Charles River Laboratories International, Inc. (NYSE:CRL) Q1 2024 Earnings Call Transcript May 9, 2024
Charles River Laboratories International, Inc. misses on earnings expectations. Reported EPS is $1.44 EPS, expectations were $2.05. Charles River Laboratories International, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: 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]. I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.
Todd Spencer: 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. Following the presentation, they will respond to questions. There is a slide presentation associated with today’s remarks, which is posted on the Investor Relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately 2 hours after the call today, and can be accessed on our Investor Relations website. The replay will be available through next quarter’s conference call.
I’d like to remind you of our safe harbor. All remarks that we make about future expectations, plans and prospects for the company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated. During this call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results from operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the Investor Relations section of our website.
I will now turn the call over to Jim Foster.
Jim Foster: 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. Biotech funding increased significantly in the first quarter of 2024 to approximately $23 billion, the fourth highest quarter on record. These trends and the improving market sentiment have led to positive discussions with our clients, including at the Annual Society of Toxicology Conference in mid-March, with clients specifically referencing the improving funding environment and optimism that this would lead to additional spending on the early-stage programs this year.
We saw increased proposal activity in the first quarter. And while this is encouraging, and we have available capacity to start certain types of work relatively quickly, our outlook for the year remains appropriately measured. We expect it will take time for additional funding and proposal activity to translate into new DSA bookings and revenue generation. Therefore, we continue to expect demand will improve later this year, consistent with our initial outlook from February. Our first quarter financial results reflect a continuation of the demand trends and client spending patterns that we experienced at the end of last year, resulting in an organic revenue decline of 3.3% in the first quarter, in line with our outlook in February. The Manufacturing and RMS segments, both reported solid quarters, primarily driven by a rebound in order activity in the Microbial Solutions and Biologics Testing businesses as well as the timing of NHP shipments benefiting the RMS segment.
As expected, DSA revenue declined at a high single-digit rate organically, due in part to the challenging comparison to the strong organic growth rate with nearly 24% in the first quarter of last year. Demand trends are continuing to stabilize, reflecting the more positive sentiment in our end markets and reinforcing our financial outlook for the year. There has also been an increasing focus on the BIOSECURE Act this year. It is too early to determine the final outcome of this proposed legislation, both the content of the final bill, if passed, and the potential impact on the broader biopharmaceutical industry. With approximately 95% of our revenue base in North America and Europe, we assume that the potential impact on Charles River would likely be a net positive, should the bill be passed, but it’s too early to determine the magnitude of the potential impact.
The long-term industry fundamentals for drug development also remain firmly intact because the overwhelming demand to find life-saving treatments for rare diseases and many other unmet medical needs is unchanged. Biotechs are beginning to move back into favor in the capital markets and will lead the way while large pharma has consistently adapted to scientific advancements, the regulatory environment and a drive to be more efficient. Therefore, we firmly believe the industry’s healthy growth prospects will reaccelerate. It’s not a matter of if, but when clients will reinvigorate their investments in early-stage R&D. As the leader in preclinical drug development, Charles River is the logical outsourcing partner to advance our clients’ programs and enhance their speed to market.
I will now provide highlights of our first quarter performance. We reported revenue of $1.01 billion in the first quarter of 2024, a 1.7% decrease on a reported basis over last year. Organic revenue declined 3.3%, as solid performances from the Manufacturing and RMS segments were offset by the anticipated decline in DSA revenue. By client segment, revenue from small and midsized biotechs declined, partially offset by higher revenue from global biopharmaceutical and academic clients. The operating margin was 18.5%, a decrease of 270 basis points year-over-year. The decline was principally driven by a lower DSA operating margin, reflecting the impact of lower sales volume as well as higher unallocated corporate costs. The restructuring initiatives that we implemented have not yet generated a full quarterly cost savings, which will occur in the second half of 2024.
Earnings per share were $2.27 in the first quarter, a decrease of 18.3% from the first quarter of last year. The decline reflects the lower revenue and operating margin as well as a higher tax rate. First quarter earnings per share exceeded our initial outlook in February, due in part to a timing shift of NHP shipments, which moved into the first quarter and benefited RMS results. For the full year, we are reaffirming our revenue and non-GAAP earnings per share guidance. We continue to expect revenue growth of 1% to 4% on a reported basis and flat to 3% growth on an organic basis. Our non-GAAP earnings per share guidance remains in a range of $10.90 to $11.40. As I mentioned, there were some movements in the forecast between quarters, but our outlook for the year is essentially unchanged.
I’d like to provide you with additional details on our first quarter segment performance, beginning with the DSA segment’s results. DSA revenue in the first quarter was $605.5 million, a decrease of 8.7% on an organic basis. Quarterly decline reflected a challenging comparison to the 23.6% growth rate last year as well as lower revenue in both Discovery Services and Safety Assessment businesses. Lower study volume in the Safety Assessment business was partially offset by a small benefit from pricing. We are modestly adjusting price on new proposals, when appropriate, to drive incremental volume. Looking at the broader demand trends, Safety Assessment, proposal activity and cancellations improved on both a year-over-year and sequential basis.
This has not yet translated fully into improved bookings, but we are cautiously optimistic that these trends will lead to improved demand during the second half of the year. As we have noted in the past, the study mix routinely shifts back and forth over time. And we believe that new funding will enable our clients to shift their R&D focus back to IND-enabling studies from post-IND work that has been the focus for much of the past year. As a reminder, there’s a natural lag between the time that a client gets new funding and reaches out for a study proposal to when the client will book and subsequently begin the new work with us. The process can take a few quarters, which is factored into our expectation that demand will improve modestly later in the year.
As a result of these trends, the DSA backlog decreased modestly on a sequential basis to $2.35 billion at the end of the first quarter from $2.45 billion at year-end. Gross bookings remained stable at above 1x, while the net book-to-bill ratio remained below 1x, but did improve slightly due to the lower cancellation rate in the first quarter. The DSA operating margin was 23.5% in the first quarter, a 550 basis point decrease from the first quarter of 2023. The year-over-year decline reflected the challenging comparison to last year’s outstanding operating margin performance. However, the first quarter operating margin was also below our longer-term targeted level in the mid- to high 20% range because lower sales volume and moderating price increases in Discovery and Safety Assessment businesses were unable to cover cost inflation.
We expect the DSA operating margin to move towards targeted levels as demand rebounds in the second half of the year. RMS revenue was $220.9 million, an increase of 3.3% on an organic basis over the first quarter of 2023. The RMS segment benefited primarily from higher NHP revenue as well as from higher sales of small research models in all geographic regions, due primarily to sustained pricing increases and from research model services. Revenue for small models increased in North America, Europe and China, due primarily to pricing, with growth in China leading all regions. While the growth rate in China has been compressed by the well-chronicled macroeconomic challenges in the country, we believe RMS demand has been less affected than other life science sector.
We believe the resilience of the Research Models business, both in China and the rest of the world, comes from the fact that small models are essential, low-cost tools for research and without which research cannot proceed. From a services perspective, revenue increased modestly. Insourcing Solutions, or IS, continued to generate higher revenue led by the CRADL operations. And we also signed new contracts for our legacy IS Vivarium management solutions. As we mentioned in February, the CRADL growth rate is expected to accelerate during the year. we are monitoring the occupancy rates and new facility ramp in light of the biotech demand environment, which remains healthy overall. We are balancing opening new sites in higher demand bio-hubs like Boston, Cambridge and San Diego, with consolidation of capacity in more saturated regions like South San Francisco.
The timing of NHP shipments to third-party clients also benefited first quarter results, both in China and from Noveprim, the Mauritius-based supplier in which we acquired a controlling interest late last year. These shipments accelerate into the first quarter. So although it would not change our RMS revenue outlook this year, it will affect the quarterly gating and pressure the second quarter RMS revenue growth rate. In the first quarter, the RMS operating margin increased by 420 basis points to 27.6%. The robust improvement was primarily driven by the benefit from higher NHP revenue in the first quarter, including the contribution from Noveprim. We do not expect the RMS operating margin will be sustained at this level for the full year as the gating of NHP shipments normalized, but continue to expect margin improvement in the RMS and Manufacturing segments will enable us to achieve our outlook for the year.
Revenue for the Manufacturing Solutions segment was $185.2 million, an increase of 10.4% on an organic basis compared to the first quarter of last year. Each of these segment’s businesses contributed to the revenue growth, led by the CDMO business. We were pleased that, as expected, revenue rebounded in both our Biologics Testing Solutions and Microbial Solutions businesses in the first quarter and Biologics Testing improved fourth quarter proposal volume led to the solid first quarter performance. Proposal and booking activity also increased meaningfully year-over-year in the first quarter, which confirmed the trends that emerged at the end of last year are continuing. Clients appear to be returning to the core testing activities, including cell banking and viral clearance, which were the services that slowed at the beginning of 2023.
In Microbial Solutions, we continue to see signs that destocking activity is winding down and believe it is now largely complete. Clients have resumed their purchases of reagents and consumables, and spending on new instruments was reactivated with an increase of new orders, particularly for the Endosafe MCS endotoxin testing system. We believe that our comprehensive manufacturing quality control testing portfolio, which continues to resonate with clients and will help to reinvigorate the Manufacturing segment’s growth rate in 2024. Our Biologics Testing and Microbial Solutions businesses are excellent examples of our focus on sustainable practices and the advancement of nonanimal alternative. In Biologics Testing, we have launched an initiative with our clients to end the remaining in vivo testing use of viral safety and lot release testing, replacing it with in vitro methodologies.
One of the alternative methods is next-generation sequencing testing that we are able to offer to clients through our partnership with PathoQuest. Our Microbial Solutions business also introduced the cartridge technology to our animal-free and Endosafe Trillium Endotoxin Testing platform, which will promote Trillium’s adoption to those clients who are looking to implement more sustainable testing practices. These are 2 examples of how we are already responsibly driving progress to reduce animal use and adopt alternative technologies, and I will provide additional details shortly on our new program to advance alternatives. The CDMO business drove the segment’s growth rate in the first quarter as a good for most of last year. generating solid double-digit growth.
Client interest continues to be strong with new projects starting almost weekly across the various phases of clinical development. Cell therapy production activities for our 2 commercial clients are beginning to ramp up as well. The second quarter growth comparison will be more challenging for the CDMO business as we anniversary the recovery of the business in the second quarter of last year. But the sales funnel remains robust, and we continue to expect solid double-digit growth this year. Manufacturing segment’s first quarter operating margin was 25.3%, significant improvement from 13.7% in the first quarter of last year. The increase was driven primarily by higher sales volume as each of the Manufacturing segment’s businesses are regaining traction as well as the comparison to last year’s lease impairment in the CDMO business.
Before turning the call over to Flavia, I’d like to provide an update on new initiatives that we are implementing to maintain our leadership position in nonclinical drug development. Last quarter, I discussed client-facing initiatives that we have implemented to become an even stronger scientific partner to our clients as well as actions to drive greater operational efficiencies. In April, we launched our AMAP, or AMAP program, to drive positive change and better position the company for the future state of the industry. AMAP, or the Alternative Message Advancement Project, is aimed at initiatives dedicated to developing alternatives to reduce animal testing. We intend to remain at the forefront of evaluating and implementing new and innovative technologies, including alternative technologies, to enhance the role that we play in helping our clients bring their life-saving therapies to market more efficiently.
We anticipate these technologies will have greater impact on drug discovery as they already have begun with screening for lead compounds rather than a regulated safety testing process. Change will take time, which is why we intend to engage key stakeholders, including clients, partner organizations, thought leaders, policymakers and NGOs, in the pursuit of scientific and technological innovation focused on advancing animal alternatives. We had already been exploring alternatives to reduce animal testing through our initial investment of $200 million over the past 4 years. A portion of that investment enabled us to acquire a partner and internally develop more sustainable technologies, including the animal-free Endosafe Trillium Endotoxin test, and our partnership with PathoQuest for next-gen sequencing that I just mentioned.
Over the next 5 years, our goal is to invest an additional $300 million to fund similar initiatives under AMAP to enhance the development and utilization of alternative technologies. We intend to continue to lead the way in driving our industry to its next frontier. To conclude, I’d like to thank our employees for their exceptional work and commitment and our clients and shareholders for their continued support. Now Flavia will provide additional details on our first quarter financial performance and 2024 guidance.
Flavia Pease: 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. First quarter 2024 organic revenue decreased at a 3.3% rate, in line with the February outlook. However, we delivered non-GAAP earnings per share of $2.27, which exceeded the outlook that we provided in February of at least $2.
The primary drivers of the earnings outperformance were the acceleration of NHP shipments into the first quarter and a strong performance from the Manufacturing segment, which delivered organic revenue growth of 10.4%. As Jim mentioned, we continue to expect full year reported revenue growth of 1% to 4% and organic revenue growth of flat to a 3% increase as well as non-GAAP earnings per share in a range of $10.90 to $11.40. We reaffirmed our annual revenue and non-GAAP earnings per share guidance because the first quarter outperformance was largely driven by the timing of NHP shipments, which only affects the quarterly gating in 2024 and not our full year outlook. Our segment outlook for 2024 revenue growth remains essentially unchanged as noted on Slide 30.
We also continue to expect consolidated operating margin expansion of at least 50 basis points in 2024. We are diligently managing the cost structure and our focus on driving efficiency, with restructuring initiatives expected to generate approximately $70 million of annualized cost savings or the upper end of our prior range. As anticipated, unallocated corporate costs were just above 6% of revenue at 6.2% compared to 4.3% of revenue in the first quarter of last year, contributing to the operating margin headwind in the first quarter. For the full year, we continue to expect unallocated corporate costs will moderate from first quarter levels to just above 5% of revenue. The first quarter tax rate was 23.3%, an increase of 160 basis points year-over-year.
The increase was primarily due to the impact from stock-based compensation. This was slightly better than our February outlook of a mid-20% tax rate because stock-based compensation was favorable due to a higher stock price during the quarter. We continue to expect our full year tax rate will be in the range of 23% to 24%, which is unchanged from our previous outlook. Net interest expense of $32.8 million in the first quarter was similar to both the prior year and fourth quarter levels as floating interest rates and debt balances were relatively stable. For the year, we expect net interest expense to trend slightly favorable, which would put us at the low end of our prior outlook of $125 million to $130 million. As a reminder, nearly 3/4 of our $2.7 billion debt at the end of the first quarter was at a fixed rate.
At the end of the first quarter, our gross leverage ratio was 2.4x, and our net leverage ratio was 2.3x. Free cash flow was $50.7 million in the first quarter compared to $2.5 million last year with a $28 million decrease in capital expenditures, driving much of the improvement. Capital expenditures were $79.1 million in the first quarter compared to $106.9 million last year, due primarily to moderating capacity expansions to match current demand. For the year, we continue to expect free cash flow to be in a range of $400 million to $440 million and CapEx is expected to be approximately $300 million. A summary of our 2024 financial guidance can be found on Slide 35. Looking ahead to the second quarter. We expect reported and organic revenue will decline at a low to mid-single-digit rate year-over-year.
Our second quarter expectations include a modest sequential increase in DSA revenue as trends begin to improve. The second quarter revenue growth rates for both the RMS and Manufacturing segments are expected to be constrained by the timing of NHP shipments in RMS and the anniversary of last year’s CDMO growth rebound in the Manufacturing segment. Earnings per share are expected to improve from the first quarter level with an outlook of mid-single-digit sequential earnings growth over the $2.27 reported in the first quarter. We expect the tax rate and interest expense will remain relatively stable from the first quarter levels, and the operating margin will remain somewhat constrained until the second half of the year when we recognize the full benefit from the cost savings and the revenue growth rate reaccelerates to cover more of the annual cost inflation.
In conclusion, we are pleased with our first quarter performance and are confident in our outlook for the year. Demand for our unique nonclinical portfolio is resilient, and we remain focused on executing our strategy, driving efficiency and gaining market share. Thank you.
Todd Spencer: That concludes our prepared remarks. We will now take your questions.
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