Important disclosures, please see Morgan Stanley Research Disclosures website at www.morganstanley.com/researchdisclosures. Thank you both for being here. Great to have you both.
Thank you.
Thank you.
Thanks for having us.
Birgit, you took over the role of CEO from Jim in May. Four months now into this new role, how has that transition been so far? You were obviously at Charles River for quite some time beforehand across different responsibilities there. So maybe, what surprised you leading the ship?
Yeah. 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 four months literally visiting over 40 of our sites in seven countries. I met with a lot of the shareholders, met with our board and a lot of our clients.
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. Glenn, you have also joined Charles River pretty recently. It will be great to hear a bit more about your five months or so in the role.
Sure. I have been with Charles River now for about five months as Chief Financial Officer. I would just say it is a complex business, so is the whole drug development process. I am up to speed and learning on a lot of different things and have gotten out to many of our sites. I have been out to, I think, 16 or 17 sites now. That is going really well. I am very fortunate to be joining the company at this point in time. 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.
We are at this inflection point for our business, which is happening here starting in the second half of 2026, where we are going to see significantly better financial performance, both top line, margin expansion, earnings per share improvement, and so forth. Fortunate to be joining the business at a good time. We have 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 have also acquired a large NHP farm. We are well-positioned here to see better performance starting in the second half of the year, and I am 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, three consecutive quarters now of a north of one 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? How are you driving those better win rates? Maybe just parse out those two dynamics.
Yeah, certainly happy to. What I would say is that both of those dynamics play a role. The industry backdrop matters. We all know funding has improved. Pharma is back to work. We are 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. Definitely, the demand is improving. We do not expect a straight line, but we do expect stabilization and acceleration of that. In addition to that, we have spent 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 timelines for starting the work, that we have the resources when our clients need them, and that we 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. Overall, I would say both are important dynamics and both are in our favor right now.
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 seeing those rates go up? 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. Then the small and mid-sized Biopharma 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?
Yeah, 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. We look at large biotech, smaller biotech, that's also got very positive trends. Biopharma has gone through the restructuring of their pipeline and portfolio. 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. 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 three or four quarters now of really strong bookings, but we'd like to see a couple more quarters before we call it a trend. We'll see how the rest of the year plays out here, but all indications are that things are moving in the right direction.
Yeah, 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. How should we be thinking about that?
Yeah. 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?
That is generally, I would say, maybe a quarter, but that can vary quite a bit. But we are 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. 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 put in place. 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?
Yeah. So what we are hearing qualitatively from our pharma clients specifically is that everything is about more programs into the clinic, more programs into commercials. So just about everyone has a program name for that, really getting more wins through internal development. The discussions have really shifted from reprioritization, from where do we find the next cost savings, to how can we speed up a 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 by your pharma 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 things. One, we're 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. 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. 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.
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?
At this point, pricing is stable. We have been saying that for a couple years, meaning discounting is happening, but not any more than it was before. We have not seen pricing return as strong as we would like to see it. At this point, we're still at the stable standpoint, but 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. But I would caution with that a little bit because once pricing is coming back, it has to flow through this two-quarter process of getting in a proposal, getting to bookings, and getting to execution. From a revenue perspective, we're a little bit out from that standpoint.
That's helpful. Then just on the book-to-bill, 1.19% in Q2, highest number we've seen in nearly four years. How should we be interpreting this metric? Is that a number we could expect perhaps for the back half of the year?
Yeah, I wouldn't call that the norm. It was the highest we've had, as you mentioned, in four years. I think the way we look at it is we want to see our net book-to-bill above one, which would give us sustainable growth for our business. Anything above one is what we shoot for, and we may see quarters where it's above that, may even have a quarter or two that's even below that. But I think having a net book-to-bill above one 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 five or six quarters ago, we were below 0.8%. We're building a lot of that backlog back. 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.
Yeah. Perhaps just talk through that relationship between book-to-bill and revenue growth. Because when I look at a 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 a 1.19%, and how bullish perhaps could we get?
Yeah, 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 one.
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. 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. 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 in 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 full process there.
Yeah, 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 market right now is between $1.2 billion and $1.5 billion. That's a lot of earlier stage work too, but also 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. 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 competitive. Also balancing it with other investment opportunities. Even though this is a really interesting market, it is an area that we're interested in, I would not expect anything there any time 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. 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 studies. What advantage does that give you?
Yeah. Non-human 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 non-human primates. 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. 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. With that, I do think we are giving our clients the best reliability they can have in the industry, and that alone means a lot to our clients. It is a great way to compete. It is a great way, obviously, to improve our margins, but it is also a great way for us to risk mitigate a very important supply chain.
Kallum, I would just add, too, just the financial benefit of that acquisition, while it happened early in the year, is not showing up until Q4. When we actually use those NHPs on studies is when we are going to see the financial benefit, and so that is one of the reasons why our Q4 margins are expected to be the best in the year.
That gets even better in 2027?
No comment.
We spoke briefly on the pipeline that you are seeing from Biopharma. Saw some pretty positive data a couple of weeks back from Moderna on personalized mRNA cancer vaccines. Some investors think that could be a real paradigm change in the way we think about mRNA medicines. Is that a real tailwind in your view? Maybe just talk about the relevance to your business.
Yeah. I was really excited seeing it and really good news for Moderna. Any innovation, any breakthroughs like that is actually putting a step into the whole demand of the drug development. The more innovation there is, the more excitement there is and the more funding there is. So it helps the whole industry, not just one client or one program, and we do not really view it one client, one program being a benefit. In addition, what is really exciting with that too is mRNA is one of those complex modalities that requires a lot of work, a lot of endpoints, a lot of bioanalytical testing. So we would love to obviously see more of that, and I do think that really sets the stage. So great news, great for Moderna, but also great for the industry and for sure great for patients.
Amazing. Maybe switching over to RMS for a little bit. It continues to face a bit of pressure there from North American small model demand and then some constrained ACA government funding. How should we think about the normalized growth rate for that business again, understanding the Investor Day is next week?
Yeah, I'll take that one. I think as we look at our 2026 guidance, we're indicating a low single-digit decline, and if you think about volume declines happening in North America, we largely offset those with price increases and also I'll call it favorable price mix, where we have higher priced mice, as an example, which are more genetically engineered versus a commodity-type mouse. We're seeing some positive indications on pricing, but it essentially offsets a lot of the volume. We still haven't seen really a recovery in our government or academia business and our CRADL businesses. I'd call those businesses stable right now, but we still haven't seen the recovery there yet. China is an area of growth, as we talked about earlier.
China for us has been growing double digits, seeing some good underlying market trends, and we expect that that will continue as we go forward. We're not going to comment on 2027 and the future of the RMS business. We'll cover that next week and we will give long-term targets and growth rates and margins for all of our segments. That is all coming next week. But it's not going to be the fastest-growing business we have, but it's still a very attractive business for us.
Understood.
Maybe also, just to chime in here, our research models business is an important supplier for our DSA segment and again gives us the assurance that we will have the models that we need for our other businesses and really mitigates any risk in that supply chain. So very important for that too.
Could you unpack a little more what you're seeing from NHP demand in 2026? We've been hearing of some inflation, particularly across Asia. So maybe what's the economic impact of that for you guys, just given how much of the supply chain you have control over?
Yeah. A lot of questions about that. There is somewhat a shortage in China, and the reason for that is that the market had closed down during COVID and had not reopened. As non-human primates are not native to the Chinese market, their breeder supply is not at the level they would like it to be. Even so they have a lot of facilities and a lot of breeding, looks like they're not meeting the demand for their drug development processes right now. They will mitigate that through some breeder purchases, but that will take a few years to mitigate.
As you know, our research models business is we have a farm in China, and our research models business is selling some in the open market. We have seen pricing there a little bit going in a positive direction, really basically resetting from where it was a few years ago, and certainly that pricing could see some positive acceleration. But for us, this is a small business, so not a major driver for us. There is the question if it will impact pricing in the West.
That is really a demand question, and that could certainly be, but I would caution that this hyperinflation, this really high spot pricing that we saw a few years ago was a very different situation. At that stage, there was a whole market that was not accessible. It was different players. We didn't own the farms that we currently owning. So we are not expecting that. We are not putting that in our models. Certainly a little bit price influence is nice, but I would not expect those hyperinflation pricing that some are asking for.
Understood. On the CRADL, we had mentioned briefly that it had not quite returned to growth yet, but stabilizing. Obviously more tied to the new company formation rather than biotech funding. Can you maybe just walk us through what you are seeing on that kind of earlier-stage biotech landscape, and then when perhaps we could see an inflection for the CRADL business?
Yeah. You are right. The CRADL business, their primary customer is this early-stage biotech. We actually have some clients that are global Biopharmas or large biotechs there too, but that is the focus segment. Over the last few years, demand has been declining. We actually took a lot of capacity out of our CRADL footprint to adjust for that. At this stage, our footprint is at the right level. We are not seeing acceleration yet. I think that requires a little bit more time with positive funding, more companies being formed, as you said. We will just be basically adjusting our footprint. Right now, we are at the right level, but as we see demand come back, we will adjust footprint to open up some new CRADL, but not on the horizon yet.
AI has been obviously top of mind. Who are the winners, who are the losers across our sector? It feels like the tone from you guys was pretty positive there from the Q2 call, maybe some early demand uptick you are seeing. Maybe just talk through how you expect that drug discovery pipeline to look maybe three, four years from now, given what AI can perhaps offer.
Yeah. We do see it as an interesting tailwind. It will take a little time. A lot of the investments are in that molecule design that will chuck out a lot more molecules, and in a lot easier way, hopefully also in a more efficient, cheaper way. Then there is focus on the clinical trial. All that maybe efficiency will be reinvested, we believe, into more drug programs. More drug programs is more revenue for us. A nice tailwind that we are expecting. Timing is hard to estimate. First of all, we need to see some successes with AI-generated or AI-assisted molecule design. That is not happening till those programs are in the clinic.
Whatever is happening today will take a few years to really show if it works, but maybe we will see some uptick from work that was happening three or four years ago, sometime soon. I do think that drug development programs will increase a few years in the future. What we are currently seeing as an early indication, but small numbers, is that companies that invest in AI platforms need to run more programs. They need to teach the algorithms and generally get better funding. Those companies are often coming in with more programs than a typical standalone biotech that uses conventional methods. That is still small, but is an indication that AI is driving demand. In addition, we are working on a lot of things that we also will showcase next week.
Good stuff. I want to hit briefly just on NAMs. It had been about a year and a half now since the FDA announced that roadmap to reducing animal testing. Quickly, maybe just describe what you have been seeing from customers there, how you are thinking about that ahead of the LRP you will give, and then maybe just talk about your strengths as well in offering NAMs.
Yeah. NAMs, new approach methodologies, is definitely the right ethical and scientific direction for the industry. All industry participants would love to see more technologies incorporated in the drug development process, but it is not going to be one platform replacing an animal study. It is going to be an integrated approach of many technologies, endpoints, and a hybrid approach of in vitro and in silico and in vivo programs. We will have a whole session on that next week, by the way, that I think you will find very interesting. We are committed to driving the NAMs integration, NAMs adoption, and we will do that by integrating it into our safety assessment processes.
Truly an integrated evidence generation. It takes an understanding of the biology, it takes understanding of the regulatory process to be able to do that, and that is Charles River. What we are hearing from our clients is interest, but they need somebody like us to drive that and to tell them where they can use NAMs as part of a study, and where they cannot. This is what we are working towards too. It opens up a lot of interesting discussions with clients, with regulatory agencies and we are driving that.
I want to make sure we quickly cover the manufacturing business. Your Microbial Solutions are high singles organic in Q2, been doing pretty well more broadly this year. What's driving that growth? And maybe just unpack the largest opportunities you see for that business more broadly.
Yeah. This is a great business that we have. It's a razor blade type model. We place equipment at these manufacturing sites, and then we have consumables growth that comes after. Most of the revenue and profitability really comes with the consumables piece of it, so the cartridges that go into doing the actual testing. We've placed more equipment. We're winning new clients. It's an area that we see good growth coming because as more manufacturing moves to the U.S., that benefits us as well. This is a business that's not just fast-growing, but has very high margins. We don't break that out specifically, but the manufacturing margins you saw last quarter were in the upper 30s, and that's a big contributor to the overall margins for that business.
I think you mentioned that could approach kind of 40% in the back half of the year. Maybe midterm, what are the different drivers constructing that manufacturing margin?
Yeah, I think first and foremost, we still have a little bit of the CDMO divestiture in our numbers from Q2, so having a full quarter with that business out, which was a business that was a big anchor to the overall profitability, is going to help us. This is a business that's done a lot of automation as well, and so they have a really efficient production process. That, coupled with getting leverage on the top line with the business now growing faster, we feel all is going to lead to some further margin expansion. I'd temper it to say it's modest improvements because this business is now approaching 40%, which is a very healthy margin business. But there's still more opportunity, is the point, and we'll lay this out again next week with some more details of what we expect.
On capital allocation, I think good feedback on the decisions made over the past year with the portfolio. Anything now you feel is left to be done here, or are you pretty comfortable with how the business composition looks?
Yeah, I think a couple things. When I think about capital allocation, I first start with the free cash flows of the business. Our business generates very healthy free cash flows. We actually just raised our guidance on the Q2 call for free cash flow. It is a business that annually should be generating, in a normal year, at least a half a billion dollars of free cash flow. We have deployed so far this year about $800 million of capital. So $500 million towards the acquisitions of K.F. (Cambodia) and PathoQuest, which is a next-generation sequencing technology, and NAMs, if you will, for lot release testing. We talked about K.F. (Cambodia) . Then we have done $300 million of share buybacks, $100 million in the most recent quarter. So we have deployed a lot of capital this year so far.
I think from the portfolio side, we are very happy with where the portfolio is at right now, so I do not expect us to do anything dramatic or significant. We will still continue to evaluate the portfolio, but I think the heavy lifting is essentially done and complete for us. Certainly, as we go forward, we want to do a couple things, right? We will be looking at acquisitions in areas where we have some core strength and where we need more scale. We are in a great position when you look at our balance sheet. So we have got about 2.5x leverage right now, net debt to EBITDA. We have got over $800 million on our credit facility at very attractive rates from a borrowing point of view. We have the ability to actually upsize that if we need to with an accordion feature.
So we are in a great position when I look at the balance sheet to support the acquisition strategy, and I am hopeful that we can get some accretive, growthy deals done over the next year or so. We will continue to invest organically as well. If you look historically, we have invested anywhere between 5%-6% of CapEx. That is important because a lot of that CapEx is really earmarked towards growth, and so you can think about that as expanding a lot of our labs and our facilities for bioanalytics, as an example, which is what we are doing right now.
In addition, we have still got about a third that we point towards maintenance. So we will still invest organically. We will invest in the sales force. We will invest in bringing people on board to support the revenue ramps. Then on share buybacks, we will continue to be opportunistic. We saw a good opportunity in the second quarter when our stock pulled back, so we bought more shares back, and we'll continue to be, I would say, opportunistic around that.
Great.
Lastly would be the debt paydown, but again, we're in a very good place when you look at our leverage and our debt right now.
Last question, Investor Day next week. You've given us a few hints of what could come. This is obviously an inflection, I think, for the broader market, so how are you thinking about the guide you're going to lay out? Maybe just talk through the philosophy you'll be putting through that.
Yeah. So obviously, providing targets is difficult in any time. But we think the market is stabilizing and accelerating a bit. But what we're laying out here is targets that are grounded in what we're executing on right now, grounded in what we're seeing right now, and opportunities we're clearly seeing ahead. So no moonshots, no things that could happen in a few years, but really grounded in what we do best. Then we will talk a lot about our strategy and how we get there.
Amazing. Okay. Glenn.
Thank you.
Thank you so much.
Thank you.