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

All right. We will get started. Hello, everyone. My name is Jay Jin, and I am part of the health care technology and distribution team here at Credit Suisse. Thanks, everyone, for joining us today. We have Birgit Girshick here today, EVP of Discovery, Safety Assessment and Biologic Solutions from Charles River Laboratories for a presentation. By way of background, Charles River Laboratories provide essential products and services to help pharmaceutical and biotechnology companies, government agencies and academic institutions around the globe to accelerate the research and drug development efforts. I will now hand it over to Birgit for the presentation. But if anyone has a question from the audience, please e-mail them to me at [email protected]. With that, Birgit, over to you.

Thank you very much, Jay. Just confirming that you're seeing my slides.

Yes, I can see it.

Right. So thanks, Jay. Good morning, everybody. Thanks for having me, and thanks for allowing me to talk about Charles River Laboratories today. So first of all, I would like to refer to our safe harbor statement. So Charles River is a leading contract research and manufacturing organization. I would like to start off my presentation today with some metrics that we are particularly proud of. So Charles River worked on over 80% of FDA-approved drugs over the last 3 years, showing the importance of Charles River in the industry and the comprehensiveness of our portfolio. We're very proud to hold the #1 position in 3 of our businesses, which are Research Models, Safety Assessment and Microbial Solutions in an approximately $20 billion outsourced addressable market. Our scientists have developed 85 novel molecules for our clients since 1999. This is more than most organizations have -- can claim. We have doubled our revenue and non-GAAP EPS since 2015, and we're growing low double digit in our organic revenue, and we expect this to continue. We have invested over $4 billion in over 25 acquisitions over the last 10 years, and we are proud to provide that these are meeting or exceeding our investment criteria. Charles River is supporting drug discovery, nonclinical development and manufacturing. Our revenue as of LTM September 2021 is $3.4 billion. Our ability to work with clients to discover new drugs and move with them downstream throughout the nonclinical development and to support their safe manufacturer is a competitive advantage for us. No single commercial client accounts for 2% of total revenue, which provides us with great stability. We are a multinational company with nearly 20,000 employees worldwide now. Our over 100 facilities are strategically located in over 20 countries, which makes us always proximate to our clients. Our client base is biotech which is 42%, followed by global of 30%, others of 17% and academia of 11%. And biotech is growing particularly fast. Our geographic revenue is split mostly between North America, which is the majority, of 67% and Europe of 29% with Asia Pacific of 4%. Our portfolio is truly unique. As you can see on that chart on the left-hand side, we are supporting the research and development continuum, all the way from discovery, all the way into commercial manufacturing. Our Research Models segment, together with new acquisitions of HemaCare and Cellero, which sell some of our product businesses, supporting everything from discovery all the way to commercial. Our Discovery Services are supporting discovery and a great feed into our Safety Assessment business, which support our clients, obviously, in preclinical, but also with a lot of testing throughout clinical trials. Our manufacturing organization is supporting Phase I, II, III into commercial manufacturing with CDMO services as well as testing services. We are reporting out in 3 segments. Discovery Safety Assessment, short DSA, is approximately 60% of revenue and provides 54% of non-GAAP OI; RMS, Research Models and Services, is approximately 20% of revenue, was approximately 20% of non-GAAP OI; and then we have our Manufacturing organization, which is currently 20% of revenue with 26% of non-GAAP OI and growing very fast. Let me talk a little bit more about our specific segments. Research Models and Services, RMS, is a global leader in breeding and distribution of research models. As a fact, approximately 1 of every 2 models sold in the Western markets comes from Charles River. We have the largest selection of the most widely used research model strains in the world, making us the #1 choice for our clients. Our expertise in biosecurity supports production of high-quality metals, and even more importantly, reduces the risk to critical research. We have a global footprint with facilities close to our clients, and we are building an increasing presence in the high-growth models market in China. We also provide services that support the use of research models in discovery and the development of new molecules. For example, genetically engineered models and services, GEMS, are breeding service for a highly complex model used in drug discovery. Insourcing Solutions, for example, is a staffing solution, and we also provide vivarium space for our clients in bio hubs such as Cambridge. We just recently acquired 2 cell supply businesses: HemaCare and Cellero, which with their growth profile enhance the RMS segment's growth profile and provide the ability to supply biomaterials to clients to support their drug research, early stage development and manufacturing activities and provide a great lead into our CDMO capabilities. We believe the RMS addressable market is $1.7 billion, and we estimate our market share at 37%. Our Discovery Services is a unique portfolio -- CRO, offering our clients a single source for services across the full discovery spectrum. The Discovery Services also allow us to engage with our clients very early on in the discovery process and then leading them through our full portfolio. Discovery Services include services such as chemistry, in vitro and in vivo capabilities such as medicinal chemistry and structural biology. We have comprehensive tumor and high throughput screening libraries, and we are a leader in pharmacology models for all major disease areas. We center our expertise around all major therapeutic areas, including, but not limited to oncology and CNS. I mentioned it before, but we're so proud of it, our scientists have discovered 85 novel molecules to our clients since 1999, an outstanding achievement. Particularly in our Discovery Services segment, we're continuing to expand the capabilities for M&A, strategic partnerships and internal investment. A couple of recent examples. We recently acquired Distributed Bio, which is a large molecule discovery business; and Retrogenix, which is a cellular microarray technology to enhance our discovery capabilities and also enhance our services for cell and gene therapy specifically. We believe the outsourced market is approximately $5 billion to $6 billion and has a low double-digit growth. We believe the outsourcing penetration is still relatively immature at approximately 25% and growing. We estimate that the top 4 provider of Discovery Services, including Charles River, have a market share of 40%. Safety Assessment is the global leader in both nonregulated and regulated Safety Assessment services. Together with Discovery Services, we're providing clients with expertise for integrated drug development all the way from target identification to IND. Safety Assessment provides non-GLP efficacy studies, provides general toxicology and specialty toxicology, for example, inhalation infusion, developmental and reproductive toxicology and many more. Our specialty toxicology services particularly set us apart from the competition. We also have a comprehensive suite of bioanalytical services, which support preclinical studies as well as clinical studies. And we are a leader in pathology service in our industry. The acquisition of Citoxlab, MPI Research and WIL Research have definitely enhanced Charles River's leading safety assessment decision and have solidified our scientific capabilities and global scale. All 3 acquisitions came with great science and considerable capacity. We believe the outsourced market sector for Safety Assessment services is $4.5 billion to $5 billion, with a mid to high single-digit growth. The outsourcing penetration is much more mature than Discovery Services at 60%, but still growing. We're estimating our market share at approximately 33%. Microbial Solutions is a global provider of quality control, QC, testing products and services for both sterile and nonsterile applications. These tests are FDA and other regulatory agencies mandated, and therefore, provide incredible stability in our revenue stream and considerable growth. The product lines are Endosafe, endotoxin detection products and services. Here, we have a conventional as well as a rapid platform; Celsis, rapid microbial detection; as well as Accugenix microbial identification products and services, all 3 leaders in the industry. We estimate the addressable market to be nearly $3 billion; whereas Microbial Solutions focuses on higher-value testing markets. We believe and are proud of that no competitor has a similar comprehensive rapid testing portfolio, which again makes us a preferred partner to our clients. We estimate that Charles River holds 50% of the endotoxin testing markets by test volume. Our Biologics Testing Solutions business is a global CRO providing services to support the manufacture of biologics, including the high-growth area of cell and gene therapy, with services such as process development and quality control. We support developers and manufacturers with testing, characterization and cell bank manufacturing. And we do that through our drug development, clinical and commercial manufacturing and for final commercial drug product release, which as you can imagine, is very sticky and is a long-term revenue stream. We believe the biologics market is growing at least in the low double digits, fueled by cell and gene therapy programs and lately COVID-19 therapeutics. The outsourced addressable market is estimated at $1.8 billion to $2 billion. We estimate that the top 5 provider in this space, including Charles River, have a market share of approximately 40%. This year, we expanded into the cell and gene therapy CDMO market. In March 2021, we acquired Cognate BioServices, which is a premier cell and gene therapy CDMO, specializing in the GMP cell and gene therapy manufacturing. We have cell therapy operations in the U.S., in Memphis and Baltimore, and gene therapy operations in the U.K. Our targeted growth for this business is approximately or over 25% CAGR over the next 5 years. We also have acquired Vigene Biosciences in June of 2021. Vigene is a premier gene therapy CDMO, specializing in viral vector-based delivery solutions. Their operations are in the U.S. in Rockville, Maryland. And with this business, too, we're targeting a growth area of over 25% CAGR over the next 5 years. Cell and gene therapy CDMO services on emerging value-added sector with a high-growth profile that will enhance our existing capabilities and support -- how we support our clients with advanced therapeutics. The reason for the expansion in cell and gene therapy CDMO sector has 3 overarching reasons. Number one, expanding our scientific expertise. Expanding our portfolio will allow us to meet clients' needs in emerging scientific areas such as cell and gene therapy. And certainly, we'll take advantage of the significant growth opportunities for advanced drug modalities. As a fact, Charles River now has over 10% of its annual revenue coming from supporting cell and gene therapy clients. The 2 companies together, Cognate and Vigene, are offering complementary capabilities across the major cell and gene CDMO platforms, creating end-to-end platform for our gene-modified cell therapies. The second overarching reason is it's a great strategic fit and a new business opportunity. Cognate and Vigene expanded the geographic scope as well as our portfolio. It's highly complementary to our existing portfolio, particularly biologics testing solutions, which provides cell banks and quality control testing for cell and gene therapy drugs. And HemaCare/Cellero with its cellular products, which is an input to the cell therapy drug manufacturing. Our clients now are able to work seamlessly to conduct analytical testing, process development and manufacturing as well as the quality control testing for advanced modalities, which they have never been able to do before. The third overarching reason is high growth potential. The current addressable cell and gene therapy CDMO sector is estimated at $2.5 billion, and we expect it to grow over 25% CAGR over the next 5 years. This growth is being driven by robust biotech funding but also by scientific innovation, which is amazing in this space. It's really fueling the rapid rise in the cell and gene therapy pipeline. So this acquisition definitely establishes Charles River as a premier scientific partner in the cell and gene therapy development testing and manufacturing. More so and maybe as important, it allows Charles River to provide a full spectrum of capabilities in all drug modalities. So for example, in small molecule, we have been able to support our clients from discovery all the way to nonclinical development or through nonclinical development. We acquired Argenta, BioFocus a few years ago, which provided us with this capability. The acquisition of distributed bio earlier this year now allows us to do the same for large molecules and antibodies going from discovery and supporting our clients through nonclinical development and, in this case, the biologics QC testing. And now with cell and gene therapy, we take this and add on the clinical and commercial production through the acquisition of Cognate and Vigene Biosciences. So we are now a preferred and comprehensive, integrated drug development partner for all drug modalities. As I mentioned earlier, over 10% of Charles River annual revenue coming from this fast-growing area of cell and gene therapy. All our business segments are participating and supporting cell and gene therapy. Research models and services, for example, provides immunodeficient rodent models, but also has the cellular product businesses of HemaCare and Cellero that are used as inputs for research, process development and manufacturing. Discovery is supporting clients with combo pharmacology safety studies. And Safety Assessment has specialized services for cell and gene therapy programs, ranging from efficacy evaluations to surgical services and GLP toxicology, just to name a couple. Our Microbial Solutions is playing a very important part in the cell and gene therapy space, providing advanced rapid screening technologies particularly important in this modality because of the fast-paced process going from manufacture into the patient. Our biologics testing organization is supporting a cell and gene therapy through analytical testing, but also through cell bank creation, storage, process evaluation, cell bank and product characterization as well as release testing. And then obviously, our cell and gene therapy CDMOs can provide the cell therapy manufacturing, but also the plasmid DNA and biovector production for gene therapies. Again, Charles River is now established as a premier scientific partner with a full end-to-end cell and gene therapy development portfolio, including testing and manufacturing. Now let me talk a little bit about our strategic imperatives. The first one is strengthen our portfolio. We are continuously looking to innovate scientifically. And with that, we're looking to find, assess and validate new capabilities and technologies, which we then either sign up for partnerships, invest organically or acquire through M&A. As you can see with our move into cell and gene therapy, we're staying abreast of emerging therapies and new modalities. And we are definitely investing in areas with the greatest potential for growth. Externally, we have multiple strategies to strengthen our portfolio. Now I'm going to talk you through 3 of those. The first one is strategic M&A, which definitely remains top priority for disciplined capital deployment at Charles River. We have invested over $4 billion in over 25 acquisitions since 2012. Here in this slide, you see some of those, which established ourselves in the cell and gene therapy sector, some of those that established an integrated portfolio in our Discovery Services and then on top of that in the Safety Assessment space. A very important strategy is the strategy of employing strategic partnerships, which we used to add innovative capabilities and cutting-edge technologies with really limited upfront risks. We entered into 15 partnerships to date with approximately $50 million invested. Our goal for these partnerships is to become a pipeline for M&A for some of them. For others, it is to provide an additional service to our clients to provide a faster and more efficient drug development. We're investing within partnerships for our discovery services, for our biologics testing services for areas like bioinformatics, safety assessment, AI and others. The third leg is investments in venture capital portfolio companies. Here, the primary goal is to become a preferred CRO to a large group of emerging biotech companies. We're very happy to report that this strategy works. We now have over 10% of Charles River's annual revenues from venture capital portfolio companies. And we believe that this strategy had a major impact on this. A secondary benefit is the returns from these investments associated with venture capitals. We have an over 30% average annual return on those venture capital relationships, which is both investments and the revenue. So a 3-pronged approach, which really drives our growth as well as the innovation at Chart River. Drive efficiency is the second imperative, very important for us in a long-term program at Charles River. We're focusing on synergies from M&A and acquisitions, process optimization, harmonization in our legacy business and the scalability of our operating model. We are employing here Lean Six Sigma, lean manufacturing. And over the last few years, we have employed dynamic work design, where we have over 1,000 people now trained and working in our operations to find the best way of doing processes and operating. So very proud of this and it definitely is driving margin accretion, as you can see from the last 2 years of 100 basis points improvement and will continue to provide us with margin improvement in the years to come. Enhancing speed, very important for our clients. As you know, in drug development, it's all about the speed. So we have decentralized decision-making to become more agile and strike a proper balance between organizational structure, process and culture. We've done that a few years ago, and it's really working as we are operating as fast and agile as we've ever been. We still strive to be faster and more responsive at every step of the early stage R&D process. And we're leveraging for this, obviously, our scientific expertise that we have. We're really focusing on regulatory compliance. We're a market leader here, and we are continuing to build our extensive portfolio, oftentimes with technologies that provide better insights and faster development time lines for our clients. We have committed to our clients that we will reduce the early stage time lines by an additional year from where it is today. And we're tracking against that, and we're certainly on track to get that done. One of the areas that we're employing for that is technology. So our fourth imperative of champion technology is all about IT technology and automation. Over the last years, we have built a best-in-class technology platform and a digital enterprise, a team of digital natives and technology people that we are really proud of. We are working on enabling our clients having real-time access to scientific data in all areas, and we want to provide self-service options in everything the clients want to do themselves. So we're digitizing the end-to-end client experience, and we're building e-commerce solutions for our unique portfolio, so a bit different. We think technology is the key to transform, the key to margin improvement. So we're embracing automation and robotics in our laboratories, and we are embracing AI and machine learning, both through partnerships as well as internally. And we are now using it to provide some insights about the client experience and operational effectiveness. And we will definitely continue working on it to improve the signs we can provide. Sustain culture, arguably the most important imperative. Our culture is built on trust, inclusion, accountability, respect and well-being. We have a very, very active D&I program. We're bringing our colleagues together to share experiences and expertise in those areas. We have trained our employees how to interview and use diverse interviewing panels. We also take pride in a social responsibility, donating monetary and nonmonetary support to communities that we live and work in. And as we said many times before, we are committed to our employees. We want to make sure they're successful and we are committed to supporting them by engaging them and by hiring and retaining the best talent. So there is an ongoing process for that, an ongoing program. And we are happy to say that we're seeing a lot of positive outcomes from that. This is all about our people. And if we take care of our people, our people will take care of the business, of our clients and developing the new drugs. Before I end my presentation, I would like to talk a little bit an update on our financial performance. First of all, let me recap our Q3. We reported a revenue of $895 million, which is a reported growth of 20.5% and a very strong robust growth organically of 13.6%. All 3 of our segments have an organic growth rate reported of double digits, which is -- showcases the unprecedented demand and sustained demand in the industry and we believe this will have impact going forward. Our non-GAAP operating margin was reported at 21.4% and as we assumed is slightly lower than last year, was 22.7%. 2020 was beneficially impacted by a discovery milestone as well as some COVID cost reductions. And additionally, for 2021, we have added the CDMO business with a lower margin profile. Our non-GAAP EPS of $2.70 shows a strong growth of 15.9% compared to last year. And free cash flow, slightly down from last year. And last year had actually a positive impact from some COVID-related CapEx delays, which we are now executing on. Let me remind you on our 2021 guidance. We have guided to revenue growth reported of 19.5% to 20.5%. Organic revenue grew 13.5% to 14.5% and approximately 21% operating margin, which we are squarely on track on achieving. Our non-GAAP EPS was guided to $10.20 to $10.30, which is a 25% earnings growth compared to last year. And free cash flow of $500 million with capital expenditure of approximately $220 million. The robust client demand is driving the strong 2021 performance, and we see no indication that this demand is changing. We normalized the organic revenue growth to a low double-digit range when adjusting for last year's COVID-related impact, but the unprecedented demand that we are seeing makes us believe that we will see a strong and sustained robust revenue growth going forward. We expect to generate 100 basis points of non-GAAP operating margin improvement for the second year in a row, which shows that we balance investments to support growth with driving efficiency and margin expansion, again, something that we expect to continue. This 2021 guidance reflects RMS Japan and the CDMO Sweden divestitures. So before I end my presentation, I also would like to talk a little bit about 2022 preliminary trends. As I said, we expect robust sustained demand trends to continue, resulting in low double-digit organic revenue growth in 2022. We expect to generate non-GAAP operating margin improvement next year with continued progress towards our longer-term target of 22.5% in 2024 we have guided to. We intend to continue to effectively manage staffing levels, including the increased cost to accommodate growth, and we have been hiring ahead of our initial plan this year. Compensation will be a headwind in 2022, as it will be for most companies, but one that will help us to support the robust client demand and achieve our growth targets that we expect in 2022 and beyond. To support this anticipated growth and to add capacity, we now believe CapEx will be 9% of total revenue in 2022. This increase is primarily driven by our legacy businesses, including Safety Assessment. Just to summarize, we believe Charles River is a stronger company as ever. We're seeing unprecedented client demand and we expect continued margin accretion. We will do continued investments that will help us to drive this profitable revenue growth in 2022 and beyond. Thank you very much.

All right. Thank you, for the presentation. Definitely looking forward to hearing more about the company moving forward. It does look like there are no questions coming from the audience. So I would just like to thank everyone for participating and all who are tuning in. Take care, everyone.

Thank you very much, everybody. Thanks, Jay.