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

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Great. With that, hello, everybody. Thank you for joining us for the fireside chat today with Charles River. Joining us from the company are David Smith, CFO; and Todd Spencer from Investor Relations. I'm Dan Leonard, the Life Science Tools, Services and Diagnostics Analyst with Wells Fargo. The format is fireside chat. If you have a question for management, please raise your hand in Zoom or you can shoot me an e-mail and we'll try to address it. And with that, I'll kick off the Q&A. Welcome, David and Todd.

Thank you.

So to start off what's on top of everybody's minds right now, I'm hoping, David, Todd, you can discuss both the temporal and maybe the structural tailwinds from COVID research activity on your business?

Sure. So at our May earnings call, we mentioned that we were working with over 40 customers on their COVID-related projects. And since then, while that number has got higher, it's still a relatively small number when we compare it to the thousands of clients that we routinely work with. Of course, we're pleased to be asked to work with the clients to help them on their solutions and we know it's critically important to them. It's critically important to society, as a whole. But one of the less obvious benefits is how motivational it has been for both our staff and suppliers. So during this sort of turbulent period, all of our sites have remained open for a number of reasons, but one is because of the work that we're doing on COVID, we're all very proud to be at the front of the preclinical sort of safety assessment work that is required before we can take some of these molecules into the clinic. And it's not just our staff that have helped us remain open and suppliers, too. For instance, some of our suppliers were having difficulties delivering to us, particularly during the lockdown period. But when they heard what we were actually doing, that we were working on COVID-related solutions, they managed to find ways to unpick some of their internal problems and actually get the stock that we needed to the various... [Technical Difficulty]. And from a client perspective, it's also been a reminder of why working with a partner like us is useful to their operating model. So some of our sites -- they are sites closed or they are partly closed. So working with an outsourced partner, like us, has helped them progress their science, and it's an important reminder of how we play in their operating model. In revenue terms, this works -- in an absolute dollar terms, this work has not been a big number. We're glad to take it, and it does make some contribution to offsetting the lower level of work that we've had, particularly in Q2. Now we did call out in our last earnings call that we estimate that the lost revenues due to COVID for the full year 2020 is about $100 million. Most of that is in research models, but it did have an impact on our other segments, particularly in Q2. So I guess, in summary, the COVID work is helping to offset some of the short-term shortfalls, but it's not meaningful enough to be a net headwind in future years.

David, though, could you elaborate on the point you made around reminding or at least promoting your operating model with your customers as a result of COVID, customer sites being shut, you're open for business. What sort of impact do you see in the past 6 months having on outsourced penetration in the areas that are important to you, like, safety, assessment in some areas, where they would fall within discovery.

So do you mean in terms of the way we've been talking to our customers or the impact that being a sort of an outsourced partner has had on our business?

The latter, does -- you see a higher level of outsourced penetration a year from now or 2 years from now in some of these areas than you might have otherwise because customers might value having an outsourced partner more today than they did 6 months ago.

Right. So maybe to answer that question, maybe it's worth as me just talking to how it's happened to us and how we're responding to that. So in terms of our Q2 earnings call, we did mention that the trends were more favorable in July. So we started off -- let me go back a bit. So we started off where we were, like everybody else, struggling to understand what COVID was going to do for us. What we have seen in terms of outsourcing is that where some clients have shut down their sites, they have made use of this. We've seen in research models, we've seen where they closed down their sites -- we'll come back to maybe that later as to how that's picking up. We've seen, in particular, genetically engineered models, where the client, rather than try and retain those models in their own vivarium, have outsourced back to us. And so one of the questions that is arising is, will those clients bring back in-house those genetically engineered models once the world rightsizes itself? And while inevitably, some will bring their models back in-house, we're already picking up some signals that some of them will retain that with us. So that's encouraging. Another change that we've seen is that we've seen a larger number of investigators who have never used us in the past, used us for the first time, and that is a new experience that we've seen coming out literally in the last few months. We suspected that, that might be the case because even in our last earnings call, we commented that some of our competitors were facing some operational challenges, and we were picking up some work that we don't normally see, but we now have some solid data on the number of investigators, and we've, actually, annotated it out to actually look at how many have never used us before. So that's also a positive signal for the future. One of the difficulties we have had, though, is in microbial, where in Q2, we saw a number of customers with strict access to their sites. A lot of those around the world have restricted people coming on to sites. And in microbial, in order to install new equipment, we really need to be on the site. So that had a drag in Q2. We are seeing Q3 pan out a little bit better, and we would expect as the world begins to rightsize itself, finding ways that we can put more our instruments in. We're actually looking at whether we can actually install virtually, so that's another way that we might be able to get around that in a temporary way.

Okay. And on the point you made around annotating out the number of investigators using you for the first time, have you annotated how many of these are, like you said, maybe competitive wins, your competitors having access issues and folks migrating to Charles River versus perhaps new outsourcing that wasn't occurring before?

So the investigators are specifically to do with research models. So that's more of a -- so the way the research model is we've got academic institutes and we tend to talk about investigators being the person whom is putting that work towards us. And as I say, as you know from previous commentary, at the end of Q1, we saw our research models business close up quite rapidly. It certainly gave us, of course, a thought as we considered our Q2 guidance. We were pleased to see that during Q2, particularly in Europe, a swifter reopening than we expected and we've seen that continue into Q3, both in Europe and the U.S. What was -- what we were doing in that sort of analysis is, we were actually seeing that we were winning work from places that we have not won work from before. Now I can't categorically say that all of that was stick. I'm sure that some of those investigators will return to their previous supplier, but we do know that many of them will stay with us because for a number of reasons. Once you start a particular strain, you don't particularly want to have to rechange that. So there is some stickiness in the way that people buy from us that once they bought a particular strain, we should be able to see that repeat. Some investigators are actually so keen to get the same strain, they insist on getting it from the same site and are not prepared to get a strain from a different site. So that would suggest to us that some of that will be business that we have and should be able to pick up and retain going forward.

Okay. In the GEMS business, within research models, I believe, is proportionately smaller than the other parts of that operating segment. Do you expect that that becomes a larger part of the business? Does this trend change the way you're viewing the growth trajectory of RMS more broadly?

Yes. So GEMS is one of our service businesses and services is small than the research models. So yes, you are right, it is a smaller business. But nevertheless, if you look at research models as a -- or Research Models and Services as a whole, it's had relatively low organic revenue growth. It's not the most attractive segment that we have in terms of growth. Its cash flow is terrific. So any expansion that we get organically in that unit does have a more noticeable impact on the growth of that unit. So yes, we're pleased to be in a position that, a, in research models, we've got more of these investigated placing orders with us; and b, that genetically engineered models, there is some commentary with some universities that are saying they don't see why they should bring that back in-house. And we did say this, the best way to encourage outsourcing is to experience it. And the more clients that touch the work that we can offer and if we provide a good service at a sensible price, then it will encourage them to have an open mind to come back. So this is our greatest market employees who actually do some work with people. So that should all play into some of this work staying with Charles River in the longer term.

Okay. And then circling back to the results in the quarter. I think one of the features that surprised investors was the strength in your DSA segment. And I don't believe you changed your forecast for that business segment at all for the full year 2020. What might have surprised you to the upside? Or what do you think surprised investors to the upside regarding the durability of your performance in DSA?

Yes. So we -- as I mentioned at the beginning, we're pleased to get that COVID work, but it's relatively small compared to this year, thousands of customers that we're working with. And some clients, as I mentioned, have shut down their site, and therefore, have put more work with us. Some have shut down their site and haven't placed the work with us. So we did have a drop in Q2 in terms of our DSA activities, particularly in safety. But that's the whole power of being an outsourced provider. If we are open and they're not and we are able to catch that work, and to the main point I'm making is that, actually, if we're open, why should they not continue to place their work with us, even if they are in a pandemic situation. So yes, DSA is doing what we said it would. We talked about how its margins would increase as we worked our way through 2020 and 2021, and we've seen that in the numbers that we've provided in recent quarters.

And then another feature of the operating environment relative -- relevant for Charles River is the strength we've seen in biotech capital raises, IPO, secondaries, et cetera. Can you provide us an update on how to frame that level of activity to business prospects for Charles River?

Yes. So I'll start by saying that we're not hearing any funding concerns from the conversations we're having with clients. And that should make sense because recent reports on the biotech funding is that year-to-date, to August. I think we're talking about $100 billion, which is from the data I saw were 75% year-over-year increase. And indeed, in 2015, the full year, and that was the highest year, was $109 billion. So this 2020 is proving to be another bumpy year, another strong year in terms of funding flows, IPO, et cetera, that's all helping to support the favorable industry sentiment that we're witnessing. And we believe that, that will continue into the future. There's ample funding to drive innovation and any promising molecules that needs to be taken into the pipeline. Biotechs still have 3 years of cash on their balance sheet. So they have the means to withstand sort of a dislocation in the capital markets or at least a short-term dislocation in the capital market. And there is certainly incentivized to move the molecule through the pipeline and to create value. Debt remains inexpensive, and in my view, that's not likely to change in the medium term, particularly with the pandemic and we don't believe that the pandemic is having a negative impact on our industry to the contrary, investors need to find places to invest that capital. And this is, particularly, the biotech industry, maybe not quite the wider health care and this is certainly biotech, seems a good choice, both currently and in the longer term. And if anything, the crisis is further highlighted the importance of the biopharma industry -- and not just the biopharma industry but contract research organizations like ourselves. All of our sites are open during the pandemic. That's done knowhow whatsoever to our reputation. And certainly, we've been there for clients when they needed us most, and that will encourage others to continue to think about outsourcing. Obviously, that lifts all boats in the CRO world. But our global scale and our leading early stage portfolio leads us to think that we should be able to differentiate ourselves from the competition. So from our advantage point, the future does look encouraging.

Okay. And I think the answer to my next question is tied up in the discussion we've already been having, but as it relates to your 2021 financial targets, you did confirm them despite headwinds from COVID. So can you elaborate on that thought process and on confirming the 2021 targets despite the uncertain environment?