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

All right. Good morning, everyone. Welcome back to the William Blair Growth Stock Conference. Our next session is Charles River Labs. Thanks for joining me. I'm John Kreger, the research analyst that covers Charles River. Before we get going, I am required to tell you that you can see our website, williamblair.com, for any conflicts or other disclosures. So thanks again. With Charles River is the CEO, Jim Foster. Jim, thank you.

John, nice to be here.

Great. We're going to do this in a fireside chat over the next 30 minutes. For those of you listening, if you've got specific questions you'd like me to ask Jim, feel free to shoot them to me, and I will do my best to work them into the discussion. So with that, let's get going. Jim, thanks again for the Investor Day that you guys hosted last week. It was a great deep dive. Always good to not only hear what you have to say but the leadership team behind you. And it was a very positive tone.

What I wanted to start with was from a macro standpoint, I felt like one of the messages was just very unusually good demand trends. So just if we kind of step back, what do you think is driving the unusual high levels of activity these days?

Several things. You've got a continued robust investment scenario going there. The funding levels continue to increase because so many of these companies are coming of age and being real operating businesses in both treating and curing diseases, which historically were not treatable. So the success of biotech continues to build on itself to some extent. And if you look at the structure and the nature of kind of historical large pharma companies and historical and large biotech companies, who used to be vertically integrated, that just continues to not be the case. So they're increasingly outsourcing things that they used to do themselves and/or not expanding or continuing to do some things and just simply not expanding them. The -- so outsourcing continues there. Some of that actually was accelerated by COVID when some of these drug companies actually had parts of their business closed abruptly and couldn't depend on themselves and suddenly had to reach out. Some already had reached out to us historically to do other things, but reached out, and we're pleased with the response. If you look at the smaller biotech companies, which is a preponderance of what we do now, providing services to them, they have no internal capabilities. And so they're often literally 5 or 10 people. And even if they get to 50 people, some of those people are only they interface with us, but can't do the fundamental work that we do for them. So the demand is driven by new modalities like cell and gene therapy, like immunotherapy, like the 2 RNA company -- with more than 2 of the RNA companies And the speed with which they're all moving, the numbers of targets that multiple companies are prosecuting at the same time and the lack of internal capacity. I think if you roll all of those together, and with a little bit of instigation from COVID that sort of put people back on their heels when either our competitors couldn't support them for a variety of reasons where they couldn't support themselves, it's all sort of coalescing to be certainly the strongest demand we've ever seen. And it's been probably a decade since we've seen virtually every part and piece of the company performing this well at the same time. And I think it's a commentary on the strength of the industry that we're supporting when we had a reflection of them, obviously.

Understood. Okay. As we watch the pipeline and as you said, some of the strongest trends we've seen in a decade or 2, we've been wondering, does -- what about the success rates? I don't know if you have the ability to monitor that. But is it likely that success rates will improve and will have more drugs ultimately getting approved? Or do we think would the industry is going to be in a fail-fast mode and maybe the success rates even go down with very, very large numbers of products in the pipe, so to speak?

Tough to predict, John. More drugs were approved last year than the prior year. So I'm talking about then, that's the U.S., it's FDA. So that's a positive. I don't think it's a proportion of what early on looked like promising drugs and what actually get to market has changed much or is changing much, unfortunately. I think it's still a relatively haphazard endeavor. I do think what's changed is, I think, the pipelines are fuller. So the ultimate hit rate might actually be worse, let me try to clearly say that. The percentage of promising drugs that actually get to market might actually be worse, although the sheer number of drugs that gets to market is actually more. So I think that's fine as long as to use your terms, the kill rate is higher earlier. So the work that we do, the earlier we can get them an answer, the more technology that's used to do that, the more they're able to come through their own work, the more that what they've done historically will kind of educate where they're going and allow them either to put their foot to the metal on things that look promising or kill things that aren't, that a broader portfolio that yields more drugs is fine as long as the cost of doing that is rational. I think you have been getting a lot of questions on AI, and I don't know whether you want to talk about that or not. But if you don't, let me just quickly say, we get a lot of questions about that. And I do think that one of the areas that AI could be beneficial to the whole industry, including what Charles River does for our clients and what they do for themselves, is provide iterative information based upon knowledge gained from thousands and thousands of compounds and as to how well your compound is likely to fare in the marketplace, right? And that may preempt people from starting to work on them at all. It may encourage them to work on or it might give them much better information to stop much earlier. And I think that's a really good thing.

Let's just cut that, and that's a fascinating topic. Does that feel to you primarily as another kind of Discovery service tool or engine to you? Or do you see AI as applicable in the other parts of your business as well?

For sure in Discovery. I mean I see that the earliest opportunities for us will be to both work with companies that we might be able to buy because a lot of them will be structured with acquisition takeout formulas. And they're very robust technology, but they would be -- come very early in the process. And I think that would help kind of bridge the client to our Discovery group, maybe bridge our Discovery group to our Safety group and kind of give them more robust information sooner. Probably has applications and other things that we do, I mean could have applications in biologics, applications in safety. I think the leap to using those technologies in a regulated format is really complicated. I think that's -- that feels like years out if ever. And to supplant some of the core animal work to discern that the drug is safe, I think in the final analysis, you have to put that into a living mammalian creature to see what the systemic effect is of that drug. But in terms of anecdotal, let me test this thesis, so I'm getting an unusual readout here in the animals. I mean let me take this off-line and do kind of a quick analysis, so very, very early coming through data I think can and will be very powerful. And what we're trying to -- we have a couple of AI deals right now, where we made some investments, and we've got some partnerships and we'll be working our way through it. For sure, there'll be more. For sure, there'll be more companies that will be available. And for sure, we'll work with more of them. Whatever debt we make when we go all in, we want to make the right ones. And John, that's not a trivial thing to do to figure out, particularly in an area that's moving that fast what's real, what's hot, what's practical, what's reliable, what's repeatable. And so we're going to spend as much time as possible being educated fully. And we will probably end up making multiple investments and using them in different parts of the business and in different applications and probably, they'll be complementary.

Got it. Okay. Good stuff. Let's just -- I want to go back and clarify one item in the macro thing before we move on, which is, as you guys think about your sort of capital budgeting and the like, are you thinking about these higher levels of demand as sustainable? Or are you assuming that once we sort of get firmly on the other side of the pandemic that they kind of come back down to a more historical trend line?

Absolutely sustainable. I don't think the volume of demand has anything to do with COVID. I think we have some modest increases in a few areas. We got -- we probably got some more Discovery work when the clients were closed. We probably got some more GEMS work, I think that's all sustainable by the way. But I don't think this is kind of pent-up demand or bolus of activity that stopped, like we never stopped. We actually had a really good 2020. We had a little bit of a headwind in the second quarter in RMS and Microbial, but otherwise, we had a very strong year. I think we ended up 7%, and our guidance was 7% to 9%. So it wasn't at the top end of the range, but still, it was still pretty strong. So I think we have a combination of all the things I said earlier, principally driven by the new modalities. So the people calling us the golden age of biotech, while that's a little hokey, I think what that is intended to describe is the appearance that you've got all these new modalities, all hitting the market at the same time. That, of course, isn't true. They've all been in development for a decade or 2. But they do seem to be now currently available, right? The RNA drugs, a lot of immuno drugs, particularly immuno-oncology drugs. And this whole plethora of cell and gene therapy drugs only less than 2 handfuls are actually in the marketplace. But the potential to treat and cure diseases, particularly early on with cell therapy in cancer, is pretty dramatic, also a lot of the monoclonals and oligos. So this just -- this is an enormous amount of scientific innovation that is getting legs, that's curing diseases and is being well funded. And it's finding the right targets or being druggable against these targets. So yes, we -- in the guidance we just gave, John, last week, I don't know what that is. Let's call it 3.5-year guidance. It's not a particularly long period of time but it's not short. We absolutely, as you heard us say, and we talked about low double-digit organic growth rates, we think that's sustainable. And with some M&A, we'll have better results than that. So yes, we feel really positive about the demand.

Great. Okay. Another theme that I heard last week from your Investor Day was this -- your ability to take a year off of time lines. That's a pretty powerful statement. Can you dig into that a little bit? Are you -- is that sort of across your portfolio? Or where are you really seeing the ability to drive that kind of value?

So it's a mindset across the whole portfolio. I'd say that the places where it will have the greatest impact is in Discovery to some degree, but primarily in Safety. So we think of it principally in the Safety business where there's a fair amount of manual work. There's a fair amount of white space that where the way that a lot of our clients, particularly large ones, work with us is not particularly nimble. There's a lot of reporting out that Canada is being shortened, both the time frame of getting a report out and how long the report is and when it's used and actually looking at interim reports and making final decisions based on interim reports, using safety end points in discovery. So you're doing -- you're only in the discovery phase, but you're looking at safety end points. So you kind of know where the safety is going. We've taken, as you know, $50 million, $60 million occasionally, $70 million of cost out of our company every year for the last 6 or 7 years. Most of that has been in Safety and most of that has helped speed up the process and reduce cost. We have this significant digitization, I don't want to call it program, initiative going on throughout Charles River, most heavily nuanced in safety. And that's a heavy connectivity of us to the client that's going to enable the client to design a study, book a study, get a quote for a study and get the study data virtually and never talk to anybody. That's going to free up the scientists to give -- to discuss the outcomes and call the science that they see to discern whether the drug looks promising or not. So you see that, that -- you can see that, that picks up the speed of getting access and moving drugs forward. So we -- in many instances, we've taken weeks out and months out. We do think that the aggregation of all the things that I just said, particularly digitization, can allow us to take as much as a year out. And so get asked a lot of questions about can we help the clients get more drugs to market? I guess the answer to that would be, I hope so. That has a lot to do with some of the stuff we just talked about earlier, how early can they call things out or how much better job can they do designing drugs that they think will be successful? So we hope we can help with that. But we certainly know we can help with doing it faster. And so if we do it faster, that gives them more nights spent in the drugs that actually are promising and get there. And for the drugs that get to market earlier, obviously, there's a huge return for companies if you have a $2 billion drug and you get to market 6 months earlier or a year earlier, that's a big deal.

Got it. Okay. I want to switch gears now to sort of competitive differentiators on where you want to play. So I think investors think of you guys as really dominating the models business, dominating the safety tox business. But now that you've entered the CDMO world, at least within cell and gene therapy, just talk about how you decide where you want to deploy capital. Why you think you can play a key role, for example, in the CDMO space?