Session. Thanks everyone for coming. My name is Mike Ryskin. I'm on the Bank of America Life Sciences Tools and Diagnostics team, and I'm pleased to host Charles River Labs for our next session. Joining me is Flavia Pease, EVP and CFO. Flavia, thanks so much for coming.
Thanks for having us, Mike. It's great to be here.
Great. We'll kick. We'll jump right in. Sort of, you know, you reported Q1 key results just last week. You know, anything you can touch on in terms of the key points you want us to take away from the quarter?
Sure. Yeah. We had our first quarter earnings call last week. It was actually a pretty straightforward call. The results were very much in line with what we had expected. So it was straightforward, and we just confirmed guidance for the year as a result of the quarter coming in as we had planned. You saw a little bit of a timing shift between the first quarter and the second quarter, driven by acceleration of some shipments within the RMS sector, segment, excuse me. And then if you look at the other businesses, DSA, we saw you know strong proposal volume, and better cancellations, so that was encouraging. But we're not seeing that yet translate to bookings, so cautiously optimistic on that. And then in Manufacturing, we had a really strong quarter with growth above 10%.
You know, it was really encouraging to continue to see the performance in CDMO. You know, we got our second commercial product with Vertex approved last year. That business continues to scale nicely. Then we have seen both biologics testing and microbio coming back, which is encouraging. Last year we talked about some of the destocking in microbio, and a little bit of a reset in the biologics, putting some pressure on those businesses. But we saw strong proposals in biologics in the fourth quarter, and it really translated into strength in the first quarter. We saw again strong proposals for biologics in the first quarter, so cautiously optimistic that that business is set up for a nice recovery this year. So all in all, you know, strong quarter.
We obviously overperformed, but the majority of that was driven by that timing that I talked about.
Okay. Great. That's a good jumping-off point. So, I'm going to leave the RMS timing aside for a sec, but in terms of the fiscal year outlook, like you said, you reiterated the guide. But if we look at, you know, where 1Q came in, where 2Q guide is, you do assume a pretty steep second-half ramp.
Yeah.
To get to that 0-3 organic target, can you walk us through the bridge there, just sort of how you see things pacing through the year and what you need to see happen to hit that second-half number?
Sure. And again, as I said, with the first quarter results as well as the guide for the second quarter, really nothing has changed in sort of our first-half, second-half outlook or the full year for that matter. So what we were planning and expecting in February in terms of demand trends and market, nothing has changed to lead us to update our forecast for the year. We'll take a step back. I think there have been a lot of questions on that ramp. And just to ground us a little bit, historically, if you look at the last 5-6 years, we've always been a stronger second-half business, if you take last year out of that picture. And on average, it's been sort of 48% on the top line in the first half and about 52% in the second half.
So we normally see an acceleration of sales between the first half and the second half of the year. And if you look at the top end of our guidance range, that's what we're planning, right? Even with the Q1 results and how we guided to the second quarter, if you do the math, that is sort of the split that you're going to get at the top end of the guidance range. And that's consistent, as I said, with the 4-6-year, excuse me, 5-6-year, trends. What is a little bit different is, you know, the margin.
So again, if you look at historically and you take maybe 2023 out of the picture because, you know, that was a outlier where the second half was quite slower, that 48-52 on the top translates to sort of 45-55 on the margin. We are a business that naturally scales, right? We have physical and people capacity that is able to absorb that increase in revenue. And so the margin that you get on that incremental sales tends to be, you know, higher. So you normally see that. So that 45-55 would be what we normally experience. We are a little bit more weighted in the second half for the guidance at the top, this year. And there's a couple of reasons for that. Number one, I talked about we had $60 million-$70 million of restructuring savings that we guided to.
I said last week that we're probably closer to that top end of the range. But I've also talked about those programs are going to be fully implemented or onboarded in the second half of the year. So we're going to have a bit more of a benefit from those restructuring savings in the second half compared to the first half. And then the second thing that I would point out is that scalability that I talked about; it's going to happen in, you know, in all of our businesses, but particularly in the CDMO space, where for the last couple of years we had to make some investments retrofitting sites, getting ready for commercial launches in, you know, investing in audit readiness. That is a business that is now primed for scalability.
So I think it's going to be a larger contributor to that margin improvement that you're going to see in the second half.
Okay. That's all really helpful. Talking again about that second half, number and sort of the, the pacing you've had through the year, I mean, I think a lot of the confidence probably still stems from your backlog, right? You had built up a pretty elevated backlog over the last couple of years. You are starting to draw it down at the same time. So can you give us an update on, on where that stands? You know, what's the book-to-bill been like and, and how you see that playing through the rest of the year?
Sure. The backlog, for most of 2023, hovered around 12 months. So for three quarters of 2023, that's where we stayed. And in the first quarter of this year, we are at 10 months. So it did come down, but the rate of decline declined. So the, you know, sequentially, if you look at how much we draw of the backlog in the first quarter of 2024, that was less than in the fourth quarter of 2023. We've talked about, I mean, the backlog in the sort of 2021, 2022 years really escalated to a level that we had never seen and candidly never thought, you know, would be possible, you know, 15, 17 months.
It's hard because for a client to really know what they're going to be needing or working that far in advance, it operationally is difficult to really happen, and to sustain. So I think what we started seeing is a revert back to a more normalized pre-COVID level. I think before the biotech funding boom, you know, we are experiencing 6-9 months. We're now at 10. So that's sufficient to provide us enough outlook to ensure we have enough capacity and gives us flexibility, that if things move and, you know, slippage happens, we can move things around. So I think we're in a good place where the backlog is. As I've said also, you know, for most of last year and as well as in this first quarter, gross bookings continue to be above 1.
It's funny because up until the escalation of the cancellations, we never used to talk about net book-to-bill. We just talk about gross, right? Because cancellation and slippage were a normal part of the business, and it was all about, are you getting enough bookings, you know, the top end of your funnel to support, you know, the demand and the revenue, down the line. We started having to talk about net and gross because the cancellations sort of escalated with that ballooning of the backlog. So over the last several quarters, we continue to experience gross book-to-bill above one. But the net book-to-bill has been below one. And it's mostly driven by that elevated cancellation that I talked about. So I think what we're hoping to see from an inflection point is first, the strength of proposals continuing.
The rate of cancellation remaining more normalized, which we saw it in Q1 and we saw it in Q3 of last year, but Q4 sort of picked up again, right? So we had 2 out of the last 3 quarters being a more normalized level, but one wasn't. So we want to see a few quarters of that pre-COVID level, and then we can go back to just talking about gross bookings and focusing on that. So gross bookings above 1, and was sequentially up, and net book-to-bill still below 1, but it also sequentially up.
Okay. So it sounds like you're okay with that net still, being a little bit negative. You're okay drawing down that 10-month backlog. And you know, you think you'll exit the year back in that 6-9 range?
Yeah. So I think what we said is, you know, if you look at our guidance range, to get to the top end of the guidance, you know, we are expecting that healthy proposal to continue and to start seeing that healthy proposal translated into bookings. And that will provide support for a modest improvement in the demand and in the second half of the year. If things take a little bit longer, if you will, you know, and the net book-to-bill remains below one. So in that high-end scenario, the high-end top end of the guidance range, we see maybe that net book-to-bill getting closer or, you know, higher than hovering the one.
If things take a little bit longer, you're going to see more of a continuation of the current demand environment and maybe just only a slight improvement. That will put us at the kind of bottom end of the range and the net book-to-bill remaining below one. So that's how we're thinking about the guidance and these leading indicators.
Okay. All right. That's real helpful. Maybe that's a good place to transition to just sort of the health of the end market and your customers, you know, both on major pharma, and early biotech. Let's start with major pharma. You know, there's been some lingering pipeline reorganization, some cautious customer spending, you know, as you talked about with the bookings trends. How's this playing out, you know, March, April, as you're going through the year and sort of what are your expectations there?
Yeah. So I think we saw both small, medium, and large clients go through a process of, you know, pipeline rationalization, prioritization, maybe driven by slightly different drivers, but kind of leading to the same outcome. Obviously, with biotech funding environment being constrained starting in 2022, that put pressure on the smaller biotechs to really protect their cash burn, given the uncertainty that they had in terms of, you know, when would that next round be, when can they get a secondary. If they were counting on an IPO, that market was closed for most of, you know, 2022 and 2023. So we definitely saw people in the smaller end make their dollars work longer and deprioritize things. For large globals, you didn't see them stop programs that were mid-flight.
and so that actually, you know, provided some protection, especially our Safety business, given that we have a big portion of our Safety supporting global pharmaceutical companies. And so you saw you still saw some strength in 2023, as they were finishing that. But in terms of new work being booked, you also saw them do some level of pipeline assessment and prioritization. I think, you know, I'm speculating here, but what we hear from them and read is obviously they're assessing the impact of the IRA. And, you know, does that change their calculus in terms of some programs that maybe make it harder to justify from a return perspective? And then obviously some of them are having to navigate some large LOEs that are coming down the pike. And that actually can be both positive and challenging for us, right?
In the sense that obviously with the LOEs, sales is pressured, and there's a need to prioritize investment. But on the other hand, they need to refill that pipeline, right? And, and so I think they, they go back to the drawing board. And once they are done with that prioritization, they really need to make sure that they have enough in that pipeline to hopefully replace and support their top line when, when those LOEs, happen. So I think it that process is, is what we experienced starting in 2022, went through 2023. And I think we're hoping that they're mostly done with that.
Okay. That was going to be my next question, but we'll move on. And then so thinking about the biotech funding environment, really strong first quarter, some encouraging signs there. You know, how many quarters do you need to see to one, gain confidence that this is durable and this isn't a temporary uptick? And how many quarters until you see some of that money start flowing through?
Yeah. I think, you know, listen, the first quarter was, was really encouraging. I think in a way more positive than, than maybe us and others thought, we were going to get to. I mean, it was the fourth strongest quarter in biotech funding history. That's really nice. The good news is April also was strong. I do think that the other part of the calculus is interest rates, on the other hand, are not coming down maybe as quick as people were planning or hoping for. I think late last year, there was, you know, a bit of a, a ramp on, on the, the biotech space, I think, under the hope or assumption that the Fed was going to be aggressively cutting down rates. That definitely is not happening maybe at the, the pace or the clip that people were maybe hoping for.
So I think there's a little bit of optimism and positivity on funding. But there's still a little bit of, okay, when are interest rates going to come down? Is inflation really tamed? Is the Fed going to take longer? That is still holding people back a little bit. And I think once we see that get better, I think people are going to be even more confident. Going back to your other part of your question, you know, we already saw an increase in proposals, which is a good sign that people are feeling more confident. We now need to see the increase in bookings following that. And that can take, you know, a couple quarters to happen. Somebody asked me earlier, "Boy, you know, why is it that long?
If you're now feeling better about, you know, your, your cash outlook, why wouldn't you just go back roaring, and get your, your studies booked?" You know, it takes some time. People have to relook at the study designs. They have to, work with the FDA or whatever regulatory agency and with us to, to think about how to do that. And then we have to price it. We have to, to start it. It takes some time to secure the test articles to get the studies back. So, you know, it's not a flip of the coin. You know, I feel good and I'm going to see that booking and revenue. It does take probably a good couple quarters to see that happen.
Okay. All right. That's helpful. I want to touch on some of the segment specific results. First, let's go to DSA. Can you talk a little bit about Discovery versus Safety, you know, how that played out in 1Q? You know, how have DSA bookings worked?
Yeah. So, you know, Discovery is still a relatively modest part of the DSA segment, probably, you know, around or below the 15% of, of the overall segment. So it's sort of the DSA goes where Safety goes. Discovery has been pressured, longer and more significantly than Safety. We had seen the Discovery slow down, in 2022. So it started, as I said, earlier than, than Safety. And the, the level of decline is definitely more pronounced in Discovery than, than in Safety. Also very different business in the sense that the Discovery work tends to be quicker, both in terms of, you know, how quick you can get into the into that backlog. The backlog tends to be shorter. Those studies tend to be shorter in nature. Safety is, is very different from that perspective. We also get some questions, right?
I think in the past, people said, "Oh, you know, Discovery is the canary in the coal mine." I think it can be on the down, but not necessarily on the up. And what I mean by that is, our clients still have quite a bit of infrastructure in the Discovery space vis-à-vis the Safety space. Discovery is only, you know, 25%-30% outsourced, where Safety is 60% outsourced. So when things start to get bad, they can take the work internally, much more so in Discovery than Safety, number one. And then when things get better, they can, again, do that work themselves before they start thinking about outsourcing.
The second reason is as people, as clients, you know, sort of prioritize their pipelines, put things on the shelf, chances are that now what they're going to go back to is things that have already been de-risked, right? That were in that late stage Discovery, early stage Safety, getting ready for an IND study before they start all the way back into kind of early Discovery, right? Those, those compounds, they have already been discovered, optimized, de-risked. So naturally, they're going to focus on that before they go back to, you know, really adding to the early stage of their pipeline. So we actually think, we'll see Safety come back before we see Discovery.
Okay. That's helpful color. Maybe let's, let's talk about NHPs a little bit. You talked about a, a benefit from pricing, and pricing NHPs overall has been a pretty big debate point over the last year. You know, remind us like where they are where are where is price today relative to peak, both for you and for the market as a whole?
Sure. And I have to thank you for like going 22 minutes before you actually asked me an NHP question. So, it's good that, you know, we're getting back to the more normalized discussion on other strategic things before we talk about NHPs.
Yep.
Pricing in the first quarter, both on what I would call sort of base price as well as NHP in the DSA segment, was still modestly positive. So, you know, we talked about that last week. There was a lot of talk last year about, you know, some channel checks and competitors suggesting some meaningful decline in NHP pricing. And I have been saying that all along, you know, we're not seeing that. We're not planning for that. And part of the reason is because we never our prices in terms of NHP never escalated to what I would call was kind of the spot market. Maybe that happened once the supply from Cambodia especially got disrupted. So NHP price was positive in the first quarter. It's modestly down versus the peak. But again, you know, overall very stable, I would I would say.
That's a testament to, I think, the robust and diversified supply chain that we had that was secured and, you know, didn't force us to have to, if you will, scramble to get, you know, NHPs when things got disrupted.
Do you expect that dynamic to continue for the rest of the year or do you see some downside risk to price? Maybe.
Yeah. I think we, you know, when we provided annual guidance, we talked about $15 million-$35 million of NHP price being a contributor to the DSA segment. I think, you know, we're still in that range, maybe a little bit to the mid-bottom part of that range rather than the top. Yeah, still looking for positive price in NHP for the year.
Okay. And you called out and you flagged this earlier. There was some timing shift from Q2 to Q1 in the quarter. You expect that just completely balance out in the second quarter, right? It was, you know, in that $10-$15, $20 million range?
Yeah. We didn't provide specifics, but yes, it was a timing shift between the second quarter that got kind of accelerated into the first quarter. Again, no change to the first half, second half. It was just a Q1 to Q2.
Okay. All right. Let's talk about RMS a little bit. You know, you've called out some growth, especially in China. You know, how are you, what's going on there? It seems like that's sort of, the one thing in China that seems to be growing anywhere in our space. So, why is it so unique?
Yeah. We're pleased with the resilience, if you will, and the continuation of the performance of our business in China. It's definitely not. We also saw an impact of the well-documented macroeconomic headwinds. But on a relative basis, you know, if you compare to the tools companies and what they're talking about in China, we're definitely not seeing. The business is still growing in China, which is great. And I think we attribute that to the fact that, you know, the small models that we sell there are very cost-effective and essential part of early stage research. Whereas, you know, if you're thinking about a large equipment in the tool space, you can probably defer that. But, you know, small models are an essential tool to enable that research to continue.
So we continue to see the resiliency of that business and, you know, pleased to continue to have growth there.
What's your customer base look like over there in the region? Is it multinationals doing local work? Is it local players, CDMOs?
Most of the work is China for China. So, you know, local players doing work for local Chinese companies, they might be doing some work for Western companies, maybe in the early Discovery side. So I would say the majority is China for China.
Okay. All right. I want to, we got a couple minutes left. Let's move down the P&L. Can you talk about sort of the margin assumptions for the rest of the year and especially, you know, given what we talked about in terms of the revenue ramp? Sort of like what's the flow through on that as you go through first half, second half?
Yeah. So as I said, it is a little bit more weighted in the second half. We have reasons for that. As I said, you know, talked about the restructurings that we've done. Those will be fully implemented in the second half. So that definitely is going to help with the margin as well as the second half higher sales volume, right, is going to leverage that fixed infrastructure in a way that is going to have a nice drop through. So we should be seeing higher margin in the second half.
Okay. Then you touched on the $60-$70 million cost savings. You know, you mentioned that's implemented already. Any, you know, any opportunity to find more beyond that? Just sort of, and where exactly are you looking for that?
Yeah. We're obviously always looking, you know. We, it's incumbent upon us every day to look at our infrastructure, both physical capacity as well as, you know, labor and, and, workforce capacity to ensure that it's right size for the demand environment that we're experiencing. You obviously don't want to cut too deep, because you want to make sure that as the market comes back, that you have the capacity to take all that extra demand and get additional share. So it's a good balancing exercise. I think we were very effective in right sizing it. It was, you know, about 3% reduction in our workforce. We shut down a couple of the smaller sites where we really didn't need that capacity. So I think we got to a good place where we were responsible and responsive to the demand environment.
We also, you know, want to make sure that we are prepared to support our clients as the market comes back.
Okay. Talking about capacity and being able to serve clients, you know, can you talk a little bit about operating cash flow needs, or just free cash flow in general, CapEx plans to go through the rest of the year?
Yeah. We, you know, I think free cash flow took a little bit of a dip over the last couple of years as we had higher than historical norm CapEx investments. We're definitely sort of past that phase. I think we got it to, you know, 7%-8% of CapEx in our last Investor Day. A couple of years ago, we said maybe we're going to get to 9%. So you can see that we definitely modulated our CapEx clip of investment, if you will. Free cash flow, I think we got it to $400 million-$440 million. So it's a nice increase from last year, much faster increase than the increase in earnings. You know, we also had some working capital investments over the last couple of years to fortify our inventories and we're past that.
I think we're going back to being a very healthy free cash flow generating company.
Okay. Great. Got about a minute left, so we'll go to our standard closing question. You know, what's most underappreciated or misunderstood about Charles River? Is there anything that you, you really feel like you need to address?
I don't know if it's underappreciated or understood, but I think I'll just reinforce, you know, the power and of our portfolio, the breadth and depth of our scientific wherewithal. I think bar none. And, you know, when the market comes back, it will come back, right? So it's a matter of when, not if. We are clearly the leader in the preclinical space and the natural partner of choice for our clients. And so I think, you know, if you believe in the underlying demand strength of this industry, you should believe that we are going to be going back to our, you know, historical mid-high single-digit growth that we have experienced, and, you know, have opportunity for margin expansion and nice free cash flow generation. So.
Great. Thanks so much.
Thank you, Mike.
Thanks, everyone. Thank you, Flavia.