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

Hello and good morning. My name is Dave Windley. I'm Managing Director with Jefferies Healthcare Equity Research Department. I want to thank you, our audience, for attending our Virtual Healthcare Conference this year as well as our next company. It is my pleasure to introduce Jim Foster, and he's Chairman, President and CEO of Charles River Laboratories, and they are our next presenting company. I want to remind you that we are taking questions through the chat function of our interface. So feel free to send questions through that portal, and we will try to address those toward the end. I'll launch here by just prefacing that Charles River did have a very, very strong first quarter and stocks reacted, obviously, very well from that, led by revenue and margin performance in both its DSA and Manufacturing Support segments. I'm going to let -- hand it over to Jim Foster to give some opening remarks about the company's recent performance and strategy, and then we'll dig into some questions. So Jim, go ahead, please.

Thanks, Dave. Nice to be here albeit virtually. So we had a particularly strong fourth -- first quarter as a fair number of companies did. Sales grew 8.2%. Our OI was 19%, which was up 270 bps over the prior year, which was -- we were really thrilled with. And our EPS was $1.84, which was up over 30% over the prior year. So very strong first quarter. We began to see the impact of COVID around the kind of second week of March so the tail end of the quarter, which had the most profound adverse impact on our research model business, where a whole host of academic medical centers in U.S. and Europe closed swiftly and I would say prematurely, looking at it in retrospect, but they just closed. And obviously, when closed, they're not either going to buy or be able to use research models. So we saw that rather swift impact. And we get to see a little bit of an impact on the DSA segment with the impact on availability of test article or the drug coming out of China or India. As a result of that, we sort of recast our guidance and said that, that would have maybe $135 million to $215 million impact from COVID. We just say conversely, even though it's really not a lot of revenue, that we had about 45 clients for which we were doing COVID-related work, either therapeutic based or vaccine based. And we revised our revenue guidance down to 1.5% to 4.5%, principally as a result of the impact on RMS, a little bit on safety and discovery, almost none on manufacturing. And our EPS is down $6.75 to $7.10. And we said we were pausing on M&A. We took down, by the way, another $150 million of cash to strengthen our balance sheet as this began to unfold. We also said at the time that we had -- proposal volume and bookings were extremely strong in safety, in DSA, and particularly in Safety Assessment, where our demand was the strongest in March that we had ever had in the history of the franchise. And so to update you on that, we continue to have a very strong April and May in DSA, where proposal volume and bookings remained strong. We continue to refrain from giving specific color on pricing, except to say that we got a meaningful amount of price in Q1, more than we had guided you to and more that was in our operating plan. I actually think clients were less focused on pricing. So I would expect to continue to see that be sustained. We anticipate that the academic institutions, which closed very quickly, would open very slowly. And that they would open totally dislocated with what the universities and colleges do with students. So while they might not bring students back at all, but they're still going to open their research centers, because they should -- probably shouldn't have closed them at all. They have PPE, they know how to deal with hot viruses, they know how to protect themselves and the work has to get reinstituted. A lot of good work was destroyed or very much disrupted. We anticipate that Europe academic centers would open slowly over the summer, and U.S. ones slowly over the fall. And we're beginning to see both of them open more quickly now. So that's how -- I don't want to overstate that, but I don't think they're going to close again. So we're -- opening now is ahead of where we had originally anticipated. I do think they'll have to work differently to get back to full strength, maybe a second to third shift, but they're opening again buying more animals, and I think that, that will continue. So that's obviously a benefit. So as we sit here today at the very beginning of the last month of the fiscal quarter, demand for DSA continues to be quite strong, and the research model demand is ahead of where we thought. We are beginning to rethink about M&A. We are rethinking about when to start our conversations, where we -- and I want to be clear about what I believe we said previously, which is that we wanted to pause and make sure we understood where sea level was and make sure we understood the demand for our products and services, what the revenue and free cash flow implications would be and what we thought of the landscape. And so as the second quarter beginnings to be as -- begins -- continues to be as strong or perhaps slightly stronger because of RMS than we thought, and we're beginning -- we continue to book in the third quarter, and we feel good about that, we're likely to reinstitute some conversations with M&A prospects third quarter. We had several of those ongoing, and I'm almost done, Dave. And I would say that I think we'll find several things. We'll find some may want to sell things sooner because there's too much uncertainty in the world. Prices may be better. I don't know that for a fact, but it may be that multiples may be better. There's likely to be less competition for deals, because I think some of our competitors are really busy with the deals that they started. Their balance sheet's not as strong as us and maybe their businesses are not as strong. And I also think we'll have less private equity at the table competing against us. So we don't know this for a fact, but we're likely to see better opportunities for M&A. And if we feel solid about our business, we will pursue some of those in the back half of the year. Again, we never know whether we'll be successful with any of them. I think more than ever, we've seen the power of our portfolio at a time where clients really need us underscore the fact where we need to continue to add to that portfolio through classic M&A and also through these technology deals that we're doing, which may be precursors to M&A. So I think that's a good lead-in, Dave. Let me stop there and take your questions.

Yes. Thank you very much. There are plenty to dig into there. So you mentioned very strong proposals continuing into the second quarter. We talked a little bit about the first quarter drivers after your results. You mentioned at the time that you thought maybe companies were more focused on preclinical because they could. The clinical is a little harder to advance at the moment. So basic question here is what do you now assess to be the drivers of this strong proposal environment, particularly for DSA?

Yes. So this is sort of fourfold. One is that, yes, the clinical trials are less easy to do, that's English. You can't -- it's tough to recruit patients, they could be sick with COVID; tough to find docs because they may have been pulled off to work on COVID. And so there's been a pause, for sure. If and when and how that -- not if, when and how that reconstitutes, I don't really know what the cadence of that will be. But -- so they shifted some more of their focus than usual on the preclinical arena, number one. And number two, there's a sort of a mania to get the geo -- the IND-enabling studies done. They always want to get done by the end of the fiscal year, and in this case, more than ever. Three is, there's a whole bunch of work on a whole bunch of therapeutic areas and new modalities that were in process anyway. There's no way they're going to stop that. Four, you've got a whole bunch of COVID work that's just been dropped on top of everything. When we reported the last conference I was talking on, that we had about 45 clients for whom we were doing work in therapeutic or vaccines for COVID, and I'm sure that will continue to anticipate. And there's probably some beneficial pricing in all of that. So the funding -- and I guess the last thing is that the funding environment has held up really well for biotech, both from directly from pharma and from the capital markets. The capital markets looks like it's accelerating. Again, very strong first quarter. Probably a -- not probably, a slower April, May is beginning to improve, and we think it will continue to improve in the back half of the year. So probably still have 3-plus years of cash. So if you roll off things, and then I'm sorry, there's so many areas. For the last one, we have so many clients that historically did their DSA work internally. We now have these sites closed, either have to not do the work or externalize it or companies that, I don't know, split it between us and another provider and maybe another one of our competitors didn't have a good business continuity plan, just don't have good proximity, don't have capacity. There's just more work coming out that historically hasn't been outsourced. So if you roll those 5 or 6 factors together, it's a pretty robust demand curve. And for us, we need to have enough people, which we do; enough capacity, which we do. We need to have our people not get sick with COVID, which is just good luck. But so far, it's been quite good. And as I said, I think on our first quarter call, our people are pretty safe at work because they're all PPE-ed up anyway, most of them. They're used to that. They're used to being careful. They always have masks and gowns, and there's positive pressure and HEPA filtration. And so I think they're at much greater risk going to the grocery store than going to work. So we've been fully open the whole time. Our G&A stands tall, but our operating units, whether they're taking care of animals or running studies, have been open the whole time with very little absenteeism, actually less than during normal times.

How do you think, Jim, about -- on a couple of these factors, the duration of impact. I know some of this around COVID is hard to predict. But if we think, I'm probably going to wrap 2 in 1 here, but if we think about the time frames that are -- the aspirational time frames that the public health officials are laying out and there's this race to move this additional bolus of COVID programs through, you talked about clients' desires to get IND-enabling studies done. And then in addition, the other one would be clients that have sites closed and are using outsourcing more aggressively now because of that, are those factors enduring demand factors? Or would you expect those to be kind of 2020 factors that could wane as we move beyond the initial bolus?

I think the work that historically was done by clients themselves, because they had a cultural preference to do it that way, that's now out of necessity come to us. Now I do think that this COVID situation is -- will be prolonged. I mean I don't think there's going to be a vaccine for 3 to 5 years, I don't think it's 3 to 5 months. So I think there's a strong propensity for this or potential for this to continue, where they outsource to us for a year or 2 years or longer, and say, wow, getting work done as fast or faster than we could do it ourselves. We're getting it done less expensively than we could do it ourselves. Science is as good or better. Why on earth would we open those facilities or bring those people back? So we repurpose the space with people. So it's the best -- I don't want to sound crass here, but the best advertisement or marketing story about the strength of our portfolio, we're living it. So clients need us to be in proximity, because they still want to drive and talk to us or clients that want to have an outside provider that's open. No, we're not just saying it, we're actually doing it. So I think some of it can be back, Dave. I think there's still some clients that want to do talks internally. But as you've heard me and other people from my company say for years, I think talks eventually gets to 85% outsourced, at least probably 100%. So I just think this might accelerate that whole situation to say, "Wow, what if there's another COVID in 3 or 4 years, we can't continue to count on ourselves. So we're close to big pharma X or small biotech company Y and Charles River remained open. We depended on them and they got the work done. And by the way, it was quite good. I don't know why we did not outsource it to begin with." So I think that's sustained. I don't know how much the COVID situation provides incremental work, for how long and how meaningfully. So yes, 45 clients, it's more work. We have thousands of clients. So it's not particularly material to our revenue, but it's more work, and so it's slightly beneficial right now. But it also proves whether they can depend on us or not. So I think there are a combination of factors which should have these, to some extent, sustainable. I think we'll be able to vet that and talk to you and others about that as we -- as this thing unfolds, where the people are like, well, thanks a lot for your work. It's coming back in-house. Well, thanks a lot for your work, we're going to continue to work with you, or some combination of both.

Got it. So briefly, I don't want to leave that vaccine comment hanging. Was -- so 3 to 5 years, talk that one out a little bit. What drives that assumption?

I hope I'm wrong. There's never been a vaccine that's gotten to market faster than 4 years, and that was mumps. Ebola was 5 years. HIV, there's no vaccine. We're 40 years into it. So -- and the average time to get a vaccine to market is 10 years. So there's no assurance there will be a vaccine, even though we all hope that there will be, and we need -- psychologically we need there to be. There are new modalities. So Moderna with its messenger RNA drug, there's never been a drug like that, working on this. A couple of other companies have DNA -- RNA-based drugs, and the manufacturing process is easier. Will we skip fundamental steps in the clinical trial process or not? As you know, and everybody listening knows, drugs are given to sick people, vaccines are given to healthy people, so they don't get sick. So in order to vaccinate the world against COVID, it's probably going to be 2 doses. We probably have to get 7 billion doses of this thing. So if you even had a vaccine available this year, which we won't, but if you did, the sheer process of manufacturing and vialing and distributing that is a -- I don't want to say a nightmare, but it's nothing that's ever been done before. So I think you have to prove it. You have to do substantial large Phase III trials. Now if there's a vaccine like at the end of -- something that looks promising by the end of this year and you give that to very sick people or first responders who want to -- who want it and want to take the risk, and that proves to be positive, well, that is a clinical trial. So that can help accelerate it. But I think that the sort of 18 to 24 months is what you're hearing, I think that's -- everybody hopes that, that will happen. I think that would be jamming the process -- it'll be accelerating the process faster than it's ever done before, and that could make a lot of people sick. So I'm just sort of personally and with regard to the way I look at it from Charles River's point of view, kind of thinking, is the fastest one is 4 years ever. Kind of 3 to 5 is kind of -- that's probably likely. Maybe 3 is better than 4. And maybe this gets so bad with the second wave and a whole bunch of more people die that the world would join hands and get something out prematurely. But I just don't think it's a matter of months or perhaps even 1.5 years, Dave. And that's just my personal feeling, talking to everybody and listening to everybody and looking at the realities of how tough this is. And just the difficulty of manufacturing and vialing, it really prevents a whole another situation that -- tough to gear up for that. And then who gets it for us of course is the whole philosophical and societal question.

Great. Thanks for that. So let's move on. I want to touch on Discovery briefly before we move into Manufacturing Support. Discovery is certainly much smaller than your Safety Assessment business, an area where you've been, I think, trying to build critical mass over a number of therapeutic areas. I think you highlighted that Early Discovery was fairly strong recently. But talk perhaps how the maturation of the Discovery business has come along. Am I right that, that's an area where your M&A is kind of to be targeted, notwithstanding the recent pause and things like that, but just in general, where you're looking to do some M&A? And how you kind of mature that business to a steady growth contributor for DSA?

Yes. So we feel that we've established sufficient mass particularly in oncology, oncology pharmacology and CNS pharmacology, in particular, in bioanalysis and then our Early Discovery business, which is principally chemistry, complex biology and a fair amount of in vitro capabilities. And we have the ability in that business to actually discover targets. So it's a very interesting portfolio. With enough complex science and mass for the clients who have taken notice of it, both large and small, pretty pleased with the client uptake. We have a bunch of big pharma clients as well as small biotech. There are more M&A opportunities there and it does have the propensity and opportunity to see more safety work. And we do the discovery work if the molecule looks promising. So we intend and anticipate to continue to expand this portfolio both organically and through M&A. It's a close analogy to safety. It's not as clean as safety. I mean it's a bigger market. Some early discovery, obviously, has to be done by the drug companies. Otherwise, what do they do, right? So they'll still do the preponderance of very early discovery. And some will do slightly later stage discovery, but so much of the late discovery and early development we can and should do for them. It's more routine, it's more industrialized, it's more larger packages. And so I think, and we're getting more discovery work because of the whole COVID thing as well, more of that work is being outsourced. So again we're being able to demonstrate that. And also given the strength of that business now in the -- how the first quarter ended and the second quarter, strong bookings as well. I think it's testament to just the important role that this plays. So I continue to anticipate that Discovery will go have similar cadence to Safety. I don't think it will be 100% outsourced, that's going to be illogical. But I think a meaningful amount can be outsourced. So we said the numbers are really tough to get kind of 15% to 25% outsourced right now. I think it sort of -- could certainly get to 50%, 50% over time. So yes, we're watching it closely, and we're pleased with the scale of the business.

Got it. So I'm going to try to squeeze in 2 here. We have about 3 minutes. In Manufacturing Support, the margin performance in the first quarter was really, really strong. That business has, at times, gotten off to slow starts in the first quarter. So it kind of bucked that trend, you've graduated through some capacity expansion and there are some various factors influencing that business. So if you could briefly kind of help me understand the mix of factors that contributed to the margin performance in the first quarter, and how sustainable is that?

So the manufacturing business is essentially unscathed by COVID, a tiny amount. So the demand is terrific. We would have had double-digit growth in that business in the first quarter, except we had this big order last year in microbial. The microbial business, there's just a lot of drugs and a lot of PPE being manufactured right now more than ever and a greater need to make sure that sterility and lack of contamination has occurred, as both of these drugs get out in the market, whether for COVID or non-COVID. And there's just gowns and masks and syringes and all that other stuff. So that business is really rocking. We had some significant process improvements in the manufacturing process of our cartridges, which is adding to the margin there. And then the biologics business, as you recall, we're building out this big site and we had duplicate costs. Those are over. The demand is exceptional because so many of those drugs have to get into the clinic to be tested, whether they're COVID or not. And even the Avian business. This small business is doing extremely well because the need for these chicken eggs is sort of quite strong. So I think the top line will be very strong. I don't want to get ahead of ourself. We said that our 2-year guidance for the sector for operating margin is 35%. It was above 35% in Q1. I certainly think we can keep it there. Whether we can get ahead of that, we'll have to see. But that continues to be a very, very strong segment for us.

Excellent. So my time keeper is telling me, we've got about 5 seconds left. So I'll say thank you. I appreciate your attendance. Hope you have a great day of meetings, and we'll talk to you soon. Thanks, everybody.

Thanks, Dave. Be well.

Thank you. You too.

Bye-bye.