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

Okay. Jim, I think we are now live. Good morning, everyone. This is Eric Coldwell. I'm Baird's Healthcare Services and Supply Chain analyst. It's our pleasure today to have Charles River with us. Of course, Jim Foster, Chairman, President and CEO; also in the background, Todd Spencer, VP of IR. Jim, we're going to jump straight in. I think you might have a few prepared comments, and then we'll go straight to fireside chat.

Sure. Nice to be here. Eric, nice to see you. We talked about some favorable trends in August when we had our second quarter call. And so I'm pleased to say that -- sorry, favorable trends in July. So I'm pleased to say that those trends continued in August. And we're pleased with how the third quarter is shaping up. And we expect that all segments will report improved growth in the third quarter. So we feel really good about that. We're seeing the Research Model business shaping up to be probably mid to high single-digit decline than we had originally anticipated and our DSA and Manufacturing segments, high single-digit growth rate. We still feel really good about delivering 20% operating margin in 2021. We're really pleased to get an acquisition done not a while ago in the cell therapy space. And even when we did that acquisition in a virtual world, in a virtual context, which is amazing, actually. And integration goes well even in a virtual world. And so we feel that the business is in a good place. I want to reiterate the fact that while we're definitely enjoying some benefit -- it feels bizarre to say that I don't want to have any benefit, but some additional business, I should say, from COVID. It's a small amount of business. In the midst of thousands of clients and thousands of molecules, we're working on a whole bunch of other indications. So we don't want people over read that or overstate that. The demand -- in some measure because of the strong funding paradigm is supporting growth and development of a whole host of drugs and a whole host of therapeutic areas. So maybe I'll just even stop there, Eric, and we can just move right into Q&A.

I'm muted there. Okay. Jim, thank you very much. So you talked about seeing some small benefit from the COVID activity, which I think is well understood across the industry. You did have some second quarter headwinds in certain segments. I'd like to go through those briefly. You mentioned RMS, what you're looking for here in the current quarter and the outlook in the near term. But academic demand was obviously the -- going to be the biggest headwind. That was, I thought, pretty obvious from the get-go. The demand was choked out in the beginning of the second quarter. You made some comments last quarter that it seemed to recover faster than perhaps you had expected. I'm just curious if we could start with an RMS academic side update, and I'll throw on there, I mean, we clearly still have a number of universities closed, operating virtually, et cetera. When does academia get back to normal, if ever? And I'll open up with that.

Yes. So the Research Model business was adversely impacted in the second quarter because of COVID and because of the very rapid, chaotic, unanticipated closure of pretty much every major university and medical academic center in Europe and the U.S. And we tried to give a prognosis as to when they would reopen. We've had some elucidating conversations with provos of these academic medical centers and deans of medical schools and a few university presidents. And so I think we have a pretty good gauge of it now. They have been opening and are opening more quickly than we had anticipated. That's a good thing. And I wanted to distinguish, for anyone that's listening, between closing these universities en masse, which they did, both undergraduates and academic medical centers; and now reopening and bringing them back online. So while many universities and colleges in the U.S. and Europe are open, many of which I personally think, unfortunately, will probably have to close because it's just impossible -- challenging to impossible to have 18-year olds who have left their parents for the first time not party. We all went to college. It's just hard. And they're all doing it, and you saw the northeastern thing where they throw a bunch of kids out of college, and you see the bunch of other colleges that had high incidents. So I think it's possible and probably probable that they'll go to virtual and send students home. I don't think that has any impact on what happens in the major medical centers that had opened. So research was destroyed or delayed severely. They wish they hadn't done it. They don't have 18-year-old kids in those labs. They have post docs in those labs, maybe a few students, but serious ones and a lot of post docs. They're all PPE'd out. They're working in hoods half the time. They can -- if they have to spread out -- well, they do have to spread out. But maybe they aren't necessitated of their shift. I think the funding is still there. And there's a lot of critical research that these medical centers are doing, not the least of which, is with regard and with respect to COVID. So we're hearing from the folks that we're talking about that they're opening and they're going to stay open. And that's notwithstanding probably what we're in now, at least in the U.S., is the second, more virulent phase of the first phase with incidents going up will probably be exacerbated by a second phase. And I think that may wreak havoc with the student population, but not in the research population. I think they'll just batten down the hatches and do their work. So there's a 2 for there -- for us, Eric. One is the work that they do in those labs that require white average Charles River animals or other products and services, we benefit. And the fact that they have ones that have closed and even have opened have outsourced a fair amount of work to us. The best example is in the GEMS business. People that were doing GEMS research still use animals for their research, but they don't have to house the animals there or do the molecular biology there to develop them there. So one of the things that's happened with us because of COVID, and I'll let you get to this in a minute, for sure, in RMS, but also in 3 or 4 of our other businesses, has been an inflection point for more outsourcing, which we've seen and we'll be the beneficiary of that long term because I think some meaningful part of the outsourcing won't be returned to the internal part of the business.

Well, I definitely have a question on that in a minute, and I will come back to it. Sticking with businesses that had short-term challenges. In no particular order of HemaCare was a recent acquisition, a very exciting acquisition, a high-growth marketplace, supporting cell and gene therapy work. That actually requires blood donors. And you have a California clinic or they had a California clinic that you acquired, which was temporarily closed during the second quarter. I'm trying to get -- if my math is correct and of course, it's an acquisition and there's a lot of debate about what you had in your model versus what we had in our model, et cetera. But based on rough math, it looks like that business was about half of our expectation, at least. We can debate that. But it did seem to be more impacted than research models and DSA overall. Was that more of a supply issue, lack of donors, lack of inventory? Was it more of a demand issue? And now that the donor site is reopened, how is HemaCare tracking here in the third quarter?

So HemaCare had a double whammy. So they -- they're in the L.A. area. So California really clamped down quite hard on COVID, and they were sheltering in place. So the donor room was closed for a couple of months. It's now reopened. It's not quite at full speed because you have to distance the donors further apart. But we can and will extend the hours. So it will approach its original capacity and capability. But the donor room being closed, which is where we bring in fresh cells, we were able to offset that somewhat by selling frozen cells. But we also had a fair number of clients, not just California based, but biotech companies, who were closed. So they were unable to order cells and unable to do their own work. So we had a double situation. So the donor rooms opened back -- back open. I'd say the majority of the clients are opened up, but not all of them, so we had a double hit there. That business will grow at least at 30% when we get to next year. Obviously, this year is quite different. The Cellero business, which we just bought, different business, somewhat smaller, different geographies, didn't disrupt the donor room as much. And so they were pretty much business as usual. So that business, even though we bought it kind of after COVID, kind of normalized, at least understanding what was going on, will be less affected. So we're really enthused about those businesses. Those are providing basic cellular -- human-derived cellular products so the people doing cell therapy, developing those drugs, all the process development and scale up and manufacturing. So you're not making a cellular therapy drug without the cells. So yes, it's also important that we get back to work so that we don't stunt the growth of a pretty important modality here. So a much better situation today than we were a few months ago.

The last one I wanted to hit on, Jim, is microbial. One of my -- as you know, one of my favorite businesses over time and one of your best growth businesses over time. Not surprisingly, some new equipment decisions were delayed. Some implementations were delayed last quarter. I know you've shifted to remote installation, virtual training, things of this sort. How is microbial coming back? Or is it a V-shape recovery in that business or more of a ratable improvement over time? What some people are calling the Nike swoosh recovery as opposed to the V shape?

I hope it's not V shaped. It's, for sure, one of our best businesses and has sustained -- has had extraordinary sustained double-digit growth for a couple of decades. So it's as simple as this. There's great demand for the products pretty much across the board, and we have 1 service, good demand there. Made some great strides in manufacturing efficiency last year in process development, great organizational forays, and clients closed and not able to take in new pieces of equipment. So you touched on one aspect. So to the extent that we can and to the extent that the clients are amenable to it, we're doing some virtual installs. So those are for less sophisticated people -- pieces of equipment, but clients really want them and they can dedicate somebody to sit there while talk them through it. My analogy will be the FDA doesn't like to do virtual audits, but they're doing virtual audits of us, and of big pharma. It's working quite well, by the way. Clients are doing virtual audits of us. I did a virtual audit of Cellero before we bought it. I didn't go there. So virtual stuff works. We have some very expensive, very sophisticated, very complex pieces of equipment, I don't think will lend themselves to virtual. Possible, but unlikely. So I guess the way I would unpack this for you is the following. A lot of our sales are still with our basic reagents. They're not even -- none of our equipment. So going well. So the basic pieces of equipment like our PTS, which -- it is a piece of equipment, but it's pretty straightforward and we could walk you through it, easier to sell. And then we have an MCS, which is like multiple PCSs. And then we have a very complex robot. And then we have some -- a bunch of systems in our Celsis business that we bought, which are also complicated. So the simpler pieces of equipment would be easier to sell, the more complex, some virtual capability. And obviously, for the installed base of equipment, particularly PTS, which is thousands and thousands of systems, people are buying the cartridges. So we have the razor blade sales. So the business will slowly emerge. It will have a better second half of the year than first. Margins should continue to be good. It's impossible, Eric, unfortunately, to predict what clients will let us in and when and why. You know, even though this pains me and is an American, it will pain you as well, European clients, if an American has to go, may not want us there because of the incidence of COVID. We do have Europeans to do this as well. Some U.S. states won't let folks from other U.S. states go in. So we just have to take it piece by piece. We talk to these clients daily -- weekly and daily. I think it will slowly, but surely open up.

So you hit on this a minute ago. I want to focus on RMS segment for a second. But first off, if I extract HemaCare and the $35 million net COVID impact that you reported last quarter, quick math would suggest that RMS overall grew in that low- to mid-single-digit core range that you were targeting in the first place. So the business was on track, sans COVID. It does feel like Research Model services have been doing better recently. And you hit on GEMS. You mentioned GEMS is a very strong business at the moment. Is there more to GEMS? And maybe you could just -- first off, you got a lot of acronyms. You have a lot of very esoteric business. Even Wall Street doesn't what they are. Maybe give 1 minute or -- 1 minute on GEMS, what it is, and then talk about what's driving that growth within RMS services?

Sure. So first off, I would agree with your characterization that we're certainly in the midst of the low mid-single-digit, if you strip all that stuff up, which is good. Obviously, the margins got crushed in the second quarter. That will improve in the back half of the year, for sure. So we've seen a couple of things. We've seen the services business be sustained and enhanced because of COVID. GEMS is Genetically Engineered Model Services, which has been solid for 5 or 6 years. One of the critical research tools to discover new drugs or animal models where you've either knocked in or knocked out genes and they're expressing human disease traits. So they're like little avatars. And with things like CRISPR, we can make them faster and cheaper and in larger numbers. So that's very, very powerful. So without COVID, we've been picking up speed pretty much across the world. We even have a little GEMS business that started in China. Big ones in U.S. and Europe, and pretty big in Japan. We do really -- we do the basic molecular biology offering with clients, but we do rederivation and scale up and shipment of these animals and keeping them pristine for the client. Now you add on to that, the sudden closure of facilities, both big pharma, big biotech and some small biotech clients that have their own GEMS colonies, and now the staff can't get in to take care of them. So they ship them to us. And then, this thing is obviously way more prolonged. You remember a few months ago, everyone thought this was going to be a few weeks and a few months. Now it's clear it's for a few years. So what's happening already, more with GEMS than anything, Eric, is clients are saying, "You're going to keep those colonies. You're going to do our GEMS work. We're going to still do the research with those animals." Well, why would we take them back and do all that work? By the way, we could just -- some of them are still disrupted by COVID. We could get more disrupted again in 6 months or a year. We don't want to take that risk. And what about the next pandemic? So this is what Charles River does. We know that you do this. This is a core part of the animal business. We've added capabilities of molecular biology and additional science. So a very strong business that has been strengthened by COVID and outsourcing that I think is sustainable. It's got very nice margins, by the way. And we're a very big player in it. The Insourcing Solutions business, just parenthetically, another part of our service business, where we manage other people's animal colonies and/or they outsource some things to us and/or we have these cradle facilities where they come in and use our facilities to do their own work, are also very strong and have been somewhat enhanced by COVID as well. And then the last part of RMS, why it's doing -- while it is doing and will do better, is that China is way ahead of the U.S. and Europe in coming out of COVID, number one. Number two, we built a new facility, big facility in outside of Shanghai. I think you know we're finishing up a facility in Wuhan, which sounds like an interesting thing to do. By the way, I'm sure you know and some of our listeners might know. Wuhan actually tested all 11 million of their population, and they have no COVID at the moment, even though it started there, and research will be robust there as well. So China is another high-growth engine for the Research Model business. And then as you add on to that, just to remind everyone, the cellular products part, Research Models going forward looks like a potentially higher growth business than it has been, and we'll refresh those numbers at some point.

That's a great setup. The other businesses, and you've talked a lot about lasting change and how client behaviors might be changing post COVID. You have other businesses that have benefited. You've hit on GEMS. You've hit on Insourcing Solutions, et cetera. But what about Biologics? Again, another business where you already had momentum, you've built a new site then improved your capacity. I believe the goal at Charles River was to grow your Biologics Testing business to maybe a #1 player over the next few years. And that business seemed to do really well last quarter. Was there -- were there knock-on effects from COVID? Or was it just you had a lot of demand, it wasn't disrupted and you had a new site that could handle the volume?