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

Good morning or good afternoon, everyone, depending on where you are in the world. I'm Dave Windley with Jefferies Healthcare Equity Research. I'm so pleased to have you join our Virtual London Healthcare Conference this year. We are in our second day and progressing through here in this time slot, we're pleased to have Charles River Laboratories here to present to you and have a fireside chat Q&A with me. And representing Charles River is the company CEO, Jim Foster. And along with him, Todd Spencer, the company's Head of IR. So here to kick off, I'm going to hand it over to Jim to make a few remarks, and then we'll get into some Q&A. So Jim, take it away.

Thanks, Dave. Always nice to be with you, albeit virtually. So we reported our third quarter recently. We had a very strong quarter. Our top line was almost 8%. Non-GAAP operating margin was almost 23%, up 330 bps, and our EPS was up almost 40%. So we're really pleased that we've raised our guidance, just now 5% to 6% on the top line and $7.75 to $7.85. We have a lot of questions. We may have some more today about how much COVID represented in terms of incremental volume. And so we sized that recently just to say it's around $50 million. So we're happy to have it. But in the scheme of things, it's a relatively modest amount. So we're proud to do the work, but it's not changing things. Research Models business grew 2%, principally China. And Services margins were way up there as well. So margins in all 3 segments -- I mean when we think about this, we're at well above our long-term targets. So RMS was close to 28%. The DSA business increased 9% top line, almost 9%. The margin was about -- was a little over 25%, which was our long-term goal, sub 300 -- over 300 basis points. So really pleased with the demand curve for Discovery and Safety. The Manufacturing business was up over 11%, and the margins there were stratospheric, they were 39.1%, up almost over 270 bps, driven actually, principally by the Biologics business. So I would say that just as a general proposition, the demand curve across the whole portfolio remains strong. We don't see any reasons why that should change meaningfully. We're back, thinking about looking at M&A opportunities we have paused in the second quarter. And we have several conversations going on right now. Obviously, M&A has been a huge element in the creation of this portfolio that's been where we have been so competitively strong. So I'm not going to talk to you a lot about '21 even if you ask me, but just to say that, I would say that just to set the table for it, I just want to repeat what I said a second ago that we do see demand strong across the portfolio, and we -- notwithstanding the fact that the virus is red hot, particularly in the U.S. and Europe right now, we don't think that will have any discernible adverse impact on the buying patterns, the demand curve from our clients nor do we think it will have an adverse impact on our folks' ability to get to work and do the work. And a lot of companies are really depending on us, always have, but these days, really depending on us, particularly the smaller and midsized biotech companies who have no internal capability depending on us to help them develop their drugs. So maybe I'll stop, Dave, with that, and let you do your thing.

Sure. Thank you. So let's -- you mentioned demand environment and kind of touched on some level of normalcy. In DSA and Manufacturing support, certainly, the demand has been particularly strong, perhaps counteracting the one area of the business that did feel some negative COVID impact in RMS. Can -- is it possible to put a -- put some context around that demand environment, either in the form of how do you see RFP flows? Certainly, as you talk about and we publish biotech funding is through the roof. And so that's very strong. But maybe you could help us to understand how that demand environment is impacting your business and metrics? How many months out are you scheduling studies? Or what's the RFP flow environment, et cetera?

Sure. The proposal volume continues to be quite strong. We have a fair number of large contracts with big clients, principally in Safety Assessment. We don't talk about them specifically because that's -- I don't think that's a useful conversation, but just generally to say, we have a host of them that are coming to the point of being rediscussed to extend the time frames out, which is great. So we're enjoying those conversations, those tend to be big slugs of business for multiple years with very big clients, typically, pharma, although it could be big biotech. So we have a lot of that. We're booking well into the first quarter. So we're pleased with that. The -- how fast people can start, particularly Safety Assessment, sort of depends on what the particular service is. So some of our specialty work, I think, is in greater demand and probably has longer lead times, where more of the general tox, we have -- our capacity situation is really quite good right now. So I would describe capacity as available, well utilized, but incremental space is always being added so that we can start reasonably quickly with some reasonable notice. The Discovery business had a terrific third quarter. We've been talking to you and others about that, Dave, for a long time. It's been a long time coming. There's no question. We said so often that we needed enough mass and diversity and depth for clients to really acknowledge us. And is -- that business is growing really nicely right now and started getting to the growth rates that we had originally anticipated when we bought all of those companies. We have improving margins there and the demand curve is also terrific. It's also pull-through from Discovery into Safety. So I have a little bit of pullback from former Safety clients into Discovery. So look, the demand curve is as good as we've ever seen it. I think it's a fair way to put it. As you said, biotech funding, I think, through September, I think is the number was the second highest year ever, likely to be the highest year ever by the end of the year for really good reasons, you got all these new modalities. Companies successfully getting drugs to market. Valuations for these companies are improving, and these companies are making a real difference in the treatment of human health. So we just don't see any rationale for a slowdown in demand, either from a competitive point of view or a market point of view or a client point of view. You're on mute. Dave, you're on mute?

Muted. Yes. Thank you. To come at that from the other direction, it sounds like your supply, your capacity is well used but not stretched. Is -- given the demand levels, is there an ability to pull more of that work into your available capacity essentially accelerate growth rates or are there study start times dictated by the clients that are just kind of governing that?

Yes. So I wouldn't say we have a lot of people waiting or being frustrated by the start times. So we're trying to accommodate them as well as possible. We have to have the incremental capacity because while I think we do a good job internally budgeting and externally guiding, what the growth rate will be in the pace, one never entirely knows. You have to accommodate for the fact that it could be faster and more robust than you originally thought. As we've said countless times, we don't have linearity in our quarter. So you can get -- you can really get crushed with demand in 1 quarter and the next quarter could be slower. I think it's -- I don't think we can artificially accelerate or pull more work into a particular quarter than the clients are willing to give us. So the clients are planning better and better all the time, just because concern might be an overstatement, but I do think they're cognizant of the fact that since they -- since biotech has no internal capacity, and pharma has less internal capacity that since they're pretty much dependent on us, they better plan well enough to give us the work well enough in advance. So I think that paradigm is working better than it used to. We have a pretty good line of sight on the work that's in backlog. And we usually have several months of backlog, something slip, but some things are always to fill the gap. So we have very, very little volatility. So capacity utilization in a very good place, demand in a better place, competitive posture, particularly in Safety, is as strong as it's ever been.

Yes. So you mentioned several of your larger clients kind of approaching, sounds like renewal discussions. You've also mentioned through the COVID environment that as larger clients trying to focus on employee safety, have tended to lean more on vendors. I think it's kind of a point that you've made, leaning more on vendors to execute work where maybe their folks weren't going into their labs. Is there an intersection of those 2 things, i.e., is that at least in 2020, temporary external or increase in outsourcing look to be more permanent as we move beyond the exacerbated COVID experience?

Yes. So I do think that we've moved well beyond it, notwithstanding the fact that infection levels are on an increase. I do think that everyone is more measured and more thoughtful and more understanding of how they keep their employees safe and how they continue to run their businesses, both in early research all the way through development. But when it hit hard, initially, there was a lot of knee-jerk reaction, academic institutions were closed, as you know. And some of our competitors were unable to service the clients. Some of the clients were some -- some parts of the businesses were closed. So we got, for sure, incremental work. All we can tell you is that based upon follow up inbound comments from clients of high levels of appreciation for the fact that, a, we were open; b, that we'll be doing the work well; and c, that we're doing it quickly. And maybe they hadn't used us historically, either at all or in large measure, and they were really pleased and maybe surprised with how responsive that we were, particularly in a COVID world. So what I love about this, I don't love anything about COVID, except we were able to demonstrate our capabilities to some people who might have been skeptical, we demonstrate for them live, real time, what we can do for them as opposed to just tell them that when they would just think that was some sort of marketing plan, and they would dismiss it. So there's no question that many clients have weighed in and said, love what you've done, keeping the work with you. Some -- I don't think have said anything and probably love what we've done and will stay with us, either in whole or in part. Some may take some or all the work back. I mean we can't -- we don't know for sure. There are some -- I think I've said this on the third quarter call. I mean, there are some European clients, in particular, that are smaller, some of which are family-owned that are resistant to changing their own internal infrastructure that I do think will hold out as long as they can. And when I say that, I mean, economically, in doing the work internally. But increasingly, clients, I'm thinking particularly of Safety and secondarily Discovery are clearly picking up the outsourcing paradigm. So I do think that the COVID has caused an accelerated inflection point for these clients to rethink both the wisdom and the timing of how much work stays internally and how much is outsourced.

And before we leave this -- Todd, thanks for that. And before we leave this topic, you talked about you kind of the knee-jerk reaction terminology. In RMS, was the area where academics shut down fairly quickly, stopped ordering research models for the most part. You also had your recently acquired HemaCare business in Southern California that was impacted by, I think, more Governor Newsom's decisions there. But as you do see the cases rise, are you seeing -- I just want to confirm, are you seeing more rational decision-making, I suppose, but things that are keeping those businesses running as opposed to the same reaction you saw back in kind of March, April time frame?

We are. It's difficult to, perhaps impossible to predict what will happen. But assuming that the infection rates stay at this level or continue to climb, it appears that most municipalities, both foreign and in the U.S. states and large cities, are being more measured and are highly resistant to major shutdowns because of the severe adverse economic impact that, that will bring. Number one. Number two, I do think that while we're all very concerned, I think we're a little bit less afraid of this because we sort of see what it is. And perhaps most importantly, from a business point of view and an academic point of view, I think operationally, people have made the appropriate accommodations and changes to be able to work safely, to not disrupt their business, to interact with a company like us, depend on a company like us, but to stay open. And I'm thinking particularly of the academic folks, as I say that, because they closed very quickly in retrospect way too quickly with some consequence to the trajectory of the work that they were doing, which is too bad. So -- which we're checking in daily. So unless you think I'm just hoping that this will happen. My senior management team is meeting weekly, and we're talking about all of our businesses and what's happening to clients with particular focus and emphasis on what's going on in RMS and particularly academic institutions. No changes have been noted so far. That's all I can tell you. I don't know what would change that. If it does, I think it would be modest. And if we call this all wrong, if everything I just said is wrong and as these pullbacks like we saw, it would cause us to take corrective expense actions, similar to what we did in the second quarter or more to protect the bottom line.

Got it. Very good. So moving on away -- maybe away from the acute COVID discussion. Charles River has made and has been very acquisitive, a nice acquisition campaign, mostly kind of small and medium-sized businesses, particularly, you want to focus in on DSA and the midsized competitors that you have acquired and integrated in Safety Assessment, the most recent of those, I think, Citoxlab, about 18 months ago or so. I'm interested in your views, having had all of those under your belt for a little while, about how you've been able to integrate the companies to get the operating efficiency and kind of best practice across those enterprises, while still allowing them to maintain enough of an identity or a service orientation to continue to serve and cultivate that biotech customer base?

Yes. We've -- you've noticed a long time, and you've seen a lot of -- we've done about 50 acquisitions since we went public, large and small, mostly on the small side. And years ago, I just don't think we were very good at the integration side of the equation. I just don't think we were large enough. We didn't know enough. We hadn't experienced some missteps, maybe. So years ago, I think we bought some companies that -- they were small. They were good companies. We just assumed things would be fine and they would meld with our culture, and we would somehow understand them well. And I think that we -- I think we broke a few companies. I'd say for the last 5 or 6 years, which is probably 15-plus acquisitions, maybe more, around that number, we've just done a much better job, not only in-sourcing them. I think we did that well or paying for them appropriately. I think we've always done that well not to overpay. I'm not aware of any deals that we've done that were actually dilutive. So they're always accretive or worst-case occasionally neutral. But it's all about the integration. So we have a full-time integration team. It's 8 or 9 people with all the various capabilities, IT, HR, finance, et cetera. In the last 4, 5, 6 years we put a full-time integration lead into the business, not to run it, but to run interference between the target and Charles River. So that we were sensitive to their cultures. And it's usually someone very senior who really understands the company well. And we enter every acquisition with a 90 or 100-day integration plan that we actually hit religiously day by day. And we're very, very thoughtful in understanding and respectful of the culture. And so just to go back to one of the deals you mentioned, Citox, which was complicated, 9 different sites, a few of them have been relatively recently purchased and not integrated, totally their own culture, weren't even part of Citox yet and here we come. Again, a big competitor of Charles Rivers. A lot of people went to Citox and didn't want to go to Charles River. And we were very, very -- we were and still are very, very thoughtful in terms of making sure that if they didn't want things to change, that they did -- in other words, they worked with whatever Citox site they wanted to, similar state direct with a similar price point and a similar turnaround time and service. So that there was familiarity. And over time, if we got them to love the larger Charles River portfolio and utilize it, great. So you look at WIL, MPI and Citox, that's collectively a couple of billion dollars spent and hundreds and hundreds of new clients, probably close to 1,000, if you added all those companies up. Didn't lose any clients. So we -- and I think the integration has really gone well. We've improved the operating margins in all of those businesses. We've got best practices in place. We've either kept to enhanced the management teams. We've gotten -- in this case because we're talking about safety, our sales force and safety to sell on behalf of those businesses as well. So I can't promise perfection in the future. I can just promise you that we've learned a lot about M&A, and we spend an appropriately disproportionate amount of time on the integration planning and the execution of integration.