So they say we're ready to go. So, Dave Windley with Jefferies Healthcare Equity Research, coming up on my 24th year, believe it or not. So welcome to Jefferies Healthcare Conference 2024, June here in New York. Very appreciative of your attendance and interest in our next presentation, which is Charles River. Flavia Pease is the company's executive corporate senior—Corporate Executive Vice President. Got that right, Corporate Executive Vice President, and CFO, more importantly, CFO. And we were just talking outside that she's just passed her two year anniversary, and with Charles River, and our fireside chat in November of 2022 in London was one of her first. So we're revisiting our discussion here. So, thanks again for being here. Good to see you.
Wanted to just start right off the top on kind of the outlook for the year and, you know, call it captured in guidance. Q1 had, you know, some factors, some transient—I think you, you're, you guys have described factors that influence growth in the first quarter. So Q1 starts a little bit below your expectations for the full year, and then you're expecting, I think, growth to ramp a little bit and margins to expand a little bit. And so maybe you could talk through kind of the key drivers of each of those to get to your guidance for 2024.
Sure. Good morning, everyone, and Dave, thanks for having us. It's great to be here. To your point, our outlook for the year after the first quarter remained consistent with the guidance that we provided in February. The way the first quarter happened was consistent with what we expected. There was just a bit of a shift in gating between Q1 and Q2, driven by timing of NHP shipments. Manufacturing performed a little bit better, but overall, the guidance and the outlook for the year remain intact. So that gets us to your question around how, how did we guide, and what are we seeing the year developed, especially with a slower start and then a bit of a ramp in the second half?
So let me first start by saying, if you actually look, historically, and you exclude last year, which is a little bit of an abnormal year in terms of the quarterly trends, we tend to have about 52% of our revenue in the second half. That's just our normal trend. And then this year, at the top end of the range, it's the same level, 52%, consistent with history. Obviously, that assumes a modest improvement in the demand environment in the second half. You know, the good news is the factors that will lead to that, we saw some of those signs in the first quarter. Funding was very robust, as you, I think you just published your May report, I think today or yesterday.
It was, again, another good month, a little bit lower than the Q1 average, but still flat to April. Funding was robust among all sources, you know, PIPEs, VC, IPOs, and especially IPOs, was nice to see that picking up in the first quarter of the year. With funding improving, we also saw an improvement in proposals, which is a leading indicator to, and, you know, eventually bookings and then revenue. I think you also talked about that in one of your reports, that it does take a little bit of time for that cycle to go through. But if you look historically, that's what we see in our industry.
So we're seeing those leading indicators that lead us to believe that there is this possibility assumption that the second half is gonna start picking up a bit of steam versus what we're seeing in the first half. There's also the comps. You know, our first half last year was stronger than the second half, and so just on a comps basis, you're gonna have, you know, declines in the first half, as we saw in the first quarter and guided to the second quarter, and then a nice growth rate in the second half.
If you go then to margin and earnings, there's an intrinsic leverage that happens in our business, and if I go back to the same last five years, on that 52% of revenue in the second half, we normally get 54% of margin. So there's a normal leverage ability in our business to deliver additional margin once your sales expands. This year, in the top end of the guidance range, is a little bit more than that, you know, 46-54, and there's reasons for that. First of all, you know, in this lighter demand environment, we have done some restructurings and some reorganizations to rightsize our workforce to the lighter demand environment. I think, you know, we talked about that in the first earnings call, and we can get deeper into it.
But we didn't, let's say, cut as deeply as perhaps we could, because there's an expectation that the demand, that this phenomenon is transient, and the demand is gonna come back. And so we have an ability to accommodate work in the second half without having to add as much staffing. So that helps with the margin expansion. In addition to that, those actions that we took, we also talked about, it's about $70 million that we guided for the year, and while we started some of those as early as last year, you know, I think last year we said they were annualizing to $40 million, and then we continued to look at, given where demand was, and now they're annualizing to $70 million.
But some of them were still being implemented and executed in the first half, the first quarter, and so they pick up steam, and they will be fully implemented by the third quarter. So you have a benefit in the second half of additional savings associating with some of these actions versus the first half of the year. And finally, I think we talked about also when we acquired Noveprim. That business has a bit of seasonality. It's strongest in the fourth quarter, given the shipping patterns and trends. So there's, y ou know, I don't like to go through a laundry list of things, but there's a bunch of items and factors that will lift that margin in the second half, more so than the first half.
Okay, great. I'm gonna kinda go segment by segment and start with RMS. So one of the themes and inbound questions that we get is around RMS growth rate in a way that portrays to me that folks kinda don't realize that this used to be a low single digit grower, and now is an upper single digit grower because of how you've reformed the kind of the composition of that segment, and part of that was some investments in cell and gene therapy support capabilities. So maybe you could talk about the faster drivers of growth in RMS that are cell and gene therapy targeted, CRADL, et cetera, and what the outlook is for those businesses to continue to drive that higher growth rate in RMS.
Sure, and just to your point on Cell and Gene Therapy, we have a couple of. We have Cell and Gene Therapy work across our entire portfolio, even in safety. And then we did a few acquisitions, to your point. We had a cell supply business that is about collecting cells that can then be used in manufacturing. That part of the business, as you pointed out, resides in the RMS segment. But then the bigger portion of our Cell and Gene Therapy portfolio is actually the CDMO portion, where we actually are manufacturing product for our clients, and that actually sits in the Manufacturing segment. That's the majority of our Cell and Gene Therapy offering.
Within the RMS business, I would actually say the biggest driver of growth acceleration is more the CRADL and services business, more so than the cell supply that you alluded to. That cell supply business was negatively impacted by COVID. You know, donors couldn't go to the donor rooms and, you know, we essentially had to sort of shut that business down for a prolonged period of time. In addition to that, since that acquisition and during this period, there's a little bit of a shift in the business itself, what is being produced and by whom. You got other players, like cell banks, coming into the market and sort of servicing the more commoditized part of the market.
So we also, similar to what we did in our CDMO business, where we retrofitted and created centers of excellence, focus on gene-modified cell therapy, plasmids, and gene and viral vector, excuse me. In the cell supply side of the business that resides in RMS, we also reconfigure our portfolio and sort of upgraded it from the more commoditized portion into kind of higher grade GMP offering. So that, you know, is still in the works. I think that business is poised to having a better year this year, but it's not the primary driver of the RMS growth that you were talking about. That is really on the services, the differentiated services, whether it is CRADL and even our GEMs, our genetically engineered models that we provide.
Those are more sophisticated models that are sold at, you know, at a higher price, and we provide services in managing those colonies for our clients. And so it's really the expansion of the services business that I would say more so is driving that increase in, you know, growth rate in RMS. And just for those of you that are not familiar with CRADLs, you know, Dave used the term, that is a vivarium as a service. We provide, you know, capacity for, you know, anywhere from like one cage you might wanna have to an entire room, and all the services that are added to it, you know, husbandry, the veterinary, regulatory, and we have the facilities.
When we started that business, Dave, sort of the assumption was gonna be, it was more of an offering for, for small biotech clients that didn't have infrastructure, that didn't wanna invest in infrastructure. But actually, it's been surprising to us in a good way, even large pharma is happy to adopt that model, and in fact, we have now sort of anchor clients that will take, you know, 50% of one of our CRADLs and just fully dedicate to a, you know, one large pharmaceutical company, for example. So those are really the drivers in RMS.
Yeah, that's great. That's a, that's a great segue, too, because I wanted to ask a specific question on CRADL. In the first quarter deck, you, there was discussion of focus in certain markets. So I think, I think you've logically built or, or established these CRADL pins on the map in major biotech hub research areas-
Exactly.
- like Cambridge, like South San Francisco, San Diego, et cetera. And you had some commentary in the deck about focusing, kind of maybe down, downplaying, I think it was South San Francisco, 'cause maybe it was a little crowded, and kind of redoubling down on Cambridge. So maybe talk about the regionality of demand or the competitive landscape.
You're spot on in how you are portraying, you know, our commentary. And you know, the market for this vivarium as a service for the CRADLs is still robust. It's not immune to, you know, the slowdown in demand that we're seeing in general in the industry, but it's still robust. And in fact, we have plans to open new CRADL facilities this year, although at a slower clip, if you will, than it has been at the last couple of years. And to your point, these CRADLs are focused in the biotech hubs and even, you know, sort of micro geographies within li ke in Boston, it's not just Boston; it's Cambridge versus other locations.
To your point, in South San Francisco, we did an acquisition of Explora just before I started with Charles River in April of 2022, and with that acquisition, there was a robust footprint in the South San Francisco area between ourselves and what Explora had. And as some of those facilities, the lease on them expire-
We're using that opportunistically to, to sort of optimize the footprint. But to your point, you know, San Diego, Boston, still very robust, and we're actually opening new locations in these, in these, regions. So it's not that South San Francisco is being deprioritized, it's being strategically optimized, I would say, at given kind of the overlap that we had, in, in some capacity there.
Yeah. I appreciate you're putting in context that Explora had a big footprint there, so that's interesting to know how that folded in and then some of the lease expiry. While we're in RMS, let's spend a minute on small animal model sales, 'cause that's historically been really the core of RMS, and it's a good kind of barometer on early research activity. So, talk about model sales, please.
Yeah. Small animal models is sort of the most, I would say, basic effective research tool. You know, I think we get questions over the last couple of years, especially in China, right? Some of the tools companies have seen, you know, that being impacted, their business being impacted, and we have a models business in China as well, and we didn't see that. It slowed down from higher years, but still healthy demand, and I think part of the reason is, it is still the most effective, cost-effective and practical way for research to be conducted. So the business is still growing.
It's this year gonna benefit more from price growth than volume, which has been historically the trend in RMS, in the small models part of the RMS business. But in Q1, we, you know, had growth across the regions, China led, and we continue to see good demand. Academic, which is a unique part of the RMS portfolio, right? We don't really see a lot of academics buying in safety or in manufacturing, but it's a big segment for the RMS business, was solid in the first quarter, so still good demand there.
Got it. Let's move on to DSA, clearly important. We need to touch on that before we run out of time. On the first quarter call, and you referenced it earlier, that funding had improved. There was a little bit of a sentiment improvement, and you mentioned proposals, so I might first of all clarify: Your comment on proposals was a first quarter comment-
Correct
- or a kind of quarter-to-date, 2Q comment?
No, and thanks for asking to clarify that, 'cause as you know, Dave, and some of you that follow us, you know, we do not provide really intra-quarter comments. You know, month by month is things move around, and so we try to make sure that we have quarters under our belts when we provide guidance, and so we'll provide more color, more robust color commentary for all of you after the second quarter. So I was referring to increasing proposals in the first quarter.
Okay. And then, in that first quarter context and commentary, first quarter call, Jim talked about using price in some, I get the sense it's more surgical, but, but using price. Talk for us about, you know, how you, how Charles River is using that, and, and where is it more NHPs? Is it more small animal? You know, where, where is that price being applied, and maybe, you know, the competitive landscape that, that you're facing in, in doing that.
And you're almost doing the work for me, 'cause I was gonna use the word surgical. So, you know, I think in the first quarter call, we talked about selectively discounting, and that, that's important to qualify because I think, you know, you and others might do channel checks and, you know, get information about a certain competitor or a certain body of work being discounted. And then appropriately so, you're asking us our perspective, and so it is not broadly based. It's not, you know, across the entire portfolio. In fact, in Q1, we still had positive price in the DSA segment. There's other parts of our business, like RMS, that we talked about. We've been able to take price year after year, and, you know, we have a lot of pricing power there.
In DSA, obviously, you know, it's not immune to a demand and supply dynamic. Over the last couple of years, we had a lot of pricing power. Obviously, if the demand softens, as we have less pricing power, you know, simple math. But the thing, to your point, Dave, is surgical in the sense that the safety business is unique, that, you know, there's not a price list. You don't go, and you buy, and it's a product, and it's, you know, a price, and then maybe you have a discount off of that. Every time you're quoting a study, it's a unique product, right? So every time we have a chance to price that, and to price it based on the supply and demand quotient, to how, you know, we are, h ow busy or not our sites are, other people's sites are, but also the type of work.
You know, if you think about the industry, and you ask about the competitive landscape, we have about 30% share in safety. The next competitor is, you know, less than half of our size, and then you have a lot of smaller players. And these smaller players, you know, they're capable and qualified, but they have a much narrower portfolio, right? And so they are more focused on the general tox space rather than specialty. So, for example, you know, we really don't have, and don't discount on the specialty side of the house.
In the general tox, we might do it if it's a new client that we've never done work with, and, you know, we're trying to have a sort of try us, a trial offer for them. So that's what we mean by selective or surgical. And, you know, I get the question: "Well, why are you, why are you even mentioning if it's selective or surgical like that?" One, because we get the question from you guys. "Well, I hear, you know, competitor A or competitor B is discounting this much. Are you guys doing it?" And two, because I think, you know, we have said the pricing power is not as robust as it had been two, three years ago, right? So it's—we want to be transparent and clear around what we are experiencing in the marketplace.
Got it. That's very helpful. So maybe coming back to the guidance question, and my next question is around cost reduction. Certainly, some of the cost takeout that you talked about at the top applies in DSA. Maybe you could comment on just how much.
Yeah. We haven't broken down by business, but I think a good rule of thumb, right? DSA is 60% of our revenue, and manufacturing is 20, RMS is 20 in round numbers. The actions that we've taken were across the entire portfolio, so there's gonna be benefit across the three segments. You know, it's not the 20, 60, 20 necessarily, precisely, but, you know, that's a good rule of thumb to try to figure out how to sort of apportion some of the savings between the businesses.
Got it. And then thinking about these two things converging, so it looks to us, and I think, kind of within your guidance, it's consistent that to get to the guidance, as we talked about earlier, you need ramps through the year. I think DSA is one of those. DSA margin, maybe in particular, goes from, you know, a 23.5% first quarter to something, you know, well into the upper 20s% to kind of get there through the year. Cost reductions are gonna help, but you also have this kind of surgical price discounting. Maybe talk about the relative balance of those influences on the margin and how that margin ramps through the year.
Yeah, and I think, you know, the size and the impact of discounting is not profound, because it's surgical, that is gonna have a major, you know, creates a major headwind on the margin acceleration that we see. The margin is really gonna be driven by that additional volume that I talked about. One, because, as I mentioned, we now have the staffing to take on work without having to add people, because even though we right-sized to the demand environment, we didn't wanna go too deep and then have to hire a lot of people and have a lot of people, you know, being trained and not be able to support that demand improvement that we are anticipating happening. So it's really the volume that is gonna help drive that margin accretion in DSA.
Got it. I'm gonna move to manufacturing in the interest of time. So in our follow-up conversation, you had described to me, helpfully that the microbial, the kind of-
Legacy.
-longtime businesses of manufacturing had worked themselves back up to what I thought I interpreted you to say, pretty normal margin. And so that kind of implies that the CDMO business is not all that profitable at the moment. Would you agree with that? And to the extent that manufacturing is the driver to get you to your targets for manufacturing margin, what does it need to have?
Yeah, and, and you are absolutely correct. If you get the focus on the two legacy businesses, I would say that they are back to the legacy margin pre-CDMO acquisition. When we acquired the CDMO businesses, we did say that they would be margin dilutive. What I would say is they were more dilutive than we had perhaps anticipated at the time of the acquisition because, as we said over the last two years, we really completely reconfigured those businesses, right? Starting with creating these centers of excellence in plasmids, viral vectors, and gene-modified cell therapy. There were facility investments, there was equipment, there was personnel that we had to add. So it was heavy investment in 2022, and then in 2023, those investments continued as we had two of our clients' products become commercial.
So there was a lot of investment in quality systems, getting ready for commercialization and regulatory audits. That's all done now, so the expectation, assumption is you now have a cost structure that can absorb a lot of additional volume without any incremental investment. And so as the business continues to grow, and, you know, we're not gonna have time to talk about cell and gene therapy, but it is a space that continues to be robust for us in terms of demand. You know, booking proposals, bookings, the pipeline is nice, so we see that path to additional revenue in that business, and with that revenue, driving additional margin as you have a scalable business now.
Got it. We're getting the flashing zeros, but I'm gonna sneak one in, which, and it's probably a big question, but maybe you could just point to one thing. On BIOSECURE.
Yep.
Where would you expect to derive the most benefit from that if that ultimately is passed and implemented?
So to your point, if it's passed and implemented, so let's assume that that's the case, we do think that it's, it's positive—it could be positive to Charles River. It's important to caveat, though, that you wouldn't see an immediate impact, right? Because there's grandfathering, both in the House and Senate versions of the bill. One is, you know, forever grandfathering, the other one is, I think, until 2034, 2025, 2035. But over time, though, so those people that are doing work with, with WuXi today are gonna probably continue doing work. But what we do think could happen is new, additional new work that is gonna be started, clients might be more risk-averse about starting work with them, and they will look for, you know, Western CROs like Charles River.
We think the biggest potential impact would actually be in the biologics and CDMO space.
Okay.
We do compete with WuXi also in discovery, but a lot of that discovery work that they do is more chemistry, you know, kinda lower cost, more commoditized, which likely would go to somewhere like India before it comes to a Western CRO. But we are actually seeing, starting to see some inquiries into the CDMO and biologics space. You know, we had a couple bookings. They're not meaningful but we're starting to see some of that.
All right. Very helpful. Thank you, Flavia. Thanks for being here, and thanks for the audience's attention.
Thank you very much.
Talk to you soon. Thank you.