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

Perfect. Good morning, everyone. Welcome to day 1 of Morgan Stanley's Global Healthcare Conference. I'm Kallum Titchmarsh, the life sciences analyst here at Morgan Stanley. Here today with the wonderful team from Charles River, we have Birgit Girshick, CEO; and then Glenn Coleman, CFO. And just before we get started, important disclosures, please see Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. So thank you both for being here. Great to have you both.

Thank you. Thanks for having us.

Birgit, you took over the role of CEO from Jim in May, 4 months now into this new role. How has that transition been so far? You're obviously at Charles River for quite some time beforehand across different responsibilities there. So maybe what surprised you leading the ship?

Yes. So the transition has been very smooth. As you said, I spent nearly my entire career at Charles River, and I know Charles River really well. So I know our strengths, but I also know where we need to be faster and sharper and had a great transition with Jim. So I was really able to prepare myself, give it a lot of thought. But what I did in addition was really looking to see that I get more feedback from our stakeholders. So I spent the last 4 months literally visiting over 40 of our sites in 7 countries. I met with a lot of the shareholders met with our Board and a lot of our clients. And what that allowed me to do is really double down on the confidence that I have that Charles River is in a great position at this stage to really scale up, accelerate as demand comes back in the industry. It allowed me to validate that our strategy that we actually will talk about quite a bit next week at our Investor Day called Pathway to Purpose is the right strategy that will accelerate revenue growth, bring margin expansion and just accelerate shareholder value. So that was great, not a surprise, but really good to see and get that feedback and make sure that we are on the right track.

Amazing. And Glenn, you've also joined Charles River pretty recently. It would be great to hear a bit more about your kind of 5 months or so in the role.

Sure. So I've been with Charles River now for about 5 months as Chief Financial Officer. I would just say it's a complex business, so is the whole drug development process. So I'm up to speed and learning on a lot of different things and have gotten out to many of our sites have been out to, I think, 16 or 17 sites now. And so that's going really well. I'm very fortunate to be joining the company at this point in time, though. I mean, if you look at our business today, we have differentiation when you look at the breadth and depth of our portfolio, we have scientific expertise that I would say nobody else has in the industry. And we're at this inflection point for our business, which is happening here starting in the second half of 2026, where we're going to see significantly better financial performance, both top line, margin expansion, earnings per share improvement and so forth. So fortunate to be joining the business at a good time. We've done a lot of good things around the portfolio, which are now essentially complete with the divestitures of our CDMO business, some smaller assets in discovery, and we've also acquired a large NHP farm as well. So we're well positioned here to see better performance starting in the second half of the year, and I'm happy to be here.

Fantastic. A lot to discuss, but maybe DSA, we can begin with. Underlying trends there have been really strong, a good turnaround, 3 consecutive quarters now of north of 1 book-to-bill. How would you characterize the demand drivers here? How much of the improvement is coming from the overall environment versus internally at Charles River, like how are you driving those better win rates? Maybe just parse out those 2 dynamics.

Yes, I'm certainly happy to. So what I would say is that both of those dynamics play a role. So the industry backdrop matters. We all know funding has improved. Pharma is back to work. We're seeing a lot of our internal metrics going in the right direction, proposal rates increase, bookings increase. And revenue is back to growth modestly in the second quarter, but that will accelerate. So definitely, the demand is improving. We don't expect a straight line, but we do expect stabilization and acceleration of that. In addition to that, we have spent a considerable amount of time really refocusing on what we do best, where we have the right to win. We have reorganized our sales force and have really been aggressive in terms of winning the work. What that means is following up on proposals, making sure that we have the best time lines for starting the work that we have the resources when our clients need them and that we are providing -- continue to provide the best science and operate and work in the areas that our clients want us to work in. Glenn already mentioned some of the divestitures. I do think that they have a benefit not only on the P&L, but also within the organization because it lets us focus on where we really should be working in. So overall, I would say both are important dynamics and both are in our favor right now.

And Kallum, let me just add to Birgit's comments. The way we measure commercial execution is our capture rates on these proposals. Are we winning at least as much or even more than we've done in the past and seen those rates go up, and we've seen some pretty good recent trends around that. So when I look at commercial execution, which is a big part of how we measure our internal success, those capture rates continuing to tick up, also help a lot in terms of how we measure ourselves.

Got it. And then the small and midsized biotech clients, I think they've been a big driver of that uplift, at least relative to what we had in the past couple of years. The funding environment helps certainly. How durable do you think trends are from your discussions on the ground with the customers? How much room do you think there is to keep those growth rates as we see them today?

Do you want to take that?

Yes. I think in general, we've seen pretty broad-based strength across the business when we look at the lead indicators. So both North America and Europe, all trending in a very good direction. When we look at large biotechs, smaller biotech, that's also got very positive trends. Biopharma has gone through the restructuring of their pipeline and portfolio. So we've seen a kind of a gradual increase there, I would say, but all moving in the right direction. Some of the very early-stage biotech funding we haven't yet seen in our business, we see that in our CRADL business, which is the early-stage funding. And that still is, I would call it, just stable right now. So we haven't seen the recovery and the inflection there yet. But on the whole, it's been broad-based. We feel like it's durable. We've seen 3 or 4 quarters now of really strong bookings, but we'd like to see a couple more quarters before we call it a trend. And so we'll see how the rest of the year plays out here, but all indications are that things are moving in the right direction.

Yes. And it's something we received quite a few questions on just how to think about the lag from a customer getting the funding to then when they start spending on preclinical work. So how should we be thinking about that?

Yes. So what we normally model out and certainly, every study is a little bit different is that once we get a proposal, it's about a quarter to get the booking and then from a booking to a revenue start is about a quarter. The funding question from funding to proposal is a little bit more difficult because it's not a straight line, I get funding. Therefore, I'm asking for a proposal. But as the funding environment improves, our clients get more confidence that they can get the funding and start spending money that is actually already in their bank accounts, right? So that is generally, I would say, maybe a quarter, but that can vary quite a bit. So -- but we're already seeing that. So that trend is in action. We are seeing more proposals. And so now it's about winning the work, continue to win the work and then start the work.

Got it. And you mentioned the kind of larger pharma customers stabilizing now. I think a lot of those budgets were finalized for the year before those MFN agreements were kind of put in place. So do you think we have that true inflection yet in kind of global large-scale pharma spending? Is that something we could perhaps think of for 2027?

Yes. So what we are hearing, so qualitatively from our pharma clients specifically is that everything is about more programs into the clinic, more programs into commercial. So they -- just about everyone has a program name for that, really getting more wins through internal development. And so the discussions have really shifted from reprioritization from where do we find the next cost savings to how can we speed up the program, how can we get this program faster into the clinic, how can we get it through the clinic into a commercial approval. So I don't see any hesitancy. I would say that most of our global biopharma clients have a clear path of what they're trying to execute, and it's benefiting us right now.

You have a pretty unique view early on in the pipeline. So any specific indications or conditions you're seeing targeted biopharma customers that's perhaps evolved differently to what we've seen in prior years? Anything that's interesting to you?

Well, there's a couple of things. One, we are seeing more complex modalities coming through, and that is positive for us because complexity creates opportunity for us. More endpoints needed, more bioanalytical testing is needed, and that is driving revenue. And so that is a positive trend. We will talk about that quite a bit next week at our Investor Day because it's a trend we're really seeing and that I do think that we have great opportunities with. And the other one is can't not mention is AI, everybody investing in it. In order to teach the AI platforms, the algorithms, more programs have to be done, have to be pushed through. That isn't quite there yet, but I do think that we will see this as a tailwind.

And how would you characterize the pricing environment right now? It feels like it was perhaps a bit softer in recent years when demand has been softer. But any green shoots you're starting to see there?

So at this point, pricing is stable, and we have been saying that for a couple of years, meaning discounting is happening, but not any more than it was before. So we have not seen pricing return as strong as we would like to see it. So at this point, we're still at the stable standpoint. But we know and we know it will happen, it always does that when capacity is filling, pricing will come back, and we would just want to be paid for, obviously, inflation and the work we do. So -- but I would caution with that a little bit because once pricing is coming back, it has to flow through this 2-quarter process of getting in a proposal, getting to bookings and getting to execution. So from a revenue perspective, we're a little bit out from that standpoint.

That's helpful. And then just on the book-to-bill, 1.19 in Q2, highest number we've seen in nearly 4 years. How should we be interpreting this metric? And is that a number we could expect perhaps for the back half of the year?

Yes, I wouldn't call that the norm. It was the highest we've had, as you mentioned, in 4 years. I think the way we look at it is we want to see our net book-to-bill above 1, which would give us sustainable growth for our business. And so anything above 1 is what we shoot for. And we may see quarters where it's above that, maybe we have a quarter or 2 that's even below that. But I think having a net book-to-bill above 1 is really important for us to grow our business, and that's what we expect to do going forward. I would just say also with some of the really strong net book-to-bills we've seen over the last couple of quarters, keep in mind, if you rewind the clock maybe 5 or 6 quarters ago, we were below 0.8. And so we're building a lot of that backlog back. And so you're not going to see this big inflection on revenue all of a sudden. It's going to be a gradual increase in our revenues as long as we continue to see these healthy net book-to-bill numbers. So that's the way we think about it.

Yes. And perhaps just talk through that relationship between book-to-bill and revenue growth because when I look at the Street, they're kind of at a mid-single-digit CAGR out kind of over the midterm here. How should we be interpreting that like 1.19? And how bullish perhaps could we get?

Yes. I think first and foremost, we mentioned on our last earnings call that we expect to see now organic growth in our DSA business in the second half of the year, and that was after a number of years of decline. So we're now starting to see that improvement in our actual revenue numbers. We would expect to see pretty healthy growth then from there going into 2027 as long as the net book-to-bill numbers continue to be above 1. And so you can't just extrapolate saying it's 1.19, you should be growing 19% because, again, we're still filling a lot of the backlog that we burned off over the last couple of years. And now that we're building it back, continue to see some healthy net book-to-bill numbers. We're now confident to say that we're going to be growing in the second half of the year. And then we'll talk more about what that means to 2027 next week.

Looking forward to it. China is one of the fastest-growing drug development markets in the world right now. You don't have a significant DSA presence in the region, but you've expressed some interest before an establishing one. How seriously are you evaluating that opportunity? I'm wondering how long that would take to build those capabilities up and whether the demand environment is still as strong by the time you could do that. So maybe just talk us through the thought process there.

Yes, certainly. So China is obviously an interesting market because of the innovation that's happening there and the funding that's happening there. So the preclinical, the market right now is between $1.2 billion and $1.5 billion. That's a lot of earlier-stage work, too, but also some quite a bit of regulated work. China for China, so meaning local support for local companies there. So that is an area that we are currently not representing, as you said. We do have a very strong presence with our Research Models and Services business. So we know how to operate in China. We have client relationships with all the leading biotech and pharmaceutical companies in China, and that positions us well to expand potentially what we're doing there. So what we're doing there right now is literally evaluating options, looking at the market. And you used the word optionality. It's exactly what we're doing. We're looking for optionality there. But we're also considering the geopolitical risk, the competitive nature of China. The Chinese market is very, very competitive. And then also balancing it with other investment opportunities. So -- even though this is a really interesting market, it is an area that we are interested in. I would not expect anything there anytime very soon. We will talk about it more next week, too, but certainly something we're watching. And if we find the right target or the right opportunity, we're going to be ready for it. So it's really strategic flexibility, I would call it.

Understood. And a lot of positive feedback, I think, on the K.F. acquisition. Do you mind just walking through what that means for the DSA business in particular? I think you now have control over 80% of the NHP supply chain for safety assessment study. So what advantage does that give you?

Yes. Yes. So nonhuman primates is an extremely critical research model for drug development, particularly the more we get into biologics, the more we get into complex modalities, the higher the need is for nonhuman primates. And so to have a source that is basically guaranteed and under our control certainly allows us to assure our clients that we can do the work. So we have acquired a farm in Cambodia that has been a long-term partner of ours. That is in addition to a farm that we have in Mauritius. That allows us now to provide our clients in our studies. So that is for study use, approximately 80%, as you said. This is our target for the future because we still want to do some third-party purchases because that is the best risk mitigation we can have. It allows us to make sure that our compliance is at the highest level, animal welfare is at the highest level. It allows us to control our costs, but it also allows us to control the breeding capacity, even so it takes a little while to ramp up. And with that, I do think we're giving our clients the best reliability they can have in the industry, and that alone means a lot to our clients. So it's a great way to compete. It's a great way, obviously, to improve our margins, but it's also a great way for us to risk mitigate a very important supply chain.