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

Hi. Good morning, everybody. Thank you again for joining our Jefferies Virtual Healthcare Conference. I'm Dave Windley, Jefferies' health care equity research. I cover pharma services space, including contract research and contract development and manufacturing organizations. And in that space, Charles River Labs has been a very effective and positive grower in the space and developer of very broad, as Jim will tell you, very broad portfolio of products and services to that pharma biotech R&D space. So CEO, Jim Foster, I should say, excuse me, Chairman, President and CEO, Jim Foster, is here to talk with me about Charles River Labs. I'm going to turn it over to him to lay some groundwork, and then we'll have Q&A. Jim, thanks.

Thanks, Dave. Always a pleasure to talk to you. We had a really strong first quarter with sales grew 13%. Our operating margin was 20.7%, and our EPS was up 37.5%. So really -- we were really pleased with that. We came out of the first quarter with terrific demand. We had our virtual investor conference last week, which I know you attended, Dave, and we gave some new targets for 2024, which is mid- to high-single digit for research miles and services with high 20% operating margins, around 10% for DSA revenue growth with operating margins at least in the mid-20s, manufacturing approaching 20%, with operating margins in the mid-20s. And consolidated a number of low double-digit growth with operating margins, it's about 22.5%. So really pleased to be able to put out those 3-ish year guidance numbers with improvement pretty much in every facet of the business. We also talked about being at least at the high end of the current guidance ranges for 2021, and we just changed our guidance a couple of weeks before that in our earnings call. So I think that sort of the bottom line here is that we have as good client demand as we've ever seen it pretty much across the entire portfolio. It's been a long time since we've seen it that broad gauge. We have very strong spending patterns and new modalities like cell and gene therapy, which are key drivers of growth. And I guess the last thing I would say is we have made a few acquisitions in the last year, very heavily nuanced towards cell and gene therapy, which we know -- not even what we believe, we know is a very, very critically important space for drug development generally and for Charles River's suite of services specifically, and I'm sure you want to chat about cell and gene therapy, Dave. So strong demand and looking forward to a very strong year here at CRL.

Excellent. You certainly have seen strong demand and off to a really strong start in 2021. So you're right. I did want to start in cell and gene therapy. You've made some very interesting acquisitions in that space and added those 2, I think what was underappreciated as a core services and products that we're touching a lot of cell and gene therapy already, and you've kind of quantified that in the base of business. So as you now think about and laid out a little bit the continuum of services that you have within Charles River that touch cell and gene therapy, perhaps you could talk about the complementarity of some of those, if folks missed that last Thursday. And then what are the keys in your mind to maximizing your share of wallet in cell and gene therapy across all these various touch points?

Sure. So as you said, before we went and bought several businesses that are purely cell and gene therapy-oriented, given the fact that there's 3,000 cell and gene therapy drugs in development, 1/3 of which are already in the clinic. We have a lot of work across the whole portfolio. So we have specialty research models and we have combination trials sort of pharmacology and safety base. We had a lot of biologics work and some in the microbial space. So had we bought none of these assets, we would continue to have, I think, significant growth in -- across the portfolio driven by cell and gene therapy, which would enhance our overall growth rate. But given the enormity of the space and the client demand and how little of this -- these activities are done internally. And none of it's going to be done internally by pharmaceutical -- by the biotech industry. It became clear to us that since we're in the business of providing services to a whole range of clients, across a whole range of modalities, across a whole range of therapeutic areas. And since this appears to be the biggest wave we've seen in terms of modality demand, we need more specific assets in this space to be able to service the clients who expect us to have these capabilities. So we bought a couple of cell product companies, which provide the cells. So you're not going to do cell therapy work without the cells. So that sort of started all of this. And then we bought a company that both has cell therapy manufacturing capabilities, U.S.-based. and plasma DNA and viral vector production capabilities at the moment, primarily Europe and recently announced the signing and not yet closed business, which has plasma DNA and biovector capability in the U.S. to complement that. So if you roll that all together, it's a pretty powerful portfolio to provide these services, to answer these questions to a lot of clients not to go back outside. It's clearly unique in terms of competitive scenario. So while we have CDMO competitors so they don't do -- they don't have a biologic capability or toxic capability and on and on. So we will continue to invest in this portfolio aggressively on an organic basis. I think there's probably some more M&A in the space. I don't think they're necessarily big companies, but there's more capabilities in the pace at which the marketplace is growing is so rapid that buying things tend to be a much better solution than organic growth. So significant part of the acceleration of our growth going forward pretty much across the historical portfolio and now almost across the entire new portfolio.

And from a selling standpoint or a connectivity of these capabilities, is it -- you mentioned biologics, for example. Is that just a natural point of demand, the client naturally thinks about those 2 things going together? Or is there -- is that a pioneering cell that you need to bring to the client and make them aware of the connectivity that you now have with these various capabilities?

I think both. I think we need to be clear what the breadth of the portfolio is in cell and gene therapy and what the handoff will be and why that enhances their activities internally. But specifically to your question, there is no question that there's a very strong connectivity and logic behind having biologics, deep biologic capabilities and being able to perform a whole other suite of services in cell and gene therapy. So much so that much of the assets that we've just acquired will be sold by the formerly biologic sales organization. So that's a great entree to the clients to say we can manufacture your drug and test it before it goes into the clinic. And by the way, if it gets to market, we can test it before it goes into commercial sale as well. And/or provide them with the plasmids and the viral vectors to do their own manufacturing, but still do the biologics testing. So I would say that the biologics piece is really important. And I would also say that while we don't break out the growth rate, I just told you that the Manufacturing segment, on which biologics is an important piece, is going to grow at 20% for the next 3 years, 3-plus years, and that's very much a large venture driven by biologics. Biologics is very much driven by cell and gene therapy manufacturing. So there's a lot of complex assays that we've set up over the last 2 years, I would say, specifically for cell and gene therapy drugs that a lot of analytical capabilities that they would have to go outside. So if we have competitors -- we have competitors in this space that can do the manufacturing, but they will have to -- the client will have to go outside to have somebody else in the biologics work, doesn't mean they can't get it done that way. It's just a less elegant and slower process.

Interesting. So this next question kind of probes specificity of geography or proximity, geography. You talked on Thursday about the importance of the convenience to the client being near the client and the network of facilities that you have broadly. I'm focused here in cell and gene therapy. Should we think about that close to the client as being kind of a continental status like you're in North America, the client's in North America? Or does it get more specific like you need biologics hub and biotech as well as California? How deeply do you need to be close to the client in the cell and gene therapy continuum of services?

I think it's not much different than other parts of our business. And so I think clients will use the best scientific provider of a service or product, regardless of geography, if that's really the best. So a great example is our Reno, Nevada tox facility is the largest and the best large animal tox facility in the world, and it's in the West Coast of the U.S., and we have European clients that use it happily. And it's not really easy for them to come and visit. So that's the unhappy part, right? It's a different time zone and blah, blah, blah. So if there's no other alternative either competitively or in the Charles River system, clients are okay with that. On the margin, though, all things being equal, clients will prefer proximity because of what I just said, time zone, language, currency, ease of visiting the site or being on the phone for long periods of time with our folks. So I do think all things being equal, there's no question that, that's a differentiator. And on the cell side, some of the cells only live a certain amount of time. While a lot of the stuff is frozen, some people want them fresh. And so yes, we have pretty deep biological capabilities in the U.S. and Europe and now with the partnership, as you heard at the Investor Day or maybe before the Investor Day, we have a Chinese partnership, which will be great in Asia. As you know, we do all of our tox stuff in both continents, all of our discovery and animal stuff. And so the rest of the portfolio is really strong. We're going to have to have sell supply businesses overseas. We may just stop them, Dave. I mean, it's not acquisitions of all of these areas. And until we do, I think it's fine, we have obviously clients outside the U.S. I feel we're going to want to have cell therapy manufacturing in Europe just because of everything I just said. Clients definitely going to want to audit those sites and be comfortable with it. That's their production site. And I think we pretty much solved the plasma DNA, which are in chronic short supply worldwide and viral vectors, which, of course, is how you deliver these things. We now have those at least in the U.S. and Europe through those 2 acquisitions. Nice complementary combination of capabilities. So yes, I mean, that the globalization of those capabilities is inevitable. I feel more comfortable saying that that's pretty much a given in U.S. and Europe, and I don't know yet about China. We did this biologics thing principally because there was a relationship with a -- in Chinese partner, in China partner, we actually -- the person who runs it is a U.S. citizen and he spent a lot of time in the states and worked for U.S. pharma companies, and competition is going in there. So we really want to be there. It may beg the question that we want to have broader capabilities as you've heard us and me say at least 200 times already. We don't know how to buy companies in China right now. The valuations aren't the same. We're just not going to do it. And it's equally as hard, maybe even harder to start them from scratch. So for the moment, it's not a major focus of ours, but U.S. and Europe definitely is.

Got you. That was going to be my next question. You've kind of answered it. But in the Investor Day, you mentioned APAC. And one of your colleagues that presented about this mentioned something about mutual recognition, regulatory challenges that influence. So you touched on valuations, that being a hurdle. What are some of the other hurdles relative to operating there?

It's really hard. And our animal business has done really well because we bought a portion of the business. We own most of it now, but the outset we bought a portion of the business. So we retained Chinese ownership and Chinese management and Chinese, I don't know, acknowledgment by the government that even though we're a U.S. company that they kind of looked and still sort of look at this asset as a Chinese-based one. We do something similar in Safety and Discovery and in the cell and gene therapy space. A, if there were assets and b, even if slight majority was at a rational price point. But as I said a moment ago, we don't have to do that right now. We don't think the valuation metrics are going to change anytime soon, unfortunately. And so maybe it's a missed opportunity. Maybe it's a marketplace that's going to be too insular anyway. It's very hard to predict. RMS is just kind of the wild west for us, and we know the marketplace needs us, and they're treating us really well, and the business is growing well. It's kind of a straight shot. And it was -- we bought it at a time before the valuation models have gone crazy. And we had a predetermined formula to buy the balance of it at those historical rational valuations. And so we like that business a lot. If and as and when that changes or if we can find a more creative way to do something because they're going to have to pay attention, the China are going to have to pay attention to what the rest of the world does on a regulatory basis. If and only if, Dave, they want to sell the drugs outside of China, some won't, by the way, many won't. So maybe that's not relevant to them. But why give up a worldwide market if you've come up with something creative. So we feel really good with our geographic footprint right now, and we're unlikely to alter it too much in the foreseeable future.

Got it. That's very helpful. So as you think about -- we had a discussion after the first quarter about the reentry into the CDMO space about the somewhat uniqueness of cell and gene therapy, how kind of nascent it is and how rapidly growing and the opportunity to buy a relatively small asset and be a leader there pretty quickly with that Cognate acquisition. Can you talk about how surgical your interest is in the manufacturing space or not? Is it primarily cells, gene-modified cell, et cetera?

Yes. It's a well-parsed question. So we had passed on the CDMO space, as you know. We had just passed. Too crowded, can't add value. We're good. We're going to -- we have enough market opportunity in the businesses that we're in. But the yes, but is we exist to serve the client base. You got a client base saying, you know what, we actually need you in the cell therapy space because there are not enough players. We're not happy with them, whatever we do all this other work with you around the manufacturing piece. So boy, it would be so much better if you would manufacture by the way, you're doing the biologic testing of someone else manufactures it. When you're doing a tox work before it gets to the clinic, blah, blah, blah. So it just feels like a niche move, even though I don't think it's going to be a small market, and I do think it provides a really good growth opportunity, but kind of a niche move. I'm not going to tell you that $900 million is not a lot of money, it is. But only half of that was the contract manufacturing piece. So we feel like it's a modest price entree for very high science, for a niche that's exploding in terms of demand, which is not particularly well served. And so it feels like we can enter -- we have entered the CDMO market in a way where we can be. We are already a leader on it and perhaps can be the leader in cell therapy and gene-modified cell therapy manufacturing. And I would say that I don't want to -- I have to be careful to say never, but it's -- I think we're more likely to stay in cell therapy and gene-modified cell therapy straight up and provide some of the tools, which are plasmids and DNA for gene therapy rather than have a big gene therapy manufacturing capability. And I think that -- and so we would be obviously involved in gene therapy, both on a testing point of view and providing some of the constituent parts and pieces. That's a bit more crowded field with some bigger and tougher players. And I suppose that paradigm or the market opportunity could shift. But we like the entry point right now, and it feels like this is significant opportunity for us to be the leader in the space.