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

Hello. Welcome to the 2022 Jefferies Healthcare Conference. My name is Steven Couche. I'm filling in for Dave Windley, who is in COVID quarantine prison, as he describes it. We are lucky to be joined here today by Jim Foster from Charles River, Chairman of the Board, President and Chief Executive Officer, and I think you'd like to lead it off with some comments.

Sure. Nice to be here, as always. We'll give Dave our regards. We had an 8-K this morning. So for those of you that missed that, I just thought I would give some context and some comments about that. So we talked about the fact that we still felt good about our guidance ranges for top and bottom line for the year. We feel really good about the overall demand for our business and the power of our nonclinical portfolio, unique nonclinical portfolio. We talked specifically about the impact of our Manufacturing segment on the quarter. And so what we indicated in the 8-K was that our reported revenue numbers were likely to be less positive than we had indicated in our Q1 call, probably high single digits. And that's a direct result of two issues. One is FX and two is the Manufacturing segment, but particularly the CDMO part of our manufacturing segment. And that's almost entirely the result of the fact that we did 7 acquisitions in the cell and gene therapy space over the last 2 years. And one of the businesses that we bought had a preexisting COVID vaccine manufacturing contract. And so a portion of the space was allocated to that, that was canceled just because it was not needed. And we're in the space that goes to making COVID vaccine, to making plasmid DNA. And so we need different staff. We need different CapEx, we need different regulatory folks, it's just taking some time, kind of impossible to -- first, we had no idea if or when the contract would be canceled, number one. Number two, kind of impossible to discern how long it will take to retrofit it for something that we historically have never done. So these are new businesses for us. Cell and gene therapy space is really attractive. The demand is exceptional. It fits really well with our legacy businesses. And we're excited to actually allocate the space again to make plasmid DNA, which was the original purpose of the acquisition. So that's essentially what's in the document, sort of a recapitulation also of the fact that for the second quarter, the organic numbers, ranges that we gave should hold. And that's in large measure a result of our anticipated very strong results in RMS and DSA for Q2. So that's probably a good place for us to start since that's new news.

Yes. And so while we're on the topic of the CDMO, Vigene, Cognate, now Explora BioLabs, which I believe in the press release you said had to tilt towards CGT, maybe excluding this COVID contract that was canceled, how are those CGT pieces coming together in general? And maybe is there any cross-selling traction that you're seeing?

Yes. So demand has been terrific. We're integrating all those businesses. So as I said, we bought 7 companies. So the integration of them into Charles River is moving forward. The integration with each other is more important. And equally important is the integration of those assets with legacy Charles River assets, particularly our Biologics business, which is one of the drivers that, I don't know, underscored our desire to be in this space because being able to test -- make the drug and then test is really powerful competitive advantage and also the connectivity with our Safety Assessment business as well. So I'd say that's going well. We're making a lot of changes in these businesses, both in general management, a lot in business development. A lot of our client-facing folks have been added to and bolstered and also connected back to Biologics as I said, a lot of enhancements in the regulatory space. We have a bunch of clients in the cell therapy manufacturing business, they're all in the clinic. Obviously, they all believe that the drugs will get to be approved and on the market. I doubt they all will be, but some will. And so we're beginning to have conversations with those folks about the timeframe to get commercial production. So going well, subject to the caveat that it's a new business that reminds us of when we went into the discovery business years ago, and we bought a chemistry business and some in vitro discovery assets and some pharmacology assets, and there's some learning curve. I would say that anybody that tells you that cell and gene therapy isn't new, really hasn't been faced with it. So I would say that the 3 or 4 companies that are in the Manufacturing space, there's a lot of learning that's going on. I think the regulators are learning a lot, and I think our clients are. So it's actually a great time to be in this space and enhancing our regulatory capability and helping [ to guide ] the clients hopefully towards commercialization. So I'd say, it's going well, it's a lot. It's a lot to have 7 companies at the same time and in multiple geographies. And the science is new and it's complex. And we've hired a lot of senior scientists as well, primarily the interface with the clients but also just to help us make decisions on what capital we needed in design of new [ rooms ] and what additional staff we need to employ.

Great. And a follow-up. You mentioned that there are a fair amount of changes being made. Is it that maybe Charles River has a different point of view about where the market is going? Is it that the market is just changing that rapidly and everybody is learning this quickly where some of these more meaningful changes need to be made? Maybe can you give us a little more color as to why these sort of material changes are...

Yes. I mean the changes are more a result of the fact that we bought disparate assets. So different businesses in different geographies, different levels of maturation. And so it's more about having a holistic cell and gene therapy portfolio. By the way, cell -- we have a cell supply business, which we report in our Research Model business, which is also part and parcel of this. So having a continuum, if you can buy the cells from us, we can do the cell therapy manufacturing for you. We have some of the plasmids that might be used in that manufacturing. And by the way, we also will do the testing and biologics. So it's more about elevating the franchise, making it much more holistic, much more of a continuum. And we want to pull through from one facet, all of it, to the next. And I think that's already going well. The other thing that happens pretty much immediately, we buy these smaller, less well-known companies, and we're making them part of the Charles River franchises. We provide access to clients that they wouldn't have otherwise had on their own. And so that -- we're getting some nice traction there.

Yes. And speaking of the client base, can you discuss the diversity of the client base in that CGT realm? Is the mix of maybe pre-commercial similar to the rest of the client base? Or is it a little bit heavier pre-commercial?

Yes. There are large and small clients. I would say that most of the clients are biotech, some of them are start-up, now small companies that have been created by venture capitalists just to be in the cell and gene therapy space. They have a shot or two on goal. They're pretty new companies, and they need a lot of handholding, just particularly in terms of regulatory compliance and getting through there. There's also some big clients. So there's some marquee biotech names and a few marquee pharma names as well. So very few companies have any internal capacity in this area. Some are building it, but most want to outsource it. So we like the mix of clients right now, and I think it's holding us in good stead. We have some clients, as I said earlier, that are moving -- potentially moving, they're in late-stage clinicals, into a commercial genre. I'm thinking about them. A couple of them are really well-known biotech companies and some are newer.

Okay. Great. And when we think about the move from the clinic to commercialization, is there any sort of upside to volumes when that occurs? Or is it more just you have visibility for a multiyear revenue stream? And maybe how much of your client base in that CGT area is moving through late-stage clinic into commercial?

It's a fair number of them that are in late stage, Phase II for sure and several in Phase III. So that's a continuum. There's only, I think, 8 cell and gene therapy drugs that have been approved. So everyone is either in preclinical or in the clinic right now and interfacing carefully with the FDA. I would say that, that will -- some of them will get there, they're all going to be different. So we're going to have to get comfortable with the client about what they think the scale is, how much space we build out. We have a fair amount of incremental space that we can build out. We have some warehouses that we'll either finish entirely or in a modular fashion. I think clients will commit to space earlier than they need it. I think they have to because this is a pretty dynamic industry. So I think it should be all of the things that you said. It should give us much better visibility, much better predictability of our business model, should you have a much better margin profile because we're making the same thing over and over again. And we should be able to enhance and improve the production methodology, obviously, within the confines of it being a regulated product and also have a much closer relationship with the clients. So yes, that's obviously the future of that business to have multiple commercial clients, who have a drug for significantly long periods of time. So it's a good business. We're very busy. We're pretty full. We're adding additional space right now. We have a bunch of clients, new ones are added. It's a pretty long sales cycle. So we're not adding them every week. It takes a while. But I think once they engage, there are so few providers of cell therapy drugs that assuming the drug continues, we're pretty much locked in with them for commercial production. So we're excited about kind of being on the precipice of that, and we're talking with several clients right now about what they think the scale will be, how much space will they need, what they think the dollar volume will be to them. And what the pricing paradigm will be for us.

Okay. Great. Maybe now we can hit on DSA. Demand has been extraordinarily strong. It sounds like your confidence in that is enough to sort of maybe backfill a little bit of the CDMO. Is that the same as we sit here today?

Yes. Our DSA business has been extraordinary, particularly the Safety Assessment piece, which is kind of the principal conversation we have -- what we have with a lot of our shareholder base. We reported in our first quarter call that we're booking well into '23, that's pretty unusual. It's more than unusual. It's never happened before that we're booking that far into the future. So I think several things have conspired to happen at the same time. We have a very strong competitive posture right now. There's just a whole host of new modalities to make drugs, particularly cell and gene therapy, immunotherapy. Obviously, there's a bunch of RNA related drugs. Monoclonal antibodies have strengthened as well. And the competitive dynamic, we're much bigger than the next biggest player, and then it falls off dramatically from there. So I think a lot of people want to work with us. We also find ourselves in a situation where clients are very interested in do you have -- do you do this type of work? Yes or no, do you have a slot for us? Yes or no. What's the turnaround time? And then they get to price as fourth or fifth tier conversation when historically it was the first tier. So we're getting a lot of price. And I think that's appropriate. The studies that we're doing are very complicated. They're increasingly more complex. We need to get paid for the work that we're doing and to the clients utilizing our staff and our people. We also do more specialty toxicology work than anybody else. So we do a lot of immunotox and genetic tox and ocular tox and bone tox and things like that, the prices are higher, the margins are better. There's less of a sort of conversation. And that work often happens late in the clinical trial process, where clients go, "Wow, this drug looks like it's going to get to market." We need all these extra bells and whistles. So we're going to see in the back half of the year since so much of this was booked last year when we hired a bunch of staff. So staff coming online to be able to do the work, the studies booked at much higher prices. So third and fourth quarter, the prices will escalate as they will in the first quarter of next year. We've also booked some studies, and the volume will increase as well. So we feel very good about that business. Capacity is well utilized. We've built the incremental capacity. It's probably 10 years now, every year, and probably 5 or 6 sites, slightly ahead of when we need it. What happened last year, as you may recall, is that our business actually performed well ahead of our operating plan. So it was good that we had incremental space because we were able to utilize it. But space is tight. We've had our first client -- I just want to make this point, our first client sign, I guess, what we'll loosely call it, dedicated space agreements, sort of a take-or-pay to lock up the space. It's surprising to us that we didn't have more clients do that years ago. If space is tight and you're a big pharma company, you're no longer doing it yourself and you have a hot drug and you want to start your preclinical work, the only certainty you have in space is that you lock up. So we have one signed. We have several under conversation right now. I think several more will be signed by the end of the year. I think more will be signed next year as well. That's kind of a nice place for us to be with our clients, stuff that absolutely -- potentially very huge drugs for unmet medical needs. They want to start those studies earlier. It's smart for them to lock up the space. And then they need to prioritize their drugs and slot them in over whatever it is, 6 to 12 months and give us better visibility as to where they're going. So I think that we're spending a lot more time on the same side of the table with our clients these days, which is how the value proposition should be designed.

And you mentioned pricing. It seems like the sector has sort of built capacity behind the demand curve over the last decade or so after a great financial crisis. And that's created a pretty firm pricing environment. Do you think that Charles River has been able to take more of the price share over the last 10 years or recently because of your strong position?

It's impossible to know for sure, but I would say yes. I mean we have a bunch of small competitors, who actually compete with us totally on price. So they're definitely not getting price. And our largest competitor, I think, has been very rational and appropriate about price. So we're definitely, readily, and as I said earlier, appropriately getting price. But it's very much in tandem with our cost structure, our labor component and the complexity of the work. And so I think we're in really good supply/demand balance, maybe for the first time that the balance has really been almost perfect in a number of years.

Great. More structurally, once again, a longer-term question, over the last 5 to 10 years, how do you think your competitive position has improved, maybe specifically within each of the segments, RMS maybe breaking out Discovery and SA and then the legacy manufacturing support business? And what luxuries does that provide?

Yes, our franchise, probably half of our growth rate is as a result of our M&A. So since we did our leverage buyer, we bought around 60 companies. And so we're able to go from target identification all the way through market approval, and no other company can do that. So I'd say, the portfolio, in and of itself, underscores the strength of all of the constituent parts and pieces. And we intend to continue to add to the portfolio through M&A and through some of the strategic partnerships that we have. But if you look at the Research Model business, we have high growth in China. The last quarter, pretty good growth in North America, which we haven't seen in a while and talked about in the core animal business, very high growth in the service parts of that business, particularly our Insourcing Solutions business, where we just made an acquisition a couple of months ago, where we have incubator space in South San Francisco, in Cambridge, Mass and Cambridge, England and Shanghai for the clients to use, interestingly large and small clients, high-growth business. And then we have our self-supply business. So I've been talking about research models as sort of the [ renaissance ] business, which used to be kind of flat to low single-digit grower, kind of a high-single-digit grower, directionally, and sort of modest competition in that business. The Safety Assessment business, we're clearly the market leader, as I said a moment ago, our principal competitor is Covance, which is kind of LabCorp, but about half our size and then a bunch of very small companies. So we're, by far, the market leader, both in terms of science, geographic scale and capability and experience. And I think that, that will continue. I think it's somewhere between unlikely and impossible for a new entrant to enter the Safety Assessment business. It's just -- it's too complex. It's too expensive, and if you have no history, so clients, I don't think, would beat a path to you door. On the Discovery side, which is also the result of probably a dozen acquisitions, we have a pretty big business now across multiple therapeutic areas. We have some competition. I think the competition is also of high quality and high science. I think that's an area where clients are much more comfortable outsourcing. So the growth rates should continue to accelerate, the margin should continue to improve, and it should continue to be feeder into our Safety Assessment business, which it has been. So that whole DSA segment is working really well in tandem in multiple geographies. And clients, particularly big pharma, is doing [ less ]. Manufacturing business is quite interesting. The Biologics business is perhaps our highest growth business right now, with improving operating margins. There's 5 companies, at least our size or larger, in the same business, all being driven by large -- obviously, it's all large molecules, but principally driven by cell and gene therapy these days. And we've been investing aggressively in that business. There's probably no M&A left, but that business should have really good growth metrics in -- Microbial Detection business, this business that where you're looking for the [ contamination ] of your drugs in the manufacturing process, where we are, by far, the market leader. The cell and gene therapy business, which we're really new at, I would say that if you add the 7 businesses that we bought with our legacy businesses, it's about 15% of our revenue and growing dramatically, will be a big business for us. We are already one of the biggest players in the world in cell therapy manufacturing and directionally could be the largest player. We have the right client base and it's successful. So it's a business we're quite serious about. Will there be more competition in that business? Probably, I think some clients will build their own space. So most of the businesses that we are engaging with the market leader, we have a couple with that [ where we're ] sort of the second-tier player, potentially the market leader. We like our prominence and all the businesses we're in. We also like the connectivity across the portfolio. And on the overall growth rate, we gave, I guess, guidance through 2024. I talked about double-digit organic growth rate. I think that's pretty much a certainty, probably elevated with some additional strategic M&A.

Okay. Great. And I think we're over time or we're right out of time. So Jim, thank you very much for joining us, and thank you for everybody on the call. Thanks.

Pleasure.