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

Welcome to the 2022 Bank of America Healthcare Conference. I'm Derik De Bruin, the Senior Life Sciences and Diagnostics Tools Analyst, also Biopharma Services. And thank you, everybody, for being here in beautiful Las Vegas. It's great to see so many people live and in person. And our next company up is Charles River Labs. And with us is Birgit Girshick, Executive Vice President and COO of the organization. Thanks for being here.

Thank you.

This is the first time that you and I have actually interacted in a venue like this. So big picture question. Because I'm basically an old man, I've covered Charles River since 2003. And when I was at lab, I was certainly a research model customer, really good quality mice. It's harder to make mice than you think. A lot has happened in the last 20 years and the company has evolved from being chiefly a research models provider. Can you kick off the check, I guess, where do you see the strengths of Charles River today versus the industry? Or put another way, it's like how do you -- when you look at what the portfolio is today, guys, like how do you continue to scientifically and competitively distinguish Charles River in the market?

Certainly, I would love to answer that question. Great question. So yes, so maybe taking a little bit of a step back. So Charles River has really evolved over the last 10, 15 years from being a pretty much a single business with some add-on small businesses into a multi-division industry-leading nonclinical contract research organization, and the way we have done that was through programmatic M&A, which is a great way for us to add on capabilities, add on capacity and add on scientific depths. So we have acquired multiple toxicology companies over time, we have integrated them into a single business, and we have done that well. We also have acquired multiple discovery organizations and early drug development organizations and have integrated them into a leading discovery organization. And we also have a manufacturing support organization that just in the last year, we added on contract research organization for cell and gene therapy, providing us with an end-to-end portfolio to provide a client from basically the gene to a commercial drug all the way, including the plasmids, the viral vectors, the cell therapy manufacturing and the testing. So certainly, one way for us to distinguish ourselves was through the M&A path, which allowed us to create a portfolio that -- where we have literally developed over 90 novel molecules ourselves, have worked on over 90 -- or 90% of all drugs approved by the FDA in the last years. And we're doing that by employing over 2,000 PhDs and many, many other employees with a lot of experience. We also have employed a lot of digital technologies. We are consistently and continuously upgrading our facilities with less paper and more technology, but we're also looking at ways of using our data better for insights. Another way of distinguishing ourselves is our partnership strategy. Just over the last few years, we have entered into 18 different partnerships. They range from compound libraries to AI technologies. We're doing that to be able to add for our clients the most innovative technologies where we possibly couldn't invest in because there are so many and you want to test drive them first to make sure they actually get client adoption and they can actually generate some revenues. This is one way for us to stay at the leading edge of science. It also allows us to have a funnel for future M&A. So many of those partnerships are actually coming with prearranged rovers and some others are basically just partnerships. But as you can see, we use M&A partnerships as well as a lot of organic development. to stay competitive and to stay at the leading edge for our clients with the ultimate goal to take actually a time out of the drug development time line, which is everybody's goal.

Got it. That's a really good overview of it. And just along those -- that last point, the evolutions we're doing with Discovery Services has taken a while because there were some false starts. I was around sort of like when the first proteomic push went in and that was sort of like discontinued. I mean is that -- it sounds like it's really coming to its own right now just in the sense of biotechs need to outsource more and more specialty services being pharma, like you have a big imaging business that goes on with this. But the question is, like we're starting to see -- we're starting to see more CDMOs, more companies popping up that all want to do back-end economics. They all want to get like this. Is that something how you're sort of structuring some of these partnerships that you're helping develop molecules? And you're not looking to become a drug development company per se and going to competition with your customers, right?

Yes, we definitely do not intend to become a drug company ourselves. We strongly believe in the service mentality for our clients. We don't want to compete with them. And by literally going into drug development ourselves, we would have to split our attention. So we definitely do not want to do that. Yes, we are looking at our portfolio as a -- in 2 ways, really. One is an integrated portfolio where a client that may not have a lot of capabilities or particular small biotech that wants to come in and do everything together -- and -- but also as a means to come in and out, depending on the capabilities the client has themselves. And every time we add on an M&A or a partnership or organic development, we're looking to see how we can do that better for our clients. And going forward, I think you will see a lot more in the terms of data. We just recently signed a partnership with Valo, for example, where we are trying to provide our clients with better targets for discovery and supporting them then with our wet labs internally.

Great. Well, now that I've kept everybody in suspense, -- let's get to the questions that everyone wants to ask, which is like biotech funding. Why is this not the battle days when we had a mothball Shrewsbury and there was too much capacity and it was the end of the world and margins collapsed, and which is sort of like where everyone is afraid of right now is this whole situation because clearly, you have a lot more early-stage biotech exposure, you should be the canary in the coal mine or the mouse in the trap or whatever. I don't know how you want to phrase that one for you.

Hopefully, not the mouse in the trap.

But let's -- but why -- let's talk about sort of like the biotech situation. It's like why or why not should we be worried?

Yes. Let me go back to the 2008, 2009, I think that's a really good point you brought up. The situation back then was very, very different than today. So first of all, I want to remind everybody that -- at that time, the downturn for CROs was really caused by pharma, not biotech. There were a few different dynamics. One, pharma companies were looking to save cost because of maybe the downturn and recession, but also because of a patent cliff. The pharma companies had considerable amount of capabilities and capacity to do toxicology studies -- and from a 0 perspective, we were all expecting a lot of growth and had several of us multiple greenfield facilities we just had built. So the industry -- the CRE industry had considerable empty space and considerable less work because the pharma companies were cutting costs, rationalizing their programs and taking the work in-house. So what happened then was, obviously, everybody tried to fill their space and we had pricing pressure, considerable pricing pressure. Now fast forward today, a very, very different dynamic. So number one, pharma and just about all biotech have very little to no capabilities, particularly not to run any start-up studies. So there is no means of taking work back in-house. The CRO space is well utilized in their space and in labor. And so there is also no means of us having empty space. We're actually building capacity right now. We have a 2-, 3-year building program that we are expecting to execute on, not big greenfield. We learned our lesson, but multiple small projects where we can add on a few rooms here and there as demand comes on, and we're expecting to execute on that. And then also that back then, the CROs were much -- many more. And since then, we have consolidated. Charles River has consolidated the space. And that means that just the pressure -- the competitive pressure is much, much lower, which allows us obviously to not have a free fall in pricing. So I do believe that the dynamics is extremely different. And in addition, just for clarity, we are actually not seeing any effects from any biotech downturn. And our demand is as high and as literally bullish as we've ever seen it.

And also, I mean, the pharma pipelines in general are just better. I mean they triaged the pipeline, it's got rid of the [ Mitry ] drugs. And they're clearly -- a lot of them clearly are filthy with COVID cash because of [ what's going on with this ]. And you also had major consolidation. You had [indiscernible] disappearing in sort of R&D budgets. And then academics were also under pressure, which has certainly hurt you. And China had yet to become a health care-focused area. It was still very much more industrial focus at the time. So that -- the battle days, hopefully, don't look like you're going to repeat in that sense. I would never say never, but it certainly sort of looks in that sense.

Derik, you make one really good point here is the pipelines for pharma are much more robust. I actually talked to a company last week where they reflecting on it used to be shots on goal. So it's many programs into the pipeline as possible and without getting more programs out, that failed. So now the pipelines are really robust, good quality programs that they're putting into the preclinical pipeline and most of them make it into toxicology, and we're seeing them. Plus, there's a lot of platform companies out there. You can name a few that are just made a ton of COVID cash. And those platform companies, once they see success with one drug really have a strong pipeline, and we are seeing that.

But I mean -- but the story is stepping back, I mean talking about the quality of products, I mean, you've partnered with companies like Valo and Atomwise these technology and able drug discovery companies, I mean, are these companies actually making real progress in putting better compounds into the pipeline?

That needs to be seen. We believe so. Otherwise, we wouldn't do the partnerships. I believe that their concepts, their algorithms are really, really good. There's plenty of companies out there. So we pick the ones that we feel have the -- maybe most science-based approach. If it's not in the short term, it definitely will be in the long term. We believe that AI will have a place of providing more solid, more robust drug targets. We don't believe that it will eliminate actual studies because you always have to run that and confirm that. But it will definitely help us to pick maybe better targets and get them through preclinical into the clinic.

So let's talk a little bit about 2022. There's a big concern among some clients about the organic revenue growth rate ramp in the second half of the year, given where the first half of the year is sort of shaking out. What's the dynamic there? Can you please discuss your DSA order book, backlog, bookings that support the sort of accelerating growth in the year-end pricing assumptions? We did hear one of your customers complaining that their margins got hit because their price of animals were so high. I assume that was you that went at one like that. So can you just talk about all these sort of things that you're sort of rolling through this and sort of like what gives you that confidence and that outlook that you're going to be able to accelerate and hit those numbers?

So let me start with the demand that we are seeing. So we have -- we're booking out further than we have ever seen before. So our backlog is between 12 and 18 months. Historically, that was a fraction of that. Our year-over-year backlog increased to 75% and we're seeing more proposals in general. So we actually saw 35% more proposals just from earlier -- late last year. So demand is definitely there. The capacity both from a space and people perspective is well utilized. That is driving some of the booking out further, but it's also the strong pipelines that companies have. We announced last week in our earnings call that we -- after probably 15 years of a pause, for the first time, have signed a take-or-pay contract on space. We brought that up because it's an indication that clients are committed to doing work that they do see strong pipelines and that they want to make sure that they have the space available when they need it and have it available flexibly. It's not -- it's not a humongous revenue driver other than doing the studies, but it definitely shows the commitment that those companies have to their pipelines and what they want to execute. We're getting volume. We're getting price. So we're both quite happy. And we're actually going to go into a kind of a strategic review over the next few months. And we're looking at where we think this will be going. But we definitely see it going up and not down.

So the take-or-pay comment is actually interesting. Just given my memory of everything that went on, but you did make the point. I mean in the -- over the last -- or that period, I mean, you acquired MPI, you acquired WIL. I mean, what's your market share now in sort of like that space and how many of the mom-and-pops have been driven out of business over time or have been acquired. I mean it seems like it's a much more rational market today than it was.

Yes. So we are estimating our market share for the safety assessment under 40%, just under 40%. Outsourcing increased to over 60%. So a very mature market in that. So people can't bring studies back in-house. And from that perspective, our competitors are quite a bit smaller. We used to chase our competitors. We now feel very secure and have definitely built the leading CRO in the space. And from our perspective of what portfolio we're providing and the staff and talent, the science we have, it's definitely unmatched.

So the RMS business has sort of gone through a big boost of growth and then people got -- a number of transgenic animals went down, you sort of built out with services. I mean it's sort of gone back and forth, back and forth in terms of the growth rates, good growth now. Can you sort of describe the sustainability of sort of like the growth rates there and what goes on with it? And there's always a perpetual question about like, well, animals are going to go away. It's all going to become simulations. What are your sort of thoughts on those new [ ones ]?

Yes. Let me start with the animals are going away and simulations. So we, as a company, are driving the 3 Rs, so reduction replace, reduce. We're always looking at ways of actually reducing the use of animals ourselves through in vitro technologies and maybe modeling. We're looking at that ourselves. But we also believe and know that there are always -- we believe, at least there will always be a need for the animal studies just because you need to look at the holistic body. But that said, we want to be at the forefront on actually the reductions. The RMS business itself, you're right. We're very happy with the growth rates that we're seeing. What we have done is very strategically morphing the business into a few different areas. Number one, the typical animal models that you -- we would have had as revenue drivers 10, 15 years ago, those numbers have declined. However, we have brought on a lot more complex models, our genetically engineered models business where we're housing models for our clients has taken off because the scientists just need a more complex model that they either need to breed themselves for specific use or we breed for them and provide to them. So with that, the ASP has gone up, even so the numbers has gone down. The other thing that we have done is morph the business into providing more services. One of them is our CRADL business, which is our Charles River Accelerator and Development Lab. That is a business that provides vivarium space as well as labor and some other services to clients, particularly very often smaller clients that need a vivarium for a month or 2 months or maybe they even need only a rack of animals for a while. So we are providing them with an outlet to do their work while helping them with our staff. This business gives us also a lot of synergies because it gives us access to clients that are in very, very early stage. We doubled down on that business. We actually made an acquisition in that space just a few weeks ago, was adding on Explora. With that now, we have 25 vivariums in the major biohubs, providing over 300,000 square foot of space and have many, many clients, many in the cell and gene therapy space, actually, interestingly, that work with us and that get to know us, trust us and where we're actually now starting to work with them, not just with the space but also in discovery. RMS also has great growth rates in China. And all those factors together allowed us to turn this business into a quite nice growing business again, and we're very happy about that.

So a bunch of questions to sort of follow-up of that. Let's talk labor, wage inflation. Are you able to hire enough people right now? I mean CRAs have always been hard to hire in good times, let alone now. I mean, I don't know, working at vivarium versus -- if you can make some money working in the vivarium versus flipping burgers at McDonald's, that's a hard one to do.

Right. So obviously, everybody knows that the labor market is tough right now. Everybody knows about the great resignation. I think every company is in the same boat. What I'm very proud of is we have really spent a considerable amount of time to improve our recruiting process and improve our branding on how we recruit. What is the vision? What is the job? What is the development opportunities? So a lot of different efforts also increased some compensation that is part of that. And we have been able to hire quite well. We actually brought in a ton of people just late last year, earlier this year because we know we need them for the growth that we're expecting. These people are in training right now, and they will be productive going forward Q2 and Q3. So we are quite happy about our ability to hire. And turnover isn't always, always, but I -- we're doing okay on that as well.

So any questions from the audience before I launch into the China and COVID questions? Let's launch into the China and COVID questions. So on COVID, how much is still in the business for -- in the -- particularly in the biologic safety testing? Is there -- does your current guide anticipate sort of like a deceleration in that business? And should we not think about anything in the model post-2022?

So from our Biologics Testing business, we're very happy with the growth rates. Yes, we had some wind in the back from some COVID vaccine testing we did over the last couple of years there. That has gone basically away. However, our ability to grow the business despite having that work, particularly in cell and gene therapy makes up for that. So last year, we had a couple of quarters of 30% growth in that business. That is moderating to maybe 20% growth. But overall, we are quite happy because we're making up for that volume.

And is there any issues in that business just because, obviously, getting the horseshoe crab blood and stuff like that is just like difficult. Is that -- are you having supply issues there or anything?

We don't have supply issues for our Microbial business. We are always looking out to make sure that we are -- have the supply chains in place, making sure that we have enough crude on stock and also looking always through innovation to make sure that the amount of crude that we need, the horseshoe blood that we need is actually getting reduced time over time. So we're good on that front.

And let's talk China. Obviously, RMS is important there, but have you seen any issues in terms of the lockdowns going through and sort of like how is that rolling through the business?

Yes. So we all know from the news that China went back into lockdown, specifically in Shanghai. Now also in Beijing. We had a small impact, not material from the lockdown in Shanghai in the first quarter. The RMS business, particularly in North America was very strong and has definitely made up for that shortfall. Again, it wasn't really material. And we don't really expect that to get into any revenue impact that we can't make up. So most of the lockdowns there are quite specific to certain regions in the city. They also allow most of the businesses to operate with a special COVID pass. So going forward, we're pretty comfortable with being able to have very little impact to no impact going forward.

So question I've gotten from some investors is from it's -- as ESG criteria become more important, does your research models business prevent some clients from investing in Charles River?

No, it does not. So we do not hear about that concern from our investors at all. We get a lot of questions about our ESG program in general, which I'm quite proud of. I'm actually the Chair for our ESG program, and we are focused as we -- as any good company certainly on the planet, how can we reduce gas house emissions? We have publicized a goal of reducing that by 50%. We already were able to reduce that by 25% just between 2018 and 2021. We are very much focusing on diversity and inclusion. Actually, our CEO, Jim Foster, is heading that up. We have diversified our Board. We have a really good diversity metrics our company overall. And what I'm very proud of is we launched employee resource groups where we have diverse groups of employees team together, organize themselves, support each other, and that's really driving the belonging for our employees within our company. So that is good for the employees. It's also good for investors to see that. We're also extremely active in our communities. We have provided our employees a pool of money where they can select organizations in their communities that they would like to donate to. And last year, we donated to 196 organization through our employees. They selected them, they went out, provided that, and we're also providing our employees with time off if they want to donate time to an organization. So we are very, very, very active, and I believe that, that showcases any investor that we are a very responsible company and a good company to invest in.

Is there another Analyst Day planned for this year? Or is that -- go ahead. I was just thinking it was like it was last May, we did the Analyst Day. Is there another one planned for this year?

I believe we will have one. I think the timing right now is for November. And we would love to welcome you.

Okay. Great. If there's no questions from the audience, I'm going to ask my standard closing question. Biggest misconceptions, misunderstandings about Charles River?

Well, I believe at the current time, it's really the misconception of our demand profile, even if there is a concern about biotech funding, which is really related to the public markets. We talk to our venture capital partners, which we have very, very close relationships. We talk to pharma companies. We talk to tons and tons of our biotech clients, and we believe good drug companies and good drug programs get funded. And so we don't believe that there will be a big impact. And our metrics actually show that we currently have more demand than we have ever seen. We're booking out further. We have great visibility. And we just built a company with an incredible competitive stance in the industry. And we believe that companies in all segments will choose us as their partners and that we will see this trajectory that we have seen in the last years and forecasting for this year also in the upcoming years.

And with that, we're out of time. Thank you, Birgit. Thank you, audience, for being here. Thank you for being supportive of BofA. We appreciate it, and have a good conference and be safe. Thank you, everyone.

Thank you.