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

Hello. This webcast presentation is for Bank of America clients only. If you are a member of or representation of the press or media, please disconnect now. And now I would like to turn the call over to the analyst. Thank you, and have a good day.

Thank you. Good morning, everybody. And welcome to the 2020 Bank of America Health Care Conference, Virtual. This is Juan Avendano, the U.S. CRO and CDMO Analyst. And it is a pleasure for me to start this off with Charles River Labs, the leading preclinical CRO. And I am pleased to be joined by Jim Foster, Chairman, President and CEO. Jim, how are you? Thank you very much

Nice to be here. Would you like me to start while -- I'm sorry. Go ahead.

Yes. Sounds good. And so maybe, Jim, if you could kick it off with some opening remarks on Charles River. You had an amazing first quarter performance and then maybe highlight some of the ways in which the business has been impacted and is reacting to COVID-19, that will be great.

Sure. So thanks, Juan. Always a pleasure to participate with you folks. So let me just sort of blast through this. So all of our sites are open and doing -- taking care of the animals and running studies for our clients. About 70% of our employees are at work. COVID-19 should have an adverse impact on our revenue sort of anywhere between $135 million and $215 million primarily, but not entirely, with the Research Model business as a result of a bunch of academic institutions being closed. We're doing work for about 40 clients right now, slightly more than 40 clients, who are working on COVID, both therapeutics and vaccines. And it feels good to be in the midst of this work. We had a really strong first quarter. We had revenue 8.2%. Operating margin was up 270 basis points at 19%. And our EPS was up 31 -- I think 31.4%, with $1.80 for us. So we're really pleased with that. On our first quarter call, we did revise our guidance downward as a result of the impact of COVID-19. And our sales guidance is now 1.5% to 4.5%, down from 7.75% to 8.75%. And our EPS is now $6.75 to $7.10, which is down from $7.45 to $7.60. Research Models was down 1.7% for the first quarter as a result of what I just said with the academic institutions being closed. We can drill into this maybe a little bit later. But the service parts of the Research Models business were strong, particularly beginning to come back in China. HemaCare operation, our new acquisition, was -- will be slightly impacted as the donor collection clinic portion of that business closed in March. Result of the sales impact. Operating margins were down 510 bps to 23%. DSA segment had a really strong quarter, up 11.6%. We're really pleased with that demand, and bookings were really strong. March was our strongest quarter, bookings quarter, we think, ever. There was a bit of study slippage beginning to sneak into the quarter as a result of a delay in test article from China and India. And the Discovery business slowed a little bit because of some very small biotech companies pulling back on Integrated Drug Discovery, initiating those studies. Operating margins were way up there, up 340 bps to 22%. Manufacturing business had a really strong quarter. It was up almost 10%. It would have been up even higher, although we had a big stocking order in the first quarter of '19 at microbial, which was a headwind to the year-over-year results. Operating margins were up 460 bps to 36.5% in that business, principally a result of succession of duplicate costs in our avian business and enhanced operating efficiency in microbial. So we were really pleased with the quarter. We guided second quarter to organic revenue growth year-over-year mid single digits and non-GAAP EPS growth of down 20% to 30% decline over '19. And for the year, just looking for 3 segments, we're guiding to at least a 10% decline in RMS, principally as a result of the second quarter, at least mid single-digit growth in DSA, slightly hampered -- slight impact in the second quarter as well, and high single-digit growth in manufacturing, which if you solve for the big stocking order, would have been up double digit. So maybe I'll stop there, Juan, and let you dig in further.

Yes. Sounds good, and thank you for that overview of your first quarter performance as well as some of the guidance on 2020. I guess as we -- now that we're talking about the guidance for 2020, one of the questions that has come up is that if there is a significant second wave of infection later this year, then relative to what we've seen in the -- what you have seen in the initial outbreak and shutdowns, how do you think about the impact to your business? I know that when it comes to RMS, perhaps, you were assuming that a fourth quarter returning to normal activity. Maybe if you could just hypothetically go through this scenario of a second wave and how would that impact your business, that would be good.

Sure. Our guidance is realistic. And I think it's doable. We are, as you said, expecting the Research Model business to be adversely impacted significantly in the second quarter and still in the third quarter, but less significantly because we're anticipating the academic research centers would open over the summer and the fall -- the summer in Europe and the fall in the U.S. If there's a -- there's definitely going to be a second wave. I don't think there's an if, and depending on the severity, I suppose, a scenario is that the academic medical centers won't open at all this year. I think a lot of the universities and colleges won't open for students this year, and some will close. But I think the academic medical centers, which are really important, where there's a bunch of PPE involved for a lot of people in the labs. And if there wasn't, there could be people working in hoods. It's a pretty safe place to work, and we need them to get back to work to solve the COVID crisis. So we don't anticipate it would cause sort of a substantial problem for any of our businesses, particularly our RMS, but it's possible. The other possible impact that a second wave could have is that a bunch of Charles River employees could get sick. I can't predict that. We have a trivial number that have been impacted by coronavirus right now. And of course, lots of people wear PPE in Charles River facilities, who are used to working with hot viruses and hot agents and are used to being careful. And so I would argue that it's a reasonably safe place to be. So I don't think even a second wave would have a big impact. We are open for business at all of our sites. 70% of our employees are working at the sites, taking care of rentals, running studies, running assays and shipping products. And all the G&A is home, but fully back at work. So I don't think the second wave impacts that. Could the second wave impact funding for biotech sector? I don't know. Maybe. Probably not. It hasn't impacted it yet and a little bit in the second quarter, mostly with the IPOs. I think that's already coming back. First quarter was strong. And of course, you've got a whole bunch of new drugs being developed and companies that I think could have some breakthroughs and make a lot of money on COVID, and all the other diseases that they were working on, work continues. So if all 3 of those factors happened as a result of the second wave, that would not be good. Having said that, the not-be-good portion of our revenue slowdown would be met by further cost reductions, which we have identified, and can and would enact to protect our operating income and our EPS. So I think in any event, while we would not enjoy our sales for just being flat as opposed to up, we could protect the expenses sufficiently.

Okay. Got it. Appreciate the color on this hypothetical scenario and we'll see how everything evolves. I guess while staying on RMS and before moving on, I mean, do you foresee any opportunity to strengthen your positioning and gain share among academic and government customers during and after because the COVID-19 hiatus? What did you do in the mean...

I do. I really do. So that I would say is we're seeing some benefit from COVID across many of our businesses. When I say benefit, it's because, oh, I don't know, some big clients who used to do whatever work we're talking about inside, could be talks, could be discovery work, could be assays and biologics, it could be having small animal colonies to enhance their ability to start studies quickly. So all that's changed overnight. And it's changed because, all of a sudden, places closed. So we had a lot of academic clients that had their own colonies of maybe specialty strains that they had developed with or without our help, that now literally had to close them and ship them out to us or sacrifice the animals. So a bolus of work, a bunch of work that came with genetically engineered model work that we do for clients. Some we've already done, but now we're getting more of those colonies. We're getting more embryology work associated with taking care of their animals in cryopreservation work. And so I think it's highly likely that they don't take those colonies back in-house. Number one, they're going to be a little gunshot with COVID. Number two, they're going to see that it was pretty smooth without doing it themselves. Number three, we can get the animals on a just-in-time basis. We're also seeing in the Research Model business, which was the nature of your question, that, while we don't have that many competitors in that business, they're all, I think, cash strapped -- several of them are cash strapped, have a small number of facilities or having trouble because they didn't have appropriate business continuity plans, a slaving around dropping prices and can't deliver animals to several parts of the U.S. and Europe. We're getting that business straight up, and I imagine that we'll keep a lot of it. So we are demonstrating to our clients, some who are already our clients, some didn't do everything with us, some didn't do anything with us, some worked with their competitors and some did work internally. We're literally demonstrating for our clients every day why our business model is superior to doing in the work themselves or working with other smaller companies, who are less well organized or financed. It's our best marketing tool we could ever have. And I think that, I know that we're doing a good job. I know that we're really satisfying a lot of clients. We're getting real positive feedback. And I would be surprised if we don't retain a meaningful amount of that business. And I don't know what that's going to be. So I can't guess for you. I can't quantify it. We'll try to give you color as we emerge from this and the world begins to right itself, which, by the way, I think, is going to be in a few years. And I think people are going to get in the habit of having these products or services outsourced. And as long as we do the work well, which we intend to do, I think we should be able to hold on to it.

Got it. And shifting gears now to your largest reporting segment, the Discovery and Safety Assessment segment. I guess starting with biotech financing, it's been solid with about $30 billion raised year-to-date. According to our biotech cash burn analysis, biotech companies have about an average of 3 years at hand of cash. So my question is, are the demand trends that you're currently seeing out of your biotech customers in line with these positive data points? Have you seen any changes in biotech customer behavior as it relates to willingness and ability to spend and outsource? And is the pricing environment, since COVID-19 started, been consistent with recent history?

Yes. So biotech is really strong, and I would argue that the whole drug industry will be stronger as a result of COVID. So the political vilification of the drug industry has stopped. And as the drug industry rides in on our white horses to try to cure this disease, I think it's going to actually enhance -- appropriately enhance the reputation of the drug industry. So that's a really positive thing. COVID hasn't stopped all the innovation in the drug industry. So all the gene therapy and cell therapy drugs in development, which are hundreds and hundreds of the immunotherapy drugs, all the RNA drugs, both interference and messenger monoclonals and on and on, I think, are continuing to be developed at a pretty healthy clip. And then you drop all this COVID stuff on top. So it's literally a new disease with a whole bunch of new work, both therapeutics and vaccines, to try to cure and prevent the disease is, I think, really a beneficial thing for the industry. So I have no doubt that money will come in from the capital markets and the credit markets and directly from big pharma. This industry will remain well financed. We hear almost nothing from our clients, about any concern about spending, except a little bit from very -- a few handful of very small biotech companies, who didn't want to sign up for these multiyear, multimillion-dollar Integrated Drug Discovery deals that we do in our Discovery business. And even that's beginning to change. So even a couple of weeks ago, we were seeing some of that. And in talking to our client services people even yesterday, they said that we have started to get some more work. And there was never a lot of work anyway. So biotech's interesting. I get this question a lot about, and there's a lot of spending in the biotech, is our business much better? And when there's a concern about spending, is it much worse? And the answer is not really. They're very careful and thoughtful about the way they spend their money. I think if they have it and they have drugs to develop, they will develop them. But they're not sloppy with the way they spend their money. So I think the funding paradigm is going to be great. One, we don't comment specifically on price, but I will tell you that pricing generally but basically for safety was better in the first quarter than we anticipated. I think we either alluded to that or actually stated that in our call. Pricing was solid. I think pricing will remain solid. I will tell you that I don't want to overstate this. Pricing will always be important to all of our clients. But I will tell you that, particularly in this COVID world, where clients have drugs to develop and get them to IND-enabling studies, when there's an overarching kind of concern about, is Charles River open? Well, okay, I'm glad they're open. Do they have enough capacity? What about Charles River's competitors? What about the fact that we did some of the tox work ourself and now we're outsourcing it? Will the outsourcees have capacity for us? Can they start when we want them to start? How's the headcount? Are there people sick? Are they coming to work? And so where price was sometimes, and with some clients all the time, the first or second thing we talked about, now it's about -- always about science. Now it's about, do you have capacity? Can you start my study? How long will it take you? And oh, by the way, what's the price? So I think we're going to enjoy. And we won't -- we'll be careful about how we respond to this, but I think we will be paid well for our services as clients continue to be a bit concerned about us having enough space, which we do. But if you're a big pharma company x and you 3 months ago did 40% of your tox in-house, and now you're doing 100% outside, you're just nervous. And we want to help them be less nervous, but the only way we can do that is to have capacity and take their work on. So it's a pretty good demand curve right now.

Got it. And I'd like to remind everybody on the line, who's participating, that they can submit questions to me via Veracast and I can relay those. With that said, I guess, staying on the Safety Assessment, one of the things that you said in the first quarter earnings call was that bookings were actually solid through the end of March. And so if you could -- and given the -- some of the headwinds that you're seeing on the early discovery part of your business that are temporary in nature, your outlook for the overall year on DSA for being at least mid-single digits, in my opinion, doesn't look that bad. So it is actually quite good instead. So can you maybe talk about some of the kind of the COVID-19-related opportunities or any others that you're seeing in Safety Assessment nowadays?

Yes. I mean, demand for Safety Assessment continues to be -- continued to be strong in April. As I said a moment ago, some of the, I don't know, hesitancy maybe is a good word with some of the very small biotech companies, but very expensive. And it wasn't just small ones, but some of the very expensive discovery studies that we do, it's beginning to ease. So we're confident that we will see the demand continue along DSA, as I said a moment ago, with less price sensitivity. Always -- they always care about prices, and that's price sensitivity with a whole host of drugs for a whole range of therapeutic area diseases, particularly for IND-enabling studies. The other thing I didn't say is, and I don't know whether this is rational and whether this is even a legitimate concern, but you get a sense from our clients who were really pushing for us to start and hopefully finish IND-enabling studies for them this year, that they're worried about the FDA's capacity to accommodate all this work, that maybe COVID has just made it a bit tougher. So there's a real intensity of demand for us to get the work done, coupled with a huge intensity of demand for COVID drugs to do the IND-enabling studies for them. And of course, as you know, a lot of the long-term tox work we do contemporaneously with the clinical trials. So we expect to see that demand at least continue at this rate, if not intensified. We're trying to give COVID work priority, so -- which we're prioritizing it over other work for obvious reasons because it's so critically important. Clients expect that, and very much appreciate that, but it's definitely providing additional revenue opportunities for us.

And a question that came in the line is, perhaps any thoughts around confidence in the 2021 margin targets? And what would it take to land above or below 20%? A question of margin expansion.

Yes. So it's an overarching focus of this company and this management team that our business structure is such that some of the costs that we were adding to kind of catch-up from a headcount point of view and a G&A point of view have now moderated. Duplicate costs that we had in biologics are now gone. Manufacturing efficiency in the microbial business is better. The drag that we had -- that we have had from some of our Discovery businesses is all the time improving, as you saw in the first quarter. And the drag that we had from 2 of the 3 big acquisitions that we made in the tox business are improving all the time. And so -- and of course, I certainly won't wish we weren't in this world. So I'm not really saying anything positive about it, except that, obviously, COVID is preventing a lot of spending by Charles River and other companies. So we're not going to be traveling for a long time. I'm doing this investor conference at home. I can't imagine there'll be another investor conference for 2 years that's not virtual. We do hundreds of trade shows in our analytical business and all of our businesses have stopped. We have salespeople at home calling on clients every day and not missing a beat. I'm not sure how much traveling they'll have to do. So costs of travel are down. We did delay some merit increases. So cost of labor, at least was -- sort of went sideways for the second quarter. And so I just think our expense is certainly not going to crank up G&A. So our expense burden will stay really tightly managed. As long as the academic institutions and some pharma and small biotech companies reopen for the animal business, the animal business should get back to, for next year, anyway, kind of historical levels. I think our other businesses should as well. And so there's no reason I can think of now unless COVID throws us a curve ball that none of us are anticipating, we're just -- for whatever reason, biomedical research slows dramatically, and I can't comprehend what would do that, we will continue on our quest to deliver 20% operating margin in '21.

And then just to wrap it up, Jim. You've sort of alluded to this question, talking about the cost cuts, the travel restrictions and then perhaps in the ways that you think that outsourcing might actually be incentivized going forward. But what do you see as the long-term implications of COVID-19? What do you think those will be? Is there anything that you're changing in the way you do business or the way that your customers are doing business that you think will persist?

Yes. I mean, there's probably 2 answers. So I mean, it creates another category, another infectious disease for which there will be a lot more drugs and vaccines being worked on. So that provides some incremental business for us, for sure. So that's -- I guess, that's an incremental positive, while I wish it wasn't happening, we're in the drug development business. So that's going to be beneficial. I don't think we're going to fundamentally work much differently. As I said, almost all of our employees are working, the vast majority of them are in PPE all the time. Our facilities are really tightly controlled in terms of human flow and the airflow and filtration and back up everything. And so -- and our G&A folks are home and are all working. I mean, at some point, they'll come back to work, I guess. Not entirely sure what the benefits are of that, but I'm sure there are some. And I think on our client side, they could and will, maybe will is more appropriate. They will definitely outsource more work, both product work and service work that historically was done internally. And some of it was done by less reliable and smaller clients. So I do think there's some benefit to our business model.

Got it. Well, thank you very much, Jim, for participating once again in our conference. Appreciate your time and insights. And also to all the participants who submitted questions, I couldn't get through all of them, but we'll follow-up off-line with you individually. And I hope you enjoy the rest of your conference, and stay safe. Thank you.

Thanks, Juan. Enjoyed it. Take care.