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

Welcome to our next session here at Morgan Stanley's Global Healthcare Conference. I'm Ricky Goldwasser, Morgan Stanley's health care services research analyst. And joining me this morning is Jim Foster, CEO of Charles River. And before we get started, please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley's employees only. It's not for a member of the press. And if you are a member of the press, please disconnect and reach out separately. And for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com. And if you have any questions, please reach out to your Morgan Stanley sales representative. And with that, I'll hand it off to you, Jim, for some introductory remarks.

Sure. Thanks, Ricky. Nice to see you, albeit virtually. We -- I think the first thing I would say is in our second quarter call, which was a positive conversation, we had talked about the favorable trends that we had in the business. We gave an update that those trends had persisted through July. And so I'm pleased to say that those favorable trends have continued through August. And we're very pleased with the way the third quarter is shaping up, and we expect all the segments to report improved growth as we go into the third quarter. The research model business is coming back more quickly than we had anticipated and should have a mid- to high single-digit decline. We're obviously not thrilled about the decline, but the second quarter was so rough that you really can't make it up. But the other 2 segments should have a high single-digit growth for the year. So we're really pleased with that. We announced -- I mean, we actually did an acquisition in the virtual world. So we announced a small cellular therapy product company that we can talk about in our second quarter call. So we're very pleased we've been able to do the deal and also to intensify our cell and gene therapy portfolio, both across our current portfolio and adding some new businesses. We are on track to -- unwaveringly on track to hit 20% operating margin goal in 2021. So notwithstanding the disruption and short-term disruption that we had, particularly in our second quarter from COVID, we're quite confident about that. So we feel that the company is in a good place and that we've really done a good job responding to this crisis, particularly providing a lot more opportunity for clients to outsource to us who weren't able to use other providers or even rely on themselves. So we've seen a little bit of an uptick and an inflection point. We have so many companies outsource discovery and talks to us over the years that will -- would have and will continue, but we feel it's been accelerated a bit by COVID out of necessity. So maybe I'll stop there on -- to questions.

Great. Thank you, Jim. [Operator Instructions] Jim, let's start with the biotech funding environment. That's always been a topic that investors have been very, very focused on. And obviously, we're seeing robust environment. In a high level, what are we seeing in the marketplace? And which segment is benefiting the most from the funding environment that you're seeing? And has it already translated to increased RFP activity? Or is this something that you expect to see more next year as the environment normalizes?

Yes. So the inflows continue at a pretty healthy clip. And this year is on track to be the highest ever. We will see whether that's the case or not. But we've been saying for a while that they've at least free with some cash on hand. So we don't hear anything from clients about we're going to delay our study or cancel our study or wait until the next fiscal quarter. By the same token, we don't have these sort of unusual surges of buying. These folks are thoughtful about where they spend their money. And so we're -- I'd say the business is consistent and persistent across biotech. Companies large and small, I think they're prosecuting the full range of the drugs that they're developing. So maybe if company x had less money, they would only have 3 drugs with us rather than 4 or 5. It's tough to discern that. So a bunch of new modalities, certainly, cell and gene therapy has enhanced the possibilities. The immunotherapy companies, I think, are doing well. You've seen 2 companies, in particular, have a strong presence in RNA, aspects of RNA. A lot of monoclonal antibodies are contributing as well. So we have -- we continue to have the preponderance of our sales coming from biotech companies, large and small, by the way. So we have a fair number of pre revenue relatively large from a market cap point of view, public biotech companies who do a lot of work with us, a lot of safety work, in particular, but work across the whole portfolio. So it's not something we spend much time worrying about. And we still get questions from shareholders about what will you do when it dries out. Those questions persist, and it doesn't dry out. And I think there's less possibility that, that will. There's just so many diseases that have been positively impacted by new modalities. And hopefully, that will be something similar with COVID.

And you've been talking about this for some time now and you mentioned that in your introductory remarks kind of like that idea declines are opting to outsource more due to the restriction during COVID, but also that, that actually is opening the opportunity for them to do more once the crisis is behind us. So what are you seeing -- how are those client conversations evolving?

Yes. They're evolving well. You had -- definitely a bunch of small biotech companies that had to shelter in place because the local government required it. Similarly, there were, not entire drug companies, but significant parts and pieces of big drug companies closed. And they needed to continue to do the work. So they ran out of money. They just ran of access to the facilities. A lot of animal work had to be outsourced because there was nobody to come in and actually literally take care of the animals, let alone do the studies. So we saw a fair amount of work come outside. We're seeing a fair amount of work come outside, the genetically engineered models business from academic institutions, from pharma and biotech. And I will be really surprised if that goes back in in-house, and I think that should generate additional work going forward because they're getting to work with us and seeing -- they have to be having conversations about why did we do this internally. The price points are as good or better. The animals can be delivered daily if they want them to. And except for that sort of historical -- I don't want to call it arrogance, maybe laziness in some of the big pharma companies that everything has to be across the hall or next door as opposed to waiting for us to ship something in. So I think that's been really helpful. Similarly, in the Discovery business, in particular, in the Safety business secondarily, because safety has been happening more rapidly. Clients that didn't outsource to us at all because they kept the work in-house or they outsourced to someone else who wasn't open or wasn't fast or who haven't prepared for catastrophe like this, they couldn't depend on them. We're seeing more of that work also. We're definitely seeing a pronounced demand in our biologics business. Some of that is outsourcing, particularly from big pharma. Some of that is just an enhanced amount of work in large molecules and particularly cell and gene therapy and particularly for COVID. We've also seen an enhanced amount of work in Microbial because there's just more drugs being manufactured to get into the clinic. So we're also hearing -- we're getting very positive unsolicited feedback from clients saying, "We're so happy you remained open. We're so happy with the quality of your work." You'll get more of that. And they have written us a letter and say, we've never taken it back. But I mean the innuendo is that they're quite happy. And so if COVID is as prolonged as unfortunately I believe it will be, I think this is a long haul we're on. And they keep the animals with us or they do whatever with us because they can't depend on themselves for 6 more months or 3 more years, they're going to get used to it. And as long as we're doing the work well, I think they'll appreciate the price points. They'll appreciate using us for leverage. They'll appreciate to expand their bandwidth, they'll appreciate the speed. And so that's obviously just a commentary on what we already do. And we didn't put this portfolio together to do exactly that, right? Our end clients are not the patients. Our end clients are the drug companies that make the drugs. And so while we've been doing really well, and I think we'll continue to do without COVID, I do think this is a very interesting inflection point. It is a force of people who might not have otherwise gotten there themselves or reluctant to for whatever reason, to at least try us. Now there are some pharma companies, both first and second tier, many European, who have an ethos and a culture and a history of doing stuff internally. They employ everyone in a certain town, whatever. So I do think some of that work will go back. And I think some of the work may go back to the big American ones that -- and there's not many left, but who just say, you know, some of the work has to be done internally because we've always done it that way or we feel that we understand the molecule better that way. That's actually nonsense. I mean because so many drug companies don't do any work inside. But that's still a reality. But now they worked with us more than they used to or worked with us when they didn't use to it all. And as long as we do good work, which obviously we try to do on every study, I think that's an interesting place for them to ponder whether they want to take it back. And they have to look at their whole internal strategy and people's internal cost structure is probably unsustainable, particularly if this is protracted. So as they reduce headcounts, perhaps, they'll probably reduce space as well. And if they can get something done externally as well rather than doing it internally, I think that they will. So it's the best -- I hate it as much as everybody else hates it. Don't get me wrong. We're not happy about this. But it almost dramatically enhances our marketing strategy because we don't have to tell them that we can do the work where we're actually doing it.

And then when we think about, obviously, this about academic clients when the academic institutions have been front-centering the news. What are you seeing in terms of the academics reopening their facilities in September? We talked a little bit about RMS progressing ahead, I think, of your expectations. What are you seeing in that market? And how long do you think it's going to take for volumes to return to kind of like the pre-COVID-19 levels given your thoughts that we're here for the long haul?

Yes. So what we've heard from all the academic institutions that we've spoken to and continue to speak to on an ongoing basis, at pretty high levels, sort of provost or dean, occasionally university president, but mostly, the people that made those decisions is that there was a sweeping decision pretty much across Europe and the U.S. after it happened in China to shut down academic institutions because no one knew what to make of COVID, and they had to keep the students safe. So they sent everybody home. And they gave, most of the institutions we've spoken to, 2 or 3 weeks tops to shut down the research, which obviously was too fast. So that did generate more animal business for us. So they shipped us entire animal colonies or had us recapitulate their animal colonies at our sites. And maybe some of their ongoing studies, they were able to send to us to work on. But basically, they had to shut down. And then pretty much immediately, they discerned that they had done that too quickly. And had they -- could they live their lives over again, they wouldn't have done that quickly. So we had a rough second quarter, as you saw. And we had a prognosis for a rougher third quarter than we've been having. And of course, the last month of the second quarter was way better than we thought as well. So we began to see academic -- the medical centers at academic institutions open more quickly than anticipated and with the caveat that they wish they hadn't closed so quickly. Unfortunately, they couldn't open as quickly and as fully as they had -- as they were before closing, but they were doing it that they understood how to open up in a COVID world, so social distancing. By the way, they often wear PPE in those labs anyway. They often work under hoods. Maybe they have a second or maybe a third shift. So I do think at some point, they get back to work. Now you are already seeing a huge infection levels in undergraduates. I'm sure it won't happen at WashU. I don't want to make you nervous, but it is happening. And so there is some possibility that a lot of kids will be sent home again or stay at the schools and go to class virtually. And I do think it will be a tale of two cities. So 18-year olds with the propensity to party and dorm rooms, whatever they're trying to work out, is a different calculus than post-docs with PhDs who are being careful working in the laboratory setting. So what we're hearing is that it's unlikely no matter how virulent the second wave or the first wave already is or the second wave will ultimately be that they intend to work through it and stay open. So we take them at their word. Number one. And it's a little bit difficult to guess when they'll be sort of back to where they're at. I would hope sometime maybe in the first half of next year as they build back, as they open up, as they social distance. I don't think their funding was impacted. And I don't think that the post-docs are afraid to go back in their labs. So I don't think they're going to have that sort of problem. So the work is still as important as it was. And in addition to the work that we're doing in cancer and CNS diseases, they're obviously doing a bunch of COVID work. Also, you know the AZ drug that's in the clinic was an Oxford University drug, so it's really important that they get back to work. So they're doing it successfully in China, assuming you can believe everything that you hear. But they are saying they're doing it successfully. So we're optimistic they won't -- they can't catch up to the work they didn't do, but they are ordering animals that are reasonably rapid clips, subject to the restrictions in headcount that I don't think is totally cut off yet.

And when we think about the government budget, how do you think about NIH increases and the potential impact on the business in the next couple of years in '21 and '22?