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

Hi and welcome. This is Erin Wright, the life sciences, tools, diagnostics analyst at Crédit Suisse and welcome to our 2020 Crédit Suisse Health Care Conference. This year, we're obviously in a virtual format, so a little bit different. If you do have any questions, feel free to e-mail me at erin.wright@crédit.suisse.com and I'll be happy to relay questions to you -- to our presenters today. Here with us, we have Charles River Laboratories. With them, we have Birgit Girshick -- I'm going to get your title right, I swear -- it's EVP, Discovery & Safety Assessment, Biologics Testing Solutions and Avian Vaccine Services, if I have it all there. So it's pretty hard-core at Charles River, it sounds like. But -- and we also have Todd Spencer, the IR maven himself on the line as well. And thank you, thank you so much for joining us today. It's a fireside chat format, so we'll get started with Q&A right away here.

I think one of the biggest question areas and one of the biggest, I guess, takeaways, I think, from the most recent quarter I felt like was seemingly the broad-based accelerating, outsourcing demand trends across your business, particularly in the COVID-19 environment. Can you detail kind of which segments that you're seeing that sort of traction? And how we should think about longer-term outsourcing trends across your business?

Sure, Erin. Thank you very much. So let me take a step back on that a little bit back to maybe the March time frame when many of our clients and a lot of the academic institutions specifically closed down really quickly, sent their employees home, literally stopped working and stopped operating vivariums in the different areas. Many of our clients were basically in a situation where they said, "Okay. So I have some programs I want to move forward. I might have some animal lines that are in a vivarium. What am I going to do with them?" And reached out to us to see if we can help them. Charles River stayed operational in all our 100 sites. We obviously did a lot of precautions. Everybody who's working have been work-from-home, including myself and Todd here are home. But all of our employees that need to be at the business, at the site to operate are at the sites with a lot of precautions and have continued to provide services and products to our clients. So over time, we have seen some accelerated outsourcing from certain clients. We believe that some of that work or all of that work will stay. We have a lot of conversations with our clients on those services, on their view, when are they coming back to work. And so from feedback from client, we actually think that a lot of that work, we will retain. I do want to, however, clarify and not overstate the impact on the accelerated outsourcing and actually on the COVID work, the therapeutics and the vaccine work that we have done on our top line. I think the top line is really a sign of the resilience of our business, on our portfolio and the continued strong market. So just to give you a little bit more information about the work we have done, the -- basically the tailwind we have seen from COVID and COVID therapeutics and the vaccine work. We have done approximately $50 million of work this year, which if you look at our scale of really coming up to $3 billion, that is not a significant amount of work. We're really proud of doing the work. We have worked with a lot of clients on their COVID therapeutics and vaccine programs. But the work, the revenue from it is actually smaller than you might think and there's a few different reasons. Number one, it's small, 150, 200 programs in scale compared to just oncology programs out there or CNS or immunology programs or cell and gene therapy, but also the fact that a lot of those drug programs are actually repurposed or have been fast-tracked by the FDA. These programs often don't have quite the revenue that a normal Biologics program, for example, would generate. And then a lot of the vaccine works, the vectors actually have been maybe already safety-tested and proven to be safe. So the vaccine programs often don't have quite the revenue generated than some normal vaccine programs. So again, we're really proud of having that work. But certainly, for me, our top line growth and our resilience for this year as well as our LOI improvements have really been a sign of the resilience of our business, of our portfolio and our operating model.

And can I dig in a little bit deeper like how much of that is existing customers versus new customers are outsourcing to you that maybe -- or maybe customers that have come back after years of not outsourcing?

So we're seeing both. So obviously, we've worked with many of our existing clients that had maybe programs internally or had programs in regions where they saw more of a problem. And we have stepped in and took on that work, but we also have seen some new PIs specifically coming along, maybe for our research models program, that have reached out and have broad research models for us, for example, that we haven't seen in a long time. And that may be just a fact that some of our competitors may have more of a difficulty operating than we have. So -- but it's really both. We see it in both ways.

And how do you differentiate then like market share gains versus the broader outsourcing trends? And which segments would you say you're actually gaining share, you think?

So we really go back to our clients and to get feedback and to see if it's market share gain or is it accelerated outsourcing. So it's not an easy calculation, but certainly something that we try to gather through feedback from our clients which, if anything, throughout the COVID time we have really stepped up the communication with clients and sometimes on the phone with them daily. Where we see some accelerated outsourcing is in several of our business lines. At GEMS, our Genetically Engineered Models and Services is one. If you can think about the vivariums closing down, it makes a lot of sense that we got quite a few requests. We have seen some accelerated outsourcing in our Discovery organization and a little bit in our Safety organization and Biologics organization. So it's quite widespread.

Okay. Great. And your 2020 guidance doesn't assume any sort of more onerous impact from the pandemic. But why is that? Or what are you seeing in certain markets where we have seen a subsequent wave and further lockdowns? And how should we think about the way that your customers are responding maybe differently than what -- how they responded initially in March?

Really good question because that's one that we have been pondering quite a bit and really talked a lot to our clients. So the obvious difference after talking to our clients is that in early March -- February, early March when Europe closed down and then North America closed down and actually before China really abruptly closed down, none of the companies were really prepared. And there were stay-at-home orders, there were regulations. So there was a lot of very quick decisions to stop operating. It wasn't quite clear who has permission to operate and how to keep our employees safe. So you saw a lot of facilities, a lot of sites, academic institutions but also biotech and some pharma companies closed down relatively quickly, and then had to figure out later on how to come back and how to operate. And I think that's a big difference from what you're seeing now. So there's been a ton of restrictions, obviously, now in Europe. But if you look at them, they're all about the social life of people, not go to restaurants and smaller group gatherings and wearing a mask. All the facilities and institutions we talked to have plans to stay open, have put in place business continuity plans, have put in place restrictions on how many people and spacing them out, maybe shifts and I think that's the big difference. Now we don't -- we can't obviously predict what's going to happen if the COVID cases increase even more. But from the feedback we're currently getting, we think that from a business standpoint, we are from out of the worst and our clients are quite prepared to operate going forward. Even institutions and universities, when you see students are sent home, that doesn't impact -- that impact obviously the students and the families, but it does not necessarily impact their research facilities and the work they do there.

Okay. And then can you break down a little bit about what you're seeing in terms of underlying demand across your small biotech customers versus midsized -- or mid biotech versus large pharma? Obviously, it seems to be relatively broad-based in terms of the outsourcing demand trends, but if there's any sort of caveats across those different buckets and also across maybe some of the more earlier-stage functions, that would be great.

So biotech has been an increasingly more important customer segment for us. Right now, 42% of our client segment or revenue is coming from biotech. And that has been increasing over the last 5 years. So the lines between biotech and pharma often are blurring because we may work with a biotech company up to a certain stage and then they out-license their program to pharma or they get bought up by pharma. And in just about all cases, we continue to work on that program and support them, the new owner of that program or company, going forward. And the reason is that we are also a strong partner to all the big biotech companies and pharma companies. So we, a few years ago, definitely made the decision and put the strategies in place to be able to service both customer segments, biotech as well as pharma. And I think we're seeing the results of that right now. From an outsourcing perspective, I think it's more, I wouldn't say -- or interruption from COVID. I wouldn't say it's more biotech versus pharma. It's really every company made their own decisions. So you see a wide spectrum of sizes of companies that have reached out and maybe have been looking for more outsourcing and other work.

Okay. Great. And we were getting a lot of questions from investors around the long-term kind of margin targets. I guess you're kind of hitting those early a little bit here. You're now expecting to achieve kind of those 2021 longer-term operating margin target of 20% by year-end of 2020. So that said, how does this performance kind of change your longer-term vision on the margin targets here? What are some of the recent cost mitigation efforts that you've completed? And what's more structural in nature versus temporary on that front?

Sure, Erin. So first of all, we announced that we should be near our 20% target by year-end. So our full focus right now is on hitting that target first before we set new targets going forward. But looking at the drivers for that, yes, there's been some temporary cost-avoidance actions and cost-savings actions that were put in place because of COVID. We announced that we -- the number is about $40 million but please also note that we also announced a headwind in revenue of about $60 million from COVID. So you can obviously do your modeling on that and see what the impact is on that. And some of -- the most of the cost savings from COVID were in Q2 with some of them in Q3, and there's a little remnant in Q4 but basically half of the cost savings in -- of Q4 -- or the cost savings in Q4 are about half than Q3 from COVID. So we think we're coming out of that. We don't think we will have much of a cost avoidance other than travel. And maybe some money for conferences going forward. And so the major part of the -- hitting the -- our target or getting close to our target a bit early is really operationally. If you look at our DSA segment specifically, you see year-over-year improvements every quarter here of 200 basis points or better. And last year, we talked a lot about this segment specifically having a lot of cost savings opportunities, having done major acquisitions throughout the year, coming out of the last major one last year with Citox. And now having to -- really the time and the processes in place to really look at this business specifically, how can we scale it better? What's -- where should we have capacity? Where shouldn't we? How do we manage it? What are best practices? And we really have executed on that. So we're quite proud of that and we will certainly continue to do that. We want to get through, obviously, our 20% target first. We have to see, obviously, how COVID impacts the next few quarters. Even so, we think that is very limited to nonexistent. And -- but we will continue to look at how we can scale the business better, how we can do improvements, but we're just not there yet on any longer-term guidance.

Okay. That's fair. And switching gears here, I did want to hit you with some questions on the DSA segment since that's an area of focus for you. You've now completed several large transactions across the DSA segment: WIL, MPI, Citoxlab. How -- what's the update in terms of integration? Is there any sort of latent synergy opportunity there too as well? And what has surprised you thus far in terms of your build-out at that DSA segment with some of these larger transactions?

Right. So yes, we had obviously the WIL acquisition and MPI and Citox. From our integration plan, WIL and MPI is complete. However, we never stopped looking for best practices and how we can do our work better. Citox, we're still working on some parts of the integration that got slowed down a little bit, obviously because of COVID, but we should be completing that very soon as well. The -- some of the initiatives we have done that we are -- particular thing that makes a difference to our clients are, for example, that client mobility. So if you look at MPI, for example, we have many clients that worked with MPI that never worked in Charles River before. And many of our Charles River's legacy customers had not used the MPI site before. I think we now have just about everybody willing and happy to work at MPI and vice versa, MPI clients working at all kinds of different sites. So -- and the same is really for Citox. So we were able to move clients around, we opened up new capabilities for them and we did open up more flexibility. So it's the more sites you can use, the more flexible the time lines become. And I think our clients are quite happy with that. So they were really trusting the Charles River quality and they were trusting, too, for us to put in the right integration initiatives. Another area is really the talent that we brought in through some of the acquisitions. We -- with every acquisition, we look at the talent that we're acquiring. And with those -- with all of those acquisitions, we got great leadership. If you look at the sites, our general managers are generally from the business that we acquired and even in other leadership. So we just, earlier this year, put a bit of an operational/regional model in place and some of the leaders are from acquired companies. And we actually, in those regions, have legacy Charles River -- so legacy Citox, WIL and MPI maybe in one region and it works really, really well. What have surprised me the most is the science that we got. I mean, obviously, every time the company is out there, competitors -- we always believe the competitors are not as good. And these acquisitions really showed us great talent, great science, great processes. So our integrations are not Charles River processes get put into the new acquisitions, but we're looking for best practices and we're getting there. And that will continue. So we are every year looking at what's the next step, how to get data faster to our clients, how to make it easier for the clients to work with us and that we'll definitely continue to do so. So yes, we do see more opportunities. So that's not complete. And we will continue to invest and we will continue to certainly harmonize and find best practices in all of those sites. Go ahead.

Sorry. From an acquisition standpoint, are you somewhat capped out in terms of your market share positioning on the DSA front? Or any other larger transactions should be there?

So specifically for Safety, we built what we wanted to build. We have the geographic reach that we were looking for. We have the scale that we were looking for and so we don't anticipate anything major in Safety. There's really not anything much to buy out there anymore so the consolidation is pretty complete in this space. We might do a tuck-in. It could be something, a technology that we want to acquire, but nothing major. From a Discovery perspective, so the D in our DSA, we see quite a bit of opportunity. So we've started building this portfolio for Discovery a few years ago. We're not done yet. We're still building organically as well as with partnerships and M&A to build out a portfolio for our clients where they could come to us and stay with us throughout the drug discovery, drug development cycle for all their therapeutic areas and modalities. So still a little work to do but really started a really good portfolio there.