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

All right. There we go. And we're live. Hi everybody, Luke Sergott from Barclays. I cover Life Science Diagnostics & Tools here. It's my pleasure to have Jim Foster from Charles River Labs. About a seasoned veteran in the space as they come, and a transparent and clear message can be provided. So if you want to take over and provide a couple of sentences or introduction, then I'll just dive into questions.

Great. Thanks, Luke. Nice to be here. Just by way of quick background. We ended fiscal '20 very strong with 7% growth rate in a COVID world, which we were extremely pleased with. We did -- we acquired 2 cell product companies with cellular therapy, research and development during the year. We ended the year with the acquisition of a large molecule discovery platform, which was one of our technology deals that we just announced a couple of weeks ago now, I think, that we signed, but hopefully, we'll close this quarter a cell therapy manufacturing deal with also the ability to make plasmid DNA. So we're really pleased with the way we've been able to fill out our portfolio. We ended the year with extraordinary demand, pretty much across our entire portfolio. And as of the last time we talked about this, we've certainly seen that demand continue, somewhat driven by increased outsourcing from our clients and the enormous amount of capital that's gone into our sector. And cell and gene therapy, I think, is also a major driver. So very good demand dynamics, and we're really delighted with our competitive posture. Our guidance, of course, for this year is 9% to 11% top line growth. So maybe I'll stop there, Luke.

Yes, it's great. Let's talk about how the portfolio has really changed, I mean, just even over the last 3 to 5 years, right? And you guys have always played in the high science area. And so give us a sense and back up a little bit, you had a CDMO with will, and now you're acquiring a CDMO in cell and gene therapy. So give us a sense of why this is the right time to move into this space? And overall, how you see the funding flowing?

Yes. Good question. So we had acquired almost inadvertently. It came with a larger acquisition in the preclinical space, a small molecule CDMO, a very small one. It did fine. It was perfectly successful enterprise. But we begin to just study the market, and we determined, as we publicly stated after we sold it, that there was a pretty crowded field of very, very big players. We like to be the market leader in whatever we do. It's unlikely we can be the market leader in the CDMO generally. So we exited. And maybe somebody else started making pronouncements like that because saying that you'll never do something as a dangerous thing to say. But at the time, that seemed to make sense. And then as we've begun to continue to build out the portfolio, particularly in the cell and gene therapy space, so we do testing all around cell and gene therapy in our Biologics and Microbial business. We also have Safety and Discovery business, a little bit of RMS. And then as we bought these cell products, which are almost -- there's some similarities to the way mice were used in research years ago and still out to some extent. It became clear that there was a small gap in the portfolio. Now if we never bought anything, I think that would have been fine. But fair number of clients were asking us, well, you're going to have be able to manufacture the drugs that you then test because that would be better for us from a speed to market point of view, and we don't want to go and qualify another supplier we would like you to do it. And also feeling that this is sort of a niche play in the CDMO space. So we could be -- we will be, when this deal closes, a leading player in cell therapy manufacturing. And directionally, that leading player, actually, our overall product and services portfolio might make us the leader in that space already. But just purely on the CDMO side, we're definitely in the hunt. So we like that. So kind of we're back to, okay, we could be a market leader in the space. It's huge modality with a lot of money flowing into it and a large number of compounds being manufactured. And, of course, there was and there are still some assets available because they're almost all private equity-owned, so they're always available. That we could add to the portfolio, there wasn't -- this wasn't -- I would never trivialize $900 million acquisition, but given the scale of the company now. And our balance sheet, it's one that we can readily do. It definitely enhances the top line. It fills out the cell and gene portfolio play. So it's now greater than 10% of our revenue -- will be greater than 10% of our revenue when this deal closes, and it feels like something that kind of immediately enhances our ability to support our clients. So that's why we did it. It definitely feels like it was the right deal at the right time, and one where we can have a strong showing in the marketplace.

Yes. And so as I understand it, it was -- you typically have played very strongly in the discovery side, right, the high throughput screening from the research models on down. But as I guess -- talk a little bit about the differences of the cell therapy manufacturing and why it helps to play also discovery and in manufacturing? Is there a scale-up difficulty that you don't see within other large molecules that you guys always had played with?

Not necessarily. I mean I think this is new complex science. So I don't think the story has been written yet. This is not trivial. So we have a -- we've acquired a very substantial capability in the production of these cell therapy drugs. And also, the linkage with our Biologics business, in particular, where we're doing all of the testing, all the analytical testing and cellular work and so culturing work, storage and a bunch of assays to enliven it. So we have competitors in the Biologics space who are in the CDMO space. And we'll have competitors in the CDMO space and not in the biologic space. But to put them both together, really strengthens the portfolio, and it's an offering that should go together. There's just a lot of logic for it. So we've had a strong -- we've been in this Biologics business actually for 25 years. The business has really popped in the last 2 or 3 years, it's a very high-growth and starting to be very high margin and very much capacity dependent. So now that we have sufficient capacity. So sort of see these 2 businesses, in particular, growing together, kind of being conduits of one another. And I think we're going to add a lot of value because the analytical -- there are very specific assays that have to be developed to test cell and gene therapy drugs that we've been developing over the last few years and have them now. So putting them 2 together is an enhancement to the value proposition.

Okay. That's really helpful thinking about the synergistic nature of the businesses. And so as you think about, in 3 years -- look, the story was, you guys had the RMS business, and then you had the manufacturing and then you had DSA, right? And so the margin mix dynamic was a headwind, but you always maintain and continue to expand on the operating side despite the gross margin headwind. As we fast forward, and you talked about the Biologics business popping and becoming even more profitable, and the RMS business is continuously deemphasized, should we continue to expect that 25 basis -- 50 basis points of margin expansion every year? Or is there an opportunity to step that up even more just from these new businesses coming online?

So we want to be careful not to get ahead of ourselves. So we have an investor conference in the spring, where we're going to give more specific long-term guidance on top line growth for all the segments of the company as a whole and bottom line margin -- actual margins and what we anticipate going forward. So I don't want to steal our own thunder, and we're still working on that. But I would say conceptually -- I will answer the question as best I can. Conceptually, so many things are working here. So number one, a little concerned with the way you phrased the question. So I actually think we're in the midst of the renaissance in the RMS business. So I don't want people to look beyond that. That should business, particularly with the cell products, the growth in China, growth in the service businesses, price and mix, that should be a segment that grows nicely. And I think we'll have the opportunity for improved operating margins, particularly since the cell piece should be an enhancement. So let's leave that one. DSA, until recently the discovery assets have definitely been a drag to the DSA margin. I think I've been really clear about that for a long time. I think we're beginning to see that ameliorate. We also had 2 of the 3 big safety acquisitions that we did in -- over the last 4 years, 2 of them were a drag on our historical margins and safety, and they're improving every single year and will continue to improve. And then if we add on top of DSA, which, of course, is 63% of our revenue, the notion that we're driving efficiency, we're going to digitize the business to take cost out but also to be more responsive to the clients where we're putting in best practices, so we've taken $50 million, $60 million or $70 million a year of cost out, most of that's been in DSA and we think we can continue to do that, continue to get price. So I would say directionally DSA is probably the biggest lever in margin expansion because the revenue, of course, is the majority of what we do. And I want to be a little bit careful with manufacturing just because it's so incredibly profitable. We're in the hunt. We're already in the hunt to achieve our long-term target, which was 35% pretax we beat that last year. But interestingly, this Biologics has been a drag even with those great margins. But it's -- as I said, it's -- top line is really pop. There's an enormous demand for biologics testing, particularly in cell and gene therapy and COVID. So that's -- and that's on top of all the natural evolution of all the large molecule projects, monoclonal antibodies, et cetera, that have been around for a long time. So if you roll those altogether, if you take the fact that we will do everything we can appropriately to keep a lid on the expansion of our G&A costs as a percentage of sales, so we're really working hard to keep it flow, and we have to have appropriate G&A to manage a much bigger business, but we think we're kind of in the hunt there. We definitely should be able to improve our margins, continue to improve our margins going forward. And we'll try to give you greater clarity on how you should slice that and think about that by segment and in total. But I think anyone that's watched the company for a period of years, even though I'm a bit frustrated, it took us so long to get to 20%, a lot of that was the headwinds from M&A. We are organized -- conceptually organized and structurally organized and philosophically organized to generate more margin. So if you talk to any sort of Lab Chief at Charles River, some Ph.D. talked to you about gross margins as much as they're going to talk to you about science because they understand that they're running a business. So we're very operating margin oriented at Charles River. We talk about it every day. And so we would -- we hope to continue to improve and enhance. Hope that's helpful?

Okay. I don't want to steal your thunder for the spring, but that's a great -- that's a fine background. So you keep talking about the new cell business within RMS, and that's I think the HemaCare and the Solero businesses, the acquisitions. Can you just give us a little more background on that? And what ultimately that is? Like, from a scientist perspective, I remember at the biotech, I was that -- we used your research models, right? And you guys provide a great service. I've been out of the industry for so long. Give me an idea of what these cell businesses are? How they're used in science? And really are they a substitute for the models? Or are they an augmentation to that tool?

So both of these businesses provide human-derived cellular products. You have donors coming in donating blood. We spin down the blood and we take the cells out. We either send them to our clients fresh or frozen, depending on what they want. Sometimes, specific patients. Sometimes they're a collection of patients. Sometimes the people who are sick with some disease that they're developing a drug again. Sometimes they're just normal cells. So there will be no cell therapy work, either at the research scale or process development scale and manufacturing scale without the cell. So it's a basic building product to cell therapy, which was already conceptually and directionally a very large new modality. And so we put it in the RMS segment because it feel -- because it's a product business. And while our investors have bunch of services now which are getting bigger, it was originally a product business, and it's an essential research tool for people doing cell therapy. Interestingly, there were 2 pretty small companies, while they're going to grow at over 30%. This still pretty small, and that was probably the couple of the bigger players. So there's not a lot of people doing this. And yet, no one is going to be able to advance cell therapy work without the cells, and it's just not something that a biotech company, like the one you worked at or even a big pharma company is going to be in cell supply side of the business, like no one in the research model -- no one -- none of our clients are making their own animal. So we feel it's comparable. It has no relationship, except sort of conceptually to think of it that way. It definitely doesn't supplant animals or even augmented. It's just basic research that. You're going to still use the animals to see what the benefit of the cell work is in animals before you put it into people. So yes. So that's why we put in that segment. It fits in that segment best. Probably we could have put in manufacturing as well, but it didn't seem to be more of a dangling processable, whereas the manufacturing is more service-oriented and RMS is more product oriented.

Okay. Great. That's -- yes, that makes sense, right? I mean it's kind of a downstream research move. You get the cells. You can't have cell therapy without cells and then it goes into the models and down the clinical paradigm. That's helpful. All right. So I guess let's dig into guidance here in the last 10 minutes. When you put out the 9% to 11% organic growth rate, so give us an idea of where you are on the recovery? The assumptions behind it? And then kind of the demand that you've seen over the first quarter? And how that's stacking up versus your early assumptions?

Yes. I would say that most of the -- not all. I'll talk about that in a second. So most of the COVID headwinds have ameliorated. So we saw most profoundly in the RMS business where the academic clients were closed. They're all essentially open. We had a few of the biotech companies in the cellular therapy production space, cell therapy research space close for a whole host of reasons what state they were located in or whatever, what their own internal policies were, pretty much worked our way through that. So it's not impossible. I mean we can't predict COVID, being out of COVID any more than anyone else can. But it's highly unlikely that we're going to go back into sort of that level of disruption. So we're assuming not in our business plan. The only place where we still have some headwind is in the Microbial business, where we still are unable to place some of the systems that clients have either bought, and they are -- that's either in their space and they're not using them or they want to buy and they're not facility and they have shipped them yet. And while we're missing, to some extent, a small amount of revenue on not being able to sell the equipment, principally, what we're missing is a lot of revenue not being able to sell the associated reagents to go along with those -- that equipment. So the clients are closed and/or they have a policy just to only keep their employees on the site or they're in a state or a country or a city this unlocked down and we just can't get in. So we've assumed -- I bet appropriately the debt situation will improve as the year unfolds, and that's what our operating plan would indicate, and that's what our guidance indicates. Obviously, if it happens more quickly, that would be beneficial to our operating plan. And if it for whatever reason they never open up, that's possible, but unlikely that would keep a lid on that. But I think that essentially we've moved through that. We're going to have a kind of funky comparison in RMS because the second quarter of '20 was so difficult, and we're not going to have that situation. So the reported numbers will be much higher than they really will be if you strip that out and do an apples-to-apples comparison. So I feel very good about the demand, the portfolio, the lack of COVID disruption on a competitive strength basis, the competition and a little bit incremental outsourcing that we're going to see, which I think COVID accelerated because we were able to do some things that our competitors couldn't or wouldn't and also able to do some things that our clients couldn't do internally because their own facilities were closed. So we feel really good about the 9% to 11% guidance.

All right. That's a great segue into my last question here, and how -- I mean the preclinical space has been considered relatively well penetrated. And I know that you guys continue to gain share as the outsourcing increases. Give us an idea of the particular instances or technologies or capabilities that actually accelerated outsourcing from COVID, right? I mean you just talked about some of the stuff that you could provide that either competitors or in-house couldn't. Give us an idea of what that looks like? And kind of -- is that ever going to go back, right?

It was very interesting. It was a manifestation and a demonstration of our -- the capabilities that we had told many clients, we can do this for you. You don't need to do it yourself. It's not a good use of your cash or your people to set up whatever. And the vast majority of clients are obviously outsourcing, but some particularly big drug companies, particularly foreign ones, tend to be pretty insulated, tend to be pretty much -- yes, yes, yes we do it better. And so what you suddenly saw was lockdown of a lot of their own facilities. And you suddenly saw for some clients that don't use us for whatever -- or use us in addition to competitors being unable to supply no business continuity plans, poorly capitalized, bad connectivity from an IT point of view, whatever. And so suddenly, work that we might never have gotten came. Some of it's still there. A lot of feedback from clients about how pleased they were that we were open, that we were working, that we had business continuity plans, we had so many sites that were so deep in the science and, wow, they never realize that we could do this in a lower price point than some of our competitors could or certainly in a lower price point that they can do it internally, and it began to -- it gave them a further taste on the benefits of outsourcing. So I think that lots of that business we have already retained and will continue to retain, and they'll be -- follow-on business will continue to come. So we've sort of pushed them over the edge. I think some other clients that did everything internally will now not do everything internally. They'll do some of it with us, and maybe they'll keep a foot in both camps. Maybe it will always stay that way and maybe it will be the beginning of further outsourcing. So look, we've been doing the safety business for 20 years, where 20% of the work was outsourced and now at 60%. Discovery is probably 25%. Maybe 20 years ago, it was 5%. We think both of those will get -- that safety could be 80%, 85% and discovery could be 50% or more. And they were on that trajectory. And this was just kind of a stimulant to that whole paradigm that caused people to really think about, can we actually depend on ourselves, a big pharma? An interesting question, probably one they never asked. And can we depend on Charles over smaller, more fragile, poorly, less well-capitalized competitors, by the way? Some of whom are private equity owner will be sold. Some of whom are on very bigger companies who might spend them. I mean there's also us of disruption, right? So it's very interesting to see how that plays out and to live it and say, yes, we could have told you that, but we're glad that we were able to demonstrate. In some ways, it's a more powerful demonstration that our salespeople could ever tell them if you follow them.

Yes. No, it's clear. I mean it actually speak louder than words, right?

Exactly. Exactly.

Well, that's great. It's all the time we have. This has been incredibly helpful informative, Jim. Thank you again for your time, and I look forward to connecting with you guys soon.

Always a pleasure. Thanks so much, Luke.

All right. Take care.

Take care. Bye-bye.