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

Thanks, everyone, for coming. My name is Mike Ryskin. I'm on the Bank of America Life Science Tools and Diagnostics team. And I'm pleased to host Charles River Labs for our next session. Joining me is Flavia Pease, EVP and CFO. Flavia, thanks so much for coming.

Thanks for having us, Mike. It's great to be here.

Great. Well we'll jump right in sort of you reported 1Q results just last week, anything you can touch on in terms of the key points you want us to take away from the quarter?

Sure. Yes, we had our first quarter earnings call last week. It was actually a pretty straightforward call. The results were very much in line with what we had expected. So it was straightforward, and we just confirmed guidance for the year as a result of the quarter coming in as we had planned. You saw a little bit of a timing shift between the first quarter and the second quarter, driven by acceleration of some shipments within the RMS sector -- segment, excuse me. And then if you look at the other businesses, DSA, we saw strong proposal volume and better cancellations. So that was encouraging. We're not seeing that yet translate to bookings. So we're cautiously optimistic on that. And then in Manufacturing, we had a really strong quarter with growth above 10%. It was really encouraging to continue to see the performance in CDMO. We got our second commercial product with Vertex approved last year, and that business continues to scale nicely. And then also, we have seen both Biologics Testing and Microbial coming back, which is encouraging. Last year, talked about some of the destocking in Microbial and a little bit of a reset in the Biologics putting some pressure on those businesses, but we saw strong proposals in Biologics in the fourth quarter, and it really translated into strength in the first quarter. And we saw again strong proposals for Biologics in the first quarter. So cautiously optimistic that, that business is set up for a nice recovery this year. So all in all, a strong quarter. We obviously overperformed, but the majority of that was driven by that timing that I talked about.

Okay. Great. That's a good jumping off point. So I'm going to leave the RMS timing aside for a second, but in terms of the fiscal year outlook, like you said you reiterated the guide. But if we look at where 1Q came in, where 2Q guide is, you do assume a pretty steep second half ramp to get to that 0% to 3% organic target. Can you walk us through the bridge there, just sort of how you see things pacing through the year, and what do you need to see happen to hit that second half number?

Sure. And again, as I said, with the first quarter results as well as the guide for the second quarter, really nothing has changed in sort of our first half, second half outlook or the full year for that matter. So what we were planning and expecting in February in terms of demand trends and market, nothing has changed to lead us to update our forecast for the year. We'll take a step back. I think there have been a lot of questions on that ramp. And just to ground this a little bit. Historically, if you look at the last 5 to 6 years, we've always been a stronger second half business if you take last year out of that picture. And on average, that's been sort of 48% on the top line in the first half and about 52% in the second half. So we normally see an acceleration of sales between the first half and the second half of the year. And if you look at the top end of our guidance range, that's what we are planning, right, even with the Q1 results and how we guided to the second quarter. If you do the math, that is sort of the split that you're going to get at the top end of the guidance range, and that's consistent, as I said, with the 4- to 6-year -- excuse me, 5- to 6-year trends. What is a little bit different is the margin. So again, if you look at historically, and you take maybe '23 out of the picture because that was an outlier where the second half was quite slower, that 48%, 52% on the top translates to sort of 45%, 55% on the margin. We are a business that naturally scales, right? We have physical and people capacity that is able to absorb that increase in revenue. And so the margin that you get on that incremental sales tends to be higher. So you normally see that. So that 45%, 55% would be what we normally experience. We are a little bit more weighted in the second half for the guidance at the top this year. And there's a couple of reasons for that. Number one, I talked about we had $60 million to $70 million of restructuring savings that we guided to. I said last week that we're probably closer to the top end of the range. But I've also talked about those programs are going to be fully implemented or onboarded in the second half of the year. So we're going to have a bit more of a benefit from those restructuring savings in the second half compared to the first half. And then the second thing that I would point out is, that scalability that I talked about it's going to happen in all of our businesses, but particularly in the CDMO space, where, for the last couple of years, we had to make some investments retrofitting sites, getting ready for commercial launches, investing in audit readiness, that is a business that is now primed for scalability. So I think it's going to be a larger contributor to that margin improvement that you're going to see in the second half.

Okay. That's all really helpful. Talking again about that second half number and sort of the pacing you've had through the year. I mean, I think a lot of the confidence probably still stems from your backlog, right? You had built up a pretty elevated backlog over the last couple of years. You are starting to draw it down at the same time. So can you give us an update on where that stands? What's the book-to-bill been like? And how you see that playing through the rest of the year?

Sure. The backlog for most of 2023 hovered around 12 months, so for 3 quarters of 2023, that's where we stayed. And in the first quarter of this year, we are at 10 months. So it did come down, but the rate of decline, declined. So sequentially, if you look at how much we draw of the backlog in the first quarter of 2024 that was less than in the fourth quarter of 2023. We've talked about -- I mean, the backlog in the sort of 2021, 2022 years really escalated to a level that we had never seen and candidly never thought would be possible, 15, 17 months. And it's hard because for a client to really know what they're going to be needing or working that far in advance, it operationally is difficult to really happen and to sustain. And so I think what we started seeing is a revert back to a more normalized pre-COVID level. I think before the biotech funding boom, we are experiencing 6 to 9 months. We're now at 10. So that's sufficient to provide us enough outlook to ensure we have enough capacity and gives us flexibility that if things move and slippage happens, we can move things around. So I think we're in a good place where the backlog is. As I've said also, for most of last year and as well as in this first quarter, gross bookings continue to be above 1x. And it's funny because up until the escalation of the cancellations, we never used to talk about net book-to-bill. We just talk about growth, right? Because cancellation and slippage were a normal part of the business, and it was all about, are you getting enough bookings at the top end of your funnel to support the demand and the revenue down the line? We started having to talk about net and gross because the cancellations sort of escalated with that ballooning of the backlog. And so over the last several quarters, we continue to experience gross book-to-bill above 1x, but the net book-to-bill has been below 1x, and it's mostly driven by that elevated cancellation that I talked about. So I think what we're hoping to see from an inflection point is, first, the strength of proposals continuing. The rate of cancellation remaining more normalized, which -- we saw it in Q1, and we saw it in Q3 of last year, but Q4 sort of ticked up again, right? So we had 2 out of the last 3 quarters be in a more normalized level, but 1 wasn't. And so we want to see a few quarters of that pre-COVID level. And then we can go back to just talking about gross bookings and focusing on that. So gross bookings above 1x and was sequentially up and net book-to-bill still below 1x, but also sequentially up.

Okay. So it sounds like you're okay with that net still being a little bit negative, you're okay, drawing down that 10-month backlog. And you think you'll exit the year back in that 6 to 9 range?

Yes. So I think what we said is, if you look at our guidance range, to get to the top end of the guidance, we are expecting that a healthy proposal to continue and to start seeing that healthy proposal translated into bookings. And that will provide support for a modest improvement in the demand in the second half of the year. If things take a little bit longer, if you will, and the net book-to-bill remains below 1x, so in that high-end scenario, the high end -- top end of the guidance range, we see maybe that net book-to-bill getting closer or higher than hovering the 1x. If things take a little bit longer, you're going to see more of a continuation of the current demand environment and maybe just only a slight improvement, that will put us at the kind of bottom end of the range. And the net book-to-bill remaining below 1x. So that's how we're thinking about the guidance and these leading indicators.

Okay. All right. That's real helpful. Maybe that's a good place to transition to just sort of the health of the end market and your customers, both on major pharma and early biotech. Less so with major pharma. There's been some lingering pipeline reorganization, some cautious customer spending as you talked about with the bookings trends. How is this playing out March, April as you're going through the year? And sort of what are your expectations there?

Yes. So I think we saw both small, medium and large clients go through a process of pipeline rationalization, prioritization, maybe driven by slightly different drivers, but kind of leading to the same outcome. Obviously, with biotech funding environment being constrained starting in 2022, that put pressure on the smaller biotechs to really protect their cash burn given the uncertainty that they had in terms of when would that next round be, when can they get a secondary. If they were counting on an IPO, that market was closed for most of 2022 and 2023. So we definitely saw people in the smaller end make their dollars work longer and deprioritize things. For large globals, you didn't see them stop programs that were mid-flight. And so that actually provided some protection, especially on Safety business, given that we have a big portion of our Safety supporting global pharmaceutical companies. And so you still saw some strength in 2023 as they were finishing that. But in terms of new work being booked, you also saw them do some level of pipeline assessment and prioritization. I think, I'm speculating here, but what we hear from them and read is, obviously, they're assessing the impact of the IRA. And does that change their calculus in terms of some programs that maybe make it harder to justify from a return perspective. And then obviously, some of them are having to navigate some large LOEs that are coming down the pike. And that actually can be both positive and challenging for us, right, in the sense that, obviously, with the LOEs, sales is pressured, and there is a need to prioritize investment. But on the other hand, they need to refill that pipeline, right? And so I think they go back to the drawing board. And once they are done with that prioritization, they really need to make sure that they have enough in that pipeline to hopefully replace and support their top line when those LOEs happen. So I think that process is what we experienced starting in 2022 and through 2023. And I think we're hoping that they're mostly done with that.

Okay. And that was going to be my next question, but we'll move on. And then -- so thinking about the biotech funding environment, really strong first quarter, some encouraging signs there. How many quarters do you need to see to; one, gain confidence that this is durable, and this isn't a temporary uptick? And how many quarters until you see some of that money start flowing through?

Yes. I think -- listen, the first quarter was really encouraging, and I think in a way more positive than maybe us and others thought we were going to get to. I mean, it was the fourth strongest quarter in biotech funding history. So that's really nice. And the good news is April also was strong. I do think that the other part of the calculus is interest rates, on the other hand, are not coming down maybe as quick as people were planning or hoping for. I think late last year, there was a bit of a ramp on the biotech space, I think, under the hope or assumption that the Fed was going to be aggressively cutting down rates. And that definitely is not happening maybe at the pace or the clip that people were maybe hoping for. So I think there's a little bit of -- there's optimism and positivity on funding, but there's still a little bit of, okay, when are interest rates going to come down, is inflation really tamed, is the Fed going to take longer? That is still holding people back a little bit. And I think once we see that get better, I think people are going to be even more confident. Going back to your other -- the other part of your question, we already saw an increase in proposals, which is a good sign that people are feeling more confident. We now need to see the increase in bookings following that. And that can take a couple of quarters to happen. Somebody asked me earlier, "Boy, why is it that long? If you're not feeling better about your cash outlook, why wouldn't you just go back roaring and get your studies booked?" It takes some time. People have to relook at the study designs. They have to work with the FDA or whatever regulatory agency and with us to think about how to do that. And then we have to price it. We have to start it. It takes some time to secure the test articles to get the studies back. So it's not a flip of the coin. I feel good, and I'm going to see that booking and revenue. It does take probably a good couple of quarters to see that happen.

Okay. All right. That's helpful. I want to touch on some of the segment-specific results. First, let's go to DSA. Can you talk a little bit about Discovery versus Safety? How that played out in 1Q? How DSA bookings looked?

Yes. So Discovery is still a relatively modest part of the DSA segment, probably around or below the 15% of the overall segment. So it's sort of the DSA goes where Safety goes. Discovery has been pressured longer and more significantly than Safety. We had seen the Discovery slowdown in 2022. So it started, as I said, earlier than Safety and the level of decline is definitely more pronounced in Discovery than in Safety. Also a very different business in the sense that the Discovery work tends to be quicker, both in terms of how quick you can get into the -- into that backlog. The backlog tends to be shorter. Those studies tend to be shorter in nature. Safety is very different from that perspective. We also get some questions, right? I think in the past, people said, "Oh, Discovery is the canary in the coal mine." I think it can be on the down, but not necessarily on the up. And what I mean by that is, one, people still have -- our clients still have quite a bit of infrastructure in the Discovery space vis-a-vis the Safety space. Discovery is only 25%, 30% outsourced, where Safety is 60% outsourced. So when things start to get bad, they can take the work internally much more so in Discovery than Safety, number one. And then when things get better, they can, again, do that work themselves before they start thinking about outsourcing. The second reason is, as people -- as clients sort of prioritize their pipelines, put things on the shelf, chances are that now what they're going to go back to is things that have already been derisked, right, that were in that late-stage discovery, early-stage safety, getting ready for an IND study before they start all the way back into kind of early discovery, right? Those compounds, they have already been discovered, optimized, derisked, so naturally, they're going to focus on that before they go back to really adding to the early stage of their pipeline. So we actually think we'll see Safety come back before we see Discovery.

Okay. That's helpful color. Maybe let's talk about NHPs a little bit. You talked about a benefit from pricing, and price in NHPs overall has been a pretty big debate point over the last year. Remind us like where is price today relative to peak, both for you and for the market as a whole?

Sure. And I have to thank you for like going 22 minutes before you actually asked me an NHP question. So it's good that we're getting back to the more normalized discussion on other strategic things before we talk about NHPs. Pricing in the first quarter, both on what I would call sort of base price as well as NHP in the DSA segment was still modestly positive. So we talked about that last week. There was a lot of talk last year about some channel checks and competitors suggesting some meaningful decline in NHP pricing. And I have been saying that all along. We're not seeing that, we're not planning for that, and part of the reason is because we never -- our prices in terms of NHP, never escalated to what I would call as kind of the spot market. Maybe that happened once the supply from Cambodia especially got disrupted. So NHP price was positive in the first quarter. It's modestly down versus the peak, but again, overall, very stable, I would say. And that's a testament to, I think, the robust and diversified supply chain that we had that was secured and didn't force us to have to, if you will, scramble to get NHPs when things got disrupted.

And do you expect that dynamic to continue for the rest of the year? Or do you see some downside risk to the price maybe...