainly, there's a little bit of a seasonal impact you get into Q4, you have a budget, you run something, you don't have a budget, you don't. So in Q4, we saw a little bit of another elevation of cancellations. But we are pretty confident that over time, we will see that going away and being more on the moderate level because of the quality of the backlog and seeing a little bit more funding, the confidence our clients have. And that will help us to get our book-to-bill for net across above 1, which will help us to have healthy growth.

All right. And then so simplistically, as I think about it, it's like these biotechs that have been cash draft, and it's finally like, okay, we're holding on, holding on financing, now, we got to cut it. And then on the large pharma side, it's this pipeline rationalization or prioritization. Where are you seeing -- is there an indication or is it like a type of pharma? Like give us a little bit deeper dive in...

So actually, there was no trend. It was smaller launch customers. It was all modalities. It was all therapeutic areas. So it was really across the board. And small companies versus large companies might have different reasons. But as you just pointed out, I'm concerned about my funding and I'm in pharma, I'm concerned about FDA Modernization Act or some other reason that I need to improve my bottom line for the next quarter or 2. So we have seen it across the board, which also speaks a little bit to the elongation of backlog was the primary reason for that. Hope that makes sense.

Yes, it does. And so from a cancellation perspective, we said you started to see it in '22 and all the way through '23. But does it feel like it's accelerating, and we're kind of at that last moment where it's just all right, well, it's going to be at this level for a little bit or maybe a little bit worse, but that's going to be kind of flushing out the rest of that shaft. Is that kind of what you feel like?

So we're hopeful that we -- it's early in the year, but we are very hopeful that the cancellation rates have moderated and that the older programs, the budget decisions has been made and that we can move forward. I can't say for sure that, that's 100% true. But certainly, trend wise, it feels right.

Yes. And from the overall discovery and staying on discovery, obviously, in the large pharma tightening their belt. And how much of it is them taking fewer shots on goal. So instead of taking 1,000 drugs into high throughput screening or doing 500? Or are they cutting the number of actual projects? Like walk through what's actually going through there? And then the follow-up is how long do you think that this can happen within the overall drug development pipeline before it starts impacting Phase I, Phase II, Phase III?

Yes. It's a good question and maybe a question for our pharma clients. From what we are seeing is that the pharma companies have taken a real good review of their pipelines and have said, what gives us returns in the future. So it's a hard look at the financial return. What space do I want to be in? What therapeutic area do I want to invest in? Do I want to do cell in gene therapy? Do I not? So every company has pivoted a little bit differently. So I don't think there is 1 good answer. And then they make decisions of what do I want to outsource versus keeping in-house? What is most cost efficient for me? And that's what we're seeing. So it's a little bit of a mixed bag. We had a really good year with pharma last year. And despite all of the discussions and the noise in the system, and we'll have to see what happens this year. So it could -- so cutting cost can be a tailwind or a headwind for us. So we never quite know that because sometimes it just leads to more outsourcing. And sometimes, it just is a cutover program. And so we generally see both sides of that coin with our clients.

Yes, that makes sense. You talked about CRADL earlier. I'd like to dig in here, this has been kind of like a surprising success for you guys, I would say. Talk about the impact that you've seen from laboratory capacity expansions, the biotech funding. There's like a lot of puts and takes. So walk us through what those dynamics look like? And just really what your outlook for CRADL is as a stand-alone service for you guys?

Yes, happy to. I actually really like this business because, we deal with a lot of very small early-stage companies who work with us in our CRADL spaces. And that allows us to build a relationship and pull them through to other services to discovery service and safety services. So what we have done about 5 years ago, we opened our first CRADL, which again is mostly the barium space in biohub. We have a little bit of lab space in there, but that is minor. So it's mostly the vivarium space. And the concept is that it should be attractive and it is to early-stage companies that don't have their own vivariums, wanted to [indiscernible] milestone if they invest in their own facilities even invest in outsourcing more complex [indiscernible] companies like us or others. I want to walk over from such in Cambridge from their office to a vivarium where they can do a little work. They get the space. They get services. They get some staff. So it's a really quick and easy way, and a very flexible way to get your work started, get your company started, to get sort of first milestone, have enough data to get funding. That said, we also have some larger companies in there who use this as either outsourcing space or some -- even their primary vivarium space. But the conceptual thing was, let's get biotech started. We do not see the empty capacity that some of the lab space companies are seeing. Number one, it's the vivarium space, it's different, but we also add expertise and staffing to it. So it's a little bit of a different concept than just here's an empty laboratory, put your own equipment in it and hire your staff, particularly in a time where funding is maybe tough, some clients are actually saying this is a good way for me to start. We did see a little bit of an impact from biotech funding. So some companies had to leave, a couple who wanted to come in, didn't come in. But overall, we're still happy with the growth rates, and we think that will accelerate again. We are now at 30 locations. It's a driver for RMS for growth, and we're really happy to have it. And as I said, it's a nice way of starting a relationship with our clients. And pulling them through to other services.

Yes, it reminds me, we were talking earlier about the work I did at Penn, but we had -- there was basically a lot of those university labs. Is that really what you're gaining share from? Is that the infrastructure wasn't there to begin with. So where were they getting that work? And how much of this is greenfield versus overall share gain from universities?

So there's probably a little bit from universities, but those are more independent founders, owners that want to get started, have a little bit of venture capital backing. Beforehand, they had to invest their $5 million, $10 million initial investment into the vivarium space. So -- and now they have a better option. So it's a little bit of a mixed bag. We don't consider it share gain from universities, just consider giving another alternative.

That makes sense. I told you we wouldn't talk much about it. I got to ask about the NHPs. So talk about the pricing that's going on. You're hearing some noise from competitors as you called it. So walk us through why it's not going to be as big of a headwind for you guys as it might be for others?

Yes. So let me start. We actually, in our earnings call, provided a number that we're actually expecting a positive pricing impact from NHPs between $15 million and [ $35 ] million. And that is half of what we experienced 2 years before. We had provided that number earlier. And so in a way, it is a headwind, but it's still a positive headwind -- positive headwinds. It's still a positive for us. The reason why we don't expect a negative impact from NHPs is that when the peak pricing went to what you heard in the industry of $40,000 to $50,000, I heard that from our competitors. Those were numbers where companies had to buy on the open market with our long-term relationships and then pass on the pricing. We have long-term relationships with our suppliers, and we have long-term relationships with our clients, and we never went to those levels of pricing. There is a ton of other information floating around. And I just want to just caution everybody because they're not apples-to-apples, right? So prices from suppliers, prices from companies that sell within the U.S. to others, there's always cost that has to be added on. So there's a share amount of noise out there that doesn't seem to make sense. But I do believe that even our competitors at this point are pretty said that pricing won't come down, particularly if demand picks up and there's going to be just demand -- demand and supply. That will drive that again.

Got you. And that's good segue into Noveprim. And so as that business folds in and the intercompany sales, just walk us through the different dynamics there from -- is there additional operating leverage that you can get now that it's wholly owned or just give...

Yes. So we acquired a majority stake of Noveprim, which is a Mauritius based breeding farm. We had a long-term relationship or have a long-term relationship with them for many, many, many years. And we actually had a minority stake before. So short term, from a perspective of animals put on study, how it impacts our DSA, there's actually no change because we're going to use the same amount of animals. There will be intercompany transactions. So this all flushes out into basically no impact from that perspective. We are, as part of the acquisition [indiscernible], we will obviously honor those. And those supply contracts are going through our RMS division. And what we had said that is I will add some revenue in the second -- mostly second half of the year. They're stronger because of gestation periods in the second half of the year, $40 million to $50 million and some margin improvement here for our RMS division.

All right. So it's basically all on the RMS side and the DSAs is not impacted at all. All right. That's fair. I want to go back to the DSA segment in the last couple of minutes here and talk about -- so the $2.4 billion that you guys have in backlog, walk us through like how the cancellation -- like you were talking about earlier about the cancellations coming out, like how much more of that do you think is likely to be adjusted, if at all, and then with your book-to-bill running under 1, how -- what do you guys have implied for the guide on the book-to-bill for you to hit your DSA guide for the year?

Yes. So I'll [indiscernible] as you stated, is down to $150 million. We're now at a 12 months average, which we think is a healthy backlog, both for us as well as our clients. So we actually have a good quality backlog and our clients have an ability to place studies, and without -- hopefully cancellations will be moderated. At the end of last year, our gross book-to-bill was above 1. And with cancellations coming down, we're pretty certain that our net gross to bill can be above 1 and support healthy growth. So we have guided to a low to mid-single-digit decline in H1 and a mid- to high single-digit growth in H2, which gives us that 0% to 3% revenue growth for the full year. At the high end, we're obviously expecting some demand in the low end, some stabilization, which talks to the cancellations.

Yes, and kind of normalizes on your back, on your book-to-bill. All right. That's great. And then lastly here, I kind of want to talk about the China side of the business. It's only 15% of RMS. But what's the risk here from the Biosecurity Act or any of other types of modes. And then what you're actually seeing on the China side from the Discovery market [indiscernible] they're dealing with their own funding issues as well?

Right. Let me start with that. So yes, the -- our China business is mostly research models for China. So we produce in China for China organization, and it's 15% of our RMS revenue, only 4% of total Charles River revenue. We're still seeing growth even though there was a little bit of softness there, but we continue to see growth going forward. I think it's an important market for us. As far as the Biosecurity Act, obviously, we would -- everything else, you have to see what happened with that. If it gets passed or not, the majority of work done in China as far as I know, as manufacturing, which we're a really small player in, Discovery, which could move to other players in China or to India or to us, hard to tell. And then there's a little bit of toxicology work that certainly we could work on, but it's way too early for me to tell. We have to see what will be passed, how it will be passed, what [indiscernible] detailed.

What about on domestically the share gain opportunity that you could get from Fuji and some of the other players?

When you say domestically, in China?

No, I mean like in the U.S. [indiscernible] allowing?

Yes, it needs to be seen. We'll have to see what happens if the bill actually passes. And then in what time frame, so it seems impossible that you can cut off in...

Alright, thank you.

Thank you.