Charles River Laboratories International, Inc. (CRL) Earnings Call Transcript & Summary

Thank you, and good morning. This is Jack Meehan with the Life Science Tools & Diagnostics team here at Barclays. And pleased to be continuing the Barclays virtual Global Healthcare Conference now with Charles River Chairman and CEO, Jim Foster; as well as Head of Investor Relations, Todd Spencer. I appreciate you guys joining us in the new format. And Jim, just like to turn it over to you for some introductory comments.

Sure. Thanks. Thanks, Jack. We reported a very strong '19. Sales up 8.5%. Operating margins 19%, up 20 bps. EPS $6.73, up 16%. We were really, really pleased with those results. The guidance for '20 is 7.75% to 8.75% revenue growth and EPS at $7.45 to $7.60. The RMS segment was up 5 -- a little over 5%, driven principally by China and strength in our GEMS business and IS business. We opened a new facility in South San Francisco, which is an incubated space like the space we have in Cambridge, Mass., really pleased with that type of activity. I'm sure we'll talk some more about this, but we're forecasting only a small financial impact in Q1 from the coronavirus. And obviously, we're closely monitoring it. And it's obviously a fluid process and dialogue. We can talk some more about that in a minute. We announced the acquisition of HemaCare right at the beginning of the fiscal year. That's a human-derived cellular products company. We're really excited about it. We've got kind of a light-touch integration going on and about $150 million worth of our revenue will be associated with cell and gene therapy generally and about $50 million specifically with this acquisition. Our Research Models and Services margins were a little over 26%. DSO business, which is about 62% of our revenue, was up 9% last year. I'm really pleased with that. We did a big acquisition in the middle of the year, a company called Citoxlab, which was 9 sites in Europe and Canada. Operating margins were 22%, up 30 bps. We were pleased with that. And we're doing a bunch of technology deals, which we can talk about if Jack has time as potential precursors to M&A. Manufacturing business was up almost 11%, 10.8%. That was even with the headwind on our Biologics business with some capacity limitations. But we had nice growth in both Biologics and Microbial. Operating margins were almost 34%, which we were very pleased with. So coronavirus aside, we feel very good about the demand curve for pretty much across the board right now and with the necessity for what we do for principally biotech companies and secondarily Big Pharma. So Jack, why don't I stop there and let you take over.

Yes, thanks, Jim. So I wanted to start, I guess, with the main, investor focus recently has obviously been on the coronavirus. Just how are you managing your operations, given the evolving situation? And if you think about the 3 businesses, what are the different puts and takes in terms of how it might impact sales in the first half of the year?

Yes. So as we said, we only have a small financial impact guided or forecasted for the first quarter. And I think that's a good number given the fact that we're at March 11 today. And that's almost entirely China and that's mostly RMS and a little bit of our Microbial Solutions business. So disruption there from our employees being quarantined and from clients' employees being quarantined. And so neither the ability to often ship product to clients nor their ability to receive them. And in the Chinese case, it is almost entirely all products. That seems to have ameliorated substantially with most of our employees back to work and most of the clients back to work. So I wouldn't imagine China suddenly going to be a difficult geography, again, although -- yes, so we have no indications of that. Since it is a fluid situation, it's just kind of inappropriate and dangerous for us to -- and too speculative for us to make any prognosis about the balance of the year, except to say the following: At the moment, I would say, it's pretty much business as usual. I think everyone's concerned. Obviously, this isn't going to impact the drug development business much less than other industries. There's this, I hate to say this, but it shows a slight benefit to the drug development business in as much as we got a bunch of clients working on coronavirus and will have to do toxicology work and eventually clinical work on that. And I do think that at least this has the aura that counteracts so much of the negative diatribe coming out of the political specter for drug companies who are suddenly arriving in white horses and hoping to help fix all of those. So I think that's just a good thing in terms of people's view of the industry, at least for a while. Anyhow, those vaccines won't get to market for a year, we're hearing. So all I can tell you is that as of today, and we obviously talk about this every day because it is so fluid, proposal volumes are still strong. Bookings are still strong. We're not hearing -- biotech funding has been strong for the first quarter, so we're not hearing any undue concern. It's just about clients thinking about, "Okay, if we can't travel, how do we interface with you?" Well, the answer to that is we got to do it more on the phone or by video or with FaceTime or whatever technologies we need because they don't believe that drug companies are going to sit there with drugs that are ready to be developed and wait until this thing subsides. I mean -- so to the extent to which they can keep working normally, they will. I haven't heard anything about -- concern about funding or access to drugs. So we use some large animals in our toxicology business. There was some noise about supply sources being limited out of China. That doesn't seem to be an ongoing problem. Even if it was, we've made arrangements with other supply sources around the world. So we won't be interrupted there to any material degree. So we're planning for the worst, meaning that we have a China effect in other parts of the world. Meaning, okay, what happens if employees has to be quarantined? That's pretty straightforward with G&A people, most of them can work from home, get on their computers and on their phones. And we will obviously have to manage people being able -- having to be able to come in and take care of the animals and being able to run studies. And we'll have to cycle our employees through that. We may have scaled staff for some period of time. There might be some sites that are unaffected, and some sites that are more affected, but we'll see and obviously we intend to manage that carefully. Interestingly, our employees, in pretty much all of what we do, and I'm not a virologist, so I'm just pointing this out, are always gowned up and masked. They have masks on all the time and gloves. And stuff that we work with is often, in the animal business, is sterilized. Before it goes in the animal room, it's sprayed down with all this stuff that will kill anything. So it's a pretty clean environment to work in and really low-risk. And the tox businesses, these study rooms are really controlled in very tight variances and with negative air pressure and all sorts of filtration systems. And again, people are gowned up. So we kind of take precautions every day mostly to keep the animals from getting sick from people. And so it's slightly safer environment or maybe a significantly safer environment to work within our facilities. Now and for -- in geographic locales where local, federal or state governments say, people are quarantined and have to stay home, we have to work around that. And we have to work with them to talk about the importance of our business to biomedical research generally and actually to fixing the coronavirus specifically. So that's how it's occurring in, literally, real-time today. Just grabbing the opportunity to say this in a webcasted comment for current and prospective shareholders, it's a fluid situation. We're all over it, and we'll manage through it as well as we can, is all that I can say. But we don't have any new warnings or storm clouds today that are worse than where they were when we gave our fourth quarter and full year guidance so whatever it was a month ago. And in fact, the situation in China is considerably better.

Great. Yes, thanks for all the updates. And wanted to see if you could elaborate a little bit more on how you're feeling about biopharma funding. I feel like we've been talking along for a while about how well the industry is funded. And I feel like now was really the time to shine, given the amount of cash on the balance sheets and keeping -- going to work. So how are you feeling about that?

Exactly. Feeling good about that. I mean we always have, putting this major incident aside, and biotech companies continue to be well-funded because there are countless multiple new modalities to treat unmet medical need and huge breakthroughs in RNA delivery and immunotherapies and obviously cell and gene therapy. And they're creating real companies with real revenue and good returns for shareholders. So I think it's a really, really important industry to the U.S. and to the world, generally, and it's become the preponderance of our clients. I don't see why this eventuality slows that down. The first quarter already has been quite strong and with more money being pumped into the system to eradicate or at least manage this virus and maybe be more thoughtful about other potential viruses that could befall us that come from animals or people. I think you're going to see more funding around sort of vaccines and viral -- drugs that are antiviral. And I do think there will be a lot less pressure and a lot less criticism of the drug companies for a while as the world is dependent on them to move quickly and thoughtfully to eradicate this, which they've been doing. There's a bunch of companies that have made a lot of progress already. And the only thing that will slow down those vaccines and drugs getting to market is proper clinical trials with the FDA and how the regulatory agencies will manage. But I think they will do everything they can to fast-track those. So I do think -- you put it well, Jack, I do think it's a time for the industry to shine and take a leadership position and show how critical we are to the world with crises like this, but also just a whole host of diseases for which there aren't currently good drugs.

Great. And next one to touch on, another thing you talked about in the opening remarks, which is the HemaCare acquisition. Obviously, a new -- you're building on an area in cell therapy here. Maybe just help investors understand a little bit more the products that they have and how proprietary they are for the cell therapy development process?

Sure. So really excited about this deal. It's a relatively small company, about $50 million in sales, but growing at least to 30% a year. So you can do the math on that, that gets to be a meaningfully sized company very quickly. They have -- their portfolio is human-derived cellular protein, so they're extracting cells from patients. They have a consistent source of -- a donor base which make sort of more consistent supply and a higher quality supply. It's also, I believe, the only place in the world or at least, the predominant place in the world where GMP production of these cells takes place. So these cells will be used in early development, in process development and in the ultimate manufacturing of cellular therapies. So this is a critical ingredient for which -- there aren't enough cellular therapies if you don't have the cells. So feel very good about the company itself. It's kind of a light-touch integration because it's not our core business. Backroom stuff is going to be integrated quickly. We will expand their very capable but relatively small, highly scientific sales force with a much larger sales force. And not to overstate on importance, but we will validate this relatively small company for large clients of ours who have never heard of them now that it's a part of Charles River. So we feel very good about it. So in addition to sort of $100 million-ish revenue that we had last year in the cell and gene therapy space across our whole portfolio. And that would be for immunocompromised animal models, which you need to put cells into so they won't reject the cell. That would be for expanded assays in our biologics business to test it. It would be expanded uses of our microbial test kits to test those drugs to make sure they haven't been contaminated. And for combination, discovery and safety assessment, preclinical trials to make sure the drugs are safe. So all of that business, we now have products to help make the cell therapy within the larger Charles River with test. We are quite interested in doing additional M&A in the space, both cell and gene therapy products, to make those drugs. Unfortunately, most of the companies are small so we will try to buy several and put them together. It will give us geographic expansion and that will give us just more depth of science and capability. And a slightly crude but I think useful analogy is that, in some ways, these are similar tools that laboratory rodents, mice and rats in particular, have been in drug development for years. These core ingredients in cell and gene therapy are similar products that are essential tools for the drugs to exist at all. So that's one of the reasons we put it into the RMS segment. We want companies to think of Charles River when they're developing -- discovering and developing their drugs that we would have the tools, both our products and services that they would need to get developed and get in the market.

Great. Next, let's move over to DSA. Also, I wanted to touch on something in the opening remarks about some of the investments you're making on the discovery side. Maybe just talk about where you see the opportunity in terms of some of these deals. And be curious like, there's been a lot of them, which one do you think has worked out the best so far? And have any not worked out as well as you might have thought?

Good question, Jack. There have been a bunch. Mostly, small; one modest size. That would be chemistry/biology company that we bought in Cambridge, England, which has allowed us to really start with the clients earlier, is the largest one. I would say that's the one that has been the toughest for us. That's 100% on us, Jack. That was a totally new business. I would say, it's the first time we did a very thorough 100-day integration plan. It was really well done, but it wasn't well done enough. I don't think we realized how different the business was. We actually bought 2 different companies that the seller had just bought and hadn't integrated them yet. So we kind of had to do double integration and double cultural integration. And I think we -- sorry, and I think we forced the SAP solution too fast. So it hasn't performed as well as we would have liked it to have. But it has -- it performed really well in '19. And we're quite optimistic for '20. So it's really on solid footing now. That's the biggest piece. I don't know, the most successful one was probably we bought a -- the first business we bought in the space was a small oncology company in North Carolina. We now have 2.5 oncology companies. I say half because one of them was really small. But 3 oncology companies, the small one was an immunotherapy company. I'd say the oncology franchise as a whole is just killing it, but that's largely because so much of the R&D dollars spent in all of the pharma companies are in oncology. And we're a critical resource, how to test new chemotherapeutic agents using animal models and human cells and sophisticated imaging systems. And it's a wonderful business. We will try to continue to expand all of those, Jack, oncology, CNS, the really core target ID. And just to jump to where -- I wanted to highlight quickly in my opening remarks, we're doing a bunch of technology deals. They will -- some of them will just be technologies that we investigate and discard. Some of them will be technologies that we help sell and continue to sell. And some of them will be precursors to acquisitions. We're making small equity investments or providing small amount of debt financing to these companies, some of which are prerevenue. Maybe the most exciting is one that we announced last year, a company called Distributed Bio, which has a large molecule discovery platform, so an antibody platform. We already have a small molecule discovery business, but to have the ability to discover targets in both large and small molecules would be very powerful. And so I would say that most of these technology deals that we do, not all, but most of them will be in the discovery space. And so those will be wonderfully powerful ways to vet technologies, make sure they're real, make sure the clients like them, make sure the science is good. And then in cases where we're interested to buy them and having them like a year or 2 of due diligence. Also, in a couple of these deals, we've actually prenegotiated purchase price structures. So we just pull the trigger when we want without negotiating purchase price, and no other buyer could come in and take these. So you should expect to see the discovery business grow through M&A.

Great. And then maybe finally, in the last few minutes, I wanted to talk about margins. I think we and others, it's been a point of criticism, some of the more muted expansion recently in the fourth quarter certainly quieted a lot of the criticism. Maybe just talk about how you're feeling about hiring, and how you're -- that's more balanced now versus growth, and how you're feeling about the ability to hit the targets now out in 2021.

Yes. We feel really good about them. We feel really good about our 2-year guidance to get to 20% all-in, fully loaded. And that will be a combination of keeping a lid on G&A spending, more nuanced, balanced hiring, to your question because we did a lot of catch-up hiring in '17 and '18, a little bit in '19. That will be about the steady improvement in operating margin in Biologics, discovery, which we just talked about, and 2 of the big toxicology acquisitions that we made, one in '19 and one in '17. Those are improving all the time. And so we're very, very confident as we continue to improve the margins in those businesses which we have done in all of the legacy safety businesses before. We've done a bunch of acquisitions with that space that we'll be able to deliver those numbers by '21.

Great. And maybe just since we have a little bit more time, talk a little bit about M&A and discovery, but you do have a -- maybe just more broadly, have a target of doubling revenue through 2024, nearly doubling revenue. Does any of the recent volatility in the markets changed maybe the pace at which you can execute against the funnel? How are you feeling about that?

Well, we'll have to see. I think that's so late-breaking. So we may pause in some of the conversations we're having now and just see how the world is dealing with all of this and see how much worse it gets or not as we may have potential sellers that pause because they can't figure out the landscape. Or we may have sellers that are more intent on selling now because they're afraid that they won't have buyers and/or their value will -- is somehow impaired by all of this. We certainly want us take a look at the world and just make sure that -- our balance sheet is very strong, but we want to make sure that we were able to do capital investments and pay our people more. And if we feel there's any pressure on that, we may pause a little bit on M&A. So we have multiple conversations going on right now as we always do. I think we have a fair amount of control over the timing in virtually all of the deals because we're often the only buyer, at least the only strategic buyer. And so we'll be -- we're checking back with all the companies we were talking about real-time and kind of talking amongst ourselves and with our Board members about whether we kind of pause and idle and neutral for a while or a few months until this ameliorates. So we'll do the right thing for our -- the company for our balance sheet and for our ability to both preserve cash or deploy cash if we don't think that we need to preserve it, but that's kind of literally something that we think about, and talk about daily, Jack.

Great. Okay. Well, thank you again for all the time. Appreciate the thoughts and participating in the new format.

Sure. Our pleasure. Nicely done. Thanks, Jack.

Yes. Have a good one. Bye.

Bye-bye.