Charles River Laboratories International, Inc. — 2024 Q1
Transcript
Each turn shows the speaker, their inferred role, the section, and that turn's net sentiment (×1000).
Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories First Quarter 2024 Earnings Conference Call. This call is being recorded. [Operator Instructions]
Good morning, and welcome to Charles River Laboratories First Quarter 2024 Earnings Conference Call and Webcast. This morning, I am joined by Jim Foster, Chair, President and Chief Executive Officer; and Flavia Pease, Executive Vice President and Chief Financial Officer. They will provide comments on our first quarter 2024.
Good morning. I'd like to begin by providing an update on the overall market trends. There has been an increasing focus on market sentiment through the first 4 months of this year from clients, investors and other stakeholders. We still believe that the end market trends for our biopharmaceutical clients remain stable with signs that demand will begin to improve later this year, which is consistent with the outlook that we gave in February. One of these signs is an improvement in biotech funding after 2 years of tempered activity.
Thank you, Jim, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results, which exclude amortization and other acquisition-related adjustments, costs related primarily to restructuring actions, gains or losses from certain venture capital and other strategic investments and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions, divestitures and foreign currency translation.
That concludes our prepared remarks. We will now take your questions.
[Operator Instructions] We'll take our first question from Michael Ryskin with Bank of America Securities.
This is [ Wolf ] on for Mike. I guess the first one would be on how should we think about pacing RMS revenues given the accelerated NHP shipment that we saw? The cadence through the back of the rest of the year would be great. We have a related follow-up.
What was the beginning of the question?
I think he was just saying he was stepping in for Mike. And the question is about timing of NHP shipments in RMS. Maybe I can take that. I think we have commented that our quarters are not linear, and I actually added when we provided guidance for this year that the -- adding the Noveprim business into the [indiscernible] would result in additional nonlinearity in our quarters because those shipments are not timed in a way that they always happen at the same time in every year.
Okay. Wonderful. And hopefully, you can hear me a bit better now. Then I would just like to ask on kind of your confidence in the ramp through the year, given your book-to-bill is still trending below one. I know you noted some improvements there, but just anything to make us more comfortable there would be great.
I mean our confidence in the back half of the year ramp is premised on a multiplicity of things. Inflows to the VCs, wonderful funding in the capital markets, fourth best in the history of biotech last quarter, the increase in proposal volume, modest reduction in cancellations and just the general dialogue with our clients, a; b, the comps of last year; and c, the fact that we can see pent-up demand on the part of our clients.
And we'll take our next question from Max Smock with William Blair.
Starting with DSA, you had the comment in the deck about modestly adjusting price on new proposals, when appropriate, to drive incremental volume. Just wanted to follow up and get a little bit more color around the rationale behind that decision and specifically how NHP pricing is playing into pricing for these proposals in the DSA segment more broadly.
So the principal way our competitors compete with Charles River is with regard to price. So competition has prices pretty much across the board, a bit slower than ours. I certainly don't think the workers is good or the science is a substantive or the infrastructure is as significant. But it's a fact. And so in challenging financial times and people are sort of worried about access to capital, I think pricing is more important.
Got it. And just following up on that. Were you anticipating having to cut prices so much coming into the year? Or has this been more of a reaction to how competitive dynamics have changed over the last few months? And then in regard to the price cuts, is there any detail you can give us around just how dramatically you've been cutting prices on some of this work? And what it means for gross margin, specifically gross margin on services, which is down, I think, nearly 350 basis points year-over-year and the lowest number that we've seen in over 5 years here.
I mean that's one of our volume. I wouldn't say we've been dramatically cutting prices. I would say that we've been cutting prices very modestly, to be more competitive, to have clients that are on the edge, to say that Charles River's science is better. I want to work with that. But I need better price and are concerned about access to capital. So as I said, we feel that we're doing it responsive, responsibly and thoughtfully.
Yes. And I would comment on the margin, I think Jim started alluding to that. It's really more the volume that is putting pressure on margins given the ability to cover cost inflation. There's a little bit of restructuring costs that are impacting on a GAAP basis, the gross margin as well. We talked about our $70 million of savings that we're going to get on an annualized basis. So that impacts gross margin as well. But I think we also talked about how this will evolve throughout the year, and we expect that as volume comes back stronger in the second half and our restructuring initiatives fully implemented that, that will have a positive impact on margin -- gross margin as well as operating margin.
We'll take our next question from Dave Windley with Jefferies.
I wanted to follow up on Max's question on price and maybe ask a slightly different way. So in your deck, you talked about moderating price increases and Flavia, the point you just made about inflation and then this discussion of adjusting prices down. I guess what I'm wondering is, does price, over the course of this year, based on what you're pricing into the backlog, does price move from what has been a pretty good contributor to a moderate contributor in the first quarter to a headwind as we move through the year? Is that kind of the way we should think about price contribution?
Yes, Dave, what I would say is price is definitely not going to be as much of a tailwind as it had been in the past few years. And I think we are, as Jim said, appropriately, pricing given the market conditions and the domain environment. In our guidance for the year, we still contemplate positive pricing. And at the top end of our guidance, we are also contemplating some flat to slightly up volume. And so I think what will be critical in the margin impact is seeing that rebound in volume as Jim said, the strength in biotech funding starts translating into not only proposals for bookings and then revenue, which we fully expect will happen. I think as we said, it's not a matter of this but when. And that will be the key contributor to the margin accelerating throughout the year.
Got it. And then from this first quarter level, to get to your segment guidance in -- for DSA, you're looking at a pretty significant intra-year increase, I guess, how much of that -- your backlog is still fairly substantial versus historical pre-pandemic standards. How much of that growth can you see in backlog versus the point that you just made and seeing volume improve? And then as an additional part to this question, is there anything built into those expectations relative to BIOSECURE? Or is that kind of left on the side, would be upside if the bill passes?
So a significant amount of revenue we can't see, we see not all of it. But as I said, proposal volume has been increasing nicely, and we anticipate that bookings will follow. There's usually a lag. So we're going to need a couple of quarters to see this, but we're confident given the dialogue with the clients that we will. BIOSECURE Act is an interesting one. Not legislation yet, but dialogue opportunity seems positive. So no, there's nothing built into our guidance that assumes anything about the BIOSECURE Act because it would be premature to do that.
Got it. If I could just sneak one last one in on the price relative to inflation comments. So Flavia, you talked about inflation that impacting margin. I guess, my assumption would have been that inflation would have been moderating along with price. Maybe you could put those in relation as to what is kind of still propping up the inflation cost side of the equation there, in terms of price to cost.
Yes. What I would say, Dave, is over the last several -- couple of years when inflation definitely escalated beyond historical levels. I talked about we were actually recouping that and plus some more, right? And so price is very strong, but also the costs have increased more meaningfully than historically. Obviously, inflation is now coming down a bit. And so obviously, our price is coming down as a result of that as well. But what I'm just saying is the relationship between those 2 maybe was a bit more favorable in the last couple of years than obviously, it is right now. And because we don't have as much of the volume, especially in the earlier part of the year, sales are still down in the first quarter. That's putting pressure on the ability to fully absorb inflation in the fixed cost that we have.
We'll take our next question from Elizabeth Anderson with Evercore ISI.
I was curious, Jim, if you could expand on your comment about sort of ability to start work right away. Can you sort of talk to capacity levels in the industry? Where are you guys on space utilization? And sort of what have you sort of doing, in terms of it's probably hard to titrate with the demand now versus what you're expecting in the back half of the year? So any further commentary there would be helpful.
So general proposition is that we try to utilize our space as fully and efficiently as possible. So we don't have huge amounts of empty space in any of our businesses. And as you know, depending on the demand, we're always adding to our capacity. Having said that, we have some incremental capacity in some of our businesses across the board. So we do have the ability to accommodate increased work in the back half of the year across multiple businesses and particularly in Safety Assessment.
Got it. That's very helpful. And then if we just think about like the incrementals in terms of DSA margins as we move through the year. What -- so the key focus is volumes and then the cost savings, any other like potential positives and then potential -- like any other major like pluses or minuses to call out as we think about that progression specifically in DSA?
No. It was a bit -- I -- Flavia -- I think it's really what you just highlighted. We are expecting sequential improvement in DSA revenue on a dollar basis, obviously, on a percentage basis as well. But with that bigger size of business, it would obviously drive margins. There's some fixed costs in our business. And in addition to that, to your point as I said, when we provided guidance, the restructuring actions that we have put in place will be fully executed in the second half. And so that also will be the additional tailwind to drive margins.
We'll take our next question from Dan Leonard with UBS.
My first question, is it possible you could quantify that increase in proposal activity you talked about in Safety Assessment?
Yes. We're -- I don't think we're going to quantify the dollar proposal activity increase. I think we talked about it being sequentially up both year-over-year at being up both sequentially and year-over-year. And I think you also saw us talk about the impact -- the net impact into the backlog of bookings and cancellations. Cancellations also went improved sequentially in the first quarter. And so our adjustment to the backlog, the decrease was smaller than the decrease on Q4 versus Q3. but I don't think it will talk specifics in terms of what percentage of the increase we saw in proposals.
And the combination of increased proposals and reduced cancellations portends increased bookings. And as I said earlier, we always have a lag on that. Clients have to be confident that the funding improvement is sustainable. And I think we all believe that it is sustainable. April was a very good funding month, by the way, for biotech as well. So we're quite confident that we'll see it. It's built into our guidance. And those are the 3 metrics that we watch cancellations, proposal volume and ultimately, bookings. So I think we're on a track to achieve second half improved performance.
Understood. And Jim, you talked a lot about the leading indicators in biotech. Can you speak to what leading indicators you're seeing on the large pharma front as well?
Yes. They're not fundamentally different. Pharma has been aggressively and continuously outsourcing loss of the type of work that we do, particularly Safety Assessment and some lesser extent, discovery to us for a period of years. We can and do, do the work faster at a lower price point and usually with better science than that. So it's a small number of pharma companies that are holding on to those. It's interesting since they have very rich balance sheets that there's still been hesitancy on their part to book work. And that's just a function of trying to make budgets like any public companies do and also the necessity to prioritize.
We'll take our next question from Casey Woodring with JPMorgan.
I guess a two-parter here. First is, did you give how many months of backlog you have? I think at the end of 4Q, you had 12 months, and you talked about your normalized ranges kind of 6 to 9 months time frame. So can you walk us through that? And then you talked a lot about safety in the prepared when talking about DSA, but can you just elaborate on how Discovery fared in the quarter relative to your expectations?
Yes. I'll just take the question on the backlog and then Jim can talk about Discovery. So the backlog is at 10 months. So to your point, Casey, I think, for 2 or 3 quarters of last year, kind of hovered around 12, trickling down a little bit. But I think we've been saying that to your point, historical norms were 6 to 9. So what we're hearing from clients is actually that kind of reversed to the norm of they are booking 2 to 3 quarters in advance. So I think that tends -- feels consistent with what we're hearing from clients terms of what they're working on and what they want to book ahead.
So Discovery is an interesting one. So no question that's been the hardest hit of all of our businesses by overall economy. And there's a lot of dialogue around as funding continues to improve, how quickly will that come back? And it certainly will come back. Studies, to some extent, shorter. But unlikely to come back first. A lot of our pharma clients still do that work internally. And as I said earlier, what we think will come back first are pre-IND work for drugs that have already been developed but haven't been filed yet as opposed to post-IND work.
That's helpful. And maybe just if I can sneak one more in, just because we haven't touched on it, is on the manufacturing rebound in the quarter. It looks like each business there is seeing nice growth, and the segment came in above Street expectations. Curious if you think there was upside to the guide in manufacturing this year just in terms of how quickly that business has began to turn to start the year?
Well, that would be nice. That would be nice. We certainly hope so. We certainly don't have that in our guide. It certainly would anticipate, necessarily anticipate that, but we're very pleased that we've had strong growth across the entire segment in the first quarter. You see that people are back to business in biologics, and we have a very strong franchise there. You see that folks that had big inventories of disposables. I have worked through those in our microbial business and the CDMO business to a distinct pleasure as a double-digit grower that we're getting a lot of traction as people recognize the quality of our assets, and we have some commercial drugs that we're working on and the facilities are -- have been expanded nicely.
Yes. And I think to Jim's point, we've modestly adjusted, right? I think the guidance in the beginning of the year was low to mid-single digit, and I think we're now saying mid-single digits. So we raised a little bit the bottom end there. But I think that's a reflection of the strength of the first quarter, but we don't want to get ahead of our skis, as Jim said, to say that there is upside to the guidance that we just provided you today.
And we'll take our next question from Tejas Savant with Morgan Stanley.
Jim, one quick one for you on NHP pricing actually. I know you talked about pricing more broadly here, but I think last time, you guys have called out about a modest $15 million to $35 million benefit in the guide for your ability to reach pricing in light of competitors being higher. Is that still the right view? Or is that now essentially off the table in light of those strategic, selective pricing adjustments you alluded to?
We would say that that's still the view. Competition had prices significantly higher than we. So they had to come. They've had to bring their prices down. I think it gives us a little bit of pricing power actually. So we're also really pleased with our sourcing of NHPs, particularly given the acquisition that we recently made.
Yes. And I'll just add. I think NHP pricing is still positive in the first quarter. We are seeing it come down from the peak, if you will. And I think as I've been saying for the last couple of quarters, I think some competitors are signaling to significant decreases. I think it's more because they're coming down to our level. So we still experienced year-over-year, a modest increase in NHP pricing, although as I said in Q1, it is modestly down from peak levels.
Got it. That's helpful. And then a couple of unrelated follow-ups. One on the CDMO piece, Jim, where is capacity utilization today? And what's embedded in the guide in terms of where you finish the year just in light of the ramping backlog of work are? And then on your comments on China. Are you seeing any sort of widening in that price disparity versus the Chinese CROs, particularly outside of China as we look to defense share at all? And any early sort of green shoots from the stimulus that just went -- I mean, that was put out there in March, in terms of how that could benefit local demand in China into your end or perhaps '25?
So we've added an appropriate amount of space. I guess, I would say that the CDMO manufacturing facility in that is lots of audits by clients and regulatory agencies. So we're in very good shape to accommodate the client base where we have already a couple of commercial clients. Hopefully, we'll have more. And we're also getting additional clinical clients I'm dealing with some of those clients myself. The feedback on the facilities has been positive. So obviously, we'll work hard to stay ahead of that, so we have sufficient capacity.
We'll take our next question from Patrick Donnelly with Citi.
Jim, maybe one more on the DSA side, just in terms of the pace of cancellations. I think in 3Q, they got a little bit better, 4Q they stepped back down, 1Q got better. How are you thinking about just the trends there? And I guess the million-dollar question is, when do you think we can get back to that kind of 1.0 book-to-bill? What's the visibility? What did cancellations trend like in the quarter? Certainly, if you have any April thoughts, that would be welcome.
Yes. So everything that happened in April is embedded in our guidance. So I don't want to cut it month-by-month. We're pleased with what's been happening, the moderation and decline of cancellations. By the way, as you know, we always have cancellations. I mean all we can say is what we said, which is that we have to see a reduction in cancellations for some sustained period of time to have confidence that it's meaningful and will continue. We believe that, that's the trajectory that we're on, but we have to. We have to experience that for that to be beneficial and in terms of our backlog.
Okay. That's helpful. And then maybe just on kind of the broad demand environment. I think in the slides around the cash flow piece, you talked about moderating capacity expansions to match current demand. You talked, obviously, a lot of questions about the pricing piece. It seems like maybe softening a little bit given the demand environment yet you sound very good in terms of kind of these conversations and the expectations of demand improvement as we go through this year. Can you just kind of marry that up and just frame up the right way to think about the demand, given again the capacity and price piece, along with your positive commentary on demand? Just want to make sure we're thinking about that right.
We work really hard, and I think we've done this quite successfully -- I don't know, for at least, 1.5 decades. The marry capacity with anticipated demand. It's not just current demand because we have to build space a year or 2 in advance. And we've lived through a period -- a long time ago, but it was painful where we and everybody else in the industry just built too much space. And that has a deleterious impact on your margins, and it's tough to manage that when you're swimming in space. So we never want to get back to that. We have worked really hard, and I think successfully and not having an adequate amount of space. That's the risk, of course. You get the [indiscernible] work and you don't have capacity. So we never want to get there.
Yes. And maybe if I can just add, I think to Jim's point, we lived through a couple of years of unprecedented demand. And at some point, we said we were going to increase our CapEx to almost 9% of revenue. And historically, we'd be more in the 5%. That was both a combination of historically, we added some capacity through M&A, and now we were doing organically as well as fueling that unprecedented demand. I think demand has normalized now. And our guidance for the 3-year horizon is 7% to 8% of capital as a percent of sales. And this year, our guidance contemplates kind of the low end of that at 7%. And so I think as Jim pointed out, we are being appropriately thoughtful in matching up the capital investment with the main environment that we're seeing.
We'll take our next question from Josh Waldman with Cleveland Research.
Jim, 2 for you, I think, if I may. First, you've talked about seeing better proposal activity in DSA. Can you comment on what you are seeing from a conversion standpoint, the timing from when you receive proposal? The proposal to booking the study and then recognizing rev? I guess have you seen the time line and conversion rate return to normal would be great to hear how you're contemplating this, and your outlook and if you've had to tweak that piece of the forecasting assumption at all.
Not sure what normal is. But I'd say it's reasonably normal. As I said before, except maybe for some periods where the demand was overwhelming, there is a lag between proposals and bookings. And particularly in this period where people are trying to ensure that they have confidence in accessibility of capital. So the conversions are pretty much as we would have expected. And hopefully, that will improve, but there's going to be kind of 2 or 3 quarters necessary to get this to be more robust. We're heartened to see the proposal volume as is. People feel -- seem to be coming out of their shells, acknowledging access to capital, obviously, desirous of developing the rest of their portfolios. And that's underlying our anticipation at the back half of the year will be much stronger. So I think it's pretty much as anticipated.
Got it. Okay. And then the follow-up on that. Just wondering if you could provide more context on how DSA performed versus your expectation in the quarter? And then curious whether there's been any change to your assumption for Q2 or the slope of organic recovery in that business for the second half.
Maybe I'll take that. I think as we said in our prepared remarks, I think what was different and drove the beat in the first quarter and is also impacting how we guided the second quarter is, obviously, RMS. There was a timing shift with NHP shipments that accelerated into the first quarter. So that was a tailwind in the first quarter and will be a headwind in the second. And then we talked about the strength of manufacturing in the first quarter, which was encouraging. I think we were silent in DSA in the sense that it performed according to our expectations, both in the first quarter and the impact of that is contemplated on the guidance for the second quarter. So I think we spoke about what was different than our expectations of the other 2 businesses.
Thank you. We'll take our last question from Jack Wallace with Guggenheim Securities.
Just quickly on the CapEx commentary. It looks like you reiterated the guide, there's the moderating of capacity expansions. You comment in the deck and just reiterate a couple questions ago. Can you just help us kind of bridge the rate or guide against those comments? And should we think about that as being more CapEx in the back half of the year? Or is the dollars being spent differently than capacity expansions?
Yes. I think I'll take that one. The guidance for the year is the same for -- I think everything we reaffirmed the guidance, right? And so the timing of our capital projects tends to kind of progress throughout the year. Obviously, our free cash flow was quite strong in the first quarter. You saw a decline of CapEx spend year-over-year. So we started the year with capital expenditures being a tailwind to cash flow, and we're going to continue to progress some of our projects as the year progresses. But there's no update, I guess, is the point.
Got it. And then in your prepared remarks, I think you mentioned some timing element in the first quarter for manufacturing as well as RMS. Was there any kind of snapback demand that was [indiscernible] surprising that might not continue in the second quarter? Or did I misinterpret that comment?
Again, I'll maybe take that. So 2 things. The timing impact was really in RMS. In manufacturing, what we saw, which was encouraging and positive is we have seen strength of proposals in the fourth quarter, especially in our testing business and that did translated improved business and stronger performance in the first quarter. What we said in the second quarter for the manufacturing business is that last year, the second quarter was one of the strongest quarters that we've had. So from a comp perspective, it's a little bit of a headwind year-over-year when we get into the second year -- second quarter.
Got it. So there's no -- so basically, the reason why we wouldn't necessarily want to raise the guidance here based on the stronger demand in the first quarter just has to deal with the tougher comps, not because that there's an expectation that the level of the strength in the first quarter wouldn't necessarily repeat in the upcoming quarters. Is that right?
Correct. And I would say for the year, when you think about guidance, it's still pretty early. I think there was a question earlier around whether we think there's upside to our manufacturing guidance. And as I mentioned, we slightly improved it, given that the guidance in the beginning of the year was low to mid and now, we are mid. So we reflected a little bit of that straight already, but it would be premature to say that there's upside to the guidance that we just updated now. I think that's the point. Thank you.
Thank you. We have no further questions in queue. I will turn the conference back to Todd Spencer for closing remarks.
Great. Thank you for joining us on the conference call this morning. We look forward to seeing many of you at some upcoming investor conferences. This concludes the conference call. Thanks again.
Thank you. That does conclude today's Charles River Laboratories First Quarter 2024 Earnings Call. Thank you for your participation, and you may now disconnect.