Charles River Laboratories International, Inc. ($CRL)

All right. Good morning, everyone. Thanks for joining us for the management presentation here. My name is Max Smock, and I'm the research analyst here at William Blair, who covers Charles River. We're pleased to be joined this morning by CEO, Birgit Girshick. Before we get into the presentation, I need to mention 2 things. First, the breakout session will be held in Richardson on the second floor immediately following this presentation. And second, I'm required to inform you that for a complete list of research disclosures or potential conflicts of interest, please visit our website at www.williamblair.com. So again, very pleased to have Charles River here with us today. And with that, I'll turn it over to Birgit. And before I do that, the presentation will likely end a few minutes early. So for those who are unable to attend the breakout, this is a good opportunity to ask a few questions following the conclusion of the presentation. And if we don't get any questions, I'll maybe lead a few minutes of Q&A on my end.

Thanks, Max. Is my mic on? Yes. Okay. Great. So thank you for having us today. I'm really excited to be here, and thanks for joining us for this presentation today. During the presentation today, I will focus on 3 things: how we are restrengthening the core, how we reaccelerate growth and how this will translate into margin expansion and durable shareholder value. Before I get started, I want to refer to the safe harbor statement. I will make forward-looking statements and non-GAAP financial measures. So Charles River is a scientific partner of choice. We enable our clients to move faster, to reduce complexity and ultimately to move molecules into the clinic more efficiently. Accelerating biomedical innovation is not abstract to us. It is shown in every molecule we advance and in every patient outcome we enable. Charles River operates at a global scale. We have over 18,000 employees, of which approximately 2,000 are scientific professionals with advanced degrees. We operate in over 100 sites and locations close to our clients in approximately 20 countries. We support approximately 1,500 INDs every year. And we compete in an over $20 billion addressable market with a long runway for future growth. Maybe most importantly, we support 80% of drugs approved by the FDA for the recent years. This doesn't just show scale, but it shows embedded criticality in the drug development ecosystem. Also important to note is that our diverse client segments, the largest client is still under 4%, but also our diverse end markets provide a reinforcement of our resilient business model. Charles River provides a comprehensive portfolio throughout the drug development continuum. Our research models and services provide the foundation that enable our clients to discover new molecules. Because of our scale, our portfolio and because of the geographies we operate in, we are the global leader in the production of the most widely used small research models and associated services. Our Discovery and Safety Assessment business, or short DSA is our core growth engine and is enabling preclinical success and efficiently advancing ideas into the clinic for our clients. Because of our scale, our science and our client relationships, we are the largest global partner for outsourced nonclinical drug development and regulated safety testing services. Our Manufacturing Solutions are mission-critical for the support of clinical and commercial manufacturing. Because of the recurring revenues and good growth opportunities, this is a very important division for us. In summary, Charles River operates at the highest value and highest dependency points of the drug discovery and drug development continuum, particularly in early stage. To accelerate Charles River into the next phase of growth, we have a strategy. It's called Pathway to Purpose. It is simple and focused. We will modernize the company by building a future version of Charles River that will be faster, more agile, more data-driven, more automated and help our clients to move faster. We will strengthen our portfolio by refocusing on our core into areas where our clients need us most, where our clients need to have the most complex answers to their questions. We will grow by delivering a customized client-centric approach. We will remain a preferred partner to the biopharmaceutical industry by building even deeper, broader and more customized relationships with our clients. In summary, we will be a simpler, better-margin, faster-growing company. We are already executing on this. This year, we're driving operating efficiencies through process optimization and cost initiatives with over $100 million in incremental savings. Cumulative, we have taken out over $300 million of cost or about 5% of our cost structure over the recent years. Now our focus is on identifying additional initiatives to continue to support future operating margin expansion and competitiveness. We're refocusing our core through M&A and divestitures. We completed the divestiture of certain European discovery services on May 22 and the CDMO and Cell Solution divestitures on May 6. We had already completed 2 acquisitions this year, one for a nonhuman primate farm in Cambodia to give our clients a secure access to critical research animals as well as PathoQuest, which is squarely in the NAMs portfolio. We will evaluate future M&A opportunities to expand in vitro testing capabilities, including lab sciences as well as geographic footprint and new technologies. Our recent actions refine and strengthen our portfolio, but also expect and drive meaningful operating margin improvement. We are leveraging technology, including AI, to enhance sales effectiveness, KPI transparencies and client engagement. Apollo is a great example of that. Apollo is a platform we have developed over the recent years to allow our clients to work with us in a less complex way, a more simpler way. It allows clients to have access to their data, to their study information, to pricing and other information 24/7. Apollo is now available in our DSA, RMS and manufacturing support business. I want to touch a bit more on NAMs because it's such a buzzword right now. Charles River is fully committed to the implementation and development of new alternative methods. We have a track record of several decades of reducing the number of animals used in studies through our 3R program: replace, refine, reduce. We also have several years ago, formalized a program called AMAP, Alternative Methods Advancement Project, under which umbrella we are implementing and investing in NAMs technologies to reduce the number of animals used in research. In 2025, we have launched a NAM strategy and a Scientific Advisory Board with some of our brightest and best scientists and led by former FDA Principal Deputy Commissioner, Dr. Namandjé Bumpus, who is now our Chief Scientific and Innovation Officer. She, together with our scientists, are driving the strategy to implement, develop, in-license and potentially M&A for NAMs technologies, always focused on reduction of animals while maintaining patient safety. We are currently expanding NAMs capabilities in many different areas. A couple to call out, our virtual control groups for safety assessment studies, where we're reducing the number of animals used in control groups and replacing it with a data-driven approach. And again, our PathoQuest acquisition is a NAMs technology. PathoQuest provides next-generation sequencing solutions that replace in vivo virology assays used in large release. I also want to touch on AI because no presentation today can start without AI. We believe AI is a structural tailwind for us. The focus of AI investments in drug development currently is very heavy in the early stage of research and discovery, particularly in target identification and molecular design. The investments are geared towards making discovery and development more productive, less failure rates. Nearly 60% of R&D executives expect AI investments to result in an increase in investigational new drug approvals and a faster pace of drug discovery. More programs equals more opportunities entering Charles River's pipeline. Now let me pivot to the demand trends, very important. So we believe demand trends have stabilized, and we see good signs of improvement. Biotech net bookings in the last quarters were highest level in over 2 years. Mid-sized biotechs have now better access to capital as they approach IND and enter the clinic. We still would like to see better funding available for start-up biotech and early discovery to increase the number of company formation in the industry. Our global biopharma clients, for the most part, have progressed through the restructuring and pipeline activities and are back to work. Let me talk a little bit about Q1. We have delivered Q1 in line with our expectations or above expectations. Our Q1 revenue is $995.8 million, which is a decline of 1.5%, definitely not where I would like to see it, but what we had forecasted. Our non-GAAP EPS was $2.06, and despite discrete headwinds, our non-GAAP operating margin was 16.3%. We expect the Q2 financial results to improve as discrete margin headwinds subside. I want to reaffirm our 2026 guidance. We expect revenue to range between 1.5% to 0.5% decline. Our non-GAAP operating margin will increase compared to 2025 in the range of 120 to 150 basis points. We have a clear line of sight into a 500 basis points improvement for the second half of the year. Our earnings per share will range in the area from $10.80 to $11.30 on a non-GAAP basis. And our free cash flow will be between $375 million and $400 million despite some discrete headwinds. Maybe most importantly is to point out that we are seeing favorable DSA demand trends in Q1 that leave us well positioned to return to DSA organic revenue growth in the second half of the year. We have a balanced and disciplined approach to capital allocation and we'll continue to do so. Our capital expenditures are down from a peak level in 2022 and range as a basis of 2025 revenue at 5.5%. Our net leverage ratio of 2.6% is considered to be in an optimal range, allowing us future M&A, but also shows our discipline in net -- in debt repayments. We have initiated stock repurchases since 2024. And since then to the end of Q1 have repurchased $650 million of our stock. And we will continue to focus on M&A, particularly in the area of science, geographic expansion and new technologies. Let me take a step back and talk about what's most important, which is performance. Charles River is a story of resilience. Despite up and downs and market headwinds, we have a very resilient business model and great results. Our revenue has increased from $1.3 billion in 2015 to $4 billion in 2025. In line with that, we have improved our non-GAAP operating income threefold during this time. Our free cash flow went from $225 million to $518 million. And maybe most importantly, our non-GAAP EPS has increased threefold as well. Again, this is a story of resiliency. As I end the presentation, I want to point out 3 things. Charles River is critical to the drug development ecosystem. This is shown by us working on 80% -- over 80% of drug approved by the FDA. It also is shown by our commitment to be the leader in the NAMs implementation. Charles River will be a structurally improved company. This is shown by our drive to modernize the company and how we are executing on cost savings. And Charles River will reaccelerate growth and move into a growth phase. Biopharma demand has stabilized. Our DSA business shows momentum and our client partnerships are stronger than ever before. We believe we are well positioned to deliver durable shareholder value. Thank you.

Okay. I know we have about 10 minutes here. So we'll spend the rest of the time doing Q&A. Birgit, thank you for walking through. That was extremely helpful presentation. Maybe just following -- I'll kick it off and then I'll open it up to the audience for questions. I think one of the topics that we talk a lot with investors about that didn't really -- I don't think came up a ton during the presentation was around your end markets today, particularly with respect to competition from China. And I know as more drug development activity shifts toward China, how are you all thinking about your presence and capabilities in that region? Is there any sense of urgency to add capabilities there in order to remain competitive over time?

Yes, Max, thanks for that question. And it's certainly an important initiative of ours to evaluate the market and see what we want to do there. So I'll approach it from a couple of different things. So the addressable market in China for our services is quite interesting. Biotech and pharma in China had great growth spurts, is reemerging. And so China for China, offering our services in addition to our current business, which is the research models and services business, is of interest. We have had a long history of working in China through our research models and services business. We had a joint venture in the beginning. Now it's fully owned. We are -- it's an organization that is 100% led by Chinese leadership. And we believe we have a great reputation and servicing just about all the participants in the drug development ecosystem there. So we believe we can build on that and have a great foundation for doing more such as services in China for the Chinese ecosystem participants. Looking at Western companies doing work in China, this is something that has happened and has a little bit accelerated over the time, but just probably for about 10 years now. So it was heavily focused on chemistry and biology that accelerated, particularly in a downturn that we have just seen in the industry. Clients are looking for better, maybe, price points. And so we have seen that chemistry and biology just in a quite heavy percentage is now being done in China, but also in India. The toxicology space is still very small in China. There are certainly players that are providing toxicology services. but they're mostly focused on companies that want to do their Phase I clinical trial in China and want to file at least initially in China. However, we are going to watch that and make sure that we are providing the necessary capabilities and value to our Western clients so we can maintain that work here. So we'll see what happens over the next few years in this space, but definitely of interest is China for China. And -- so working with our clients here to make sure that we have the right value, the right insights, the right speed for them to operate on a day-to-day basis.

And if you do see more of that toxicology work start shifting to China, have you thought about the ways that you would make sure you remain competitive in that market? Is it inorganic, organic, a mix of the 2? Like how do you all think about just the different routes you can take to maintain or build your presence there over time to remain competitive?

Yes. So from an entry into China with services, M&A would be easier because it's faster. You also can build on capabilities. But again, I want to point out that I personally would be most focused on China for China, providing services to the clients that are located in China. That could be Western, but also Chinese-originated companies. The other area that we are really focusing on is modernizing the company, becoming faster, becoming more cost competitive, providing more insights, and that is really geared to providing our clients here the incentive to work with our sites here in North America as well as in Europe.

Does anybody in the audience have a question? If not, I can keep going here. Okay. Maybe one on NAMs, which I think you spent -- the overview in the presentation was extremely helpful. I think when the news broke, it was last year, there was a lot of concern. We're all -- we're moving away from animal models overnight. And I think over time, people have realized that there's a long way to go before that becomes a reality as well as the fact that you all can actually take a leading role in driving that initiative. But I'd be curious to get your thoughts on what you've been hearing from your clients in terms of their willingness to adopt NAMs as well as just more context around the limitations associated with the models that are out there currently. I know you mentioned the virtual control groups. But just in general, like where are we at in terms of willingness to adopt these models? And what are the bottlenecks that are preventing more adoption of these models here in the near term?

Yes. It's certainly a hot topic and been a hot topic now for the last year. For us, NAMs has been a topic of investment, topic of discussion for nearly a decade now. Overall, our clients, I think there's not one person who doesn't think that it's the right scientific and ethical direction. And everybody would like to see fewer animals used in research. So there's zero doubt about it. What we need to make sure is that the answers we're getting maintain patient safety, that the answers we're getting are as good or better than what we currently have and that we can actually scale it up and make sure that the studies that we are given to execute on can be executed on. So that said, there are a lot of interesting technologies out there. We are evaluating them all as they come into our pipeline. What we're looking for is what context of use can they be used for. So a lot of times, they can answer one question, but not the whole host of questions that we would like to see. And sometimes, they're just really early stage and cannot be scaled yet. Technology will advance. We'll move through this. The way you should see NAMs is there is no technology that will replace an animal. There will be multiple technologies to provide us more answer that allows us eventually to reduce the number of animals. So think about virtual control groups, that is one way of reducing animals used in control groups. We will not have virtual control groups ever available for every single study, but we can make a big difference in animals used in that space by implementing this, teaching the models more and more and getting our regulators and clients comfortable with that new technology. At the end of the day, eventually, it won't be about technology. It will be about integration. And a company like ours is well positioned, maybe best positioned, maybe the only positioned company out there that can actually bring multiple technologies into a safety assessment study and have this integrated approach for our clients using fewer animals, but giving them as good or better data. So we are leading that effort in the area that we are operating in, and we are committed to continuing to invest, continuing to develop and continuing to lead.

Maybe a final one here, I know we have a couple of minutes left, on AI, right, which I think you made a very compelling case and certainly one we agree with in terms of AI being accretive to your business over time. I think where we hear the most concern from investors is around AI in the discovery space in terms of pharma in-sourcing those capabilities. It seems like that's where a lot of the investment from larger players has gone in particular. You divested actually some of your NAMs capabilities in that discovery space. Can you just maybe frame out for us the total exposure you'll have to discovery today? And then just thinking about how that market evolves moving forward in light of those investments that we've seen from large pharma in AI-based drug discovery.

Yes. So we divested some of our European early-stage discovery assets because we want to refocus on our core. We still have discovery assets, but they are really closely linked to our Safety Assessment businesses, either supporting them, those studies really closely or are located in our facilities. What our goal is to really serve our clients primarily in that regulated space. So if you look at AI and you look again where the investments are in target identification, molecular design, that is now pre-Charles River, but the wet lab that still needs to be done once you have that target identified is the work that we are doing. So -- and that's why we believe this is actually a tailwind for us. We are very excited about it, both from what the industry is doing, but also what Charles River is doing here.

All right. I think we have a couple of minutes. We'll go ahead and wrap it up there, save a few for the breakout. Thank you, everybody, for joining. Birgit, thank you again for your time. It was great catching up and looking forward to seeing everybody upstairs for the breakout here in about 10 minutes or so.