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

And joining us for our next session is Charles River Labs. Thanks so much. We're joined by Birgit Girshick. Format will be a fireside chat, but we're happy to open it up to questions in the end. Just raise your hand, and we'll call over a mic to you. So Birgit, maybe just to kick things off, you recently reported 1Q results. It was an eventful quarter, a lot of updates. Maybe you could just high level talk us through the key points, and then we'll dive into them.

Certainly, happy to. And thanks, Mike, for having me here today. Much appreciated for the invitation. So yes, we have, just a week ago, updated on our quarter, which was, I would say, an interesting quarter for us. First of all, on a positive news, we were very happy to see that we outperformed our previous outlook. So we came in slightly better than we had anticipated from a revenue perspective. This was primarily driven by our DSA division. We have seen net book-to-bill above 1 in the first time in 2 years, which was really good. It's a really good indicator. And that was primarily driven by an increase in bookings in the first quarter and a moderation of cancellations, which we actually have seen now for multiple quarters. This allowed us to improve our guidance for the remainder of the year. So we improved our revenue outlook by 1% to minus 4.5% to minus 2.5%. And we improved our outlook for EPS by $0.20 to $9.30 to $9.80 really reflecting the first quarter improvement in our guidance. We are continuing to take a cautious outlook and because of the complex environment, but also that we are, at this point, only seeing 1 quarter and we'll see how the rest of the year will shape up for them. We also spent considerable amount of time educating and updating on the FDA announcement that happened about three weeks ago now, where the announcement stated that the FDA is seeking to reduce animal testing over the next few years. And as we stated in our earnings release, this is actually something that Charles River has been extremely committed to has done a lot of investments over the last years and sizes as part of our business model and mission. And we certainly can talk more about that. I'm sure you have some questions about that. Yes, interesting quarter and -- but I think a pretty positive outlook.

Okay. Great. That's a good place to start. And yes, I want to touch on both of the topics you spent time on. But first, maybe let's go into the results, the DSA component, you talked about the increase in bookings, moderation of cancellations. You talked about some of the trials and some of the types of bookings that you saw. Could you talk about what you saw between maybe biotech and pharma, where you've seen some of the moderation of cancellations? Just sort of how that played out through the quarter and how that impacts your thinking on DSA bookings and revenues for the rest of the year?

Yes, certainly. So as I said, net book-to-bill above 11th time in 2 years, long awaited for, happy to see it. Our bookings were up 20% year-over-year in sequential. The bookings mostly led by our global biopharma clients, and a lot of the bookings we have been seeing actually short term in nature, meaning their work getting into Q1 and into Q2. So having capacity available that our assurance that we had staff available worked out for us in this particular case very, very well. Global Biopharma, even so the bookings were up, were declining for us in Q1. And the reason for this is that the decline for global pharma for us didn't come until H2 of 2024. So we have not really seen an anniversary of global biopharma demand yet for us. Our mid-tier or biotech clients, we saw an increase in revenue in Q1. We have seen that now for multiple quarters, which probably reflects the slight improvement in funding and environment they have been seeing last year where many of our clients have some money to spend and move their programs forward. So definitely quite positive seeing that. We also saw a little bit of a mix benefit in our DSA organization, which helped us with Q1 as well. I want to reiterate that some of the short-term bookings we're really seeing for H2. Clients have not indicated a general change in their outlook and their demands. So we are very cautious about H2, and that's how our guidance of a slight improvement in our guidance came about, and we will be watching that going forward.

Just talking about some of those bookings, you talked about it being shorter term in nature. I would make some programs shorter in term in nature? Is it the type of -- the type of work you do? Is it indication based? Is it customer based?

Yes. So what I mean with that really is that they started relatively quickly. So normally, we see clients looking out multiple months ahead of time, planning out their studies. And the longer that goes, the more cancellations, you will see again because things change in their prioritization or in their data, what we are seeing in Q1 was really a bunch of quick study starts, which helped, obviously, H1 for us and -- but also shows that clients are continuing to work on their programs. And to me, it indicates that pharma has probably, for the most part, done their work on what programs they move forward, where they're prioritizing their work, what R&D they are doing. And so it's good to see likely coming out of their budget approvals early in the year ready to do some work.

And right now, you have capacities. That's why those sort of study started, you were able to slot in right away or relatively. All right. I want to move to the other point you touched on the NAMs, the FDA policy announcement from a couple of weeks ago, obviously set the stock down pretty meaningfully. Can you take us through sort of your interpretation of what that policy calls for because it was a wide-ranging statement that covered a lot of different things.

Yes.I'm very happy to. So yes, let me start with -- so the FDA, the Commissioner announced more of a press release type of we are going to reduce or eliminate animal testing the FDA will have new guidelines. And so if you really look at it, it's -- names is kind of a continuation of the work that has previously been done. So the evolution of NIM is not really new. So if you think about the work we have done in our -- we and the industry have done over the last decades, the -- we used to talk about 3 Rs. So thinking about just our outbred rodent sales utilization over the last 10 years has reduced by half over -- from where we were a decade ago, while Charles River's revenue has increased. So just to indicate that reduction of animal studies, finding other solutions, other in vitro and silico models and technologies has been an ongoing initiative for the industry and for Charles River. Charles River launched a formalization of its program last year. We call it AMAP. We press released that I think about a year ago, and we have stated that we had invested roughly $200 million and plan to invest, continue to invest about the same or more over the next 5 years. Things that we have done to drive names, new approach methods or new alternative methods forward are things like in M&A, we have acquired an organization like called Retrogenix, which is a cell-based off-target screening technology, but we also have done a bunch of partnerships with companies that are squarely in names development space as well as in AI, where we use data to provide a better target and maybe less of a fallout in preclinical. So we did the partnership with Valo, which is an AI-based discovery platform. where we're really driving forward with them better targets and better compounds and with that pure animal studies. So as you can see, Charles River has been part of this initiative and we will continue to be part of that initiative. We also announced last week that in the strict definition of NAMs, our revenues are now about $200 million a year. That will increase as new technologies become available, and we are uniquely positioned to implement the technologies or support the validation of those technology or innovate on those technologies. From a time line perspective, the FDA has specifically mentioned maps, which makes complete sense because they are much more defined targets and molecules and lower toxicity. And they specifically mentioned chronic studies. Many of our clients have already gotten waivers for chronic studies when applicable. So there is a process that the FDA has where they can apply for that. We believe that will continue and maybe accelerated that. And for us, we sized about -- so maps, the chronic studies for us is about 15 million. we believe that not all of that will be going away, but maybe some of it over the next few years. And it's -- to us, this is actually a really good pilot study for the FDA to take on. Other areas like small molecules and cell and gene therapy. NAES technologies will be a little bit part of the get-to. There's a lot more to consider. But as those technologies become available, we will certainly help validate and implement them but the time lines will be driven by patient safety and science. So -- and again, we applaud the FDA for making this announcement, and we have and will continue to work with the FDA and on some other regulatory agencies to see where we can implement them and how we can support the industry doing that.

Okay. That's really helpful. And let me just focus on a couple of things you called out. One is on the implementation plan from that press release announcement I mean it's not like this is all being enacted today. It was sort of an initial shot. There's a comment period. There's going to be a trial initiative later this year. So this is still realistically years away from being broadly implemented and possibly a decade away, right? This is not -- nothing is going to happen on this in 2025. Very likely, very little where nothing will happen in 2026. So we're talking years down the line.

Yes, I see it more as a continuum of what we have done before. So as I said, the Animal testing has been considerably reduced from what we have done a decade ago. And the focus on them is a good thing, and maybe we find some new technologies quicker. But as you said, it will take a long time, and we will be a part of it.

Yes. And -- yes, and then the other point is on what the NAMs are in terms of organoids, organs on the chip. AI, some of these technologies on around for 10, 20 years, and they're not fully ready yet, right? They can be using select cases, but it's not like that uniquely be swapped out. So sounds like the industry has been working on this. We cover a lot of the other companies that are that are in this space as well. And if the end go is patient safety, you can't sum this in and now it's going to require more investment.

Yes. In the short term, we actually potentially will see some upside from hybrid studies. Where those names need to be run alongside the animal studies. So we'll see how this works out for us.

All right. Great. I want to just pivot on some of the other business segments real quick. One is I want to talk about the manufacturing business and particularly CMO. Just can you give us an update on how that played out in the first quarter, your expectations for the rest of the year?

Yes, certainly. So we had announced that our we have a decline in revenue because of some commercial clients that one of our commercial clients that refocus their supply chain, and we will not be doing any work in the future for them. and then another commercial client where the revenues will be lower. So there's 500 basis points impact on our manufacturing division because of this in Q1 and for the full year. But overall, we are seeing -- we have a pretty good pipeline of interest and new entrants into the business. It will take a little time to rebuild that. Our focus for this business for the last few years has been heavily taking the CDMO from an early clinical CDMO into a commercial CDMO, which is a heavy lift and quite complex. And -- but I'm very happy where we are today. We have really good leadership as well as have made real good progress over the last couple of years, particularly in the last year, I'm seeing a lot of improvements. So going forward, I do believe that this CDMO is positioned for growth and is positioned for getting new clients from clinic into commercial. Also good to say that our gene therapy part of the CDMO has been growing. And so showing that even so the market demand is a little less than we anticipated a couple of years ago, the interest in our services is there and is robust, and I'm sure we can rebuild that.

I was going to touch on cell and gene therapy next. What does the funnel look like there? You just mentioned it's growing. Is that from existing customers? Is that from projects progressing through the clinical trial phases? Or is that new programs adding on?

Yes. So we are -- in our gene therapy, it's a lot of new clients coming in, looking for clinical and later on commercial manufacturing of the of gene therapies for us. So we have three centers of excellence. We have a plasmid CDMO in Europe, and we have a bio vector CDMO in the U.S. and then our cell therapy, which is the larger part in the U.S. And so we are seeing a lot of clients come in looking for a future -- current and future manufacturing opportunities. For cell therapy, our growth historically, it was mostly with existing clients, we are now rebuilding that pipeline, and we see good interest of new clients coming in that are looking for a CDMO that does have capability, taking a program from clinical into commercial. And I think we are positioning ourselves well for that.

Okay. Any questions in the audience? Let's talk about RMS a little bit. We touched on it already briefly talking about the NAND situation. But can you talk about what you're seeing in terms of pricing in terms of -- I'll start with pricing.

Yes. So our RMS division, as you know, historically, and that will continue that the use of animals will be reduced. We have seen that for many years. But in this division specifically, we have always been able to get price to offset the decline of volumes in that space. We also have a positive mix here. So the animals that we are selling become increasingly complex, so genetically engineered models or humanized models. So there's a lot of innovation and R&D going into that. What is the best model for our client studies, what can we offer, where do we offer it, and with that, we have seen quite good price/mix uptake. And then also, we have been able to maintain or increase our market share in that, in RMS. Because of the services we offer, but also because of the efficiencies and client centricity we offer our RMS organization is heavy into e-commerce and things like that and make it really easy for our clients to order and receive the animals and get background diet and things like that. So happy where we are with RMS.

This segment is also where you've got a little bit more exposure to academic and government, NIH, things like that. How much of that policy headwind have you factored into your outlook? And sort of how does that materialize as the year progressed?

Yes. So our academic and government, the North American academic and government should specify that is about 20% of RMS. So not insignificant, but for our overall company. Not really huge. At this stage, our government, academic and government has -- actually, we've seen growth in Q1. So short term, we have seen no impact from NIH cuts or from academic research grants being cut. We certainly talk to our clients quite a bit, and there's a lot of uncertainty there and grants that may be cut by later in the year. So we're taking a cautious outlook, and that's part of our outlook that we factored in that there will be some impact in pockets. I think we're still working through what that means. One of the items to consider is that animal purchases are actually direct cost. So for our academic clients, it might be more beneficial buying animals than breeding animals internally. But we're working through those kind of variables. It's I think too -- a little bit too fresh for our academic clients from leadership down to the researcher who actually orders the animals. Unclear what grants will stay what will go, and then NIH is still working through exactly where they're finding their cost cuts that they are required to make.

Are you seeing any difference here in terms of orders versus revenues? If there's a lag here where the strength you saw in 1Q was just sort of people finishing up studies that have already been planned?

No, not really. So our research models orders are relatively short term, right? So in large cases, they actually come in Friday, for Monday shipment. Even so we know what we can actually plan ahead because we know what their outlook is. From an NIH perspective, a lot of the work we do directly our in-sourcing contracts where we manage something Colony for the NIH, so we would have long-term discussions about changes that are there. And we're in the middle of discussions to see how this works out for us and for them. So where we can help them to cut cost without cutting scientific capabilities. But so far, we have not seen an immediate impact.

I also want to touch on the NHP situation. Again, there was a lot of noise earlier this year following that site's proposal to restrict an H3 trade from Cambodia, then it was sort of delayed, put on hold, Sort of what's the way as you've heard on that? And how should we think about the odds of that being implemented and the impact that would have?

Yes. Mike, I said, I get away with no energy questions today. Certainly. So just -- just -- I don't know if everybody has the same information. So Citi is the organization that governs kind of the permits of animals coming in but going -- exporting and importing into various countries and NHPs are part of that permitting process. And earlier this year, there was a recommendation to the CITES Staining Committee of suspending trade for Cambodia, which came kind of to a surprise to some of the governing countries even. In February, the meeting happened, the recommendation was not to do the suspension but there is some follow-up work to be done, which we know that the Cambodian government and CITES is working through that process. And so we'll need to see what happens, but I'm pretty confident we can work through this and hopefully mitigate any kind of impact there. As you know, Charles River has diversified supply over the years. We continue to diversify supply as much as we can. So if something would happen, we try to mitigate the impact as much as we can. But -- so at this point, we don't see anything happening in 2025 and certainly confident somewhat confident that we can work through this with the CITES Committee or Cambodia can work through that with the CITES Committee and not have any impact going forward. In the meantime, we're looking at supply chains and things. On the supply chain front, how much of your NHP supply still comes from Cambodia? Don't know if we have given that percentage. So it might have been in our NHP report that we're actually publishing every year. So we still have a considerable percentage. So I think it's less than 30%, but don't quote me if that's not quite the accurate number right now. But we have diversified into Mauritius and we have done an acquisition of one of the farms there. and we are working to increase the capacity and we'll have more supply coming from the Mauritius farms after 2026. So there's a lot of effort of diversifying and increasing supply from other areas.

In terms of building up that supply externally, how long does that take? How quickly will you be able to pay that if this does come to pass to build up some of those other supplier else?

Yes. I mean there are multiple strategies that can be applied. One is moving our clients with a different background of the animals like the Mauritius animals. Some of it is the location of the studies we can do. And then also, what's the impair the imports that we be able to do this year versus next year. So we have not completely worked through there. If Cambodia would not happen, there would be some impact on the industry but we're working through that right now.

Okay. I want to make sure we touch on margins and cost savings real quick. Can you give us an update on the cumulative cost savings you announced, I think you could say $175 million of that to be realized this year, where in particular are you finding the most opportunities?

Yes. So it's down 175 million annualized this year and then 225 million annualized in 2026. So we are increasing -- we continue to work on cost savings and efficiencies in the organization. And the areas that we're working on, obviously, there was some staff reduction because of the volumes, but there's also some efficiencies in G&A and other areas that don't need to be rehired. So there's about $75 million of the cost saving that we don't believe need to be rehired if volumes come up. Other areas that we have focused on is site consolidation. We announced in the process of consolidating 20 of our smaller sites, that will give us some cost savings between this year and then going to next year. And then we are looking at other areas for automation and more holdbacks and certain things like that. Our digital investments are delivering cost savings as we speak now, and that will increase to going over into next year. So -- and those are part of the reasons we have roles that we believe that we don't need to rehire if the volumes come back. So that's a considerable focus for Charles River, making sure that our infrastructure is rightsized, that we are scalable, but that we are also protecting our ability to increase volumes when the work is coming back.

Some of that site consolidation, is that specific to DSA?

No, it's actually -- so we took a holistic view of the whole portfolio. So it's not specific to DSA. It's actually in all of our businesses. And what we have looked at is what are sites that are relatively small and can be from a service offering incorporated into other sites that we currently have. This is actually something that many of our clients prefer larger sites with more capabilities rather than working with smaller sites just because of relationships, but also the requirement to audit and just -- it's easier for clients to work in a larger side than in a smaller site. So -- and as I said, we're pretty well through the consolidations. A couple are still ongoing will be completed soon.

Okay. I want to ask a couple of policy related questions at the end to tie it up. One is on potential impacts of the pharma industry from most ever nation drug pricing, things like that. Any indication of pharma's decision or priorities in terms of outsourcing or types of programs and post both later-stage clinical but also early clinical, early research development. Just have conversations changed in that in the last couple of weeks.

No. So for us, they haven't changed yet. I think it's too fresh, two new -- our clients just basically have completed their last restructuring. I think right now for them, at least in the preclinical space, it's -- let's execute and why they're figuring out what that means and if it means something to them.

And on the competitive front, any changes there in terms of recent market pressures impact any of your smaller competitors more so less so than you? Is that impacting their willingness to price more aggressively?

Yes. I mean it's -- as a smaller competitor, you're always clear to be impacted by capacity reductions, volume reductions. And when clients are looking for more efficient ways of doing work, better pricing, they're generally consolidating their contracts. So I don't want to speak for any of our competitors, specifically. But I would have to believe that they're struggling probably more than we do as we can either absorb or use our pricing power and our portfolio to work through times and areas like that.

Does that create any incremental opportunities for consolidation or for M&A? Maybe just broadly, how are you thinking about capital deployment in this environment.

Potentially. Right now, our focus for capital deployment is more towards share repurchases. We just did $350 million in the first quarter. executing half or nearly half of that $1 billion that was approved, and we'll be looking to see with our new SPAC committee, what we want to do going forward. Otherwise, we have done debt repayment, getting our interest down and really making sure that we have a solid and capable organization going forward. M&A, certainly potential, but I would have to think about what if any competitor would be attractive to us.

And then I'll go through our final standard closing question. So what do you think is the most misunderstood or underappreciated about Charles River? A lot to choose from.

Other than the stock price? Well, I have to come back to the FDA announcement. The stock price was so impacted that I believe that -- maybe what's misunderstood is Charles River is a drug development company. We do both in vivo and in vitro. We use modeling technologies whatever our clients need to get a drug to market, we are here for them, and we will execute that. We are always trying to be the first 1 or even to guide regulatory agencies towards new technologies. And our M&A and partnerships have been geared towards a lot of the nonanimal technologies. So I think that's maybe the most -- not so well understood fact of Charles River.

Great. Thank you.

Thank you so much.

Thanks, everyone. Thanks, Birgit.